[House Hearing, 112 Congress]
[From the U.S. Government Printing Office]
REDEFINING `FIDUCIARY': ASSESSING THE
IMPACT OF THE LABOR DEPARTMENT'S
PROPOSAL ON WORKERS AND RETIREES
=======================================================================
HEARING
before the
SUBCOMMITTEE ON HEALTH,
EMPLOYMENT, LABOR AND PENSIONS
COMMITTEE ON EDUCATION
AND THE WORKFORCE
U.S. House of Representatives
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
HEARING HELD IN WASHINGTON, DC, JULY 26, 2011
__________
Serial No. 112-34
__________
Printed for the use of the Committee on Education and the Workforce
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COMMITTEE ON EDUCATION AND THE WORKFORCE
JOHN KLINE, Minnesota, Chairman
Thomas E. Petri, Wisconsin George Miller, California,
Howard P. ``Buck'' McKeon, Senior Democratic Member
California Dale E. Kildee, Michigan
Judy Biggert, Illinois Donald M. Payne, New Jersey
Todd Russell Platts, Pennsylvania Robert E. Andrews, New Jersey
Joe Wilson, South Carolina Robert C. ``Bobby'' Scott,
Virginia Foxx, North Carolina Virginia
Bob Goodlatte, Virginia Lynn C. Woolsey, California
Duncan Hunter, California Ruben Hinojosa, Texas
David P. Roe, Tennessee Carolyn McCarthy, New York
Glenn Thompson, Pennsylvania John F. Tierney, Massachusetts
Tim Walberg, Michigan Dennis J. Kucinich, Ohio
Scott DesJarlais, Tennessee David Wu, Oregon
Richard L. Hanna, New York Rush D. Holt, New Jersey
Todd Rokita, Indiana Susan A. Davis, California
Larry Bucshon, Indiana Raul M. Grijalva, Arizona
Trey Gowdy, South Carolina Timothy H. Bishop, New York
Lou Barletta, Pennsylvania David Loebsack, Iowa
Kristi L. Noem, South Dakota Mazie K. Hirono, Hawaii
Martha Roby, Alabama
Joseph J. Heck, Nevada
Dennis A. Ross, Florida
Mike Kelly, Pennsylvania
Barrett Karr, Staff Director
Jody Calemine, Minority Staff Director
SUBCOMMITTEE ON HEALTH, EMPLOYMENT, LABOR AND PENSIONS
DAVID P. ROE, Tennessee, Chairman
Joe Wilson, South Carolina Robert E. Andrews, New Jersey
Glenn Thompson, Pennsylvania Ranking Minority Member
Tim Walberg, Michigan Dennis J. Kucinich, Ohio
Scott DesJarlais, Tennessee David Loebsack, Iowa
Richard L. Hanna, New York Dale E. Kildee, Michigan
Todd Rokita, Indiana Ruben Hinojosa, Texas
Larry Bucshon, Indiana Carolyn McCarthy, New York
Lou Barletta, Pennsylvania John F. Tierney, Massachusetts
Kristi L. Noem, South Dakota David Wu, Oregon
Martha Roby, Alabama Rush D. Holt, New Jersey
Joseph J. Heck, Nevada Robert C. ``Bobby'' Scott,
Dennis A. Ross, Florida Virginia
C O N T E N T S
----------
Page
Hearing held on July 26, 2011.................................... 1
Statement of Members:
Andrews, Hon. Robert E., Ranking Minority Member,
Subcommittee on Health, Employment, Labor and Pensions..... 4
Kucinich, Hon. Dennis J., a Representative in Congress from
the State of Ohio, prepared statement of................... 6
Roe, Hon. David P., Chairman, Subcommittee on Health,
Employment, Labor and Pensions............................. 1
Prepared statement of.................................... 3
Rokita, Hon. Todd, a Representative in Congress from the
State of Indiana, prepared statement of.................... 6
Statement of Witnesses:
Bentsen, Hon. Kenneth E., Jr., on behalf of the Securities
Industry and Financial Markets Association................. 78
Prepared statement of.................................... 80
Borzi, Hon. Phyllis C., Assistant Secretary, Employee
Benefits Security Administration, U.S. Department of Labor. 8
Prepared statement of.................................... 10
Mason, Kent A., Davis & Harman LLP........................... 52
Prepared statement of.................................... 53
Myers, Donald J., partner, Morgan, Lewis & Bockius LLP....... 47
Prepared statement of.................................... 49
Stein, Norman P., on behalf of the Pension Rights Center..... 61
Prepared statement of.................................... 62
Tarbell, Jeffrey, Houlihan Lokey............................. 73
Prepared statement of.................................... 75
Additional Submissions:
Mr. Andrews:
``The Fiduciary Reference,'' compilation of articles,
Internet address to.................................... 46
Hutcheson, Matthew D., professional independent
fiduciary, prepared statement of....................... 98
The Profit Sharing/401k Council of America (PSCA),
prepared statement of.................................. 100
Letter, dated July 25, 2011, from Anne S. Tuttle,
executive vice president, Financial Engines............ 102
Ms. Borzi:
Response to questions submitted for the record........... 144
McCarthy, Hon. Carolyn, a Representative in Congress from the
State of New York:
Letter, dated May 10, 2011, from the New Democrat
Coalition.............................................. 32
Questions submitted for the record....................... 142
Chairman Roe:
The American Council of Life Insurers (ACLI):
Prepared statement of................................ 106
Comment letter to the Department of Labor, dated
February 3, 2011................................... 107
Roberts, Tom, chief counsel, ING Insurance U.S.,
prepared statement of.............................. 116
Clarification of earlier testimony................... 119
Letter, dated July 25, 2011, from the American Institute
of Certified Public Accountants (AICPA)................ 120
Letter from the American Society of Appraisers (ASA)..... 122
Letter, dated July 26, 2011, from the Investment Company
Institute (ICI)........................................ 124
Letters of concern from the American Bankers Association;
the Financial Services Roundtable; the Financial
Services Institute; the Insured Retirement Institute;
the National Black Chamber of Commerce; and the
National Association of Insurance and Financial
Advisors............................................... 129
Letter, dated July 29, 2011, from Steve Bartlett,
president and CEO, the Financial Services Roundtable... 136
The ESOP Association (Employee Stock Ownership Plan),
prepared statement of.................................. 137
Letter, dated August 5, 2011, from Hon. Greg Walden, a
Representative in Congress from the State of Oregon.... 142
Letter, dated August 31, 2011, to Ms. Borzi with
additional questions submitted for the record.......... 142
Mr. Rokita:
Questions submitted for the record....................... 143
Mr. Stein:
Comments filed February 3, 2011, on the Department of
Labor's proposed regulations........................... 64
REDEFINING `FIDUCIARY': ASSESSING THE
IMPACT OF THE LABOR DEPARTMENT'S
PROPOSAL ON WORKERS AND RETIREES
----------
Tuesday, July 26, 2011
U.S. House of Representatives
Subcommittee on Health, Employment, Labor and Pensions
Committee on Education and the Workforce
Washington, DC
----------
The subcommittee met, pursuant to call, at 10:05 a.m., in
room 2175, Rayburn House Office Building, Hon. David P. Roe
[chairman of the subcommittee] presiding.
Present: Representatives Roe, Thompson, Walberg, Hanna,
Rokita, Bucshon, Barletta, Roby, Heck, Andrews, Kucinich,
Loebsack, Kildee, Hinojosa, McCarthy, Tierney, Holt, and Scott.
Also present: Representatives Kline and Biggert.
Staff present: Andrew Banducci, Professional Staff Member;
Katherine Bathgate, Press Assistant/New Media Coordinator;
Casey Buboltz, Coalitions and Member Services Coordinator; Ed
Gilroy, Director of Workforce Policy; Benjamin Hoog,
Legislative Assistant; Ryan Kearney, Legislative Assistant;
Brian Newell, Deputy Communications Director; Krisann Pearce,
General Counsel; Molly McLaughlin Salmi, Deputy Director of
Workforce Policy; Linda Stevens, Chief Clerk/Assistant to the
General Counsel; Alissa Strawcutter, Deputy Clerk; Joseph
Wheeler, Professional Staff Member; Kate Ahlgren, Minority
Investigative Counsel; Aaron Albright, Minority Communications
Director for Labor; Tylease Alli, Minority Clerk; Daniel Brown,
Minority Junior Legislative Assistant; Jody Calemine, Minority
Staff Director; John D'Elia, Minority Staff Assistant; Brian
Levin, Minority New Media Press Assistant; Megan O'Reilly,
Minority General Counsel; Meredith Regine, Minority Labor
Policy Associate; and Michele Varnhagen, Minority Chief Policy
Advisor/Labor Policy Director.
Chairman Roe. This hearing of the Labor and Pensions
subcommittee will come to order.
Good morning everyone.
Welcome Assistant Secretary Borzi. We appreciate the time
you have taken to be with us today.
Recently, we learned about the challenges confronting
retirement security of workers and retirees. The lingering
effects of the recession and the uncertain regulatory
environment reaffirmed the need for policy makers to tread
carefully as they consider changes to the rules that govern
retirement investment.
Policies in this area should provide clear guidance that
protect workers but also be flexible enough to permit a wide
range of investment opportunities. Striking the right balance
between these two competing demands remains a constant policy
goal.
We are here this morning to discuss the Labor Department's
proposal to redefine the term fiduciary. The Employee
Retirement Income Security Act (ERISA) charges fiduciaries with
the highest level of care to individuals participating in a
retirement plan.
Anyone who provides investment advice should be well
trained, committed to high ethical and professional standards,
and devoted to the best interests of those financial resources
are entrusted to their care. However, the dramatic shift
proposed by the department may well disrupt stable effective
relationships between retirement savers and service providers.
For more than 35 years regulations surrounding fiduciary
responsibilities have provided certainty to employees and other
retirement plan sponsors. Currently an investment advisor is
considered a fiduciary under the law if they offer
individualized advice on a regular basis for a fee.
The fiduciary's advice must be provided pursuant to a
mutual agreement and be the primary basis for resulting
investment decision. However, the labor department has now
decided to rewrite the rules of the road. Among other changes
proposed by the department, fiduciary status would no longer
hinge on whether advice was provided regularly or served as a
primary reason for an investment decision.
While we support looking at ways to enhance this important
definition, the current proposal is an ill-conceived expansion
of the fiduciary standard. It will undermine efforts by
employers and service providers to educate workers on the
importance of responsible retirement planning. Regrettably, the
proposal may deny investment opportunities and drive up cost
for the individuals it is intended to protect.
Remarkably, the department failed to examine all the
potential costs of its proposal. For example, despite clear
indications this proposal may force small business plan
sponsors to face higher fees and receive fewer services. The
department neglected to conduct any analysis of the potential
ramifications.
Similarly, the department failed to explore how its
proposal could affect the IRA market. One study suggests that
some IRA related fees may increase by as much as 195 percent.
That is an unacceptable amount of money that will never make it
into a retirement account.
This is a difficult issue, and we should never lose sight
of the real world impact these changes may have on the
investments and long-term retirement security of workers and
retirees. We need to challenge any proposal that would curb
investment opportunities, raise the cost of investing and
reduce the return on those investments for individuals saving
for retirement.
I would like to note that leaders on both sides of the
aisle have expressed worry about the department's proposal. In
April, Chairman Kline and other Republican committee leaders
across the Capitol expressed their concerns and urged the
department to re-propose the rule.
On May 10th, members of the Democrat's Blue Dog
coalitiondescribed a number of uncertainties raised by the
proposal and the rushed regulatory process. And finally,
members of the new Democrat coalitionasked the administration
to heed public concern and begin anew.
It is not every day that such a diverse group of lawmakers
find common ground on an issue. Boy, will I ever second that.
[Laughter.]
Conceding the challenges that plague this proposal, the
department has promised to address concerns for either targeted
exemptions or future rulemaking. I am afraid this will only
exacerbate the uncertainty facing investment professionals and
increase risk for workers and retirees.
With all due respect, Assistant Secretary, if this proposal
is so disruptive to our system of retirement saving, then the
department needs to take a step back and start over. I would
like to join my Republican and Democrat colleagues in urging
the administration to do just that.
Once this proposal has been set aside, we believe we can
work together on policies that will strengthen the retirement
security of millions of Americans.
Again, we welcome Assistant Secretary Borzi, and we look
forward to your testimony and the testimony of our other
witnesses.
I will now yield to Mr. Andrews, the senior Democrat member
of the subcommittee for his opening remarks.
Mr. Andrews?
[The statement of Dr. Roe follows:]
Prepared Statement of Hon. David P. Roe, Chairman, Subcommittee on
Health, Employment, Labor and Pensions
Good morning everyone. Welcome Assistant Secretary Borzi. We
appreciate the time you have taken to be with us today.
Recently, we learned about the challenges confronting the
retirement security of workers and retirees. The lingering effects of
the recession and an uncertain regulatory environment reaffirm the need
for policymakers to tread carefully as they consider changes to the
rules that govern retirement investment. Policies in this area should
provide clear guidelines that protect workers, but also be flexible
enough to permit a wide range of investment opportunities. Striking the
right balance between these two competing demands remains a constant
policy goal.
We are here this morning to discuss the Labor Department's proposal
to redefine the term ``fiduciary.'' The Employee Retirement Income
Security Act charges fiduciaries with the highest level of care to
individuals participating in a retirement plan. Anyone who provides
investment advice should be well trained, committed to high ethical and
professional standards, and devoted to the best interests of those
whose financial resources are entrusted to their care. However, the
dramatic shift proposed by the department may well disrupt stable,
effective relationships between retirement savers and service-
providers.
For more than 35 years, regulations surrounding fiduciary
responsibility have provided certainty to employers and other
retirement plan sponsors. Currently, an investment adviser is
considered a fiduciary under the law if they offer individualized
advice on a regular basis for a fee. The fiduciary's advice must be
provided pursuant to a mutual agreement and be the primary basis for a
resulting investment decision.
However, the Labor Department has now decided to rewrite the rules
of the road. Among other changes proposed by the department, fiduciary
status would no longer hinge on whether advice was provided regularly
or served as the primary reason for an investment decision. While we
support looking at ways to enhance this important definition, the
current proposal is an ill-conceived expansion of the fiduciary
standard. It will undermine efforts by employers and service providers
to educate workers on the importance of responsible retirement
planning. Regrettably, the proposal may deny investment opportunities
and drive up costs for the individuals it is intended to protect.
Remarkably, the department failed to examine all of the potential
costs of its proposal. For example, despite clear indications this
proposal may force small business plan sponsors to face higher fees and
receive fewer services, the department neglected to conduct any
analysis of the potential ramifications. Similarly, the department
failed to explore how its proposal could affect the IRA market. One
study suggests that some IRA-related fees may increase as much as 195
percent--that's an unacceptable amount of money that will never make it
into a retirement account.
This is a difficult issue, and we should never lose sight of the
real world impact these changes may have on the investments and long-
term retirement security of workers and retirees. We need to challenge
any proposal that could curb investment opportunities, raise the costs
of investing, and reduce the return on those investments for
individuals saving for retirement.
I'd like to note that leaders on both sides of the aisle have
expressed worry about the department's proposal. In April, Chairman
Kline and other Republican committee leaders across the Capitol
expressed their concerns and urged the department to re-propose the
rule. On May 10, members of the Democrats' Blue Dog coalition described
a number of uncertainties raised by the proposal and the rushed
regulatory process. And finally, members of the New Democrat Coalition
asked the administration to heed public concern and begin anew. It's
not every day such a diverse group of lawmakers find common ground on
an issue.
Conceding the challenges that plague this proposal, the department
has promised to address concerns through either targeted exemptions or
future rulemaking. I am afraid this will only exacerbate the
uncertainty facing investment professionals and increase risk for
workers and retirees. With all due respect, Assistant Secretary, if
this proposal is so disruptive to our system of retirement saving, then
the department needs to take a step back and start over. I would like
to join my Republican and Democrat colleagues in urging the
administration to do just that. Once this proposal has been set aside,
I believe we can work together on policies that will strengthen the
retirement security of millions of Americans.
Again, welcome Assistant Secretary Borzi, we look forward to your
testimony and the testimony of our other witnesses. I will now yield to
Mr. Andrews, the senior Democrat member of the subcommittee, for his
opening remarks.
______
Mr. Andrews. Well, good morning, Chairman. I apologize to
you, the other members, and our witnesses for my tardiness. I
try to be prompt, and I apologize for that this morning.
There was a survey released last week that said that about
half the people in the country think the American dream is
dead. That is a very sobering thought, irrespective of which
political party we come from or what point of view we come
from. I would think we have a very high common purpose here to
rejuvenate the reality of the American dream and people's faith
in the American dream.
A big piece of that American dream for people is that they
work very hard week after week, month after month, year after
year, and they save money for their retirement. They count on
that money to give them the kind of lifestyle that they have
earned and so richly deserve in their retirement years.
The rule we are talking about today is about protecting
that piece of the American dream. It is about making sure that
every one of the 70 million people, who are now really their
own pension board of trustees, because they have a defined
contribution account for their pension, that every single one
of those 70 million Americans, when they get advice, are
getting advice that is solely in their best interest and not in
someone else's. That is a common purpose that I think we should
share and agree with.
Now, we are concerned about the situation where one of
those 70 million Americans is about to make a decision about
whether to put her retirement savings in Sam's mutual fund or
Mary's mutual fund. That person turns to a person who is
somehow affiliated with the retirement plan that they enroll in
at work. They really need to know that the person giving them
advice doesn't make more money if they steer them towards Sam's
mutual fund or Mary's mutual fund.
They really need to know that the advice that the advisor
is giving them is based upon their interest and what will be
best for their fund.
The ERISA law has enshrined in statute this conflict of
interest provision since its inception. Section 321 of that law
says, ``A person is a fiduciary with respect to a plan that he
or she renders investment advice for a fee or other
compensation, direct or indirect, with respect to any monies or
any property of such plan or has any authority or
responsibility to do so.''
Since 1974, when that statute was written, the world has
changed. The number of people relying upon defined contribution
accounts has skyrocketed, the complexity of investments has
deepened, and the importance of the account has broadened for
people.
So the purpose of this rule, which I think we need to
support, is that we never want one of those 70 million
Americans to be in a position where the person giving them
advice about whether it is Sam's mutual fund or Mary's mutual
fund has interests that are not strictly aligned with the
pensioner or the workers of whom they are giving advice.
Now, we know that there are practical issues here that need
to be addressed and resolved. And we have two terrific panels
today. Secretary Borzi has expressed in our discussions a
sincere willingness to address these practical issues, and I
think she and her team are in the process of doing that.
And the second panel is really outstanding; people who know
this issue from their perspective as legislators, academics, or
advocates of the field. So I am looking forward to hearing what
both panels have to say.
But understand this: many of us do share with the
department a conviction that whether you are getting advice
about what the next decision is in your work life or what the
next decision is when you roll over your defined contribution
plan to some other account, we want to be sure that the
underlying principle of ERISA that avoids conflicts of interest
in the giving of advice is universally adhered to so that piece
of the American dream where someone can retire with the
certainty that their assets are protected as well can become
real again for the people of our country.
Seventy million Americans depend on this, and I believe it
is our obligation to make sure that their dependence is well
placed.
So, Mr. Chairman, I appreciate the chance to hear the
panels.
Chairman Roe. Thank you, Ranking Member.
I now yield to Mr. Kildee, from Michigan, for his opening
comments.
Mr. Kildee. Thank you, Dr. Roe. I appreciate this courtesy.
I came to Congress about 34-and-a-half years ago when Frank
Thompson was your counterpart, and we had a special task force
on ERISA. He told me one day very early, he said, ``There are
only two people in Washington who understand ERISA, and that is
Phyllis Borzi and John Erlenborn.''
John was your counterpart, the Republican, and Phyllis, it
is good to have you here again. You have been a fountain of
wisdom for us through these years.
Since then I can add one more, just by the good luck of
buying a good place, my neighbor right across the street is Don
Myers, and if I have a question coming up on ERISA, I wait
until Don walks to his mailbox, and I will walk over there
then.
Stand up, Don.
He gives me some pro bono advice on this, and I appreciate
it.
Mr. Andrews. Does that make him a fiduciary? I wonder about
that, huh? [Laughter.]
Mr. Kildee. So, anyway, thank you, Mr. Chairman.
I will say this, Dr. Roe, if everyone conducts themselves
around here as you, we would have a body of civility in this
Congress. Thank you, Dr. Roe.
Chairman Roe. Thank you, Mr. Kildee, for yielding back.
Pursuant to committee rule 7c, all members will be
permitted to submit written statements to be included in the
permanent hearing record. And without objection, the hearing
record will remain open for 14 days to allow such statements
and other such extraneous material referenced during the
hearing to be submitted for the official record.
[The statement of Mr. Rokita follows:]
Prepared Statement of Hon. Todd Rokita, a Representative in Congress
From the State of Indiana
Thank you Mr. Chairman. I would like to recognize the leadership
this committee, and subcommittee, have taken on this issue. We are here
talking about a proposed regulation by the Department of Labor that
would have significant unintended consequences on the financial
services industry, as well as active and retired workers.
While I think we all support efforts that would modernize the
enforcement of the rules and laws that govern retirement investment,
moving forward with this regulation--that the Department itself
acknowledges the costs and effects are unknown--is just foolish.
Moreover, with the recent recession and continued problems with
underfunded pensions, countless active and retired workers are already
facing a number of challenges. We do not need to add to that with this
proposed rule.
I have significant concerns regarding the Department of Labor's
proposal to redefine ``fiduciary.'' These concerns range from the
process of the rulemaking--with DoL noting in the preamble of the
regulation that its costs are unknown; to the potential impact the rule
will have on those that can least afford it--workers and retirees. This
rule will reduce the access of workers to financial education, increase
the costs of administering certain retirement plans, and potentially
decrease the return on a workers' investment.
Approximately 90 Members of Congress, Republicans and Democrats,
have called for DoL to listen to stakeholder feedback and go back to
the table and redraft this regulation. While I agree that those who
provide investment advice should be highly trained, licensed, ethical,
and dedicated to the interests of their clients--this is a hastily
written rule that will have far reaching implications. At a time when
employers and workers are looking for economic certainty, Washington
should carefully examine any proposal that could undermine the
retirement savings of employees.
______
[The statement of Mr. Kucinich follows:]
Prepared Statement of Hon. Dennis J. Kucinich, a Representative in
Congress From the State of Ohio
Chairman Kline and Ranking Member Miller: I strongly support the
Department of Labor's (DOL) proposed rule updating the circumstances
under which individuals who provide investment advice for a fee must
act as a fiduciary to workers. The proposed rule would modernize the
definition of fiduciary under the Employee Retirement Income Security
Act (ERISA) and would dramatically reduce the confusion that has long
made hard-working Americans vulnerable to exploitation and led to the
loss of millions of dollars of retirement assets.
Under the current rule, any person paid to provide investment
advice is a fiduciary, someone who must put their client's interest
first. Yet in practice, the interpretation of the term ``paid
investment advice'' has long been used as a giant loophole by those
looking to flout the meaning and the spirit of the law. Advisers can
avoid the legal responsibility of a fiduciary if they claim that they
didn't know their advice would be used to make an investment decision,
or that they only gave the advice once and not on a regular basis.
When ERISA was adopted in 1975, neither Individual Retirement
Accounts (IRAs), nor 401(k) retirement plans were in existence. The
ERISA law simply attempted to define ``fiduciary'' in a way that tried
to prevent self-dealing and conflicts of interest by those who provide
financial advice. Yet today the majority of such plans are 401(k) plans
where workers contribute a portion of their salary and the employer
matches some or all of it. The process of investing in a 401(k) means
that an employee places a significant amount of trust--and risk--in the
decisions made by investment professionals selected by their employer.
Seventy million Americans want to maximize the return on their
hard-earned retirement savings and many of them put their trust in
investment advisors and broker-dealers. It only makes sense that the
laws protecting workers and their retirements should be as clear as
possible. Those criticizing the proposed rule argue that requiring both
the DOL and the Securities and Exchange Commission (SEC) under the
Dodd-Frank Act to create rules regarding fiduciaries will result in
further confusion. However, both agencies have stated publicly that
they are working and will continue to work together to coordinate the
rules which both agencies are promulgating.
I recognize that those who level criticisms of the proposed rule
are concerned about the impact of both the DOL's and the SEC's final
rules will have on the investment industry. I believe those concerns
are allayed by the fact that both rules are being promulgated with full
public and Congressional input. Also mitigating the potential negative
impact of the rules, under the Department of Labor's proposed rule,
brokers would still be allowed to earn commissions on securities,
mutual funds, insurance products and annuities. Brokers would still be
allowed to act as sellers without becoming a fiduciary. They would also
receive an exemption from the rule when they undertake transactions
that benefit workers.
For many Americans, especially those heading into retirement, their
largest asset is their home. In the wake of a recession in which
Americans watched $7 trillion worth of home values disappear, they
deserve the most clear and reasonable protection that the law provides
when they seek out advice from someone who represents themselves as an
investment professional. Adopting a clear fiduciary standard will
ensure that Americans who seek to invest their money receive advice
that is in their best interest, regardless of their advisers'
compensation or other interests.
______
Chairman Roe. Today we will have two panels of witnesses.
It is my pleasure now to introduce our first witness, Phyllis
Borzi, well known to most people here, who is the Assistant
Secretary of Labor of Employee Benefits Security
Administration.
As agency head, she oversees the administration,
regulation, and enforcement of Title 1 of ERISA. Previously Ms.
Borzi was a professor at George Washington University Medical
Center School of Public Health and Health Services.
She has also practiced law in the private sector and served
as a pension and employee benefit counselor for the predecessor
to this subcommittee, the House Subcommittee on Labor
Management Relations of the Committee on Education and Labor
for 16 years. I am glad we changed the name.
Among numerous other professional affiliations and honors,
Ms. Borzi is the former chair of the American Bar Associations
Joint Committee on Employee Benefits. She holds a Master of
Arts degree in English from Syracuse University and a J.D. from
Catholic University Law School.
Before I recognize you to provide your testimony, let me
briefly explain our lighting system, which I am sure you know
well. You have 5 minutes to present your testimony. You will
begin and the light in front of you will turn green, at one
minute amber, and then red we will ask you to wrap your
testimony up at that point.
Now, will open--have your opening statement.
STATEMENT OF HON. PHYLLIS BORZI, ASSISTANT SECRETARY, EMPLOYEE
BENEFITS SECURITY ADMINISTRATION
Ms. Borzi. So, thank you and good morning, Chairman Roe,
Ranking Member Andrews, members of the subcommittee. Thank you
so much for inviting me to discuss the Department of Labor's
fiduciary proposal.
You know, a key part of EBSAs job is helping to safeguard
the money that workers and employers set aside for workers
retirement.
Today the retirement universe is dominated by 401k plans
and IRAs, both of which require individual workers to decide
how to invest their money. The vast majority of these workers
and probably some of us in the room are not financial experts.
They must rely on professional advisors.
Under both the Employee Retirement Income Security Act of
1974 (ERISA) and the Internal Revenue code, any person paid to
provide investment advice to plan participants or IRA owners is
a fiduciary.
As fiduciaries, they must refrain from self-dealing and
that is when a fiduciary puts his or her own interest first. In
the case of plans, they must also act prudently and in the
participant's sole interest. This has been the loss since ERISA
was enacted in 1974.
So on its face the law is clear enough. When retirement
savings are at stake, advisors should put their clients'
interests first. But, as always, the devil is in the details.
So the critical question is what constitutes paid investment
advice.
The proposal we are discussing today will amend a 35-year-
old regulatory interpretation which severely narrowed the laws
protections. The outdated rule too frequently allows advisors
to avoid responsibility for ill-considered recommendations and
those involving financial conflicts of interest and self-
dealing.
Current business practices have focused on building a trust
relationship between the advisor and the client. However, under
the current rule advisors are not fiduciaries if they claim
that they didn't understand that their advice would serve as
the primary basis for the investment decision.
Likewise, an advisor is not a fiduciary if the advice is
given just once and not on a regular basis. So when a worker
nearing retirement is advised to invest both his or her savings
to purchase a particular annuity product, the advisor is not a
fiduciary.
Let me put a human face on this problem. Larry Brown who
lives in Tennessee lost one-third of his retirement savings
after relying on conflicted broker recommendations.
The broker promised Larry that if he retired he could
retire at 55, withdraw an amount equal to his monthly salary at
work and still have a nine-percent growth rate on the money he
invested with him. Instead, to make ends meet, Larry had to
take odd jobs for his church as a janitor and at the daycare
center.
The narrowness of this regulation has harmed plans,
participants, and IRA holders. We see it in the research that
is linked advisor conflicts with under performance. We see it
in the SEC reviews of certain financial sales practices and in
FINRA adjudications.
We see it in EBSAs own enforcement experience. And finally,
we see it in the underperformance of IRAs relative to plans.
EBSA estimates that from 1999 to 2007 the average annual
return for IRAs, controlling for risk in any other factors,
were 4.5 percent compared with 5.4 percent for 401ks.
The problems we are seeing with biased advice weren't
contemplated when the department wrote its regulation 35 years
ago. There were no 401k plans, congress didn't even recognize
them until 1978, and not many IRAs.
Today there are trillions of dollars in each of these
markets. The variety and complexity of financial products have
increased, innovations in products and compensation of
multiplied opportunities for self-dealing and made fee
arrangements far less transparent.
Our proposal is a response to these dramatic changes to the
market and addresses the problems that have emerged.
Let me just quickly, I know I am running out of time,
respond to some of the concerns.
First, the new definition will not limit access to
investment education or information. Second, brokers will not
have to eliminate commission-based fee arrangements,
restructure all their compensation as wrap fees, or convert all
brokerage IRAs to advisory accounts. Exemptions are already on
the books to allow brokers who provide fiduciary advice to
receive commissions for trading the types of securities and
funds that make up the large majority of IRA assets today.
And finally, we are continuing to coordinate our efforts
with the SEC, the CFTC, Treasury, and the IRS. I can assure you
that we are working together to integrate our rules and won't
put out final regulations that contradict each other.
We continue to work to improve the rule with input from the
public. The October proposal drew more than 200 comments. We
held 2 days of hearings, left the record open for additional
comments.
I met with more than 20 external parties representing
financial service providers, some of them multiple times, and
with 30 members of Congress and their staffs. We are committed
to developing a rule that doesn't unduly limit the financial
industry's ability to provide valuable services, but at the
same time we need to correct an important problem.
Employers, employees, and IRAs investors are not well
served by the current regulation.
So thank you so much for the opportunity to testify. I look
forward to working with you and your questions.
[The statement of Ms. Borzi follows:]
Prepared Statement of Hon. Phyllis C. Borzi, Assistant Secretary,
Employee Benefits Security Administration, U.S. Department of Labor
Good morning Chairman Roe, Ranking Member Andrews, and Members of
the Subcommittee. Thank you for inviting me to discuss the Department
of Labor's proposed amendment to its fiduciary regulation and
activities we have undertaken to date in connection with this
initiative. I am Phyllis C. Borzi, the Assistant Secretary of Labor for
the Employee Benefits Security Administration (EBSA). EBSA is committed
to pursuing policies that encourage retirement savings and promote
retirement security for American workers.
A key part of EBSA's job is establishing policies that safeguard
the money that workers and employers set aside for workers' retirement.
There are about 48,000 private-sector defined benefit plans that hold
approximately $2.6 trillion in assets.\1\ In addition, there are nearly
670,000 private-sector 401(k) and other defined contribution account
plans that hold about $3.9 trillion in assets.\2\ Individual Retirement
Accounts (IRAs) hold an additional $4.7 trillion.\3\ In fact, nearly 50
million households own some type of IRA. That number represents more
than 40 percent of the households in the United States.\4\ Americans'
retirement security depends in large measure on the sound investment of
The Employee Retirement Income Security Act of 1974 (ERISA)
expressly provides that a person paid to provide investment advice with
respect to assets of a private-sector employee benefit plan is a plan
fiduciary. The Internal Revenue Code (the ``tax code'') has the same
provision regarding investment advisers to IRAs. ERISA and the tax code
prohibit both employee benefit plan and IRA fiduciaries from engaging
in a variety of transactions, including self-dealing--when a fiduciary
puts his or her own financial interests first--unless the relevant
transaction is authorized by an ``exemption'' contained in law or
issued administratively by the Department of Labor. In the case of an
employee benefit plan, but not an IRA, under ERISA a fiduciary also
owes a duty of prudence and exclusive loyalty to plan participants, and
is personally liable for any losses that result from a breach of such
duty. This has been the law since ERISA was enacted in 1974.
The law on its face is simple enough: advisers should put their
clients' interests first. But as always the devil is in the details--in
this case, in the question of what constitutes paid investment advice.
The Department's current initiative will amend a flawed 35-year-old
rule under which advice about investments is not considered to be
``investment advice'' merely because, for example, the advice was only
given once, or because the adviser disavows any understanding that the
advice would serve as a primary basis for the investment decision.
Investors such as pension fund managers and workers contemplating
investing through an IRA should be able to trust their advisers and
rely on the impartiality of their investment advice. That is the
promise written into law in 1974. The Department's initiative sets out
to fulfill this promise for America's current and future retirees. The
impact of investment advice depends on its quality. Prudent,
disinterested advice can reduce investment errors, steering investors
away from higher than necessary expenses and toward broad
diversification and asset allocations consistent with the investors'
tolerance for risk and return. Accordingly, it is imperative that good,
impartial investment advice be accessible and affordable to plan
sponsors and especially to the workers who need it most.
The Department's October 2010 proposed amendment to its fiduciary
rule represented its approach to accomplishing these goals. The
proposal has prompted a large volume of comments and a vigorous debate.
The Department is committed to developing and issuing a clear and
effective rule that takes full and proper account of all stakeholder
views, and that ensures that investment advisers can never profit from
hidden or inappropriate conflicts of interest.
The Law
In enacting ERISA in 1974, Congress established a number of
provisions governing investment advice to private-sector employee
benefit plans and IRAs. Under ERISA and the tax code, any person paid
directly or indirectly to provide investment advice to a plan or IRA is
a fiduciary.
Prohibited transactions--Substantially identical provisions in
ERISA and the tax code prohibit fiduciaries from engaging in a variety
of transactions, including those that result in self-dealing, unless
they fall within the terms of an exemption from the general
prohibition. The relevant ERISA provisions apply to private-sector
employee benefit plans, and the related tax code provisions apply to
both plans and IRAs. In either case, fiduciaries who engage in
prohibited transactions are subject to excise taxes. ERISA and the tax
code each provide the same statutory exemptions from the general
prohibition against self-dealing. The Secretary of Labor is authorized
to issue additional exemptions.
What is an exemption? From the fiduciary's point of view, an
exemption is permissive: it allows the fiduciary to engage in certain
transactions that would otherwise be prohibited. From a worker's point
of view, an exemption should be protective, because it establishes
rules of the road that fiduciaries must follow when they self-deal so
that transactions are in workers' interest. In other words, if an
investment adviser is compensated for steering a worker's retirement
savings toward a particular financial product, the adviser must first
satisfy conditions established by Congress or the Department to protect
the worker's interests and rights.
Section 102 of the Reorganization Plan No. 4 of 1978 generally
transferred to the Department of Labor the Treasury Department's
authority to interpret the tax code's prohibited transaction provisions
and to issue related exemptions, thus consolidating interpretive and
rulemaking authority for these substantially identical ERISA and tax
code provisions in one place--the Department of Labor. At the same
time, the IRS's general responsibility for enforcing the tax laws
extends to excise taxes imposed on fiduciaries who engage in prohibited
transactions. Thus, the Department shares with the IRS responsibility
for combating self-dealing by fiduciary investment advisers to plans
and IRAs.
Fiduciary duties--ERISA additionally subjects fiduciaries who
advise private-sector employee benefit plans to certain duties,
including a duty of undivided loyalty to the interests of plan
participants and a duty to act prudently when giving advice.
Fiduciaries face personal liability for any losses arising from
breaches of such duties. ERISA authorizes both participants and the
Department to sue fiduciaries to recover such losses. These ERISA
provisions, however, generally do not extend to fiduciaries who advise
IRAs.
Problems with the Existing Regulation
In 1975, the Department issued a five-part regulatory test defining
``investment advice'' that gave a very narrow meaning to this term. The
regulation significantly narrowed the plain language of the statute as
enacted, so that today much of what plainly is advice about investments
is not treated as such under ERISA and the person paid to render that
advice is not treated as a fiduciary. Under the regulation, a person is
a fiduciary under ERISA and/or the tax code with respect to their
advice only if they: (1) make recommendations on investing in,
purchasing or selling securities or other property, or give advice as
to their value; (2) on a regular basis; (3) pursuant to a mutual
understanding that the advice; (4) will serve as a primary basis for
investment decisions; and (5) will be individualized to the particular
needs of the plan.
An investment adviser is not treated as a fiduciary unless each of
the five elements of this test is satisfied for each instance of
advice. For example, if a plan hires an investment professional on a
one-time basis for advice on a large complex investment, the adviser
has no fiduciary obligation to the plan under ERISA, because the advice
is not given on a ``regular basis'' as the regulation requires.
Similarly, individualized, paid advice to a worker nearing retirement
on the purchase of an annuity is not provided on a regular basis. Thus,
the adviser is not a fiduciary even though the advice may concern the
investment of a worker's entire IRA or 401(k) account balance.
In a different example, consider an IRA holder who consults
regularly with a paid adviser, and regularly buys and sells securities
pursuant to that person's advice. The IRA holder may rely on the advice
as a primary or even the sole basis for investment decisions, but if
the adviser cannot be shown to have agreed or understood that the
advice would be a primary basis for the investment decisions--then the
adviser avoids fiduciary status and is free to self-deal. This example
is particularly important. Today many service providers (such as
brokers) attempt to avoid fiduciary status simply by including
disclaimers in their written agreements with IRA holders explaining
that they are not acting as registered investment advisers and that
their advice will not constitute a primary basis for the IRA holders'
decisions.\5\ An authoritative study by RAND for the SEC demonstrated
that consumers often do not read such agreements and do not understand
the difference between brokers and registered advisers or the services
they provide.\6\
The narrowness of the existing regulation opened the door to
serious problems, and changes in the market since the regulation was
issued in 1975 have allowed these problems to proliferate and
intensify. The variety and complexity of financial products have
increased, widening the information gap between advisers and their
clients and increasing the need for expert advice. Consolidation in the
financial industry and innovations in products and compensation
practices have multiplied opportunities for self-dealing and made fee
arrangements less transparent to consumers and regulators. At the same
time, the burden of managing retirement savings has shifted
dramatically from large private pension fund managers to individual
401(k) plan participants and IRA holders, many with low levels of
financial literacy. These trends could not have been foreseen when the
existing regulation was issued in 1975.
In 1975, private-sector defined benefit pensions--mostly large,
professionally managed funds--covered over 27 million active
participants and held assets totaling almost $186 billion. This
compared with just 11 million active participants in individual-
account-based defined contribution plans with assets of just $74
billion.\7\ Moreover, the great majority of defined contribution plans
at that time were professionally managed, not participant directed. In
1975, 401(k) plans did not yet exist and IRAs had just been authorized
as part of ERISA's enactment the prior year. In glaring contrast, by
2008 defined benefit plans covered just 19 million active participants,
while individual-account-based defined contribution plans covered over
67 million active participants--including 60 million in 401(k)-type
plans.\8\ Ninety-five percent of 401(k) participants were responsible
for directing the investment of all or part of their own account, up
from 86 percent as recently as 1999.\9\ Also, in 2010, almost 50
million households owned IRAs.\10\ In dollar terms, by 2010, defined
benefit plans, with $2.6 trillion in assets, had been eclipsed by
defined contribution plans which held $3.9 trillion. IRAs held the
most: $4.7 trillion, with most of this attributable to rollovers from
plans.\11\
The narrowness of the regulation has harmed some plans,
participants, and IRA holders. Research has linked adviser conflicts
with underperformance. SEC reviews of certain financial sales practices
may also reflect these influences. Finally, EBSA's own enforcement
experience has demonstrated specific negative effects of conflicted
investment advice.
One academic study found that investors purchasing funds through
brokers generally get lower returns, even before paying the brokers'
fees, than those who buy them directly, and do no better at asset
allocation. The study's authors say this might be evidence of harmful
conflicts of interest, but might also be evidence that investors are
buying something ``intangible'' from their brokers.\12\ Another study
finds that advisers' compensation structures matter--those with
conflicts give poorer advice. 13 Other research, relevant to valuation
advice, finds that accountants value property higher when working for
sellers than for buyers.\14\ Still other research finds that disclosure
of conflicts fails to protect consumers. A conflicted adviser may feel
morally licensed by disclosure to pursue his self interest, and he may
exaggerate his advice to compensate for the possibility that a consumer
will discount it. The consumer may be reluctant to question the advice,
not wanting to imply that the adviser is being dishonest or come
between the adviser and his pay.\15\
It is worth noting that none of this research evidence necessarily
demonstrates abuse. On the contrary, it seems to suggest that conflicts
may color advice in some instances from honest advisers without their
even realizing it. But whether deliberate or inadvertent, the result
where conflicts exist is often the same: adviser conflicts are a threat
to retirement security. Academic research suggests this, and experience
bears it out.
For additional evidence, consider the underperformance of IRAs
relative to plans. Some gap might be expected, as the comparison is
between retail and institutional customers. But the size of the gap is
troubling. Unlike plan participants, IRA holders do not have the
benefit of a plan fiduciary, usually their employer, to represent their
interests in dealing with advisers. EBSA estimates that from 1998 to
2007, the average annual returns for IRAs were 4.5 percent, compared
with 5.4 percent for 401(k)s.\16\ Further, in a recent report, the
Government Accountability Office stated that IRA holders often pay fees
that can be two to three times higher than the fees paid by employee
benefit plan participants for in-plan investments.\17\
A 2007 SEC report provides more evidence. The report examines
``free lunch'' sales seminars that market financial products to
retirees. The SEC conducted 110 examinations of financial services
firms providing ``free lunch'' seminars. Of these, only five found no
problems or deficiencies. More than half found that materials used
might have been misleading or exaggerated. Twenty-five found that
unsuitable recommendations were made. Seminar attendees often may not
have known that presenters had a financial stake in the products they
recommended, the SEC said.\18\
Finally, consider the evidence provided by EBSA's enforcement
experience. Too often advisers who put their own interests first escape
fiduciary status through a loophole in the existing regulation. For
example, consider the following case: A financial services firm often
recommended mutual funds that paid it revenue sharing. Even though some
of its consulting agreements with plans acknowledged the firm's status
as an ERISA fiduciary, it denied being a fiduciary for any ERISA
clients. Consequently, the Department had to interview dozens of the
clients in order to determine whether the firm's advice met the current
regulation's five-part test. In many cases, the advice did not meet the
``regular basis'' requirement because the firm's representatives had
infrequent contact with plans after the selections of mutual funds. Due
to the ambiguous nature of the evidence on the firm's fiduciary status
under the existing rule, DOL could not pursue enforcement against it.
Another example involves improper appraisals in connection with
employee stock ownership plans (ESOPs). Since the early 2000s, EBSA
began to identify issues involving ESOPs, encompassing a variety of
different violations of ERISA and affecting over 500,000 participants.
In many instances, the most important investment advice to a plan
concerns how much to pay for an asset. In the case of ESOPs, in
particular, the key decision is typically not whether to buy stock--the
plan was established precisely to buy and hold employer stock--but
rather what price to pay for the stock. The Department has uncovered
abuses reflecting flawed valuation methodologies, internally
inconsistent valuation reports, the use of unreliable and outdated
financial data, and the apparent manipulation of numbers and
methodologies to promote a higher stock price for the selling
shareholders. Under ERISA, a loss remedy is only available from plan
fiduciaries. As a result, under the current regulatory structure,
neither the Secretary nor plan participants can hold the appraiser
directly accountable for disloyal or imprudent advice about the
purchase price, no matter how critical that advice was to the
transaction. The sole recourse available to the Secretary and plan
participants is against the trustee who relied on the advice, rather
than against the professional financial expert who rendered the
valuation opinion that formed the necessary basis for the transaction.
Consequently, the Department believes there is a need to re-examine
the types of advisory relationships that should give rise to fiduciary
status on the part of those providing investment advice services. The
1975 regulation contains technicalities and loopholes that allow
advisers to easily dodge fiduciary status. Plan fiduciaries,
participants, and IRA holders are entitled to receive impartial
investment advice when they hire an adviser. Overview of Proposed
Regulation
On October 22, 2010, the Department published a proposed regulation
defining when a person is considered to be a ``fiduciary'' by reason of
giving investment advice for a fee with respect to assets of an
employee benefit plan or IRA. The proposal amends the current 1975
regulation that may inappropriately limit the circumstances that give
rise to fiduciary status on the part of the investment adviser.\19\ The
proposed rule takes into account significant changes in both the
financial industry and the expectations of plan fiduciaries,
participants and IRA holders who receive investment advice. In
particular, it is designed to protect participants from conflicts of
interest and self-dealing by correcting some of the current rule's more
problematic limitations and providing a clearer understanding of when
persons providing such advice are subject to ERISA's fiduciary
standards, and to protect IRA holders from self-dealing by investment
advisers.
The proposed regulation would modify the 1975 regulation by: (1)
replacing the five-part test with a broader definition more in keeping
with the statutory language; and (2) providing clear exceptions for
conduct that should not result in fiduciary status. Under the proposal,
the following types of advice and recommendations may result in
fiduciary status: (1) appraisals or fairness opinions concerning the
value of securities or other property; (2) recommendations as to the
advisability of investing in, purchasing, holding or selling securities
or other property; or (3) recommendations as to the management of
securities or other property.
To be a fiduciary, a person engaging in one of these activities
must receive a fee and also meet at least one of the following four
conditions. The person must: (1) represent to a plan, participant or
beneficiary that the individual is acting as an ERISA fiduciary; (2)
already be an ERISA fiduciary to the plan by virtue of having any
control over the management or disposition of plan assets, or by having
discretionary authority over the administration of the plan; (3) be an
investment adviser under the Investment Advisers Act of 1940; or (4)
provide the advice pursuant to an agreement or understanding that the
advice may be considered in connection with investment or management
decisions with respect to plan assets and will be individualized to the
needs of the plan.
At the same time, the proposed regulation recognizes that
activities by certain persons should not result in fiduciary status.
Specifically, these are: (1) persons who do not represent themselves to
be ERISA fiduciaries, and who make it clear to the plan that they are
acting for a purchaser/seller on the opposite side of the transaction
from the plan rather than providing impartial advice; (2) persons who
provide general financial/investment information, such as
recommendations on asset allocation to 401(k) participants under
existing Departmental guidance on investment education; (3) persons who
market investment option platforms to 401(k) plan fiduciaries on a non-
individualized basis and disclose in writing that they are not
providing impartial advice; and (4) appraisers who provide investment
values to plans to use only for reporting their assets to the DOL and
IRS.
Concerns Raised about the Proposed Regulation and the Department's
Preliminary Responses
The proposed regulation has prompted a large volume of comments and
a vigorous debate. The Department is working hard to hear and consider
every stakeholder concern.
The October proposal itself drew more than 200 written comments,
many raising important and complex issues that require serious
attention. The Department followed up by holding two days of hearings
on March 1 and 2, providing an additional forum for 36 witnesses and
prompting more than 60 additional, post-hearing written comments. We
also have met individually with many groups that sought additional
opportunities to explain their views. Altogether, the Department has
heard from many representatives of the financial services industry, as
well as from plan sponsors, advocates for small investors, service
providers, academics who study the roles of financial intermediaries
and the effects of conflicts between consumers and expert advisers, and
interested Members of Congress. The Department is devoting a major
effort to appropriately resolve the concerns raised by stakeholders.
Let me offer examples of how we are thinking about some of the major
ones.
Coordination with Other Federal Agencies--We have received many
comments emphasizing the importance of harmonizing the Department's
proposed rulemaking with certain Securities and Exchange Commission
(SEC) and Commodities Futures Trading Commission (CFTC) rulemaking
activities under the Dodd-Frank Act, including activities related to
SEC standards of care for providing investment advice and CFTC business
conduct standards for swap dealers. There are concerns that
inconsistent standards could negatively impact retirement savings by
increasing costs and foreclosing investment options. Likewise, concerns
have been raised about the adequacy of coordination between the
Department and other relevant agencies, including the SEC, Treasury
Department, and Internal Revenue Service, with respect to oversight of
IRA products and services.
The Department, Treasury Department, Internal Revenue Service, SEC,
and the CFTC are actively consulting with each other and coordinating
our efforts. Our shared goal is to harmonize our separate initiatives.
We are also committed to ensuring that the regulated community has
clear and sensible pathways to compliance. We are confident that these
goals will be achieved.
The SEC is currently considering staff recommendations to establish
uniform fiduciary duties under the securities laws for advisers and
brokers. While the Department and the SEC are committed to ensuring
that any future fiduciary requirements applicable to investment
advisers and broker-dealers under the applicable laws are properly
harmonized, the Department is also committed to upholding the separate
federal protections that Congress established in 1974 for plans, plan
participants, and IRAs under ERISA and the tax code.
The Department also plans to harmonize its fiduciary regulation
with the CFTC's and SEC's proposed business conduct standards for swap
dealers. The Department does not seek to impose ERISA fiduciary
obligations on persons who are merely counterparties to plans in arm's
length commercial transactions. Parties to such transactions routinely
make representations to their counterparties about the value and
benefits of proposed deals, without purporting to be impartial
investment advisers or giving their counterparties a reasonable
expectation of a relationship of trust. Accordingly, the Department's
proposed regulation provides that a counterparty will not be treated as
a fiduciary if it can demonstrate that the recipient of advice knows or
should know that the counterparty is providing recommendations in its
capacity as a purchaser or seller.
Costs and Unintended Consequences for IRAs--Many comments also
raised concerns about the proposed regulation's impact on IRAs and
questioned whether the Department had adequately considered possible
negative impacts. Similar concerns were voiced by other stakeholders,
especially those providing advice in connection with brokerage
services. Some stakeholders have provided their own estimates of high
costs and other major negative impacts.
The stated concerns can be summarized as follows:
Today a large proportion of IRAs, especially smaller
accounts, are brokerage accounts. Brokers often advise the IRA holders,
and are compensated for that advice by means of commissions paid for
trades and often by third parties, as with revenue sharing and 12b-1
mutual fund fees. Though the brokers give advice, they typically
contend that they are not fiduciaries under the Department's existing
rule because they disclaim any understanding that their advice might
constitute a primary basis for the IRA holders' investment
decisions.\20\
The proposed rule would make brokers fiduciaries because
IRA holders will at least ``consider'' their advice. As fiduciaries,
the brokers could not accept commissions or revenue sharing payments.
To do so would constitute fiduciary self-dealing, a prohibited
transaction, and would trigger a requirement to return the commissions
or payments to their sources and to pay an excise tax.
Brokers therefore would be forced to restructure their
compensation as ``wrap fees'' expressed as a percentage of assets in
the account. Receipt of wrap fees in turn would force the advisers to
register and conduct their business as registered investment advisors
(RIAs) under the Investment Advisers Act of 1940. IRAs would have to be
converted from brokerage accounts to either advisory accounts (which
cost more and deliver more service than most IRA holders want) or
internet-based discount brokerage accounts (which offer no personalized
advice), or be closed. Advisory accounts require high minimum balances
so small accounts would lose all access to advice and many would be
closed.
The result will be dramatically higher fees and widespread
distributions from small accounts, both of which will undermine
retirement security.
There will be no benefits to offset these costs and other
negative impacts. There is no evidence that the quality of advice
currently is diminished by the conflicts that are present, so there is
no reason that the proposed regulation will improve advice.
IRAs should not be treated like plans. They are retail
accounts and should be treated like other retail accounts. IRA holders
do not require as much protection as plan participants because they
have unlimited choice of vendors and products and are therefore
empowered to secure quality services.
The Department will continue to carefully study these arguments. We
have, however, the following observations on some of the comments.
We did not propose to force brokers to eliminate commission-based
fee arrangements, restructure all of their compensation as wrap fees,
or convert all brokerage IRAs to advisory accounts. Exemptions already
on the books authorize brokers who provide fiduciary advice to be
compensated by commission for trading the types of securities and funds
that make up the large majority of IRA assets today. We will attempt to
provide this clarification in a more formal manner as we proceed in
this process.
The Department is considering providing interpretive
guidance to make this clear, as well as issuing additional exemptions.
Such additional exemptions might cover, for example, revenue sharing
arrangements that are beneficial to plan participants and IRA holders,
and/or so-called ``principal'' transactions, wherein a fiduciary
adviser, rather than acting as an agent, itself buys an asset from or
sells an asset to an advised IRA. Such exemptions would carry
appropriate conditions to protect plan participants' and IRA holders'
interests.
The Department believes there is strong evidence that
unmitigated conflicts cause substantial harm, and therefore is
confident that the proposed fiduciary regulation would combat such
conflicts and thus deliver significant benefits to plan participants
and IRA holders. As noted above, this evidence is found in academic
research, IRA underperformance, SEC examinations, and EBSA's own
enforcement experience. While no single piece of evidence by itself
directly demonstrates or provides a basis for quantifying the negative
impact of conflicts on plans and IRAs, taken together the available
evidence appears to indicate that the negative impacts are present and
often times large. Plans, plan participants, and IRA holders will
benefit from advice that is impartial and puts their interests first.
The tax code itself treats IRAs differently from other
retail accounts, bestowing favorable tax treatment, and prohibiting
self-dealing by persons providing investment advice for a fee. In these
respects, and in terms of societal purpose, IRAs are more like plans
than like other retail accounts. Most IRA assets today are attributable
to rollovers from plans.\21\ The statutory definition of fiduciary
investment advice is the same for IRAs and plans. The proposed
regulation therefore sensibly set forth a single consistent definition,
addressing practical differences between the two by tailoring
exemptions accordingly. As for the level of protection that is
appropriate, while IRA holders have more choice, they may nonetheless
require more protection. Unlike plan participants, IRA holders do not
have the benefit of a plan fiduciary, usually their employer, to
represent their interests in dealing with advisers. They cannot sue
fiduciary advisers under ERISA for losses arising from fiduciary
breaches, nor can the Department sue on their behalf. Compared to those
with plan accounts, IRA holders have larger account balances and are
more likely to be elderly. For all of these reasons, combating
conflicts among advisers to IRAs is at least as important as combating
those among advisers to plans.
The Department believes that the assessment of economic
impacts it provided with the proposed rule provided an economic basis
for the proposal. I agree, however, that a fuller analysis is called
for at this point, and we are undertaking such an analysis now. The
expanded analysis will be informed by all relevant stakeholder input,
as well as by our consultations with other federal agencies, and will
be provided along with any final regulation pursuant to applicable
requirements.
Appraisals and valuations--Another issue raised by stakeholders
relates to whether the valuation of employer securities should
constitute ``investment advice'' as the proposed regulation would
require. Although the current regulation includes advice as to the
value of securities within the term ``investment advice,'' a 1976
advisory opinion issued by the Department took the position that advice
to an ESOP on the value of employer securities would not be so treated.
A number of witnesses at our hearing on this proposed rule testified
that the proposal would cause many qualified appraisers to discontinue
ESOP valuations and would significantly increase costs of appraisals
for small businesses that sponsor ESOPs. It is the Department's opinion
that, in many instances, the most important investment advice to a plan
concerns how much to pay for an asset. In the case of closely-held
companies, ESOP trustees typically rely on professional appraisers and
advisers to value the stock, often with little or no negotiation over
price. Unfortunately, in our investigations and enforcement actions,
the Department has seen many instances of improper ESOP appraisals--
often involving most or all of a plan's assets--resulting in millions
of dollars in losses. Accordingly, we believe that employers and
participants will benefit from being able to rely on professional
impartial advice that adheres to the fundamental fiduciary duties of
prudence and loyalty. However, we will continue to work with
stakeholders to structure a rule that adheres to these duties but does
not cause unnecessary harm or cost to small businesses.
Distinguishing Education from Advice--A number of witnesses
expressed confusion over how the proposed regulation will impact
participant investor education. There were concerns about what will be
considered financial literacy and education and what will be considered
investment advice under the proposed regulation. In particular, there
were concerns that the proposal appears to significantly reduce what
constitutes financial education and raises the question as to whether
Interpretive Bulletin 96-1 (IB 96-1) is still in effect. The Department
believes education is important for plans and plan participants. Under
the proposed regulation, employers who provide general financial/
investment information, such as a recommendation on asset allocation to
401(k) participants under IB 96-1, would not be considered fiduciaries
under the new regulation. The Department also has general education
resources available to plans and plan participants.
Next Steps
Our current approach to the fiduciary regulation consists of
multiple steps.
First, we are working to better understand how specific
compensation arrangements would be affected by the proposed rule and
whether clarifications of existing prohibited transactions exemptions
would be appropriate. We have already begun to issue subregulatory
guidance describing some of these clarifications and will continue to
do so as necessary as we complete our analysis.
Next, as we further develop our thinking in this rulemaking, we are
paying special attention to the two primary exceptions to fiduciary
status under the proposed rule: (1) clarifying the difference between
investment education that does not give rise to fiduciary status and
fiduciary investment advice; and (2) clarifying the scope of the so-
called ``sellers' exception'' under which sales activity is not
fiduciary advice. In both cases, we will make sure to analyze and
address the comments and concerns that were raised during our extensive
public comment period.
Finally, we are exploring a range of appropriate regulatory options
for moving forward, taking into consideration public comments submitted
for the record, EBSA's economic analysis, and relevant academic
research. In so doing, we are aiming to address conflicted investment
advice while not unnecessarily disrupting existing compensation
practices or business models.
Conclusion
Thank you for the opportunity to testify at this important hearing.
The Department remains committed to protecting the security and growth
of retirement benefits for America's workers, retirees, and their
families.
endnotes
\1\ For estimates of the number of plans, see U.S. Department of
Labor, Private Pension Plan Bulletin Abstract of 2008 Form 5500 Annual
Reports (Dec. 2010), at http://www.dol.gov/ebsa/PDF/
2008pensionplanbulletin.pdf. For asset estimates, EBSA projected ERISA
covered pension assets based on the 2008 Form 5500 filings with the US
Department of Labor (available at http://www.dol.gov/ebsa/publications/
form5500dataresearch.html), and the Federal Reserve Board's Flow of
Funds Accounts Z1 Release (available at http://www.federalreserve.gov/
releases/z1/Current/).
\2\ Ibid.
\3\ Federal Reserve Board, Flow of Funds Accounts of the United
States, June 2011, at http://www.federalreserve.gov/releases/z1/
Current/.
\4\ Peter Brady et al., The U.S. Retirement Market, Third Quarter
2010, Investment Company Institute, Jan. 2011, at http://www.ici.org/
pdf/ppr--11--retire--q3--10.pdf. this money. While some investment
decisions are made by large professional money managers, today most are
made by individual workers who must manage their own 401(k) accounts
and IRAs. To guide their decisions, workers often rely on advice from
trusted experts.
\5\ The Department does not necessarily agree that the inclusion of
such language in an agreement ensures that a broker is not a fiduciary
under the existing regulation.
\6\ Angela A. Hung, Noreen Clancy, Jeff Dominitz, Eric Talley,
Claude Berrebi, Farrukh Suvankulov, Investor and Industry Perspectives
on Investment Advisers and Broker-Dealers, RAND Institute for Civil
Justice, commissioned by the U.S. Securities and Exchange Commission,
2008, at http://www.sec.gov/news/press/2008/2008-1--randiabdreport.pdf.
\7\ U.S. Department of Labor, Private Pension Plan Bulletin
Historical Tables and Graphs, (Dec. 2010), at http://www.dol.gov/ebsa/
pdf/historicaltables.pdf.
\8\ U.S. Department of Labor, Private Pension Plan Bulletin
Abstract of 2008 Form 5500 Annual Reports, (Dec. 2010), at http://
www.dol.gov/ebsa/PDF/2008pensionplanbulletin.PDF.
\9\ U.S. Department of Labor, Private Pension Plan Bulletin
Abstract of 1999 Form 5500 Annual Reports, Number 12, Summer 2004 (Apr.
2008), at http://www.dol.gov/ebsa/PDF/1999pensionplanbulletin.PDF.
\10\ Peter Brady et al., The U.S. Retirement Market, Third Quarter
2010, Investment Company Institute, Jan. 2011, at http://www.ici.org/
pdf/ppr--11--retire--q3--10.pdf.
\11\ Federal Reserve Board, Flow of Funds Accounts of the United
States, June 2011, at http://www.federalreserve.gov/releases/z1/
Current/; Peter Brady, Sarah Holden, and Erin Shon, ``The U.S.
Retirement Market, 2009,'' Investment Company Institute, Research
Fundamentals, Vol. 19, No. 3, May 2010, at http://www.ici.org/pdf/fm-
v19n3.pdf.
\12\ Daniel Bergstresser et al., Assessing the Costs and Benefits
of Brokers in the Mutual Fund Industry, The Review of Financial
Studies, 22, no. 10, Oct. 2009.
\13\ Ralph, Bluethgen et al., High Quality Investment Advice
Wanted! , SSRN Working Paper Series, Feb. 2008, at http://
papers.ssrn.com/sol3/papers.cfm?abstract--id=1102445&http://
scholar.google.com/scholar?cluster=10674815933415125485&hl=en&as--
sdt=0,9.
\14\ Don Moore et al., Conflict of Interest and the Unconscious
Intrusion of Bias, Judgment and Decision Making, Vol. 5, No. 1, Feb.
2010.
\15\ George Loewenstein et al., Pitfalls and Potential of
Disclosing Conflicts of Interest, American Economic Review, forthcoming
May 2011.
\16\ EBSA's estimation approach was inspired by similar findings in
an article using older data, see Alicia H. Munnell et al., ``Investment
Returns: Defined Benefit vs. 401(k) Plans,'' Center for Retirement
Research at Boston College, Issue Brief No. 52, Sep. 2006, p. 6.
\17\ GAO, 401(k) Plans: Improved Regulation Could Better Protect
Participants from Conflicts of Interest, Report to the Ranking Member,
Committee on Education and the Workforce, House of Representatives,
GAO-11-119 (Jan. 2011).
\18\ Securities and Exchange Commission, Office of Compliance
Inspections and Examinations, Protecting Senior Investors: Report of
Examinations of Securities Firms Providing ``Free Lunch'' Sales
Seminars, Sep. 2007, at http://www.sec.gov/spotlight/seniors/
freelunchreport.pdf.
\19\ The proposed regulation would also supersede the conclusion
set forth in Advisory Opinion 76-65A (June 7, 1976), where the
Department held that the valuation of closely-held employer securities
that an ESOP would rely on in purchasing the securities would not
constitute investment advice under the regulation.
\20\ As noted above, the Department does not necessarily agree that
the inclusion of such language in an IRA agreement ensures that a
broker is not a fiduciary under the existing regulation.
\21\ Peter Brady, Sarah Holden, and Erin Shon, The U.S. Retirement
Market, 2009, Investment Company Institute, Research Fundamentals, Vol.
19, No. 3, May 2010, at http://www.ici.org/pdf/fm-v19n3.pdf.
______
Chairman Roe. Thank you. If you have any other comments,
please go ahead.
Ms. Borzi. No, that is okay. My written testimony is much
more detailed. So I know that will be in the record.
Chairman Roe. Okay.
Ms. Borzi. I am just happy to take your questions.
Chairman Roe. Thank you.
Dr. Heck?
Mr. Heck. Thank you, Mr. Chairman.
Thank you, Madam Secretary, for your testimony and for your
written statement.
I know you mentioned in your comments that this will not
cause brokers to switch from commission based to value-asset
based. Yet, I am hearing from many brokers in my district that
that is exactly what is going to happen is that they are going
to have to switch.
I would like for you to try to kind of clear that up. Why
are so many brokers under the impression that they are going to
have to switch if you are saying they are not?
And if they do switch, it would appear that it would price
out small accounts that would not be able to afford the value
asset based commission and how are we going to take steps to
prevent that so that people do get the advice that they need?
Ms. Borzi. Well, we have heard that as well. And I think
the simplest way to answer your questions is there appears to
be a lot of concern, nervousness, misinformation perhaps,
misunderstanding of what the current law is.
Since brokers are not--at least they take the position that
they are not currently fiduciaries under ERISA. Although, I
might add that if you look at the five-part test that, I think,
some of them even under the current five-part test who do give
advice on a regular basis and who do understand that their
advice is going to be taken by their clients, might still be
fiduciaries.
But I just think that there is a lot of misinformation. One
of the reasons that we put these charts together is that there
seems to be that first column in the fiduciary proposal, first
chart, brokers would be allowed under this regulation, and
certainly under our current regulations, to earn commissions on
securities, mutual funds, insurance products and annuities.
That is very important because if you look at the kinds of
investments that small IRA investors are invested in, those are
the kinds of things they are invested in. They are not in the
sophisticated financial instruments by in large.
And so, I think, to the extent that the brokers, the broker
community doesn't understand that these kinds of transactions
are already permitted, we have a job to do in clarifying and
making them understand that they are. Because we are not
intending to overturn a commission based system.
And if I could just--the regulation does exempt traditional
broker activities--sell--simply selling securities. So there is
what is called a seller's exemption which says if I am your
broker and I come to you and you understand that all I am doing
is selling you a product, I am not giving you investment
advice. I am not telling you to, you know, that this is the
best product you could ever buy that does not make you a
fiduciary.
And to the extent that their practices beyond commissions,
which we are hearing from some of the financial institutions,
we are prepared to work with them to see if we can provide an
exemption from the fiduciary prohibited transaction.
Mr. Heck. And I appreciate that. I guess the concern is
that the smaller investor, perhaps the more unsophisticated
investor----
Ms. Borzi. Exactly.
Mr. Heck [continuing]. Sets this up so that that individual
would have to come to the broker and say this is what I want to
buy. Not necessarily being able to receive any type of
comparison, let us say, between two or three different products
that that broker might provide and then allowing the buyer to
make a decision on which they would want to purchase.
Ms. Borzi. Yes. I mean, the simple fact is that, as I said
well, we have no interest. The Department of Labor has spent
the better part of 20 years encouraging people to save for
retirement, both inside of plans and in IRAs. So we wouldn't
have any interest at all, and we would be very concerned about
closing off advice to the small investors.
What puzzles us, of course, is that the industry seems to
take the position that there are only two methods to continue
to survive. One would be to keep the current broker dealer
rules or the broker dealer perception that they are not
fiduciaries under ERISA and do nothing to address the
conflicted advice problem or the other extreme, which is to
convert to an investment advisor model which will be more
expensive.
We have talked with all of our sister agencies that
regulate IRAs, that deal with IRAs and lots of people in the
private sector looked at academic literature and we think that
there is plenty of room for business models between the current
conflicted advice model and going to a pure investment advisor
model.
And we were happy to work with the industry to figure out
how to deal with that. But I think that the broker's concern is
perhaps due to misunderstanding.
Mr. Heck. Thank you, Madam Secretary.
Thank you, Mr. Chair. I yield back.
Chairman Roe. Thank you.
Mr. Andrews?
Mr. Andrews. Thank you, Mr. Chairman.
Madam Secretary, thank you for your testimony and your
openness to members of the committee and to the public to talk
about this issue. It is characteristic of your service.
A week from today, there is an increasing probability that
the United States of America will lose its ability to borrow
money to run our government. Presently, we borrow about 42
cents of every dollar that we spend. So we will find ourselves
in a position, if this happens, where we will have 58 cents of
revenue and a dollars' worth of obligations.
I am sure on a morning like this you are glad you are not
the Secretary of the Treasury, who would have the obligation to
figure out which bills not to pay.
There is some debate about what the consequences of this
calamitous event would be for the bond market and the equity
markets. The consensus of opinion is that at some point there
would be significant damage to each of those markets. It is not
a unanimous opinion, but I think it is a broadly held opinion.
I think that our near death experience with the TARP in
2008 when Dow Jones fell by nearly 1,000 points during the
floor vote when the TARP was not adopted is a precursor of what
might happen.
I know that this hearing is about fiduciary
responsibilities, and there are fiduciaries all over the
country who are managing pension funds, both in the private and
public sector.
What is your best assessment as to what the impact on
pension funds around the country would be if the United States
of America were to either default on its debt service
obligations or receive a downgrade in our credit rating from
the ratings agencies because of the present crisis?
Ms. Borzi. Well, it is hard to really speculate because
this has never happened before. But let me just focus on a
couple of things.
The first thing we know is that it would be very, very
disruptive; create a climate of uncertainty. In a number of
pension funds, particularly the large funds, public funds as
well as--funds, their investment policy would require them to
have AAA bonds.
If the treasury bond, and most of them have treasuries in
one form or another, and if those bonds were no longer AAA, the
fiduciaries would certainly have to figure out how to comply
with their investment policy guidelines without--how not to
violate their investment policy guidelines.
Mr. Andrews. So in other words, many trustees would find
themselves in a position where purchasing of treasury
securities would be prohibited by their own internal rules?
Ms. Borzi. I am afraid that is true.
Mr. Andrews. Which would----
Ms. Borzi [continuing]. Certainly with the larger funds. I
am not sure about the smaller funds.
Mr. Andrews. My understanding is about a third of all the
capital domestically held in the United States is in pension
funds.
Ms. Borzi. That sounds right to me.
Mr. Andrews. A pretty significant cut in the demand for
federal securities, which I assume would raise their price and
raise their interest rates, if that were to happen.
Ms. Borzi. Yes. I mean one other thing that concerns me
about your question is I think this would not just have an
effect on the investment decisions of fiduciaries. I think it
would also have a profound effect on individuals particularly
in the 401k plan and IRA marketplace.
We have been, as I said, have been encouraging people to
save for retirement. If individuals thought their ability to
borrow outside of the retirement savings universe would be
impaired because credit would be tightened up and, of course,
we are still seeing that for small businesses. That is one of
the problems with small business----
I think they would be less likely to put money in their
plan because once it is in there it is much more difficult to
get it out. So I would also be concerned on the effect of the
savings rate, which we know is much lower than other countries.
Mr. Andrews. Of course, if people put less money in their
plans, there are fewer equities purchased, fewer bonds
purchased, less money available----
Ms. Borzi. Right. I think the ripple effect in the economy
would be very significant.
Mr. Andrews [continuing]. Investment in corporate America.
Would you care to add any comments further about the other
consequences of such a risk to the U.S. economy?
Ms. Borzi. You know, it is really very hard to figure out
what would happen. It is very interesting to me because part of
the debate has been that we need to get, and this ism I am now,
this is Phyllis Borzi, public citizen. You know, I am not
speaking for the Department of Labor or the administration on
this----
Mr. Andrews. We won't tell them what you said, go ahead.
[Laughter.]
Ms. Borzi. You won't tell anybody that I said this.
One of the important parts of the debate has been the need
to get certainty into, make people understand that Congress is,
Congress and the administration is serious about reducing the
deficit. And a default, it seems to me, would go in the
opposite direction.
It would certainly send a message to the American public
that people aren't really serious about dealing with this. And
I think that uncertainty will certainly not do anything to
encourage businesses to add more jobs or, as I said, for people
to save more money for retirement.
I am not an economist. I don't play one on TV, but I think
nothing good could come from a default in terms of the American
public and the pension system.
Mr. Andrews. Thank you, Madam Secretary.
Thank you, Mr. Chairman.
Chairman Roe. Thank you.
Mrs. Roby?
Mrs. Roby. Well, since my colleague brought it up, I would
just like to make a comment and say that all the more reason
that we get our fiscal house in order here in the federal
government. Men and women, families all over this country have
been tightening their belt for the past several years and it is
time this federal government tightens their belt, too.
Which is exactly what House Republicans are proposing, and
we need to do all that we can to ensure the American people
that we are removing this uncertainty so we can get Americans
back to work.
Ms. Borzi. Well, and the administration and the Democrats
believe that we need to get moving on this and be serious about
the debt as well.
Mrs. Roby. Well, tax increases----
Ms. Borzi. I don't think it is a partisan issue. I think
that people have different ways of getting to the same point.
But I think the goal is a shared goal.
Mrs. Roby. Well, raising taxes on the American people right
now is certainly not going to get Americans back to work.
Madam Secretary, thank you for being here.
Mr. Chairman, thank you.
President Obama issued an executive order this winter he
urged regulators to ease regulatory burdens. And with all of
the concerns being raised around this rule, how does this
proposal fit within the president's initiative to ensure rules
do not have a negative impact on investors, businesses, and the
economy?
Ms. Borzi. Well, it fits within the president's executive
orders, several executive orders that deal with this in a
number of different ways.
First of all, the president, through an executive order,
asked us to go back and look at all the regulations that all
the agencies had issued over the past years to determine
whether any of them were outdated, outmoded and needed to be
updated.
And, honestly, that is the reason we selected this project
because in reviewing these regulations, this is the one that is
the linchpin to our program and it also is the one most
obviously crying out for updating.
Now, as far as burdens are concerned, when we propose a
regulation we are required to look at burdens. We are required
to make findings in the finalization of a reg, for sure, as to
the extent of the burden, and we have to describe any
alternative mechanisms we may have looked at to address the
same issue.
Our proposal was just that, a proposal. It is like a first
draft and it was designed to get the kind of public discussion
and debate that it is engendered. And as we move along to
finalize the regulation, we have a responsibility to and have
been working to do a couple of things.
The first thing we have a responsibility to do is interact
with the public, get public comments. Another executive order
that was issued asked the agencies to allow people to comment
on the comments.
When you put forward a regulation, you seek public
comments, and that is what we did. We gave the public 90 days
to comment on our regulation.
We got about 200 comments which isn't, you know, it is
about average for the comments that we get on major regulations
like this. We recognized from the beginning that this was a
major regulation.
We then had requests from the public to extend the comment
period, which we did twice. We then scheduled 2 days of public
hearings, wherein we had, I believe it was 38 public witnesses,
and then we reopened the public hearing record.
Now, typically what we do is we open the record for the
people who testified. In this case, we opened the record to
anybody who wanted to comment on the testimony or who wanted to
renew comments.
And then, 2 weeks after we opened that comment period we
extended it for another 2 weeks because we posted the
transcript of the hearing----
Mrs. Roby. And let me just say this, and I appreciate that
process but both parties, members from both parties, have
expressed concern about the proposed rules and yet there seems
to be increasing efforts to finalize the implementation of this
rule by the end of this year.
So why do you feel with all of the process that is going
on, with all of the comments from both sides, why do you feel,
does the administration feel that it is necessary to go ahead
and rush ahead?
Ms. Borzi. We are not rushing ahead. It is more important
to get this right than to comply with the dates that we have
set forward on our regulatory schedule.
The reason I talk about the end of the year is because that
is what our regulatory agenda calls for. But believe me, we are
taking the comments that are being made by the members of
Congress, by the public, very, very seriously.
We are talking, as I said, we are talking with our sister
agencies. We are trying to work through issues. But it is most
important for us to get it right----
Mrs. Roby. Well, I----
Ms. Borzi [continuing]. Rather than meet that regulatory
agenda. On the other hand, the process under the Administrative
Procedures Act is you make a proposal and then you work towards
finalization of that proposal.
Mrs. Roby. Sure. And my time is out. But I just want to say
that all of these issues, regulatory burdens, as well as the
issues that are confronting Congress right now, today, this
week, you are right. It is not a Democrat problem or Republican
problem. It is an American problem and we gotta get it right.
And with that, Mr. Chairman, I yield back.
Chairman Roe. Thank you, gentlelady for yielding.
Dr. Loebsack?
Mr. Loebsack. Thank you, Dr. Roe, and thank you, Madam
Secretary, for being here today. I am really happy that we are
having this hearing on this important rule which updates a 35-
year-old rule.
I think the importance of it is demonstrated by the fact
that there are a lot of members here today. Many of us have
probably the same concerns on both sides of the aisle, I think,
as was already expressed.
We know that much has changed in the last 35 years, and as
our country struggles to recover from the worst economic
downturn since the Great Depression, I think this proposed rule
is all the more important and applicable, especially given that
in recent times we have had a lot of folks see their retirement
savings lose 40 percent of their value in some cases.
Some saw their money disappear in risky financial gambling
products. Recent employees, Employee Benefit Research Institute
studies show the percent of workers saying they are very
confident of retirement security is at its lowest level ever,
and I think that in itself is a concern that we should all
have.
While we are barely seeing some slight recovery in
retirement savings, we are reminded of how quickly and how
easily the market can wipe out years of years of sweat, scrimp,
and save for retirement for the average individual in America.
Social Security does remain the bedrock of our retirement
security in America, and it is concerning to me to think of a
proposal to subject Social Security to future market crashes as
well. That is another issue, but nonetheless something I think
we should be thinking about.
Especially when wages have not kept up with economic
growth, and we just seen the Pew study that came out that talks
about a wealth gap that continues to grow in this country. I
think we need to be more vigilant than ever in ensuring that
employee's and IRA investor's retirement savings are protected.
There is no better standard, as I think we could all agree,
than a fiduciary standard. So I do applaud your attempt to
provide certainty by improving the test for investment advice
as they relate to the fiduciary status, but I have a couple of
concerns I would like to express.
I know we sent a letter to the Labor Secretary, and you did
respond on ESOPs in particular. I sent a letter to you; it was
signed by a couple of my colleagues from Iowa as well.
I have a number of companies in my district that are
enthusiastic Employee Stock Ownership Plan, or ESOP,
participants and I have heard first-hand on the buy-in from how
the buy-in employees feel that they have in the future of that
company as well because of that ESOP structure. I think it is
very important.
Again, this is a concern that cuts across party lines that
I am going to express. I know that the IRS and DOL require
ESOPS to receive yearly valuations performed by independent
appraisers and this rule would now require those appraisers to
be fiduciaries, as I understand it.
We do need accurate information on valuations but the
question I have is: can you explain how this rule might affect
the cost of those valuations, and is there a way to ensure that
the costs don't rise for the ESOP businesses and for their
employees?
Ms. Borzi. That is a very good question. I am happy to
address it. The plan sponsors, employers, who want to establish
an ESOP have to hire or typically hire an appraiser to value
the stock that is going to be contributed to the ESOP.
The most important decision to make that deal--the
appraiser--the decision to invest in employer stock has already
been made. That is the nature of an ESOP.
But the most important decision, or the most important
piece of information to make that deal a reality is the
valuation decision. How much the stock is worth.
And what we have seen over the years is a number of
problems with the appraisers including flawed methodologies,
including use of flawed financial data, manipulation of numbers
and methodologies to tilt the scale one way or the other, to
put a finger on the scale.
It is interesting because at our public hearing we had some
testimony on this and we had witnesses who said, ``Oh, well you
are just talking about these sort of fly by night appraisers.
You know if they are licensed, if they are credentialed, they
don't do that.''
Well, that is not our experience. The big appraisers also
have appraisal problems. And the difficulty is that there is
already money in the system. Money is already being paid to an
appraiser to do a valuation of the stock.
And if that valuation is not objective, fair, and no finger
on the scale so that when the plan is, let me see if I can get
this straight, when the plan is buying stock they pay too much
because they are relying on the valuator. And when they plan is
selling stock they get too little. That is all the purview of
the person who performs the valuation.
So the argument that people are making is that this is
going to cost a lot more if people have to give valuations that
are fair and objective and not tilted. I am not sure that I
fully understand that because they are paying for these
valuations now.
And if what the argument is it will cost more if we give
you a valuation that is fair and objective as oppose to the
valuations they give now, I am not sure that I need to see some
evidence of that.
Clearly there is going to be some additional costs. I am
not saying that there is no additional cost, but I am not sure
of the magnitude of the cost.
What this is all about is accountability. Accountability.
And in my written testimony, if you look beginning on page
eight you will see a variety of examples where appraisers have
given faulty appraisals that have resulted in huge liabilities
to the plan and the plan sponsor where the appraiser would not,
could not be held accountable because of our five-part test.
Mr. Loebsack. Okay. Thank you, Madam Secretary. We will
keep working on this issue together. I really appreciate it.
Ms. Borzi. Yes, absolutely.
Mr. Loebsack. Thank you, Dr. Roe.
Chairman Roe. Thank you.
Mr. Rokita?
Mr. Rokita. Thank you, Mr. Chairman. And thank you, Madam,
for your testimony today.
I want to follow up on the ESOP question that the last
gentleman asked and your response.
Ms. Borzi. Sure.
Mr. Rokita. Back in February Secretary Solis was here in
your seat, and I asked a question about the appraisers and the
appraisals as well in regard to this proposed regulation.
Just for some background, I was the Secretary of State in
Indiana for 8 years and had regulatory responsibility over
these very issues. And I see the value, at least from the SEC
standpoint, in addressing the fiduciary standard issue.
Not that I agree necessarily how it is being handled, but I
do see the evolution that you testified about in products and
in the way we access information and what technology has done
for us. It empowered us as investors.
But with regard to these appraisals, Ms. Solis' response
said that out of 50,000 appraisals she sighted six appraisals
that had problems. And how many do you list in your testimony?
Ms. Borzi. I am sorry. I couldn't hear your question.
Mr. Rokita. How many faulty appraisals that you talk about
were listed in your testimony? You said on page eight.
Ms. Borzi. I gave you some examples of faulty appraisals.
Mr. Rokita. And Secretary Solis gave----
Ms. Borzi. This isn't something that----
Mr. Rokita [continuing]. Excuse me.
Ms. Borzi. I am sorry.
Mr. Rokita. And Secretary Solis gave six out of 50,000.
They weren't examples necessarily, they were just----
Ms. Borzi. Right.
Mr. Rokita. So for six bad apples maybe and some that you
list in your testimony, we have to go and re-do this whole law?
This whole rule?
Ms. Borzi. Well, the simple fact is just because we have
six examples of it doesn't mean that it isn't more widespread
than that. The----
Mr. Rokita. But where is your quantified data to prove
that?
Ms. Borzi. The----
Mr. Rokita. How do you know there is----
Ms. Borzi. We don't have the resource----
Mr. Rokita. Ah. Okay.
Ms. Borzi. I mean, what you are really asking us to do is
examine every single ESOP----
Mr. Rokita. You don't have the resources to do that so
based on your intuition, based on six examples----
Ms. Borzi. This is not based on intuition. It is based on--
--
Mr. Rokita. Where is the quantifiable data?
Ms. Borzi. We are happy to supply you more data.
Mr. Rokita. Oh. I thought you said you didn't have the
resources.
Ms. Borzi. But I can't give you an exact quantification of
how many transactions go on and how many are faulty valuations.
There is simply not able----
Mr. Rokita. But that doesn't stop you from what the Oliver
Wyman study said could be a 73 to 196 percent increase in the
cost.
Ms. Borzi. The Oliver Wyman study suffers from the problem
that I was discussing with your colleague a little while ago.
It starts from what we believe is a faulty premise that the
only two options are keep the current conflicted system in
place or move to an investment advisor structure which will be
more expensive.
As I said before, we have talked with our colleague--our
sister agencies that regulate this marketplace that have a lot
of enforcement expertise in this marketplace, and they have
assured us that there are a number of other business models
between the stark model that the Oliver Wyman study starts
with.
And, of course, if you start with a flawed premise--there
are two flawed premises in the Wyman study. That one----
Mr. Rokita. But you are acting on, excuse me, let me get my
final----
Ms. Borzi. Certainly.
Mr. Rokita. You are acting on assurances or you have seen
these other studies? Or what kind of analysis have you done?
Ms. Borzi. We are in the process of doing much more
thorough economic analysis that was in----
Mr. Rokita. Okay. I will submit a question if you would
like later, but I would like to hear you analysis and see if
after you are done with it.
Ms. Borzi. Sure.
Mr. Rokita. Secondly, Ms. Solis said in response to my
question that, and this goes along the same lines, a more full
economic analysis of the regulation would be provided when the
rule becomes final. Now maybe to make a crude analogy, that
sounds a lot like you can find out what is in the bill after
you pass it.
Why would we be doing--I find that totally inadequate, and
I am not trying to put her words in your mouth, but I would
like your response to the idea that full economic analysis of
the regulation could be provided after the rule becomes final.
In your practice----
Ms. Borzi. Well if you are--the final--that is what the
requirements are. The OMB requirements are an agency cannot put
forward a final or proposed analysis, a proposed rule for that
matter, without some type of----
In a proposed rule you have to have an economic analysis as
well. It is not required to be as fulsome as in the final, I
mean----
Mr. Rokita. As fulsome?
Ms. Borzi. I mean, the point of proposing a rule and
putting out a proposed analysis is that you get public input so
that you can refine and strengthen your analysis. I am not--
maybe the words aren't clear----
Mr. Rokita. Oh, maybe I am taking it the wrong way and I am
happy to stay and have that clarified, but----
Ms. Borzi [continuing]. But what we are trying to do when
we are--when we are trying to finalize a rule at the same time
that the final rule is submitted to OMB, we have to have an
economic analysis. And the procedure is----
Mr. Rokita. But there is no intention from your agency to
do any kind of an economic analysis after the rule becomes
final? It will all be before?
Ms. Borzi. No.
Mr. Rokita. Okay.
Ms. Borzi. It is simultaneously with it and believe me
there is a lot of give and take within the administration
within all the economists within the administration who have an
opportunity to look at and work with us on the economic
analysis.
Mr. Rokita. How about economists outside the
administration?
Ms. Borzi. We solicit comments from economic, from
economists----
Mr. Rokita. Thank you.
I yield back. Thank you, Chairman.
Chairman Roe. Thank you, gentleman, for yielding.
Mr. Kildee?
Mr. Kildee. Thank you very much, Mr. Chairman.
Phyllis, I am going to ask a question that is just
tangential to this but I--my district was the headquarters at
one time of Delphi Corporation, and there are two types of
Delphi salaried workers--two types of workers, salaried and the
non-salaried, the hourly.
The hourly workers are protected by a contract with the UAW
and General Motors, the parent corporation of what became
Delphi. The salaried employees are not protected by that;
therefore, they depend totally upon what help they can get from
ERISA.
I know this is tangential to the purpose of this, but since
you are here, do you have any suggestions of what can be done
to relieve some of the real pain that the salaried people have?
Ms. Borzi. You know, this is such a hard question because
while my heart goes out to the salary workers, you know the
title for statutory language doesn't give them any comfort
because everybody's benefits, both salary and hourly, in terms
of the PBGC guarantees are the same.
Well, I mean based on their work history, et cetera, but
the framework is the same. And the top up, if you will, as you
indicated, came from a side arrangement, a side negotiation in
the 1990s between the UAW and GM.
There certainly is nothing that the PBGC can do without
violating the statutory provisions. The only recourse, I would
think, that the Delphi salaried folks have is against GM. But I
don't have any, believe me, Secretary Solis has asked me this
question many, many, many times, and I just don't have an
answer for them; although, I am quite sympathetic.
If I wanted to give a glib answer, it would be that the UAW
was smart enough to figure out that there might come a time
that they needed this protection. At the time that they
negotiated it, as far as I could tell from the reading that I
have done, it wasn't clear that they needed it, but they did.
I wish there was something that we could do because it is a
very, very tragic situation.
Mr. Kildee. Well, I appreciate your candor. I mean, you
have given it exactly the only answer you can give.
I will just throw in my own feelings on this. This
illustrates that millions can help. The UAW looked ahead and
saw and protected. They could see what might come, whereas the
nonunion members did not have that foresight.
Ms. Borzi. Well, and as I understand it, even some of the
other unionized hourly employees, their unions didn't negotiate
those kinds of protections. And I guess, after the fact, some
of them have gotten some sort of a guarantee and others have
not.
Mr. Kildee. [Off mike.]
Ms. Borzi. So there is no question that there is disparate
treatment, different treatment. I don't want to use a loaded
word in the EEOC context, but there is no question that there
is different treatment of these retirees, and that is really
very sad.
Mr. Kildee. Well, I appreciate you responding to a question
that was not really relevant to this hearing but I appreciate
it.
I go to the meetings of these people, and it is pretty hard
to try to justify----
Ms. Borzi. I know.
Mr. Kildee [continuing]. But I appreciate your candor.
Thank you very much.
I yield back.
Chairman Roe. I thank the gentleman for yielding.
Mr. Thompson?
Mr. Thompson. Thank you, Assistant Secretary, for being
here.
I want to follow up to, kind of follow along to a line of
questioning Mr. Rokita had raised and opened.
Your testimony states that the department is undertaking a
``fuller,'' and that is a quote from your testimony, ``economic
analysis'' of the impact of the proposed role.
Will the department's forthcoming economic analysis take
into account the substantial likelihood of increased litigation
by the department and the plaintiff's bar and the effect that
such litigation will have on plan costs and ultimately
participant balances as well as the employers concerns about
plan establishment and plan maintenance?
Ms. Borzi. Well, our economic analysis will take into
consideration all the internal and external factors. So that
factor will be taken care of or will be factored in.
It is very hard to predict what the impact will be, though,
but for sure we will take a look at it.
Mr. Thompson. Okay. You talked a lot about, you know, and I
apologize for getting into the hearing late, but just the time
I have been here I have heard a lot about trust. Trust me,
trust us, trust us, trust us.
And I am of the school of trust, but verify. I think that
gives us all confidence.
The department thought it drafted the proposed regulation
in a manner to accomplish exactly what was intended. But,
again, based on comments and the department's own admissions
have fell short in that regard.
Why are you so confident the department will get it right
in a final regulation without further opportunity for public
comment?
Ms. Borzi. Well, we haven't cut off public comment. As I
said in my statement we have met with more than 20 outside
financial services people to get their input, some of them more
than once. And we have met with at least 30 members of Congress
to get their input.
We continue to take, there isn't anybody who is a stake,
you know, there isn't any stakeholder that is asked to meet
with us that we don't meet with. We are very interested in
getting public comment.
But there comes--I said to the ERISA advisory council the
other day when I was asked a similar question like this, there
comes a point where, and the computer literate people will know
what I am talking about, where you push that button on your
computer that says close all tabs.
There is only so much--we have been continuing to take
public input. It has been weeks since we had any sort of new
information given to us but we continue to take the meetings
because we are open to that. And we still are open to that.
But at a point you can't just keep meeting and having the
same discussion over and over again like that movie Groundhog
Day. At a point, you have to move forward using your best
judgment.
Now that doesn't mean that we aren't going to, still, as we
develop the final rule, that we aren't going to still reach out
and ask people for input. That is what we have done with all of
our rules.
We haven't--once we figure out a direction and a set of
amendments that we might want to implement, we often reach out
to people and, while we don't hand them over the piece of
paper, which, you know, we are not allowed to do under the
Administrative Procedures Act, we do have discussions.
If we have options, we might call people and say well which
of these options? Here is one way to go or another way to go or
another way to go. And we still continue to get public input
even as we move to finalize.
But this is a very, very important problem and we think it
needs to be addressed. If people, and we say to people who come
in, if you recognize the problem, acknowledge the problem, and
you have other mechanisms that we can use short of the way that
we have gone, we are open to hearing that but so far people
haven't come forward.
Mr. Thompson. Well, first of all, let me say representing
Punxsutawney, Pennsylvania, I can't get enough of Groundhog
Day. [Laughter.]
I am okay with it.
Just for the record, Mr. Chairman. [Laughter.]
But can you share with us any of the concerns that were
identified by the ERISA advisory council on this?
Ms. Borzi. They were just asking me about it.
Mr. Thompson. In terms of----
Ms. Borzi. What happens is whenever the council meets----
Mr. Thompson. Because if they have concerns about not
having enough public comment or input based on your----
Ms. Borzi. No. I mean, some of them, they are all private
sector--experts from the private sector. Some of them work for
companies that put through comments, that filed comments.
Their questions to me the other day were just procedural.
Mr. Thompson. Okay. Well, thank you.
Thank you, Chairman.
Chairman Roe. Thank you, gentleman, for yielding.
Mrs. McCarthy?
Mrs. McCarthy. Thank you, Mr. Chairman. Thank you for
calling this hearing. I think it is very important. Obviously,
we need to know what the department's proposals are going to
really be redefined as a fiduciary.
I want to thank Madam Chairman. You have been terrific
meeting with us, sitting down with different groups, and we
appreciate your time and your staff's time. I know that we have
spoken before on this issue, and I still will appreciate it as
we continue our discussions.
Listen, for matters of retirement security, especially for
people my age and certainly my friends, accountability should
always be paramount for your department and certainly for this
Congress.
Retirement options have evolved greatly over the passage of
ERISA law in 1974, I believe. I do believe that changes can and
must be made in order to bring further accountability for
financial advisors and protection for investors.
I think that we did a very good job with Dodd-Frank on
putting in a lot of those protections. I also believe that we
did a great job on protecting the consumer by giving them more
information. I believe we still need to do a better job on
financial literacy, for all ages.
But especially because of the wide scope of ERISA, changes
must be conducted with utmost caution and thoroughness in order
to ensure that the intent of the changes is realized in the
final product. I think that is what we are both working for.
I can say wholeheartedly that I agree with your intent, and
I do. I agree that folks deserve access to accurate and
unbiased information, and I agree that a structure must be put
in place that incentivizes employee's investment and long-term
accumulation of retirement savings. That is what we have always
worked for.
However, I am afraid I still disagree with the process by
which this rule came about and ultimately what will be the
final rule should this process go forward.
As a Democrat, this issue has been particularly difficult
for me. In this committee and others, our friends on the other
side of the aisle have made it a habit to assume that any and
all agency rule makings under a Democratic administration are
burdensome, overreaching, and are adverse to free-market
principles.
Luckily for us, they are wrong an overwhelming majority of
the time. However, in this case, I still cannot defend this
rule making process. I do not believe--I do believe it is
overbearing and has a potential to hurt our national economy.
This shouldn't come as a surprise because we have talked
about this. We have had those discussions, and like I said, we
have spoken many times at great length.
I also worked with the new Democrats, and we sent a letter
signed by 28 of our colleagues on the Democratic side asking
the department to repose this rule given coordination and
consultant concerns.
Mr. Chairman, at this time I would like to ask unanimous
consent of the letter that I sent to the new Democrats that was
signed forth.
[The information follows:]
------
Chairman Roe. Without objection.
Mrs. McCarthy. Thank you.
Madam Secretary, in the preamble of the proposed rule, the
department recognizes the potential broad effects that it may
have. In fact, the department openly admits that there may be
an uncertainty and a large market impact that may also create a
smaller field of service providers.
I understand that there is always a measure of uncertainty
regarding any potential rule making. However, I do think the
department did not do its due diligence to ensure that it had
the most information available to have a more accurate analysis
of the impact.
Madam Secretary, no request for information was issued for
this rule. DOL has a history of issuing RFIs on issues of
retirement security. Given the overlap with other agencies, and
I know you talked about speaking with other agencies, the
uncertainties in regards to the market impact and the great
concerns you have heard from the stakeholders throughout the
industry, I ask: why wasn't an RFI issued? In hindsight, don't
you believe an RFI would have paved the way to a better draft
rule for folks to comment on?
Ms. Borzi. Well, that is a very good question. I am happy
to answer it for you.
The regulatory process gives an agency a variety of tools
to gather information. The--the RFI process is typically used
really in two circumstances.
When an agency is not completely sure that there is a need
to regulate or when they are thinking that there might be a
need to regulate but that there are a wide variety of
mechanisms to do that.
In this case, we were not unsure. We were very sure that
there was a problem here. And we had nearly 40 years of
experience in our own enforcement activities to identify the
problem.
In addition to that, we had the benefit of an SEC study
that was done a couple of years ago on consultants and advisors
that confirmed, if you will, the existence of the problem. And
in addition to that, there was lots of academic literature
about this.
So there was no question that this was a problem that
needed to be solved. And given the statutory tools that we had
to solve it, there really was only one statutory way that we
could through regulations deal with the problem and that was
through the prohibited transaction route.
Now having said that, I contrast that with another process
that we used where we used the RFI and that had to do with
lifetime income. We were very concerned that a lot of people
were now taking lump sums and not having the kind of lifetime
income stream, monthly benefits, if you will. But we weren't
sure that it necessarily was the job of the federal government
to get in there and start making rules.
So we did do an RFI in conjunction with our colleagues at
the treasury and the IRS. And we are now in the process--and we
got lots of comments. We got over 700 comments and lots of good
information. So that is the contrast.
We knew that there was a reason to regulate. We had limited
pathways to do so and so we crafted the best rule we knew how,
but we put it out for proposals.
Mrs. McCarthy. I know my time is up, and I thank the
Chairman for indulgence.
I disagree with you on the SEC study, because it also shows
that it is going to have a great impact on basically the
brokerage relationship. But we will talk about that in the
future.
Ms. Borzi. Absolutely.
Mrs. McCarthy. Thank you, Mr. Chairman.
Chairman Roe. I thank the gentlelady.
Mr. Barletta?
Mr. Barletta. Thank you.
Why has the Department of Labor decided not to make its
plan changes available for public comment?
Ms. Borzi. We did make the plan changes available for
public comment. We went through extensive public comment. I
guess I am not quite sure what you are talking about.
Mr. Barletta. Well, you know, in light of all the questions
and concerns would the department consider re-proposing the
rule for the public comment and the questions and the concerns?
Ms. Borzi. Well, we certainly never say never to anything.
But re-proposal is typically used when you put out a proposal
when the commentators offer alternative approaches to solve the
same problem and the public hasn't had the opportunity to
comment on the alternative proposals.
We had lots of public comment. Many of the issues were
issues we had actually flagged for ourselves. We have been
working through the drafting issues. We have been meeting with
lots of people.
But aside from don't do anything, which I guess is an
alternative structure, nobody has really suggested to us an
alternative structure from the structure we have proposed. They
have had criticisms and comments and they have said quite
accurately, because we knew we had to do it, that we need to
focus more on the cost.
But I am not quite there yet that the kinds of public
comments that we have gotten have suggested such a fundamental
alternative that we need to re-propose it.
Mr. Barletta. All right. Thank you.
Chairman Roe. Dr. Holt?
Mr. Holt. Thank you, Mr. Chairman.
Thank you, Secretary Borzi, for coming. I really appreciate
your expertise and your dedication over the years to making
sure that the financial integrity is protected for the benefit
of ordinary people.
I have long been an advocate, as you know, and as I have
told you many times, for more investment education. Clearly,
people are not well informed. Surveys show that over and over
again, and we see that people are ill-prepared for the tough
times that come in their non-wage earning years. I get that
from my constituents and lots of places.
I appreciate the efforts of your department to help
Americans prepare. As you know, Representative Petri from this
committee and I have introduced the Lifetime Income Disclosure
Act which is intended to help people understand better where
they stand and prepare for where they need to be.
I strongly support, you know, a regular basis test for
increased clarity for advisors and investors so that people are
armed with trusted, reliable information. But I have some
questions about how we are going about this.
I have asked you before and still have not received data.
You know, what is the cost of this perceived problem? We must,
and you must, I think, characterize, describe, and quantify the
problem that you are trying to solve. It is easy for me and it
seems to be very easy for you to imagine that people will be
misled and hurt by this so-called conflicted advice.
But we shouldn't make policy on what we imagine to be the
problem. In your testimony, when you get to the part of the
testimony where you are talking about the problem, the first
part is sort of, sort of legalistic.
You are saying, well, the practice out there doesn't really
meet the test that was set up 35 years ago in ERISA. Then you
start to give some examples and you say, well, you have
uncovered abuses of flawed valuation methodologies and
internally inconsistent valuation reports. No doubt. It is not
clear that they come from the so-called conflicted advice.
So let me ask again. How many people will be affected? What
will be the cost? Where are the data on investor behavior?
Where are the data on advisor behavior and dealer behavior?
It seems to me you can break out of this, what did you call
it, the repetitious interactions that you were talking about,
and I won't call it Groundhog Day, by actually working harder
to draw out the evidence and then draw out the guidance from
that evidence.
You know, I got into this because some years ago I
innocently asked a few questions about where these, before you
even started working on these regulations when other people
were talking about it. As you said, academics have written
about it.
I realized that it seemed to be focused more on trying to
restrain the investment corporations than empowering the
employee investor. A moment ago you said there, this is, I
think, pretty close to a quote, there is no question about the
problem.
I get a little bit worried when somebody is so sure that
they will look right past the evidence. I mean the absence of
evidence here might be a problem in itself, and you said we
were very sure. That is what seems to be behind these
regulations, and that is what troubles me a great deal.
You say that there can be a model between investment
advisor or broker dealer. Well, sketch that out for us, please.
And----
Ms. Borzi. I will be happy to send you some press articles
that gave us some information on that.
Mr. Holt [continuing]. And, yes. It is, I mean, if we are,
you know, our job here in Congress is not to preserve the
business model that has existed for 35 years, but if you are
going to upset that business model, we had better know why and
we had better know where we are going. I have yet to see that.
So, I mean, I have not given you time to answer; I have
been talking. But I hope you will, because these will respond
more than you could, I mean, this will require a response of
more than a few seconds or a few minutes anyway. I hope you
will respond to these.
And then ask, and then answer, you know, right now there
are so many other regulations to be implemented by the SEC,
through Dodd-Frank, and so forth, section 913 for example on a
standard of conduct.
Why, after this has been around for 35 years, has it moved
to the head of the queue something to be dealt with now in the
next 5 months in final form while all of these other things are
still in play, related other things?
So----
Chairman Roe. If the Secretary will hold----
Mr. Holt. With that, I should yield back. I thank you----
Chairman Roe. If the Secretary will hold that thought, I am
going to continue his line of the questioning.
Ms. Borzi. Okay. Could I just answer----
Chairman Roe. Well, I am going to continue in just a
moment.
Ms. Borzi. Okay.
Chairman Roe. Dr. Bucshon?
Mr. Bucshon. Thank you, Mr. Chairman. I am going to yield
my time to Mr. Rokita.
Mr. Rokita. Thank you, Mr. Chairman. I thank the gentleman
from Indiana.
Two quick questions just following, I have been listening
intently to what you are talking about and, again, with my
background I truly believe in transparency and the due process
of rulemaking.
And I am intrigued by the answer you gave to former Mayor
Barletta when you talked about re-proposing and the idea that
you re-propose a rule when there is an alternative presented
that may not have been thought of.
What about the comments, if there were any, that disagreed
with your premise, your agency's premise, that there was even a
problem? What about the comments and specifically how do you
weight the comments that said, we don't need an alternative. We
just don't need to do this. This is where I am headed.
Ms. Borzi. Well, maybe you can help me out how re-proposal
would address that we don't think there is a problem we think
you should do nothing. What could we re-propose that would
address that?
Mr. Rokita. Well, that is not my question. I am just saying
you said the only time you re-propose is when there was an
alternative. But what about withdrawing? What about proposing
something that was in line with the comments that were made
that weren't just an alternative but were saying--my question
is how do you weight the comment in your agency that says don't
change anything?
Ms. Borzi. We take all of the comments very seriously.
Mr. Rokita. But how do you weight them equally with those
proposals that say we do need to change or we have some
alternatives or we need to----
Ms. Borzi. There are always people who don't want any
change and we do weigh them. I can't say that we weigh them
equally.
Mr. Rokita. What is your formula for weighing comments?
Ms. Borzi. We don't have a formula for weighing it because
we look at what the rationale behind the comments----
Mr. Rokita. How do you judge that rationale in a comment?
What formula do you use to judge?
Ms. Borzi. We put it in the context of all the comments
that we have, we weigh it against the other evidence we might
have, and I eluded to some of it, that there is a problem, and
then we spend a lot of time talking with people trying to
understand exactly what their concerns are.
Mr. Rokita. And that is my second question and then we can
get on with the hearing. You mentioned a couple of times that
you have met with groups, you have met with people. Are these
private meetings? Are these meetings on the record? Is there a
transcript of these meetings?
Ms. Borzi. Well, they are--no, there are not transcripts.
Mr. Rokita. Do you have a list?
Ms. Borzi. We keep a list. I mean, we are required to keep
a list of who we met with, who the people were at the meetings,
and then for our own purposes we all have our own notes.
And what we would do in the preamble to the final rule what
we typically do is we list, you know, we talk about, because we
are required to respond to the public comments and that is one
way that----
Mr. Rokita. So according to the Administrative Procedures
Act, have you published this list of meetings?
Ms. Borzi. Yes. We do.
Mr. Rokita. Okay. Okay. So that is available.
Ms. Borzi. Well, it is available in the final regulation.
We can certainly----
Mr. Rokita. Would you mind getting my office a copy of that
list?
Ms. Borzi. I am sure we could. I would have to check with
my lawyers, but I don't see a reason that we couldn't.
Mr. Rokita. I mean before the final rule goes out and all
that sort of, as soon as possible?
Ms. Borzi. Sure, we can certainly give you; it is not
secret who we meet with.
Mr. Rokita. Okay. Great. Thank you very much.
I yield.
Chairman Roe. I thank the gentleman for yielding.
Mr. Tierney?
Mr. Tierney. Thank you, Mr. Chairman.
Thank you for your testimony here today, the work that you
are doing, and the cooperation of your office in answering a
number of questions that we have had on a variety of issues. I
appreciate that.
I know that a lot of material has been covered here, and
you did speak to the ESOP issue, the Employee Stock Option
Plan, just a little bit. But I was wondering, there is
indication from your office that you were going to try to
clarify that the fiduciary standard only required an impartial
evaluation. Is that correct?
Ms. Borzi. Yes. We have had this back and forth with the
appraisers who seem to think that being a fiduciary means you
have to put the finger on the scale towards participants and
that is not how ERISAs fiduciary rules work.
What ERISAs fiduciary rules say is that you have a duty to
be fair, objective and meet professional standards of conduct.
And what we have said to the appraisers is if there is any
concern that that is not what we mean, we are more than happy
to clarify it.
Mr. Tierney. Do you have an idea of how it is you are going
to clarify it?
Ms. Borzi. I am sorry?
Mr. Tierney. Do you have an idea of how it is that you are
going to clarify it?
Ms. Borzi. Well, we would put in an----
Mr. Tierney. Specifically state that----
Ms. Borzi [continuing]. Operative text of the regulation so
that there would be no question about it, yes.
Mr. Tierney. Okay. Thank you very much. I have no further
questions.
Chairman Roe. I thank the gentleman for yielding.
Mr. Tierney. I yield to my--I am sorry, I will yield to my
colleague.
Mr. Holt. Thank you because I didn't give you a chance to
answer. As I said, a full answer to my various questions will
take more than either the remaining time now or even this
morning.
Let me add one more question to that and give you a few
seconds to make any comments on what I said.
What if a call center representative says, for example, a
particular mutual fund is good for people interested in
investing in large cap equities? Would that violate----
Ms. Borzi. If that is all the person said, no. It would
fall under this----
Mr. Holt. So that is education. So you actually said
earlier we won't limit access to education, which is great. I
mean, it is a high principle for me.
What if a call center representative says younger investors
should hold some equities in their portfolio to help grow their
savings? Is that--?
Ms. Borzi. That is general advice. It is what we might call
generally accepted financial and investment----
Mr. Holt. But, well, it is reassuring to hear you say that.
Ms. Borzi. If that is all the person said, but if the
person went on to say, and here are three funds that would help
you achieve that objective. That might cross the line.
But if all they are doing is giving generalized investment
information and honestly, that distinction that we are drawing
in this discussion has been true since 1996 since our
investment bulletin 96.1 was issued.
And there are people who have asked us to be more clear as
to what this line is between investment advice and investment
education and that is certainly one of the things that we are
working on in conjunction with this.
Could I just say one thing about you question about cost?
Mr. Holt. Please.
Ms. Borzi. We are taking seriously your questions, and we
are in the process of working through the cost issues,
collecting information. And we haven't completed that process
yet. So----
Mr. Holt. Thank you for doing that. I am surprised that you
didn't do that up front; that we had to ask for it, actually.
Ms. Borzi. We did. We did. And in fact in our own
regulation in the preamble, we asked people to help us out by
giving us information about it and the Wyman study that some of
your colleagues referred to is one bit of information.
It is not the dispositive. As I said before, it is not
dispositive because it is premised on what we think is not a
correct two premises that the only alternative is not this
investment advisor model.
And the second problem with the Wyman study is that it
assumes that commissions can no longer be paid, and that is not
correct. But it is certainly not that we are disregarding it.
It is certainly a piece of information and every one of the
people who come in to talk with us, we have asked them. Do you
have information about cost? Please give it to us so that we
can try to make our best estimates. And we are working with
others in the administration about that on that issue as well.
We all have a very, very--we all consider it very, very
important to get the best cost estimates that we can. There is
always going to be some uncertainty in it but we are looking to
have the most solid cost information that we can get to justify
the rule.
And if it turns out, I mean, that is part of what is going
on here, if it turns out that there are features that we have
proposed that we can figure out a less burdensome, less costly
way of doing, that is what we will be working towards.
Mr. Holt. Okay. Also, those data that we have asked for
about the behavior of investors, the behavior of advisors
versus feelers?
Ms. Borzi. Yes. Well, we have some studies on that.
Mr. Holt. And I thank Mr. Tierney for yielding time to give
you a little more opportunity to elaborate.
Thanks.
Mr. Tierney. You bet.
Ms. Borzi. Sure.
Chairman Roe. I thank the gentleman for yielding.
We have a member of the full committee here, Mrs. Biggert,
and you are now recognized.
Mrs. Biggert. I thank the chairman. I appreciate the being
able to participate.
Welcome. We have met before and we have discussed this
issue. And I just wanted to follow up on a couple of questions
that we have discussed before.
In your testimony earlier this morning, you mentioned that
you are coordinating with other agencies to ensure that your
proposals do not conflict. And, as you are aware, Congress has
mandated that the SEC study this matter under section 913 of
the Dodd-Frank Act.
Can you explain why you are moving forward with the
regulations proposal before the SEC has finished their study
and how does that affect the Department of Labor?
Ms. Borzi. Well, it is my understanding that the staff
study is completed. The commission hasn't taken any action on
it.
There are a couple of things. First of all, our proposal
was preceded Dodd-Frank. We have been working on this for a
couple of years.
But second of all, we have two entirely different statutory
structures. The section 913 study in Dodd-Frank, the research
question that the staff was asked to address was whether or not
broker dealers under the securities law should be held to the
same standard as investment advisors under the securities law.
Our statute is very different. Under the securities law it
is basically a disclosure statute and our statute is not a
disclosure statute. It is a statute that is designed to
prohibit conduct that is potentially harmful to plan
participants and plan sponsors unless there is an exemption
administrative or statutory exemption for that conduct.
So we have two fundamentally different statutory structures
and two different we protect plan sponsors and participants. So
we have two different statutory structures and that is why
before our regulation, our proposed regulation was even sent
through our own building for clearance or through OMB and the
administration for clearance, we consulted our friends at the
SEC.
We sent them the draft regulation. We asked them whether
they saw anything in the draft regulation that would conflict
with or impair their ability to do their job under Dodd-Frank.
And those conversations, they said no as part of those
conversations. So we went forward.
Mrs. Biggert. Could you elaborate a little bit more with
your discussions with the SEC on that?
Ms. Borzi. Well, I wasn't--it is a discussion our staff,
our two sets of staff talked about it. They had a few
questions, as I understand it, they had a few questions about
some of the provisions in our regulation, but the bottom line
was they didn't see anything that would conflict with what they
were doing. And so we went forward.
We have had this longtime working relationship with the SEC
including an MOU on enforcement, and so we have continued to
have multiple conversations with them as they move forward to
implement their responsibilities under Dodd-Frank and as we
move forward on this regulation. And, I must say, a variety of
other issues including target date funds and a bunch of other
things.
Mrs. Biggert. Have you considered, since the SEC study has
been completed, was there any consideration for any of the
things that were in that study for you making your ruling?
Ms. Borzi. Well, I mean, we certainly discussed--we had a
briefing on the study and we certainly discussed the direction
that the SEC believed it was going in, which was not
incompatible with our direction, different, but they have
different statutory mandates than we do.
And so what I have said over and over again I said at the
public hearing is that our job is not to let the industry have
only one standard. There are multiple fiduciary rules that
apply to every industry.
But we do have an absolute responsibility, and I take it
very seriously, that we do not put plan sponsors or financial
institutions in the position where compliance with one set of
rules will put them out of compliance with another set of
rules. So that is why my pledge is they won't be conflicting
standards. I can't promise they will be the same standards
'cause we have got two different statutory frameworks.
Mrs. Biggert. Okay. It just seems that, you know, the
financial services industry is really concerned about----
Ms. Borzi. Yes, they are.
Mrs. Biggert [continuing]. About the consequences of this
proposal. Do you see any way to alleviate those concerns?
Ms. Borzi. Well, I am not sure what else except giving, I
mean, we pledge to continue working with the SEC and we have
done the same with CFDC. We are working with treasury and the
IRS as well, because all of them have responsibilities under
Dodd-Frank.
And by working with them, I don't mean just sending paper
or, you know. We have discussions with them. They tell us what
they are thinking about doing. We think about and talk about
how what one agency does will impact another, and we do promise
that we won't, that the industry will not be subject to
conflicting regulations because we intend to fully continue
that harmonization process.
But I can't guarantee that they won't wind up with
different rules because the statutory frameworks are just too
different sets of rules.
We don't have any intention of trying to put anybody out of
business. There is no interest on our part in doing anything
but getting rid of the potential conflicts of interest because
we think this is all about accountability, transparency, and
eliminating conflicts of interest.
And the SEC rules have a very different--a very different
focus.
Mrs. Biggert. I have asked them, too. Thank you.
Ms. Borzi. You are welcome.
Mrs. Biggert. I yield back.
Chairman Roe. I will finish up this round of testimony with
a couple of things.
I think Dr. Holt had hit on some questions that I was going
to have is that, I guess, what I would start out by saying is,
and I am going to bring us back down to the real world because
I have dealt with this as being a, and I am, I was never quite
sure whether I was a fiduciary or not trying to interpret these
rules, to run the pension plan in my own practice. We had about
300 people that participated in our pension plan.
And trying to go through these rules, and I will just tell
you what will happen to us and what will happen to small IRA
owners, right now we can afford to purchase financial advice
who is a fiduciary, they would be a fiduciary, I understand
that.
I was never quite sure whether I was on our pension
committee or now, whether I was a fiduciary or not, and I am
less sure when I look at these rules that I have seen so far.
What we do is, and to put that in perspective of what we
have here in Congress. Here the best I can tell it is just a
free-for-all. You pick out whatever you think will work, which
is not a good idea.
Education is an extremely important part. We bring all of
our employees in. We sit down and we explain all their options
to them. And I think that is a good thing. And I think Dr. Holt
brought that up.
The question I have is what problem are you trying to fix.
And I understand this won't fix Bernie Madoff.
Ms. Borzi. No.
Chairman Roe. A crook is a crook. So it is not going to fix
that. So by doing this it looks to me like it is going to be a
little more complicated and what problem out there that you
have identified with information? I am not talking about
personal testimonials like I got the best doctor in the world.
That is a personal testimonial. Maybe you do, maybe you don't.
But real data. Are there data that you can put in this
record right here to say that this is a problem. Not an
individual person out there that--it is like if I give
penicillin to somebody and one person has a reaction, it
doesn't mean you quit using penicillin.
Ms. Borzi. No, and we wouldn't act if we thought it was not
an important problem.
Chairman Roe. Well, where is the data?
Ms. Borzi. Let me focus on your question vis-a-vis small
business. Let me tell you what the problem is for small
business.
Small business owners sacrifice a lot to have pension plans
for their employees.
Chairman Roe. That would be me.
Ms. Borzi. That would be you. And I will be that you are
not the only small business owner in this room who provided a
pension plan for your employees.
But I also bet that you are not in the business, I know you
are not because we talked, you were not in the business of
providing--you weren't an investment professional.
Chairman Roe. No.
Ms. Borzi. So you sought assistance from an expert and you,
I would assume, and correct me if I am wrong, you assumed when
you hired that expert that that expert was going to give you
the very best advice for you and for your employees. And I
hope, and I am sure that lots of those experts do do that.
But here is the problem. There is no guarantee that the
person who you hired is going to give you the best advisement
for you and your employees. I know you don't want to talk about
cases, but we have numerous examples where the advice that was
given was conflicted.
The person giving the advice got additional compensation,
enhanced compensation, because he or she steered----
Chairman Roe. Let me interrupt you there. As long as that
is transparent, and I do well with that advice, I don't have a
problem with that.
Ms. Borzi. But it is not transparent.
Chairman Roe. Well, we talked about this last year, this
past year on making that transparent. That is one of the things
that we did do. And I think one of the things that the
investment advisors that are out there is that they were like I
was. They were trying not to break the law and yet advise
people and give them the best investment advice that they
could.
And let me ask one other question real quickly because my
time is about to expire.
Ms. Borzi. And then may I finish my example?
Chairman Roe. Yes, quickly, if you would.
Ms. Borzi. So here is the problem. Then the advice that the
small businessman has been given is inappropriate, imprudent,
and a loss occurs to the participants in the plan. In comes the
Department of Labor and we investigate. And we conclude, yes,
there is been a breach of fiduciary duty. But we cannot go
after, under the current regulation, the advisor who gave that
employer the advice.
We have to go after the small employer who is the victim.
He paid for advice that was not appropriate. So that is the
problem we are trying to solve in the plan space.
Chairman Roe. If you have someone who is involved in a swap
transaction, will they be a fiduciary?
Ms. Borzi. Not under our regulation, and we have been
working closely with the CFTC to make sure that whatever they
do in their in their business conduct rules do not make them a
fiduciary under ERISA.
And in fact I sent a letter, which we can certainly provide
from the letter, to CFTC Chair, Gary Gensler, saying that we do
not intend that in these swap transactions they become a
fiduciary solely for compliance in the rule. And we have said
we will clarify that in our final regulation.
Chairman Roe. Okay. And one last, very quick question is
someone who does an appraisal for an ESOP, Mr. Tierney was
asking this question, someone who does that, are they
considered a fiduciary? Because people that have differing
accounts of what something is worth. Look at what bank
examiners do to certify the appraisers right now. That doesn't
mean that anything was done wrong.
Ms. Borzi. Well, certainly with respect to the initial
valuation of the stock, how much is this stock worth, they
would, yes, be fiduciaries under this rule.
Chairman Roe. Okay. I have used up my time.
Mr. Andrews. Mr. Chairman?
Chairman Roe. Yes?
Mr. Andrews. If I may, because it is relevant to this
section of the hearing, I would ask you unanimous consent to
submit for the record a document from the committee for the
fiduciary standard which is selected articles on fiduciary
duties applicable to personalized investment advice.
[The compilation of articles may be accessed at the
following Internet address:]
http://thefiduciarystandard.org/images/
2010__August_The_Fiduciary_Reference_Law_RIA_BD_Issues_final_.pdf
______
Chairman Roe. Without objection, so ordered.
I would like to thank you, our witness for taking your time
this morning. Certainly it has been very helpful.
I will now ask the second panel to come forward and you are
excused, and thank you for being here.
Ms. Borzi. Thank you, Mr. Chairman. I look forward to
working with you and talking to all of you and your staff.
Chairman Roe. Thank you.
Ms. Borzi. Thank you.
Chairman Roe. It is now my pleasure to introduce our second
panel of witnesses.
Mr. Donald Myers. Mr. Myers is a partner of Morgan, Lewis,
& Bockius, LLP where he focuses his practice on the fiduciary
responsibility provisions under ERISA.
Prior to entering private practice, Mr. Myers was counsel
for ERISA regulations and interpretations at the U.S.
Department of Labor. He has chaired various subcommittees of
the American Bar Association and has been an adjunct professor
at Georgetown University Law Center.
Mr. Myers lectures and writes extensively on employee
benefits issues including seminal text on ERISA class
exemptions. He earned his LL.M. in taxation from Georgetown
University Law Center and his J.D. from Cornell Law School, and
his B.A. from the College of the City of New York.
Welcome.
Mr. Kent Mason. Mr. Mason is a partner of Davis & Harmon,
LLP where he works primarily with major employers, large plans
and national vendors of retirement plan services. He also
serves as a council to trade associations including the
American Benefits Council.
Prior to joining Davis & Harmon, Kent served as a
legislation attorney for the joint committee on taxation as an
attorney advisor in the office of tax policy for the U.S.
Department of Treasury.
Mr. Mason has a B.A. from Amherst College and received his
J.D. magna cum laude from the University of Pennsylvania. After
law school he served as a law clerk on the 11th Circuit.
Mr. Norman Stein. Before joining the faculty at Drexler
University, Professor Stein was a Douglas Arant Professor of
Law at the University of Alabama. He is the co-author of a
treatise on Qualified Deferred Compensation Plans.
Professor Stein is a member of the GAOs expert panel on
retirement security. He also served on the Department of Labor
advisory council on Employee Welfare and Pension Benefits Plan
and was a delegate at the White House conference on retirement
savings.
He is currently a member of the Board of Governors of the
American College of Employee Benefits Council, a fellow of the
National Academy of Social Insurance, a member of the Board of
Advisors of BNA Pension and Benefit Reporter and a senior
policy advisor to the Pension Rights Center.
Professor Stein received a J.D. from Duke University School
of Law.
Mr. Jeffrey Tarbell. Mr. Tarbell is the Director of the
Houlihan Lokey, San Francisco office. He is a member of the
firm's Financial Opinions and Advisory Services Practice.
He has 20 years of experience providing transaction related
financial opinions and advisory services to private and
publicly traded companies.
Mr. Tarbell speaks frequently on securities of valuation,
capital markets, and other financial issues. He has served as
reviewer, editor, contributing author, or technical advisor for
several valuation text books and publications.
Among other professional accreditations and affiliations,
Mr. Tarbell is an Accredited Senior Appraiser of the American
Society of Appraisers and an elected member of its Business
Valuation Committee.
He is a member of the National Center of Employee Ownership
and the Valuation Advisory Committee of ESOP Association.
Mr. Tarbell earned a BS from the University of Oregon, an
MBA from the University of Chicago Booth School of Business.
And welcome.
Kenneth Bentsen. Mr. Bentsen is the Executive Vice
President for Public Policy and Advocacy at the Securities
Industry and Financial Markets Association.
From 1995 to 2003 Mr. Bentsen served as a member of the
United States House of Representatives from Texas where he sat
on the House Financial Services Committee and on the Budget
Committee.
He has extensive private sector investment banking
experience. Mr. Bentsen has a B.A. form the University of St.
Thomas and MPA from American University.
And I can say, as an obstetrician, all these lawyers make
me a little nervous. [Laughter.]
Before I recognize you for your testimony, let me explain
the lighting system as we did previously. The red light, excuse
me, the green light goes on for 4 minutes, amber light for one,
and then, please, we won't interrupt you, but if you would wind
up your comments at the end of that time I would appreciate
that.
And now, I will recognize Mr. Myers for your opening
statement.
STATEMENT OF DONALD MYERS, PARTNER,
MORGAN, LEWIS & BOCKIUS, LLP
Mr. Myers. Thank you. Chairman Roe, Ranking Member Andrews,
other members of the subcommittee, thank you for the
opportunity to speak today.
I have provided a written statement, and I will just
summarize the high points of that statement. I will briefly
provide some background on the proposal and then talk about
some of the process issues involved at the Department of Labor.
The centerpiece as we heard today of the ERISA fiduciary
rules is the fiduciary. ERISA defines the fiduciary using a
functional test to the extent a person provides investment
advice for a fee. To that extent, the person is a fiduciary.
Fiduciaries are subject to ERISAs general fiduciary
standards as well as its prohibited transaction rules. The
latter prohibits a wide variety of transactions, many of which
occur in the ordinary course of business.
There are serious consequences for violating these rules.
Where the transaction is prohibited, the fiduciary who caused
the transaction has potential liability and the disqualified
person involved in the transaction, which could be the
fiduciary, would be liable for an excise tax of 15 percent of
the amount involved in the transaction until the transaction
were corrected. There are additional taxes and civil penalties
that could be imposed.
One of the major problems raised by the proposed
redefinition of the term fiduciary is DOLs broad interpretation
of these rules. According to DOL, if a person is a fiduciary by
giving investment advice and receives compensation that can
vary according to the advice, then the fiduciary would
automatically violate ERISA even if the transaction is in the
interest of the plan that would otherwise be prudent.
To lessen the potential impact of the prohibited
transaction rules, DOL has granted individual and class
exemptions. The latter are available to anyone who can meet the
conditions of the exemption. DOL has granted 59 class
exemptions and several hundred individual exemptions.
The class exemptions have created a regulatory-like
framework that along with the statutory exemptions govern a
significant portion of plan activities.
The proposed regulation would apply to both IRAs and ERISA
plans, although they are fundamentally different. Both Congress
in enacting ERISA and DOL in issuing exemptions and regulations
have acknowledged those differences.
The proposal would make significant changes to the
regulatory guidance that was adopted in 1975 and on which the
financial services industry and others have come to rely. If
adopted as proposed, the regulation would require fundamental
changes in the way business is conducted.
The impact of specific provisions will be addressed by
other witnesses. I will now focus the remainder of my comments
on the regulatory process.
Many of the issues raised by the financial services
industry stem from the concern that currently accepted and
longstanding practices may suddenly become prohibited.
The DOL staff has responded that these issues can be
addressed to the exemption process. I see two problems with the
exemptions approach.
First, existing class exemptions would not provide
necessary relief without a number of modifications or
clarifications. DOL could modify or clarify existing class
exemptions or propose a new exemption. So this by itself would
not be an insurmountable barrier.
The second problem is that modifying a class exemption or
granting a new exemption can be a long, complicated process. It
is crucial to coordinate the exemptions with the final
regulation.
We expect, based on the large number of comments submitted
and the issues discussed at this hearing today, that there will
be a number of changes to the proposal. That alone should be a
reason for DOL to re-propose its regulation.
There is also a need for the public to comment on whether
any new or modified exemption effectively addresses the
prohibited transaction issues. The affected public will have to
determine whether the conditions of the exemptions are feasible
or, on the other hand, too complicated or unworkable.
This cannot be done unless the exemptions are proposed in
conjunction with re-proposal of the regulation so that the two
can be considered together and modified as necessary.
For these reasons, it is my view that only by re-proposing
the regulation at the same time as it proposes exemptive relief
will DOL give the public sufficient opportunity to review and
comment on all aspects of this new regulatory scheme.
I would be happy to answer any questions.
[The statement of Mr. Myers follows:]
Prepared Statement of Donald J. Myers, Partner,
Morgan, Lewis & Bockius LLP
Chairman Roe, Ranking Member Andrews and other members of the
Subcommittee, I want to thank you for giving me the opportunity to
testify today.
My name is Donald Myers. I am a partner in the law firm of Morgan,
Lewis & Bockius LLP in Washington DC. My practice focuses on the
fiduciary responsibility rules of the Employee Retirement Income
Security Act of 1974 (``ERISA''), primarily relating to investment
matters. I assist pension plans and financial institutions in
structuring investments for plans, and represent clients before
government agencies, including the Department of Labor (the ``DOL''),
on ERISA-related issues.
Before entering private practice in 1984, I was Counsel for ERISA
Regulation and Interpretation at the DOL. Previously, I was Assistant
Chief of the Office of Disclosure Policy and Proceedings at the
Securities and Exchange Commission. I have chaired various
subcommittees of the American Bar Association dealing with employee
benefit plans and ERISA fiduciary responsibility matters, and have been
an Adjunct Professor at Georgetown University Law Center. In addition,
I am a Charter Fellow of the American College of Employee Benefits
Counsel. I have lectured and written extensively on employee benefits
issues, with my publications including the book ERISA Class Exemptions,
and chapters on class exemptions and trustee responsibility in the
treatise ERISA Fiduciary Law.
My testimony today will provide some background on the ERISA
fiduciary rules and then focus on the DOL's regulatory and exemptions
process in the ERISA area, based on my experience at the DOL and in
private practice. I am speaking here today on my own behalf.
ERISA Fiduciary Rules, Prohibited Transaction Provisions and Exemptions
The centerpiece of the ERISA framework for the administration and
management of employee benefit plans is the role of the fiduciary.
ERISA defines who is a fiduciary using a functional test, including the
activities of discretionary management over plan assets and, as
relevant to today's hearing, rendering ``investment advice'' for a fee
or other compensation regarding plan assets.
A person who is an ERISA fiduciary is subject to the ERISA
fiduciary responsibility rules, which can be divided into two
categories--the general fiduciary responsibility rules, and the
prohibited transaction rules.
The general fiduciary responsibility rules impose standards of
fiduciary conduct. They require a fiduciary to act prudently and solely
in the interest of the plan participants and beneficiaries, to
diversify plan investments unless clearly prudent not to do so, and to
follow the plan documents and instruments so long as they are
consistent with ERISA.
The prohibited transaction rules consist of two parts. The first
part prohibits transactions between a plan and parties with certain
relationships to the plan, so-called ``parties in interest'' or
``disqualified persons''; these include non-fiduciary service
providers. The second part prohibits plan fiduciaries from engaging in
self-dealing and conflicts of interest.
There are two sets of consequences to a breach of fiduciary duty.
First, the breaching fiduciary can be personally liable to the plan for
any loss suffered by the plan in the transaction that was a breach, or
any gain received by the fiduciary as a result of the transaction.
Second, where the transaction is prohibited, the disqualified person
engaging in the transaction with the plan (which person may or may not
be the fiduciary) is liable to the government for an excise tax of 15%
of the amount involved in the transaction for each year until the
transaction is corrected; if the transaction is not corrected, a 100%
excise tax may be imposed. The DOL also may impose civil penalties of
20% of the amount it recovers from a breaching fiduciary in an
enforcement action. These are serious consequences.
In my experience, financial services firms seek to avoid these
potential liabilities and penalties by implementing policies and
procedures intended to comply with DOL regulations and interpretations
of the ERISA fiduciary rules.\1\
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\1\ It should be noted that, with limited exceptions, individual
retirement accounts (``IRAs'') are not subject to ERISA, but are
subject to the prohibited transaction rules through parallel provisions
in the Internal Revenue Code. While fiduciaries of IRAs thus would not
be subject to liability for a fiduciary breach under ERISA,
disqualified persons (such as fiduciaries) of IRAs could still be
subject to an excise tax under the Internal Revenue Code for engaging
in prohibited transactions.
---------------------------------------------------------------------------
This is in large part because the DOL has interpreted the
prohibition on fiduciary self-dealing in an expansive way. According to
the DOL, a fiduciary violates this prohibition wherever it has the
authority to affect the amount of compensation it receives from the
plan, or in connection with a transaction involving plan assets. Under
this view, if a person becomes a fiduciary by giving investment advice
for a fee for a transaction involving plan assets, and receives
variable compensation as a result, the person has violated ERISA, even
if the transaction is in the interests of the plan and is otherwise
prudent.
To lessen the potentially broad scope of the prohibited transaction
rules, ERISA contains a series of exemptions from those rules, and
authorizes the DOL to establish a procedure for granting exemptions.
The DOL may grant an individual exemption to a particular party, or a
``class'' exemption that is available to anyone in a defined class that
is able to comply with its conditions. To grant an exemption, the DOL
must first find that the exemption is (1) administratively feasible,
(2) in the interests of the plan and its participants and
beneficiaries, and (3) protective of the rights of plan participants
and beneficiaries. Exemptions are published for comment in the Federal
Register, and, if the exemption provides relief from the prohibited
transaction provisions on fiduciary self-dealing and conflicts of
interest, there must be an opportunity for a hearing. Using this
authority, the DOL has granted 59 class exemptions, several hundred
individual exemptions, and additional exemptive relief through an
expedited exemption procedure. The class exemptions have given rise to
a regulatory framework that, along with the statutory exemptions,
governs a significant portion of plan activities.
1975 Fiduciary Regulation and Class Exemptions
The ERISA fiduciary rules came into effect on January 1, 1975.
According to the ERISA conference report, the conferees were concerned
that the application of ERISA's fiduciary standard could be disruptive
to the established business practices of financial institutions.
In 1975, the DOL both granted an exemption, Prohibited Transaction
Exemption (``PTE'') 75-1, covering securities brokerage transactions
and related services, and issued a regulation defining the scope of the
``investment advice'' prong of the fiduciary regulation. PTE 75-1
established the conditions under which broker-dealers could continue to
provide multiple services to plan clients without running afoul of the
prohibited transaction rules. The regulation created a five-part test
for determining when a ``person'' becomes a fiduciary to a plan by
reason of providing ``investment advice.''
For almost 36 years, this five-part test has provided certainty and
clarity as to whether a person had entered into a relationship that
would subject that person to the ERISA fiduciary rules. It forms the
basis upon which financial services firms historically have based their
compliance procedures, structured their financial products and
services, implemented their fee and compensation arrangements,
established their business relationships and distribution channels, and
generally interacted with their plan clients. The five-part test has
now been in place for nearly four decades without any objection from
Congress that it was contrary to legislative intent.
Rules for Individual Retirement Accounts of IRAs
There are currently more than 40 million IRAs. Most IRAs are not
subject to ERISA or ERISA's standard of care. However, they are covered
by the Internal Revenue Code's (the ``Code's'') prohibited transaction
provisions, which are substantially parallel to those of ERISA. While
responsibility for interpreting the Code's prohibited transaction
provisions has been transferred to the DOL, the Internal Revenue
Service (the ``IRS'') retains full enforcement authority over these
Code provisions. Thus, DOL has no enforcement jurisdiction over the
vast majority of IRAs.
As individual accounts, IRAs are fundamentally different from ERISA
plans. These accounts are generally small and are overseen by the IRA
beneficiary, who has the ability to choose an IRA's service providers
and can generally move the account at will. Congress recognized these
differences when it applied a comprehensive fiduciary standard of care
to ERISA plans and only applied the prohibited transaction rules to
IRAs. On a number of occasions, the DOL also recognized these
differences, applying different conditions when crafting certain of its
prohibited transaction exemptions and regulations. For example, PTE 86-
128 (and its precursor PTE 79-1), a class exemption for securities
brokerage, and the Interim Final regulation under ERISA section
408(b)(2), which contains disclosure requirements, do not apply certain
of their conditions to IRAs.
Proposed Fiduciary Regulation
The proposed regulation that is the subject of this hearing would
make significant changes to the regulatory guidance that was adopted in
1975, and upon which the financial services industry has come to rely.
I am not going to speak on the pros and cons of specific features of
the proposal--those issues have been addressed in several hundred
comment letters, and will be discussed further by the other witnesses
on this panel. Instead, I am going to focus on the regulatory process.
There is much concern in the financial services industry about
potential ramifications if the proposal is adopted in its current form.
Many (if not most) of the issues being raised by the financial services
industry stem from concern that currently accepted and long-standing
business practices may, under the new regime, suddenly become
prohibited transactions. The DOL staff has responded that these issues
can be addressed through the exemptions process. In view of prior DOL
practices, this is a logical response where new-found fiduciary status
raises concerns about violations of the ERISA prohibited transaction
rules.
What could facilitate this process is that there are already
several class exemptions that could cover some of the transactions that
would be affected by the new DOL rule. The three that come to mind are:
(1) PTE 86-128, for a fiduciary to cause a plan to execute securities
transactions for a fee through itself or an affiliate (i.e., agency
brokerage); (2) PTE 84-24, for a fiduciary to cause a plan to pay the
fiduciary or an affiliate a commission as an insurance agent or broker
in connection with the purchase of an insurance or annuity contract
(i.e., insurance brokerage) or as a mutual fund principal underwriter;
and (3) PTE 75-1, Part II, for transactions in third-party mutual fund
shares.
The question is whether the approach of dealing with the
anticipated impacts of the new rules through the exemptions process
would be effective here. I see two problems with the exemptions
approach.
The first problem is that the existing class exemptions would not,
without modification or clarification, provide exemptive relief for all
transactions that would be affected by the proposal. The DOL could work
to modify and/or clarify the existing exemptions, or propose a new
class exemption more specifically focused on the business practices
that would be affected. So this, standing alone, would not necessarily
be a barrier.
However, this leads to the second problem, which is that modifying
a class exemption, or granting a new class exemption, can be a long,
complicated process. On average, the process usually takes at least a
year, and frequently longer. For more complicated transactions and
arrangements, as could be involved here, more time may be needed to
sort through the necessary relief and to develop conditions that are
workable for the plan fiduciaries and service providers. Yet more time
would be necessary if a hearing were requested, which could be the case
for a major exemption that affects a large portion of the financial
services industry. The point is that modifying existing exemptions
takes time, and developing a new exemption would take even more time--
the process must allow for that.
The timing issue is important when considering how to coordinate
the exemptions with the finalization of the regulation. It is likely,
based on the 201 comments that were filed with the DOL on the original
proposal, the testimony at the DOL hearing in March and the 65
additional comments submitted after the hearing, that there will be a
number of significant changes to the proposal. That alone should be a
reason for the DOL to re-propose its regulation, in order to give
affected firms an opportunity to review the new provisions and comment
on how they are dealing with the issues that were raised on the
original proposal. Another reason is that the proposal did not mention
IRAs, except for a brief reference in the opening summary, and provided
no economic analysis of the impact on IRAs (the focus of the economic
analysis was entirely on ERISA plans). There should be an analysis of
the effect on IRAs, including whether there is any benefit to
additional regulation of IRAs under the Code's prohibited transaction
rules in light of the current regulatory regimes that govern the IRA
market, and an opportunity to comment on that analysis.
There also is a need for affected parties to comment on whether any
new or modified exemption proposed by the DOL effectively addresses the
prohibited transaction issues created by the new rules. The parties
will have to determine whether it is feasible for them to operate under
the conditions of the exemptions--if the conditions are too complicated
or unworkable, the exemptions will not be of any help. This cannot be
done unless the exemptions are proposed in conjunction with re-proposal
of the fiduciary definition regulation, so that the two can be
considered together and modified as necessary based upon the comments.
For these reasons, it is my view that if the DOL elects to rely on
exemptions to deal with the effects of an expanded fiduciary
definition, it should re-propose the changes to the fiduciary
definition in coordination with its proposal of exemptive relief. This
would give affected parties sufficient opportunity to review and
comment upon all aspects of this new regulatory structure.
Again, thank you for giving me the opportunity to testify, and I
would be happy to answer any questions that you may have.
______
Chairman Roe. Thank you.
Mr. Mason.
STATEMENT OF KENT MASON, PARTNER,
DAVIS & HARMAN, LLP
Mr. Mason. Thank you.
My name is Kent Mason. I am with the law firm of Davis &
Harmon, and I have to admit that having worked in the benefits
area for almost 30 years, hard since I am, you know, just 35.
[Laughter.]
I want to thank you, Mr. Chairman, Ranking Member Andrews
for holding this hearing and for inviting me to testify.
I want to focus today on five issues. First, I want to
focus on really on something that hasn't been talked about
which is the common ground between the industry and the
department.
Second, I would like to talk about the process, third, I
would like to talk about the issue of conflicted advice,
fourth, I would like to talk about swaps which have been
briefly mentioned, and fifth, I would like to talk about the
effect on small business.
Okay. First, although there has been a tremendous amount of
concern articulated with respect to these proposed regulations,
I think that there is actually a significant amount of common
ground between the department and the industry.
For example, I think the basic notion that we should be
revisiting and--and reviewing a regulation that is 36 years old
and was written at a time that was vastly different, I don't
think that is something that I think the industry as I talk to
them have any concern about.
In addition, I think a number of the principles that the
department has articulated, you know, make solid sense. For
example, the department has said that advisors should be
legally required to stand behind their advice. That makes
sense.
Another thing the department has said is that if an advisor
tells a customer that they are a fiduciary they shouldn't be
able to disclaim that status later on. Again, that makes sense.
These are just examples.
Second, I want to turn to process. Briefly, this regulation
needs to be re-proposed. The department did not do an economic
study of IRAs. This department in its preamble repeatedly
indicated that they were not sure what the economic effect of
the regulation would be.
These economic studies need to be completed and they need
to be available for public comment. It would not be appropriate
for these economic studies to show up for the first time in a
final regulation with no opportunity for public comment.
In addition, the concern that has been noted here today
with respect to this regulation is widespread and bipartisan.
Republicans and Democrats have written, far more Democrats than
Republicans, employer groups, the Consumer Federation of
America, all have expressed the same concern that this
regulation has the potential to greatly reduce the availability
of investment services and thus retirement savings.
So the question really isn't whether to re-propose. The
question is why would anyone not want to re-propose? The
important part is we need to get this right.
Third, and I want to briefly talk on this, some have
suggested that the industry position is in favor of what is
called conflicted advice. On the contrary, the industry
position supports the fiduciary principles articulated in Dodd-
Frank, and I don't think there are many in Congress who believe
that Dodd-Frank stands for the principle of conflicted advice.
Fourth, swaps. There is a direct conflict between the
proposed fiduciary regulations and the proposed business
conduct standards coming out of the CFTC. That conflict would
prohibit plans from using swaps which could cost plans, large
plans, somewhere in the neighborhood of 100 million to a
billion dollars annually.
The department has written a letter to the CFTC, as Phyllis
mentioned, saying there isn't a conflict. The ask in this
regard is very simple and that is what the department said in
its letter needs to be reflected in binding legal guidance
issued on or before the final business conduct standards are
issued.
The last thing, I want to talk about small business. Today
broker dealers and other financial institutions provide
critical help to small businesses in putting together their
retirement plans. Under these regulations, that help would be
illegal.
In addition, under these regulations investment education,
unless this is clarified, investment education would dry up and
that is critical to small businesses.
Lastly, the small business owners would face much higher
costs and potential liabilities in forming a plan. All of this
will sort of greatly decrease plan formation along small
businesses and exacerbate our coverage challenges.
Thank you, and I would be happy to take any questions.
[The statement of Mr. Mason follows:]
Prepared Statement of Kent A. Mason, Davis & Harman LLP
My name is Kent Mason. I am a partner in the law firm of Davis &
Harman LLP and I have worked in the retirement plan area for almost 30
years. I am currently working with plan sponsors, plan sponsor trade
associations, and a wide array of financial institutions on the
concerns that have been raised with respect to the Department of
Labor's proposed regulation modifying the definition of a fiduciary.
I want to thank you, Mr. Chairman and Ranking Member Andrews, for
holding this hearing and for inviting me to testify. It is important
that the critical issues raised by the proposed regulation be addressed
in a robust public dialogue.
I am speaking today on my own behalf based on extensive discussions
with plan sponsors, plan sponsor trade associations, and numerous
financial institutions. I have been asked to focus my comments today
primarily on the challenges that the proposed regulation creates for
plan sponsors. That is an area that has received less attention, and I
am very happy to address it.
But first I will discuss three fundamental questions: (1) should
the definition of a fiduciary be reviewed, (2) if so, what process
should be used to review that definition, and (3) if the proposed
regulation is revised to address industry concerns, would harmful
conflicted advice be permitted?
Should the Fiduciary Definition Be Reviewed?
The threshold question is whether the definition of a fiduciary
should be reviewed and updated. The community that I work with
understands the desire to update a regulation that was drafted 36 years
ago when the retirement savings world was vastly different.
In addition, the community I work with agrees with certain basic
objectives that the Department has set out to achieve. For example:
Those who provide advice regarding investments should be
required to stand behind their advice legally. I believe that that is
generally the case already, but to the extent it is not, that should be
made clear.
A service provider who represents himself or herself to be
a fiduciary should not be permitted to later contest that status if an
investor makes a claim against the advisor. When a service provider
purports to be a fiduciary acting exclusively for the benefit of a
plan, participant or IRA owner, the service provider should not be able
to retroactively disclaim that status.
The law regarding fiduciary status needs to be clear so
that all parties fully understand the nature of their relationship.
It is critical to draw a distinction between selling and
advising, so that the fiduciary rules do not preclude normal selling
activities.
In short, I believe that there is a vast amount of middle ground
where the Department and the industry can come together.
The Process
Background. The definition of a ``fiduciary'' is a critical
component of the protections provided by ERISA. The definition can also
trigger enormous responsibility and potential liabilities. In this
context, it is essential that the issue be addressed deliberately
through a full public policy dialogue.
The Department has in recent years approached numerous topics in a
very deliberate, inclusive manner by issuing a ``Request for
Information'' (``RFI'') prior to issuing a proposed regulation. This
was not done here. That put the Department at an informational
disadvantage as it set out to draft the proposed regulation.
This information disadvantage naturally was reflected in the
proposed regulation:
The Department did not perform any cost analysis with
respect to the effect of the proposed regulation on IRAs.
In the preamble to the proposed regulation, the Department
repeatedly stated that it did not know the effect of the proposed
regulation on the market.
``The Department's estimates of the effects of this
proposed rule are subject to uncertainty * * * It is possible that this
rule could have a large market impact.''
``For example, the Department is uncertain regarding
whether, and to what extent, service provider costs would increase * *
*. The Department is also uncertain whether the service provider market
will shrink because some service providers would view the increased
costs and liability exposure associated with ERISA fiduciary status as
outweighing the benefit of continuing to service the ERISA plan
market.''
``The Department * * * tentatively concludes that the
proposed regulation's benefits would outweigh its costs.'' (emphasis
added)
``The Department is unable to estimate the number of small
service providers that would be affected by the proposal.''
``The Department also is unable to estimate the increased
business costs small entities would incur if they were determined to be
fiduciaries under the proposal.''
``It is possible that some small service providers may
find that the increased costs associated with ERISA fiduciary status
outweigh the benefit of continuing to service the ERISA plan market;
however, the Department does not have sufficient information to
determine the extent to which this will occur.''
The proposed regulation has raised grave concerns across
the political spectrum, among Democrats and Republicans, among employer
groups and the Consumer Federation of America. The concern is that the
proposed regulation would have very adverse unintended consequences and
result in a dramatic decrease in both the availability of critical
investment information for low and middle-income employees and the
efficient delivery of workforce retirement plans.
The existence of these unintended consequences run
contrary to the Department's stated goal of ensuring that individuals
have access to reliable advice, and result from the Department's
information disadvantage; without the RFI process, the Department had
to write the regulation in a data vacuum.
A study in the IRA area stated that if the proposed
regulation is finalized in its current form:
Approximately 360,000 fewer IRAs would be established
every year.
Solely within the study example, over seven million IRAs
would lose access to an investment professional. Since the study sample
included 40% of the IRA market, this could mean that nationally
approximately 18 million IRAs could lose such access.
Within the study sample, it was established that there
could be a $96 billion reduction in IRA assets through 2030; if that
number is extrapolated to the national market, the loss would be
approximately $240 billion.
Costs for those who retain access to an investment
professional would roughly double.
The Department has informally stated on many occasions
that in order to make the proposed regulation workable and avoid
depriving investors of investment information, the class exemption
rules needs to be modified. To date, no modifications have been
proposed.
The Department's regulations would force the restructuring
of plan systems that have developed over 36 years based on the current
definition of a fiduciary. To avoid widespread disruption, it is
critical that any changes to this fundamental rule be done very
carefully based on a full public policy dialogue. Without such a
careful review, we are risking an enormous reduction in investment
information and retirement savings. We could also trigger a very
significant wave of job losses throughout the industry, including, for
example, registered representatives who are not licensed to provide
advice.
Recommended process. The point here is that the proposed regulation
could well have vast and very serious unintended consequences. In that
context, the next steps seem clear.
The economic studies of the effect of the proposed
regulation need to be completed.
Those studies need to be the subject of public comment. It
would be strikingly inappropriate not to give the public an opportunity
to review the economic basis for the regulation.
At the same time that the economic study is made available
for public comment, the regulation itself should be reproposed. In the
light of the concerns that have been raised on a bipartisan basis and
the importance of the topic, there would not appear to be any reason
not to repropose. Why not get this right through a robust public
dialogue?
At the same time as the regulation is reproposed, all
associated new class exemptions needed to make the regulation work need
to be proposed. The regulation and these new class exemptions have to
work together. To finalize the regulation and then work on the class
exemptions does not make sense. Moreover, if the regulation is
finalized first, financial institutions will need to immediately begin
work on restructuring their businesses to reduce services; they cannot
wait based on the possibility that helpful class exemptions may someday
be adopted.
If the proposed regulation is revised to address concerns, would
harmful conflicted advice be permitted?
The regulation can easily be modified to address concerns without
permitting harmful conflicted advice.
First, many of the concerns regarding the proposed regulation
relate to the fact that almost any casual discussion regarding
investments becomes fiduciary advice. For example, if an employee in a
company's human resources department is asked whether a participant's
investment choices resemble other employees' choices, any casual
response--such as ``I am not an expert, but they seem similar''--would
be fiduciary advice. This result is clearly erroneous and should be
corrected, and correcting this type of problem cannot be said to permit
conflicted advice.
Second, the Department itself recognizes that there is a sharp
difference between advising and selling, and that the elements of a
sale may occur over a period of time, and are not just a moment in time
event. If an entity (1) is selling products or services, (2) can
benefit from which product or services is chosen, and (3) makes full
disclosure regarding that potential benefit, such actions are selling,
not advice. Clarification of that point through a reproposal process
would be extremely helpful, without raising any possibility of
conflicted advice.
Third, we can all benefit from the deep consideration given to the
fiduciary issue by Congress in the context of the Dodd-Frank Act. In
Dodd-Frank, Congress determined that the receipt of variable
compensation based on the investment advice given is consistent with a
fiduciary duty and does not give rise to a harmful conflict of
interest, provided that the variable compensation is fully disclosed.
The industry is supportive of the principles underlying the Dodd-Frank
provision and would be pleased to see those principles applied to the
proposed regulation.
In short, I believe that the modifications needed to the regulation
will not give rise to harmful conflicts of interest.
Plan Sponsor Concerns
Swaps
Plan sponsors use swaps to manage the funding risks inherent in
defined benefit plans. Without risk mitigation strategies, fluctuations
in interest rates can cause pension liabilities to fluctuate wildly,
leading to extremely volatile funding obligations. A company's funding
obligations can easily move by hundreds of millions of dollars--or even
billions of dollars--by reason of interest rate movements. This can
jeopardize the company's stability as well as undermine the security of
the participants' benefits.
There are three ways to address this volatility. First, a company
can reserve enormous amounts of cash in order to be prepared for the
volatility. In today's economic climate, that would result in massive
layoffs and stalled economic recovery. Second, a company can use swaps,
which were designed for exactly this purpose. Third, a company can use
bonds to hedge the risk; bonds are far less effective and more
expensive than swaps. The bond approach could, for example, cost large
companies from $100 million to $1 billion or more annually, when
compared to swaps.
Unfortunately, the plans' ability to use swaps is threatened by the
Department's fiduciary definition. There is a direct conflict between
the Department's proposed fiduciary definition and the proposed
business conduct standards issued by the Commodity Futures Trading
Commission (``CFTC'') pursuant to the Dodd-Frank Act. Briefly, the
proposed business conduct standards require swaps dealers and major
swap participants (``MSPs'') to take three actions that would, under
the Department's proposed fiduciary regulation, convert swap dealers
and MSPs into ERISA fiduciaries with respect to plan counterparties:
(1) the provision of information regarding the risks of the swap, (2)
swap valuation, such as providing mandated daily marks, and (3) a
review of the ability of the plan's advisor to advise the plan with
respect to the swap. Even under the Department's current investment
advice regulations, we believe that the third action could convert swap
dealers and MSPs into ERISA fiduciaries. If the swap dealer is a plan
fiduciary, a swap with the plan would be a prohibited transaction and
thus illegal. In such a case, all ERISA fiduciaries participating in
the transaction could have liability, and the dealer or MSP could be
subject to an excise tax equal to 15% per year of the amount involved
in the transaction. The penalties are so severe that absent regulatory
clarity, no one would risk them.
The Department has written a letter to the CFTC that takes the
position that the business conduct standards would not convert swap
dealers and MSPs into fiduciaries under the proposed regulation,
because of the ``seller's exception'' (also referred to as the
counterparty exception) in the proposed Department regulation. Further,
the Department confirms that the treatment of swaps dealers and MSPs as
fiduciaries was not intended.
The letter's statement of the Department's intent is helpful, as is
the letter's analysis of the regulation. Unfortunately, the letter is
(1) non-binding, (2) only an informal analysis of two proposed
regulations, and (3) in the view of the private sector lawyers I have
talked to, inconsistent with the regulatory language. Accordingly, the
Department's letter cannot be relied on by attorneys in analyzing the
law or giving opinions with respect to this issue. Based on extensive
discussions with the swap industry, ERISA plans, investment advisers,
and swap dealers would generally be unable to obtain opinions from
internal or external counsel that a swap dealer's compliance with the
CFTC's business conduct standards would not expose such dealers and the
plan fiduciaries to the risk of a prohibited transaction under ERISA.
As noted above, because of the severe penalties involved, unless the
regulation is modified so that this issue is clear, most swaps with
plans will likely cease. Major plans will not take a chance that they
are entering into prohibited transactions in the face of a regulation
that is unclear at best and adverse at worst. Plans, their fiduciaries,
and their counterparties are meticulous in their efforts to comply with
the Department's prohibited transaction rules. They would likely
conclude that it would be inadvisable, from both an ERISA and business
perspective, to rely on a non-binding letter in the face of a
regulation that is, as noted, at best unclear and at worst adverse.
Groups have met with the Department and have suggested that the DOL
issue binding guidance that simply makes it clear that the two
regulations are not in conflict. Briefly, the guidance would state that
no action required by reason of the business conduct standards will
make a swap dealer or major swap participant a fiduciary. The
Department has, however, expressed reluctance to do this. That has set
off alarm bells throughout the swap industry. If the Department is not
comfortable stating that there is not an irreconcilable conflict
between the regulations, it is hard to imagine that the private sector
can get comfortable with entering into swaps involving ERISA plans.
Very specifically, here is the language that was recommended be
inserted in the preamble to the CFTC's final business conduct
standards. This language can only be inserted with the Department's
approval.
The Department of Labor has informed the Commission that, in the
case of a swap with a plan subject to the Employee Retirement Income
Security Act of 1974 (``ERISA''), no action of a swap dealer or major
swap participant that is required by reason of these business conduct
regulations will make such swap dealer or major swap participant a
fiduciary under ERISA with respect to such plan, either under current
law or under the final version of the Department of Labor's proposed
regulations with respect to the definition of a fiduciary. The
Department of Labor has further informed the Commission that the
Department will, within 180 days of publication of the Commission's
final business conduct regulations, state in regulations, rules, or
similar guidance, effective as of the effective date of the
Commission's final business conduct regulations, that no action of a
swap dealer or major swap participant that is required by reason of
these business conduct regulations will make such swap dealer or major
swap participant a fiduciary under ERISA with respect to such plan.
If the business conduct standards are finalized without this or
similar language, swaps with plans will generally cease. Such language
is essential.
In short, in order to avoid the very negative consequences to
pension plans of being unable to use swaps, on or before the
finalization of the business conduct standards there needs to be legal
clarity on the fundamental point that no action required by reason of
the business conduct standards will make a swap dealer or an MSP a
fiduciary under current law or under the final version of the DOL's
proposed regulations.
Effects on Small Businesses
As discussed more fully below, the effects of the proposed
regulation would be very adverse with respect to the retirement
security of employees of small businesses:
Neither broker/dealers nor other financial institutions
would be able to assist small businesses with respect to critical
elements of plan maintenance. If such entities cannot help small
businesses in this regard, plan formation would fall sharply.
Investment education, which can give employees the
knowledge needed for them to be comfortable participating in a plan,
would largely dry up.
Small business owners who consider starting a plan would
face massive increases in potential liability and uncertainty and in
the cost of services, which would make them far less likely to adopt a
plan.
Plan maintenance/investment options. It is very well known that
retirement plan coverage among small businesses is far lower than among
all other organizations. The reasons are straightforward: cost,
burdens, liability, and complexity. In this context, please consider
the following scenario.
A financial institution approaches the owner of a 12-employee
hardware store about setting up a 401(k) plan. The owner is willing to
consider adopting a plan as long as the plan's formation is simple and
inexpensive and does not create any material liability for him.
The financial institution discusses the plan terms and structure.
Then, the subject of investment options is raised: when the plan is
established, the owner will have to choose investment options to be
made available to plan participants. The financial institution has, for
example, 500 investment options, which the hardware store owner will
need to narrow down to, for example, approximately 20 or 25, so as not
to overwhelm the employees. Today, the financial institution could, for
example, provide the owner with model portfolios chosen by similar
employers and could explain the differences among the portfolios so
that the owner can make an informed choice.
For a plan maintained by a small business owner, in particular, the
investments will predominantly be mutual funds. The funds pay the
financial institution various forms of ``revenue sharing.'' The amount
of revenue sharing will vary from fund to fund and is generally paid
whether or not the fund is held in a retirement account. It is this
system of revenue sharing that has made mutual funds an affordable
investment form.
Under the proposed regulation, helping the owner choose the plan's
investment options would make the financial institution a fiduciary.
This would mean that such help would be a prohibited transaction if, as
is the norm, some options benefit the financial institution more than
others by reason of different levels of revenue sharing and/or the
existence of both proprietary and non-proprietary funds. The help would
be a prohibited transaction regardless of how small any additional
benefit may be and regardless of the soundness of the help provided by
the financial institution.
So the financial institution would have to tell the owner that he
has two choices. First, the owner could review thousands of pages of
information provided by the financial institution regarding the 500
investment options and make his own choice, subject to fiduciary
liability. Or second, the owner could try to find a qualified third
party to help make the selections, pay that third party for that
service, and continue to pay the third party indefinitely to monitor
the investment options.
This scenario would play out across the country if the Department's
proposed regulation is adopted. The effect on small business retirement
plan coverage would be very adverse.
Plan maintenance/brokers and dealers. Brokers and dealers play a
major role in helping small businesses adopt plans. Often, a broker/
dealer will have a relationship with a small business owner. The
broker/dealer who handles the owner's non-retirement retail account may
raise the possibility of the owner adopting a 401(k) plan. Like the
financial institution situation described above, this is a very common
means by which small business owners adopt plans.
Unfortunately, under the proposed regulation, the commission-based
brokerage model becomes illegal due to the broker/dealer's receipt of,
for example, fully disclosed revenue sharing. So the broker/dealer
cannot be compensated for helping the owner with the formation and
operation of a 401(k) plan. Logically, then, the broker/dealer will
instead work with the owner on her non-retirement retail account, since
that is the only account the broker/dealer is permitted to work with.
Investment education. It is common today for financial institutions
to provide plan participants and plan sponsors with investment
education. This can be very helpful in encouraging business owners to
adopt plans and in encouraging employees to participate in those plans.
Under current law, it is generally agreed that information about
asset allocation principles is ``education'' and does not trigger
fiduciary status. So investment professionals can, without becoming
fiduciaries, educate plan participants about different asset classes,
and what mix of asset classes is most appropriate in different
circumstances. The basis for the understanding regarding education is
Department Interpretive Bulletin 96-1 (``96-1''). Reliance on this
bulletin is widespread and the concepts behind it are generally well
received. In small businesses especially, this type of education can be
helpful in encouraging employees to participate in a plan. If such
education triggered fiduciary status, the provision of the education
would largely dry up, due largely to the prohibited transaction rules,
but also due to liability concerns.
There is great concern that the proposed regulation would sharply
decrease the provision of investment education. It is true that the
proposed regulation expressly states that education under 96-1 does not
give rise to fiduciary status. However, unlike present law, it appears
that under the proposed regulation information about asset allocation
would trigger fiduciary status but for the explicit exception for 96-1
education. This has caused the following concern. If education does not
comply precisely with 96-1, education becomes fiduciary advice. But 96-
1 is not a detailed set of rules; it is largely conceptual, which makes
it hard to be certain of compliance.
In this context, many education providers have expressed grave
doubts that they would continue providing investment education if the
proposed regulation were finalized. This is not an unfounded concern by
any means, since 96-1 itself notes that whether information is
education or fiduciary advice is turns on the facts and circumstances
of the particular situation. The proposed regulation states that
information may be advice if it ``may be considered'' in connection
with making plan investments. Since it can reasonably be expected that
education about investment may be considered by the recipient in making
investment decisions, providers of needed education will likely
restrict the information that they provide due to the chance that they
might become fiduciaries for providing what they consider to be
educational materials.
Distribution education. In the preamble to the proposed
regulations, the Department raised the possibility of modifying the law
to treat distribution counseling and education as investment advice.
This issue has the potential to create significant uncertainty and
dramatically reduce the provision of basic information regarding
distribution issues. At a minimum, any change in the law should be
implemented through the regulatory process with an opportunity to
comment on proposed regulatory language.
Liability and uncertainty. Under the proposed regulation, almost
any discussion of investments would give rise to fiduciary status. So
small business owners would face very serious potential liabilities and
uncertainties if they or their managers respond to any employee
inquiries regarding plan investments. This type of exposure would be a
very significant disincentive to plan formation and maintenance.
Similarly, if service providers are converted into fiduciaries, the
service providers will need to charge more to cover their increased
potential liability. This will be another powerful disincentive to plan
formation.
In short, the proposed regulation would dramatically reduce small
business plan formation by precluding financial institutions from
assisting small businesses in this regard. Investment education would
largely dry up, making employees far less comfortable about
participating in a plan. And small business owners would be discouraged
from establishing a plan by the creation of far more potential
liability and higher costs.
Additional Plan Sponsor Concerns
Because the proposed regulation was written without the benefit of
prior input, the list of concerns is extremely extensive. I will simply
provide two additional examples of plan sponsor concerns.
Plan sponsor employees: who should be a fiduciary? By very
significantly lowering the threshold for fiduciary status, the proposed
regulation raises serious questions regarding which plan sponsor
employees may be treated as fiduciaries. For example, it is, of course,
common for a plan sponsor to form a committee of senior executives to
oversee plan issues, including plan investment issues. It is certainly
clear that such committee has fiduciary status. But plan sponsors have
expressed concern about the status of other employees who perform the
research and analysis necessary to present investment issues for the
committee's review and resolution.
Such other employees may provide recommendations for the committee
to consider. This is simply how companies work. Middle-level employees
frame issues for senior employees to resolve; issues are best presented
in the context of a recommendation based on the advantages and
disadvantages of any decision, so that senior employees can quickly
appreciate the relevant factors. Many employees may participate in the
research and the preparation of the recommendations to the committee.
If all of these employees were fiduciaries, the effects would be
severely negative.
The cost of fiduciary insurance would skyrocket, if such
insurance would be available at all for such employees.
It would certainly become more difficult to get employees
to work on these projects in the face of potentially staggering
liabilities and lawsuits.
Creative work and recommendations would likely be stifled
as middle-level employees propose conservative approaches with less
downside (and correspondingly less upside).
The bottom line is that the employees preparing the reports for the
plan committee are not the decision-makers. They are the researchers
who prepare recommendations based on objective criteria for the
committee members to evaluate and resolve. And the proposed regulation
could potentially sweep in a huge number of employees, since the
middle-managers formulate their recommendations based on the work of
employees who in turn work for them.
The regulation needs to address the situation where a company or
committee within a company serves as a fiduciary with respect to
investment decisions or recommendations. In that case, the employees
who help the company or committee make those decisions or
recommendations should not be fiduciaries. Otherwise, we could have a
real problem as potentially hundreds of employees without decision-
making power become fiduciaries. This is not to suggest that employees
of a fiduciary company cannot be a fiduciary. For example, an advisor
company's employee may have the advisory relationship with a plan or
participant and may become a fiduciary by reason of that relationship.
But such cases are different. In these cases, employees involved are
making direct investment recommendations that are not filtered through
supervisors or entities that are fiduciaries.
``Management of securities or other property'': the proposed
regulations would transform contract reviews and other non-investment
advice into investment advice. The proposed regulation would include
within the definition of ``investment advice'' the following: ``advice
* * * or recommendations as to the management of securities or other
property.'' The preamble states that:
This would include, for instance, advice and recommendations as to
the exercise of rights appurtenant to shares of stock (e.g., voting
proxies), and as to selection of persons to manage plan investments.
The broad language of the proposed regulations raises many
questions:
A plan decides to change trustees, chooses a new trustee,
and begins negotiating a trust agreement with the new trustee. The plan
asks for advice with respect to the terms of the trust agreement from
the plan sponsor's internal and external ERISA and contract attorneys,
as well as the plan sponsor's compliance personnel, human resources
department, and tax department. The trustee is involved in the
``management'' of plan assets, and the terms of the trust agreement
affect that management. Does that mean that all of the above personnel
advising the plan with respect to the trust agreement are fiduciaries?
If it does, the cost of trust agreements and many other routine plan
actions will increase exponentially with the imposition of new duties
and large potential liabilities. Also, many of the above persons may
refuse to work on the project without a full indemnification from the
plan sponsor. We do not believe that this type of cost increase and
disruption was intended.
What about the persons working on the agreement for the new
trustee? If such persons make any ``recommendations'' to the plan in
the course of negotiations, they would become fiduciaries because the
seller exemption, on its face, only appears to apply to sales of
property and not services. Any such recommendations would thus trigger
fiduciary status and corresponding prohibited transactions.
Theoretically, this could chill all meaningful give-and-take during the
negotiations, and many institutions may be unwilling to act as trustee.
Again, we do not think that this was intended.
A plan has decided to enter into a swap and must execute a
swap agreement. The terms of the swap agreement will have a significant
effect on the plan's rights with respect to the swap. The plan asks its
internal and outside securities counsel to work on the swap agreement,
and to consult with the plan's internal and outside ERISA counsel. The
plan also asks its investment manager for input on the types of
provisions that are important for plans to include (or exclude) in swap
agreements. The plan accountant is also asked to review the agreement.
Finally, the company's own compliance personnel, contract experts, and
finance department also review the agreement.
The terms of the swap agreement affect the ``management'' of the
swap. So do all of the above personnel become fiduciaries under the
proposed regulations? If the answer is yes, plans' cost of investments
will skyrocket, as an enormous new set of individuals and companies
that have little material role in plan investments become fiduciaries,
with far greater potential liability and a higher standard to meet. In
addition, as noted above, many persons would likely refuse to review
the agreement absent a full indemnification by the plan sponsor.
A plan negotiates a loan agreement in connection with an
ESOP. Is everyone who works on the loan agreement a fiduciary? Could
individuals working on the loan agreement for the lender become
fiduciaries if they make any ``recommendations'' during negotiations?
To avoid the inappropriate results described above and many other
similar results, the regulation should provide a precise and
appropriately narrow definition of ``management'' in the regulation.
Under the definition, ``management'' would include:
The selection of persons to manage investments;
Individualized advice as to the exercise of rights
appurtenant to shares of stock; and
Any exercise of discretion to alter the terms of a plan
investment in a way that affects the rights of the plan, unless such
exercise of discretion has been specifically reviewed and agreed to by
a plan fiduciary. In the swap context, for example, swap terms can be
modified without plan review and consent by, for example, swap data
repositories. If any such changes are made, anyone making those changes
is acting for the plan and should be treated as a fiduciary. Moreover,
such treatment is necessary in order to prevent harm to the plan.
This would target the actions identified by the Department in the
preamble. But it would not have the inappropriately broad consequences
illustrated above.
Summary
The critical message is that the decision regarding this proposed
regulation could have a dramatic effect on the retirement security of
millions of Americans for years to come. To rush through this project
without adequate study, without a full public policy dialogue, and
without all exemptions needed to make the regulation work would be very
harmful. Reproposal of the regulation is needed, as discussed above.
______
Chairman Roe. Thank you, Mr. Mason.
Professor Stein?
STATEMENT OF NORMAN STEIN, PROFESSOR,
EARLE MACK SCHOOL OF LAW, DREXEL UNIVERSITY
Mr. Stein. Thank you, Chairman Roe, Mr. Andrews, and
members of the subcommittee.
I am testifying on behalf of the Pension Rights Center this
morning, a nonprofit consumer organization that has been
working since 1976 to protect the retirement security of
American workers and their families.
The proposed regulations describe when a person who renders
investment advice to a plan or plan participant is considered a
fiduciary under ERISA. One of the principle congressional goals
in enacting ERISA was to ensure that those individuals who
provided investment advice with respect to retirement plan
assets would be fiduciaries and as such would be subject to
ERISAs prohibitions against fiduciaries entering in--
transactions.
ERISA was clear and unequivocal in this issue. The term
fiduciary is expressly defined to include any person who
renders investment advice for a fee or other compensation,
direct or indirect, with respect to any monies or other
property of the plan.
The Department of Labor's 1975 regulation, however,
improperly narrowed this definition providing that investment
advisors would not be considered fiduciaries unless their
advice was provided pursuant to an agreement, arrangement or
understanding that such services would serve as a primary basis
for investment decisions with respect to plan assets and are
provided on a regular basis.
In the context of the times, however, the regulations
inconsistency with the statute did not create serious issues.
The retirement world was then dominated by defined benefit
pension plans and the rules permitting today's 401k plans were
more than 5 years away.
Investment professionals were primarily advising
sophisticated fiduciaries who were more capable of synthesizing
market information and better able to identify and evaluate
conflicts of interest than today's typical participant in a
self-directed 401k plan.
Today the world is different. Most people saving for
retirement are on 401k plans and individual retirement
accounts, which basically or most of the money there is
rollover money from employer plans, and they have to make their
own investment decisions despite their lack of investment
experience or knowledge.
They are, thus, highly dependent on the advice offered to
them by the investment industry but unfortunately the advice
they receive is sometimes subject to serious conflicts of
interest.
Indeed, today some investment advisors receive revenue
sharing and other payments from the vendors of the products
they recommend. ERISA would prohibit some such payments if the
investment advisors are ERISA fiduciaries, but a significant
part of the advice industry claims that the 1975 regulations
shield them fiduciary status and allow them to accept such
third party payments so long as they include metaphorical fine
print indicating that the investment services are not provided
under an agreement, arrangement, or understanding that the
advice will be a primary advice for investment decisions or are
not provided on a regular basis.
The Government Accountability Office has shown that such
conflicts can have significant costs to plan participants and
401k plans.
I thought I would put a human face on this. My own. In
1987, while I was a visiting professor at the University of
Texas, a man knocked at my office door. He had gotten my name
from a colleague on the Texas faculty and he wondered whether
he could talk with me for a moment about a 403(b) investment
product.
During the conversation he learned, among other things,
that I was in my 30s and that I would be at Texas for only that
semester and, thus, that the contributions that I made during
the semester would be my only contributions to the product he
advised me to purchase.
I cannot now remember everything he told me, but he was
charming and fun and was a University of Alabama fan where I
was then teaching full time, and I ended up following his
recommendation.
During the year I contributed $1,165 dollars in salary
reductions to this investment product. Today, 24 years later, I
brought the statement but I left it on my desk, the value of
the investment contract is $1,506.89 which provided me, for
those who are interested, in annual yield of just a smidgen
over 1 percent per year. And because of inflation, my
investment in 1987 dollars is worth approximately $350.
The reason that this investment performed so poorly was
after various fees and charges relative to the investment
earnings were substantial. The sales person should have known
that this was a terrible investment choice for a person in my
circumstances and my age.
But he either knew no more than I did about investing or,
more likely, was motivated by the amount of compensation he
would earn by selling me that particular product rather than a
more appropriate product.
My real problem was that he was an investment salesman
posing as an investment advisor. If he had been a fiduciary and
had been free of conflicts, I would have received better
advice.
And if all investment advisors to ERISA plans were
fiduciaries as Congress intended and these proposed regulations
would provide, millions of Americans, some who were even less
sophisticated than I was in 1987, would receive better quality
advice.
[The statement of Mr. Stein follows:]
Prepared Statement of Norman P. Stein, on Behalf of the
Pension Rights Center
Thank you, Chairman Roe and Mr. Andrews, and members of the
subcommittee, for inviting me here to speak with you this morning on
the Department of Labor's proposed regulation on the definition of
fiduciary. I am testifying this morning on behalf of the Pension Rights
Center. The Center is a nonprofit consumer organization that has been
working since 1976 to protect and promote the retirement security of
American workers, retirees, and their families.
The proposed regulations that are the subject of today's hearing
describe when a person who renders investment advice to a plan or plan
participant is considered a fiduciary under Title I of ERISA and under
the Internal Revenue Code. These regulations would replace 1975
regulations, which reflect an improper agency constriction of the
relevant statutory language and congressional intent. In addition, as
the Department suggests in its preamble to the proposed regulations,
economic and legal developments in the fields of investments and
employee benefit plans have increased the original regulations' harmful
impacts.
One of the principal congressional goals in enacting ERISA was to
ensure that those individuals who provided investment advice with
respect to retirement plan assets would be fiduciaries, subject to
ERISA's prohibitions against fiduciaries entering into certain
conflict-tainted transactions. ERISA was clear and unequivocal on this
issue: the term fiduciary is defined to include any person ``who
renders investment advice for a fee or other compensation, direct or
indirect, with respect to any moneys or other property'' of a plan.
The Department of Labor's 1975 regulation narrowed this definition,
providing that investment advisers would not be considered fiduciaries,
unless their advice was provided ``on a regular basis'' and ``pursuant
to an agreement, arrangement or understanding that such services will
serve as a primary basis for investment decisions with respect to plan
assets.'' There is nothing in the legislative history that supported
these extra-statutory limitations on the definition of fiduciary.
Moreover, the terms ``regular basis,'' ``mutual agreement, arrangement
or understanding,'' and ``a primary basis'' are subjective and
ambiguous and have created confusion.
In the context of the times, however, the regulation's
inconsistency with the statute did not create serious problems. The
retirement world was then dominated by defined benefit pension plans,
and the regulations permitting today's 401(k) plan were almost six
years away. Investment professionals were primarily advising
sophisticated fiduciaries, who were more capable of synthesizing market
information and better able to identify and evaluate potential
conflicts of interest than today's typical participant in a self-
directed 401(k) plan.
Today, the world is different: most people saving for retirement
are in 401(k) plans and individual retirement accounts (most of which
hold rollover money from employer plans), and these account holders
have to make their own investment decisions despite their lack of
investment experience or knowledge. They are thus highly dependent on
the advice offered to them by the multi-billion-dollar investment
industry, but unfortunately the advice they receive is sometimes
subject to serious conflicts of interest. Indeed, today some investment
advisers receive payments from the vendors of the products they
recommend.
ERISA would prohibit some such payments if the investment advisers
are ERISA fiduciaries, but a significant part of the advice industry
claims that the 1975 regulation shields them from fiduciary status and
allows them to accept all third-party payments, so long as they include
fine print indicating that investment services rendered are not
provided under ``an agreement, arrangement or understanding that the
advice will be a primary basis for investment decisions'' or are not
provided on a ``regular'' basis. The Government Accountability Office
has shown that such conflicts can have significant costs to
participants in 401(k) plans.
I can tell a story from my own experience to illustrate the impact
of such conflicts. In 1987, while I was a visiting professor at the
University of Texas, a friendly and confident man knocked at my door.
He had gotten my name from a colleague on the faculty, and he wondered
whether he could talk with me about investing in a flexible premium
fixed annuity. During the conversation he learned, among other things,
that I would be at Texas for only that semester and thus the
contributions I made during the semester would be my only contributions
to the product he advised me to purchase. I am not certain now exactly
everything he told me then, but he was a polished salesman and I ended
up following his recommendation.
During the year I contributed $1,165.19 in salary reductions to
this annuity product. Today, 24 years later, the value of this
investment contract is $1,506.89, which provided me, for those who are
interested, an annual yield of just a smidgen over 1 percent. And
because of inflation, my investment today, in 1987 dollars, is worth
only $229.73. I would have done better putting my money in an insured,
passbook savings account at my credit union.
The reason that this investment performed so poorly for me is that
the actual earnings under the plan were themselves very low, and the
fees, relative to the earning, were very high. The salesperson should
have known that this was a terrible investment choice for a person
still in his 30s. He either knew no more than I did about investments
or, more likely, was motivated by the amount of fees he would earn by
selling me that particular and inappropriate product rather than
another product. My real problem was that he was an investment salesman
posing as my investment adviser.
If he had been a fiduciary and had been free of conflicts, I would
have received better advice. And if all investment advisers were
fiduciaries, millions of Americans--some even less sophisticated than I
was in 1987--would receive a better quality of advice.
Some segments of the investment community have argued that the
proposed regulations would make it impossible for broker-dealers to
give advice or sell products to participants in 401(k) plans and
individual retirement accounts. The proposed regulation, however, would
not prohibit broker-dealers from giving investment advice, and indeed
many broker-dealers today give investment advice by complying with
statutory and regulatory exemptions to the prohibited transaction
rules.
The argument that broker-dealers would be excluded from giving
investment advice apparently is based on the notion that the only
permissible form of compensation paid to an investment adviser would be
on a fee basis. This is not correct: the Department of Labor has a
prohibited transaction exemption that permits fiduciaries to receive
commission-based compensation for the sale of mutual funds, insurance
and annuity contracts and has signaled its willingness and intent to
issue additional exemptions. In addition, the statute itself includes a
prohibited transaction exemption for investment advice if fees are
leveled or if the investment advice is determined through objective
computer programs. And broker-dealers are also free to provide
investment education rather than investment advice.
But it is true that under the new regulations broker-dealers will
not be able to use certain business models in which their objectivity
is compromised by serious conflicts of interest. Will these people
abandon the retirement savings market? Perhaps some will, but we are
confident, given the size and importance of that market, that most will
adapt. And in our view, those who are unwilling to eschew serious
conflicts have no business advising retirement-plan participants.
Finally, we think public policy would be better served if those are
currently trying to kill these proposed regulations instead devoted
their efforts to working with the Department of Labor to help craft
exemptions from the prohibited transaction rules that will accommodate
a wide variety of reasonable compensation structures for those who
sell, directly or indirectly, their services to participants in 401(k)
and individual retirement plans. That would be good for participants
and good for the industry.
(Attached to this testimony are comments of the Pension Rights
Center and the National Employment Lawyers Association on the
regulations, which were submitted to the Department of Labor on
February 3, 2011.)
______
[Filed Electronically],
Washington, DC, February 3, 2011.
Re: Definition of Fiduciary Proposed Rule.
The Pension Rights Center (the Center) and the National Employment
Lawyers Association (NELA) submit the following comments on the
Department of Labor's proposed regulations on the definition of
fiduciary. The Center is a nonprofit consumer organization that has
been working since 1976 to protect and promote the retirement security
of American workers and their families. NELA has been advancing
employee rights and serving lawyers who advocate for equality and
justice in the American workplace since 1985.
The proposed regulations would replace current regulations, adopted
in 1975, that tightly circumscribe the circumstances under which a
person or entity becomes a fiduciary when providing investment advice
to a plan or participant for a fee. The regulations would also reverse
a 1976 advisory opinion holding that a firm valuing employer stock for
an ESOP was not a fiduciary.
The 1975 regulation and 1976 advisory opinion were not compelled by
the statute and, in our view, reflected an improper narrowing of the
congressional definition of fiduciary. In addition, as the Department
suggests in its preamble to the proposed regulations, economic and
legal developments in the fields of investments and employee benefit
plans have rendered the earlier positions anachronistic and, at times,
at cross-purposes with the statute. The proposed regulations are much-
needed and long-overdue.
Background
When Congress passed ERISA in 1974, it included rules governing the
conduct of fiduciaries. Senator Harrison Williams, Chair of the Senate
Labor Committee and a key co-sponsor of ERISA in the Senate, explained
the need for these rules when he presented the ERISA Conference
Committee resolution reconciling the House and Senate versions of
pension reform legislation: ``Despite the value of full reporting and
disclosure, it has become clear that such provisions are not in
themselves sufficient to safeguard employee benefit plan assets from
such abuses as self-dealing, imprudent investing, and misappropriation
of plan funds.'' \1\ In other words, fiduciary standards were essential
for the protection of participants in employee benefit plans. Congress
crafted rules applying fiduciary standards not only to plan trustees,
but to a range of individuals and entities whose actions affect the
security and use of plan funds and the benefits of participants. These
rules of conduct applied to ``fiduciaries,'' which Congress defined as
any person who fits one of the following categories:
(1) exercises any discretionary authority or discretionary control
respecting management of a plan;\2\
(2) exercises any authority or control respecting management or
disposition of a plan's assets;\3\
(3) renders investment advice for a fee or other compensation,
direct or indirect, with respect to any monies or other property of a
plan, or has any authority or responsibility to do so;\4\ or
(4) has any discretionary authority or discretionary responsibility
in the administration of a plan.\5\
The 1975 regulations addressed the third aspect of the definition--
a person who renders investment advice for a fee. The regulations
narrowed the statutory language (which broadly provided that a person
is a fiduciary if he renders investment advice ``for a fee or other
compensation, direct or indirect, with respect to any moneys or other
property of'' a plan) to two narrow circumstances: first, if a person
has discretionary authority or control with respect to purchasing or
selling securities or other property for a plan;\6\ and second, if a
person renders investment advice to a plan on a regular basis, pursuant
to an agreement or understanding that the advice will be a primary
basis for the plan's investment decisions, and that the advice is
individualized to the particular needs of the plan.\7\ In the preamble
to the presently proposed regulations, the Department describes this as
a five-part test, with a person found to be a fiduciary only if all
five parts of the test are met.
The regulations also provided, in effect, a definition of the type
of advice that concerned plan investments: advice concerning the value
of securities or property, or advice concerning the advisability of
investing in, purchasing, or selling securities or other property.
A year after the 1975 regulations were promulgated, the Department
held that a consultant that provided an evaluation of employer
securities for an ESOP was not a fiduciary under the regulatory
definition, because the valuation would not ``involve an opinion as to
the relative merits of purchasing the particular employer securities in
question as opposed to other securities,'' and would thus not serve as
a ``primary basis'' for plan investment decisions nor ``constitute
advice as to the value of securities.''
The newly proposed regulations would substitute a simpler and more
easily understood, enforced, and administered test that bears greater
fidelity to the statutory language and is appropriate to developments
over the intervening 35 years in the areas of retirement plans and
investments. The new test would provide that a person renders
investment advice for a fee under ERISA if the person gives certain
types of advice to a plan, plan fiduciary, or plan participant or
beneficiary, and also falls within one of four categories of persons.
The types of advice covered by the proposed regulation are: (1)
advice, appraisal, or fairness opinion concerning the value of
securities or other property; (2) advice or recommendation as to the
advisability of purchasing, holding, or selling securities or other
property; and (3) advice or recommendations as to the management of
securities or other property. The new regulations thus expand the ambit
of covered investment advice from the 1975 regulations to fairness
letters and appraisals of property, and eliminates the cumbersome five-
part test that depends on the proof of the details of the relationship
between advisor and advised and eliminates from the realm of investment
advice much that any layperson would understand to be such advice.
By including advice as to the management of securities or other
property in the definition of investment advice (not just advice as to
valuation or the advisability of purchasing or selling securities), the
Department makes explicit in the text of the regulation, its
longstanding interpretation of the existing regulation, which included
advice as to the selection of managers and investment options. DOL Adv.
Op. 84-04A, 1984 WL 23419, *1-3 (Jan. 4, 1984). The regulations also
make clear that advice as to the management of a particular asset, e.g.
advice as to proxy voting or how to maximize the income incident to a
piece of real property, is also fiduciary advice. In addition, they
make explicit that investment advice gives rise to fiduciary status if
it is furnished to a plan participant or beneficiary.
To be considered a fiduciary under the proposed regulations, a
person who gives such advice meets the requirement of the regulations
if the person: (1) represents or acknowledges that it is acting as a
fiduciary; (2) is already a fiduciary under the other legs of the
statutory definition of fiduciary; (3) is an investment adviser under
the Investment Advisers Act of 1940; or (4) provides advice or makes
recommendations pursuant to an agreement, arrangement, or understanding
between such person and the plan, plan fiduciary, participant, or
beneficiary that such advice may be considered in connection with
making investment or management decisions with respect to plan assets
and will be individualized. The proposed regulations' most important
departure from the 1975 regulations is that under the fourth category,
the advice does not have to be rendered on a regular basis and need not
be provided pursuant to an agreement or understanding that it will
serve as a ``primary'' basis for investment.
As discussed below, however, the advice must be provided pursuant
to an agreement or understanding that such advice may be considered in
connection with making investment management decisions and will be
individualized to the needs of the plan, a plan fiduciary, or a
participant or beneficiary. The existing regulations provide that
advice be individualized to the needs of the plan. The new regulations,
in what we understand is clarification of the Department's existing
interpretation, make clear that the advice may be individualized to the
needs of the plan, plan fiduciary, plan participant, or beneficiary,
i.e. to the needs of the recipient of the advice, to distinguish such
advice from the generalized buy recommendation that a broker might
issue to all of its clients on a given publicly traded stock.
The regulations also include a number of limitations on the
regulations' coverage. One of the limitations provides that a person
offering advice or recommendations is not an investment-adviser
fiduciary if such person can demonstrate that the recipient of the
advice knew, or should have known, that the person is providing the
advice in its capacity as a purchaser or seller (or agent for a
purchaser or seller) of securities or other property, whose interest
are adverse to the plan or its participants or beneficiaries, and that
the person is not undertaking to provide impartial investment advice.
The regulations also do not apply to persons who provide only
investment education or persons who make available to a plan a group of
investment options from which a plan fiduciary will decide which
options to offer. The term investment advice also does not include
advice or an appraisal or fairness opinion for purposes of complying
with reporting and disclosure requirements of ERISA or the Internal
Revenue Code unless such report involves assets for which there is not
a generally recognized market and which serves as a basis on which a
plan may make distributions to plan participants and beneficiaries.
The Preamble to the Regulations also invites comments on the
question of whether a person who gives advice to participants with
respect to distributions is providing investment advice.
Revision of the 1975 Regulations is Warranted
Developments in Retirement Plans and Investments Since 1975
The existing regulations were promulgated in 1975, at the dawn of
the ERISA era. Since then, there have been significant changes in the
retirement plan and investment universe that have undermined whatever
justification there might have been for the regulations' cramped scope.
As the preamble to the proposed regulations notes, there has been a
seismic shift in the retirement plan world from defined benefit plans--
in which investment advice was generally rendered to sophisticated plan
fiduciaries--to self-directed defined contribution plans--in which
investment advice is issued to individual participants, many of whom
have only rudimentary financial literacy. Mutual funds, and sellers and
brokers for mutual funds, who played a relatively small role in
retirement plans at the time ERISA was enacted, have become dominant
players in the new order. The variety and complexity of investment
products has also changed markedly over the last three decades.
At the time of the 1976 advisory opinion on valuations of employer
stock for ESOPs, there were only 250,000 participants in 1,600 ESOPs.
Today ESOPs cover more than 12 million participants in over 10,000
plans, which hold almost 1 trillion dollars in employer securities.\8\
The exponential growth of ESOPs has been accompanied by numerous cases
involving improper valuations of employer stock purchased or sold by
ESOPs.\9\ Yet, the 1976 opinion letter effectively shields these plans'
valuation advisers from fiduciary liability.
There have also been significant legal developments since the time
the regulations were promulgated. The Supreme Court ruled in Mertens v.
Hewitt Associates, 508 U.S. 248 (1993), that a participant generally is
entitled to legal relief under ERISA only if the defendant is a
fiduciary who caused monetary loss to a plan.\10\ A participant can sue
a person other than a fiduciary only for equitable relief, and the
Supreme Court has narrowly circumscribed the extent to which such
equitable relief is available. Great West Life & Annuity Ins. Co. v.
Knudson, 534 U.S. 204 (2002). The Labor Department, which filed amicus
curiae briefs arguing against these positions, could not have known in
1975 that its narrowly drawn regulations and ERISA preemption would
effectively create an unregulated playing field for so many actors who
have a direct and substantial impact on plan investments.
Finally, in the period since 1975, the Department has determined
that voting of proxies and similar issues are part of investment
management and has concluded that investment advice as defined in the
regulations includes advice regarding the selection of investment
managers. This last point has caused controversy see Cohrs v. Salomon
Smith Barney, 2010 WL 2104535 (D.Or., Aug. 31, 2005). and recently
required the DOL to file an amicus brief to defend its interpretation
of the old regulations. See DOL amicus brief in In Re Beacon Securities
Litigation, 09-CV-077 (LBS), 2010 WL 3895582 S.D.N.Y. Although the
Department's position prevailed in district court, the issue remains
hotly contested and will likely be the subject of an appeal by
defendants in Beacon if plaintiffs prevail on the merits. It is
therefore appropriate for the Department to revise the regulations to
address investment advice concerning such issues to eliminate any doubt
in the courts that such advice should give rise to fiduciary status.
We have heard it argued that this view, that investment advice
should include advice regarding the selection of fiduciaries to manage
assets, will have the baneful effect of discouraging informal advice
about, for example, the selection of independent fiduciaries from
trusted advisors such as plan counsel. We disagree. Advice as to the
selection of an independent fiduciary is not legal advice if it goes
beyond evaluating whether a particular firm meets the legal
requirements to act as an independent fiduciary or advising as to the
nature of a prudent selection process. If lawyers choose to go beyond
providing legal advice and provide advice as to whom a plan should
select to manage plan assets, then there is no reason why those lawyers
should receive a special dispensation from fiduciary status as compared
to a consultant who habitually makes recommendations about asset
allocations and asset manager selections, unless we adopt the too-
convenient fiction that no one heeds the advice of lawyers who exceed
the ambit of their professional competence. The concern that plans will
be deprived of the unique perspective of lawyers who have experience
working with independent fiduciaries is overblown. Lawyers can identify
the independent fiduciaries with whom they have worked and describe
factually their experiences with them without purporting to make a
recommendation. Alternatively, they can make a recommendation and
lawyers, more than anyone, understand that the implicit claim of
competence in giving such advice will give rise to fiduciary
responsibility.
The 1975 Regulations Improperly Narrowed the Meaning of Investment
Advice
ERISA Sec. 3(21)(A) provides straightforwardly that a person is a
fiduciary if he ``renders investment advice for a fee or other
compensation, direct or indirect, with respect to any moneys or other
property of such plan, or has any authority or responsibility to do
so.'' The 1975 regulations narrowed the scope of this language by
limiting it to investment advice that was ``regular,'' rather than one-
time or episodic; advice that was rendered pursuant to an agreement or
understanding that it would be a ``primary basis'' for investment; and
advice that is ``individualized'' to the particular needs of the
plan.\11\ These limitations are not consistent with the plain meaning
of the term ``investment advice,'' and at least in retrospect can be
said to impede rather than advance the congressional goals of limiting
self-dealing and of assuring prudent investment of plan assets.\12\ As
the Preamble to the Proposed Regulations notes, people providing
investment advice not covered by the regulations have considerable
influence on the decisions of plan fiduciaries and sometimes have
conflicts of interest that result in lower returns and less retirement
income for plan participants and their beneficiaries. The regulatory
definition is also inconsistent with judicial language indicating that
Congress generally intended the term fiduciary to be ``broadly''
construed.\13\
The problems of the regulatory definition are illustrated in
judicial decisions. In Farm King Supply, Inc. Integrated Profit Sharing
Plan and Trust v. Edward D. Jones & Company, 884 F.2d 288 (7th Cir.
1989), a plan followed a brokerage firm's conflicted investment advice
and suffered a loss, but the court held that the brokerage firm was not
a fiduciary because ``there was no mutual understanding that Jones'
advice would be a primary basis for Plan investments.''
In a recent district court case, Bhatia v. Dischino, 2010 WL
1236406 (N.D. Tex. March 30, 2010), the trial court held that the
actuarial consulting firm was not a fiduciary under the regulations,
because the plaintiffs did not plead adequate facts to show that the
firm ``rendered advice on a regular basis as part of a mutual agreement
that such advice serve as the primary basis of investment decisions.''
The Department has explained that developing proof of the elements
of the regulations, even where proof exists, has slowed and impeded
enforcement of ERISA for the Department of Labor. The lack of support
in the statute for the conditions in the regulation and the
difficulties for enforcement are reasons enough for the regulation. But
the Center and NELA would like to point out that Congress intended that
ERISA would be enforceable by ordinary participants and beneficiaries
who, unlike the Department of Labor, do not have subpoena power and
have no ready access to the documents and testimony that would
demonstrate fiduciary status under the detailed existing regulation.
This has always been a severe impediment to enforcement of fiduciary
responsibility by private plaintiffs, but it has been greatly
exacerbated in recent years because the Supreme Court has adopted a
``plausibility'' standard for the evaluation of complaints on a motion
to dismiss. As a consequence, complaints alleging fiduciary status may
be dismissed if they fail to allege factual support for some element of
the regulation, and factual support will typically be unavailable or
limited without discovery. See e.g. Glen Ridge Surgicenter, LLC v.
Horizon Blue Cross Blue Shield of New Jersey, Inc., No. 08-6160 (JAG),
2009 WL 3233427, at *6 (D.N.J. Sept. 30, 2009) (``[P]roof of
[defendant]'s fiduciary status is an element of the fiduciary duty
claim, and `a formulaic recitation [in the complaint] of the elements
of a cause of action will not do.' '' (quoting Bell Atl. Corp. v.
Twombly, 550 U.S. 544 (2007)); see also Braden v. Walmart Stores, Inc.,
588 F.3d 585, 598 (8th Cir. 2009) (discussing the problem that
participants are often without access to information that would allow
them to plead factual support for each element of a claim).
The new regulations recognize that investment advice is no less
important merely because it is rendered on a one-time basis. An
individual who advises on the purchase of employer stock with all of
the assets of an ESOP on a one-time basis is not less worthy of
regulation than an individual who advises quarterly on asset allocation
in a defined benefit plan. Moreover, the regular basis requirement
finds no support in the statute or the legislative history.
Similarly, the requirement that advice be offered pursuant to an
agreement or understanding that the advice will be a primary basis for
making a decision is and always has been unsupported by the statute and
extremely difficult to prove. As a practical matter, contracts with
investment advisors are simply not written this way. An advisor agrees
to provide advice of a particular sort in exchange for some form of
compensation. There is no reason why the contract should specify how
the advice may be used by the plan fiduciary. So while the advice may
be the only real basis for an investment decision by the plan
fiduciary, there will be no written agreement that the advice will be
primary or even significant. Almost invariably, such an agreement or
understanding will have to be inferred and will be rebutted by an
integration clause in any written agreement providing for the advice.
This hurdle, which the new regulations eliminate, seems to have been
designed to give almost all advisors who did not specifically seek to
be treated as fiduciaries a good faith argument that they are not
fiduciaries. Consequently, this requirement in the old regulations is
profoundly destructive of ERISA's purpose to protect participants and
beneficiaries. The elimination of this requirement in the new
regulations is not merely warranted, it is of critical importance.
The new regulations do not eliminate the requirement that advice be
individualized, but clarify that advice should be individualized to the
needs of the plan, a plan fiduciary, or a participant or beneficiary.
This reflects the Department's interpretation of the existing
regulations but it is an important clarification. An enormous
percentage of plan assets are managed in pooled vehicles holding plan
assets of many plans. These may be master trusts, insurance separate
accounts, fund-of-funds, and hedge funds usually organized as LLC's and
operating pursuant to private placement memoranda. Advice that is
``individualized'' for the fiduciaries of these pooled vehicles is not
individualized for a particular plan, and yet such advice is no less
worthy of regulation than advice provided to one plan at a time. If
anything, regulation of such advice is more critical than advice given
to a single plan with the needs of that plan in mind. Similarly, many
investment decisions are made by participants in 401(k) plans, and the
advice given to them should not escape regulation because individual
participants are uniquely vulnerable to self-interested investment
pitches.
The decision in the new regulations to cover appraisals is
warranted. As a practical matter, appraisers set the price of assets
that are purchased or sold by plans, including and especially the
closely-held employer stock that plans purchase or sell. To suggest
that this advice is not investment advice defies common sense. Often an
appraiser is the only outside advisor a fiduciary relies on in deciding
to purchase an asset at a particular price.
In an ESOP, price is the critical concern, since diversification is
excused and the courts have been skeptical of claims that employer
stock may be ``too risky'' to be a prudent investment. We anticipate
that appraisers will argue that they should not be held to fiduciary
standards when their appraisals are only used for compliance and
distributions. We think the proposal as it stands is appropriate. Note
that the courts seem to provide a more deferential review of decisions
(and by extension advice) involving only distributions. See Armstrong
v. LaSalle National Bank, 446 F.3d 728(7th Cir. 2006) (fiduciary
setting a value for ESOP distributions is entitled to deference because
he must balance the interests of those taking a distribution with the
interest of those who stay in the plan).
Equally important, the Department's longstanding interpretation of
its regulation to exclude appraisals is difficult to defend. The
opinions of appraisers are at least ``a primary basis'' for a typical
plan's decision to buy or sell a hard-to-value asset at a particular
price, and this is certainly understood by appraisers hired to value
stock or other assets for a transaction. At best it might be argued
that an appraiser is often hired for one transaction or one appraisal
at a time, so an appraiser's opinion may well not be provided on a
regular basis. Following the plain meaning of the statute, if not the
old regulations, the advice given by appraisers that guides the
fiduciary's decision to purchase or sell a particular asset at a
particular price certainly falls within the plain meaning of
``investment advice.''
The Current Regulations Create Legal Uncertainty
The 1975 regulations also introduce inherently vague definitional
concepts into the definition of investment advice. The regulations do
not define what is meant by providing advice on a ``regular basis,''
what is meant by advice that will be ``a primary basis'' for the plan's
investment decisions, nor what is meant by advice that is
``individualized to the plan's'' needs. These must be determined on a
case-by-case basis. The inherent ambiguity and subjectivity of these
concepts creates uncertainty in the law and strains Departmental,
judicial, and private resources in litigation of issues not related to
the core concept of investment advice.
Comments on the Proposed Regulations
As we earlier indicated, we strongly support the Department's
initiative to redefine the meaning of investment advice, although we
offer the following comments that would strengthen the proposed
regulation and more faithfully implement Congressional intent.
1. Section 2510-3-21(c)(ii)(D) makes a person who issues investment
advice a fiduciary if, among other requirements, the advice ``will be
individualized to the needs of the plan, a plan fiduciary, or a
participant or beneficiary.'' At least in cases of individual
participants and beneficiaries, we are not certain why a person would
be a fiduciary only if their advice was sufficiently individualized
(and the regulations do not discuss when advice is sufficiently
individualized to meet the proposed regulatory requirement). We have
doubts that a typical participant or beneficiary will be able to
discern a difference between individualized and non-individualized
advice.
We are also concerned that some advisers who do not have the
interests of participants at heart may be focused on selling a
particular investment, rather than providing individualized advice
about a variety of investments or strategies. In such instance, if the
advice is directed to an individual, that advice might influence that
individual's investment choices within a plan just as surely as advice
that is individualized.
Finally, this aspect of the regulation might provide a perverse
incentive to some providers of investment advice to not tailor the
advice to the particular needs of the individual in order to avoid
fiduciary status. Our concern for advice given to individual
participants is heightened when the person giving the advice has been
given an aura of legitimacy by virtue of having been appointed to
provide advice by a plan fiduciary or who otherwise has the imprimatur
of the plan, e.g., a custodian or contract administrator. At least with
respect to participants, we would prefer that the regulations provide
that the advice be directed to a particular participant rather than
that it be ``individualized.'' \14\
As to advice given to plans and plan fiduciaries, the regulation
should be modified to eliminate the requirement that there be an
agreement to provide individualized advice.
It should be sufficient that there is an agreement to provide
investment advice and that the service provider performs the agreement
by the providing individualized advice. Agreements generally do not
specify that advice will be individualized, even when individualized
advice is contemplated. For example, when a consultant is hired to
recommend investment managers for a particular fund, the agreement to
provide individualized advice may be unspoken or assumed by the
parties--generally such a consultant will take into account the needs
of the fund by providing more than a generic ranking of manager
performance. Consequently, some of the very proof and investigational
difficulties that inspired the new regulations will still be present
unless this requirement is modified.
Moreover, the definition of ``individualized'' should be clarified
further. The Center and NELA understand that the Department does not
wish to encompass within the definition of fiduciary mere brokers or
others who provide ``research'' on stocks, bonds, and other
investments, rating them as buys, sells or holds, calculating betas or
other risk measures or predicting returns. But it should be clear that
when an advisor tells a fiduciary with control of plan assets (pooled
or not) or a participant to buy or sell a particular investment, or
that an investment without a ready market that the fiduciary is
considering purchasing or selling has a particular value, then that
advice is sufficiently individualized. The distinction should be
between saying ``you should consider buying Xerox'' and ``our firm
rates Xerox a buy;'' the first statement should be considered
``individualized,'' regardless of the thinking or specific intent
behind it. A focus on portfolio composition and diversification fails
to capture this concept. Further clarification, perhaps with examples,
should be undertaken in the final regulations.
2. Section 2510-3-21(c)(2)(i) provides that a person shall not be
considered to be a fiduciary investment adviser if such person can
demonstrate ``that the recipient of the advice knows or, under the
circumstances, should have known, that the person is providing the
advice or making the recommendations in its capacity as a purchaser or
seller of a security or other property, or as an agent of, appraiser
for, such a purchaser or seller, whose interests are adverse to the
interests of the plan or its participants or beneficiaries, and that
the person is not undertaking to provide impartial investment advice.''
While we believe that this limitation may be appropriate when such
advice is provided to a sophisticated plan fiduciary, it is not
appropriate when the advice is given to individual participants or
their beneficiaries. The Center and NELA have worked with participants
for 35 and 26 years respectively, and it is our experience that most
plan participants will not be able to discern when advice is impartial
or conflicted. In addition, even if there is disclosure, in a one-to-
one meeting, whether in person or by phone, an unsophisticated investor
will often regard the adviser as acting in his interest. This is
particularly true if the participant does not have access to other
advisers. Indeed, an adviser's success may depend on a client's belief
that the adviser is interested primarily in the customer's welfare,
despite a declaration of self-interest. There is the further fact that
most participants will not be knowledgeable about the types of fees and
benefits that can accrue to the purchaser or seller of securities.
Thus, we strongly urge the Department to revise this limitation so that
it only applies to advice and recommendations given to plan
fiduciaries.\15\
3. Section 2510-3-21(c)(2(iii) of the proposed regulations provides
that investment advice does not include an appraisal or fairness
opinion that reflects the value of an investment of a plan or
participant or beneficiary, provided for purposes of reporting and
compliance under ERISA or the Internal Revenue Code, unless such report
involves assets for which there is not a generally recognized market
and serves as a basis on which a plan may make distributions to plan
participants and beneficiaries. We believe that the Department should
consider revising the limitation so that it would not apply to
situations when an appraisal of property for which there is not a
generally recognized market would have a material effect on the funding
status of a defined benefit plan. The Center and NELA recognize that
appraisers will typically include scope limitations in their
appraisals. For example they will say that they are relying on
management projections in preparing a discounted cash flow. In such
cases, it is up to the user of the appraisal to assure himself that the
projections relied upon are reasonable. The Department should be able
to address the concerns of appraisers by indicating that scope
limitations will be respected, and appraisers will be held responsible
only for the opinions that they express (complete with limitations),
subject to section 405 of ERISA, so that an appraiser who knew that he
was being provided with unreliable information would have a duty to
take steps to remedy the situation.
4. The Department asked for comment on whether and to what extent
the final regulation should define the provision of investment advice
to encompass recommendations related to taking a plan distribution. The
Department has taken the position that a person providing investment
advice to a participant in an individual account plan is a fiduciary,
even if the person is chosen by the participant and has no other
connection to the plan.\16\ The Department has also held that if a plan
fiduciary responds to participant questions about the advisability of
taking a distribution or the investment of amounts drawn from the fund,
that fiduciary must act for the sole and exclusive benefit of the
participant. Moreover, a fiduciary that advises the participant to
invest in an IRA managed by the fiduciary may be in violation of the
prohibited transaction rules of ERISA and the Internal Revenue Code.
However, the Department has also opined that, if the person
providing such advice on distributions is not connected with the plan,
that person can recommend that the participant take a distribution and
invest in a fund managed by that person and that does not constitute
investment advice under the current regulations.\17\ We see no reason
for this distinction and believe that the regulations should be
changed.
A recommendation to remove assets from the plan and invest them
elsewhere is, in effect, a judgment about the relative merits of the
plan options and the other investment(s). The person making the
recommendation can have interests adverse to the plan participant and
the recommendation can have a substantial effect on a participant's
retirement security, both in terms of future investment performance,
the loss of an economically efficient means of taking retirement income
in annuity form, and tax considerations. Moreover, under the current
interpretation, the person giving advice in these circumstances has no
obligation under ERISA to reveal their conflict of interest. Such
advice should be considered investment advice under the new
regulations.
We are especially concerned about the problem of advice given by
plan custodians and non-fiduciary administrators. We are aware of
participants and beneficiaries who call plans to arrange for or inquire
about a distribution who are then solicited to invest in products
offered by the plan service provider. At a minimum the regulations
should address this concern by making the entities that provide this
``advice'' fiduciaries. Participants and beneficiaries are inclined to
believe that the persons assigned to address their inquiries regarding
their rights in the plan have their interests at heart. In truth, they
are unknowingly exposed to salesmen with a financial interest, whether
disclosed or not. Persons using their privileged access to plan
participants and beneficiaries gained through their positions (even
ministerial positions) with a plan to steer participants and
beneficiaries into their investment products should be held to
fiduciary standards.
1. Section (c)(ii)(B) of the regulations should be clarified by
adding ``a plan fiduciary'' after ``individualized needs of the plan''
and ``managers'' after ``securities.'' More importantly, we are
concerned that such menus that are excluded from investment advice be
limited to those that give the fiduciary a broad choice to select from.
At one extreme, if fiduciaries are presented with a specific or very
limited lineup, it is hard to see why the individual promoting that
lineup should be excused from being deemed a fiduciary, even if he
discloses that he is selling a product and is not disinterested. In
addition, such disclosure should specify the nature of the individual's
financial interest--i.e., how is he being paid and how much he is being
paid to recommend these alternatives.
2. The Preamble to the Regulations should be revised to indicate
that the Department has taken litigation and administrative positions
prior to the issuance of the proposed regulations interpreting the
existing regulations that investment advice to a plan encompasses; a)
advice to plan fiduciaries, including fiduciaries of pooled vehicles;
b) advice with regard to the selection of managers; and c) advice paid
for by third parties, e.g., commissions. Likewise, the Department
should clarify in the Preamble that it does not view its interpretation
of the existing regulations' requirement of individualized advice as
precluding advice individualized to the needs of plan fiduciaries of
pooled vehicles rather than a particular plan. Without such
clarification, defendants will argue that the new regulations
implicitly recognize that such advice would not give rise to fiduciary
status under the existing regulations.
Conclusion
In sum, this is a much needed regulatory change that will better
protect plans and participants and facilitate more effective
enforcement when misconduct is uncovered. The Pension Rights Center and
NELA applaud the Department for pursuing this initiative that will
benefit both retirement plans and their participants and beneficiaries.
Respectfully submitted,
Norman Stein, Senior Policy Adviser,
Eric Loi, Staff Attorney,
Pension Rights Center.
endnotes
\1\ Comments of Senator Harrison Williams, Legislative History of
the Employee Retirement Income Security Act of 1974, Vol. III, at
4741(Aug 22, 1974)(comments concerning the Committee of Conference on
H.R. 2).
\2\ ERISA Sec. 3(21)(A)(i).
\3\ ERISA Sec. 3(21)(A)(i)
\4\ ERISA Sec. 3(21)(A)(ii)
\5\ ERISA Sec. 3(21)(A)(iii).
\6\ We note that a person who has such authority would be an
investment adviser even without the ``investment advice for a fee''
component of the statutory definition, since the person would be
exercising discretionary control of a plan asset.
\7\ 29 C.F.R. Sec. 2510.3-21(c)(1)(ii)(B).
\8\ The National Center for Employee Ownership, ``A Statistical
Profile of Employee Ownership,'' http://www.nceo.org/main/article.php/
id/2. These figures do not include 401(k) plans with employee stock
funds.
\9\ See, e.g., Keach v. U.S. Trust Co., N.A., 239 F. Supp. 2d 820
(C.D. Ill. 2002) (appraiser not a fiduciary); Clark v. Ameritas
Investment Cor., 408 F.Supp. 2d 819, (D. Neb. 2005)(appraiser not a
fiduciary).
\10\ ERISA Sec. 409(a). A fiduciary who breaches its
responsibilities under the statute is also obligated to return to the
plan any profits the fiduciary made through the use by the fiduciary of
plan assets. Id. In Mertens, the Court specifically held that a non-
fiduciary who knowingly participated in a breach of trust was not
subject to section 409(a)
\11\ The Preambles to the proposed and final 1975 regulations
include virtually no explanation for the Department's introduction of
these extra-statutory conditions on the meaning of investment advice.
The few comments noted in the Preamble to the 1975 final regulations
asked that the definition of investment advice be narrowed (the
Department responded to these comments by adding to the final
regulations additional limitations on the meaning of investment
advice); asked that the meaning of ``fee or other compensation'' be
clarified (the Department responded to these comments by indicating
that it was still studying this issue); asked that the applicability of
the regulations to investment companies subject to the Investment
Company Act of 1940 be limited (the Department responded to these
comments by adding to the final regulations some conditions and
limitations related to the purchase and sale of securities by
investment companies); and asked for clarification of certain issues
involving broker-dealers and investment advice (the Department
responded to these comments with a discussion of these issues in the
Preamble to the final regulations). The Preamble to the final
regulations is silent as to whether it received any comments suggesting
that the regulations defined investment advice too narrowly, suggesting
that it did not. From conversations we have had with other groups
representing interests of participants, it does not appear that such
groups submitted comments on the 1975 proposed regulations (neither the
Center nor NELA existed in 1975). In any event, the Department, in
response to a FOIA request, has indicated that it cannot locate the
comments submitted on the proposed regulations.
\12\ We also note that the Supreme Court had not yet decided
Chevron U.S.A., Inc. v. Natural Resources Defense Counsel, Inc., 467
U.S. 837 (1984). In Chevron, the Court wrote that in determining what
deference to give to an agency decision, the first question ``always,
is the question whether Congress has directly spoken to the precise
question at issue. If the intent of Congress is clear, that is the end
of the matter; for the court, as well as the agency, must give effect
to the unambiguously expressed intent of Congress.'' There is no
ambiguity about the meaning of the term ``investment advice'' and the
only limitation that Congress placed on whether a person becomes a
fiduciary because it rendered investment advice is that the investment
advice was rendered for a fee or other compensation. Yet the
regulations substituted a unique definition of investment advice by
providing that the advice had to be offered on a regular basis, had to
be a primary basis for a plan's investment decisions, and had to be
part of an agreement to provide individualized advice.
\13\ See, e.g., LoPresti v. Terwilliger, 126 F.3d 34, 40 (2nd Cir.
1997).
\14\ Non-individualized advice on asset allocation and the like,
however, will generally be characterized as investment education rather
than investment advice.
\15\ We also note an additional concern: the proposed rule appears
to undercut the prohibited transaction exemptions that apply when
fiduciaries provide investment advice under certain limitations
designed to protect plan participants from conflicts of interest. See
ERISA Sec. 408(g). Under the proposed regulations, an investment
adviser could claim that it did not become a fiduciary under the ``sale
or purchaser'' limitation and thus was free to give investment advice
without complying with section 408(g).
\16\ DOL Advisory Opinion 2005-23A.
\17\ Id. See also Walsh v. Principal Life Insurance Co., 49 EBC
1344 (S.D. Iowa 2010).
______
Mr. Andrews. I think the Chairman and I agree, we can say
this because Mrs. Roby is not here, that listening to an
Alabama fan should be a prohibited transaction----
Chairman Roe. Should have been University of Texas----
Mr. Andrews. It is a prohibited transaction under ERISA.
[Laughter.]
Chairman Roe. Should have been UT, you would have been all
right.
Thank you.
Mr. Stein. Thank you.
Chairman Roe. Mr. Tarbell.
STATEMENT OF JEFFREY TARBELL, DIRECTOR,
HOULIHAN LOKEY
Mr. Tarbell. Thank you, Chairman Roe, Ranking Member
Andrews, and members of the committee for the opportunity to
testify.
I am testifying today to voice concerns regarding certain
unintended consequences of the proposed redefinition of the
fiduciary.
These concerns are not simply shared by my firm, Houlihan
Lokey, but by other providers of valuation and fairness opinion
providers who I am representing today.
National associations such as the American Society of
Appraisers, the ESOP Association and the American Institute of
Certified Public Accounts also have raised similar concerns.
As reflected at the DOLs hearing on the subject in March,
these concerns are two-fold. First, as you know, the White
House issued an executive order earlier this year directing
federal agencies to use the least burdensome tools for
achieving regulatory ends and to select in choosing among
alternative regulatory approaches, those approaches that
maximize net benefits.
However, the DOL has provided no meaningful cost-benefit
analysis that would satisfy this directive.
Insurance has long been used by plan fiduciaries to
mitigate ERISA litigation risk, but no such product currently
exists for firms like ours that provide valuation and fairness
opinion services. Nor has the DOL produced any evidence
projecting the cost of that insurance.
The group of firms that I represent has estimated that cost
to be up to $180 million annually.
The proposed rule would also lead to a substantial increase
in litigation costs to valuation and fairness opinion providers
and those increase costs would translate into higher fees for
employee benefit plans and their sponsors.
For many firms, the cost to defend a single case, whether
found guilty or not, would likely exceed their annual profits
and for smaller firms is likely to put them out of business.
Given the direct cost and increased risk, many firms,
including my own, would find it difficult to continue providing
these services related to ERISA plans. Thus, it wouldn't
surprise me if many firms left the market which would result in
reduced competition and increased cost. And, again, those
increased costs will translate into higher fees for plans and
plan sponsors.
Valuation and fairness opinion providers also would need to
retain separate ERISA counsel to represent them on ESoft
transactions which is projected to add between $30,000 and
$100,000 to the cost of each transaction. The total cost for
the thousands of Esoft-owned companies is estimated to exceed
$50 million a year.
Second, the proposed rule directly conflicts with
impartiality requirements under professional standards of
valuation practice and the internal revenue code. The core
elements of the ethical standards of the valuation profession
require that a valuation be performed independently.
The Uniform Standards of Professional Appraisal Practice,
known as USPAP, which is the generally recognized ethical
standard for the valuation profession, imposes specific conduct
requirements on valuation providers, including an impartiality
requirement. Federal regulations promulgated by the IRS
incorporate these ethics standards.
Furthermore, IRS regulations require valuations of employer
securities to be performed by a qualified independent appraiser
who is not a party to the transaction and is not related to any
party to the transaction.
An independent appraiser will be deemed to have prepared a
qualified appraisal if the appraisal has been prepared in
accordance with the substance of principles of USPAP according
to the IRS.
Thus, it is impossible for a valuation provider to provide
an impartial opinion of value of privately held securities and
be a fiduciary as required by the proposed regulation.
As a fiduciary, the valuation provider's duty to act with
loyalty that is solely in the interest of the participants and
beneficiaries would contradict the provider's ability to act
impartially. The unintended consequences of the DOLs proposed
rule are not outweighed by any perceived benefits. The DOL
claims the proposed rule is aimed at correcting a common
problem of substantial valuation work; however, the DOL has
provided no empirical support showing that such a problem is
widespread and, to my knowledge, the agency has no in-house
expertise to make such a determination.
The agency has also provided no explanation as to the
nature of the problem.
The DOLs stated goal to regulate valuation and fairness
opinion providers by making them fiduciaries will lead to
expensive litigation brought by plaintiff's firms but it will
not transform careless valuation providers into careful ones.
Nor does the agency's stated goal actually articulate any
standards by which the agency would evaluate whether valuation
work is satisfactory or substandard.
The DOL issued a proposed adequate consideration regulation
more than 20 years ago that was intended to provide standards
for plan fiduciaries in the ESOP area; however, that proposed
guidance has never been finalized.
Valuation and fairness opinion providers are willing to
work with the DOL to develop guidelines on valuation issues of
concern to the agency.
I close by noting that valuation professionals like me
share the DOLs desire to make sure that valuations are prepared
carefully and appropriately. To that end, my firms and other
firms I represent today welcome an opportunity to discuss
standards and an appropriate enforcement framework that avoids
the unintended consequences posed by the DOLs proposed rule.
Thank you for the opportunity to testify, and I look
forward to questions.
[The statement of Mr. Tarbell follows:]
Prepared Statement of Jeffrey Tarbell, Houlihan Lokey
Good morning. Thank you Chairman Roe, Ranking member Andrews, and
members of the Subcommittee for the opportunity to testify this
morning. My name is Jeff Tarbell. I am a Director with Houlihan Lokey,
an investment bank that, among other things, provides valuation and
fairness opinion services related to Employee Stock Ownership Plans
(``ESOPs''). I have more than 20 years of experience rendering
valuations and fairness opinions, many of these related to ESOPs.
I am testifying today to voice concerns regarding certain
unintended consequences of the proposed regulation issued by the
Department of Labor (``DOL''), which would amend the definition of
``fiduciary'' under the Employee Retirement Income Security Act of
1974, as amended (``ERISA''). These concerns are not shared simply by
Houlihan Lokey, but by other providers of ESOP valuations and fairness
opinion services whom I am representing today.\1\
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\1\ The firms include: Chartwell Capital Solutions, Columbia
Financial Advisors, Inc., ComStock Advisors, Duff & Phelps, LLC,
Houlihan Lokey, Prairie Capital Advisors, Inc., Stout Risius Ross, and
Willamette Management Associates.
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As reflected at the DOL's March 1st and 2nd hearing on the subject,
our concerns are two-fold: (1) the costs of the proposed rule on
employee benefit plans and the employers who sponsor them would be
significant; and (2) the proposed rule directly conflicts with
longstanding professional and regulatory standards of valuation
practice requiring that an appraiser provide an independent and
impartial opinion of value. Furthermore, if the DOL's goal is to
regulate valuation and fairness opinion providers directly, then the
agency first needs to put in place regulatory standards governing the
provision of valuations and fairness opinions. Houlihan Lokey and other
providers of valuations and fairness opinions, as well as the ASA, are
ready and willing to discuss a reasonable framework of standards and
enforcement, but enforcement through fiduciary labeling is a misguided
and problematic approach.
Before specifically addressing those concerns, it should be noted
that the DOL's proposed rule represents a sudden reversal of the
agency's longstanding treatment of providers of valuations and fairness
opinions related to employee benefit plans. Firms providing ESOP
valuations and fairness opinions long have relied on the DOL's 1976
advisory opinion that a person retained to conduct a valuation of
privately held stock to be offered to, or held by an ESOP does not
function as a fiduciary under ERISA. The factual bases for that
advisory opinion continue to be true today. As the DOL noted in that
opinion, an ESOP valuation or fairness opinion does not make a
recommendation as to a particular investment decision, does not address
the relative merits of purchasing particular employer securities, nor
does the ESOP valuation or fairness opinion provider have any decision
making authority over a trustee's decision whether to purchase or sell
the employer securities. In other words, an ESOP valuation or fairness
opinion does not constitute ``investment advice.'' Consequently, it is
contrary to the DOL's 35 year-old position and unreasonable that ESOP
valuation and fairness opinion providers, or other providers valuing
assets belonging to ERISA plans, now should be singled out for
fiduciary treatment.
Concerns with the DOL's Proposed Fiduciary Definition
I. The Public Record Shows That The Costs Of The Proposed
Rule Would Be Substantial To Employee Benefit Plans
And Their Employer Sponsors
As you know, earlier this year, the White House issued an Executive
Order directing federal agencies to use ``the least burdensome tools
for achieving regulatory ends,'' and to ``select, in choosing among
alternative regulatory approaches, those approaches that maximize net
benefits.'' Executive Order 13563, 76 Fed. Reg. 3821 (Jan. 18, 2011).
However, the DOL has provided no meaningful cost-benefit analysis that
would satisfy the Administration's directive.
While insurance has long been used by plan fiduciaries to mitigate
their ERISA litigation risk, the administrative record is clear that no
such product currently exists for firms providing valuation and
fairness opinion services related to ERISA-covered plans. Based on the
stringent cost-benefit analysis that is now required by the executive
branch, reliable data must be obtained to quantify the identified
insurance cost. And yet, no evidence has been introduced by the DOL as
to the projected cost of that insurance. The group of firms that I
represent has attempted to estimate the cost of a valuation-specific
insurance product by considering the cost of fiduciary insurance
coverage for ESOP trustees, which is typically based on assets under
management. The group understands from conversations with industry
representatives and other information in the public domain that
premiums range between $100 to $200 per $1 million of assets under
management. See Fiduciary Insurance--Understanding Your Exposure, at
12, available at http://www.naplia.com. The ESOP professional
associations project that the total assets owned by ESOPs are roughly
$900 billion. See National Center for Employee Ownership statistics,
available at http://www.nceo.org/main/articl/php/id/21; The ESOP
Association statistics, available at http://www.esopassociation.org/
media/media--statistics.asp. Using that ratio, the aggregate fiduciary
insurance costs for valuation and fairness opinion providers would
range from $90 million to $180 million annually.
In addition to increased insurance costs, the proposed rule also
would lead to a substantial increase in litigation costs to valuation
and fairness opinion providers. As I understand it, fiduciary insurance
policies often contain a high deductible before coverage begins. Thus,
a provider may be faced with substantial out-of-pocket costs just to
establish its compliance with professional standards. For many firms,
the cost to defend a single case would likely exceed their annual
profits. Those increased costs would translate into higher fees for the
employee benefit plans and their sponsors.
In addition, internal costs driven by the regulation, such as
additional records maintenance, and the development of policies and
procedures, also will be incurred. Valuation and fairness opinion
providers would need to consider these new costs in pricing their
services. These increased fees would not only impose direct, immediate,
and incremental costs on employers, most of whom are small or mid-size
businesses, but those costs would likely increase over time. In this
regard, given all the direct costs and increased risk, many firms,
including my own, would find it difficult to continue providing
valuation and fairness opinions services relating to ERISA plans. Thus,
commentators believe that many firms--particularly the larger, better
capitalized firms--would have a disincentive to continue providing
valuations and fairness opinion to ERISA plans in light of the
increased costs and litigation risk. Such a decrease in competition
would result in further increasing costs which, again, would translate
into higher fees for employee benefit plans and their sponsors.
In addition to the cost of insurance, retention and regulatory
compliance, ESOP valuation and fairness opinion providers, as proposed
fiduciaries, also would bear the cost of hiring their own separate
ERISA counsel to represent them in ESOP engagements. It is projected
that retaining ERISA counsel would add $30,000 to $100,000 to the
overall cost of each ESOP purchase or sale transaction. This estimate
is based on what an ESOP trustee's ERISA counsel generally charges in a
transaction, and the cost of legal counsel retained by valuation or
fairness opinion providers in non-ERISA transactions. One ESOP trade
organization estimates that, on average, approximately 1,000 ESOP
transactions occur annually. Using that figure, the projected added
cost for ESOP transactions would range from $30,000,000 to $100,000,000
annually. In addition, assuming the cost of retaining counsel to review
a valuation is, on average, approximately $5,000, the total cost for
the 11,500 existing ESOP companies would exceed $50 million a year.
Again, these costs would be passed directly on to plans and their
sponsors.
II. DOL's Proposed Rule Is At Odds With Impartiality And
Independence Requirements Under Professional
Standards Of Valuation Practice And The Internal
Revenue Code
The core elements of the ethical standards of the valuation
profession require a valuation to be performed independently and
without bias in favor of any party. The Uniform Standards of
Professional Appraisal Practice (``USPAP''), which are the generally
recognized ethical standards of the valuation profession, contains an
ethics rule which imposes specific conduct requirements on valuation
providers, including an impartiality requirement. See USPAP Ethics
Rule, http://www.uspap.org/2010USPAP/ USPAP/frwrd/uspap--toc.htm.
(appraiser ``must not perform with bias'' and ``must not advocate the
cause or interest of any party or issue. * * *'').
Federal regulations promulgated by the Internal Revenue Service
(``IRS'') incorporate these industry ethical standards. In particular,
IRS regulations provide that an ESOP can only be considered a qualified
trust under the Code if ``all valuations of employer securities which
are not readily tradable on an established securities market with
respect to activities carried on by the plan are by an independent
appraiser,'' see Code Sec. 401(a)(28)(C), as defined in Treasury
regulations promulgated under Code Sec. 170(a)(1) (emphasis added). A
``qualified independent appraiser'' under these regulations is a person
who, among other things ``is not a party to the transaction, and is not
related to any party to the transaction.'' 26 C.F.R. Sec. 1.170A-
13(c)(5)(i)(emphasis added). Under IRS advisory guidance, a ``qualified
appraisal'' has been conducted by a ``qualified appraiser'' within the
meaning of Sec. 1.170A-13 only if it is done ``in accordance with
generally accepted appraisal standards.'' I.R.B. 2006-46. The IRS has
clarified that this would include appraisals ``consistent with the
substance and principles of [USPAP].'' See Proposed Reg. 26 C.F.R.
Sec. 1.170A-17(a) (1)-(2) (proposing to codify guidance under I.R.B.
2006-46).
It is impossible for a valuation provider to provide an impartial
opinion of the value of privately held securities and be a fiduciary to
the holder, purchaser or seller of those securities, as required by the
proposed regulation. As a fiduciary, the valuation provider's fiduciary
duty to act ``solely in the interest of the participants and
beneficiaries'' would contradict the provider's ability to act
impartially. For example, the valuation provider would have a fiduciary
duty to advocate the advisability of making a particular investment.
However, the standards under the Code and well-established professional
standards provide that the role of such a person is not to advocate for
a value, or an investment, on behalf of anyone, but instead provide an
impartial opinion as to the value of a particular security, no matter
who asks the question. Asking a valuation provider to ignore its
ethical responsibility and be partial to plan participants is akin to
asking a judge to be biased in handing down a verdict to his own
client.
III. If The DOL Wishes To Correct Any Perceived Problems
With Valuation Standards Of Practice, The Agency
Should Establish What Those Standards Are First
Before Turning To The Question Of Enforcement
The DOL has claimed that the proposed rule is designed to correct
the ``common problem'' of substandard valuation and fairness opinion
provider work. However, the DOL has provided no empirical support in
the record showing that such a ``problem'' is widespread, and, to my
knowledge, has no in-house expertise to even make such a determination.
The agency also has provided no explanation as to the nature of the
problem; that is, whether ``faulty'' valuations are the product of
insufficient fact-gathering or analysis, computational errors,
unreasonable use of assumptions on critical factors, or improper
reliance on valuation methodologies that the DOL opposes as a policy
matter.
The DOL's stated goal to regulate valuation and fairness opinion
providers by making them fiduciaries, will lead to expensive litigation
brought by plaintiffs' firms, but it will not transform those careless
valuation providers into careful ones. Nor does the agency's stated
goal actually articulate any standards by which the agency would
evaluate whether valuation work is satisfactory or substandard. The DOL
issued a proposed adequate consideration regulation more than twenty
years ago that was intended to provide standards relating to ESOP
valuation. See Proposed Regulation Relating to the Definition of
Adequate Consideration, 53 Fed. Reg. 17,632 (1988). Ironically, that
proposed guidance has never been finalized. Valuation and fairness
opinion providers are willing to work with the DOL to develop guidance
on valuation issues of concern to the Agency. Established standards
would be important not only for firms providing valuation and fairness
opinion services, but for ERISA fiduciaries and DOL personnel charged
with reviewing and evaluating such valuations or opinions. Whether that
person is an ``internal'' fiduciary within the company, or retained
independently, the ERISA fiduciary must conduct a prudent investigation
as to the merits of a proposed transaction and, therefore, would need
to have a basic understanding of governing standards.
As it stands, the DOL's proposed rule is the proverbial example of
putting the cart before the horse. Regulatory standards of practice
governing valuation and fairness opinion provider services should be
agreed upon before turning to the question of enforcement of such
standards. With respect to enforcement, for the reasons above, making a
valuation or fairness opinion provider a fiduciary is a misguided
approach because it imposes unnecessary costs on the backs of ERISA
plans and their employer sponsors, and directly contradicts established
professional and regulatory standards.
I close by noting that valuation professionals like me join the
DOL's desire to make sure valuations are prepared carefully and
appropriately. To that end, my firm and the other valuation and
fairness opinion firms I am representing welcome an opportunity to
discuss standards and an appropriate enforcement framework that avoids
the unintended consequences and insurmountable conflicts posed by the
DOL's proposed rule.
I appreciate the opportunity to testify this morning and welcome
any questions from you, Ranking member Andrews or other members of the
Subcommittee at this time.
______
Chairman Roe. I thank you.
And, Mr. Bentsen, welcome back. And you may be glad you are
on the other side of the dice today instead of here.
STATEMENT OF KENNETH BENTSEN, JR., EXECUTIVE VICE PRESIDENT,
SECURITIES INDUSTRY AND FINANCIAL MARKETS ASSOCIATION
Mr. Bentsen. Well, I don't know. Thank you, Mr. Chairman,
though, and I appreciate the hall pass to come around the
corner from the Financial Services Committee.
I appreciate, Mr. Chairman, Ranking Member Andrews, and
members of the committee for holding this very important
hearing.
However well intentioned, we believe the department's
proposed regulation has far broader impact than the problems it
seeks to address. As has been stated numerous times, this
proposed rule would reverse 35 years of case law enforcement
policy and the understanding of plans and plan service
providers as well as the manner in which products and services
are provided to plans, plan participants and IRA account
holders without any legislative direction to move from the
department's contemporaneous understanding of the statute.
And, of course, the enforcement rationale behind this
proposed rule cannot apply to IRAs because the department has
no enforcement authority over IRAs. I would add, however, and
it has not been mentioned, that the SEC and FINRA do have
enforcement authority in that area as it relates to brokers and
advisors.
After months of discussion with the department both in
anticipation of the proposed rule and following its
publication, we strongly believe the regulation should be re-
proposed, and in particular re-proposed without IRAs.
The breadth and complexity of the provisions and many
significant changes that need to be made and the uncertainty
regarding the exemptions that will be required based on the
final language underscore the need for the department to go
back to the drawing board.
Further, based on our numerous conversations with the
department and their acknowledgement for the need for
significant change to the draft, we believe such changes in and
of themselves would require re-proposal under the
Administrative Procedures Act.
In addition, as has been stated, the proposed rule lacks
sufficient cost-benefit analysis and absolutely no cost-benefit
analysis related to its impact on IRA owners. We cannot think
of a single reason barring re-proposal of this regulation,
especially when the Securities and Exchange Commission will
almost certainly be proposing a uniform fiduciary standard of
conduct for brokers and advisors providing personalized
investment advice pursuant to section 913 of the Dodd-Frank Act
this fall. And that is an action that I would note that SIFMA
has strongly supported throughout the consideration and final
passage of Dodd-Frank.
It is also important to note that the SEC through their
study, through the consideration of Dodd-Frank has been working
on many of these very issues that we believe will be in
conflict with where the department is heading with their rule.
By upending 35 years of established precedent and imposing
a fiduciary status on a service provider who may have no
relationship to a plan, the rule creates prohibited
transactions and co-fiduciary liability on entities who have no
understanding what the plan, or IRA, that any services at all
will be provided. The selling exception in the puzzle does not
even cover commissioned base sales or the selling of services
let alone common investment transactions such as agency trades,
futures, repurchase agreements, swaps, and security lending.
Absent a re-proposal to address such concerns and the
advanced promulgation of the prohibited transaction
exhibitions, our member firms will be forced to alter and in
many cases curtail services to their clients upon final
publication.
To be clear, extending the implementation timeline of any
final rule in order to consider a draft and promulgate
exemptions, as some have suggested, will not forestall the
necessity of firms to adjust their business planning operations
and service delivery based upon the rule as drafted.
Firms must operate their businesses on rules as written,
not based on the possibility of exemptions to come in the
future.
While the department asserts that IRA owners, participants,
and beneficiaries would directly benefit from the department's
more efficient allocation of enforcement resources than are
available under the current regulation. No example or
explanation of such benefits is provided that would justify the
sweeping changes, nor the unintended negative consequences to
IRA owners, plans, and their participants.
And I might add that the secretary noted that while the
premise of a lot of the studies that have been provided by
multiple parties would suggest that there are only two business
models, the broker-dealer commission based business model and
the Registered Investment Advisor model and that some new model
might come into play.
The fact of the matter is that hasn't happened yet, and we
would argue, we would assert that it is inappropriate to design
a rule based upon something that hasn't happened yet. The data
is pretty clear about where the market is here.
Mr. Chairman, Ranking Member Andrews, I would like to close
with this.
Obviously, the industry has a great deal of concern about
this and what the impact will be on our ability to serve our
clients. But it is not just the industry that has raised
concerns on this. I think it is important to look at what
investor advocates have said about this.
Over the last few weeks two prominent investor advocates
have testified before various committees of the congress.
Barbara Roper from the Consumer Federation who has been a
leading advocate in the area of a uniform fiduciary standard of
care has repeatedly stated in testimony and to the media and
elsewhere that this rule will be harmful to investors and
should be re-proposed and further that this rule will directly
conflict with Congress's under Dodd-Frank with regards to
swaps.
In addition, Mercer Bullard from the University of
Mississippi Law School, again a prominent investor advocate,
testified, I believe, 3 weeks ago before the Financial Services
Committee and also published in an article in Morningstar that
this rule would be bad for investors and should be re-proposed.
So we believe that the evidence is very clear that this
rule needs to be withdrawn and re-proposed.
Thank you for the opportunity to testify.
[The statement of Mr. Bentsen follows:]
Prepared Statement of Hon. Kenneth E. Bentsen, Jr., on behalf of the
Securities Industry and Financial Markets Association
Good morning. I am Ken Bentsen, Executive Vice President for Public
Policy and Advocacy at the Securities Industry and Financial Markets
Association.\1\ We appreciate the Committee's decision to hold a
hearing on the Department of Labor's proposed revision to the
definition of fiduciary.
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\1\ SIFMA brings together the shared interests of hundreds of
securities firms, banks and asset managers. SIFMA's mission is to
support a strong financial industry, investor opportunity, capital
formation, job creation and economic growth, while building trust and
confidence in the financial markets. SIFMA, with offices in New York
and Washington, D.C., is the U.S. regional member of the Global
Financial Markets Association. For more information, visit
www.sifma.org.
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The Proposed Regulation
However well intentioned, we believe the Department's proposed
regulation has far broader impact than the problems it seeks to
address. This proposed rule would reverse 35 years of case law,
enforcement policy and the understanding of plans and plan service
providers as well as the manner in which products and services are
provided to plans, plan participants and IRA account holders, without
any legislative direction to move from the Department's contemporaneous
understanding of the statute, in order to make it easier for the
Department to sue service providers. That seems to us to be an
inadequate basis for proposing such a dramatic change. And of course,
this enforcement rationale cannot apply to IRAs, over which the
Department has no enforcement authority.
After months of discussion with the Department, both in
anticipation of the proposed rule, and following its publication, we
strongly believe the proposed regulation should be re-proposed and in
particular, re-proposed without IRAs. Many groups and individual
entities representing plan sponsors, service providers, the financial
services industry and investor advocates have raised issues about the
proposed rule's impact on plans and participants and individual savers.
The breadth and complexity in the provisions, the many significant
changes that need to be made, and the uncertainty regarding the
exemptions that will be required based on the final language,
underscore the need for the Department to go back to the drawing board.
Further, based on our numerous conversations with the Department, and
their acknowledgment of the need for significant changes to the draft,
we believe such changes in and of themselves would require re-proposal
under the Administrative Procedures Act. In addition, the proposed rule
lacks sufficient cost benefit analysis, and absolutely no cost benefit
analysis related to its impact on IRA owners. We cannot think of a
single reason barring re-proposal of this regulation, especially when
the Securities and Exchange Commission will almost certainly be
proposing a uniform fiduciary standard of conduct for brokers and
advisors pursuant to Section 913 of the Dodd-Frank Act in the fall, an
action that SIFMA strongly supports.
By upending 35 years of established precedent and imposing a
fiduciary status on a service provider who may have no relationship to
a plan, the rule creates prohibited transactions and co-fiduciary
liability on entities who have no understanding with a plan or IRA that
any services at all will be provided. The selling exception in the
proposal does not even cover commission based sales or the selling of
services, let alone common investment transactions such as agency
trades, futures, repurchase agreements, swaps and securities lending.
It requires the seller to announce it is adverse to the client,
contrary to where the SEC is likely to go based on their Section 913
fiduciary study. Absent a re-proposal to address such concerns and the
advance promulgation of prohibited transaction exemptions, our member
firms will be forced to alter, and, in many cases, curtail services to
their clients upon final publication of this rule. To be clear,
extending the implementation timeline of any final rule in order to
consider, draft and promulgate exemptions, as some have suggested, will
not forestall the necessity of firms to adjust their business planning,
operations and service delivery based on the rule as drafted. Firms
must operate their businesses on the rules as written, not based on the
possibility of exemptions to come in the future.
While the Department asserts that IRA owners, participants and
beneficiaries would directly benefit from the Department's more
efficient allocation of enforcement resources than are available under
the current regulation, no example or explanation of such benefits is
provided that would justify these sweeping changes nor the unintended
negative consequences to IRA owners, plans and their participants.
Instead, we believe the individual investors who hold them will suffer
increased costs, significantly fewer choices and greatly restricted
access to products and services--new asset-based advisory fees to
replace a commission/spread based structure, additional transaction
costs, elimination of investment options and alternative vehicles,
constriction of the dealer market, limits on permissible assets in
IRAs, and the elimination of pricing of anything other than publicly
traded assets. Absent a re-proposal, we have no confidence that these
fundamental flaws will be fixed. Nor are we confident that the
necessary exemptions will be in place before the effective date.
Millions of savers will find that they cannot invest in the products
and services that they have been accustomed to having available in
their retirement accounts and that the cost of such products will
dramatically increase.
Costs of the Change to Plans and Participants
The proposed regulation states that the Department is uncertain
about the cost of the proposal in its preamble. Promulgation of a broad
and far reaching regulation, with no change in the law to prompt such
change and no indication from Congress that a change is needed should
not be done without adequate cost analysis. The Department's cost
estimates focus on certain costs to service providers, and not the cost
to plans, beneficiaries and IRA holders. While we believe the
Department greatly underestimated such costs to service providers, more
importantly we think this emphasis is misplaced. The real question is
the cost to plans and their participants and the impact on their
retirement savings. And while the Department's cost analysis leaves
alarming gaps in what it does appear to understand or be certain about,
its list of uncertainties does not even once mention IRAs. IRAs hold
more than $4.3 trillion as of March 2010. The vast majority of these
assets are in self-directed accounts. The total lack of analysis on the
effect on these accounts is very hard to understand.
The costs to such account holders would be significant. From data
pulled quickly from a handful of our member companies, there are over 7
million accounts that are under $25,000 and use a commission-based
model. In addition, over 1 million of those accounts are under $5,000.
These are currently commission-based accounts, not advisory fee
accounts. This proposal will push them to an advisory model. And, most
firms require a minimum account balance for advisory accounts that
could result in millions of IRA account holders being dropped.
While current exemptions to the prohibited transaction rules of
ERISA (PTE 86-128) permits fiduciaries to select themselves or an
affiliate to effect agency trades for a commission, there is no
exemption that permits a fiduciary to sell a fixed income security (or
any other asset) on a principal basis to a fiduciary account. Lack of
exemptive relief in this area is contrary to what Congress explicitly
stated in authorizing the SEC to promulgate a uniform fiduciary
standard of care for brokers and advisers providing personalized
investment advice under Section 913 of Dodd-Frank. The result of that
conflicting prohibition is that the broker would not be able to execute
a customer's order from his own inventory but rather purchase the order
from another dealer, adding on a mark-up charged by the selling dealer.
That mark-up would result in an added cost for these self-directed
accounts, and would disproportionately fall on smaller investors, such
as small plans and IRAs. And of even more concern, it would eliminate
the most obvious buyer when a plan wants to sell a difficult to see
security. Further, given that the rule would eliminate a clear
understanding when a broker is acting as a fiduciary, and thus increase
liability risk, it is likely that brokers will transform such accounts
into asset based fee arrangements or wrap accounts with their brokers
so the brokers can comply with the prohibited transaction rules that
govern fiduciaries under ERISA and the Code. Asset based fee accounts
or wrap accounts are designed to provide on going advice at a higher
fee than traditional self-directed commission based accounts. However,
most individual investors with IRA accounts and most personal brokerage
accounts are lower cost self -directed commission based accounts. The
result would be imposing higher costs and less choice on investors.
This is particularly critical in assisting small businesses when
they start up new plans. Many broker dealers help small business owners
in their local communities establish retirement plans for their
employees by educating them about the benefits of plans. By prohibiting
commission-based sales, the proposal would make it economically
unfeasible for most brokers to continue to offer this service. Payment
of a separate advisory fee to set up a plan will likely deter many
small businesses from providing this important employee benefit.
Intersection with Dodd Frank
As I stated, the Department's rule is in conflict with Section 913
of Dodd-Frank that authorizes the SEC to establish a uniform fiduciary
standard of care for brokers and advisors when providing personalized
investment advice. SIFMA strongly supported that provision of Dodd-
Frank and we recently submitted a letter to the SEC encouraging the
Commission to move forward with such a rule. I have submitted our
letter with my testimony for the record.
Also, during consideration of the Dodd-Frank Act, Congress
considered the question of a counterparty providing a fiduciary duty to
plans engaging in swaps and it rejected such an approach because it
wanted to be sure that plans could continue to engage in such
activities principally for hedging purposes. However, as currently
drafted, the Department's proposed rule would result in a counterparty
being deemed a fiduciary, which would eliminate the ability for plans
to enter into swaps. Again, the SEC and the Commodities Futures Trading
Commission (``CFTC'') were directed by Congress to establish business
conduct rules for dealers engaging in swaps with plans, and yet the
Department's rule would conflict with those rules, which are currently
in the proposal stage. Absent a significant change in the Department's
final rule, or better a re-proposal, the Department's proposed rule
will directly conflict with Congress expressed intent in Dodd-Frank.
Conclusion
Finally, while financial services providers continue to express
grave concerns about the proposed rule's impact, I would point out that
similar views regarding the far reaching and unintended consequences
have been voiced by leading investor protection and consumer advocates.
Barbara Roper of the Consumer Federation of America, in testimony
before Congress last week also called for a re-proposal and asserted
that the proposed rule would conflict with the business conduct
provisions under Dodd-Frank. Also, University of Mississippi law
professor and investor advocate Mercer Bullard, both in a published
article and testimony has said the rule is bad for investors and should
be re-proposed.
Mr. Chairman, Members of the Committee, SIFMA and its members have
provided substantial comment and data to the Department as to why this
rule must be withdrawn and re-proposed and that necessary exemptions
must be promulgated in advance of any final rule. Further there must be
sufficient coordination with and consideration of the SEC's likely
action under Section 913. Otherwise, this proposal will have
significant negative impact to millions of accountholders.
I thank you for permitting SIFMA to testify today, and would be
happy to answer any questions.
______
Chairman Roe. I thank the panel.
I will take just a couple of minutes here to ask a couple
of questions and one recurring theme is that there was no cost
analysis done prior to implementation of the rule, and I think
that is one of the things the uncertainty of that, about how
much is this thing going to cost. And then at the end, again, I
bring back the question of what problem are you fixing?
Now Professor Stein made a good point. Certainly there are
outliers out there, but I know in my own dealing with my own
small business that this was--we understand the rules basically
now. We sort of get the rules. This is going to make it harder.
As I listen to this rule I am playing through how I go to
my practice to my pension committee and how I would advocate--
and it is going to be difficult.
And especially, Mr. Bentsen, if you would bring up or any
of the panel members would like to, what about a small IRA
investor that has got say $10,000 or $15,000 or $20,000 or
$25,000? What happens to them?
I mean when you call one of these education lines the
following question is going to be, ``Well, what do you think I
ought to invest in?'' They may not know. So would you all?
Anybody can take that one.
Mr. Bentsen. Mr. Chairman, it is a very good question. The
dilemma that this rule poses is that it changes the established
standard that is understood by providers and how they operate.
At the very same time that the--and as it relates to IRAs.
At the very same time that brokers and advisors, the same
people, are going to have their standard of care changed,
again, something that we support, under section 913 of Dodd-
Frank.
And the problem that exists in this rule is this rule is so
broadly written without clarity to determine when is one giving
advice and when is one not giving advice. And if that is not
made clear, then the liability risk to a broker is going to be
too great. So they will then have no choice but to move such
accounts into advisory accounts where there is an established
fiduciary duty.
Advisory accounts are more expensive than basic commission
accounts. Most IRAs are in basic commission accounts. And so it
will raise the cost.
But the other problem is the industry is organized, like
any business, based upon scale and efficiency. And so most
advisory accounts have a minimum amount, a minimum balance that
they can have because below that it is inefficient for the firm
or the broker or the advisor rather to operate it.
And so what will happen, and most of those are around
$50,000 per account. So this will force a number of accounts
that can't move into that advisory account to go looking for
services somewhere else and at a higher cost.
Chairman Roe. Mr. Mason?
Mr. Mason. Yes, I just wanted to jump in, and I completely
agree with everything Ken was saying.
I think the Oliver Wyman study, I want to just briefly
mention that, it found, because of the phenomenon that Ken
mentioned, it found sort of concrete, in response to your
question, that within the study sample alone over 7 million
IRAs would just be on their own.
They would just say, the broker's would have to say you are
on your own. There is the computer. Good luck. That is a sad
situation.
If you extrapolate that to the entire market, you are
talking about 18 million IRAs being cut off and put on their
own.
And I want to just correct, very briefly, correct one
thing. I would disagree with Secretary Borzi. I think she was
saying there was a flaw in the Wyman study in the sense that it
did not take into account the exemptions for commissions. It
did.
What the basis for the Wyman's study's conclusion was that
the standard practice in the way that the brokers sort of get a
significant amount of their compensation is through revenue
sharing, and that there is no privative transaction for.
The Wyman study was very accurate in that regard. So I just
wanted to correct that point.
Chairman Roe. Well, there is no question that a small IRA
owner can't--$20,000 or $10,000 or whatever, can't afford to
pay. I know our fees went down as the size of our plan went up.
And obviously a small firm would spend most of their money
on fees if it was a fee-based instead of----
Mr. Myers?
Mr. Myers. Yes, I would just like to elaborate on the
common model today is for lots of intermediaries like brokers
and banks to be compensated for their services to the plan from
fees they receive from third parties like mutual funds.
And in fact several years ago the Department of Labor was
concerned that smaller plans were paying higher fees. And they
conducted a study and then hearings and they learned that it
does cost more per participant to provide services to a smaller
plan as oppose to a larger plan. And at the same token, it
costs more per participant to provide service to an IRA.
And the way the system now works is these intermediaries
get compensated for that service with the fees that they
receive from the funds, which they would no longer be able to
receive if there are fiduciaries in the absence of an
exemption.
And I would just like to elaborate or clarify a point that
Ms. Borzi made that a lot of the class exemptions today would
not provide the type of relief that is necessary so those
exemptions would have to be modified or revised. So currently
if they receive these fees in their fiduciaries, they are just
going to have to, as explained by other panel members, just
change their model dramatically.
Chairman Roe. Okay. Thank you.
Mr. Kildee?
Mr. Kildee. Thank you, Mr. Chairman.
First of all, I would like to see if Mr. Stein would like
to reply, I know there is some interest there, to Mr. Mason's
comments.
Mr. Stein. Yes. One of the things that I think, you know,
we often lose sight of when we talk about whether people will
be able to afford this if people have to charge. The revenue
sharing is a fee. Right? The revenue sharing is a fee. That is
not understood by most participants.
If the revenue sharing didn't take place, presumably that
money would end up in the accounts of the people, ultimately as
business models change, in the accounts of the people who were
investing.
I mean, these services are not being provided for free.
They are being provided for money and it is just that the money
is provided in a way that is not visible to participants and
can result where some vendors of investment products pay more
in revenue sharing than others. That, in my mind, has to
influence the people who are doing the selling.
Mr. Kildee. Thank you very much.
Mr. Myers, could you further discuss what changes you would
make to the proposed rule? Can it be changed? Can it be made
whole or good? And how, then, could you, if you could improve
it, what areas would you address?
Mr. Myers. Well, let me go back to the original regulation
which was adopted in 1975. And let us examine what was the
basis for that regulation.
When ERISA was enacted there was a real concern of the
consequence of being a fiduciary and there was a belief at the
time that taking on a fiduciary responsibility should not be
thrust upon an individual but it should be as a result of some
mutual understanding between two parties.
And so for that reason, the regulation as adopted had that
five part test. And what it was concerned about was that
sending out recommendations to buy or sell a particular
security should not cause someone to be a fiduciary.
If a plan believes that it is getting advice from someone
who is a fiduciary but the person giving the information
believes it is not a fiduciary, that person who is giving the
information shouldn't be subject to the fiduciary rules because
they would have to change their conduct dramatically.
So the thinking at the time was you need a mutual
understanding between two parties. You need an ongoing
relationship that would subject that person who would be a
fiduciary to all these fiduciary rules.
And so that is where--while the regulation has been
criticized, I think it had a solid basis in what the concern
was of the government of the time. And I think the Department
of Labor was also reacting to concerns by the conferees that
gave rise to ERISA that ERISA should not disrupt ordinary
business practices.
So taking that into account, they came up with the five-
part test, and it has worked pretty well. There are lots of
courts have applied that definition.
No one has questioned the regulation, and in fact there was
a recent court case involving a Madoff related investment where
the plaintiff argued in that case that the advisor was a
fiduciary because it met the five-part test and gave investment
advice.
The other side argued no, it was not a fiduciary. The court
went through all five parts and concluded that yes, that person
was a fiduciary because they were giving investment advice and
met all the conditions of the regulation.
So despite what Department of Labor is saying, there are
courts that are concluding that people are giving advice by
virtually satisfying this five-part test. So basically it has
worked pretty well, and so I don't, I would say we stick with
the regulation.
If the Department of Labor, despite all the comments,
decides that it wants to go forward, as I mentioned in my
opening statement, and I agree with other people who made the
same point, the DOL should re-propose because it is so
controversial, because it is going to have such an impact on
business, because there are so many concerns about it, and it
is likely DOL will make a number of changes to it, it should
give the opportunity to the public to examine the re-proposed
versions, figure out how that is going to work and how people
can live with it.
Mr. Stein. I agree partly with those comments that when in
1975 when we were dealing with sophisticated plan fiduciaries
maybe making ERISA, even though this wasn't what the statute
contemplated, making investment advice fiduciary status
voluntary they made sense.
But if you are a participant in a 401k plan and you see an
advertisement like that which says we have talked to you one-
on-one so you can develop a plan that is right for you, you get
personalized, practical help focused on meeting your retirement
needs, you are going to think that person is giving you
investment advice.
But the fine print simply quotes the regulation and says we
are not giving advice that should be the primary basis of you
investment decisions. It quotes the regulation word for word
and it makes fiduciary status voluntary and there I disagree
with Don. I don't think Congress intended ERISA fiduciary
standards to be voluntary, and I think it is good it didn't.
Mr. Myers. Well, I would say that maybe the solution is to
have better transparency and better disclosure and move that
fine print further up into the body of the commercial. It
doesn't necessarily require a wholesale change in the
regulation.
Mr. Stein. Well, if the regulation is not changed I am not
sure how you can get that stuff higher up in the commercial.
Chairman Roe. Okay. I thank you gentleman for yielding.
Dr. Heck?
Mr. Heck. Thank you, Mr. Chairman.
My question is for Mr. Bentsen. Do broker-dealers who
provide advisory programs charge an advisory fee?
Mr. Bentsen. Most broker-dealers will, or many broker-
dealers will either provide brokerage services on a commission
basis and often will also provide advisory services. They are
two different--they are definitely regulated, they are
definitely registered. And many firms are duly registered, not
all. But they operate under different rules.
Now, as Mrs. Biggert mentioned, this is something that
frankly the administration in their original white paper back
in 2009 and the Congress subsequently changed to authorize the
SEC to establish a new uniform standard of care between brokers
and advisors operating under two different statutes.
And, in fact, we believe strongly, based upon what the SEC
has told us, that they will do so, that they will promulgate a
rule this fall establishing that.
Mr. Heck. Well, we have seen that throughout this process.
The DOL doesn't quite understand that issue. And I was
wondering, have you advised DOL on this issue and if so, what
is been their response?
Mr. Bentsen. Absolutely. We have raised it with DOL. I
think many others have raised it with DOL. I think that the
members of Congress have raised it with DOL, and I think that
it is important. The secretary said, well, look, we have been
working on this before Dodd-Frank came around.
But again, Dodd-Frank began in the administrations white
paper in response to the financial crisis in May of 2009. I am
not sure when the DOL started working on this proposed rule.
But the House worked on Dodd-Frank through 2009. This was
in the House bill, section 913. There was a similar provision
in the Senate bill. This was going to happen.
And our concern, as we have said repeatedly, is let this
process play itself out and then see where it all fits together
because our member firms will have to operate under all these
rules.
Mr. Heck. Great. Thank you very much.
Thank you, Mr. Chairman. I yield back.
Chairman Roe. Mrs. McCarthy?
Mrs. McCarthy. Thank you, Mr. Chairman, and thank you for
your testimony. I appreciate it.
I happen to sit on not only this committee but the
Financial Services Committee, and when we were working through
the Dodd-Frank bill, especially here, we spent a year-and-one-
half looking at every piece that we could, because when we did
the first section we had to make sure that the first section
wouldn't interfere with the second section and go forth.
One of the things that many of us on the committee,
bipartisanly, felt very, very strongly about was the consumer
financial literacy part. I think that is extremely important
for people to know.
That is something that I certainly worked on here on this
committee, but I also worked on it on Dodd-Frank.
One of the things that concerns me most is that when the
president put out an executive order, he emphasized the need
for more interagency cooperation, and we heard the secretary
talk about that.
But as far as what we number of us as members, by meeting
with her and talking with her and asking her direct questions.
Has she talked to the SEC? Has she talked to your group? Has
she talked to those interested parties?
As far as I am concerned, I don't see how this proposal has
really followed the spirit of the executive order, and that is
one of the things that I am concerned about.
But I think that what I would like from you gentleman, you
heard her testimony. Most of you were sitting here through it.
To me there were some discrepancies in her testimony from when
we had talked to her, some of our colleagues, when we had met
with her a couple of times.
So I guess I want to give you guys an opportunity to
basically talk about where again you might disagree, where the
DOL is going, where we are trying to go to come to an answer.
And the final thing I will say to you is that I think the
majority of us on both sides of the aisle want to certainly
protect all investors. I believe that with all my heart and
soul.
ERISA has been something there, in my opinion, that has
been there to protect. But again, things have changed over the
last 30 years plus, and I think that we have to move with that
to give our constituents who certainly are better informed
today than they ever were.
Mr. Stein, I understand where you were going back years
ago. I probably would have said I was the same way. But then,
when I started saving, I had to look to see what were the best
investments.
I think the first thing I would have done if someone came
knocking at my door, I would have said no thank you.
So with that I will open it up.
Mr. Stein. That is what I should have done but people don't
do that. Some people don't and some people do, and ERISAs there
to protect those who don't.
Mrs. McCarthy. I agree, and that is what we are still
trying to do is protect ERISA.
But again with legislation that we have gone through with
the Dodd-Frank and basically where we are today, I happen to
think that the rule that the DOL is coming through is going to
be, in my opinion, difficult for people to get the advice that
they need, and I think that is something that we need to do,
because financial literacy is the only way they are going to
learn.
The consumer still has, in my opinion, due diligence to
learn as much as possible. One of the other things in Dodd-
Frank was also to give the consumers an idea what it was
costing them, and those regulations are being put forward.
If anyone looks at any of their statements, there is
paperwork coming through now in the mail telling you what it is
costing you to be in certain plans, what the commission--I
mean, that is transparency. That is when somebody can make up
their mind.
Mr. Bentsen. Congresswoman, if I could just make two points
to respond and you know this from your work on Dodd-Frank. The
secretary said that this proposal would not ban commission
business but, in fact, in our view, it would.
In particular, it would in direct conflict with something
that you all did in Dodd-Frank in section 913 in which you said
there could be principal transaction very explicitly within the
act under this new fiduciary standard.
But under the standard as proposed by the department, if I
am engaging with my broker for my IRA my broker will not, as it
is written right now without any exemption, my broker will not
be able to sell me a bond from his or her inventory. He will
have to sell it to me on an agency basis where I will have to
pay a mark-up outside of where he has to go buy it from the
street.
And that raises the cost to the transaction. That is
something that the committee in the Congress recognized in
drafting 913 that the department in their proposal doesn't
recognize. And so I think it is just one area where there is a
direct conflict in the rule.
Mr. Mason. If I could just jump in for one quick comment.
I think the question is sort of what take-aways did I have
from the secretary's discussion this morning, which I thought
she was both eloquent and spirited and passionate. I think the
one take-away was there wasn't, in the testimony this morning,
in the written testimony as well as the oral, a significant
amount of new data, new studies, new information.
I think what we, in some sense, I found the testimony
reinforcing the need for re-proposal because we need to have a
dialogue about those, that new information, that new data that
we have never seen before.
It raised interesting points but it is the way our process
works. The process is intended to allow that data, that
information to be subject to public comment.
Mr. Myers. Let me just elaborate on that.
I think there was one thing I found comforting is she said
she wants to get it--oh, I am sorry.
Chairman Roe. I thank the gentlelady for yielding.
Mrs. Roby?
Mrs. Roby. Well, thank you. I am sorry. I missed my
colleague's comments earlier, but Mr. Stein, I don't have any
questions for you, but I would tell you, Roll Tide. [Laughter.]
So I have many concerns relating to this proposed
regulation and I have one specific concern related to the
Employee Stock Ownership Plan or ESOP.
And I recently met with Mr. Spencer Coates who is the
president of Houchens Industries and even though he is not a
constituent of mine he is a constituent of our colleague
Representative Guthrie from Kentucky. But almost 400 of my
constituents back in the 2nd district of Alabama are employed
by him.
And if this proposed regulation goes into effect it would
make finding a valuation firm more expensive, it would
substantially increase the cost of the transaction for
companies, such as Houchens Industries as they expand by
acquiring non-ESOP companies.
So for Mr. Tarbell, if you wouldn't mind answering just a
couple of questions for me.
Is the ESOP appraisal valuation business sufficiently
lucrative to justify assuming fiduciary liability and if not,
are firms comparable to your firm driven from the market due to
liability concerns who will then be left in the valuation
space?
Mr. Tarbell. Okay. Well, the ESOP valuation world is a
subsegment of all the various reasons valuations are performed,
and I would characterize it as one of the rather low margin
businesses. I have not heard the word lucrative used to
describe it ever in 21 years.
I don't believe that there are room for advisors to absorb
significant fees and remain in that business. I think
consistent with past practice and common sense additional fees
will be passed on to the client. You don't incur the risk if
you don't incur the client, and so the client will pay for the
risk.
But there will always be risks that cannot be passed on.
You know, the risk of the first part of litigation, for
example, that is not covered by insurance. And these costs are
such that I think it is quite easily predictable that the fees
charged on appraisals will increase, perhaps dramatically. They
can't not increase.
Mrs. Roby. I mean it was even suggested to me by Mr. Coates
who I referenced that it could go from a $300,000 fee upwards
of a million to $3 million because of the increased risk
associated with the appraisal.
Mr. Tarbell. Your ratios are correct, but the realistic fee
level for ESOP appraisals is more like going from $20,000 to
$30,000. It would be a rare, rare ESOP that has a fee of the
numbers you quoted.
This is a small appraisal business. The fees are not
dramatic and one of the reasons they are not dramatic is
because we have enjoyed not being the fiduciary in those
transactions. That isn't to say, though, that there isn't a
fiduciary; there is.
Mrs. Roby. If you became the fiduciary then that could----
Mr. Tarbell. Well, of course. There is a fiduciary in an
ESOP valuation. It is the trustee. So there is a system already
in place and one of the concepts that is a matter of law but
has been ignored by the DOL on this is that it is the trustee,
not the appraisal firm, who is responsible for determining the
value of the stock.
We provide advice and they make a choice among a range of
values we provide. Choosing to accept our valuation as, for
example, as the middle of the range is as much of a choice as
choosing one end of the range.
Mrs. Roby. Well, and so to further expand on that can you
discuss the importance of your independence in the appraisal
profession that why would it be so bad to put a thumb on the
scale? And this is just expounding on what you have already
said.
Mr. Tarbell. Well, you know, the DOL says that they are not
putting a thumb on the scale, but I would say that that is, you
know, that is just patently wrong. This regulation as it is
written would absolutely force us to render an appraisal that
is biased, that is in favor of one party, being the plan
participants.
I don't understand the logic of the discussion that all
they are looking for is for us to be fair and balanced. First
of all, that is what we already do.
Mrs. Roby. I was about to say, that is what you are doing
right now.
Mr. Tarbell. And so if that is all we are, if that is what
we are doing right now I don't know how making us fiduciary
will make us do appraisals any differently.
But secondly, this concept of asking us to be fair and
balanced is only half of the equation. Being a fiduciary
requires care but it also requires loyalty and it is that
aspect of the fiduciary duty that has been ignored by the DOL,
in my opinion, asking us to be loyal to the plan, act in their
best interest, yet render an unbiased and impartial opinion of
value is just fundamentally inconsistent and incurable.
Mrs. Roby. Thank you so much.
And Mr. Chairman, I yield back.
Chairman Roe. I thank the gentlelady for yielding.
Mr. Scott?
Mr. Scott. Thank you, Mr. Chairman.
And Mr. Bentsen, it is good to see you again.
I think one of the things about the discussion is really a
question of what perspective we are taking in this debate, and
I think as legislators our perspective ought to be how these
laws apply or affect unsophisticated investors that may not
have the fundamental information about how to invest and how we
protect them from bad advice.
I mean, there is kind of generally accepted theories of how
a young person, how a middle-aged person, and how an older
person ought to be investing pension funds. I guess the first
question is: do we, in fact, have a responsibility to
unsophisticated investors, or should we just let the
marketplace do what it does?
Mr. Bentsen. I will start with that. I think the real
question here comes down to when someone is giving advice on
which someone is making a decision and when they are not and,
again, I am going to go back like a broken record that Congress
did feel it was responsible, was appropriate to do so section
913 of Dodd-Frank as it related to individual investors.
And so Congress did act in that regard. I think that was
appropriate. We thought it was appropriate. We supported that
effort. We support the SEC going forward. In fact, we wrote the
SEC the other day and said they should go forward with that.
I think in this instance, frankly, this is such a far-
reaching proposal that lacks clarity, that has raised a number
of questions that the secretary even has said she intends to--
--
Mr. Bentsen [continuing]. That she intends to fix that
actually given the breadth of the change it is probably
appropriate for Congress to insert itself here because it
almost rises to a legislative type change.
Mr. Stein. Yes. One of the things I think is sort of
interesting, if this regulation, the 1975 regulation didn't
exist and we were simply dealing with statutory language, that
was a congressional judgment. And the congressional judgment
was that people who give investment advice should be subject to
ERISAs fiduciary standards.
The 1975 regulations, at least to my mind, clearly narrowed
that without any justification. If these 1975 regulations were
simply withdrawn and these proposed regulations were withdrawn,
I think there would be considerably more difficulty for the
industry than these new regulations propose, than these
regulations could conceivably create.
Mr. Scott. Let me ask a more specific question, then. If
somebody is selling what is essentially an S&P 500 mutual fund
at a 2 percent annual fee when you can get exactly the same
product at a .2 percent fee, and it is suggested that this is a
good investment, I mean shouldn't people be protected from that
kind of advice?
Mr. Stein. Well, I certainly think they should, and I think
that is what ERISA was about. ERISA is a different statute than
the securities laws and had a different underlying purpose and
the underlying purpose of ERISA is this is going to cover lots
and lots and lots of people with relatively small investments
going into their account, under 401k plans now, every month.
All right?
And those are the people who need the protection of ERISA
and the protections of the securities acts, while important,
are not sufficient.
And the idea that these statutes are somehow the same
animal and that there is a uniform concern running through
these statutes of protecting all investors, I just think is
inaccurate.
Mr. Myers. Let me just say, I don't think it is an issue of
this regulation or no regulation. The question is whether
considering the regulatory scheme already in place that covers
brokers who deal with customers, do we need another layer of
regulation?
A broker is subject to FINRA rules, which is the self-
regulatory organization, security law regulations, they have an
obligation to----
Mr. Scott. I am going to ask: what does the designation of
not being a fiduciary, what does that allow the person to
inflict onto an unsophisticated investor?
Mr. Stein. One of the things it allows is somebody to sell
a product because they are going to make more money selling you
that particular product than they would if they sold you a
different product. Rather than evaluating the products that
their offering and saying this is, in fact, right for you.
We know, right, human nature, people have an ability to
rationalize what they are doing that is in their own self-
interest and believe that it is actually in their customer's
self-interest also.
And what I think happens in the market, and I think this
was a judgment that Congress, not the Department of Labor
today, made in 1974 is that these kinds of conflicts are going
to hurt people and we need to prevent them.
Mr. Mason. I just wanted to jump in. We want to protect
that person, that sort of low income person who doesn't have a
lot of access to services and investment education.
And, just as Donald was saying, it is not as though current
law has no protections. What we are saying is this current rule
actually is severely counterproductive for exactly the persons
you are trying to protect because it will say to them we can't,
the financial services industry will not be able to provide you
these services at all.
So you are on your own, and that is the danger. So we need
to find that sort of sweet spot where the folks are protected
but not with the regulation that sort of eliminates the ability
to provide investment services and investment education for the
people who need it the most.
Mr. Stein. But it doesn't protect, prevent the ability to
give investment education and information. It simply prevents
you from, if you have a conflict of interest from selling a
product, a specific product, not giving investment education.
Chairman Roe. We can carry this on afterwards. [Laughter.]
Mrs. Biggert?
Mrs. Biggert. Thank you, Mr. Chairman.
I guess I am beginning to sound like a broken record
because I have been asking this question.
But, Mr. Bentsen, could you discuss a little bit the
potential benefits of harmonizing the fiduciary regulations
between DOL and the SEC?
Mr. Bentsen. Well, brokers and advisers who are providing
personalized retail investment advice, brokers and advisors
generally have to organize their operations based upon who they
are regulated by.
So brokers are regulated by the SEC, they are regulated by
FINRA, to the extent they are engaged by ERISA products they
are regulated by the Department of Labor.
Registered investment advisors are regulated by the SEC and
they are regulated by the Department of Labor to the extent
they are in ERISA products, and they are also both under
different statutes.
Having a uniform standard given the fact that you have many
firms that operate in both camps allows firms to have a more
efficient operation and compliance mechanism in place.
So we think that that is one of the reasons why we thought
going to a uniform standard of care made sense and why we
supported it.
Now having one uniform standard of care as it relates to
the SEC and another standard of care as it comes from the
Department of Labor that applies to the same client and having
a brokerage account with multiple accounts.
So a client who may have a purely commissioned based
account, personalized investment account, they may have an IRA
account most likely, based upon the data, a self-directed IRA
account because most IRAs are invest and hold, and then they
may have a discretionary account that all of these operating
under different statutes and different rules should be
harmonized so the client gets the best service they can from
their financial advisor.
Mrs. Biggert. So you think that that is possible to do
that?
Mr. Mason. One example? Sort of a simple example that we
have been dealing with is a situation where say a customer
comes to me as a broker and says I have got $30,000 in my
retail account and $30,000 in my IRA.
He says what should I do with my regular retail account? I
give some advice under the, sort of consistent with the SEC
rules. And then they turn to me and say, well, what do I do in
my IRA?
And I say, I can't, first of all I can't speak to you about
that, and second of all you have to disregard everything I just
said about the retail account in thinking about investments in
thinking about investments in the IRA.
That is the kind of unworkable situation that this rule
would thrust us into.
Mr. Bentsen. And just to add to that further, that is a
very good point. These are issues that the SEC is dealing with
right now and it is not easy. But they are having to say, for
instance, the customer comes and says, ``I want my commission
account but I also have an account that I am bringing of stock
that I own because I worked for GE forever. And if I am going
into an advisory account then I am going to have a
concentration problem related to that.''
And so the SEC is trying to work through all these, and
they will. And then you are going to have the DOL come around
with a completely different rule that is going to lay over this
that is going to make it very difficult to operate these
businesses efficiently.
Mrs. Biggert. And I want to get to that because what is
bothering me is particularly, I think, the Assistant Secretary
said she wants to finalize this by the end of the year and at
the same time do class exemptions.
So all of the sudden there is going to be a rule but then
there is going to be all these exemptions and how will that
affect the SEC rulings and how--if there is going to be such a
wide group that is going to be exempt to this it seems like
that is not really fair as far as putting all of this together.
And I know, Mr. Myers, that you said something about this--
--
Mr. Myers. Yes, and, you know, it was comforting to hear
the secretary say she wants to get it right. And I think, as a
regulator, and I did that for many years, you really are
concerned that you get it right and that is the whole purpose
of the public comment process so you can make sure that while
you are acting consistent with your statutory mandate you are
not disrupting normal business practice.
And so particularly since there are lots of comments, she
is talking about proposing a class exemption, it just seems
like the reasonable thing to do.
Mrs. Biggert. Well, when you are talking about a class
exemption, what does that mean? What class is this?
Mr. Myers. Well, a class exemption is--the Department of
Labor has the authority to provide relief or exemptions for
some of these prohibited transactions that we have been
discussing today. And the Department of Labor has issued a lot
of individual exemptions and a number of class exemptions that
are like regulations.
And so DOL has said that they are considering issuing some
class exemptions to deal with these various issues that have
been discussed today, for example, to allow principal
transactions or to allow payment of revenue sharing payments or
other types of conditions. But that is a fairly complicated
process.
And so while they are considering the regulation, and
exemption is supposed to take care of the problem created by
the regulation. So since the exemption is supposed to do that
it seems to a lot of us it makes sense to re-propose the
regulation at the same time you are proposing the class
exemption so people can see how they work together and then
come up with a final solution for both. To do one before the
other I don't think makes--makes sense as the way to go.
Mrs. Biggert. And thank you. My time is expired.
Chairman Roe. Mr. Andrews?
Mr. Andrews. Mr. Chairman, I would like to thank you, our
colleagues, and the members of the panel for what I anticipated
and hoped would be a very edifying discussion, and I have not
been disappointed.
This really has been an oasis of rationality in a sea of
chaos around here, so we appreciate that.
Ken, it is great to have you back. We miss you here and
appreciate your contribution as a public servant and now in
your new iteration.
The rest of the panel, predictably, was great.
Mr. Myers, obviously your stellar legal education helped
you give very trenchant testimony, but I hear two broad points
of consensus and one area of reason disagreement here.
The first is that I think there is broad consensus that the
law should protect investors and workers against conflicted
advice and that people should have a good, solid advice when
they make decisions. Secondly, I hear people saying that there
will no doubt be some unintended consequences of this rule that
could do real harm in the marketplace, and we have to address
that.
Where there is disagreement is the procedure by which we
might avoid those unintended consequences, and I would like to
focus, Mr. Mason, on your example of the swaps transactions.
Now, if I understand the fact pattern now correctly, I
agree with you that sponsors and others who involve in swaps
transactions should be outside the parameters of this rule.
They are really not, in my view, interacting with the
participants in a way that would impose fiduciary
responsibilities, and in fact, they are providing liquidity and
risk management for plan sponsors in a way that benefits
everyone. I think you are correct in that conclusion.
You suggested that the Secretary's letter to the CFTC was
encouraging but what you wanted, I think I got the phrasing
right, was authoritative guidance that would have the force of
law. Did I get that right? And if I did, what would that be? In
what legal iteration would that manifest itself?
Mr. Mason. Yes, and let me sort of just back up for one
second. One of the things that we did after the secretary wrote
the letter to Chairman Gensler was I actually worked with a
group of about eight or nine of the largest pension plans in
the country and I said to them, ``Are you going to be able to
rely on this letter?''
And the answer from them and their legal teams was a
unanimous no.
Mr. Andrews. So what would they like instead?
Mr. Mason. Excuse me?
Mr. Andrews. What would they want instead of the letter?
Mr. Mason. And that was exactly what, when we met with the
department, they said that is what we need to know. And we gave
them precise language and it is actually language. It is a
system that is actually very common in the Department of Labor
working with the IRS because they sort of do so many things
together. It is not as common DOL and other agencies because
they are rarely working in conjunction.
Mr. Andrews. Right.
Mr. Mason. And we gave them this preamble language stating
in the preamble to the CFTCs final business conduct standards
to say the Department of Labor has informed us that its final
regulations will state that no action taken by a swap dealer
solely to comply with the business conduct standards will make
that swap dealer a fiduciary.
Mr. Andrews. So they are really asking for two things, if I
understand this correctly. The first would be the preamble
language at CFTC would have this--incorporate the point you
just made.
Mr. Mason. Correct.
Mr. Andrews. Then secondly, that the final rule promulgated
by DOL would in fact reflect that preamble.
Mr. Mason. Correct.
Mr. Andrews. I understand that is not the only issue you
have, but I understand.
Now, let me come back to something Mr. Myers said, because
he makes the argument that modification of class exemptions or
the creation of new class exemptions is a process that is too
timely and cumbersome, and marketplace participants cannot rely
upon it; therefore, it would still have the problems that we
talked about before.
Did I correctly state your view?
Mr. Myers. Let me just modify. It is a complicated, time
consuming process but it can be a solution if there is no
regulation that is already in effect. If the regulation is in
effect, then people have to live with the regulation and you
can at that time propose exemptions.
But if the regulation is re-proposed at the same time,
Department of Labor could propose class exemptions to deal with
lots of these issues.
Mr. Andrews. Is there a middle course here? In other words,
if the new regulation went into effect, hypothetically, and
there were discussions of these modifications, is there some
instrument like a guidance letter that would serve the same
function in the marketplace? In other words, an enforcement
policy that would be consistent with your views?
Mr. Myers. That wouldn't work, in fact--works at the SEC.
The problem with prohibited transactions, if one engages in a
prohibited transaction it is automatically a violation of the
law. It automatically gives rise to an excise tax and there is
nothing that the Department of Labor could do absent of an
exemption.
Mr. Andrews. Does the department have any discretion to
define what that prohibitive transaction is?
Mr. Myers. Well, it has the ability, it has interpretive--
--
Mr. Myers. I am sorry?
Mr. Andrews. In terms of its prosecutorial decisions?
Mr. Myers. Well, see, it doesn't impose the excise tax so
it is imposed by the IRS and so the Department of Labor has no
authority to control what the IRS is going to do.
The Department of Labor could take an interpretive position
that something is not prohibited or grant a class exemption.
Mr. Andrews. I see my time has expired.
Mr. Chairman, I do think there is a fruitful area here for
us mutually to talk about about some procedure. I know the
witnesses, many of them want the rule withdrawn, and I
understand that.
But in the eventuality that doesn't happen, I am not saying
it won't, but in the eventuality it doesn't happen, I don't
think we should abandon our mutual effort to find responses to
these unintended consequences that I have made reference to.
I thank the witnesses for their testimony.
Chairman Roe. I thank the gentleman for yielding.
Dr. Holt?
Mr. Holt. Thank you, Mr. Chairman.
Forgive me for having to duck out. I got word that several
dozen people had occupied my office. They were all concerned
citizens, but I am pleased to report they were friendly.
[Laughter.]
But I did get to hear----
Mr. Andrews. Could you send them to my office, then?
[Laughter.]
Mr. Holt. I did get to hear all of the testimony and it was
very helpful.
Mr. Bentsen, again, good to see you. You have been a good
friend to many of us for a long time.
One sentence in your testimony caught my attention. ``That
firms must operate their business on the rules as written not
based on the possibility of exemptions to come in the future.''
Sseveral people have told me that in their conversations with
the Department of Labor, the Department has said that, well,
after the regulation is finalized, we surely can work out a lot
of the problems about prohibited transactions.
It seems to me a little bit backwards, and I just wanted to
ask you to elaborate a little bit on your statement.
Mr. Bentsen. Thank you, Congressman. And I think this fits
in as well with what Mr. Andrews was talking about also.
What our members have told us is regardless of what the
implementation time period is once there is a final rule, the
firms will have to organize based upon that final rule.
So even given the comments by the secretary today and many
of us have talked to the secretary and her staff about where we
think there would need to be prohibitive transaction exemptions
made. In our second comment letter we listed a number of areas.
We have been in to meet with the staff on this issue; I know
others have as well.
But because of the points that Don raised, our firms can't
take the risk. First of all, as he points out the law is very
explicit and there is no exception except through a PTE
structure that can be done.
So our firms have to operate under the rule as written, not
as the rule that may be modified by a PTE later. If the PTE
comes out later, then they can make the adjustment but they
have to organize their compliance operations, their training of
their people, their communications with their clients and it
takes time.
So they can't wait if there is a long, you know, say there
is a year implementation period, they can't wait 6 months, 8
months, and think that this PTE will be promulgated. Hence the
reason why we suggested re-propose, put the PTEs out now, and
take all the comments at this point in time. What is the rush?
Mr. Holt. Okay. Thank you.
Earlier I tried to put to the Secretary some comments or
actions to ask whether they might run afoul of the regulation
being considered.
Can any of the witnesses give me examples of comments or
actions that might run afoul that you think would be desirable
comments or actions but would run afoul of the way you see the
regulations going now?
There won't be time, but I would like to hear from any of
you whether you see a model that is somewhere between the
personal financial advisor that we would all like to have and
the impersonal so-called conflicted dealer salesperson model.
Two different questions, but the first one first, please.
Mr. Mason. I think one of the questions, and this goes back
to something that I think Norman raised a little bit ago which
is the question of what does this regulation do to investment
education?
And there have been very disparate sort of views on that
point. Here is the concern of the industry is that under the
prior law, or current law, there is sort of investment advice
in one place and there is sort of a principally different
investment education and people have felt comfortable, their
over here in the investment education world.
This regulation actually takes a different tact. It takes,
technically, it takes a tact that says that sort of everything
is investment advice, you know, implicitly, including
investment education. And then carves out investment
education----
Mr. Holt. You know, what I was hoping was for something
more specific. Something that a simple thinker like me could
say----
Mr. Mason. Well, I guess what I am saying is investment
education, for example, people asking a question, can I get, as
a sort of 32-year-old, can I get information about what sort of
asset allocation I should do.
Should I be heavily in bonds or should I be heavily in
equities? And the answer, unfortunately, from the industry at
this point under this regulation is I can't answer your
question because of the lack of clarity that I was just
describing.
Current law, they can say to you, yes, for someone at your
age with your risk tolerance you should be 60 percent in
equities, 30 percent in bonds, and 10 percent in cash or
whatever sort of, they can give you sort of a breakdown.
Under this, because of the way it is structured, and I do
think it is not hard to fix, but it needs to be fixed, the
professionals that I have talked to would be very hesitant to
even answer that question, which is a critical question and an
important question they need answers to.
Mr. Holt. I thought the Secretary was saying that was not a
problem, but thank you.
Chairman Roe. I thank the gentleman for yielding back.
And, again, would like to thank all the witnesses. It has
been a great panel. Thank you for being here.
And I will recognize the Ranking Member for any closing
comments.
Mr. Andrews. Well, first, Mr. Chairman, I would ask consent
for three letters to be entered into the record pertaining to
today's discussion.
[The information follows:]
Prepared Statement of Matthew D. Hutcheson,
Professional Independent Fiduciary
My name is Matthew Hutcheson. I am a professional fiduciary
(professional decision maker) for over 900 employers, consisting of
401(k), profit sharing, and traditional pension plans. Over 2.5 million
American workers collectively participate in those plans.
The fiduciary duty debate is an important one. The debate is about
when fiduciary duty applies, to whom it applies, and whether
individuals saving for retirement are entitled to those protections (or
not), and why. It is also about which type of professional is entitled
to exemptions, and which ones are not.
Having pondered this matter deeply for several years, I have come
to several conclusions. First, our retirement system is severely under
served. There are over 30 million American workers without access to a
quality retirement plan. Second, many of those might never have access
unless more professionals are willing to enter into the qualified
retirement plan profession. Third, those barriers must be removed
without injuring vulnerable plan participants.
That challenge may be easier to solve than one might think.
It is understood that independent SEC registered advice givers
(Registered Investment Advisors) are not more honorable than
representatives of a broker-dealer or insurance company. Both can be
equally honorable, educated, astute, etc.
Registered Investment Advisors by law must place the interests of
their clients above their own. Representatives of financial
institutions are expected to place the interests of their employer
above their own. If we look at this too narrowly, we may incorrectly
presume that with respect to interacting with plan participants, one is
good, and the other is bad. I've come to the conclusion that it's not
either or; but rather both are good and both have their place.
The challenge before us is not about who should or should not be
able to interact with participants. Rather, the answer to the challenge
is providing participants with an easy way to discern whether he or she
needs general information, needs advice, or wants/needs plan decisions
to be made for them by a discretionary fiduciary on their behalf.
A plan could actually be sufficiently diverse that all three
(general information, advice, decisions made automatically) are needed
by plan participants at one point or other. In such a scenario, a
Registered Investment Advisor, a Registered Representative, and a
discretional fiduciary could work side-by-side on the same plan,
harmoniously, each providing a specific needed service. Thus, this
debate should not be viewed as one approach is better than the other.
Each might be required at some point for a given need.
Therefore, this debate should be about encouraging more individuals
to enter the retirement plan profession; thus contributing to the
greater good of society, coupled with a simple way to help a
participant (or plan sponsor) know when one approach is needed over
another. Professional understanding and courtesy between plan sponsors,
plan participants, and professional service providers is required to
make it easy for the transition to occur from one approach to another.
Defining when a retirement plan professional is treated explicitly
or implicitly as a fiduciary is difficult to do, and hence exemptions
have been proposed to clarify the role of one that simply sells
retirement plans and provides the accompanying information necessary
for a participant to understand. The challenge with such exemptions is
that participants find it difficult to discern between advice and
information, and are usually unable to tell when that line has been
crossed.
The line is frequently crossed as a registered representative
becomes a trusted ``advisor'' to the plan participants; frequently
discussing personal matters about finances, retirement, etc., even
though the representative believes he or she is not giving ``advice''
as defined in ERISA.
When that line is crossed, the plan participant becomes vulnerable
because a relationship of trust exists. The participant begins to
personally rely on the information shared by the registered
representative, with the expectation of favorable outcomes.
Vulnerability, Reliance, and Expectation together create a fiduciary
relationship.
For example, a plan participant may share personal financial
information with a non-fiduciary registered representative. Sharing
personal information usually conveys or creates vulnerability on the
part of the participant.
Perhaps a feeling of vulnerability exists that he or she will not
be able to retire when they had hoped and are sharing that
vulnerability with the representative in the hope information will be
shared he or she can rely upon.
If the information is acted upon, it is because he or she relied
upon it because of the trust that exists between the parties, and the
expectation that something good will occur as a result of that
reliance.
If a participant is unable to discern that they are personally
vulnerable, the registered representative has a professional obligation
to point it out, and to refer him or her to a fiduciary for specific
advice.
If a non-fiduciary professional will adhere to that professional
standard of care, it is reasonable to conclude they are not acting as a
fiduciary, but rather a professor of information, not advice.
The following model disclosure would solve virtually every element
of this debate:
Disclosure of professional duty
My name is Jane Representative. My employer is ABC Broker Dealer,
and I am obligated to be loyal them just as you are to your current
employer. In other words, my first responsibility is to help my firm
succeed.
In accordance with that responsibility, I have a professional duty
to provide you with accurate and relevant information. It is your
responsibility to consider that information in light of your
experience, knowledge, understanding, and objectives.
During our interaction, it will be your responsibility to inform me
immediately if you ever feel vulnerable because you do not understand
the information I have shared with you, or you are unsure how to
implement it. In such an instance, you may require advice specifically
suited to your personal circumstances. We will then introduce you to
one or more independent SEC register investment advice givers.
We will always be here to serve, and we also understand that there
are times where specific, reliable advice is required to meet specific
individual needs or expectations.
If at any time you feel vulnerable due to a lack of understanding
about how information shared applies to you personally, and you need
customized information upon which you can trust and rely with the
expectation of specific outcomes, we will immediately introduce you to
a Registered Investment Advisors.
It is your responsibility to tell us and your employer (or its
designated fiduciary) when you are experiencing those feelings so we
can involve another professional to provide the advice you require.
If you do not request individualized advice in writing, we will
presume you understand the information conveyed, and that no further
clarification or elaboration is required.
______
In conclusion, there is a great need for many more individuals to
enter the retirement plan profession. It is an honorable profession
that has greatly improved the lives of tens of millions.
There are different roles professionals can play, including:
Conveyors of general information (non-fiduciary)
Advice givers (fiduciary)
Decision makers (fiduciary)
If a conveyor of general information is approached by a participant
that has questions about their personal situation, and feels
vulnerable, needs to rely on specific information, and will expect a
favorable outcome for having relied on that information, then a
fiduciary advice giver should be brought in.
Exemptions that permit a general conveyor of information to cross
over into the life-impacting realm of advice giving without being held
to the high level responsibility that accompanies that advice (that of
fiduciary), should be against public policy.
There's enough room at the table for all of the different types of
service providers. It may not be ``either/or,'' but it could be
``both.'' In other words, a plan may need two or more types of service
providers to serve the needs of the participants and beneficiaries.
This can easily be done without increasing the overall cost of the
plan. In fact, it could decrease total costs, and I have participated
in just that scenario hundreds of times.
Registered Representatives or agents should not be expected to be
mind-readers. If a conventional 401(k) plan requires a participant to
choose individual funds from a complex and diverse menu, then the
participant should also be responsible for knowing when they need
fiduciary assistance. If fiduciary advice is not immediately available,
the registered representative or agent should facilitate that advice to
clearly delineate between their services and that of a fiduciary advice
giver.
This simple solution does not impugn a non-fiduciary
representative, nor does it impair their ability to compete. Such a
representative can continue in their client relationship management
role just as they have in the past. They need only to explain that
given the participant's vulnerability, need for reliance, and
expectation of a favorable outcome, a fiduciary advice giver is
required in that specific instance. There are many Registered
Investment Advisors that will provide such advice on an as-needed
basis.
That solution solves the dilemma without adding complexity that is
difficult to understand, remember, or implement.
______
Prepared Statement of the Profit Sharing/401k Council of America (PSCA)
The Profit Sharing / 401k Council of America (PSCA) supports the
Department of Labor's proposed rule amending the definition of a
fiduciary adviser, with some recommendations for changes and
clarifications.
For more than sixty years, PSCA, a national non-profit association
of 1,000 companies and their six million employees, has advocated
increased retirement security through profit sharing, 401(k), and
403(b) defined contribution programs to federal policymakers. PSCA
provides practical assistance to our members on plan design,
administration, investment, compliance, and communication. PSCA is
based on the principle that ``defined contribution partnership in the
workplace fits today's reality.'' PSCA's services are tailored to meet
the needs of both large and small companies with members ranging in
size from Fortune 100 firms to small entrepreneurial businesses.
The elimination of the subjective ``regular basis'' and ``primary
basis'' tests in the proposed rule will reduce uncertainty for plan
sponsors, participants and beneficiaries, and service providers. Today,
the potential exists for plan fiduciaries and participants to believe
that they are receiving impartial advice while the advice provider
believes that ERISA's fiduciary standards are not applicable. PSCA
believes that removing this misunderstanding by applying the fiduciary
standard regardless of the regularity of the advice or to what degree
the recipient will consider it is a very positive development.
In the preamble to the proposed rule, the Department of Labor
requested comments on whether it should reexamine its current position
that a recommendation to take a distribution, even when combined with a
recommendation as to how the distribution should be invested, may not
constitute investment advice.
PSCA, in its formal comments on the proposed rule, urged the
Department to reverse its position. The decision by a participant or
beneficiary to request a distribution of their account assets, and how
to subsequently invest those assets, can profoundly affect an
individual's retirement. We believe the public policy benefit of our
position is self-evident and that a recommendation to take a
distribution constitutes a recommendation to sell a particular plan
investment.
The expansion of activities that will be considered advice under
the proposed rule raises concerns that the provision of marketing,
informational, and educational materials will be constrained by new
liability concerns. PSCA believes that the Department shares our
concerns, as evidenced by provisions in the proposed rule relating to
limitations for selling activities, educational activities pursuant to
Interpretive Bulletin 96-1, and marketing and assistance provided under
a platform arrangement. We made several suggestions in this regard.
The Department should clarify in the preamble and the body
of the final rule that educating participants about distribution
options, including discussions of the advantages and disadvantages of
seeking a distribution and managing retirement assets outside the plan,
does not constitute advice. As long as these communications do not
include a clear recommendation to seek a distribution, they should not
be treated as advice.
Education, information, and advice regarding the tax
effects of taking a distribution should not constitute the provision of
advice under the proposed rule. This important information is
frequently sought by or provided to plan participants that are
contemplating taking a distribution of their plan assets.
In the course of the Department's joint inquiry with the
Department of the Treasury on lifetime income products, the agencies
requested comments regarding the provision of information to help
participants make choices regarding management and spend down of
retirement benefits. PSCA and several other organizations identified
the expansion and clarification of Interpretive Bulletin 96--1 to
explicitly apply to the provision of information to help participants
and beneficiaries make better-informed retirement income decisions. We
urged the Department to take this action in conjunction with the
development of this rule.
The proposed rule specifies in subparagraph (c)(2)(ii)(B)
that marketing or making available securities or other property from
which a plan fiduciary may designate investment alternatives under a
fund platform or similar arrangement does not constitute the provision
of advice if certain disclosures are made. Subparagraph (c)(2)(ii)(C)
provides that general financial information and data to assist a plan
fiduciary's selection or monitoring of such securities or property does
not constitute the provision of advice if certain disclosures are made.
PSCA strongly supports these provisions and urged the Department to
retain and expand them in the final rule. The relief provided for the
provision of general financial information and data is currently
limited to information provided in conjunction with a platform
arrangement. It should be available for all plans, regardless of
whether or not it is offered in conjunction with a platform
arrangement.
It is common for a fund investment manager to provide
newsletters, economic market analyses, and forecasts to plan
fiduciaries. For example, the recent worldwide debt crisis and its
effect on capital markets, the economic impact of political crises in
the Middle East and Africa, or reports about emerging markets such as
China or Brazil might be discussed in these reports. Another common
topic of analysis is the Washington political environment and its
potential impact on industries and markets. These reports and analyses
may influence a plan fiduciary's decision about the selection and
monitoring of plan investments. PSCA believes that the Department does
not intend that these activities constitute the provision of advice. We
requested that the final rule include specific provisions that clarify
our interpretation.
Under the proposed rule, the provision of advice, or an appraisal
or fairness opinion, concerning the value of securities or other
property of an employee benefit plan constitutes the provision of
advice. The Department simultaneously announced that the proposed rule
supersedes its position in Advisory Opinion 76-65A, where it held that
making valuations to be used in establishing an ESOP does not establish
a fiduciary relationship because a plan did not yet exist; and that
advice provided to an existing ESOP regarding the value of employer
securities does not constitute the provision of advice.
These changes will result in creating a new fiduciary relationship
for a large group of service providers that provide valuation and
appraisal services for all types of retirement plans. According to the
preamble of the proposed rule, ``The Department would expect a
fiduciary appraiser's determination of value to be unbiased, fair, and
objective, and to be made in good faith and based on a prudent
investigation under the prevailing circumstances then known to the
appraiser.'' PSCA supports this standard of conduct and generally
supports the assumption of fiduciary status by plan service providers
that deal with plan investments. However, we also share the significant
concerns in the retirement plan community about the increased costs
that may result from the proposed changes. For example, questions have
been raised if the Department's standard of impartiality is consistent
with a fiduciary duty of loyalty. The magnitude of the costs and the
willingness of providers to provide valuation services under the
proposed rule are, we believe, undetermined. PSCA urged the Department
to carefully consider these issues when formulating a final rule.
At a minimum, valuations, fairness opinions, and appraisals of
assets traded on ``generally recognized markets'' should never be
considered the provision of advice. Additionally, the Department's
position in Advisory Opinion 76-65A that ``Where a plan is not yet in
existence, a fiduciary relationship within the meaning of section
3(21)(A) cannot be established'' is widely recognized as established
law that applies to all retirement plans subject to ERISA. We urged the
Department to clarify that it is not superseding this particular
finding in the Advisory Opinion.
______
------
Chairman Roe. Without objection, so ordered.
Mr. Andrews. Second, I, again, would like to thank you, our
colleagues, and the witnesses for a really well, and Secretary
Borzi as well, for really well-reasoned information which lets
us approach this problem. Again, it is refreshing to hear
people actually speak about solving a problem instead of
reading their talking points. So, not that any of us would ever
do that. [Laughter.]
Thank you very much.
Chairman Roe. Just as I close I want to make one closing
comment, I would like to make. I want to thank all of you all
for the education process you have done here.
And, quite frankly, just listening for a long time I guess
I will use a medical metaphor, it sounds like we are doing a
heart transplant when all you need to do is get up off the
couch and walk around the block. [Laughter.]
And, I mean we want to protect people from bad advice,
Professor Stein, as you pointed out. No question that we want
to do that. And yet, we want to make this system as efficient
for people like me that have been out there trying to run a
pension plan to maximize, and I can assure you no one had more
interest in making it work than me because my retirement
savings was also invested there.
So, thank you for this information. I think we do need to
step back and re-look this rule. I appreciate you being here.
Being no further business, this meeting is adjourned.
[Additional submissions of Dr. Roe follow:]
Prepared Statement of the American Council of Life Insurers (ACLI)
The American Council of Life Insurers (ACLI) commends this
subcommittee for holding this hearing on the Department of Labor's
(DoL) proposed rule on the definition of ``fiduciary'' for purposes of
offering investment advice. We applaud Chairman Phil Roe (R-TN) and
Ranking Member Rob Andrews (D-NJ) for holding this hearing to receive
testimony from the Assistant Secretary of the Employee Benefit Security
Administration, DoL, Phyllis Borzi, and various stakeholders on the
impact this proposal would have on individuals saving for retirement
and small businesses ability to provide investment education to their
plan participants. Members on this subcommittee from both parties have
already urged DoL to re-propose the rule to address a substantial
number of revisions that need to be made to it to ensure the rule does
not negatively impact these savers or businesses. We thank these
members for their efforts and urge them to reach out to the
Administration to share these concerns.
The American Council of Life Insurers is a national trade
organization with over 300 members that represent more than 90% of the
assets and premiums of the U.S. life insurance and annuity industry.
ACLI member companies offer insurance contracts and investment products
and services to qualified retirement plans, including defined benefit
pension, 401(k), 403(b) and 457 arrangements and to individuals through
individual retirement arrangements (IRAs) or on a non-qualified basis.
ACLI member companies' also are employer sponsors of retirement plans
for their employees.
Consistent with the comments submitted by stakeholders and concerns
raised by Members of Congress, we have urged the DoL to re-propose the
rule so that stakeholders have an opportunity to review and comment on
the DoL revisions to address these comments and concerns. A re-
proposal will provide an opportunity to ensure that plan sponsors, plan
participants and IRA owners continue to have affordable access to
investment education and investment choices. We have urged the DoL to
address prohibited transaction exemptions (PTEs) in conjunction with
its development of a new rule. Lastly, we also urge the DoL to re-
propose the rule so that stakeholders will be able to review and
provide comment on DoL's economic analysis of the impact the proposal
would have on IRA holders, plans and plan participants.
Background
On October 22, 2010, the DoL proposed a new rule to expand the
definition of fiduciary with respect to the provision of investment
advice. The proposed rule broadens the definition, for example, by
removing the ``regular'' and ``primary'' basis conditions necessary for
advice to be considered fiduciary advice. The DoL received over 200
public comment letters in response to the proposal.
There have been over 25 bipartisan, bicameral letters sent to the
Administration outlining Members of Congress concerns about the impact
the proposal would have on their constituents. These letters represent
over 80 Members. Most notably, the Chairman and Ranking Member of the
following Committees have sent letters to the agency heads expressing
their concern about the proposal: Senate HELP, House Education and
Workforce, Senate Banking, House Financial Services, Senate
Agriculture, House Agriculture, Senate Finance and the House Ways and
Means Committee.
DoL Should Re-propose the Rule so that Stakeholders Can Have an
Opportunity to Review How It Plans to Address Comments and
Concerns Raised
We recognize the DoL's authority to review its rules, especially in
light of the responsibilities individuals have to plan for their
retirement. We also appreciate the DoL's willingness to listen to
stakeholders concerns about the proposal. However, the rule's expansion
of who would be considered a fiduciary will interfere with employers
and their management of plans and investment sales and distribution
practices that are customary in the marketplace, well understood, and
commonly relied upon by financial services providers, plans and
participants alike. We are concerned that these changes will result in
plans, plan participants, and IRA owners having less access to
investment information and investment choices. We want to make sure
that this result does not occur. We have offered comments to the DoL
that seek to preserve the DoL's enforcement objective and avoid
unnecessary disruption and negative impacts to plans, participants and
individuals. Despite these efforts, we are unsure of whether and, if
so, how the DoL will address these comments, and therefore seek to
review its efforts once again to make sure the rule does not negatively
impact individuals or small businesses.
Additionally, the DoL has acknowledged that it will need to revise
a number of existing prohibited transaction exemptions (PTEs) which
financial providers currently rely upon. ACLI has asked the DoL to
issue a new proposal together with any proposed changes to or
confirmations of exemptive relief. ACLI believes it is important to
review and comment on these together. Absent a re-proposal, these
revisions will be presented in conjunction with a final rule which may
or may not address the concerns raised by ACLI, other organizations and
companies. Stakeholders need an opportunity to review any proposed PTEs
in conjunction with a proposed rule and provide comment as to whether
they are workable within the newly revised rule.
DoL Should Re-propose the Rule so that Stakeholders Can Review and
Provide Comment on DoL's New Economic Analysis
Assistant Secretary Borzi has recently announced that she will
include a complete economic analysis on the impact of the rule on IRA
holders, plans and plan participants in the final rule. Unfortunately,
if issued as a final rule, stakeholders would not be able to comment
upon the DoL's analysis. Given the rule's potential impact, such
regulatory action should not occur without stakeholder review and
comment.
A recent report issued by Oliver Wyman outlined the tremendous
negative impact this proposed rule would have on IRA owners, especially
those with smaller balances. Nearly 40% of IRAs in the study sample had
less than $10,000 in their accounts. 98% of investor accounts with less
than $25,000 were in brokerage relationships. This proposed rule would
lead IRA providers to offer these small account owners either a higher
fee-based advisory account or a no service account in order to comply
with the proposal. Many low to middle income IRA owners would not be
able to afford the estimated 75--195% increase in cost to pay for the
advisory account. The DoL failed to include a similar analysis in its
proposal, and needs to fully consider such analysis before initiating a
rulemaking.
As an addenda to this statement, ACLI has attached a copy of its
initial comment letter on this issue to the DoL dated February 3, 2011,
its statement that it provided at DoL's public hearing on March 1,
2011, and additional comments in response to hearing questions dated
April 12, 2011.
We look forward to working with this subcommittee, the larger
committee, and DoL to address the concerns raised in this statement and
to ensure Americans have abundant access to investment education and
appropriate investment advice. (See attached addenda.)
ACLI Comment Letter to DOL February 3, 2011
On behalf of the American Council of Life Insurers (``ACLI''), we
are writing to comment on the proposed rule promulgated under Section
3(21)(A)(ii) of the Employee Retirement Income Security Act
(``ERISA''), which was published at 75 Fed. Reg. 65263 (October 22,
2010) (``Proposed Rule'' or ``Rule''). The Proposed Rule would
dramatically enlarge the universe of persons who owe duties of
undivided loyalty to ERISA plans and to whom the prohibited transaction
restrictions of ERISA and the Internal Revenue Code would apply1, by
re-defining and substantially broadening the concept of rendering
``investment advice for a fee'' within the meaning of ERISA Section
3(21)(a)(ii).
The American Council of Life Insurers is a national trade
organization with more than 300 members that represent more than 90% of
the assets and premiums of the U.S. life insurance and annuity
industry. ACLI member companies offer insurance contracts and other
investment products and services to qualified retirement plans,
including defined benefit pension, 401(k) and 403(b) arrangements, and
to individuals through individual retirement arrangements (IRAs) or on
a non-qualified basis. ACLI member companies also are employer sponsors
of retirement plans for their own employees.
1. Although not covered under Title I of ERISA, individual
retirement accounts and annuities (``IRAs'') fall within the scope of
the prohibited transaction excise tax provisions of Code Section 4975.
The Proposed Rule would similarly enlarge the universe of persons
defined as fiduciaries for purposes of applying Section 4975 to
transactions involving IRAs.
2. Subject, of course, to any limitations on marketing and
promotional practices imposed on sales of financial products generally.
3. ERISA Sec. 3(21)(A)(ii)
ACLI appreciates the Department's concern that under some
circumstances the current rule impinges the Department's ability to
bring enforcement actions in situations that are clearly abusive. We
share the Department's interest in seeing that plans and participants
who seek out and are promised advice that is impartial and
disinterested ultimately receive advice that adheres to the rigorous
standards imposed by ERISA. At the same time, we are concerned that the
Proposed Rule's pursuit of this objective interferes with investment
sales and distribution practices that are customary in the marketplace,
well understood, and commonly relied upon by financial services
providers, plans and participants alike. We are concerned that these
changes will result in plans, plan participants, and IRA owners having
less access to investment information. Our comments seek to preserve
the Department's enforcement objective while avoiding unnecessary
disruption and negative impacts to plans, participants and individuals.
Persons engaged in the sale and distribution of investment product
and services need to have confidence that ordinary course sales
recommendations will not, in hindsight, be subjected to a fiduciary
standard that disallows the payment of sales commissions and other
traditional forms of distribution-related compensation. Please note
that regulatory efforts are underway by the Securities and Exchange
Commission (``SEC'') regarding the standard of care under the
securities laws for broker-dealers and investment advisers that provide
investment advice about securities to retail customers. On January 21,
2011, the SEC issued a study on broker-dealers and investment advisers.
We are reviewing this study which may lead to additional comments on
the Proposed Rule. We urge the Department to provide the public
sufficient opportunity to consider the SEC's regulatory efforts and
offer additional comments on the Proposed Rule.
Parties engaged in transactions with ERISA plans and IRAs need
clear, unambiguous rules by which to determine their duties and
obligations in order for the marketplace to function efficiently and to
ensure that plans, plan participants and IRA owners continue to have a
broad range of investment products and services available to them,
including investment advice and educational services. We offer these
comments to assist in the development of such rules.
1. Recommendations Made by Sellers
Firms seeking to sell investments and investment products to plans
and plan participants should be able to both (1) promote their products
and recommend them to prospective purchasers,2 and (2) benefit
financially from the successful sale of those products. Without a
financial interest, economic activity is stifled and opportunities for
buyers and sellers to meet and transact are lost.
Sales activities naturally include recommendations to purchase and
invest in products and services offered by the seller. For that reason,
the seller's limitation provided by paragraph (c)(2)(i) (the ``seller's
limitation'') recognizes financial institutions such as life insurers
and their sales representatives should not be categorized as
fiduciaries under ERISA or Code section 4975(e)(3)(B) when they are
engaged in selling activities and are clear that they are acting in a
sales capacity. The seller's limitation is a critical component of the
Department's Proposed Rule.
Sales Activites. We believe it is absolutely critical to make sure
that the wording of the seller's limitation be sufficiently inclusive
to encompass the full scope of ordinary course selling and distribution
activity. As written, the wording of the seller's limitation, which
describes sellers and their agents, raises some uncertainties about the
availability of the seller's limitation for other distribution
channels, such as independent insurance agents, insurance affiliated
and unaffiliated broker-dealers and registered investment advisers that
offer life insurer products, whether exclusively or as one of many
other products from a variety of different product manufacturers.
Impartial, not ``Adverse.'' Our membership is deeply troubled by
the wording of the paragraph requiring that the recipient of the advice
know or have a basis for knowing that the interests of the selling firm
and its distributors are ``adverse'' to the interests of the plan and
its participants. While the seller of a financial product has a
financial interest in the outcome of a transaction, we think it is
inappropriate to describe that financial interest as necessarily
entailing broad adversity of interest. As responsible providers, we
have an interest in seeing that our customers are well served, are
happy with our products and services, and that our customers found
those products and services useful to the attainment of their financial
goals.
The process whereby purchasers and sellers bargain for and agree
upon the terms of a proposed transaction is fundamental to the
efficient operation of a market transaction. Adversity of interests
exists in the area of price negotiation, where the seller of a product
or service has an interest in maximizing profit and the purchaser has
in interest in minimizing cost.
We believe the seller's limitation needs to parse this key
distinction. It should make the point that a seller of an investment or
an investment product has a financial interest in the transaction it is
recommending and, if applicable, that less costly versions of an
investment product may be available. So long as purchasers are provided
with that information, they will have the requisite basis for
evaluating the recommended transaction in light of the seller's
financial interest, and will be in a position to understand that the
selling firm's recommendation is not impartial.
Illustrate with Examples. The rule should provide an example or
examples of circumstances in which a person would reasonably
demonstrate that the recipient of information knows that a
recommendation is being made by someone in a capacity as a seller. For
example, a written representation would suffice if it clearly notes
that the person is a seller of products and services, that the person
and, if applicable, its affiliates, will receive compensation in the
event the plan, plan fiduciary or participant/individual selects the
product and services, and that such compensation may vary depending
upon which product is purchased or which investments under a product or
products are selected. This type of representation would provide a
clear indication to the plan, plan fiduciary or participant/individual
that the person is a non-impartial seller of products and services. It
would also address the Department's stated concern about undisclosed
conflicts of interest. Again, ACLI urges the Department to adopt a rule
that leaves the nature of the relationship unambiguous to all parties.
Ongoing Sales Relationship. The Department should clarify that the
seller's limitation covers all aspects of both an initial sale and the
subsequent ongoing relationship between a plan, plan fiduciary or
individual and an investment provider or any agent, broker, and/or
registered investment adviser involved with the sale of the investment
provider's products and services. This would include information and
recommendations regarding the use of a product, e.g., advice regarding
the choice of investments available under a product's menu of
investments. It is common for defined contribution plans to request of
potential investment providers a sample menu of investments from among
a provider's available investments which, in the opinion of the
provider, best match the plan's current investment options. There
should be no expectation that any such recommendation is impartial or
that the plan seeks advice upon which it will rely for its investment
decisions. The nature of this relationship should not change after a
sale. A product provider, agent, broker, and/or registered investment
adviser may continue to make recommendations regarding products and
services. There should be no expectation that these recommendations
differ in nature following the initial sale.
2. Representations of ERISA Fiduciary Status Should be Written
In its preamble, the Department expresses the belief that
explicitly claiming ERISA fiduciary status, orally or in writing,
enhances the adviser's influence and forms a basis for the advice
recipient's expectation that the advice rendered will be impartial. The
Proposed Rule reflects that view by applying fiduciary status to all
persons affording those acknowledgments and disallowing the
availability of the paragraph (c)(2)(i) seller's limitation to such
persons.
We are concerned about the potential proof issues inherent in
claims that an adviser provided oral representations of fiduciary
status. Advisers may be hard put to dispute erroneous or otherwise
fictitious claims by plans that oral assurances of fiduciary status
were provided. At the same time we think prudence dictates that where a
plan, plan participant or individual seeks out impartial, disinterested
advice delivered in a manner consistent with ERISA's fiduciary standard
of conduct, then the plan, plan participant or individual should obtain
the appropriate acknowledgment in writing in order to secure the
acknowledgement in a permanent form.
For these reasons, we strongly suggest that paragraph (c)(1)(ii)(A)
be modified to apply only to persons who represent or acknowledge in
writing (electronic or otherwise) that they are acting as a fiduciary
within the meaning of ERISA with respect to the advice they are
providing to the person or persons for whom they are so acting. This
concept is consistent with the recently promulgated section 408(b)(2)
regulations which require that a service provider acting in a fiduciary
capacity acknowledge such in writing.
3. Separately Consider a Rule for Individual Retirement Arrangements
ACLI requests that the Department take additional time to study the
IRA and Keogh/one-participant plan markets and carefully consider the
economic impact of the Proposed Rule on both individuals and providers
of products and services. We ask the Department to consider IRAs and
these Keogh plans apart from the scope of a final rule for time to
consider the IRA and Keogh market place, changes in its regulatory
environment, the economic impact of a change to the current rules to
the non-ERISA marketplace, a meaningful investment education safe
harbor tailored to this marketplace, and to clarify the application of
existing exemptions and/or issued new exemptions tailored to this
marketplace. We believe that this would be similar to the Department's
decision to separately consider welfare benefit plans under the
recently issued 408(b)(2) regulations. The Department has held hearings
and is close to issuing newly proposed regulations governing fee
disclosure for welfare benefit plans. We urge the Department to
consider a similar approach for IRAs and Keogh plans.
Unlike employer sponsored 401(k) plans that generally provide a
limited number of investment options selected by a plan fiduciary, IRAs
and Keogh plans offer individuals a practically unlimited number of
options. Brokers and registered investment advisers who prefer to offer
a wide range of options find it impossible to create a level sales
compensation structure. Because that universe of investments is
virtually unlimited, it is nearly impossible to design a computer model
to take into the account every possible option. The rights of IRA
owners are protected by way of their individual agreements and direct
relationships with financial institutions.
Seller's limitation. We believe that the Department should confirm
that the seller's limitation applies to IRAs. It is common for advisors
and agents to engage clients and prospective client on their particular
goals and objectives to better understand their product and service
needs. Based on these conversations, an advisor might explain the pros
and cons of various investment vehicles including variable annuities,
mutual funds, brokerage accounts, banking products, fixed annuities,
alternative investments and several types of advisory accounts. Within
each of these types of securities and property, advisors/agents can
usually recommend several different specific securities that may have
different features. It is extremely difficult to design different
product types so that the product pays the advisor the same
compensation regardless of the investment allocation within the
product. It is virtually impossible to do so across product types. For
instance, compensation charged for executing a stock trade will differ
from compensation received for selling a variable annuity. Absent a
seller's limitation, it would be next to impossible to provide
recommendations as to products and services because generally fees are
not level.
For example, a broker may receive 50 bps if the individual invests
in Product A (a large cap growth fund), 25 bps if the individual
invests in Product B (a bond fund) or 0 bps if the individual invests
in Product C (a money market account). For an individual with $10,000
in her account, a recommendation to put all assets into Product A would
result in compensation of $50. A recommendation to use two products,
60% to Product A and 40% to Product B would result in compensation of
$40. If the seller's limitation is too narrow, a broker may avoid
making a recommendation, thereby leaving the individual without any
professional assistance. The individual could instead pay a fee-only
advisor (typically $500) to get the recommendations that may well be
identical to the recommendations the broker would otherwise have
provided at a far lower cost. The economics of small plans and small
accounts make it so that the only advice available is often the
incidental advice provided by brokers. Absent a broad seller's
limitation, the average individual may receive no advice at all.
Other Limitations--The limitations provided at Section 2510.3-
21(c)(2)(ii) should be available to IRAs. The Proposed Rule carves out
from the definition specific acts related to the dissemination of
investment information and defined contribution plan ``platforms.''
However, these carve outs are limited to individual account plans as
defined in ERISA Sec. 3(34). ACLI urges the Department to explicitly
extend these carve outs to include IRAs.
Insurers issue variable IRAs (IRC Sec. 408(b) Individual
Retirement Annuities) that invest in insurance company separate
accounts. These accounts may offer a variety of investment options in
different asset classes to address a range of possible investment
objectives or asset allocations of different annuity owners all within
a single separate account. The limited number of the funds in the
separate account is similar to the ``platform'' of funds available to a
defined contribution plan participant. The principal of the
``platform'' limitations described in 2510.3-21(c)(2)(ii)(B) & (C)
should be equally applicable to IRAs.
Regarding education, the Department has provided considerable
guidance regarding the line between activities that would result in
fiduciary investment advice as opposed to activities that would be
deemed non-fiduciary investment education. The Proposed Rule
specifically references Interpretive Bulletin 96-1 (29 CFR 2509.96-1)
to preserve this guidance for ERISA individual account plans, but does
not provide a limitation for these activities to IRAs. Interpretive
Bulletin 96-1 assumes that the investment education being provided
relates to an ERISA individual account plan with a limited number of
investment options. It addresses asset allocation models, but does not
address the range of choices available for IRAs or Keogh plans such as
annuity products, mutual funds, REITs, brokerage accounts, or an
advisory wrap program to name just a few. Information that models the
use of these various arrangements by hypothetical individuals should be
viewed as ``investment education'' rather than investment advice.
Furthermore, the educational activities that apply to individual
account plans are even more important with regard to IRAs. As indicated
above, the investment options available to IRA owners could almost be
limitless, as compared to employer sponsored plans which generally have
limited options. The typical IRA owner needs help in picking the
investment options needed to achieve their retirement goals and the
concepts of IB 96-1 are therefore very important to IRA owners. We
request that prior to issuing a final rule applicable to the IRA and
Keogh plan marketplace, the Department issue a Field Bulletin that
addresses investment education in IRAs and Keogh plans and make it
clear that the ``education limitation'' applies to model information
regarding the use of these various types of investment arrangements and
asset allocation models for IRAs and Keogh plans.
Consumer Impacts--ACLI is extremely concerned that the Rule, if
adopted as proposed, will negatively impact the very people the
Department seeks to protect. We believe that the Rule may lead to less
choice, reduced access and increased costs for products and services.
Compensation structures vary by investment products for a variety of
reasons, for example, to account for the increased time needed to
explain a product that is not well understood or more complex than
another. Sales agents must be able to address the needs of their
customers. The Rule must permit this or, we fear, there will be fewer
opportunities for IRA customers to learn about and consider a range of
products and services.
We are not aware of a computer model that would advise an
individual as to choices among different IRA product types. If typical
sales activities, including recommendations regarding one or more IRA
products under varied compensation structures, are not permitted by the
final rule, IRA customers may find that advice is only available under
a ``wrap program.'' Under these arrangements, a set fee, either on a
dollar or percentage formula basis, is paid for advice on the assets
within the arrangement. Wrap programs are generally not available to
individuals with small accounts. In many instances, wrap programs are
more expensive than commission-based accounts, yet may be appropriate
for certain IRA account holders. However, they are not necessarily as
suitable a choice for other IRA account holders, such as buy and hold
investors. Guaranteed lifetime income products are a ``buy and hold''
investment on which an ongoing wrap fee would not be a good fit. As
annuities are sold on a commission basis, they are generally not
available under a wrap program.
Individuals should not be limited in making IRA rollover decisions.
A provider should be able to sell and an individual should be able to
purchase an IRA insurance product even when the provider's products are
used to fund the plan from which a rollover will be made. Fiduciary
status should not be applied in a way that would restrict the options
available to the participant seeking to purchase a rollover product. As
we noted in section 1 above, so long as it is clear that the provider
seeks to sell products, the seller's limitation in the Proposed Rule
must apply here.
4. Recommendations to Take Distributions Not Investment Advice
The Department has requested comment on whether and to what extent
the final rule should define ``investment advice'' to include
recommendations related to the taking of a plan distribution. A
decision by the participant to effect a distribution cannot be assumed
to be an investment decision with respect to the plan as the Department
noted in Advisory Opinion 2005-23A. A recommendation regarding whether
to take a distribution from a plan might include advice which results
in a new investment outside the plan (e.g., ``you should rollover your
benefit to your new employer's plan) or on what such distribution
should be spent (e.g., ``you may be eligible to take a hardship
distribution to cover our repair to your home''), but it should not be
construed to be advice ``with respect to any moneys or other property
of the plan.''3 While a plan may need to liquidate various investments
to make the distribution, liquidation of plan assets is merely
incidental to the primary transaction which is a distribution from the
plan. In addition, a distribution will not necessarily result in a
liquidation of assets if the plan distributes cash or other investments
in-kind, i.e., no change in investment. To the extent that a
recommendation to effect a distribution is also accompanied by specific
advice regarding the plan's investments (e.g., to liquidate certain
plan investments but retain others), the provision of such investment
advice would be subject to the Proposed Rule. However, a recommendation
regarding whether to contribute to or take a distribution from a plan
is not investment advice and should not be considered investment advice
regardless of the fiduciary status of the financial professional making
the contribution or distribution recommendation.
Fiduciary Responsibilities can be Limited by Agreement
In the preamble, the Department cited Advisory Opinion 2005-23A and
noted its position that a recommendation to a participant to take a
distribution does not constitute investment advice within the meaning
of the regulation. We urge the Department to use the preamble to the
final regulation to clarify an important issue raised by question 2 of
the advisory opinion, i.e., the extent to which responses by a party
who is ``already a fiduciary'' to participant questions regarding
distributions are the exercise of discretionary authority regarding
management of the plan which is subject to ERISA fiduciary
restrictions. Specifically, we ask the Department to clarify that
responding to a participant's question regarding plan distribution is
not subject to fiduciary standards merely because the party responding
to the question or its affiliate provides fiduciary services under a
written agreement with the plan that are separate and unrelated to
participant distributions. Such a clarification would be consistent
with the understanding that fiduciary responsibilities can be limited
by agreement and that no party is an all-purpose fiduciary merely
because it or its affiliate has entered into an agreement to perform
specific fiduciary services. More specifically, ERISA uses a functional
definition of fiduciary. Therefore a person is only a fiduciary to the
extent the person performs a specific fiduciary function. For example,
an agent is a fiduciary due to an arrangement to provide plan
participants with investment advice regarding designated plan
investments. If that agent recommends that a participant take a
distribution from the plan, this action is separate and apart from the
scope of the fiduciary's duties under the arrangement. We urge the
Department to confirm this functional definition of fiduciary and
clarify that activities such as a recommendation to contribute to a
plan or take a distribution from the plan, whether directly or via an
IRA roll-over, do not fall within the scope of a fiduciary's duties
merely because the person is a fiduciary for other purposes, e.g.,
participant level investment advice. We also urge the Department to
confirm that the seller's limitation is available to persons
recommending IRA arrangements to a plan participant or individual to
receive a rollover from a plan or another IRA.
5. Status as RIA Alone Should Not Give Rise to Fiduciary Duty
Absent the application of the limitations in paragraph (2), section
2510.3-21(c)(1)(ii)(C) of the Proposed Rule provides that all
registered investment advisors (``RIA'') are ERISA fiduciaries. ACLI
believes that this provision is both unnecessary and unworkable. We
find the provision unnecessary as paragraph (D) of that subsection
already includes any person that provides advice or makes
recommendations to plans and plan participants as described. The
provision is unworkable as its application in conjunction with the
affiliate rule leads to fiduciary status even when no advice or
recommendations have been made to the plan or plan participants.
Should the final rule include the provisions of section 2510.3-
21(c)(1)(ii)(C), ACLI requests that the rule limit the application of
the affiliate provision to only those instances in which an affiliate
engages in actions or has authority with respect to the plan that is
sufficient to cause a reasonable plan fiduciary to believe it is
receiving fiduciary-level investment advice. Under the Proposed Rule,
the mere affiliation with an RIA would result in fiduciary status.
Specifically, the Proposed Rule says that a person may attain this
status ``directly or indirectly (e.g., through or together with any
affiliate).'' Affiliation with an RIA should not trigger ERISA
fiduciary status unless the RIA is providing advice services to the
plan. If the RIA is not providing advice services to the plan, the
affiliate should be able to rely on the multi-factor test in section
2510.3-21(c)(1)(ii)(D) of the Proposed Rule in determining its
fiduciary status.
Similarly, affiliation with, or even direct status as, an ERISA
fiduciary other than by providing investment advice should not trigger
the presumption that a person is an investment advice fiduciary unless
such status would give plans and participants a reasonable expectation
of impartial investment advice and the person is in a position to
influence investment decisions. Thus, for example, status as an ERISA
fiduciary for a limited purpose unrelated to investment decisions
(e.g., directed trustee, investment manager of a ``plan asset''
investment vehicle in which a plan invests such as an insurance company
separate account or collective trust), either directly or through an
affiliate, should not trigger the presumption of investment advice
fiduciary status because the fiduciary's limited status alone would not
give rise to a reasonable expectation that the fiduciary should provide
impartial investment advice and does not put the fiduciary in a
position to influence investment decisions. To impose investment advice
fiduciary status on these persons solely because of these other limited
and unrelated functions would be contrary to the functional nature of
fiduciary status under ERISA, which generally only imposes fiduciary
responsibility on persons to the extent of their fiduciary activities
with respect to the plan.
ACLI understands that the language assigning fiduciary status
through an affiliate relationship is in the existing rule today so it
may seem reasonable to continue this concept in the Proposed Rule.
However, the difference between the existing rule and the Proposed Rule
is that the existing rule is primarily focused on activity, not status.
For example, under the current rule, the mere affiliation of a person
with an RIA or a directed trustee would not trigger fiduciary status.
Instead, the affiliate would have to engage in actions or have
authority with respect to the plan that is sufficient to cause a
reasonable plan fiduciary to believe it is receiving fiduciary-level
investment advice. Because the Proposed Rule would presume fiduciary
status based on status alone in some cases, extending that presumption
based solely on the status of an affiliate is inappropriate.
6. Reasonable Expectations for Fiduciary Status
The Department should revise section 2510.3-21(c)(1)(ii)(D) to
provide greater clarity as to which arrangements lead to fiduciary
status. ACLI believes that fiduciary status should not apply when
advice merely ``may be considered.'' The current rule provides that a
person will be a fiduciary when the person and the plan agree that the
advice ``will serve as a primary basis'' for investment decisions with
respect to plan assets. ACLI believes that this is reasonable and in
keeping with the intent of ERISA. The fiduciary standards of ERISA
should only apply when the parties reasonably expect that the advice
given and received will serve as a basis for a decision. That
reasonable expectation should be evidenced by a written agreement
between the parties or a written disclosure from the provider. Due to
the nature of such a relationship, this advice should be subject to the
fiduciary duties and responsibilities of ERISA. However, the Proposed
Rule would subject such duties and responsibilities to persons whose
advice or opinions hold no such import. A plan may solicit advice from
a number of persons without engaging any one to serve as an advisor.
When a plan's interest in the advice is cursory at best, there is
clearly not a relationship which would warrant the extension of ERISA
obligations to the advisor.
7. Platform Provider Limitation
The Department should provide greater clarity on the ``platform
provider'' limitation in section 2510.3-21(c)(2)(ii)(B) as it pertains
to ``individualization'' in the context of the sales, marketing and
retention activities of platform providers. In particular, we believe
the platform provider limitation should be clear that platform
providers are not providing investment advice for a fee when they
suggest to plans sample menus, or otherwise, when the platform provider
(1) does not hold itself out as a plan fiduciary, (2) discloses that
its recommendations are not intended to be impartial advice, and (3)
discloses that it has a financial interest in the transaction, which
may include indirect compensation paid to the platform provider or its
affiliates from investment fund complexes.
This is important to platform providers because in the ordinary
course of selecting a platform provider, or determining whether to
continue a contract with a platform provider, plan sponsors often
require, either through a formal request for proposal or by means of an
informal request by an intermediary acting for the plan such as a
broker or consultant, that a platform provider supply a sample menu of
investment funds (e.g., a subset of funds available from the provider's
investment platform) for consideration by the plan sponsor and its
advisers. Platform providers that fail to respond to such requests are
often excluded from the sales opportunity, or fail to retain an
existing plan customer.
In some cases, such requests may be accompanied by certain criteria
or parameters supplied by the plan sponsor or its intermediary, to
guide the platform provider such as the plan's investment policy, fund
performance history requirements, Morningstar classifications and other
similar criteria. Often, however, the plan sponsor's (or its
intermediary's) request may be simply that the platform provider supply
a suggested list of funds from the provider's platform that are
substantially identical or closely comparable to the plan's existing
designated investment funds.
In responding to these requests, platform providers engage in non-
fiduciary sales activity. Platform providers strive to suggest sample
menus that are consistent with the goals and objectives communicated to
the platform provider by the plan sponsor, and consistent with the
economic needs of the platform provider's non-fiduciary business model.
Therefore, similar to the activity described in the seller's limitation
at section 2510.3-21(c)(2)(i), the platform provider will typically
attempt to respond to these requests by suggesting a sample menu or
suggested list of funds that both (1) attempts to reasonably satisfy
any criteria accompanying the request and (2) meets the platform
provider's target revenue needs. Accordingly, we believe it is
important that the limitation in section 2510.3-21(c)(2)(ii)(B) be
clarified to include these types of sales activities.
8. Investment Product Offerings are not Investment Advice
The Department should clarify in a final rule or its preamble that
the development and offer of an investment product with a limited
investment menu, e.g., a bond fund, a stock fund and a balanced fund,
is not a provision of investment advice. Investment providers such as
insurers should have the flexibility to offer a range of products with
varied investment menus.
9. Confirm Status of Existing Exemptions
The last time a new fiduciary standard was created to govern sales
of products by brokers and other investment advisers, the Department
responded immediately issuing a number of exemptions applicable to
broker-dealer activity to protect certain activities. Creating a
bright-line test to determine who is an advice fiduciary is a laudable
goal. However, the bright-line test should not end at the determination
of who is a fiduciary, but rather extend to the determination as to
whether such advice creates a prohibited transaction when the broker or
other financial professional receives fully disclosed direct or
indirect compensation from such sale or service.
It is difficult to assess the impact of the Proposed Rule without a
clear understanding of whether prior exemptions would continue to apply
and whether new exemptions are contemplated. The Department has
provided a broad exemption for the sale of annuities (PTE 84-24). We
would appreciate the Department's confirmation that this exemption is
still available and would cover sales of affiliated and unaffiliated
annuities as well as any compensation, direct or indirect, received by
an affiliated insurance company, affiliated money managers of variable
annuity subaccounts, and any revenue sharing paid to the broker.
Further, we seek the Department's confirmation that if the requirements
of PTE 84-24 are met that the exemption covers the provision of
investment advice. The Department should also confirm the status of
exemptions such as PTE 75-1 and 86-128. In particular, it should
confirm that these exemptions apply to the provision of investment
advice. Product providers, agents and brokers need to know that these
exemptions still apply, and cover advisory programs which meet the
requirements of the exemption.
Finally, the Department has issued Advisory Opinions to investment
providers that also provide investment advice to ERISA plan
participants on whether the receipt of compensation under the
arrangements in question result in prohibited transactions. In both
Advisory Opinion 97-15A (the ``Frost'' letter) and Advisory Opinion
2001-09A (``the SunAmerica'' letter), the Department concluded that,
based upon the facts, the receipt of compensation described under these
arrangements did not result in a prohibited transaction under ERISA
Sec. 406(b). ACLI members agree with the Department's conclusions in
these Opinions. We ask that Department continue to support these
conclusions and leave no doubt as to the status of these Opinions under
a final rule.
10. Valuations are not Investment Advice
ACLI requests that the Department remove the provision of appraisal
services from the rule. ERISA section 3(21)(A)(ii) provides that a
person is a fiduciary if he or she ``renders investment advice for a
fee * * *'' The determination of the current price of an asset is not
``investment advice,'' i.e., it is not a recommendation to purchase or
sell property or securities nor an opinion regarding the merits or
value of investing in such property or security. The Department
elaborated on the matter shortly after it issued the current rule in
Advisory Opinion 76--65A, clarifying that the provision of valuation
services is not ``investment advice.'' The Department noted, absent an
opinion as to the relative merits of purchasing a particular asset as
opposed to some other asset or assets, the valuation of securities is
neither investment advice, nor advice as to the value of securities.
There are good reasons for not treating appraisal services as
investment advice. When a plan fiduciary directly engages an appraiser
to obtain current prices on property or securities that are under
consideration for purchase or sale or for assets already held by the
plan, the fiduciary must act prudently in selecting and monitoring the
appraiser. A plan's service arrangement with an appraiser is subject to
the provisions of ERISA Sec. 408(b)(2). As for the Department's
concerns regarding undisclosed conflicts of interests, the interim
final rule under ERISA Sec. 408(b)(2) makes clear that to satisfy the
prohibited transaction exemption under ERISA Sec. 408(b)(2), an
appraiser who provides services for indirect compensation must disclose
to the fiduciary any and all indirect compensation it expects to
receive for services rendered to the plan. Thus, with respect to
appraisals, there already is a plan fiduciary to ensure that appraisal
activities are performed under an arrangement and in a manner that
protects the interests of the plan and its participants and
beneficiaries.
Extending fiduciary status to appraisers under this Proposed Rule
would, at the very least, substantially raise the costs of what are
already objective independent valuations for no discernible purpose.
For appraisal work performed for insurance company separate accounts,
it would make such appraisers fiduciaries to all ERISA covered plans
that invest in these separate accounts. In general, these appraisers
would have no direct relationship with or knowledge of these ERISA
plans. ACLI members expect many appraisers to avoid ERISA plans and
investment vehicles in which plans invest altogether if this Proposed
Rule take effect. In that event, there would be severe market
disruption for both plans seeking to invest in separate accounts and
other non-publicly traded securities. At best, we anticipate fewer
appraisers and increased valuation fees due to the reduction in the
number of willing appraisers and the need for willing appraisers to
insure against potential law suits, all of which are costs that will
ultimately be borne by plans and their participants.
If the Department extends the definition to include appraisal
services, we note that the limitation on the application of the
Proposed Rule at (c)(2)(iii) raises two key concerns. First, the scope
of the exclusion for ``general reports * * * provided for purposes of
compliance with the reporting and disclosure requirements'' is too
narrow. It is common for insurers to prepare and provide reports and
statements more frequently than ERISA's minimum reporting requirements.
For example, it is common to provide access to daily online account
values to plan participants. It is also common for interim reports to
be prepared for a plan's investment committee. Second, and more
importantly to insurers, the rule's exclusion for reports on assets for
which there is ``not a generally recognized market'' is quite
problematic.
Both a plan's equity investment in an insurer's separate account
(units of the separate account) and an undivided interest in the
separate account's investment in other vehicles (e.g., units of the
separate accounts investments in real estate funds, hedge funds,
private equity funds) are ``plan assets.'' Accordingly, any party
passing along information to the separate account investment manager
(the insurer or its affiliate) on the value of the separate account's
investment in the underlying investment vehicles (units in the
underlying fund) or on assets of that vehicle that are used in
computing unit values of that vehicle is potentially a fiduciary under
the Proposed Rule because it is giving advice on the value of
securities or other property owned or to be purchased by a plan. This
would be true whether the underlying investment vehicle invests in
publicly offered securities or in non-public assets (with values
determined by appraisal). The parties swept into the fiduciary
definition include investment managers of underlying investment
vehicles, custodians or sub-custodians and appraisers.
Many insurers offer real estate separate accounts and hire
appraisers to determine the values of separate account holdings. Those
values are used for client reporting purposes and to set unit values
used for a plan's purchase or sale of separate account units. The
Proposed Rule would impose fiduciary status and liability on real
estate appraisers to separate accounts in which ERISA plans invest. By
valuing the underlying properties of a real estate fund, an appraiser
would be advising the real estate fund manager on the value of fund
units, an ERISA ``plan asset,'' because the appraisal is for an
underlying asset of the insurer's separate account.
Units of a non-registered separate account are not publicly offered
securities. This is true even when the underlying assets of the
separate accounts are registered securities. Under the Proposed Rule,
establishing separate account unit values would be a fiduciary act of
``advice,'' leading an insurer to become a fiduciary for purposes of
the valuation. Insurers typically hire sub-custodians who have no
direct contact with any plan investor to handle recordkeeping as well
as the calculation of separate account unit values. The Proposed Rule
would make these sub-custodians ERISA fiduciaries.
The Department should not use this proposed rule to attempt to
extend the definition of fiduciary under ERISA 3(21)(A)(ii) to persons
providing appraisal services because such services do not constitute
the rendering of investment advice. This portion of the proposal along
with the ``limitation'' in the Proposed Rule at (c)(2)(iii) should be
dropped. If the Department finds it necessary to study valuation issues
more broadly, ACLI suggests that Department issue a Request for
Information.
11. Effective Date
ACLI believes that an effective date of at least one year following
the publication of a final rule is necessary and reasonable. The
Proposed Rule states that final rule would be effective 180 days
following publication. As indicated in our comments above, the
implications of the new rule would require significant changes. Our
members will need sufficient time to fully understand and address a new
regulatory regime, particularly given that any violations would result
in a prohibited transaction. Should the Rule be implemented as
proposed, in addition to time required for compliance review, there may
be significant changes required to information technology
infrastructure, sales processes and compensation arrangements and other
agreements.
______
On behalf of the ACLI member companies, thank you for consideration
of these comments. We welcome the opportunity to discuss these comments
and engage in a productive dialogue with the Department on these
important issues.
Sincerely yours,
Walter C. Welsh,
Executive Vice President, Taxes & Retirement Security.
James H. Szostek,
Vice President, Taxes & Retirement Security.
Shannon Salinas,
Counsel, Taxes & Retirement Security.
______
Prepared Statement of Tom Roberts, on Behalf of the
American Council of Life Insurers
Good morning. My name is Tom Roberts and I am Chief Counsel at ING
Insurance U.S., testifying on behalf of the American Council of Life
Insurers. ACLI member companies represent more than 90% of the assets
and premiums of the US life insurance and annuity industry, and offer
insurance contracts and other investment products and services to
qualified retirement plans, including defined benefit pension and
401(k) arrangements, and to individuals through individual retirement
arrangements (IRAs) or on a nonqualified basis. ACLI member companies
also are employer sponsors of retirement plans for their own employees.
We appreciate this opportunity to offer our views of the proposed
rule with the Department. ACLI submitted written comments describing
eleven key concerns. Today, I focus on three of them: the importance of
the seller's limitation; our suggestions to ensure all interested
parties clearly understand when advice is subject to ERISA; and our
concerns regarding the proposed rule's applicability to IRAs and the
need for further inquiry on the nature of these programs and the
products and services offered to support them.
The Proposed Rule would dramatically enlarge the universe of
persons who owe duties of undivided loyalty to ERISA plans and to whom
the prohibited transaction restrictions of ERISA and the Internal
Revenue Code would apply. It substantially broadens the concept of
rendering ``investment advice for a fee.''
ACLI appreciates the Department's concern that under some
circumstances the current rule impinges the Department's ability to
bring enforcement actions in situations that are clearly abusive. We
share the Department's interest in seeing that plans and participants
who seek out and are promised advice that is impartial ultimately
receive advice that adheres to the rigorous standards imposed by ERISA.
At the same time, we are concerned that the Proposed Rule's pursuit of
this objective interferes with investment sales and distribution
practices that are customary in the marketplace, well understood, and
commonly relied upon by financial services providers, plans and
participants alike. We are concerned that these changes will result in
plans, plan participants, and IRA owners having less access to
investment information and or increased costs. Our comments seek to
preserve the Department's enforcement objective while avoiding
unnecessary disruption and negative impacts to plans, participants and
individuals.
Seller's Limitation on fiduciary status
In the preamble to the proposed rule, the Department notes that, in
the context of selling to a purchaser, communications with the
purchaser may involve advice or recommendations and that such
communications ordinarily should not result in fiduciary status. This
point is critical to the development of a workable rule. Persons
engaged in the sale and distribution of investment product and services
need to have confidence that ordinary course sales recommendations will
not, in hindsight, be subjected to a fiduciary standard that disallows
the payment of sales commissions and other traditional forms of
distribution-related compensation. Parties engaged in transactions with
ERISA plans and IRAs need clear, unambiguous rules by which to
determine their duties and obligations.
Financial institutions such as life insurers and their sales
representatives should not be treated as fiduciaries under ERISA when
they are engaged in selling activities and are clear that they are
acting in a sales capacity.
As written, the wording of the seller's limitation, which describes
sellers and their agents, raises some uncertainties about the
availability of the seller's limitation for other distribution
channels, such as independent insurance agents, insurance affiliated
and unaffiliated broker-dealers and registered investment advisers that
offer life insurer products, whether exclusively or as one of many
other products from a variety of different product manufacturers. These
parties must be covered by the limitation.
The seller's limitation is only available when the recipient of the
advice knows or has a basis for knowing that the interests of the
selling firm and its distributors are ``adverse'' to the interests of
the plan and its participants. We think that the word ``adverse'' is
not right word to explain that a seller is not impartial. While the
seller of a financial product has a financial interest in the outcome
of a transaction, we think it is inappropriate to describe that
financial interest as necessarily entailing broad adversity of
interest. As responsible providers, we have an interest in seeing that
our customers are well served, are happy with our products and
services, and that our customers find them useful to the attainment of
their financial goals.
We believe the seller's limitation should make the point that a
seller of an investment or an investment product has a financial
interest in the transaction it is recommending. So long as purchasers
are provided with that information, they will have the requisite basis
for evaluating the recommended transaction in light of the seller's
financial interest, and will be in a position to understand that the
selling firm's recommendation is not impartial.
The rule should provide an example or examples of circumstances in
which a person reasonably demonstrates that the recipient of
information knows that a recommendation is being made by a ``seller.''
For example, a written representation would suffice if it clearly notes
that the person is a seller of products and services, that the person
and, if applicable, its affiliates, will receive compensation for the
selection of the product and services, and that such compensation may
vary depending upon which product is purchased or which investments
under a product or products are selected. This type of representation
would provide a clear indication to the plan, plan fiduciary or
participant that the person is a non-impartial seller of products and
services. It would also address the Department's stated concern about
undisclosed conflicts of interest.
The Department should clarify that the seller's limitation covers
all aspects of both an initial sale and the subsequent ongoing
relationship between a plan, plan fiduciary or individual and an
investment provider or any agent, broker, and/or registered investment
adviser involved with the sale of the investment provider's products
and services. This would include information and recommendations
regarding the use of a product, for example, advice regarding the
choice of investments available under a product's menu of investments.
It is common for defined contribution plans to request of potential
investment providers a sample menu of investments from among a
provider's available investments which, in the opinion of the provider,
best match the plan's current investment options. There should be no
expectation that any such recommendation is impartial or that the plan
seeks advice upon which it will rely for its investment decisions. The
nature of this relationship should not change after a sale. A product
provider, agent, broker, and/or registered investment adviser may
continue to make recommendations regarding products and services. There
should be no expectation that these recommendations differ in nature
following the initial sale.
Written Representations
In its preamble, the Department expresses the belief that
explicitly claiming ERISA fiduciary status, orally or in writing,
enhances the adviser's influence and forms a basis for the advice
recipient's expectation that the advice rendered will be impartial. The
Proposed Rule reflects that view by applying fiduciary status to all
persons affording those acknowledgments and disallowing the
availability of the seller's limitation to such persons.
We think prudence dictates that where a plan, plan participant or
individual seeks out impartial, disinterested advice delivered in a
manner consistent with ERISA's fiduciary standard of conduct, then the
plan, plan participant or individual should obtain the appropriate
acknowledgment in writing in order to secure the acknowledgement in a
permanent form. We are concerned about the potential proof issues
inherent in claims that an adviser provided oral representations of
fiduciary status. Advisers may be hard put to dispute erroneous or
otherwise fictitious claims that oral assurances of fiduciary status
were provided.
For these reasons, we request that the rule be modified to apply
only to persons who represent or acknowledge in writing, electronic or
otherwise, that they are acting as a fiduciary within the meaning of
ERISA with respect to the advice they are providing to the person or
persons for whom they are so acting. This concept is consistent with
the recently promulgated section 408(b)(2) regulations that require
that a service provider acting in a fiduciary capacity acknowledge such
in writing.
Separately Consider Rule for IRAs
ACLI requests that the Department take additional time to study the
IRA and self-employed plan markets and carefully consider the economic
impact of the Proposed Rule on both individuals and providers of
products and services. The Department is separately considering welfare
benefit plans under the recently issued 408(b)(2) regulations. We ask
the Department to do likewise for IRAs and self-employed plans and hold
them apart from the scope of a final rule. The Department should take
time to consider the IRA and Keogh market place, and the economic
impact a change to the current rules would have on this retail
marketplace.
In addition, the Department should consider changes in the
regulatory environment affecting retail products. In particular, there
are regulatory efforts are underway by the Securities and Exchange
Commission regarding the standard of care under the securities laws for
broker-dealers and investment advisers that provide personalized
investment advice about securities to retail customers. On January 21,
2011, the SEC issued a study on broker-dealers and investment advisers.
It is important that the SEC and DOL efforts lead to rules that are
complimentary in nature. We urge the Department to provide the public
sufficient opportunity to consider the SEC's regulatory efforts and
offer additional comments on the Proposed Rule.
The Department should consider a meaningful investment education
safe harbor tailored to this marketplace. The Department should also
clarify the application of existing exemptions and/or issued new
exemptions tailored to this marketplace.
As we read the proposed regulation, the seller's limitation applies
to IRAs. It is common for advisors and agents to engage customers and
prospective customers on their particular goals and objectives to
better understand their product and service needs. Based on these
conversations, an advisor might explain the pros and cons of various
investment vehicles including variable annuities, mutual funds,
brokerage accounts, banking products, fixed annuities, alternative
investments and several types of advisory accounts. Within each of
these types of securities and property, advisors/agents can usually
recommend several different specific securities that may have different
features. The compensation paid by product and service will vary. For
instance, compensation charged for executing a stock trade will differ
from compensation received for selling an annuity. The seller's
limitation, with an appropriate indication of the seller's interest,
makes it possible to recommend products and services to customers.
______
I want to thank the Department again for holding this hearing, and
for inviting ACLI to testify. I am happy to answer any questions you
may have.
______
ACLI Clarification of Earlier Testimony
On behalf of the American Council of Life Insurers\1\ (``ACLI''),
we write to you today on the proposed rule promulgated under Section
3(21)(A)(ii) of the Employee Retirement Income Security Act
(``ERISA''), which was published at 75 Fed. Reg. 65263 (October 22,
2010) (``Proposed Rule'' or ``Rule'') and to offer a response to
questions raised at the March 1st hearing by DOL staff to our witness
Thomas Roberts.
---------------------------------------------------------------------------
\1\ The American Council of Life Insurers is a national trade
organization with more than 300 members that represent more than 90% of
the assets and premiums of the U.S. life insurance and annuity
industry. ACLI member companies offer insurance contracts and other
investment products and services to qualified retirement plans,
including defined benefit pension, 401(k) and 403(b) arrangements, and
to individuals through individual retirement arrangements (IRAs) or on
a non-qualified basis. ACLI member companies also are employer sponsors
of retirement plans for their own employees.
---------------------------------------------------------------------------
Clarification of Seller's Limitation
In our February 3rd comment letter and in our testimony, we asked
that the proposal be modified to provide examples of circumstances that
would reasonably demonstrate that the recipient of information knows
that a recommendation is being made by a ``seller.'' One example would
be a representation that:
The person is a seller of products and services, that the person
and, if applicable, its affiliates, will receive compensation in the
event the plan, plan fiduciary or participant/individual selects the
products and services, and that such compensation may vary depending
upon which product is purchased or which investments under a product or
products are selected.
The proposed regulation provides that the seller's limitation is
not applicable to a person ``who represents or acknowledges that it is
an ERISA Fiduciary.'' Our letter states that this constraint on the
seller's limitation should only apply if the seller has represented or
acknowledged in writing (electronic or otherwise) that it was a
fiduciary.
During our testimony it was suggested that the seller's limitation
might be protected by some form of disclosure stating that the seller
was not an ERISA Fiduciary. Such a disclosure could be added to the
representation (described above) that the ``person is a seller * * *.''
In addition to examples, the rule could include one or more safe
harbor model notices. For example:
I, (Name), am a representative of (Agency/Company). I would like to
be of assistance to you. Before we proceed, I need to be clear with you
that my firm and I may have a financial interest in the sale of any
product or transaction that we might recommend to you. Our financial
incentive to recommend a particular product or investment may vary by
asset class, investment choices or product type, or according to the
particular investments available within a given asset class or product
type. My firm and I do not agree to act as your ERISA fiduciary
investment advice provider. An ERISA fiduciary is not permitted to take
its own financial interests into account when making a recommendation.
In certain circumstances, it may be appropriate to bifurcate this
disclosure to make clear that, while the selling firm does not agree to
serve as an ERISA fiduciary investment advice provider in connection
with recommendations made by the particular representative making the
disclosure, it may agree to serve as an ERISA fiduciary investment
advice provider in connection with recommendations made outside of the
scope of the relationship between the representative and the plan, plan
fiduciary or participant/individual to whom the disclosure is made. In
such cases, the disclosure should be revised to remove all references
to the selling firm and add the following:
I also need to be clear with you that my firm may have a financial
interest in the sale of any product or transaction that I might
recommend to you and my firm does not agree to act as your ERISA
fiduciary investment advisor in connection with any of my
recommendations.
This type of representation would provide a clear indication to the
plan, plan fiduciary or participant that the person is a non-impartial
seller of products and services. It would also address the Department's
stated concern about undisclosed conflicts of interest.
As you are aware, regulatory efforts are underway by the Securities
and Exchange Commission (``SEC'') regarding the standard of care for
broker-dealers and investment advisers that provide investment advice
about securities to retail customers. Depending upon the SEC's actions,
there may be a need to expand this ``seller's'' disclosure to describe
the seller's status and obligations under federal securities law
including whether the seller is a fiduciary under federal securities
law.
Finally, the Department should clarify that, for purposes of the
seller's limitation, the ``recipient'' of advice or recommendations may
be the plan, the plan's sponsor or other plan fiduciary, plan
participant, plan beneficiary or an individual (in the case of an
individual retirement arrangement).
Proposed Rule and Exemptive Relief
In light of the substantive comment letters and testimony at the
hearing, we expect that the Department will make a number of useful
revisions to the Proposed Rule. With substantive revisions, the
Department should provide the public with an opportunity to review and
comment on the next iteration of the rule before a final rule is
promulgated. The current Proposed Rule would dramatically enlarge the
universe of persons who owe duties of undivided loyalty to ERISA plans
and to whom the prohibited transaction restrictions of ERISA and the
Internal Revenue Code would apply, by re-defining and substantially
broadening the concept of rendering ``investment advice for a fee''
within the meaning of ERISA Section 3(21)(a)(ii).
At the hearing, we were asked about compensation disclosure and
noted that the Prohibited Transaction Exemption 84-24 requires such
disclosure. We note this exchange to emphasize the need for the
Department to confirm the status of current exemptions and solicit
public input on whether amendments are needed to existing exemptions
and/or whether new exemptions are in order.
We ask that the Department issue a new proposal together with any
proposed changes to or confirmations of exemptive relief. We believe it
is important to review and comment on these together. We remain
committed to offering comments that seek to preserve the Department's
enforcement objective while avoiding unnecessary disruption and
negative impacts to plans, participants and individuals.
______
On behalf of the ACLI member companies, thank you for consideration
of these comments. We welcome the opportunity to discuss these comments
and engage in a productive dialogue with the Department on these
important issues.
______
July 25, 2011.
Hon. Phil Roe, Chairman; Hon. Robert Andrews, Ranking Member,
Subcommittee on Health, Employment, Labor and Pensions, Committee on
Education and the Workforce, U.S. House of Representatives,
Washington, DC 20515.
Dear Chairman Roe and Ranking Member Andrews: Tomorrow, the House
Subcommittee on Health, Employment, Labor and Pensions is holding a
hearing entitled ``Redefining `Fiduciary': Assessing the Impact of the
Labor Department's Proposal on Workers and Retirees.'' On behalf of the
American Institute of Certified Public Accountants (AICPA) Forensic and
Valuation Services Executive Committee, I am writing to express
significant concern and reiterate our position regarding the approach
being taken by the Department of Labor (DOL) in its Proposed Rule
(``Proposal'') \1\ that would broaden the DOL's interpretation of a
``fiduciary'' under the Employee Retirement Income and Security Act
(ERISA). Specifically, the Proposal would significantly expand the
circumstances under which a person would be considered a ``fiduciary''
under ERISA by reason of providing an appraisal or fairness opinion
concerning the value of securities or other property. As currently
drafted, certified public accountants (CPAs) and others who perform
appraisal services for Employee Stock Option Plans (ESOPs) would be
included in this new definition of fiduciary. While we appreciate the
concerns which have been expressed by the DOL regarding the quality of
some appraisals performed for ESOPs, we believe that the Proposal
raises significant legal issues, which are set forth below.
The AICPA believes that the Proposal's treatment of appraisers as
fiduciaries would create a clear conflict between an ERISA fiduciary's
strict duty of loyalty to plan participants and beneficiaries, and an
appraiser's obligation, pursuant to professional appraisal standards
and the Internal Revenue Code (IRC), to perform assignments with
impartiality, objectivity and independence. ERISA requires plan
fiduciaries to act ``solely in the interest'' of, and for the
``exclusive purpose of'' providing plan benefits to plan participants
and beneficiaries. Thus, the capacity in which a fiduciary is bound to
act cannot be described as independent.
During public hearings on the Proposal, DOL officials asserted that
there is no conflict between an appraiser's obligation to act with
independence and fiduciary status because ERISA does not require a
fiduciary to serve as an advocate. We disagree. Fiduciaries have a
clear obligation to constantly and single-mindedly consider and
represent the interests of the plan participants and beneficiaries. One
cannot adequately represent--or act for the exclusive benefit of--the
interests of a party without, in some way, being an advocate.
---------------------------------------------------------------------------
\1\ 75 Federal Register 65,263 (October 22, 2010)
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DOL officials also stated during recent hearings that appraiser
independence and fiduciary status are not mutually exclusive because an
``independent appraiser'' and ``fiduciary appraiser'' have the same
goal: to ascertain the correct valuation of ESOP securities. While such
a conclusion may be warranted in circumstances where there is only one
``right'' answer (e.g., single figure), valuations are typically stated
in terms of a reasonable range. Notwithstanding that a great deal of
judgment is involved, the valuation analyst must be able to fully
support and document any number within that range.
To illustrate this point, consider an ESOP's first purchase of
stock from an employer. ERISA would require a ``fiduciary appraiser''
to assist the plan fiduciary negotiating the purchase by generating an
appraisal that resolves each and every judgment call in favor of the
plan participants and beneficiaries (within a reasonable range) rather
than steer a middle course. In comparison, an independent appraiser/
valuation analyst would not necessarily take into consideration best
interests of the plan participants and beneficiaries but would,
instead, consider the best objective criteria regarding the value of
the stock. We do not see how a fiduciary appraiser can reconcile his or
her duty to act for the exclusive benefit of one party with the
requirement that he or she make independent and disinterested judgment
calls at various stages in the appraisal process.
The AICPA further believes that the elevation of an appraiser to
fiduciary status under ERISA, a consequence of the DOL's Proposal if
approved, is incompatible with Section 401(a)(28)(C) of the Internal
Revenue Code, which requires ESOPs to obtain valuations from an
``independent appraiser'' for employer securities that are not readily
tradable on an established market.\2\ For purposes of IRC Section
401(a)(28)(C), the term ``independent appraiser'' is defined as ``any
appraiser meeting requirements similar to the requirements prescribed
under IRC Section 170(a)(1).'' Under Section 170, as interpreted by the
IRS, we believe it is reasonably clear that a fiduciary could not serve
as ``qualified appraiser.'' IRS regulations3 which set forth guidance
on the definition of ``qualified appraiser'' specify that one is
disqualified as serving as a ``qualified appraiser'' if he or she has
prohibited relationships with parties who have a direct interest in the
property being valued. In the context of a valuation of an ESOP's
securities that are not readily tradable, the interested parties
include the ESOP and the plan's participants and beneficiaries. We
believe that being a fiduciary to an interested party disqualifies a
person from being a ``qualified appraiser.''
---------------------------------------------------------------------------
\2\ 26 U.S.C. Sec. 401(a)(28)(C) 3 Section 1.170A-13(c)(5)(iv) of
the Income Tax Regulations.
---------------------------------------------------------------------------
The clear and significant conflicts raised by this Proposal also go
against Executive Order 13563 which directs regulators to promote
coordination across agencies, consider the combined effect of their
regulations on particular sectors and industries and reduce the
burdens, redundancies and conflict created by such requirements. This
Proposal would put appraisers in an untenable position with respect to
valuations performed for all employee benefit plans, and ESOPs in
particular because of a clear conflict between the DOL Proposal and the
IRS Rules.
Importantly, we believe that this change would have a direct
adverse effect on CPAs and other appraisers and, more significantly, on
the employees covered by the employee benefit plans. By defining
valuation preparers as fiduciaries, preparers would face increased
insurance rates and risk premiums resulting from increased liability
risk. Such increases would necessarily be passed on to employers
requiring the valuations and ultimately to plan participants.
Finally, the AICPA also believes that the DOL's proposed change
does not address the underlying issue: sponsor company valuations can
currently be performed by any individual, regardless of qualifications.
The AICPA believes a better solution would be for the DOL to mirror
other regulatory agencies regarding regulation of appraisers and
require proper qualifications and standards for performing valuation
services. Specifically, we recommend that the DOL implement rules that
would require appraisers to meet minimum specialized training
requirements, hold relevant credentials, and comply with applicable
professional standards.
We understand that the DOL anticipates completing its Final Rule
soon. We hope that our concerns regarding the inconsistency between the
requirement to remain independent under the Internal Revenue Code and
the duties owed as a fiduciary as contemplated by the DOL's proposed
rule can be resolved. Please contact Diana Huntress Deem at
202.434.9276 in our Washington office if you have any questions
regarding our concerns.
Sincerely,
Thomas Burrage, CPA/ABV/CFF, CVA Chair,
AICPA Forensic and Valuation Services Executive Committee.
______
Hon. Phil Roe, Chairman; Hon. Robert Andrews, Ranking Member,
Subcommittee on Health, Employment, Labor and Pensions, Committee on
Education and the Workforce, U.S. House of Representatives,
Washington, DC 20515.
Dear Chairman Roe and Ranking Member Andrews: The American Society
of Appraisers (ASA) \1\ is writing to express its appreciation to the
Subcommittee for today's hearing into the Labor Department's proposed
fiduciary rule; and, to express our profound concerns over that portion
of the rule which mandates the inclusion of appraisers who perform ESOP
valuations within the definition of ``fiduciary''.
---------------------------------------------------------------------------
\1\ ASA is a multidiscipline professional appraisal society which
teaches, tests and credentials its members for professional appraisal
practice in the areas of business valuation, commercial and residential
real property and the valuation of tangible and intangible personal
property, such as fine art and machinery and technical equipment.
---------------------------------------------------------------------------
ASA, many of whose credentialed business appraisers provide ESOP
valuation services, has worked closely and successfully with many
federal agencies to establish regulatory requirements that improve
their ability to ensure the integrity of appraisals they oversee and
sanction appraisers for abusive or unprofessional valuations. We
mention our record of support for strengthened federal agency oversight
of valuations in the hope it will demonstrate to Subcommittee members
our organization's unwavering commitment to federal appraisal reforms
that hold out the promise of effectiveness. Regrettably, we do not
believe DOL's proposed rule holds out that promise. Instead, its
inevitable effect will be to greatly increase the costs of ESOP
valuations without doing anything to improve the competency of
appraisers practicing before the agency or the reliability of their
valuations.
ASA's reasons for strongly opposing the appraiser-as-fiduciary
provisions of the proposed rule are summarized below:
First, making appraisers fiduciaries is fundamentally irrelevant to
DOL's stated public policy objective, which is to improve the
reliability and integrity of appraisals performed in connection with
ESOPs or other pension plans. While making appraisers fiduciaries will
expose them to the likelihood of endless law suits, it will do nothing
to improve their valuation skills or the quality of the appraisals
themselves;
Second, DOL's proposal is totally out-of-sync with the appraisal
enforcement programs of every other federal agency. These agencies--
including IRS which shares ERISA enforcement authority with DOL--have
improved the reliability of appraisals they oversee by requiring
appraisers to meet rigorous qualification requirements (e.g.,
experience, training, education and testing in connection with specific
categories of property) and by mandating that they adhere to uniform
appraisal standards (i.e., the Uniform Standards of Professional
Appraisal Practice or USPAP) . The appraisal reform requirements
adopted throughout the federal government are consistent with the
appraiser qualifications and appraisal standards promulgated by the
Congressionally-recognized Appraisal Foundation. As stated above, ASA
has played an active role with many federal agencies to modernize and
reform their appraisal regulatory programs. We would like to continue
that role with DOL and have so advised them;
Third, a DOL rule making appraisers fiduciaries would directly
violate the Ethics obligation of all professional appraisers under the
Uniform Standards of Professional Appraisal Practice to be completely
independent of all parties and interests to a transaction for which a
valuation is performed. An appraiser cannot be a fiduciary and,
simultaneously, be independent of all parties. DOL's proposed rule, if
finalized, would cause a severe breach in an independence requirement
that goes to the essence of professional appraisal practice. This is
not only the opinion of ASA, it is the conclusion of the Appraisal
Standards Board of The Appraisal Foundation--the Congressionally
recognized arbiter of appraisal standards in federally-related
transactions. The Foundation has written DOL and urged the agency not
to adopt the appraiseras-fiduciary proposal. It would be ironic if DOL,
which is deeply committed to preventing conflicts of interest by those
involved in ESOPs, were to adopt a rule that undermines the ethical
obligation of every professional appraiser to avoid any and all
conflicts of interest.
Moreover, if DOL's proposal were to become law, it would put an
agency of the federal government--for the first time--in direct
conflict with the enforcement responsibilities of the real estate
appraiser licensing boards in the 50 states and territories; and, with
the Ethics Committees of the professional appraisal organizations, like
ours, which credential professional appraisers. Both the state
appraiser licensing agencies (pursuant to state laws) and the
professional appraisal organizations (pursuant to contractual agreement
with their credentialed members) are obligated to take disciplinary
action against appraisers who violate USPAP's independence provision;
Fourth, if a central purpose of DOL's proposed rule is to make
appraisers accountable for abusive valuations, that purpose has already
been accomplished. Appraisers are already subject to serious sanctions
for ethical lapses or improper appraisals under a wide variety of
federal and state laws, as well as under the Ethics agreements they
enter into with professional credentialing organizations. State real
estate appraiser licensing boards regularly bring enforcement actions
against their licensees for such infractions, as do the professional
credentialing organizations, such as ours. Even without an appraiser-
as-fiduciary rule, there are numerous ways DOL could seek sanctions
against appraisers for improper ESOP valuations: They could refer such
cases to IRS which shares ERISA authority with DOL and has effective
sanctioning authority against appraisers; to state appraiser licensing
agencies (for improper real estate appraisals) and to professional
appraisal credentialing organizations when infractions are committed by
their members;
Fifth, the proposed DOL rule would require appraisers to obtain
fiduciary errors and omissions insurance--a product which does not even
currently exist and which, if it were developed, would be prohibitively
expensive. The inevitable result would be a large increase in the cost
of ESOP and other pension plan appraisals--a cost which would have to
be borne by the ESOP plans and their beneficiaries. It would be ironic
indeed if the federal agency responsible for safeguarding the financial
interests of pension plan beneficiaries were to adopt a rule which
would greatly--and unnecessarily--raise the costs of operating and
administering the plans.
In order to avoid the negative consequences of the proposed
appraiser-as-fiduciary rule, ASA has urged DOL to adopt the proven and
successful appraisal reform blueprint which exists at many federal
agencies (and referenced in item ``Two'' above). Adopting that
blueprint would effectively address DOL concerns about the reliability
of ESOP appraisals but without the dramatic increase in appraisal costs
that the proposed rule would cause; and, without the other disruptions
to the ESOP valuation process that would result.
ASA respectfully requests that this letter be made part of the
hearing record. If the Subcommittee has any questions or seeks
additional information, please call me at my Philadelphia office (1-
484-270-1240) or email me at jfishman@finresearch.com. Alternatively,
please contact ASA's Government Relations Consultant in Washington,
D.C., Peter Barash, at 202-466-2221 or peter@barashassociates.com, or
John Russell, ASA's Director of Government Relations at 703-733-2103 or
jrussell@appraisers.org.
Jay Fishman, Chairman,
Government Relations Committee.
______
------
Prepared Statement of the American Bankers Association; the Financial
Services Roundtable; the Financial Services Institute; the Insured
Retirement Institute; the National Black Chamber of Commerce; and the
National Association of Insurance and Financial Advisors
I. We support retirement security
The undersigned organizations\1\ share the Congress' and the Obama
Administration's goal of increasing opportunities for Americans to save
and plan for their retirement. We support increased incentives and
opportunities for Americans to save and invest. It is our belief that
providing these opportunities for Americans is important because
savings increase domestic investment, encourage economic growth, and
result in higher wages, financial freedom, and a better standard of
living. We believe that most Americans should approach retirement with
a comprehensive strategy that incorporates a number of retirement
vehicles. Consumer education about retirement savings products can help
consumers make sound investment decisions and allow them to maximize
their retirement savings.\2\ Further gains can be achieved through
better use of investment advice, and by promoting policies that provide
for more diversified, dynamic asset allocation, and exploration of new
and innovative methods to help individuals make better investment
decisions.
As a partner with the Congress and the Obama Administration in our
collective efforts to protect Americans' retirement security, we
strongly believe that one of the largest challenges currently
confronting pension plans, plan sponsors, small business owners,
individual retirement account owners, employees, and retirees is the
Department of Labor's (the ``Department'') proposed rule that would
expand the definition of the term fiduciary\3\ under Title I of the
Employee Retirement Income Security Act of 1974 (``ERISA'').\4\ In our
view, the Department's Proposal will negatively impact the ability of
hard-working Americans to save and plan for their retirement. Moreover,
the Department's Proposal would substantially increase the categories
of service providers who would be deemed fiduciaries for purposes of
ERISA,\5\ and thereby decrease the availability of retirement planning
options for all Americans.\6\ We respectfully request the Department
formally withdraw its proposed definition of fiduciary\7\ and re-
propose a more narrow definition of fiduciary that targets specific
abuses.
II. We believe that the proposed expansion of the definition of
fiduciary would jeopardize the retirement security of millions
of Americans
Most Americans rely on retirement plans to supplement Social
Security and private savings.\8\ For instance, Americans have increased
their participation in 401(k) plans by 250 percent over the last
twenty-five years.\9\ In addition, a 2009 study showed that over two-
thirds of ``U.S. households had retirement plans through their
employers or individual retirement accounts (``IRAs'').'' \10\
IRAs are the fastest growing retirement savings accounts.\11\ IRAs
are widely held by small investors\12\ who seek to maximize return by
minimizing overhead on their accounts. According to the OLIVER WYMAN
REPORT, smaller investors overwhelmingly prefer to use a brokerage
account for their IRAs (rather than an advisory account) \13\ because
of the lower operating costs associated with brokerage accounts. In
fact, 98% of IRAs with less than $25,000 in assets are serviced by
securities brokers.\14\
We believe that the sheer breadth of the proposed expansion of the
definition of fiduciary would have the unintended--but entirely
foreseeable--consequence of reducing alternatives available to hard-
working Americans to help them save for retirement, and increasing the
costs of remaining retirement savings alternatives. The resulting
increase in the number of persons who could be subject to fiduciary
duties, increased costs, and increased uncertainty for retirement
services providers will very likely reduce the level and types of
services available to benefit plan participants and IRA investors by
making benefit plans and IRAs more costly and less efficient.\15\
Thus, if the Department were to adopt the expanded definition of
fiduciary in its present form,\16\ we believe it is clear that fewer
Americans would have access to the advice they need to help them make
prudent investment decisions that reflect their financial goals and
tolerance for risk as they prepare for their retirement because of
their reluctance to pay the increased costs that will likely be
associated with professional investment advice.\17\
We also are concerned that the Department's Proposal could lead to
lower investment returns, and ultimately, a reduced amount of savings
for retirement.\18\ Moreover, if the Department were to adopt its
expanded definition of fiduciary in its present form, millions of hard-
working Americans are likely to have reduced access to meaningful
investment services or help from an investment professional,\19\ and
likely would incur greater expense to access the broad range of product
types associated with brokerage accounts.\20\ We find the potentially
adverse consequences that the Department's proposed expanded definition
of fiduciary would have on our nation's retirement system and the
retirement security of all Americans to be untenable.
In summary, our specific concerns with the Department's proposed
expansion of the definition of fiduciary are:
The Department has not demonstrated that the current definition
needs to be completely re-written.
The proposed expansion of the fiduciary definition to encompass
IRAs is ineffective and counterproductive.
The Department's rule could result in significantly fewer
retirement accounts and less retirement savings.
The Department has not evaluated the economic impact on small
business owners.
Consultation and coordination with each of the relevant regulatory
authorities is needed, including without limitation the Securities and
Exchange Commission and the Commodity Futures Trading Commission.
The Department provided insufficient regulatory analyses.
Given the substantive concerns raised in the public comment record
concerning the adverse impact of the rule, the Department should
publish notice of its proposed revisions to the definition of
fiduciary, and solicit public comment on the proposed revisions.
1. The Department has not demonstrated that the current definition
needs to be completely re-written.
Despite 35 years of experience with the current definition of
fiduciary,\21\ the Department has not provided adequate justification
for its wholesale revisions to the current definition.
The Department's stated rationale is to pursue bad actors (i.e.,
pension consultants and appraisers) who allegedly have provided
substandard services and who failed to recognize or disclose conflicts
of interest.\22\ If this is the goal, then the Department should more
narrowly tailor the proposed changes to reach those particular bad
actors.
The Department also should consider whether other regulations
(including those enforced by other authorities) already provide
adequate safeguards. For example, the Department's recent disclosure
regulations will require pension consultants to disclose all direct and
indirect compensation they receive before entering into a service
arrangement with a plan.\23\ This may address the Department's
concerns.
2. The proposed expansion of the fiduciary definition to encompass
IRAs is ineffective and counterproductive.
The proposed expansion of the definition of fiduciary would
constrain the availability of lower-cost commission-based IRAs, which
would increase costs for IRA owners and reduce retirement savings.\24\
The Department previously expressed the view that regulatory
initiatives designed for ERISA employee benefit plans were neither
necessary nor appropriate for IRAs.\25\
Sales practices for IRAs currently are subject to oversight by the
Securities and Exchange Commission and FINRA. If the Department is
concerned about oversight of sales practices, it should work together
with those regulators to address those concerns, as opposed to
overhauling a much broader regulatory regime.
Service providers to IRAs should be expressly excluded from any
definition of fiduciary for purposes of Title I of ERISA.
3. The Department's rule could result in significantly fewer
retirement accounts and less retirement savings.
The Department issued the Proposal without having done any study or
survey--or providing any data--on the Proposal's projected impact or
effect on IRA owners or IRA service providers.\26\
According to the OLIVER WYMAN REPORT, the effect of the
Department's rule ``could well result in hundreds of thousands of fewer
IRAs opened per year.'' \27\
``Nearly 90% of IRA investors will be impacted by the proposed
rule.'' \28\
The Department's Proposal would make service providers fiduciaries
when merely providing a valuation of a security or other asset held in
the account. This may lead service providers to withdraw from providing
valuation services for real estate, venture capital interests, swaps,
or other hard to value assets. As a consequence, investors will have
far fewer investment choices available to diversify assets in their
accounts as they seek to increase their retirement savings.
4. The Department has not evaluated the economic impact on small
business owners.
Small plan sponsors are not likely to be able to absorb the
potentially substantial increase in costs arising from the expanded
definition of fiduciary.\29\
Small business owners are struggling to recover in the U.S.
economy.\30\
We urge the Department to ensure that its regulations not only
protect retirement plan participants and beneficiaries, but also remove
undue burdens that constrain the feasibility for small business owners
to provide retirement plans for their employees.
5. Consultation and coordination with each of the relevant
regulatory authorities are needed, including without limitation the
Securities and Exchange Commission,\31\ FINRA, and the Commodity
Futures Trading Commission.
Investors and retirement services providers need a regulatory
regime that provides clarity and certainty.
Regulations that establish conflicting rules create confusion,
increase costs to service providers, and tend to lessen the
availability of retirement services overall.
6. The Department provided insufficient regulatory analyses.
The Department was obligated under Executive Order 12866 \32\ to
determine whether its proposed expansion of the definition of fiduciary
was a ``significant'' regulatory action.\33\ Even though the Office of
Management and Budget determined the Department's proposed definition
was economically significant,\34\ the Department performed an
insufficient Regulatory Impact Analysis of the Proposal.\35\
The Department stated ``it is uncertain about the magnitude of
[the] benefits and potential costs'' of its regulatory action.\36\ Yet,
the Department failed to provide any data whatsoever in support of its
Regulatory Impact Analysis, in which the Department ``tentatively
conclude[d] that the proposed regulation's benefits would justify its
costs.'' \37\
The Department's Initial Regulatory Flexibility Analysis failed to
provide either an estimate of the number of affected small entities\38\
or the increased business costs small entities would incur if they were
determined to be fiduciaries under the proposal as required by the
Regulatory Flexibility Act.\39\ As a consequence, it appears that the
Department of Labor performed an insufficient analysis under the
Regulatory Flexibility Act when it estimated the impact of its rule
proposal on small businesses, a segment of the market also impacted by
the proposed expansion of the definition of fiduciary.
On January 18, 2011, President Barack Obama issued Executive Order
13563 ``Improving Regulation and Regulatory Review.'' \40\ The Order
explains the Administration's goal of creating a regulatory system that
protects the ``public health, welfare, safety, and our environment
while promoting economic growth, innovation, competitiveness, and job
creation,'' \41\ while using ``the best, most innovative, and least
burdensome tools for achieving regulatory ends.'' \42\
The Department's Proposal contravenes the Obama Administration's
publicly articulated goal to ``identify and consider regulatory
approaches that reduce burdens and maintain flexibility and freedom of
choice for the public.'' \43\
7. Given the substantive concerns raised in the public comment
record concerning the adverse impact of the rule, the Department should
publish notice of its proposed revisions to the definition of
fiduciary, and solicit public comment on the proposed revisions.
The definition as proposed would require substantial changes to
address concerns identified in the public comment file.\44\
It is likely that class exemptions will be necessary and should be
part of the rule itself, so that hard-working Americans do not lose
access to investment products they need to fund their retirement while
the financial services markets wait for the Department to adopt the
required prohibited transaction class exemptions.
The current definition of fiduciary\45\ has informed almost 35
years of Department guidance on investment advice for ERISA retirement
plans and IRAs. Revisions to such a mature rule ordinarily should not
require ancillary exemptions in order for the final rule to work in the
real world.
III. In light of the substantive concerns raised by the public, we
believe the department should withdraw its proposed expansion
of the definition of fiduciary, and re-propose a defintion of
fiduciary that addresses deficiences noted in the public
comment file
We and other parties have filed comments and supplemental materials
with the Department that generally have raised these and other concerns
about the adverse impact of the Proposal.\46\ At present, it is our
understanding that the Department is considering substantial revisions
to its Proposal in response to the views expressed during the public
comment period.\47\
It is in the interest of the millions of hard-working Americans who
are saving for retirement that the Obama Administration and the
Congress collaborate actively with the private sector--in particular,
the small business community and the retirement security community--to
develop a regulatory regime that will benefit consumers and expand
Americans' retirement savings.
IV. Conclusion
In closing, strengthening the retirement security of all Americans
is our priority. Strong and vibrant retirement programs benefit
employees and their beneficiaries. As well, it strengthens the
financial health and well-being of our nation. We, therefore, reiterate
our request that the Department withdraw and re-propose a definition of
the term fiduciary.
While we support policies that encourage safeguards in retirement
savings programs to protect consumers and our markets from fraudulent
practices, we vigorously oppose regulations that would discourage
participation by employers and employees in retirement programs or
would imperil retirement security for millions of hard-working
Americans.
We urge policymakers to work with us to preserve a retirement
system that helps strengthen retirement security for all Americans. We
encourage the Congress to support policies that help promote retirement
savings and enable the financial services industry to better meet the
long-term retirement needs of hard-working Americans.
We stand ready to work with you and the Department on this
important issue.
endnotes
\1\ The American Bankers Association represents banks of all sizes
and charters and is the voice for the nation's $13 trillion banking
industry and its two million employees. Many of these banks are plan
service providers, providing trust, custody, and other services for
institutional clients, including employee benefit plans covered by the
Employee Retirement Income Security Act of 1974. As of year-end 2010,
banks held over $8 trillion in defined benefit, defined contribution,
and retirement-related accounts (Source: FDIC Quarterly Banking
Profile, Table VIII-A (Dec. 2010)).
The Financial Services Roundtable represents 100 of the largest
integrated financial services companies providing banking, insurance,
and investment products and services to the American consumer. Among
the Roundtable's Core Values are fairness (``We will engage in
practices that provide a benefit and promote fairness to our customers,
employees or other partners.''); integrity (``[E]verything we do [as an
industry] is built on trust. That trust is earned and renewed based on
every customer relationship.''); and respect (``We will treat the
people on whom our businesses depend with the respect they deserve in
each and every interaction.''). See Roundtable Statement of Core
Values, available at http://www.fsround.org/. Roundtable member
companies participate through the Chief Executive Officer and other
senior executives nominated by the CEO. Roundtable member companies
provide fuel for America's economic engine, accounting directly for
$92.7 trillion in managed assets, $1.2 trillion in revenue, and 2.3
million jobs.
The Financial Services Institute, which was founded in 2004, is the
only advocacy organization working on behalf of independent broker-
dealers and independent financial advisors. Our vision is that all
individuals have access to competent and affordable financial advice,
products, and services delivered by a growing network of independent
financial advisors affiliated with independent financial services
firms. Our mission is to create a healthier regulatory environment for
independent broker-dealers and their affiliated independent financial
advisors through aggressive and effective advocacy, education, and
public awareness. Our strategy supports our vision and mission through
robust involvement in FINRA governance, constructive engagement in the
regulatory process, and effective influence on the legislative process.
The Insured Retirement Institute has been called the ``primary
trade association for annuities'' by U.S. News and World Report and is
the only association that represents the entire supply chain of insured
retirement strategies. Our members are the major insurers, asset
managers, broker dealers and financial advisors. IRI is a not-for-
profit organization that brings together the interests of the industry,
financial advisors and consumers under one umbrella. Our official
mission is to: encourage industry adherence to highest ethical
principles; promote better understanding of the insured retirement
value proposition; develop and promote best practice standards to
improve value delivery; and to advocate before public policy makers on
critical issues affecting insured retirement strategies. We currently
have over 500 member companies which include more than 70,000 financial
advisors and 10,000 home office financial professionals.
National Association of Insurance and Financial Advisors
(``NAIFA'') comprises more than 700 state and local associations
representing the interests of approximately 200,000 agents and their
associates nationwide. NAIFA is one of the only insurance organizations
with members from every Congressional district in the United States.
Members focus their practices on one or more of the following: life
insurance and annuities, health insurance and employee benefits,
multiline, and financial advising and investments. According to a Fall
2010 survey, nearly two-thirds of NAIFA members are licensed to sell
securities, and 89% of NAIFA member clients are ``main street''
investors who have less than $250,000 in household income. The
Association's mission is to advocate for a positive legislative and
regulatory environment, enhance business and professional skills, and
promote the ethical conduct of its members.
The National Black Chamber of Commerce The NBCC is a nonprofit,
nonpartisan, nonsectarian organization dedicated to the economic
empowerment of African American communities. 140 affiliated chapters
are locally based throughout the nation as well as international
affiliate chapters based in Bahamas, Brazil, Colombia, Ghana and
Jamaica and Businesses as well as individuals who may have chose to be
direct members with the national office. In essence, the NBCC is a
501(c)3 corporation that is on the leading edge of educating and
training Black communities on the need to participate vigorously in
this great capitalistic society known as America. The NBCC reaches
100,000 Black owned businesses. There are 1.9 million Black owned
businesses in the United States. Black businesses account for over $1
trillion in expendable income each year according to the US Bureau of
Census. The National Black Chamber of Commerce(r) is dedicated to
economically empowering and sustaining African American communities
through entrepreneurship and capitalistic activity within the United
States.
\2\ The financial services industry has developed numerous
financial literacy initiatives, including initiatives directed toward
elementary and high school students and programs presented to investors
in the local community. See The Financial Services Roundtable,
COMMUNITY SERVICE IMPACT REPORT at 64-69 (2010), available at http://
www.fsround.org/publications/pdfs/CS10-ImpactReport.pdf; Insured
Retirement Institute, Retirement Planning Resources for Consumers,
available at http://www.irionline.org/consumers/
retirementPlanningResources; Securities Industry and Financial Markets
Association Foundation, available at http://www.sifma.org/Education/
SIFMA-Foundation/About-the-SIFMA-Foundation/; Investment Company
Institute, available at http://ici.org/#investor--education; and FINRA,
available at http://www.finra.org/Investors/.
\3\ Definition of the Term ``Fiduciary'' [RIN: 1210--AB32], 75 Fed.
Reg. 65263 (Oct. 22, 2010) (the ``Proposal'').
\4\ 29 U.S.C. Sec. 1001, et seq.
\5\ See Oliver Wyman, Inc., OLIVER WYMAN REPORT: ASSESSMENT OF THE
IMPACT OF THE DEPARTMENT OF LABOR'S PROPOSED ``FIDUCIARY'' DEFINITION
RULE ON IRA CONSUMERS at 13 (Apr. 12, 2011) (the ``OLIVER WYMAN
REPORT''), available at http://www.dol.gov/ebsa/pdf/1210-AB32-PH060.pdf
(noting that ``practically every investment-related conversation or
interaction with a client [could become] subject to [a] fiduciary
duty''). ``Even * * * discussions with call center and branch staff[ ]
could be curtailed (so as to avoid inadvertently establishing a
fiduciary duty.'' Id. at 15. The OLIVER WYMAN REPORT is based on
aggregate proprietary data furnished by ``[twelve] financial services
firms that offer services to retail investors.'' Id. at 1. These firms
``represent over 19 million IRA holders who hold $1.79 trillion in
assets through 25.3 million IRA accounts [or roughly forty percent
(40%) of IRAs in the United States and forty percent (40%) of IRA
assets].'' Id.
\6\ OLIVER WYMAN REPORT, supra note 5 at 19-20. If the Department
were to adopt the Proposal, the likely result would be a ``[r]educed
choice of investment professional, level of investment guidance, and
investment products,'' according to the OLIVER WYMAN REPORT. Id. at 19.
\7\ It also would afford the Department an opportunity to receive
further information and analyses from the public on the effectiveness
of the proposed revisions. See Natural Resources Defense Council v.
Environmental Protection Agency, 279 F.3d 1180, 1186 (9th Cir. 2002)
(reviewing the ``notice and comment'' requirements, the court stated
that ``one of the salient questions is `whether a new round of notice
and comment would provide the first opportunity for interested parties
to offer comments that could persuade the agency to modify its rule'
'').
\8\ Insurance Information Institute and The Financial Services
Roundtable, THE FINANCIAL SERVICES FACT BOOK at 37 (2011) (``THE
FINANCIAL SERVICES FACT BOOK''), available at http://www.fsround.org/
publications/pdfs/2011/Financial--Services--Factbook--2011[1].pdf.
\9\ Retirement Security: 401(k)s (Sept. 23, 2010) (``Retirement
Security''), available at http://www.fsround.org/fsr/pdfs/fast-facts/
2010-09-23-RetirementSecurity.pdf. In 2009, $2,121 billion of
retirement assets were held in defined benefit plans compared to $3,336
billion of assets in defined contribution plans. THE FINANCIAL SERVICES
FACT BOOK, supra note 8 at 43 (2011) (Source: Securities Industry and
Financial Markets Association).
\10\ THE FINANCIAL SERVICES FACT BOOK, supra note 8 at 37.
\11\ OLIVER WYMAN REPORT, supra note 5 at 4.
\12\ Id. at 10 (``[A]pproximately half of IRA investors in the
report sample have less than $25,000 in IRA assets, and over a third
have less than $10,000.'').
\13\ Id. at 12. Investors who hold IRA assets in a brokerage
account pay commissions to the brokers who buy or sell securities for
their IRAs. In the alternative, investors can hold IRA assets in an
``advisory'' account and pay a fee that is a percentage of the assets
held in the IRA. A study of 7,800 households conducted by Cerulli
Associates found that more affluent investors also ``prefer paying
commissions.'' See Fee vs. commission: No doubt which investors prefer,
BLOOMBERG (June 8, 2011), http://www.investmentnews.com/apps/pbcs.dll/
article?AID=/20110608/FREE/110609950 (reporting that the survey
examined ``households with more than $50,000 in annual income or more
than $250,000 in * * * assets'').
\14\ OLIVER WYMAN REPORT, supra note 5 at 2.
\15\ Id. at 19-22.
\16\ Proposal, supra note 3 at 65277-78.
\17\ See OLIVER WYMAN REPORT, supra note 5 at 2; Fee vs.
commission, supra note 13.
\18\ OLIVER WYMAN REPORT, supra note 5 at 22 (``These increased
investment costs would serve as a drag on long-term investment gains,
and therefore on the ultimate retirement savings available to impacted
[IRA] holders.'').
\19\ Id. at 19.
\20\ Id. at 20.
\21\ 40 Fed. Reg. 50842 (Oct. 31, 1975). See also, Mercer Bullard,
DOL's Fiduciary Proposal Misses the Mark (June 14, 2011), available at
http://news.morningstar.com/articlenet/article.aspx?id=384065 (``It is
unfair to the industry because it disregards decades of administrative
law and practice under ERISA. It is bad for investors because it strips
them of fiduciary protections when they are needed most.'').
\22\ Proposal, supra note 3 at 65271 (citing a Securities and
Exchange Commission staff report that found a majority of the 24
pension consultants examined in 2002-2003 ``had business relationships
with broker-dealers that raised a number of concerns about potential
harm to pension plans''); GAO, Conflicts of Interest Can Affect Defined
Benefit and Defined Contribution Plans, GAO-09-503T, Testimony Before
the Subcommittee on Health, Employment, Labor and Pensions, Education
and Labor Committee, House of Representatives at 4 (Mar. 24, 2009),
available at http://www.gao.gov/new.items/d09503t.pdf (noting that 13
of the 24 pension consultants examined by the Securities and Exchange
Commission's staff ``had failed to disclose significant ongoing
conflicts of interest to their pension fund clients'').
\23\ Fiduciary Requirements for Disclosure in Participant-Directed
Individual Account Plans; Final Rule [RIN: 1210--AB07], 75 Fed. Reg.
64910 at 64937 (Oct. 20, 2010).
\24\ OLIVER WYMAN REPORT, supra note 5 at 2 (noting that
``estimated direct costs would increase by approximately 75% to 195%
for these investors'').
\25\ See Preamble to Interim Final 408(b)(2) Regulations, 75 Fed.
Reg. 136 (July 16, 2010).
``The Department does not believe that IRAs should be subject to
the final rule, which is designed with fiduciaries of employee benefit
plans in mind. An IRA account-holder is responsible only for his or her
own plan's security and asset accumulation. They should not be held to
the same fiduciary duties to scrutinize and monitor plan service
providers and their total compensation as are plan sponsors and other
fiduciaries of pension plans under Title I of ERISA, who are
responsible for protecting the retirement security of greater numbers
of plan participants. Moreover, IRAs generally are marketed alongside
other personal investment vehicles. Imposing the regulation's
disclosure regime on IRAs could increase the costs associated with IRAs
relative to similar vehicles that are not covered by the regulation.
Therefore, although the final rule cross references the parallel
provisions of section 4975 of the [Internal Revenue] Code, paragraph
(c)(1)(ii) provides explicitly that IRAs and certain other accounts and
plans are not covered plans for purposes of the rule.'' Id.
\26\ Proposal, supra note 3 at 65274-76.
\27\ OLIVER WYMAN REPORT, supra note 5 at 2.
\28\ Id. at 19-20 (IRA holders who cannot qualify for an ``advisory
account'' would be ``forced to migrate to a purely `low support'
brokerage model * * * and have little access to investment services,
research and tools'' to support their IRA savings goals.). See also,
Most Americans Haven't Planned for Retirement and Other Areas of
Concern, WALL ST. J., June 6, 2011, available at http://blogs.wsj.com/
economics/2011/06/06/most-americans-havent-planned-for-retirement-and-
other-areas-of-concern/ (``Efforts to make people essentially their own
money managers may also be futile. Only 21% to 25% of respondents said
they have used information sent to them from Social Security.'')
\29\ While the costs associated with providing various employee
benefits (including retirement plans) impact all employers, smaller
companies typically are more sensitive to the costs associated with
these programs. To the extent that service providers' expenses
increase, those costs are passed through to their clientele. An example
of expenses associated with the Department's Proposal is the legal cost
associated with the initial ``compliance review.'' According to the
Department, the cost of legal review would average sixteen (16) hours
of time at a rate of $119 per hour. Proposal, supra note 3 at 65274.
This rate, however, is significantly lower than the average billing
rate of $295 per hour for 10,913 lawyers surveyed by the National Law
Journal. SURVEY OF LAW FIRM ECONOMICS, NAT'L L. J. (2010) (``LAW FIRM
SURVEY''), available at http://www.alm.com/pressroom/2011/02/10/alm-
legal-intelligence-releases-2011-survey-of-billing-and-practices-for-
small-and-midsize-law-firms/.
\30\ See, Kelly Greene, Retirement Plans Make Comeback, With
Limits, WALL ST. J., June 14, 2011, available at http://
professional.wsj.com/article/
SB10001424052702303714704576384072497942338.html (reporting that in the
face of a ``slowly improving job market, [many companies] seek to
balance the need to retain highly skilled workers with the need to
limit costs'').
\31\ The Securities and Exchange Commission released a study
evaluating the regulatory regimes applicable to investment advisers and
broker-dealers who provide advice to retail customers, as required by
section 913 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act [Pub. L. No. 111-203, Sec. 913, 124 Stat. 1824 (2010)
(the ``Dodd-Frank Act'')]. STUDY ON INVESTMENT ADVISERS AND BROKER-
DEALERS AS REQUIRED BY SECTION 913 OF THE DODD-FRANK WALL STREET REFORM
AND CONSUMER PROTECTION ACT (Jan. 21, 2011), available at http://
sec.gov/news/studies/2011/913studyfinal.pdf. Section 913(f) authorized
the Commission to engage in rulemaking to address the legal or
regulatory standards of care applicable to investment professionals who
provide ``personalized investment advice about securities'' to retail
customers. Section 913(f) of the Dodd-Frank Act, 124 Stat.1827-28.
\32\ 58 Fed. Reg. 51735.
\33\ 75 Fed. Reg. at 65269.
\34\ Id. (According to the Office of Management and Budget, the
Department's proposed rule ``is likely to have an effect on the economy
of $100 million in any one year.'').
\35\ For example, the Department estimated that service providers
would incur about sixteen (16) hours of legal review at a rate of $119
per hour. While the complexity of the compliance review likely would
far exceed the Department's estimate of sixteen (16) hours, an
allocation of just $119 per hour for legal services vastly understates
the cost of legal services in the United States. See LAW FIRM SURVEY,
supra note 29 and accompanying text.
\36\ 75 Fed. Reg. at 65275 (``[The Department's] estimates of the
effects of this proposed rule are subject to uncertainty.'').
\37\ Id.
\38\ Id. at 65276.
\39\ Id.
\40\ Improving Regulation and Regulatory Review--Executive Order
13563 (Jan. 18, 2011), available at http://www.whitehouse.gov/the-
press-office/2011/01/18/improving-regulation-and-regulatory-review-
executive-order.
\41\ Id. at Section 1.
\42\ Id.
\43\ Id. at Section 4.
\44\ See infra note 46.
\45\ 29 C.F.R. Sec. 2510.3-21(c).
\46\ See, e.g., Employee-Owned S Corporations of America (Jan. 12,
2011), available at http://www.dol.gov/ebsa/pdf/1210-AB32-040.pdf;
American Council of Engineering Companies (Jan. 19, 2011), available at
http://www.dol.gov/ebsa/pdf/1210-AB32-048.pdf; American Institute of
CPAs (Jan. 19, 2011), available at http://www.dol.gov/ebsa/pdf/1210-
AB32-050.pdf; National Association of Realtors (Jan. 20, 2011),
available at http://www.dol.gov/ebsa/pdf/1210-AB32-052.pdf; Glass Lewis
& Co. (Jan. 20, 2011), available at http://www.dol.gov/ebsa/pdf/1210-
AB32-053.pdf; Securities Law Committee of Business Law Section of the
State Bar of Texas (Jan. 11, 2011), available at http://www.dol.gov/
ebsa/pdf/1210-AB32-039.pdf; Retirement Industry Trust Association (Jan.
26, 2011), available at http://www.dol.gov/ebsa/pdf/1210-AB32-064.pdf;
International Corporate Governance Network (Jan. 21, 2011), available
at http://www.dol.gov/ebsa/pdf/1210-AB32-065.pdf; New York City Bar
Committee on Employee Benefits & Executive Compensation (Jan. 28,
2011), available at http://www.dol.gov/ebsa/pdf/1210-AB32-070.pdf;
Investment Adviser Association (Feb. 2, 2011), available at http://
www.dol.gov/ebsa/pdf/1210-AB32-082.pdf; International Data Pricing and
Reference Data, Inc. (Feb. 2, 2011), available at http://www.dol.gov/
ebsa/pdf/1210-AB32-082.pdf; The ERISA Industry Committee (Feb. 2,
2011), available at http://www.dol.gov/ebsa/pdf/1210-AB32-090.pdf;
Institutional Shareholder Services Inc. (Feb. 2, 2011), available at
http://www.dol.gov/ebsa/pdf/1210-AB32-104.pdf; U.S. Chamber of Commerce
(Feb. 3, 2011), available at http://www.dol.gov/ebsa/pdf/1210-AB32-
111.pdf; CFA Institute (Feb. 2, 2011), available at http://www.dol.gov/
ebsa/pdf/1210-AB32-128.pdf; Business Roundtable (Feb. 3, 2011),
available at http://www.dol.gov/ebsa/pdf/1210-AB32-139.pdf; and
Committee of Federal Regulation of Securities of the Section of
Business Law of the American Bar Association (Feb. 3, 2011), available
at http://www.dol.gov/ebsa/pdf/1210-AB32-152.pdf
\47\ Definition of the term ``Fiduciary'' Proposed Rule Public
Comments, available at http://www.dol.gov/ebsa/regs/cmt-1210-AB32.html.
______
July 29, 2011.
Hon. Phil Roe, Chairman; Hon. Robert Andrews, Ranking Member,
Subcommittee on Health, Employment, Labor and Pensions, Committee on
Education and the Workforce, U.S. House of Representatives,
Washington, DC 20515.
Dear Chairman Roe and Ranking Member Andrews: We are writing today
to personally thank you for holding a hearing on July 26, 2011 that
focused entirely on the U.S. Department of Labor's proposed rule
defining the term ``fiduciary.'' Tuesday's hearing was critically
important because the public gained firsthand insight to the
Department's approach to redefining the term fiduciary. We think the
hearing made it abundantly clear that the Department should withdraw
its fatally flawed proposal and re-propose a definition that corrects
the numerous deficiencies in the current proposal.
Our members share the Department's laudable goal to protect and
promote retirement savings. Unfortunately, the long-term consequences
of the proposed rule will jeopardize the retirement security of
millions of hard-working Americans. The hearing highlighted the fact
that the Department is unable to clearly present its rationale for why
its proposal is necessary. More specifically, Secretary Phyllis Borzi
never directly addressed the following critical issues:
What specific harm is the Department trying to prevent?
What data is currently available that quantifies the
Department's concerns?
Why is the definition of ``fiduciary'' being extended to
IRAs?
Why were essential exemptions not introduced with the
proposed rule?
A holders historically have used commission-based
brokerage accounts or advisory (or wrap-fee) accounts. What other
feasible business models exist for IRA holders?
Why is the proposed rule the least restrictive way to
address the Department's concerns under ERISA?
After Tuesday's hearing, we are more convinced than ever that the
Department should withdraw and re-propose a more effective definition
of fiduciary. In summary, the Department has not demonstrated that the
current definition needs to be completely re-written. Our members share
the overwhelming, bi-partisan concern that American consumers will
suffer harm over the long-term, because the proposed rule will reduce
customer access to investment education.
As leaders of the subcommittee, you are uniquely positioned to
address the negative impact of the Department's proposed rule. Your
leadership is needed to make sure that the Department takes the
appropriate, measured steps to reach the right result for American
consumers and our markets. The Roundtable stands ready to work with you
and the Department on this important issue.
If you have any questions, please have your staff contact Brian
Tate at 202.589.2417 or Ryan Caruso at 202.393.0022.
Best Regards,
Steve Bartlett, President and CEO,
The Financial Services Roundtable.
Dale Brown, President and CEO,
Financial Services Institute.
______
Prepared Statement of the ESOP Association
(Employee Stock Ownership Plan)
The ESOP Association's statement for the record will cover several
topics concerning the Department of Labor's (DOL) proposed regulation
on the definition of a fiduciary including:
Part I. Association's Education Mission Focuses on ERISA Compliance
Part I explains why education is an important tool in helping to
create well-managed, high performing ESOP companies.
Part II. Concerns Regarding the Definition of a Fiduciary
The ESOP community address its concerns with the appropriateness of
converting ESOP appraisers into ERISA fiduciaries.
Part III. Legal Precedent and ERISA Legal Regime Overlooked by Proposed
Regulation
Part III will address the following concerns:
The Proposed Regulation Exceeds the DOL's Authority
The Proposed Regulation Interferes with the
Trustee's Traditional Oversight Role over the Appraiser
Part IV. Negative Impacts on Pension Benefits
In Part IV, how making an ESOP appraiser an ERISA fiduciary will
create a negative impact on retirement benefits.
Part V. Alternative Approaches
Two alternative approaches will be discussed:
Provide Guidance
Appraiser Credentials
Part VI. Conclusion
Final thoughts on the negative impact the DOL's proposed regulation
on the definition of a fiduciary will have on the ESOP community.
The ESOP Association's statement for the record
The following information will give you an understanding of the
Association and its membership. These statistics are intended to
provide an understanding of the natural pride and passion ESOP
companies, and ESOP beneficiaries, have in their ownership structure.
Of our 1,400 corporate members, 91.2% have fewer than 500 employees
and 53.9% have fewer than 100 employees. Membership in the Association
is dominated by small privately--held businesses.
In each year since 1975, between 80% and 95% of ESOPs were created
when an exiting shareholder(s) of a private company sold his or her
stock to an ESOP. ? The Association's 2010 survey of its members showed
22.1% are manufacturing companies, by far the dominant category,
followed by construction companies at 13.2%. ? On average, the
Association's corporate members have sponsored their ESOPs for 15
years. ? ESOPs sponsored by Association corporate members owned an
average of 77% of the stock of the sponsoring corporation.
The average individual ESOP account balance of corporate members,
according to the Association's survey, is $192,223. Among Association
corporate members, 78% also sponsor a 401(k) plan.
When creating their ESOPs, 96.7% of the corporations did not reduce
wages or other benefits, and 70.35% did not utilize another plan's
assets, to fund their ESOPs.
Approximately 900 professionals are secondary members of the
Association. Approximately 100 members provide valuation services to
privately-held ESOP companies, which are required by law to obtain an
independent valuation of ESOP shares annually. Other professional
members include lawyers, plan administrators, lenders, trustees, and
ownership culture management consultants.
Privately-held small businesses that sponsor ESOPs, businesses
considering ESOPs, and professionals that provide services to ESOP
trustees and companies would be directly impacted by the Proposed
Regulation ``Definition of the Term Fiduciary,'' (Federal Register,
Volume 75, Number 204, Pages 65263-6578, October 22, 2010, Proposed
Regulation).
On behalf of our membership, the Association appreciates the
opportunity to express its views in regard to redefining of the term
fiduciary.
Part I. Association's Education Mission Focuses on ERISA Compliance
The mission of the Association is ``To educate and advocate about
employee ownership with emphasis on ESOPs.'' The leaders of the
Association purposely listed ``education'' first, as a basic tenet of
the Association is that well-managed, high performing ESOP companies,
visible in local communities, are the best and most effective way to
execute the advocacy mission.
Over 50% of the Association's annual resources are spent on
education. In 2010, 8,089 individuals attended Association educational
programs. Education of ESOP company fiduciaries, focusing on their
obligations to retain competent valuation firms, understand the
valuation report, and decide whether to accept a valuation report, is a
major topic at Association national and Chapter meetings. Other
conference and meeting attendees had exposure to the topics related to
ERISA compliant valuation of ESOP shares of private companies.
The members of the Association's Advisory Committee on Valuation
(VAC) are key to the quality of fiduciary education on valuation
matters. They lead discussions involving thousands of attendees and
write articles for the Association's monthly newsletter on valuation
``hot'' issues, produce white papers on best practices, prepare
booklets and handbooks on valuing ESOP shares, and contribute the
chapter in the ``ESOP Fiduciary Handbook'' on reviewing, and rejecting
or accepting a valuation report. VAC members educate companies,
fiduciaries, and other professional members, and ensure that the latest
information on valuation best practices is available.
VAC members are volunteers. They agree with the basic premise that
the best way to maintain current laws permitting and encouraging
employee ownership via the ESOP model--the advocacy mission--is to have
excellent ESOP practices, and ensure that ESOP trustees and
fiduciaries, internal and institutional, understand and comply with
ERISA. Compliance with ERISA law is the best path to a high performing
company that will provide adequate retirement security to its ESOP
participants.
Part II. Concerns Regarding the Definition of a Fiduciary
In proposing the expansion of the definition of investment advice
for purposes of the definition of a fiduciary under Section 3(21) of
the Employee Retirement Income Security Act of 1974, as amended
(``ERISA''), the Department of Labor (DOL) has identified three areas
of concern: (i) a significant shift in the marketplace for employee
benefit plan services since the DOL last provided fiduciary rules in
1975, (ii) avoidance of conflicts of interest that may exist with
service providers, and (iii) incorrect valuations of employer
securities. The proposal states that these concerns were identified in
the DOL's Consultant/Advisor Project (CAP), recent testimony before the
Government Accountability Office (GAO) and in the Employee Benefits
Security Administration (EBSA) national enforcement project relating to
ESOPs.
The Association believes the marketplace for ESOP transaction
services generally has not changed since 1975, with the overwhelming
majority of ESOPs created when a shareholder(s) of a privately-held
company sells her/his shares to an ESOP.
With regard to conflicts of interest, it is not apparent to the
Association that ESOP appraisers regularly have conflicts of interest
with respect to the plans for which they work. This would, of course,
be contrary to Section 401(a)(28) of the Internal Revenue Code which
requires appraisers be independent. Moreover, the DOL proposed
regulation setting forth the definition of adequate consideration
(Prop. Reg. Sec. 2510.3-18, referred to herein as the 1988 Proposed
Regulation) also requires the independence of an appraiser as a
condition to a prohibited transaction exemption.
With regard to incorrect valuations of private company ESOP stock,
the Association acknowledges and shares the DOL's concern but questions
whether the problem is as widespread as the DOL implies. The
Association has not heard significant numbers of complaints from its
corporate or fiduciary members about incorrect ESOP valuations. The
Association provides seminars and educational sessions on the valuation
of employer securities at conferences, and publishes written material
on valuation.
If the DOL is correct in its assessment, the Association also
questions the effectiveness and appropriateness of converting ESOP
appraisers into ERISA fiduciaries as means of reducing the number of
incorrect ESOP appraisals. The Association believes there are other
means of addressing the DOL's concern short of a wholesale change to
over thirty five (35) years of statutory guidance, and respectfully
requests the opportunity to engage in a dialogue with the DOL to assist
in fashioning an appropriate and effective means for addressing such
concerns.
Part III. Legal Precedent and ERISA Legal Regime Overlooked by Proposed
Regulation
The Proposed Regulation Exceeds the DOL's Authority
Section 3(21)(ii) of ERISA creates fiduciary status for a person
who ``* * * renders investment advice for a fee * * *'' The preparation
of an appraisal of an asset, whether employer securities, real estate
or otherwise, was not intended by Congress to create an ERISA fiduciary
status. Neither an appraisal, nor a fairness opinion rendered in a
transaction, makes a recommendation to the trustee of a course of
action. In either instance, it remains the trustee's ERISA fiduciary
responsibility to make an investment decision, with the appraisal or
fairness report a tool in that process.
Federal courts have correctly instructed ESOP trustees that an
independent appraisal does not automatically establish a transaction
price for employer securities. Rather, the trustee is responsible to
prudently review and then utilize the report in making an investment
decision. In order to add asset valuations and fairness opinions to the
list of items that constitute ``investment advice'' we believe the DOL
would need Congress to add a new subsection to Section 3(21) of ERISA
to this effect.
The Proposed Regulation Interferes with the Trustee's
Traditional Oversight Role over the Appraiser
We assume the DOL believes that making the ESOP appraiser a
fiduciary will create a system of oversight over the ESOP appraiser
which has somehow been absent. This belief would be an incorrect
understanding of the role that has developed between the ESOP appraiser
and the ESOP trustee under current law and regulatory guidance. It is
important to understand that an oversight system already exists. As the
plan fiduciary, the ESOP trustee is responsible for determining the
fair market value of the employer securities to be acquired by or held
under the ESOP. The ESOP trustee retains and works closely with the
ESOP appraiser as its financial advisor, to assist the ESOP trustee
with undertaking the financial review and ultimate valuation
determination. If the ESOP appraiser's skill, or analysis, is lacking
under applicable professional standards, then it is the ESOP trustee's
responsibility to investigate the relevant issues and make a
determination regarding whether the ESOP appraiser can continue to
provide the ESOP trustee with the necessary financial assistance on
behalf of the plan. This relationship allows the ESOP appraiser to
focus on the specific task of providing advice to the ESOP trustee who
is the party responsible for decisions regarding transactions and the
related fair market value of the employer securities. (See Chapter 6.C,
``Review of Valuation Report'', ESOP Fiduciary Handbook, The ESOP
Association, 2010, pages 36-42.) Further, the current structure already
provides the DOL with adequate redress for an incorrect valuation, but
such redress rests with the ESOP trustee the plan fiduciary charged
with making the fair market value determination and ensuring a correct
valuation.
Part IV. Negative Impacts on Pension Benefits
The DOL's stated goal in expanding the definition of investment
advice is to create a bright line identifying who is a fiduciary. The
DOL states that its limited resources are stretched by the task of
assessing who is a plan fiduciary, impacting its ability to assess
whether a breach occurred. This reasoning is not justified, and is
short sighted, because this sweeping shift in the fiduciary rules will
have significant negative consequences for ESOP companies and the ESOP
participants that the DOL seeks to protect. Further, because the ESOP
trustee is always a plan fiduciary and acts in a fiduciary capacity in
determining fair market value and adequate consideration, in each and
every instance where the perceived ill is the incorrect valuation, the
DOL's argument that it is unable to establish the ESOP trustee as the
fiduciary is unfounded.
In the Regulatory Impact analysis section of the proposal, the DOL
submits a list of three benefits the proposed regulation will provide,
but states that ``* * * the Department is unable to quantify these
benefits, [but] the Department tentatively concludes they would justify
their cost.'' The DOL then estimates the service provider community
would incur a cost of $10.1 million to assess its fiduciary status
under ERISA. Setting aside any disagreement over this initial cost, the
Association's view is that the larger costs of the proposal will be
felt by plan participants through: (i) a shrinking of the marketplace
for competent appraisers (ii) higher costs to ESOP sponsors to retain
competent appraisers and (iii) greater costs of protecting against
litigation (i.e. additional involvement of counsel and greater
documentation). The overarching cost however, is not so easily
quantified and will be seen when business owners, instead of pursuing a
transaction with burdensome regulation as well as cost, business owners
choose to pursue other means of ownership transition, such as sales to
third parties, which may result in less wealth in qualified plans.
Many of the best appraisers currently work for large or mid-sized
multi-disciplinary financial service organizations. Such firms have
resources, depth of expertise, breadth of experience, and work on a
variety of types of non ESOP assignments and bring this experience to
their ESOP appraisals. Generally, none of the professionals in these
organizations are ERISA fiduciaries, or fiduciaries under any set of
Federal or state laws. The Association believes these firms will not
have a financial incentive to accept fiduciary status related to ERISA
appraisals and may cease providing services to ESOP sponsors and
trustees. ESOP companies and trustees will lose the expertise that
these firms bring to their clients when performing an ESOP valuation
engagement. The ESOP community, including peer firms, will also lose
the benefit of these firms' knowledge.
For those firms that choose to continue to perform ESOP appraisals,
significant costs will be incurred beyond the initial compliance
assessment cost detailed by the DOL. First, firms will need to obtain
fiduciary liability insurance, a more complex and expensive product
than the current errors and omissions insurance most hold; second,
valuation firms will need ERISA legal counsel for each engagement to
advise on their fiduciary duties and responsibilities in a particular
transaction or valuation; third, valuation firms will likely change
their interactions and business relationships with ESOP trustees in
order to manage their own ERISA fiduciary risks; fourth, ongoing
compliance costs may increase; and fifth, instances of litigation will
increase.
For ESOP sponsors, this means: (i) higher costs of valuation
services, (ii) fewer qualified appraisers, and the need to replace
appraisers who leave the market; (iii) confusion as to who is
responsible for certain fiduciary functions; and (iv) loss in the
industry of the benefits of working with multi-disciplinary
organizations.
The DOL has identified ``incorrect valuations'' as the principal
concern in the Proposed Regulation. The Association disagrees that the
Proposed Regulation will, in and of itself, result in more accurate
appraisals when fewer qualified appraisers will perform ESOP
valuations, and the remaining firms may be less well capitalized
entities that may not have the resources to defend their opinions.
Further the Association fails to see how making more parties
fiduciaries solves the problem when a clearly identified plan
fiduciary, the ESOP trustee, is already responsible for the ESOP
valuation and its accuracy.
Part V. Alternative Approaches
Provide Guidance
We are not aware, and do not acknowledge, there is a widespread
problem with ESOP valuations among our membership.
However, to the extent the DOL perceives a problem, the Association
believes it is more effective to focus regulatory efforts on prevention
rather than punishment. Valuation standards already exist in a variety
of professional organizations such as the American Society of
Appraisers (ASA), American Institute of Certified Public Accountants
(AICPA), as well as guidance used by the IRS, and could be easily
adopted by the DOL. Hard-to-value securities held on companies' and
ERISA plans balance sheets have been a significant focus of accounting
standards. It would be very reasonable for the DOL to adopt general
operating principles of valuation that are already generally accepted
and well understood in the valuation profession.
DOL's 1988 Proposed Regulation defining ``adequate consideration''
provides guidance on valuing employer securities. Though not issued as
final, and therefore not binding. many appraisers choose to rely on the
1988 Proposed Regulation as if it were final. With better guidance, the
ESOP trustee's task of reviewing and approving valuations before
accepting them would be improved because it would know the standard
against which to measure the appraisal
We respectfully suggest the DOL finalize the 1988 Proposed
Regulation, and amend it to include a more detailed description of the
trustee's role in assessing a valuation or the valuation report.
Appraiser Credentials
The Association's Valuation Advisory Committee, whose members
consist of the most prominent ESOP valuation advisors in the United
States, was formed to bring professionals together to discuss ESOP
valuation issues. The Association also provides forums for the
interaction among various ESOP professionals to address ESOP issues,
including a recently formed Interdisciplinary Committee. ESOP
valuations have, for the most part, been self regulated by those
professionals who have endeavored to build solid ESOP valuation
practices based on generally accepted valuation methods and procedures.
These experienced ESOP professionals have worked together to develop
consensus on many ESOP valuation issues.
Most ESOP appraisers are well educated, informed, and credentialed
and continue their education by reading industry materials and
scholarly journals, and attend conferences and seminars to keep abreast
of financial theory, regulatory changes, and other factors affecting
business appraisals. Many have advanced degrees in finance and maintain
appraisal-related credentials such as the ASA, Chartered Financial
Analyst, or AICPA designations. One of the duties of an ESOP trustee is
to choose a qualified appraiser, and various credentials can help an
ESOP trustee discern who is qualified.
In light of the fact that most ESOP appraisers are already
credentialed, the Association believes that the DOL's resources would
be best served by engaging in a dialogue with ESOP professionals,
including the Association, to identify the DOL's specific concerns
about appraiser competence so the ESOP community can self-regulate. For
example, the DOL may find that those ESOP appraisals that it believes
are ``incorrect'' are performed by appraisers without appropriate
valuation credentials, or who are not part of the various professional
organizations that provide training and education related to ESOP
valuation. Further discussion and guidance may help the Association's
members choose the most qualified appraisers.
Part VI. Conclusion
The valuation of privately held stock is an imprecise science. This
is the very nature of advanced finance theory. There is often no single
``correct'' answer to the question of valuation. Imposing fiduciary
standards on ESOP appraisers would expose ESOP appraisers to increased
liability, without addressing the DOL's perceived need for improved
financial advice regarding valuation.
On behalf of our 1,400 corporate members, we believe the proposal
to mandate appraisers of privately-held ESOP company stock be ERISA
fiduciaries will increase the cost of the valuation substantially. We
also believe there are more efficient, less economically burdensome
ways to ensure valuations are done properly without reducing ESOP
companies' profits (and the accounts of ESOP participants). The
Proposed Regulation will confuse and blur responsibilities between the
trustee and the valuation firm. The Proposed Regulation will confuse
interpretation of the law about ESOP trustee decisions and will be very
expensive for ESOP companies if more private parties sue ESOP companies
and ESOP trustees in cases that Federal courts currently dismisses.
Finally, ESOP companies provide locally controlled jobs, many in
the manufacturing sector, that provide average pay employees with
significant retirement savings. In fact, DOL's Office of the American
Workplace under former Secretary of Labor Robert Reich labeled ESOP
companies as examples of high performing companies, and highlighted
quotes from The ESOP Association's then leader, the late Charles
Edmunson.
We respect and support the important and difficult job of DOL
investigators in uncovering improper valuation work and agree that
those responsible should be held accountable. We would welcome the
opportunity to work with you to discover an approach that will help the
DOL achieve that goal.
______
------
[Questions submitted for the record and their responses
follow:]
U.S. Congress,
Washington, DC, August 31, 2011.
Hon. Phyllis Borzi, Assistant Secretary,
Employee Benefits Security Administration, 200 Constitution Avenue, NW,
Washington, DC 20210.
Dear Assistant Secretary Borzi: Thank you for testifying at the
July 26, 2011, Subcommittee on Health, Employment, Labor, and Pensions
hearing entitled, ``Redefining `Fiduciary': Assessing the Impact of the
Labor Department's Proposal on Workers and Retirees.'' I appreciate
your participation.
Enclosed are additional questions submitted by Committee members
following the hearing. Please provide written responses no later than
September 14, 2011, for inclusion in the official hearing record.
Responses should be sent to Benjamin Hoog of the Committee staff, who
may be contacted at (202) 225-4527.
Thank you again for your contribution to the work of the Committee.
Sincerely,
Phil Roe, Chairman,
Subcommittee on Health, Employment, Labor, and Pensions.
questions from representative rokita
1. Can you provide the Committee with your reasoning for why it is
unnecessary to reopen the comment period on this rule following the
many changes that DOL is planning to make?
2. Following up an earlier question I had regarding the comments
DOL received during the open comment period, please explain how DOL
weighted the comments?
Were all the comments treated equally?
If not, how was a formula derived to weigh the comments?
3. Would you please provide the Committee with the studies DOL used
as the basis of this proposed rulemaking?
4. DOL has indicated that if the proposed regulation is finalized,
it will likely release a series of prohibited transaction exemptions
(PTEs) to remedy the negative consequences of the proposal. What actors
and transactions are you considering for exemptive relief? Why were
these actors and transactions covered by the initial proposed
regulation?
questions from representative mccarthy
1. In your testimony, you indicated that the proposed regulation
would not disrupt the broker-dealer model, suggesting that existing
class exemptions enable commissions to be paid without violating
prohibited transaction rules. Would you explain how existing exemptions
will enable fully disclosed revenue-sharing to continue under the terms
of the proposed regulation?
2. At the hearing, you assured Members that the Department would
complete a robust economic analysis by the time that a final rule is
proposed. You stated: ``We are looking to have the most solid cost
information we can to justify the rule * * * We are in the process of a
doing a much more thorough economic analysis.'' Could you please
describe in detail the steps the Department is taking to ensure a
robust economic analysis? Have you commissioned any outside experts to
consider the issue? Will your analysis carefully evaluate the indirect
costs to participants who lose access to information they need to make
savings and investment decisions? In your view, how much uncertainty
surrounding costs to participants, plan sponsors, and providers is
acceptable?
3. In addition to its impact on individual retirement accounts, I
am also very concerned about the proposed regulation's impact on
qualified plans. Under current regulations, a financial institution is
able to provide extensive guidance--including model portfolios--to the
owner of a small business who is considering establishing a plan. But
as I understand, under the proposed regulation, helping the owner
identify investment options would make the financial institution a
fiduciary, which could make such guidance a prohibited transaction. Is
my understanding correct? If so, how can we guard against considerable
adverse consequences for plan sponsors?
______
Response to Questions Submitted for the Record
questions from representative todd rokita (r-in)
Rokita Question 1: Can you provide the Committee with your
reasoning for why it is unnecessary to reopen the comment period on
this rule following the many changes that DOL is planning to make?
Answer: On September 19, the Department announced it will re-
propose its rule on the definition of a fiduciary. The decision to re-
propose was in part a response to requests from the public, including
members of Congress, that the agency allow an opportunity for more
input on the rule. The extended rulemaking process also will ensure
that the public receives a full opportunity to review the agency's
updated economic analysis and revisions of the rule. The new proposed
rule is expected to be issued in early 2012. When finalized, this
important consumer protection initiative will safeguard workers who are
saving for retirement as well as the businesses that provide retirement
plans to America's working men and women.
Rokita Question 2: Following up an earlier question I had regarding
the comments DOL received during the open comment period, please
explain how DOL weighted the comments? Were all the comments treated
equally? If not, how was a formula derived to weigh the comments?
Answer: As I stated at the July 26 hearing, the DOL does not have a
formula for weighing comments. Instead, we examine each comment and
consider its factual content and its policy and legal arguments.
Rokita Question 3: Would you please provide the Committee with the
studies DOL used as a basis of this proposed rulemaking?
Answer: The Department cited the following studies in the
regulatory impact analysis for the proposed rulemaking: U.S. Securities
and Exchange Commission, Office Compliance Inspections and
Examinations, Staff Report Concerning Examination of Select Pension
Consultants (Washington, DC: May 16, 2005), accessible at http://
www.sec.gov/news/studies/pensionexamstudy.pdf; GAO, Conflicts of
Interest Can Affect Defined Benefit and Defined Contribution Plans,
GAO--09--503T, Testimony Before the Subcommittee on Health, Employment,
Labor and Pensions, Education and Labor Committee, House of
Representatives (March 24, 2009), accessible at http://www.gao.gov/
new.items/d09503t.pdf; Bergstresser, Daniel B.,, John Chalmers, and
Peter Trufano. ``Assessing the Costs and Benefits of Brokers in the
Mutual Fund Industry,'' Social Science Research Network Abstract 616981
(Sept. 2007), accessible at: http://papers.ssrn.com/sol3/
papers.cfm?abstract--id=616981; Bullard, Mercer, Geoffrey C. Friesen,
and Travis Sapp. ``Investor Timing and Fund Distribution Channels''
SSRN Working Paper, Dec. 2007, accessible at: http://ssrn.com/
abstract=1070545; and Zhao, Xinge. ``The Role of Brokers and Financial
Advisors Behind Investments into Load Funds,'' December 2005,
accessible at: http://www.ceibs.edu/knowledge/papers/images/20060317/
2845.pdf.
The Department is reviewing a wide range of additional academic
studies and information submitted by commenters as we work to re-
propose the rule.
Rokita Question 4: DOL has indicated that if the proposed
regulation is finalized, it will likely release a series of prohibited
transaction exemptions (PTEs) to remedy the negative consequences of
the proposal. What actors and transactions are you considering for
exemptive relief? Why were these actors and transactions covered by the
initial proposed regulation?
Answer: ERISA prohibits broad categories of transactions between
plans and their fiduciaries, but authorizes the Department to issue
exemptions when specific transactions or classes of transactions are in
plans' and participants' interests and protective of participants'
rights. For example, there are already exemptions on the books
authorizing brokers who provide fiduciary advice to plans and IRA
customers to receive commissions with respect to securities, mutual
funds, and insurance products. We are considering issuing additional
exemptions to address concerns about the impact of the new regulation
on the current fee practices of brokers and advisers, and considering
clarifying the continued applicability of existing exemptions. The
Department will carefully craft new or amended exemptions that can best
preserve beneficial fee practices, while at the same time protecting
plan participants and individual retirement account owners from abusive
practices and conflicted advice.
The original proposed regulation, consistent with ERISA's statutory
language, covers actors who provide investment advice for a fee to a
plan or IRA. ERISA's statutory provisions dictate what transactions are
prohibited.
questions from representative carolyn mccarthy (d-ny)
McCarthy Question 1: In your testimony, you indicated that the
proposed regulation would not disrupt the broker-dealer model,
suggesting that existing class exemptions enable commissions to be paid
without violating the prohibited transaction rules. Would you explain
how existing exemptions will enable fully disclosed revenue-sharing to
continue under the terms of the proposed regulation?
Answer: Existing exemptions do not enable brokers who give
fiduciary investment advice to receive revenue-sharing arrangements,
even if they are fully-disclosed to the advice recipient. We will
consider, in the context of the re-proposed rule, whether additional
exemptions are warranted for revenue-sharing arrangements that are
beneficial to plan participants and IRA holders.
McCarthy Question 2: At the hearing, you assured Members that the
Department will complete a robust economic analysis by the time that a
final rule is proposed. You stated: ``We are looking to have the most
solid cost information we can to justify the rule. * * * We are in the
process of doing a much more thorough economic analysis.'' Could you
please describe in detail the steps the Department is taking to ensure
a robust economic analysis? Have you commissioned any outside experts
to consider the issue? Will your analysis carefully evaluate the
indirect costs to participants who lose access to information they need
to make savings and investment decisions? In your view, how much
uncertainty surrounding costs to participants, plan sponsors, and
providers is acceptable?
Answer: To ensure a robust economic analysis, we are reviewing
academic studies addressing the ability of the market to address
conflicts of interest by those who provide investment advice and the
effect that such conflicts have on investment returns. We are also
carefully reviewing relevant information contained in the comments on
the original proposed regulation. We will then re-propose a rule to
ensure that the public receives a full opportunity to review the
Department's updated economic analysis and revisions of the original
proposed regulation. Although we disagree with the assertion that plan
participants will lose access to needed information as a result of the
changes we are considering, we would take into account reliable
information supporting such an indirect cost. Any effort to predict the
economic effect of a regulation is subject to uncertainty. The degree
of uncertainty will vary based on the quality of the available
information and other factors. Whether the level of uncertainty on a
particular issue is acceptable for purposes of informing a rulemaking
decision depends on a wide range of considerations.
McCarthy Question 3: In addition to its impact on individual
retirement accounts, I am also very concerned about the proposed
regulation's impact on qualified plans. Under current regulations, a
financial institution is able to provide extensive guidance--including
model portfolios--to the owner of a small business who is considering
establishing a plan. But as I understand, under the proposed
regulation, helping the owner identify investment options would make
the financial institution a fiduciary, which could make such guidance a
prohibited transaction. Is my understanding correct? If so, how can we
guard against considerable adverse consequences for plan sponsors?
Answer: Under the original proposal, financial institutions would
be able to market and make available, without regard to the individual
needs of the plan, a selection of securities or other investments from
which a plan fiduciary may designate investment alternatives for a
participant-directed plan. The financial institution may also provide
general financial information and data to assist a plan fiduciary's
selection of such investment alternatives for a plan, if the financial
institution discloses in writing that it is not undertaking to provide
impartial investment advice. The Department is considering the numerous
comments it received on this particular issue.
______
[Whereupon, at 1:09 p.m., the subcommittee was adjourned.]