Ring the bell for the latest round of consumer financial protections. Progress for consumer financial protections might not be over, but they are clearly knocked down heading into the second half of 2020. In the last week:

●     The Labor Department announced a new rule proposal that would weaken the fiduciary standard of care for retirement accounts

●     The Securities and Exchange Commission’s Reg BI went into effect on June 30

●     The Consumer Financial Protection Bureau suffered a major setback in the Supreme Court

●     And an outstanding lawsuit to stop Reg BI concluded in favor of the SEC.

The Labor Department’s proposed rule would potentially have the biggest impact of any of the aforementioned events in the past few weeks. The reason? The rule would allow a tremendous amount of conflicted advice and compensation models not currently allowed by fiduciaries who are giving advice to retirement accounts under the Employee Retirement Income Security Act of 1974 (ERISA).

This essentially is a complete turn from the previous administration’s fiduciary rule, which looked to expand the fiduciary requirements of ERISA to more types of advice and to IRAs. That rule was defeated in the 5th Circuit by now-Labor Secretary Eugene Scalia.

Scalia has been one of the most successful attorneys in defeating administrative rulemaking and knows the ins and outs of the processes better than almost anyone in the country. It is safe to assume that the rulemaking processes that the Labor Department is engaging in will likely withstand future challenges. So, if this rule becomes final and goes into effect, expect it to withstand any court challenges.

What is the New Proposed Rule?

ERISA prohibits self-dealing or direct compensation for advice inside of ERISA covered retirement accounts if the compensation differs based on what the consumer decides. The new proposed exemption would allow financial institutions and individuals who provide advice to retirement plan investors to receive otherwise prohibited compensation on conflicted advice recommendations.

Peter Gulia, who provides advice to fiduciaries on ERISA and is the owner of Fiduciary Guidance Counsel, said that the “proposal is controversial.” Additionally, Gulia said that the new rule would “set protections fewer and weaker than those of the 2016 department rule.

Gulia also stated that the new proposed rule would “require less than ERISA’s fiduciary responsibility.” Think about that! That’s actually in the new document! It’s actually hard to read and write out!

How to Receive the Exemption

To receive the new exemption, the professional or financial institution needs to comply with the Labor Department’s “Impartial Conduct Standards, including a best interest standard, when providing fiduciary investment advice.” To receive the exemption, the institution needs to acknowledge fiduciary status under ERISA and provide in writing the services they will provide and material conflicts of interest. Additionally, the financial institutions need to adopt policies and procedures designed to ensure compliance and conduct a review of their compliance procedures.

Honestly, these parts sound nice. They are the right steps, but they miss a hugely important aspect: enforceability. The new rule is an exception, not a rule expanding duties. As part of that, there is no private right of action to enforce these standards. So it will be almost impossible for a consumer that is harmed here to enforce anything against an institution or financial professional if they are not meeting all of the exemption requirements.

The Enforcement Problem

Simply put, this proposal is an exemption from rules, and the requirements to meet the exemption won’t be strictly enforced by the Labor Department and cannot be enforced by the individual. The rule lacks teeth.

The enforceability of a rule is crucial to its success. Laws without enforcement are not helpful.

What the rule does is provides the guise and paper trail of doing the right thing, without actually having to be a fiduciary. The rule allows people to say they are fiduciaries, then exempts them from being a fiduciary!

The Five-Part Fiduciary Test

Since the rule does not expand the fiduciary requirements, the current five-part test remains to determine if someone who is providing investment advice for a fee under ERISA is a fiduciary. This creates a whole other set of issues. The five-part test to determine if someone is an ERISA fiduciary for providing investment advice for a fee is as follows:

1. Advice to the value, sale, trading, or holding of securities or other property 2. on a regular basis 3. pursuant to a mutual agreement 4. serves as a primary basis for the investment decisions, and 5. advice is individualized.

This five-part fiduciary rule has been in effect since the 1970s, but has always left open issues regarding important aspects of retirement plans. In part, this is why the Labor Department attempted to update the test just a few years back.

Consider a one-off recommendation to roll over a 401(k) to an IRA, which is then placed into a single insurance product. Even though the advice creates an almost permanent investment outcome for the individual, this scenario would likely not meet the regular basis requirement and therefore that salesperson who is receiving a large commission on the recommendation would not be a fiduciary under ERISA – despite providing advice, relied upon, conflicted, and personalized because it was not on a regular basis but a single sale. The new proposed rule acknowledges this specific area.

A Step Back for Consumer Financial Protections

The failure of the department to expand the fiduciary rules to these types of transactions puts American retirement assets at risk for subpar and conflicted advice. These types of decisions are almost impossible to undo and is one of the most important decisions someone makes when it comes to their retirement security and should be covered under the fiduciary standard of care.

This exemption reduces ERISA fiduciary protections for consumers and, by its own admission, the proposed rule opens up the opportunity for more conflicted advice and compensation models. This is a big step back for consumer financial protections. While the onus to really understand the advice you are receiving with regard to retirement assets generally falls on the consumer, if this rule is passed, it will become exceptionally difficult for a consumer to distinguish between true fiduciary advice and someone selling a conflicted product.