New Fiduciary Rule Stayed by Court as ERISA Turns 50
Written By: Rick Rodgers, AIFA® and Sydney Aeschlimann
These things will turn 50 before 2025: the Rubik’s Cube, Post-it® Notes, Leonardo DiCaprio, and the Employee Retirement Income Security Act (ERISA). Much like Leo, ERISA has never been voted the sexiest man (or law) alive, but that does not diminish the law’s importance in protecting retirement savings for millions of Americans.
In April 2024, just months before ERISA’s birthday, the Department of Labor (DOL) gave the law an early birthday gift: the Retirement Security Rule, designed to expand protections for Americans’ retirement accounts by requiring financial professionals to act in the best interest of investors. Some financial professionals did not appreciate this gift – a higher standard of care when giving investment advice would now be required of them.
Certain financial professionals are held to a suitability standard, meaning recommended investments and advice must fit or suit the client's investment objectives and needs but does not require that the presented option is in the client’s best interest. Other financial professionals are held to a fiduciary standard, legally requiring recommended investments and advice to be suitable for the investor and that the client's interests be placed ahead of the professional’s interests. The fiduciary standard is significantly more stringent than the suitability standard.
The new DOL rule would require many professionals, once held to the suitability standard, to now operate under a fiduciary obligation when making recommendations related to an investor’s retirement savings. Hence, the birthday blues from some insurance companies, recordkeepers, brokers, financial advisors, etc.
In response, several insurance groups filed lawsuits against the DOL, and a Texas federal court issued a stay on the rule, meaning that the court temporarily blocked the new rule pending further notice and review.
For several decades, many financial professionals have taken advantage of countless retirement plan participants, making recommendations to roll assets out of their low-cost employer-sponsored plan to an IRA or annuity. In many cases, the new arrangement resulted in substantially greater expenses that benefited the professional through commissions for the sale of investment or insurance products. The White House Council of Economic Advisors issued a report in 2015 finding biased advice drained an estimated $17 billion annually from retirement accounts[1]. Some liken the expense of these investment arrangements to a hotel mini bar!
Background
The world looked much different in 1974 when ERISA was enacted. Most retirement plan investment advisors managed defined benefit (DB) or pension plans before the establishment of 401(k), 457(b), and other defined contribution (DC) arrangements. Most of us have replaced our 70's shag carpet with a more modern look; why do we not do the same with the interpretation of ERISA law? In 1975, the DOL issued its first fiduciary rule for retirement plan investment advice providers, defining an ERISA fiduciary advisor as someone who provides regular advice to the plan under an agreement that the advice will serve as the primary basis for investment decisions.
The rule considers someone a fiduciary advisor when they meet all five conditions of the following test:
They provide advice or make recommendations regarding investing in, purchasing, or selling securities or other property while receiving a fee;
The advice is provided on a regular basis;
There is a mutual understanding;
The advice will be the primary basis for investment decisions concerning the plan; and
The advice will be individualized based on the needs of the investor.
Over successive decades, 401(k) plans, 457(b) plans, and IRAs grew in popularity, eventually overtaking DB plans as the most prominent investment vehicles for plan sponsors and individuals. As a result, rather than having a professional investment advisor manage the assets, individual participants became responsible for making investment decisions, including rolling over their savings from a retirement plan to an IRA or annuity, often a monumental action with long-lasting repercussions. Surprisingly, the 1975 rule did not consider point-in-time advice from a financial professional as fiduciary advice under ERISA. Decades later, the DOL sought to address these shortcomings, replacing the shag carpet, if you will, and protect participants’ retirement savings.
In 2016, the DOL attempted to update the definition of a fiduciary advisor through the “Fiduciary Rule,” which attempted to replace the five-part test and broadened the definition of fiduciary advisors. This rule also sought to close the loophole for point-in-time advice and deem all advice related to retirement plan assets as fiduciary advice.
Brokers, insurance companies, and associations representing those industries resisted the new rule. They argued the rule would substantially decrease their representatives’ ability to sell products and earn commissions, among other claims. Implementation of the rule was delayed several times due to the consternation of its supporters. The DOL received over 178,000 letters opposing delayed implementation. Three lawsuits were filed against the DOL, alleging that the 2016 Fiduciary Rule was too broad and beyond the DOL’s jurisdiction to regulate IRAs. The most prominent was the lawsuit filed by the Chamber of Commerce, the Securities Industry and Financial Markets Association, and the Financial Services Roundtable[2]. The Fifth U.S. Circuit Court of Appeals eventually vacated the rule in 2018, finding that the DOL exceeded its authority.
The April 2024 release of the Retirement Security Rule defines who an investment advisor is under ERISA and amends some prohibited transaction exemptions. It replaces the current five-part test (established in 1975) with the following:
Meet a professional standard of care when making recommendations (give prudent advice);
Never put their financial interests ahead of the retirement investor's when making recommendations (give loyal advice);
Avoid misleading statements about conflicts of interest, fees, and investments;
Charge no more than what is reasonable for their services; and
Give the retirement investor basic information about the advisor's conflicts of interest.
Current Status
Due to the stay issued by the Texas Court, the 1975 standards remain in effect until further notice. Plan sponsors should be aware of the risks for their participants and diligently create and maintain an attractive retirement plan with low-cost investment options, robust participant and investor services, and fiduciary oversight. Many brokers, recordkeepers, insurance companies, and investment advisors are aggressively pursuing assets held in retirement plans. While some arrangements may be beneficial for investors, many are not and may subject former retirement plan participants to lost retirement income attributable to excess expenses and fees. Without fiduciary protections, other financial services organizations are free to sell their products under the suitability rule. Until a reasonable solution can be established, plan sponsors should consider implementing proactive pre-retirement education campaigns to inform and warn participants of these risks.
[1] Jason Furman and Betsey Stevenson, “The Effects of Conflicted Investment Advice on Retirement Savings”, https://obamawhitehouse.archives.gov/blog/2015/02/23/effects-conflicted-investment-advice-retirement-savings
[2] Chamber of Commerce v. U.S. Department of Labor (Fiduciary Rule Appeal). Case 3:16-cv-01476-G. Filed 06/01/16.