The Department of Labor recently proposed seven rules imposing new obligations on firms selling securities to retirement plans and individual retirement account (IRA) investors. If implemented, these rules will harm the investing public, small businesses, the securities industry, and the overall economy.

Among other things, the rules would substantially broaden the class of persons deemed a fiduciary under current law. Most importantly, the rules would extend this status to persons providing investment advice pursuant to an agreement, arrangement, or understanding where the advice is individualized or specifically directed to the recipient for making investment or investment management decisions regarding plan assets.

The Problem Being Addressed

The central issue that the rules are intended to address is that persons selling investments or providing investment advice for retirement plans often imply—or directly state—that they are looking out for the “best interests” of the investor when in fact they are not.

This problem is legitimate. However, the proposed rules are not the right approach to solving it.

Similar Requirements Were Recently Implemented

Broker-dealers and registered representatives must already comply with Financial Industry Regulatory Authority (FINRA) Rule 2111 relating to suitability. The language in the rule states:

[A] broker-dealer or associated person [must] “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile.”

This rule already provides a high degree of protection to investors, while imposing fewer duties, less risk of litigation, and less regulatory risk on broker-dealers and registered representatives than a fiduciary duty would impose.

FINRA Rule 2111 is relatively recent, having taken effect in 2012. The economic research that the Department of Labor and the Council of Economic Advisers used to support the new rules predates the application of Rule 2111 and hence should be considered largely irrelevant.

Indeed, officials need to reevaluate the situation in light of the FINRA rule before imposing any additional regulations.

Hurts Those It Seeks to Help

Under the proposed rules, the considerable risks and costs of being a fiduciary would make securities professionals much less likely to provide services to low-income and moderate-income individuals and small businesses. The regulatory and litigation risks of assuming the fiduciary role and the difficulty of receiving adequate compensation for these risks and the cost of providing the services would make servicing small accounts unattractive.

Furthermore, the proposed rules would disproportionately harm small firms in the securities business and lead to a further concentration in the industry. This is because the cost of regulatory compliance is not directly proportional to size; rather, it constitutes a much higher share of a small firm gross revenues. Consequently, the proposed rules would disproportionately harm small firm profitability.

Ethical Concerns

If the “investor advisor,” broker-dealer, registered representative, or insurance agent makes it clear to the investor that he or she is not looking out for the investor’s “best interests,” then both parties should be free to move forward.

In a free society, it is inappropriate paternalism for the government to prevent people from making investments that they judge to be good opportunities or from choosing to invest for reasons other than pecuniary gain, such as a personal relationship or affinity for the mission of the enterprise. As long as the seller of the investment or advice is honest about his or her duties (or lack thereof) toward the investor and about the nature of the investment, the investor should be entitled to choose that investment product or make that investment. Similarly, the government should not force investors to follow the opinions or judgment of fiduciaries about what is or is not good for the investor.

A Better Approach

New York City Comptroller Scott M. Stringer has outlined a much more favorable approach to the problem, and the New York legislature is considering his proposal. His proposal would require non-fiduciaries to confirm both aloud and in writing that:

I am not a fiduciary. Therefore, I am not required to act in your best interests, and am allowed to recommend investments that may earn higher fees for me or my firm, even if those investments may not have the best combination of fees, risks, and expected returns.

This approach would ensure that investors understand that non-fiduciaries are not required to act in the investors’ best interests, but are salespersons. It would inform investors about the person with whom they are dealing and make it clear that non-fiduciaries are not obligated to look out for the best interests of the investors.

Such an alternative, in combination with the previously adopted FINRA rule, would provide additional protection to investors without risking unnecessary harm to the economy.


To read David Burton’s comments to the Department of Labor, click here.

For additional information on the proposed rules or to submit comments to the Department of Labor, click here.