Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Wednesday, September 14, 2011

Brokers as Fiduciaries: The Dept. of Labor Proposed Rule

In previous posts, I have described the current debate over whether the SEC should adopt a uniform fiduciary duty standard for broker-dealers and investment advisers that provide investment advice to retail investors, and, if so, what that standard should be.   In this post I look at a related and equally contentious issue: whether the Department of Labor should adopt a proposed rule that would redefine the types of investment advice relationships that give rise to fiduciary duties under ERISA.  Since the DOL’s Employee Benefits Security Administration (EBSA) proposed the rule in October 2010, it has received over 260 comment letters and held a two-day hearing in March 2011 at which 36 witnesses presented testimony.  Phyllis C. Borzi, Assistant Secretary of Labor, EBSA, has stated that she expects a final rule out by year-end.

The DOL website sets forth the proposed rule, the transcripts of the hearings, the public comments and other commentary on the proposal.

Proposed Rule (this is taken verbatim from the DOL fact sheet)

A person gives fiduciary investment advice if, for a direct or indirect fee, he or she –

Provides the requisite type of advice:
• Appraisals or fairness opinions about the value of securities or other property;
• Recommendations on investing in, purchasing, holding, or selling securities; or
• Recommendations as to the management of securities or other property;

And meets one of the following conditions:
• Represents to a plan, participant or beneficiary that the individual is acting as an ERISA fiduciary;
• Is already an ERISA fiduciary to the plan by virtue of having any control over the management or disposition of plan assets, or by having discretionary authority over the administration of the plan;
• Is an investment adviser under the Investment Advisers Act of 1940; or
• Provides the advice pursuant to an agreement or understanding that the advice may be considered in connection with investment or management decisions with respect to plan assets and will be individualized to the needs of the plan.

Limitations recognizing that certain activities should not result in fiduciary status:

• Persons who do not represent themselves to be ERISA fiduciaries, and who make it clear to the plan that they are acting for a purchaser/ seller on the opposite side of the transaction from the plan rather than providing impartial advice.
• Employers who provide general financial/ investment information, such as recommendations on asset allocation to 401(k) participants under existing DOL guidance on investment education.
• Persons who market investment option platforms to 401(k) plan fiduciaries on a non-individualized basis and disclose in writing that they are not providing impartial advice.
• Appraisers who provide investment values to plans to use only for reporting their assets to the DOL and IRS.


Section 3(21)(A) of ERISA provides three alternative standards for determining when a person is a fiduciary.  Under § 3(21)(A)(ii), a person is a fiduciary with respect to a plan to the extent that (ii) it renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so.  On its face, then, section 3(21)(A)(ii) sets out a two-part test for determining fiduciary status: A person renders investment advice with respect to any moneys or other property of a plan, or has any authority or responsibility to do so, and the person receives a fee or other compensation, direct or indirect, for doing so.

However, in 1975, shortly after the enactment of ERISA , DOL adopted a regulation that narrowed the definition of a fiduciary by creating a five-part test.  For advice to constitute ‘‘investment advice,’’ an adviser who does not have discretionary authority or control with respect to the purchase or sale of securities or other property for the plan must—

(1) render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property
(2) on a regular basis
(3) pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary, that
(4) the advice will serve as a primary basis for investment decisions with respect to plan assets, and that
(5) the advice will be individualized based on the particular needs of the plan.

In addition, DOL further limited the term “investment advice” in 1976 by stating in an advisory opinion that a valuation of closely-held employer securities that an ESOP would rely on in purchasing the securities would not constitute investment advice.

In contrast, the proposed rule specifically includes appraisals and fairness opinions and advice and recommendations as to the management of securities and other property.  Under the proposal, fiduciary status may result from providing advice to a plan participant or beneficiary  as well as to a plan fiduciary.  In addition, the proposed rule does not require that the advice be provided on a regular basis or that the parties have a mutual understanding that the advice will serve as a primary basis for plan investment decisions.  The proposal, however, reflects the Department’s understanding that, in the context of selling investments to a purchaser, a seller’s communications with the purchaser may involve advice or recommendations, within paragraph (c)(1)(i) of the proposal, concerning the investments offered. The Department has determined that such communications ordinarily should not result in fiduciary status under the proposal if the purchaser knows of the person’s status as a seller whose interests are adverse to those of the purchaser, and that the person is not undertaking to provide impartial investment advice.

Rationale for Changing the Definition

According to DOL, the proposed rule “is designed to protect participants from conflicts of interest and self-dealing by giving a broader and clearer understanding of when persons providing advice are considered fiduciaries.”  In explaining the need to re-examine the types of advisory relationships that give rise to fiduciary duties, DOL emphasizes the changed circumstances in the thirty-five years since promulgation of the current rule: the shift from defined benefit to defined contribution plans  and the growth of individual IRAs:

[w]ith the shift to 401(k)-type plans, investment advice has become increasingly important to employers, particularly small and medium-sized employers, when choosing an appropriate menu of plan investments for their workers, and for workers when selecting among investments for their individual accounts.”  Moreover, “[w]ith the increase in the amount of assets held in IRAs, IRA holders shoulder a greater amount of investment responsibility, like 401(k) plan participants.  But, unlike 401(k) plan participants, IRA holders are more vulnerable since no other plan fiduciary protects the IRA investments.

In addition, DOL believes there is strong evidence that unmitigated conflicts cause substantial harm and that disclosure may not always be sufficient to protect investors.

Impact on Broker-Dealers

The broker-dealer community argues that the DOL proposed rule conflicts with Dodd-Frank §913 and the goals of protecting investors, preserving investor choice, and avoiding undue increased costs to investors.  In particular, they assert that adoption of the proposal would have serious negative impact on smaller investors by decreasing their access to brokerage advice and investment options.  For example, a large proportion of small investors’ IRAs are brokerage accounts, and the proposed rule would make these brokers fiduciaries.  Accordingly, broker-dealer groups are concerned that as fiduciaries they could not accept commissions and revenue sharing payments and would have to restructure the brokerage accounts as advisory accounts with wrap fees, thus increasing the costs to the investors.  In response, DOL asserts that existing exemptions already authorize brokers who provide investment advice to be compensated by commissions and it would provide further clarification later in the process.  Needless to say, “the devil is in the details.”

Next Steps

Ms. Borzi has stated that as it moves forward in the process DOL is paying special attention to two primary exceptions to fiduciary status under the proposed rule:  (1) clarifying the distinction between investment education and investment advice and (2) clarifying the scope of the “sellers’ exception.”  In so doing, it aims to address the problem of conflicted investment advice while minimizing the impact on existing compensation practices and business models.

Will DOL issue a final rule this year?  If it does, will it withstand judicial challenge?  Stay tuned.

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