Financial professionals who give one-time investment advice will soon be legally required to act in their clients’ best interests under the Department of Labor’s new fiduciary rule.
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This will be a significant change to the financial services industry. Advisors who help investors roll over their retirement accounts or purchase annuities previously did not have a fiduciary duty to clients if those recommendations weren’t made on a “regular basis.”
Under the new rule, which is set to go into effect Sept. 23, 2024, investment advisors, brokers and insurance agents must act as fiduciaries when making an investment recommendation for compensation.
Here’s what you need to know about the new rule.
Retirement Security Rule
On April 25, the Department of Labor updated the Employment Retirement Income Security Act (ERISA) rules governing investment advice related to retirement plans, expanding who is a fiduciary and when the fiduciary standard applies.
The new rule, known as the Retirement Security Rule, makes two significant updates to ERISA.
First, the rule changes the definition of an “investment advice fiduciary” to be more inclusive. Financial services providers will be considered fiduciaries under ERISA if they:
- Make investment recommendations to clients
- Accept a fee for their practice
- Act in a way that would make a reasonable person believe this advice was given in the client’s best interest
As fiduciaries, retirement advisors will have the same duty to their clients as lawyers and doctors.
Second, the new rule updates the restrictions and requirements placed on a fiduciary under ERISA. This is known as the list of Prohibited Transaction Exemptions (PTEs). It details how advisor fiduciaries must behave and what some prohibited behaviors are. And if you need help finding a fiduciary advisor, this free tool can connect you with one who serves your area.
One-Time Recommendations
As fiduciaries, retirement advisors will be legally required to act in their clients’ best interests, even if they aren’t providing on-going investment advice. This hasn’t been required under the previous ERISA rules, which were first instituted in 1975.
For example, one-time recommendations to purchase an annuity with retirement savings or roll money out of a workplace retirement account and into an IRA were not considered fiduciary advice since they weren’t made on a regular basis, the DOL said.
“Yet, one-time advice is often the most important advice the retirement investor will ever receive,” the DOL wrote on April 23. “For example, few recommendations are likely to be more important than advice to pull a lifetime of savings out of a retirement plan to buy an annuity that is supposed to cover benefits for the rest of the investor’s life.”
The DOL says the new rule closes this one-time advice “loophole” and treats any financial services provider who makes a rollover recommendation as a fiduciary “if every element of the fiduciary definition is satisfied.”
The statute that’s being updated was written in 1975, when pensions and Social Security paid for most Americans’ retirements. Today, in the wake of the rise of defined contribution plans like 401(k)s, most households must fund their own retirements. This means relying on increasingly complicated investment products in an increasingly sophisticated market. Since few people have that level of technical knowledge, they oftentimes rely on the advice of a financial professional.
Under the new rules, an advisor will be required to recommend the best outcome for the client regardless of – or even in spite of – the advisor’s interests.
Unlike many general rules of practice, a fiduciary duty is legally enforceable. A client or principal can sue for breach of fiduciary duty and can recover both losses and punitive damages. For example, if a financial advisor accepts kickbacks for putting clients in a higher-fee fund, the client could sue to recover fees and damages.
Finally, this rule updates the Prohibited Transaction Exemptions for an investment fiduciary. In relevant part, retirement advisors must provide:
- “Prudent and loyal” advice
- Accurate information regarding conflicts of interest, fees and investments
- Policies designed to protect the client’s best interest
- Reasonable fees for all services
- Disclosures about any conflicts of interest
Opposition and Potential Changes
However, the new rule is being challenged in court. The Federation of Americans for Consumer Choice Inc., an insurance industry lobbying group, and others have filed a federal lawsuit in U.S. District Court for the Eastern District of Texas, asking the court to vacate the rule.
Fiduciary rules have long faced opposition from the financial industry and the Republican party.
In 2015, the Obama administration began the rulemaking process to make investment advisors legal fiduciaries. After drafting and comment periods the DOL issued its rule in 2016, near the end of the administration’s term. When Donald Trump took office, his administration halted enforcement of the new fiduciary rule, preventing it from taking effect.
Shortly after, a series of financial industry groups sued. The Fifth Circuit voided the existing fiduciary rule, and the Trump administration declined to appeal or rewrite it.
In October 2023, the Biden administration released its proposed fiduciary rule. This version, the current Retirement Security Rule, is an updated version of that 2016 rulemaking. It once again establishes that investment advisors owe their clients a fiduciary duty.
Bottom Line
The Department of Labor has issued a new rule that holds any financial professional who provides investment recommendations to retirement investors to the fiduciary standard. The DOL says the new rule closes a loophole that allowed advisors to circumvent fiduciary duty when making one-time recommendations of rollovers or annuity purchases.
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