SEC, DOL Advance New Fiduciary Rule After Adverse 5th Circuit Ruling

Jonathan W. Benowitz, CPA
Senior Editor
Loyola University Chicago School of Law, JD 2019

Both the Securities Exchange Commission (SEC) and Department of Labor (DOL) are pushing ahead with fiduciary standards for investment advisers despite the 5th Circuit striking down the DOL’s previous fiduciary rule earlier this year.

Prior History: Why a Fiduciary Rule?

The DOL’s fiduciary rule enacted was proposed during the Obama Administration.The regulation called for making all financial professionals who work with retirement plans or provide retirement planning advice fiduciaries. A fiduciary, such as a trustee of a trust, owes the highest legal duty to act in another’s best interests. There are a wide variety of common business relationships that the law recognizes as producing fiduciary duties. Fiduciaries are required to act in the best interest of the person whom is owed the duty. The law recognizes fiduciary duties owed by corporate board members as well as executors, guardians, and even lawyers. However, until now, that category did not automatically include financial advisors, brokers or insurance agents, except for registered investment advisors.

The DOL’s fiduciary was finally enacted during 2017, after a failed attempt at delay by the Trump administration, following a 15-day comment period during which 193,000 comment letters were submitted with close to 178,000 opposing the delay. While some financial advisors support the standard, it is opposed by brokers and other industry groups. The current standard requires that investments be determined to be “suitable” for the investor, which is considered a far looser standard than the fiduciary standard requiring that investments be “in the best interest” of the investor.  Fiduciary standards threaten many established industry practices, but especially problematic are certain common fees.  Many groups were concerned that fee practices such as front-end loaded commissions and annual mutual fund fees would violate the new fiduciary standard.

What the 5thCircuit Said about the Fiduciary Rule

Industry groups immediately sued over the implementation of the rule, and on March 15, 2018, the 5th Circuit ruled against the fiduciary rule. The 5th Circuit explained that it found merit in several of the industry groups objections to the fiduciary rule, including: inconsistency with the applicable statutes, DOL overreaching by regulating services and providers beyond its authority, DOL’s unauthorized imposition of contract terms other than what the parties negotiated, arbitrary and capricious treatment of annuities, and first amendment violations.

How the Fiduciary Rule may still be Implemented

Despite the set-back in the courts, the SEC decided to go ahead with its own version of the fiduciary regulations just a month after the 5th Circuit decision. The DOL has also said it will also reconsider the rule. Recently, industry insiders have reported that the two organizations appear to be harmonizing their regulations.

While these regulations may not reflect the final regulations, the SEC proposed regulations are actually far narrower than the earlier DOL rule. For example, the SEC “Regulation Best Interest” proposal would require financial advisors and broker-dealers to make certain disclosures and exercise care to “have a reasonable basis” that certain recommendations serve some clients’ “best interest.” The detailed requirements of this regulation certainly differ from the all-encompassing requirement on a fiduciary that they act on a client’s best interests.

Another proposed regulation would prohibit broker-dealers from using the term “advisor” as their title.

Conclusion: Heavily-Contested Rule may be Subject to Congressional Revision

While the SEC rule is still being written, it is important to note that Congress has the option to step in at any time and clarify how they want fiduciary standards to apply to brokers. If the SEC rule is too weak, a Democratic Congress might end up establishing its own much more robust fiduciary rule.

Regardless of what rules are implemented by the SEC and DOL, it appears likely that the standards that broker-dealers, financial advisors, and other financial professionals have to abide by will be in flux over the next few years, given the heavily contested nature of these rules.