May an adviser give retirement plan participants conflicted investment advice?
The U.S. Labor department published (on November 20, 2009) its withdrawal of a controversial rule that would have interpreted some conditions under which an adviser may provide investment advice without breaking ERISA's rules against self-dealing conflicts. Three days earlier, the Labor department published the last of three extensions of the now-withdrawn rule's effective date.
Background: On January 21, 2009, the U.S. Labor department published a controversial rule that would have stated interpretations of a Pension Protection Act of 2006 provision concerning the conditions under which an adviser may provide investment advice without breaking ERISA's rules against self-dealing conflicts. The now-withdrawn rule included interpretations that leading members of Congress said are contrary to the statute that the rule ostensibly interprets.
The withdrawal notice says that the Labor department is at work on a new interpretation. This revised rule will be "limited to the application of the statutory exemption". The now-abandoned class exemption would have allowed greater tolerance for an adviser's conflicts.
Legislation, too? Moreover, there's a real likelihood that Congress could enact legislation that clarifies or adds to the conditions that an adviser must meet in providing investment advice. With Democrats holding more power in both the legislative and executive branches, one might expect that a change would at least restore, and could further strengthen, Democrats' views about what an adviser must do to avoid or manage a conflict of interest.
What's next? Whatever administrative law or legislation comes next, it seems clear enough that the law will favor an investment adviser that has fewer compensation conflicts.
What's the fight about? The Pension Protection Act of 2006 permits - with some conditions - a person licensed or registered under banking, insurance, or securities law to render advice about investments for which he, she, or it receives compensation from persons other than the retirement plan or the person advised. The 2006 Act attempts to protect an advised person from recommendations that could be influenced by an adviser's interest in its own compensation or other business interests. The issues remain controversial. Some associations suggest that conflicts should be tolerated (and managed with disclosures and other information) to help make investment advice more widely available to retirement plan participants. Others say that participants need uncompromised investment advice. Some say that conflicted advice is worse than no advice at all.
What's the argument about? There's a choice of two different ways for an investment adviser to manage its conflicts of interests.
Advice with level fees: An adviser may cure self-dealing conflicts by "levelizing" fees so that total fees and compensation can't vary based on a participant's investment choices. Under the defunct interpretation, this leveling need not relate to the fees or other compensation of those of an adviser's affiliates that are not involved in rendering the adviser's advice. The views of those unconnected to makers or sellers of investment products generally oppose any potential for influence based on any affiliation or relationship.
Advice "cleansed" by an independent expert: An adviser may avoid conflicts by rendering advice from a computer model that's approved by an independent expert. Under the statutory exemption, that independent advice must be the only advice. Moreover, some observers expect a Labor department "crack-down" against "off-model" advice, even if affirmatively requested by the participant. Even when restrained by conditions, off-model advice presents obvious opportunities for recommending investments based on the adviser's, rather than the participant's, interests. And disclosure wouldn't protect participants because those who seek advice are unlikely to have enough skills to evaluate whether an adviser's business interests compromise its recommendations.
2009-11-20 © Peter Gulia PC Fiduciary Guidance Counsel