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  • Writer's pictureSEDA Experts

Retirement Income Security, The Standards Are Toughening

By Richard A. Marin, Managing Director of SEDA Experts

The US Department of Labor (the “DOL”) has now enacted a new regulation titled “Retirement Security Rule: Definition of an Investment Advice Fiduciary” (the “Retirement Security Rule”) in a notable effort to expand the criteria for determining who qualifies as an “Investment Advice Fiduciary” under ERISA, and thereby force those fiduciaries to comply with Prohibited Transaction Exemption (“PTE”) for fee and other investment conflicts. Ever since the promulgation of ERISA in 1974, the regulatory agencies, including the DOL and the Securities Exchange Commission (the “SEC”) have more or less continuously tweaked the definitions of fiduciary obligation. What everyone agrees is that a fiduciary has several basic duties including to act exclusively in the best interest of their client (for whom they are managing money or property), to manage their money and property carefully and prudently, to keep that money and property separate from all other, especially their own, and to keep very good records of all transactions that affect that money and property. And, of course, a fiduciary is supposed to do all that at a reasonable and fully disclosed fee. This standard applies to a broad range of clients ranging from individuals for both their taxable and retirement funds and to ERISA pension plans of all sorts. Professionals in the industry have argued for years about who has fiduciary obligations and whether there are different standards for different levels of fiduciary obligation. This has been the source of much debate and litigation over the years.

I grew up at Bankers Trust Company, the bank formed by J.P. Morgan and others, specifically to act as a fiduciary in ways that the commercial banks increasingly thought they could not. Over the 20th Century, the bank built a formidable fiduciary business and was one of the three leading trust and custody banks in the world. On the 100th anniversary of its founding, its successor owner, Deutsche Bank sold that fiduciary business to State Street Bank and Trust.  For much of the 1990’s I ran large parts of that fiduciary complex both for ERISA pension clients and for private high net worth clients, and for a number of those years I was the senior fiduciary for the bank. The fiduciary obligations to both pensioners and private banking clients alike are part of my fabric.

In 2015, President Obama addressed the fiduciary issue directly by saying, "Today, I'm calling on the Department of Labor to update the rules and requirements that retirement advisors put the best interests of their clients above their own financial interests. It's a very simple principle: You want to give financial advice, you've got to put your client's interests first." In response, the DOL expanded the fiduciary rules to include the “investment advice fiduciary” definition under ERISA.  This addition serves to elevate financial professionals of all types (including insurance salespeople who sell products like annuities) that work with retirement plans and retiring individuals to being designated as fiduciaries and thus obligated to these higher standards. Plan fiduciaries under ERISA (trustees, administrators and plan sponsor investment committees) already work under those obligations. This change captured all those who provide investment advice, administer plans or provide any type of financial advice to plans, participants or individuals.  These fiduciaries have to act prudently and diversify the plan's investments in order to minimize the risk of large losses. In addition, they need to follow the terms of plan documents to the extent that those terms are consistent with ERISA. Importantly, they also are required to steadfastly avoid conflicts of interests. For example, they cannot engage in transactions that benefit parties other than the plan and its participants, such as other fiduciaries, services providers or the plan sponsor. And they now have to be able to show that their fees are justifiable under the new rule. This is all about ensuring the optimal creation of retirement income security for the burgeoning cohorts of retirees coming on line soon through the Baby Boom generation and beyond.

The new DOL fiduciary rule was scheduled to go into effect on April 10, 2017, but of course, there was a new sheriff in town in the form of the Trump Administration.  Not surprisingly, after a quickly mandated “study” period, on June 21, 2018, the Fifth Circuit Court of Appeals vacated the proposed rule. Meanwhile, the SEC was busy working to resurrect the rule. This was a very hotly debated rule to be sure, with most brokers, investment firms and insurers working hard to keep it from enactment. To them, suitability standards were sufficient. The proposed fiduciary standards insisted on a higher standard, one that clearly put their client’s best interests first, rather than simply finding “suitable” investments. The reality was that this higher standard could well undermine the industry’s commission structure as well as a host of things like proprietary product sales and that is a big deal.

On June 30, 2020 the SEC implemented Regulation Best Interest (Reg BI) as part of the Securities Exchange Act of 1934, establishing the best interests standard for broker-dealers and investment advisors in their recommendations to retail customers, including the types of accounts they should establish (like discretionary versus non-discretionary). This portends at least as high a standard is needed for retirement investment accounts under the purview of ERISA and is thus a leading indicator of where DOL regulations had to return in one form or another.

The financial services industry has seen the retirement locomotive barreling down the tracks for over thirty years. Demographers have made it very clear that the combination of the Baby Boom generation and the increase in longevity are combining to create an impending pension crisis. Much of the focus has been on what are called unfunded pension liabilities-in some private sector arenas, as well as most public sector plans. There has recently been some improvement in funding levels thanks to strong markets, but nowhere near enough. The world at large, and especially in the United States, has chosen to address the problem by replacing defined benefit plans with defined contribution plans. These, like 401(k), 428 and 403(b) plans as designated by the Internal Revenue Service regulations (not to mention the full array of IRA accounts) are sponsored and organized by the companies and organizations where employees work, but are self-directed and voluntary. This may seem to eliminate the unfunded pension liability problem by taking it out of the easily measured spotlight, but it in no way reduces the gap in retirement income sufficiency. And certainly, none of that leaves the plan participants without responsible fiduciaries to exercise due care over the investment programs of these participants. Those who provide investment advice, administer plans or provide any type of financial advice or products and services to participants will be affected.

The new Retirement Security Rule enacted by the DOL this month is specifically designed to address all of this and is notably being referred to as the “retirement security rule” rather than the “fiduciary rule”, and is clearly intended to go even further in the direction first outlined by President Obama. The DOL is saying that the rule will capture "practices of investment advisers, and the expectations of plan officials and participants, and IRA owners who receive investment advice, as well as developments in the investment marketplace, including in the ways advisers are compensated that can subject advisers to harmful conflicts of interest." That seems pretty clear and it’s fair to suggest that broker-dealers and investment advisors are girding their loins for the change. In the meantime, we can be assured that there will be a Battle Royale ongoing in the courts by the industry practitioners. I, for one, work on the assumption that, given the scale of the pension crisis still facing our world in the coming years, attempts to avert these new best interest, retirement security and fiduciary standards are likely to fail. What will remain will be a boatload of litigation against any and every fiduciary, as newly and precisely defined, that has fallen short of these standards.



Richard A. Marin

Richard Marin is a former finance senior executive with over 40 years of industry experience, and as a former clinical professor at Cornell University is a world class testifying expert in asset management, alternative investments, private equity investments, securities lending, retirement and pensions, and real estate / project financing.

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