Before the Labor Department formally delayed the full implementation of the fiduciary rule in November of 2017, regulators were sending clear signals that clean shares of mutual funds would play a prominent role in revisions to the regulation.
A FAQ issued in May 2017 by the agency noted the emerging prospect of broker-dealers and fund managers using clean shares as way to comply with the Obama-era regulation, which was written in an attempt to protect investors by reducing conflicts of interest in mutual fund recommendations.
"Such an approach is a potentially powerful means of reducing conflicts of interest with respect to mutual fund recommendations," Labor wrote in the FAQ.
When the Department ultimately delayed the rule by 18 months, it based its reasoning, in significant part, on product innovations such as clean shares, and the additional time industry would need to address the "logistical obstacles" of implementing a new share class industry-wide.
"The delay provides firms with additional time to address these issues and successfully launch products that benefit investors," wrote Labor when it issued the delay of the rule.
Clean shares of mutual funds unbundle the fees and commissions brokers and advisors are paid on investment products. Other share classes embed varying levels of compensation in the cost of funds, raising potential conflicts of interest by incentivizing recommendations based on the level of compensation, and not on the prudence of the investment.
In January 2017, the Securities and Exchange Commission issued an interpretive letter in response to inquiries from the Capital Group, owner of American Funds, an action that was widely viewed as paving the way for clean shares.
As the Trump administration undertook a review of the rule, ordered by the president, a consensus in industry soon after followed: The Labor Department would streamline the regulation criticized by stakeholders as overly burdensome by crafting a new clean share exemption.
A Solution in Search of a Problem?
But that outcome is now much less certain. For all of the promise initially seen in clean shares, some of industry's most influential players have since raised concerns to Labor and the SEC over conditioning an exemption on clean shares.
And a decision in the 5th Circuit Court of Appeals vacating the fiduciary rule has raised the prospect that the Trump administration will cease revising a rule that a court has said is defunct.
"It is still possible DOL could issue a streamlined clean share exemption, but I'd have to guess that if the fiduciary rule dies, DOL will move on to other priorities," said Kevin Walsh, an attorney with the Groom Law Group.
"Without the fiduciary rule, clean shares are a solution in search of a problem," added Walsh.
Even before Labor delayed full implementation of the rule, stakeholders were cautioning regulators of the potential negative unintended consequences of an exemption conditioned on clean shares.
In an August 2017 comment letter to Labor, Vanguard asked the Department to craft new streamlined exemptions to the rule that protect investors from conflicts of interest.
