Background
On April 8, 2016, after a proposal and comment process, the DOL issued its new Rule and related PTEs under ERISA, and the Internal Revenue Code, governing advice given to retirement savers investing in qualified accounts that include ERISA plans and IRAs. A primary focus of this Rule is to protect retirement savers from risks associated with advisors receiving conflicted compensation. Under the Rule, the new Impartial Conduct Standards were set to become effective April 10, 2017. These Standards require that advisers and Financial Institutions provide investment advice in the Retirement Investor’s Best Interest; not recommend transactions that will result in more than reasonable compensation; and not make misleading statements to the Retirement Investor about recommended transactions. The new DOL publications also include the Best Interest Contract, or BIC exemption, which is the primary vehicle to allow advisers to continue to be paid commissions. The BIC exemption creates a private right of action and is considered the source of significant anticipated litigation, including class actions. The current deadline for issuing the BIC contracts is January 1, 2018.
On February 3, 2017, President Trump issued an Executive Order requiring the DOL to revisit the Rule. The April 10 effective date for the compliance with the Impartial Conduct standard was postponed to June 9, 2017. The deadline to start entering BIC contracts and comply with other operational requirements remains January 2018, at the moment. Although speculation is rampant in the industry, no one knows whether the Rule and PTEs will go forward in their current form, or be amended, or if the Rule and PTEs will be discarded. This leaves businesses in the financial services and insurance industries in the challenging position of trying to prepare for a Rule that may or may not change.
The stakes are quite high, because failing to hit this “moving target” could lead to significant litigation exposure, including class actions. Under the current form of the Rule, companies cannot force customers to waive their rights to bring class actions under the BIC exemption. We anticipate that this provision will continue to be the subject of extensive debate as the DOL analyzes the future of the Rule. We also expect that future litigation relating to compliance with the Rule will be extensive, notwithstanding where the class action discussion ends.
Key Questions
An important threshold question to consider is how does one effectively advise your business to comply with regulations, when those requirements are in flux? We understand this challenge, but also do not believe that ignoring the problem is a wise approach. We recommend starting your analysis by identifying the most important business risks associated with the Rule change. For example:
- Should we change compensation structures?
- Do we need to update our compliance program?
- What new training, if any, do we need?
- Do our policies, procedures, or contracts need to be amended?
All of these questions -- and your responses -- will likely be the subject of scrutiny in future litigation.
Best Practices Going Forward
Although no one knows exactly where the Rule and related PTEs will end up, we can safely predict that a key battle will focus on class actions under the BIC exemption. This debate is particularly important because it is well known that the DOL and IRS are simply not equipped to enforce the new rules. This lack of sufficient enforcement staffing with the regulators is the reason why the private right of action exists within BIC, and why class actions cannot be waived in the current version of the exemption. This delegation of enforcement authority to the plaintiffs’ bar will be hotly debated in the coming months. However, even if industry is successful and class actions are not permitted to enforce rights under the BIC exemption, the litigation is still coming. This prolonged and highly publicized regulatory process has created significant scrutiny by investors and plaintiffs’ lawyers over fees and the risks associated with conflicted advice. The plaintiffs’ bar will scrutinize all possible theories to bring these claims.
Given this anticipated litigation, we suggest that companies continue to review, evaluate and improve their compensation structures and compliance programs to reduce the likelihood for conflicted advice that is not in clients’ best interests. Here are some recommended best practices:
- Create a strong record of thoughtful analysis of issues regarding conflicts, compensation, and preventing material misstatements
- Think about how your efforts will be perceived by a jury during closing arguments in a case alleging that your company did not do what it should have done to prevent harmful conflicted investment advice that was not in the customers’ best interests
- Review existing contracts to reduce potential liability
- Review existing training
- Review policies and procedures
- Review supervisory functions – and leverage existing compliance support
- Put yourself in a position to establish value for the money paid to advisers, as this is the best way to show that compensation was reasonable
While making changes to your business, focus on the future litigation cases with an eye toward what your discovery will look like and what your narrative will be. Whether the future cases are class actions or individual claims cases – brought under ERISA or state law – we believe that making thoughtful decisions now to reduce the risks associated with conflicted advice will pay off down the line.
Client Alert 2017-121
