House Ed and Workforce Hearing on DOL Fiduciary
House Education and the Workforce Committee
Subcommittee on Health, Employment, Labor, and Pensions
“Restricting Access to Financial Advice: Evaluating the Costs and Consequences for Working Families and Retirees”
Wednesday, June 17, 2015
Key Topics & Takeaways
- Opposition to the Proposed Rule: Chairman David Roe (R-Tenn.) said the proposal “will hurt retirees, families, small business owners, and could not come at a worse time.” He continued that the fiduciary regulation “moves the country in the wrong direction” and eliminates financial advice families and small businesses rely on.
- Support for a Best Interest Standard: Ranking Member Jared Polis (D-Colo.) said Congress and the financial services industry believes in a best interest standard, but it has to be implemented in a way that “makes sense.” He continued that most Americans are not saving enough for retirement, and what is invested should not be impacted by adverse advice from FAs. Polis stressed that “no one thinks current rule is perfect” and that ensuring investors are receiving unbiased advice “should be our end goal here.”
- Coordination with Regulators: Many lawmakers questioned the amount of coordination among regulators in drafting the proposal, including Rep. John Kline (R-Minn.), chairman of the full committee, who noted that the “extensive” outreach to the SEC may depend on what “extensive” and “outreach” means. He asked Perez if the 827 pages of outreach coordination the committee received represented the entirety of written communications between the DOL and SEC. Perez stated that it did not and mentioned there were “extensive” conversations with committee staff. He noted a staff oral briefing that would go more in depth on the coordination efforts.
Speakers
- The Honorable Thomas E. Perez, Secretary, U.S. Department of Labor
- Kent Mason, Partner, Davis & Harman LLP
- Jack Haley, Executive Vice President, Fidelity Investments
- Dennis Kelleher, President and CEO, Better Markets
- Dr. Brian Reid, Ph.D., Chief Economist, Investment Company Institute
- Dean Harman, CFP, Managing Director, Harman Wealth Management
Opening Statements
In his opening statement, Chairman David Roe (R-Tenn.) said he “wished the proposal had broad bipartisan support, but instead it will hurt retirees, families, small business owners, and could not come at a worse time.” He continued that the fiduciary regulation “moves the country in the wrong direction” and eliminates financial advice families and small businesses rely on. Roe explained that financial advisors (FAs) are subject to many requirements, a “complex system” of rules and regulations that have worked well “for decades,” and while the standards should be improved, they should not make it harder for investors to get the advice they need. He stated that wealthy Americans “will do just fine,” but the proposed rule will hurt those who need help the most and encouraged the Secretary of Labor to withdraw the rule so the committee could help create new bipartisan legislation.
In his opening statement, Ranking Member Jared Polis (D-Colo.) said Congress and the financial services industry believes in a best interest fiduciary standard, but it has to be implemented in a way that “makes sense.” He continued that most Americans are not saving enough for retirement, and what is invested should not be impacted by adverse advice from FAs. Polis stressed that “no one thinks current rule is perfect” and that ensuring investors are receiving unbiased advice “should be our end goal here.”
Panel 1 Testimony
The Honorable Thomas E. Perez, Secretary, U.S. Department of Labor
In his testimony, Thomas Perez described an example of a couple who trusted the FA but the broker’s conflicted advice cost them over $50,000. He estimated the cost of conflicted advice as $17 billion annually and said “the stakes could not be higher.” Perez explained that since consumers are now in control of their own accounts rather than a traditional pension system, a secure retirement is “less predictable.” He stressed that while most FAs do look out for the best interest of their clients, many are not fiduciaries and operate under “no such commitment” to do what is in the best interest of clients.
Perez claimed that consumers have an “informational disadvantage” and that the “playing field is not level.” He stated that FAs are operating within a “structurally flawed system” where their financial interest is misaligned with the best interest of customer. The goal of the Department of Labor (DOL), Perez noted, is to create an enforceable best interest standard (BIS) so there is certainty that FAs are working for the client “first and foremost.” He discussed “lengthy outreach” with the Securities and Exchange Commission (SEC), consumer groups, the financial services industry, and Congress while creating the rule. Perez concluded that the BIS rule is “not just the right thing to do, it is the smart thing to do.”
Question & Answer
Best Interest Standard
Rep. Mark Takano (D-Calif.) stated his concern that the proposed rule might disincentivize people from saving. Perez stated that establishing the best interest rule will help bridge the trust gap between FAs and clients.
Rep. Rick Allen (R-Ga.) stated that the financial industry is already highly regulated and that the problems with ENRON and others were accounting-based, not investment advice, and asked how the DOL will make the proposed rule work. Perez explained that if a client goes to an FA for advice, the FA will “just have to look out for their best interest.”
Rep. Buddy Carter (R-Ga.) stressed that he is “deeply disturbed by this and not in favor of it at all,” and noted that the Investment Company Institute (ICI) disputes that conflicts of interest have resulted in higher fees for those in IRAs than 401(k) plans. He continued that “this is already an overregulated field” and that the rule is a “solution in search of a problem.” Perez replied that “many people in the industry” are saying there is a need for a BIS because “the system is misaligned.”
Rep. Bobby Scott (D-Va.) asked Perez to clarify if an FA can sell a product knowing they will make more money and the clients will make less. Perez explained the suitability threshold and stated that the current system has no prevention of taking advantage of that incentive.
Best Interest Contract Exemption
Roe questioned the best interest contract (BIC) exemption and stated it is “very simple” for investors to understand what their returns are, net of fees, on their account statements. Perez explained that the problem is that people do not know what their fees are because they are “hidden,” and a more opaque, transparent system will “empower” consumers.
Polis noted that in order to use the prohibited transaction exemption (PTE) the advice has to comply with significant disclosure requirements, and asked if the additional burden is worth it. Perez referred to the BIC exemption as a “Ronald Reagan provision” to “trust but verify” that the information consumers are receiving is the best option for them.
Rep. Virginia Foxx (R-N.C.) questioned the need to sign a contract before having a conversation with an FA about opening an individual retirement account (IRA), and stated it would “intimidate” new investors that are needed in the market and discourage them to save. Perez explained that a contract would not have to be signed before that conversation and noted that there are concerns regarding the timing of when the contract requirement would go into place. He stated that investors should be able to “shop around” and have conversations about asset allocation risk tolerance thresholds without needing a contract.
Rep. Mark Pocan (D-Wis.) stressed the need for clarification about when a contract would have to be signed with the FA. Perez replied that he has heard the same from the financial services industry and DOL is “doing their best” at integrating feedback received.
Rep. Suzanne Bonamici (D-Ore.) asked when the contract has to be signed for an FA to discuss accounts with the client and if the DOL is open to working on clarifying this rule. Perez stated that there is a “heck of a lot you can do right now without signing a contract,” and that he is confident a “line will be drawn even sharper” to clarify the distinction as a result of industry input.
Rep. Joe Heck (R-Nev.) stated his concern that the proposed rule would limit the ability to provide services to the client because they have to have a contract signed and disclose any fees prior to a conversation. Perez stated that the implementation is “a lot easier” than industry implies as there are already policies and practices for mitigating conflicts.
Rep. Glenn Grothman (R-Wisc.) asked Perez about the public database of FA compensation required under the BIC exemption. Perez stated that it will not be a public database and that he wants to ensure consumers understand how much fees cost so they can make an informed judgment.
Coordination with Regulators
Polis questioned the input Perez received from the SEC and other regulators. Perez noted he had meetings and calls with SEC Chair Mary Jo White throughout the process that were “incredibly helpful” and helped inform judgment in “every aspect” of the rule.
Rep. John Kline (R-Minn.), chairman of the full committee, criticized the extension of the comment period by 15 days, stating that “45 would have been better.” He noted that the “extensive” outreach to the SEC may depend on what “extensive” and “outreach” means, and asked if the 827 pages of outreach coordination the committee received represented the entirety of written communications between the DOL and SEC. Perez stated that it did not and mentioned there were “extensive” conversations with committee staff. He noted a staff oral briefing that would go more in depth on the coordination efforts.
Rep. Frederica Wilson (D-Fla.) asked about the process that the DOL will take to ensure all interested parties are heard in the formation of the final rule. Perez stated that there will be a public hearing to make additional comment on rule, then the transcript of the hearing will be provided and invite comment on that, and they will continue to have regular meetings with regulators and industry. He stressed that “the goal is to get it right.”
Rep. Luke Messer (R-Ind.) stressed concern over the coordination with the SEC as SEC Commissioner Daniel Gallagher stated the DOL had not consulted with the SEC as of February. Perez stated that he did not coordinate with Gallagher because he coordinated directly with White, and noted that he took a trip to the United Kingdom to learn from their experience with a fiduciary standard. Perez continued that White thinks the best interest standard is the “right way to go” for an SEC regulatory standard.
Messer asked about the DOL’s coordination with FINRA, as Chairman Richard Ketchum stated in March that many firms would lose IRA business due to the proposed rule. Perez replied that Ketchum stated that a BIS is the right way to go and that the DOL met with FINRA staff as recently as last week.
Changes from the 2010 Proposal
Rep. Joe Courtney (D-Conn.) eluded to some of the changes the DOL implemented compared to the 2010 proposal, to include removing employee stock ownership plans (ESOPs) from the scope of the rule, and noted the education piece “needs more work.” Perez stated that the conversation among industry has evolved from there not being a conflict of interest problem to an increasing recognition that a BIS is needed.
Rep. Hakeem Jeffries (R-N.Y.) asked Perez to explain changes made from the 2010 proposal. Perez explained that concerns were raised regarding a more extensive economic analysis in the 2010 proposal, so the new proposal includes one. He continued that ESOPs were removed due to industry feedback, and that the BIC exemption is the attempt to create “guardrails but not straight jackets.”
Cost of Rule Implementation
Roe asked Perez how the $17 billion number he quoted in his testimony was reached and stated that “a lot of assumptions and extrapolations” were made, including that investors pay for a loaded mutual fund every year instead of just the one-time load. Perez did not answer his question and instead explained how the proposed rule will make it easier for workers and employers to get financial advice.
Education vs. Advice
Polis asked Perez to clarify the distinction between education and advice for investors. Perez explained that one of the most important conversations FAs have with their client is about asset allocation and noted that employers can provide advice within the proposed rule.
Guthrie asked how it works if an employer is making a presentation that explains the different retirement accounts available to the employee. Perez stated that employers can provide seminars and advice and not fall within the rule.
Litigation
Foxx stated that the proposed rule would ensure “full employment for trial lawyers” and asked why the rule is needed if FAs are already putting the best interest of their clients first. Perez stated that the rule is “trusting but verifying” and that there is “no evidence” of a litigation boom with FAs that are already fiduciaries, as there is a mandatory arbitration clause under the BIC exemption.
Rep. Tim Walberg (R-Mich.) stressed his concern about the cost of proposal, to include potential litigation and administrative costs and asked how many additional Employee Retirement Income Security Act (ERISA) lawsuits will be filed annually if the rule is finalized. Perez stated that a provision in the proposal allows for mandatory arbitration under the BIC exemption, a provision that was taken from the Financial Industry Regulatory Authority (FINRA). He continued that there is a controlled experiment being conducted in order to get numbers on the additional ERISA lawsuits that may be filed, but noted that there is “no evidence” that advisors who are fiduciaries get sued more often.
Takano asked what the process is for investors who feel they have been misled, and asked if there are remedies other than mandatory arbitration. Perez stated that the Employee Benefits Security Administration (EBSA) has a “robust docket” of enforcement cases and that in this rulemaking they are trying to create a remedy for the individual who has been wronged through the BIC exemption.
Cybersecurity
Regarding the extensive disclosures required under the proposed rule, Pocan asked if the DOL has the cybersecurity levels and funding to protect the sensitive data that will be collected.
Walberg asked what the DOL is doing to make sure the data collected is secure when it comes to investors and fiduciaries. Perez noted the DOL’s budget request for 2016 is “robust” for information technology (IT) in order to make sure their infrastructure is as “impermeable as possible.”
Small Accounts
Rep. Gregorio Kilili Camacho Sablan (D-N.M.I.) asked how small accounts will be managed under the new proposed rule. Perez explained they will be managed “the same way you manage every account,” and that the rule is most designed for small investors as they are the “most vulnerable.”
myRA
Rep. Brett Guthrie (R-Ky.) asked about the President’s “my Retirement Account” (myRA) program and how the rule will treat these accounts differently. Perez noted that myRAs are not covered under the proposed rule because the Treasury Department controls those accounts.
Panel 2 Testimony
Kent Mason, Partner, Davis & Harman LLP
In his testimony, Kent Mason stressed three key points: (1) the industry is absolutely fine with a BIS, that the concern has always related to prohibited transaction rules; (2) the 2015 proposal significantly cuts back on permissible financial education while the 2010 proposed rule preserved it; and (3) the perception is that this has been an evolution, updating the 2010 proposal, but the 2015 proposal is actually “much worse and much less workable than the 2010 rule.”
Mason focused on two points: the effects of the proposal on small accounts, and the “critical need” for legislation. He explained that there are two ways IRA owners can get assistance: the brokerage model which is commission-based and payments come from mutual funds; and the advisory model where the FA has a “24/7, 365 fiduciary responsibility” in exchange for a flat fee. Mason stated that the proposed rule effectively makes the brokerage model illegal and that the rule structure will not work for small accounts. Mason stressed that bipartisan legislation is needed that establishes a workable BIS rule, not an “unworkable” rule.
Jack Haley, Executive Vice President, Fidelity Investments
In his testimony, Jack Haley stated that “Fidelity acts in the best interest of clients and investors” and while they support a BIS, “details matter.” He continued that the BIC exemption has “so many problems, it is unworkable.” Haley stressed that small business owners do not have the time, expertise or desire to manage retirement savings plans, which is why they turn to Fidelity, but the DOL’s proposed rule would prohibit service providers from assisting them. He explained that without relief from ERISA, Fidelity would not be able to provide service to small businesses “even if it is in the best interest.” Haley explained that the rule would jeopardize every day conversations at his company about education and guidance to employees, and that the proposal will “harm the very people it intends to protect.”
Dennis Kelleher, President and CEO, Better Markets
In his testimony, Dennis Kelleher said that it is “unacceptable” that brokers and others are allowed to put economic interests above a client’s best interest, and that conflicted advice is “costing money every year.” He continued that ending this conflicted advice is “what the DOL proposed rule is about.” Kelleher explained that often the products with higher fees do not perform as well over time as those with lower fees, and therefore clients are “doubly victimized.” Kelleher stated that the industry objects to the proposed rule because they do not want to “change the status quo” and work under such a “simple” principle, one that that puts clients’ interests first. He concluded that “Americans need to keep every penny in their accounts, not in their broker’s pockets.”
Dr. Brian Reid, Ph.D., Chief Economist, Investment Company Institute
In his testimony, Dr. Brian Reid, Ph.D., said that the Regulatory Impact Analysis (RIA) the DOL conducted was “fatally flawed” and supports the DOL’s agenda rather than investors, and questioned whether the DOL understands the market of retirement advice. He noted five points: (1) that the DOL is flawed when it says retirement savers will lose $1 trillion – – investors with front end loads bought funds that outperformed other funds, which eliminates almost all rationale to justify the rule proposal; (2) it ignores market realities as investors will pay more under proposal; (3) the DOL does not and cannot measure whether investors will get better results based on their studies conducted; (4) the proposal fails to identify new burdens created, as many IRA investors would not be able to obtain advice; and (5) the difference between what an IRA investor pays and a 401(k) investor is 85 percent less than the White House Council of Economic Advisors (CEA) assumes. Reid stated while he supports a BIS, the rule is “hopelessly complex, confused, and unworkable.”
Dean Harman, CFP, Managing Director, Harman Wealth Management
In his testimony, Dean Harman, CFP, who was representing the Financial Services Industry (FSI) said that one way the rule is unworkable is that for a client to pay for services using a commission model, the firm would have to comply with BIC exemption. He continued that due to the BIC exemption, he would have to predict investor performance, which would put him in conflict with SEC and FINRA rules and can create “unrealistic expectations” for investors. Harman stated that the proposal is “too complex,” and that compiling internet disclosures would be a “massive undertaking” resulting in errors that could lead to litigation.
Harman continued that investors will find it difficult to access “valuable retirement advice and products” due to the proposed rule and that while he does not want to have to turn away clients looking for advice, “this will be a consequence of the proposal.” He explained that the advisory fee model does not make sense to lower net worth, young professional and elder clients, and that the commission-based model is appropriate because it would eliminate out-of-pocket costs. Harman stated that he “wants to make sure” the rule written by the DOL makes it easier for clients to continue receiving services but “the rule fails them.” He concluded that while FSI supports a uniform BIS, the DOL’s proposal is “costly and unworkable.”
Question & Answer
Best Interest Standard
Scott asked Haley if he could help write the rules to administer a BIS, which Haley agreed to.
Best Interest Contract Exemption
Allen asked Harman to clarify the earnings prediction he would have to make for customers under this rule. Harman explained that under the BIC exemption he would have to make assumptions about returns in order to predict fees.
Grothman asked about the website that would contain confidential information. Harman explained that his concern about the website is that it would be used publicly and that it would add additional confusion for investors because they “do not know how to interpret data.”
Roe stated that in the new rule it says future earnings have to be predicted, but that past performance does not predict future returns. Harman stated that this is a “tremendous conflict that has the potential to undermine trust,” as numbers will not be where they think they will be 10 years from now. He continued that this conflict is problematic as it crosses FINRA and SEC regulations.
Roe asked if it is true that higher cost plans always yield lower returns. Reid stated that “obsession over fees alone can be blinding,” and that this is the “most vigorous bull market in the past 100 years.”
Roe asked who would have access to the website that contains confidential information. Mason answered that every participant in the plan would have access to information stored on the website.
Small Accounts
Scott asked Mason how much money an FA would have to receive on an account in order to make it “worth your while.” Mason explained that financial institutions set different minimums in terms of how much they require for advisory accounts that receive 365 day liability and responsibility, which cannot be offered for a small amount of money. He continued that under the brokerage model it is different because advice can be given but there is no ongoing duty to council them.
Allen asked Mason how large the brokerage side of the financial industry is. Mason stated that 98 percent of IRAs under $25,000 are held in brokerage accounts, and that the “damage” that would be done to small investors through this rule is “incalculable.”
Current Regulatory Structure
Foxx asked what Perez meant when he said the system was “structurally flawed.” Mason explained that many of the FA “horror stories” are illegal under current laws and that it does not constitute a structural flaw. Harman continued that advisors are highly regulated as it is and that FAs need to have multiple solutions for clients based on their needs, which is what the current structure allows.
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House Education and the Workforce Committee
Subcommittee on Health, Employment, Labor, and Pensions
“Restricting Access to Financial Advice: Evaluating the Costs and Consequences for Working Families and Retirees”
Wednesday, June 17, 2015
Key Topics & Takeaways
- Opposition to the Proposed Rule: Chairman David Roe (R-Tenn.) said the proposal “will hurt retirees, families, small business owners, and could not come at a worse time.” He continued that the fiduciary regulation “moves the country in the wrong direction” and eliminates financial advice families and small businesses rely on.
- Support for a Best Interest Standard: Ranking Member Jared Polis (D-Colo.) said Congress and the financial services industry believes in a best interest standard, but it has to be implemented in a way that “makes sense.” He continued that most Americans are not saving enough for retirement, and what is invested should not be impacted by adverse advice from FAs. Polis stressed that “no one thinks current rule is perfect” and that ensuring investors are receiving unbiased advice “should be our end goal here.”
- Coordination with Regulators: Many lawmakers questioned the amount of coordination among regulators in drafting the proposal, including Rep. John Kline (R-Minn.), chairman of the full committee, who noted that the “extensive” outreach to the SEC may depend on what “extensive” and “outreach” means. He asked Perez if the 827 pages of outreach coordination the committee received represented the entirety of written communications between the DOL and SEC. Perez stated that it did not and mentioned there were “extensive” conversations with committee staff. He noted a staff oral briefing that would go more in depth on the coordination efforts.
Speakers
- The Honorable Thomas E. Perez, Secretary, U.S. Department of Labor
- Kent Mason, Partner, Davis & Harman LLP
- Jack Haley, Executive Vice President, Fidelity Investments
- Dennis Kelleher, President and CEO, Better Markets
- Dr. Brian Reid, Ph.D., Chief Economist, Investment Company Institute
- Dean Harman, CFP, Managing Director, Harman Wealth Management
Opening Statements
In his opening statement, Chairman David Roe (R-Tenn.) said he “wished the proposal had broad bipartisan support, but instead it will hurt retirees, families, small business owners, and could not come at a worse time.” He continued that the fiduciary regulation “moves the country in the wrong direction” and eliminates financial advice families and small businesses rely on. Roe explained that financial advisors (FAs) are subject to many requirements, a “complex system” of rules and regulations that have worked well “for decades,” and while the standards should be improved, they should not make it harder for investors to get the advice they need. He stated that wealthy Americans “will do just fine,” but the proposed rule will hurt those who need help the most and encouraged the Secretary of Labor to withdraw the rule so the committee could help create new bipartisan legislation.
In his opening statement, Ranking Member Jared Polis (D-Colo.) said Congress and the financial services industry believes in a best interest fiduciary standard, but it has to be implemented in a way that “makes sense.” He continued that most Americans are not saving enough for retirement, and what is invested should not be impacted by adverse advice from FAs. Polis stressed that “no one thinks current rule is perfect” and that ensuring investors are receiving unbiased advice “should be our end goal here.”
Panel 1 Testimony
The Honorable Thomas E. Perez, Secretary, U.S. Department of Labor
In his testimony, Thomas Perez described an example of a couple who trusted the FA but the broker’s conflicted advice cost them over $50,000. He estimated the cost of conflicted advice as $17 billion annually and said “the stakes could not be higher.” Perez explained that since consumers are now in control of their own accounts rather than a traditional pension system, a secure retirement is “less predictable.” He stressed that while most FAs do look out for the best interest of their clients, many are not fiduciaries and operate under “no such commitment” to do what is in the best interest of clients.
Perez claimed that consumers have an “informational disadvantage” and that the “playing field is not level.” He stated that FAs are operating within a “structurally flawed system” where their financial interest is misaligned with the best interest of customer. The goal of the Department of Labor (DOL), Perez noted, is to create an enforceable best interest standard (BIS) so there is certainty that FAs are working for the client “first and foremost.” He discussed “lengthy outreach” with the Securities and Exchange Commission (SEC), consumer groups, the financial services industry, and Congress while creating the rule. Perez concluded that the BIS rule is “not just the right thing to do, it is the smart thing to do.”
Question & Answer
Best Interest Standard
Rep. Mark Takano (D-Calif.) stated his concern that the proposed rule might disincentivize people from saving. Perez stated that establishing the best interest rule will help bridge the trust gap between FAs and clients.
Rep. Rick Allen (R-Ga.) stated that the financial industry is already highly regulated and that the problems with ENRON and others were accounting-based, not investment advice, and asked how the DOL will make the proposed rule work. Perez explained that if a client goes to an FA for advice, the FA will “just have to look out for their best interest.”
Rep. Buddy Carter (R-Ga.) stressed that he is “deeply disturbed by this and not in favor of it at all,” and noted that the Investment Company Institute (ICI) disputes that conflicts of interest have resulted in higher fees for those in IRAs than 401(k) plans. He continued that “this is already an overregulated field” and that the rule is a “solution in search of a problem.” Perez replied that “many people in the industry” are saying there is a need for a BIS because “the system is misaligned.”
Rep. Bobby Scott (D-Va.) asked Perez to clarify if an FA can sell a product knowing they will make more money and the clients will make less. Perez explained the suitability threshold and stated that the current system has no prevention of taking advantage of that incentive.
Best Interest Contract Exemption
Roe questioned the best interest contract (BIC) exemption and stated it is “very simple” for investors to understand what their returns are, net of fees, on their account statements. Perez explained that the problem is that people do not know what their fees are because they are “hidden,” and a more opaque, transparent system will “empower” consumers.
Polis noted that in order to use the prohibited transaction exemption (PTE) the advice has to comply with significant disclosure requirements, and asked if the additional burden is worth it. Perez referred to the BIC exemption as a “Ronald Reagan provision” to “trust but verify” that the information consumers are receiving is the best option for them.
Rep. Virginia Foxx (R-N.C.) questioned the need to sign a contract before having a conversation with an FA about opening an individual retirement account (IRA), and stated it would “intimidate” new investors that are needed in the market and discourage them to save. Perez explained that a contract would not have to be signed before that conversation and noted that there are concerns regarding the timing of when the contract requirement would go into place. He stated that investors should be able to “shop around” and have conversations about asset allocation risk tolerance thresholds without needing a contract.
Rep. Mark Pocan (D-Wis.) stressed the need for clarification about when a contract would have to be signed with the FA. Perez replied that he has heard the same from the financial services industry and DOL is “doing their best” at integrating feedback received.
Rep. Suzanne Bonamici (D-Ore.) asked when the contract has to be signed for an FA to discuss accounts with the client and if the DOL is open to working on clarifying this rule. Perez stated that there is a “heck of a lot you can do right now without signing a contract,” and that he is confident a “line will be drawn even sharper” to clarify the distinction as a result of industry input.
Rep. Joe Heck (R-Nev.) stated his concern that the proposed rule would limit the ability to provide services to the client because they have to have a contract signed and disclose any fees prior to a conversation. Perez stated that the implementation is “a lot easier” than industry implies as there are already policies and practices for mitigating conflicts.
Rep. Glenn Grothman (R-Wisc.) asked Perez about the public database of FA compensation required under the BIC exemption. Perez stated that it will not be a public database and that he wants to ensure consumers understand how much fees cost so they can make an informed judgment.
Coordination with Regulators
Polis questioned the input Perez received from the SEC and other regulators. Perez noted he had meetings and calls with SEC Chair Mary Jo White throughout the process that were “incredibly helpful” and helped inform judgment in “every aspect” of the rule.
Rep. John Kline (R-Minn.), chairman of the full committee, criticized the extension of the comment period by 15 days, stating that “45 would have been better.” He noted that the “extensive” outreach to the SEC may depend on what “extensive” and “outreach” means, and asked if the 827 pages of outreach coordination the committee received represented the entirety of written communications between the DOL and SEC. Perez stated that it did not and mentioned there were “extensive” conversations with committee staff. He noted a staff oral briefing that would go more in depth on the coordination efforts.
Rep. Frederica Wilson (D-Fla.) asked about the process that the DOL will take to ensure all interested parties are heard in the formation of the final rule. Perez stated that there will be a public hearing to make additional comment on rule, then the transcript of the hearing will be provided and invite comment on that, and they will continue to have regular meetings with regulators and industry. He stressed that “the goal is to get it right.”
Rep. Luke Messer (R-Ind.) stressed concern over the coordination with the SEC as SEC Commissioner Daniel Gallagher stated the DOL had not consulted with the SEC as of February. Perez stated that he did not coordinate with Gallagher because he coordinated directly with White, and noted that he took a trip to the United Kingdom to learn from their experience with a fiduciary standard. Perez continued that White thinks the best interest standard is the “right way to go” for an SEC regulatory standard.
Messer asked about the DOL’s coordination with FINRA, as Chairman Richard Ketchum stated in March that many firms would lose IRA business due to the proposed rule. Perez replied that Ketchum stated that a BIS is the right way to go and that the DOL met with FINRA staff as recently as last week.
Changes from the 2010 Proposal
Rep. Joe Courtney (D-Conn.) eluded to some of the changes the DOL implemented compared to the 2010 proposal, to include removing employee stock ownership plans (ESOPs) from the scope of the rule, and noted the education piece “needs more work.” Perez stated that the conversation among industry has evolved from there not being a conflict of interest problem to an increasing recognition that a BIS is needed.
Rep. Hakeem Jeffries (R-N.Y.) asked Perez to explain changes made from the 2010 proposal. Perez explained that concerns were raised regarding a more extensive economic analysis in the 2010 proposal, so the new proposal includes one. He continued that ESOPs were removed due to industry feedback, and that the BIC exemption is the attempt to create “guardrails but not straight jackets.”
Cost of Rule Implementation
Roe asked Perez how the $17 billion number he quoted in his testimony was reached and stated that “a lot of assumptions and extrapolations” were made, including that investors pay for a loaded mutual fund every year instead of just the one-time load. Perez did not answer his question and instead explained how the proposed rule will make it easier for workers and employers to get financial advice.
Education vs. Advice
Polis asked Perez to clarify the distinction between education and advice for investors. Perez explained that one of the most important conversations FAs have with their client is about asset allocation and noted that employers can provide advice within the proposed rule.
Guthrie asked how it works if an employer is making a presentation that explains the different retirement accounts available to the employee. Perez stated that employers can provide seminars and advice and not fall within the rule.
Litigation
Foxx stated that the proposed rule would ensure “full employment for trial lawyers” and asked why the rule is needed if FAs are already putting the best interest of their clients first. Perez stated that the rule is “trusting but verifying” and that there is “no evidence” of a litigation boom with FAs that are already fiduciaries, as there is a mandatory arbitration clause under the BIC exemption.
Rep. Tim Walberg (R-Mich.) stressed his concern about the cost of proposal, to include potential litigation and administrative costs and asked how many additional Employee Retirement Income Security Act (ERISA) lawsuits will be filed annually if the rule is finalized. Perez stated that a provision in the proposal allows for mandatory arbitration under the BIC exemption, a provision that was taken from the Financial Industry Regulatory Authority (FINRA). He continued that there is a controlled experiment being conducted in order to get numbers on the additional ERISA lawsuits that may be filed, but noted that there is “no evidence” that advisors who are fiduciaries get sued more often.
Takano asked what the process is for investors who feel they have been misled, and asked if there are remedies other than mandatory arbitration. Perez stated that the Employee Benefits Security Administration (EBSA) has a “robust docket” of enforcement cases and that in this rulemaking they are trying to create a remedy for the individual who has been wronged through the BIC exemption.
Cybersecurity
Regarding the extensive disclosures required under the proposed rule, Pocan asked if the DOL has the cybersecurity levels and funding to protect the sensitive data that will be collected.
Walberg asked what the DOL is doing to make sure the data collected is secure when it comes to investors and fiduciaries. Perez noted the DOL’s budget request for 2016 is “robust” for information technology (IT) in order to make sure their infrastructure is as “impermeable as possible.”
Small Accounts
Rep. Gregorio Kilili Camacho Sablan (D-N.M.I.) asked how small accounts will be managed under the new proposed rule. Perez explained they will be managed “the same way you manage every account,” and that the rule is most designed for small investors as they are the “most vulnerable.”
myRA
Rep. Brett Guthrie (R-Ky.) asked about the President’s “my Retirement Account” (myRA) program and how the rule will treat these accounts differently. Perez noted that myRAs are not covered under the proposed rule because the Treasury Department controls those accounts.
Panel 2 Testimony
Kent Mason, Partner, Davis & Harman LLP
In his testimony, Kent Mason stressed three key points: (1) the industry is absolutely fine with a BIS, that the concern has always related to prohibited transaction rules; (2) the 2015 proposal significantly cuts back on permissible financial education while the 2010 proposed rule preserved it; and (3) the perception is that this has been an evolution, updating the 2010 proposal, but the 2015 proposal is actually “much worse and much less workable than the 2010 rule.”
Mason focused on two points: the effects of the proposal on small accounts, and the “critical need” for legislation. He explained that there are two ways IRA owners can get assistance: the brokerage model which is commission-based and payments come from mutual funds; and the advisory model where the FA has a “24/7, 365 fiduciary responsibility” in exchange for a flat fee. Mason stated that the proposed rule effectively makes the brokerage model illegal and that the rule structure will not work for small accounts. Mason stressed that bipartisan legislation is needed that establishes a workable BIS rule, not an “unworkable” rule.
Jack Haley, Executive Vice President, Fidelity Investments
In his testimony, Jack Haley stated that “Fidelity acts in the best interest of clients and investors” and while they support a BIS, “details matter.” He continued that the BIC exemption has “so many problems, it is unworkable.” Haley stressed that small business owners do not have the time, expertise or desire to manage retirement savings plans, which is why they turn to Fidelity, but the DOL’s proposed rule would prohibit service providers from assisting them. He explained that without relief from ERISA, Fidelity would not be able to provide service to small businesses “even if it is in the best interest.” Haley explained that the rule would jeopardize every day conversations at his company about education and guidance to employees, and that the proposal will “harm the very people it intends to protect.”
Dennis Kelleher, President and CEO, Better Markets
In his testimony, Dennis Kelleher said that it is “unacceptable” that brokers and others are allowed to put economic interests above a client’s best interest, and that conflicted advice is “costing money every year.” He continued that ending this conflicted advice is “what the DOL proposed rule is about.” Kelleher explained that often the products with higher fees do not perform as well over time as those with lower fees, and therefore clients are “doubly victimized.” Kelleher stated that the industry objects to the proposed rule because they do not want to “change the status quo” and work under such a “simple” principle, one that that puts clients’ interests first. He concluded that “Americans need to keep every penny in their accounts, not in their broker’s pockets.”
Dr. Brian Reid, Ph.D., Chief Economist, Investment Company Institute
In his testimony, Dr. Brian Reid, Ph.D., said that the Regulatory Impact Analysis (RIA) the DOL conducted was “fatally flawed” and supports the DOL’s agenda rather than investors, and questioned whether the DOL understands the market of retirement advice. He noted five points: (1) that the DOL is flawed when it says retirement savers will lose $1 trillion – – investors with front end loads bought funds that outperformed other funds, which eliminates almost all rationale to justify the rule proposal; (2) it ignores market realities as investors will pay more under proposal; (3) the DOL does not and cannot measure whether investors will get better results based on their studies conducted; (4) the proposal fails to identify new burdens created, as many IRA investors would not be able to obtain advice; and (5) the difference between what an IRA investor pays and a 401(k) investor is 85 percent less than the White House Council of Economic Advisors (CEA) assumes. Reid stated while he supports a BIS, the rule is “hopelessly complex, confused, and unworkable.”
Dean Harman, CFP, Managing Director, Harman Wealth Management
In his testimony, Dean Harman, CFP, who was representing the Financial Services Industry (FSI) said that one way the rule is unworkable is that for a client to pay for services using a commission model, the firm would have to comply with BIC exemption. He continued that due to the BIC exemption, he would have to predict investor performance, which would put him in conflict with SEC and FINRA rules and can create “unrealistic expectations” for investors. Harman stated that the proposal is “too complex,” and that compiling internet disclosures would be a “massive undertaking” resulting in errors that could lead to litigation.
Harman continued that investors will find it difficult to access “valuable retirement advice and products” due to the proposed rule and that while he does not want to have to turn away clients looking for advice, “this will be a consequence of the proposal.” He explained that the advisory fee model does not make sense to lower net worth, young professional and elder clients, and that the commission-based model is appropriate because it would eliminate out-of-pocket costs. Harman stated that he “wants to make sure” the rule written by the DOL makes it easier for clients to continue receiving services but “the rule fails them.” He concluded that while FSI supports a uniform BIS, the DOL’s proposal is “costly and unworkable.”
Question & Answer
Best Interest Standard
Scott asked Haley if he could help write the rules to administer a BIS, which Haley agreed to.
Best Interest Contract Exemption
Allen asked Harman to clarify the earnings prediction he would have to make for customers under this rule. Harman explained that under the BIC exemption he would have to make assumptions about returns in order to predict fees.
Grothman asked about the website that would contain confidential information. Harman explained that his concern about the website is that it would be used publicly and that it would add additional confusion for investors because they “do not know how to interpret data.”
Roe stated that in the new rule it says future earnings have to be predicted, but that past performance does not predict future returns. Harman stated that this is a “tremendous conflict that has the potential to undermine trust,” as numbers will not be where they think they will be 10 years from now. He continued that this conflict is problematic as it crosses FINRA and SEC regulations.
Roe asked if it is true that higher cost plans always yield lower returns. Reid stated that “obsession over fees alone can be blinding,” and that this is the “most vigorous bull market in the past 100 years.”
Roe asked who would have access to the website that contains confidential information. Mason answered that every participant in the plan would have access to information stored on the website.
Small Accounts
Scott asked Mason how much money an FA would have to receive on an account in order to make it “worth your while.” Mason explained that financial institutions set different minimums in terms of how much they require for advisory accounts that receive 365 day liability and responsibility, which cannot be offered for a small amount of money. He continued that under the brokerage model it is different because advice can be given but there is no ongoing duty to council them.
Allen asked Mason how large the brokerage side of the financial industry is. Mason stated that 98 percent of IRAs under $25,000 are held in brokerage accounts, and that the “damage” that would be done to small investors through this rule is “incalculable.”
Current Regulatory Structure
Foxx asked what Perez meant when he said the system was “structurally flawed.” Mason explained that many of the FA “horror stories” are illegal under current laws and that it does not constitute a structural flaw. Harman continued that advisors are highly regulated as it is and that FAs need to have multiple solutions for clients based on their needs, which is what the current structure allows.
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