Regulatory Outlook | 08.21.18
The Fiduciary Rule is Dead, But Litigation Risks Live On
Crafted by the Obama Administration's Department of Labor, the so-called “Fiduciary Rule” sought to require financial service professionals who advise on retirement assets to put clients' interests first. It partially went into effect on June 9, 2017.
But under the Trump administration, the rule's full implementation was delayed as new DOL leadership quickly signaled it was bent on either revising it or rescinding it altogether. Ultimately, the rule was struck down by the 5th U.S. Circuit Court of Appeals. And when the DOL not unexpectedly declined to petition the Supreme Court to appeal the appellate court ruling, the brief, fraught life of the DOL Fiduciary Rule officially came to an end. That was on June 13, 2018.
The date may not live in infamy, but those industry members who had fretted over the rule, indeed, fought hard against it, could at least exhale a sigh of relief.
Or could they?
At the crux of the bank and brokerage industry’s vehement opposition to the rule was a provision that would have disallowed arbitration agreements requiring investors to waive their right to bring or participate in class-action lawsuits, thus increasing the risk of litigation.
But industry members should recognize that while the rule may have vanished — litigation risks have not.
Galvin Versus Scottrade
Referencing an enforcement action taken by Massachusetts Secretary of the Commonwealth William Galvin against Scottrade Inc., attorney Joshua Lichtenstein recently told InvestmentNews that any new policies adopted in advance of the rule, and which remain in place, had best be followed — or companies could find themselves facing similar actions.
"You need to make sure you are following them or change them back," said Lichtenstein, a partner at Ropes & Gray. In the Scottrade case, according to Galvin, the company violated an internal policy prohibiting IRA sales contests.
On Aug. 16, a U.S. District Court Judge in Massachusetts ruled in favor of Galvin who sought to retain jurisdiction, according to ThinkAdvisor.
Scottrade argued that Galvin was overstepping his authority “to enforce the fiduciary rule because the federal government would not,” and that the case should be removed from a state-level proceeding and into a federal court.
“Federal ingredient jurisdiction is not present in this case,” the judge ruled.
All Eyes on the SEC
Meanwhile, the Securities and Exchange Commission is pushing ahead with its version of an advice-standards reform proposal. Language contained in it is making some industry members nervous with respect to, again, opening the door to future litigation.
In the preamble to its proposed set of rules, collectively known as Regulation Best Interest, the SEC lays out actions brokers should consider taking to mitigate or remove conflicts. One example is the elimination of sales contests. Mark Schoeff Jr., writing in InvestmentNews, pointed out that the SEC's proposed directives are similar to prohibitions included in the best-interest-contract exemption of the DOL rule. In a comment letter underscoring industry concern, attorney Kent Mason, a partner at Davis & Harman, told the agency it should replace the DOL rule-based preamble provisions on mitigation and elimination of conflicts with a simple principles-based statement. The mere fact that the proposed directives advising against specific activities, such as contests, are even included in the preamble is "unsettling," Mason said.
Why is he so spooked? Because, Mason said, it "could be relied on by a court."
Still, opponents of the fiduciary rule who were mainly concerned about litigation risks should be feeling much better. Most opponents to the SEC Regulation Best Interest proposal make the point that it limits disputes to FINRA arbitration hearings. That’s a major reason why in her dissenting statement, Commissioner Kara Stein said that the proposal fails to provide comprehensive reform and should instead have been called “Regulation Status Quo.”
“The Commission’s best-interest rule drubbed out the legal axe that hung over the necks of broker-dealers and their associates who failed to pick up the nuances of the DOL’s Fiduciary Rule,” wrote William R. James, a Senior Editor at Kaplan Financial Education. “The DOL provided a path for customers to sue brokers in class-action lawsuits. The SEC-proposed rule has no such blade in it. FINRA’s Code of Arbitration will remain the backbone of dispute resolution.”
Rich Blake A veteran journalist based in New York City, Blake has covered the financial world for numerous publications, including Institutional Investor, ABCNews.com and Reuters. Blake was a co-founder and executive editor of Trader Monthly magazine. The Buffalo native is the author of three nonfiction books, including “The Day Donny Herbert Woke Up,” which is currently being adapted into a motion picture. In 2004, Blake was nominated for a National Magazine Award in the Reporting category for Institutional Investor.