Lawyers warn that the Labor Department is working more closely with the SEC to investigate widespread abuses and conflicts of interest. Qualified plan providers react and are conducting fire drills and mock audits.
The Department of Labor has grabbed the SEC’s regulatory baton and started hunting for “improper or undisclosed” compensation, forcing advisors to decide whether to face a new sheriff or run for the hills.
“We are aware of several broker-dealers recently receiving letters initiating DOL investigations,” says Bruce Ashton, a partner in national law firm Drinker Biddle’s Los Angeles office.
News of the audits come as a shock to many in the industry who spent most of the year waiting for DOL to release new guidance on what advisors who work with retirement plans will and won’t be able to do.
Advisors who thought they weren’t even under DOL supervision are even more confused.
But as far as the regulators are concerned, this isn’t so much a case of jumping the gun as it is closing loopholes that have been around for years, Ashton says.
“The market has changed and now DOL is working more closely with the SEC,” he explains.
“Some of the things they’re looking at have been on the books for three to five years but never really enforced.”
Accidental fiduciaries on the firing range
Word has it that the SEC is giving DOL examiners tips on which firms to look at, but they gave me the standard “refusal to comment on ongoing investigations” speech when I asked.
In any event, most of the records the regulators are asking for relate to compensation, services offered and the circumstances under which it was provided.
The common link here seems to be trying to catch firms that acted as fiduciaries and so became subject to SEC and DOL discipline, even if they did it unintentionally.
According to SEC logic, providing individualized investment recommendations -- telling workers which fund to buy -- creates a fiduciary bond between the advisor and the plan, which means that steering plan participants to the funds that pay the biggest commissions is forbidden.
A lot of advisors think that as long as they disclose who pays their rent, they’re in the clear.
Unfortunately for them, the SEC has taken a firm line here: you can be a fiduciary even if you don’t know it, and if you break the fiduciary rules, you can be punished.
Figuring out that a plan consultant offered or provided investment advice is the trigger for looking into conflicts of interest that a non-fiduciary would be able to get away with.
The penalties aren’t going to be huge, Bruce Ashton says -- the worst case scenario boils down to reversing the suspicious trade, returning the commissions and maybe paying excise tax.
“I don’t think any of my clients are in this situation, but it generally means unwinding what you did,” he explains.
That said, the long statute of limitations could easily subject advisors who thought they were in the clear to give back income they spent years ago, so some firms are now conducting “practice” audits to gauge their exposure.
A warning shot ahead of the new rules
And while even tighter fiduciary regulations have been pushed back, it’s clear that the DOL is spoiling for chances to fight the impression that it’s been letting American workers get ripped off over a dismal decade in the markets.
Phyllis Borzi, the head of the Employee Benefits Security Administration, bristles at the thought of plan consultants making money by steering 401(k) investors off course, even if they disclose where every cent comes from.
"Investment advisors shouldn't be able to steer retirees, workers, small businesses and others into investments that benefit the advisers at the expense of their clients,” she says.
She initially wanted to simply declare that everyone who provides retirement plan advice would be bound to the fiduciary code and violators would be punished.
Congress and the industry rebelled at that one, but it’s clear that if DOL catches an advisor breaking the rules -- old or new -- there will be hell to pay.
As Borzi famously warned, “We’ve seen case after case in which investment advisors put in a contract that they agreed to be fiduciaries, and when the trustee tried to hold them responsible, they would hide.”
Initially, there were rumors that DOL wanted to ban all advisor commissions on 401(k) accounts, which would effectively force all brokers out of the market.
But Borzi has mellowed a little on that one, most recently saying she’s willing to extend long-standing exemptions for brokers who abstain from making recommendations directly to individual participants.
Bruce Ashton expects that compromise to happen, even as the broader crackdown continues.
“You don’t have to give up commissions as long as you’re careful about avoiding transactions that obviously enrich yourself over the client,” he predicts.
Biting off too much?
Granted, there’s a risk here that Borzi’s enforcement team is already stretched too thin as it is.
In the old days, DOL examiners spent most of their time talking to retirement plan sponsors and administrators with a clear-cut fiduciary duty to American workers.
To save resources, they were willing to leave the consultants alone unless they uncovered signs of gross misconduct.
Now, even though there are still only maybe 300 to 400 of them in the field, they’re opening up an entire new front by taking on the advisors as well.
“I think they are overworked but very thorough,” Ashton says.