Thursday, September 06, 2012

In Letter to Congress, Fiduciary Group Says ERISA and Investment Advisers Act Fiduciary Standards Should Not be Harmonized

On June 25, 2012, 33 members of Congress wrote to Secretary of Labor Hilda Solis and SEC Chair Mary Schapiro, urging the Department of Labor and the SEC to coordinate closely on their respective fiduciary rulemaking initiatives and arrive at a workable, consistent set of regulations. While supporting efforts of both agencies in strengthening fiduciary protections for investors, Fi360, a fiduciary support and training organization, said that matching regulations would not be consistent with the original intent of Congress when it passed ERISA and the Investment Advisers Act.

In an August 16, 2012 letter to all 33 of those representatives and to each member of the House Financial Services and Education and the Workforce Committees, the organization described why harmonization should not be a central objective of the rulemaking process. Despite the appealing sound of the concept, noted the group, harmonization could undermine important investor protections for retirement plans that were intentionally established under ERISA. It could also restrict flexibility provided by design in the Investment Advisers Act.

The fiduciary standard under each law is quite different in its practical application to investment advice. If the SEC and DOL were to harmonize their rules, said the group, the agencies would be left with one of two stark choices: 1) require the SEC to impose a higher standard commensurate with ERISA standards, or 2) require the DOL to violate clear legislative requirements under ERISA and thereby weaken the strong fiduciary protections now afforded to retirement plan participants.

While both laws generally impose a fiduciary duty of loyalty and care on the investment adviser, ERISA’s prohibited transaction rules and its exclusive purpose standard are far more stringent, and absolutely prohibit transactions between the plan and a plan fiduciary, as well as any party in interest.  Disclosure and consent is the traditional remedy for managing conflicts of interest under the Advisers Act. However, it is less common to rely on disclosure to manage conflicts under ERISA. Instead, the Department may combine disclosure with other solutions under prohibited transaction exemptions, such as requiring level fees and having independent audits of advice arrangements.

Given the 34-year gap between passage of the Advisers Act and ERISA, noted the group, and the rapid growth of self-directed retirement accounts in subsequent years, Congress would have indeed found the task of contemplating the practical consequences of its legislative work nearly impossible. The Advisers Act imposed broad regulation over the entire business of investment advisers, emphasized the organization, rather than focusing primarily on the nature of their duty to investors. ERISA, on the other hand, sought to protect employees by establishing standards of conduct, responsibility and obligation for fiduciaries of employee benefit plans.

The fiduciary standards under both laws are historically quite different in their purpose and application, resulting in significant challenges when attempting to harmonize rules. The Advisers Act contained no reference to a fiduciary duty when it was passed by Congress in 1940. A seminal 1963 US Supreme Court decision confirmed the fiduciary standard under the Advisers Act. Under the Advisers Act, the Court reasoned that advisers must adhere to a strict fiduciary standard including a duty of utmost good faith, full and fair disclosure of all material facts, and an obligation to use reasonable care to avoid misleading clients. As a result, in enforcing the Advisers Act, the SEC generally places great emphasis on disclosure as a remedy for conflicts of interest.

The application of a fiduciary standard under ERISA is far different, in that it imposes fiduciary duties in addition to any specified duties of disclosure. In fact, Congress replaced the Welfare and Pension Plans Disclosure Act of 1958 with ERISA because, among other reasons, it found that relying primarily on disclosures would not protect participants adequately.