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Labor Department Weighs New Definition of Fiduciary

March 31, 2011

When you try to change a regulation that has been virtually untouched for 35 years, there’s bound to be a lot of feedback.

That is what officials at the Labor Department discovered at a two-day hearing in March on a proposed regulation that would dramatically expand a 1976 rule defining when a person providing investment advice becomes a fiduciary to a retirement plan.

“I’ve been at the Labor Department for more than 20 years, and I’ve never seen something like the lobbying effort I’ve seen here,” says Tim Hauser, the department’s associate solicitor in the plan benefits security division.

While the department is taking a careful look at the more than 200 comments by individuals and organizations as well as reviewing the testimony from 38 people who attended the hearings, it expects the final regulation will be out by the end of the year, Hauser says.

Right now, people who provide advice for a fee must pass a five-part test to be labeled a fiduciary. Their advice must be provided on a regular basis and it must be mutually agreed (between adviser and recipient) that it is the primary information used in making investment decisions.

Under the 1974 Employee Retirement Income Security Act, a fiduciary must act in the best interest of the plan and its participants.

The proposed rule, first published in the Federal Register in October 2010, abolishes the five-part test and says people who meet any one of the five elements can be labeled fiduciaries. The department specifically noted that even one-time advisers would be considered fiduciaries under the proposed rule, as would advisers who give recommendations on how to manage securities and those who provide advice directly to retirement plan participants. The new rule would apply to broker-dealer firms and other providers of advice for individual retirement accounts.

The department’s main complaint is that the current regulation is outdated and doesn’t work, considering the significant changes in the financial industry and the massive shift to defined contribution plans.

“In today’s world, a lot of a plan’s success depends upon investment advice,” says Norman Stein, professor of law at Drexel University, who testified on behalf of the Pension Rights Center. “If people are doing something wrong, they shouldn’t be able to hide behind this ancient regulation.”

But many critics have a wide array of concerns, mainly charging that the change would cast too wide a net and would wind up raising costs for plan sponsors, force providers to exit the business and ultimately not benefit participants.

“Any casual conversation had about investments will make you a fiduciary,” says Kent Mason, partner at Washington-based law firm Davis & Harman. “Advice has to play a significant role in decision-making.”

Mason, who testified on behalf of the American Benefits Council, said there are too many circumstances where accepted practices, like record keepers helping plan sponsors whittle down thousands of investment choices based on the plan sponsor’s investment criteria that would trigger fiduciary status unintentionally. Knocking out this kind of assistance may discourage employers from offering retirement plans, he says.

But the Labor Department’s Hauser says the proposed rule will help plan sponsors, especially small and midsize companies, because the financial experts will be held liable for their advice, not the business owner or their managers who made decisions based on that information.

“Right now employers are right in the bull’s eye,” Hauser says. The proposal allows “other fiduciaries to be held liable and more appropriately held liable.”

But some plan sponsors, like Bob Steen, fiduciary to his company’s ESOP, say the proposal would be “a game changer,” driving up costs and limiting what the plan could pay out to retirees.

“There are people who don’t understand their fiduciary duty, and we have plenty of laws to deal with those folks,” says Steen, CEO at Bridge Community Bank in Mount Vernon, Iowa.

Stock valuation firms would become fiduciaries under the rule. Steen estimates the cost for an appraisal will more than double because these firms will need to buy fiduciary insurance and will pass that cost onto ESOPs.

“It matters that the stock value is as reasonable as it can be because we pay out people based on it,” Steen says, adding the rule shouldn’t apply to ESOPs. “We give our employees recourse if they question any aspect of the stock value.”

Hauser says the labor department is set with its position on valuation firms, but it understands the need for clarity and concern about costs in other areas, and hopes to address many issues brought up in the comments and hearings in the final regulation. He added that if providers who question their fiduciary status can show that their practice is sound, the department has “expansive authority to grant exemptions” to the rule.

“It’s critical we get this right and figure out who should be considered a fiduciary,” he says.

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