Why New DOL Fiduciary Rule Is Not a 'Rehash' of 2016

By Melanie Waddell

Analysis January 12, 2024 at 11:13 AM

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As the architect of the Labor Department's 2016 fiduciary rule, Phyllis Borzi is no stranger to controversy.

Borzi, the former head of Labor's Employee Benefits Security Administration under President Barack Obama, faced a barrage of criticsm as she crafted the department's 2016 rule, which was eventually struck down by the U.S. Court of Appeals for the 5th Circuit — a case that many independent legal experts, and Borzi, believe was wrongly decided.

In an interview, Borzi explained to me why she believes the current Labor officials' job in writing the 2023 fiduciary rule "was both easier and harder" than she and others at Labor faced in crafting the 2016 rule.

Borzi also relays why critics' complaints that the new rule is "a rehash of the 2016 rule are simply mistaken."

Read on as Borzi discusses how the department's 2023 rule differs from that of 2016, if she believes the new rule will face lawsuits, why the new rule fills gaps left by the Securities and Exchange Commission's Regulation Best Interest and the National Association of Insurance Commissioners' Model Rule, and when a final rule may be released.

THINKADVISOR: What are the biggest changes between the current fiduciary rule proposal and the one from 2016?

PHYLLIS BORZI: There really are two major changes: first, the scope of the new DOL proposal has been significantly reduced through a much narrower, better focused and targeted definition of an investment advice fiduciary and second, the new proposal provides a more workable approach to accountability for independent insurance agents.

First, in a clear response to the 5th Circuit decision, the new proposal limits fiduciary status for investment advice fiduciaries to situations in which the person providing the advice or recommendation to an "investor" (i.e., a plan, a plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary or IRA fiduciary) for a fee or other direct or indirect compensation is in a relationship of trust and confidence with the investor or has explicitly accepted fiduciary status.

However, determining whether such a relationship exists is based on the expectations and understanding of the investor. And looking at the "regular basis" prong of the 1975 five-part test [determining fiduciary status] from the point of view of the investor, rather than the person making the recommendation, is consistent with the establishment of a relationship of trust and confidence.

It is far more reasonable for an investor to have greater reliance on the advice or recommendations of a person who regularly gives investment advice or makes investment recommendations than to focus, as the 1975 test did, on whether the recommendation itself was for one-time advice or not. Again, this is consistent with the notion of assuring that fiduciary status attached in connection with a relationship of trust and confidence, as the 5th Circuit said was appropriate.

This more limited and focused scope of the definition of "fiduciary" is clearly consistent with the letter and spirit of ERISA, and addresses the articulated concern of the 5th Circuit majority opinion that the 2016 proposal swept too broadly. I say this even though I, and many other independent legal experts (i.e., those who do not represent industry players) strongly believe that the 5th Circuit decision was wrong and regret the decision of the Trump Administration not to appeal that decision.

Nonetheless, the department clearly and unmistakably took the 5th Circuit decision at face value and did its best to address the concerns the majority raised. So those in the industry who claim that this proposal is simply a rehash of the 2016 are simply mistaken.

Second, the biggest concern I had about our 2016 rule was that it didn't sufficiently address the problems we saw with oversight/accountability of independent insurance agents for their investment advice recommendations.

On the one hand, according to the information the department received from the insurance industry and its representatives, these independent agents generally were not selling only proprietary products which raise their own set of potential conflicts issues.

On the other hand, it was difficult to apply the conditions for financial institution oversight (particularly the application of the rules governing the implementation and enforcement of policies and procedures to independent agents whose recommendations might encompass the products of a variety of product producers).

So rethinking the structure and relationships between PTE 2020-02 [which covers rollover advice] and PTE 84-24 [which deals with annuities] to more clearly address these concerns makes sense and I believe the department's approach is a good one. But like any other proposal, I hope the affected stakeholders make a good-faith effort to work with the department to refine the proposal, rather than simply oppose it.

What I heard at the recent DOL hearing on the proposal and reading some of the industry comments, didn't sound encouraging, but I am ever the optimist that some in the industry will try to be constructive and not just obstructionists.

Do you see any trouble spots in the current proposal?

There are always going to be issues that arise where affected stakeholders want special rules.

Some of the industry witnesses at the recent [DOL] hearings complained about special rules that were included in the 2016 rule that do not appear in the current proposal, but it was both amusing and frustrating for me to hear these witnesses claim to have supported those provisions in the 2016 rule. My recollection differs.

In many cases, after we accommodated their requests and worked diligently with them to craft rules addressing their concerns, few, if any, did anything but oppose the rule and work with their congressional allies to kill it.

Do you wish Labor had handled any aspects of the new rule differently?

One issue that I wish the department had been more specific about (and which was addressed in some detail in the 2016 rule) is the distinction between investment education and investment advice.

What we learned as we engaged in substantial public education and outreach in connection with the 2016 rule is that a number of large financial institutions were claiming to be merely providing investment education when it was clear from the facts and circumstances that they were also providing investment advice.

And the claim from these financial institutions that all communications that flowed through their call centers should be exempt from fiduciary status because all were investment education was a non-starter in my estimation.

During my 45-plus year career in the employee benefits business, I have visited a number of call centers all over the country, including while I was at DOL. Those call centers included those run by third-party claims administrators/recordkeepers and by internal claims departments of my plan sponsor clients, and I have observed a mixed bag of investment advice and education being provided by those call centers.

I have reviewed and drafted scripts used by those in call centers and at some point in the conversation, even with the call center employee dutifully following the script, there usually comes a time when the caller asks: "What should I do?" How the call center employee responds can mean the difference between advice and education. Looking at the script and materials used to train these employees can be helpful but is not dispositive of this question. So a blanket exemption for all call center operations is not a good idea.

But remember, this is just a proposal — the purpose of a proposal is to put something on the table to generate discussion and debate. As that process unfolds, I know that the EBSA staff will be listening and learning, just like they did in the run up to the issuance of the current proposal, which shows the impact that these important stakeholder interactions can have if everyone approaches them with a good faith and constructive mentality.

When do you think Labor will send the proposal to OMB and a final rule would be issued?

It will take some time for the EBSA leadership and staff to sort through all the comments and testimony they received so it is hard to tell, but, depending on how useful the comments they received are, I suppose it might be possible to send the final regulation to OMB for clearance by the end of April or May.

Since the finalization of the rule is an administration priority, I expect EBSA would continue to work with representatives of the Executive Office of the President and other federal agencies to secure their technical assistance and input prior to the formal OMB clearance process.

This was a very useful process as we worked on the 2016 rule. Depending on how long that OMB clearance takes, it is possible that a final rule could be published by the end of June, but that is sheer speculation on my part.

Groups are already saying this proposal will face lawsuits. Do you agree?

Regardless of what the DOL proposes, there are many powerful players in the financial services and insurance industry that have nearly unlimited resources to litigate over the proposal.

The fact that they are so willing to continue to spend millions of dollars to sue to block the implementation of a rule that at its core requires everyone who gives investment advice or makes investment recommendations for a fee to put their client's best interest above their own pecuniary interests tells you how much money they are making from the weakness in the regulatory and enforcement structure of the current system.

This isn't about bad people giving advice — most brokers and insurance agents genuinely try to do the right thing — it's all about business models and/or compensation structures that reward people who steer their clients to certain products or investment strategies that generate the greatest profit margin, even though those products or strategies may involve high-fee, low-productivity, non-transparent or illiquid investments that lead trusting clients into believing that they're getting advice in their best interest.

And the people who lose the most under the current system are those low-income families and people of color who can least afford to lose any of their hard-earned savings.

The so-called "choice" the industry wants so much to preserve is hardly investor choice — who among us would deliberately choose an advisor who is not legally required to put the investor's interest above the financial interest of the advisor?

No, the choice they want to preserve, is the choice of the advice-giver to continue to hold himself or herself out as a trusted advisor when really what the advice-giver is trying to do is convince the investor that a relationship of trust and confidence exists so they can sell the investor a product. If you doubt my view, simply look at the marketing materials of the biggest industry opponents and judge for yourselves (or read the comment filed by the Consumer Federation of America, which details some of these materials).

Anything else you'd like to say about Labor's new rule?

The department has made an important contribution to the applicable regulatory and enforcement structure to protect plans, plan sponsors, participants and beneficiaries and IRA owners. In many ways, I think that their job was both easier and harder than we faced in crafting the 2016 rule.

In 2016, we were the first federal agency to tackle the problem of conflicts of interests that were built into the business models and compensation structures of the financial services industry (including the insurance industry) that resulted in real losses in retirement income to investors. That made the hill we had to climb higher.

By the time the new proposal was unveiled on Oct. 31, 2023, two important developments had occurred: the SEC had issued its Reg BI package and the NAIC had issued its model regulation on financial advice.

While both documents had substantial weaknesses and left unfilled substantial gaps in regulation (the NAIC document by far the weakest), at least the DOL had something to build on.

As I have said many times, neither of these entities could, on their own or together, solve the problems caused by financial conflicts of interest in the investment advice world, even if their rules were perfect and consistent.

The SEC's statutory jurisdiction is limited to securities, including insurance products regulated as securities. Moreover, Reg BI does not apply to investment recommendations made to plan sponsors or plans — an important omission.

The NAIC model laws and regulations are even less comprehensive because they require voluntary adoption by the states (that have the ability to adopt them in whole or in part) and only apply to insurance products. Moreover, they enshrine a weaker version of the current suitability rule as their standard and, more seriously, exclude cash incentives and compensation from the type of material conflicts that must be disclosed. Independent data shows that these incentives are the most significant source of financial conflicts of interest for sellers of insurance products.

Employee benefit plans and IRAs invest in many more categories of investment products than securities and insurance, including for example, direct real estate and REITs, bank products (such as collective investment trusts), private equity, other hard-to-value assets and, albeit controversial, cybercurrency).

These asset classes are not covered by the SEC or the NAIC standards. On the other hand, the department has authority to regulate investments that cover these asset classes, plus securities and insurance. So the only way to assure a uniform regulatory structure to protect retirement savers in all asset classes is through exercise of the department's authority.

Finally, the department had a disadvantage that had to be overcome in the new proposal because it had to work carefully to accommodate the 5th Circuit's concerns, even though, as I said previously, many think the case was wrongly decided.

The 5th Circuit had both procedural and substantive concerns and the department has done a good job of addressing both.

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