Securities Litigation

The Department of Labor ("DOL") released a controversial proposed rule on April 20, 2015, that seeks to expand fiduciary duties in the context of retirement-investment advice. Specifically, the proposed rule would rework a 1975 five-part test that greatly limits the fiduciary responsibilities of advisors for plans covered under the Employment Retirement Income Security Act ("ERISA"). The new fiduciary-duties standard proffered by the rule would require advisors to put the best interests of the client ahead of any profit motive, especially the incentives inherent to certain low-return, high-fee investments. Moreover, the proposed rule would expand the newly defined fiduciary duties to certain IRA provisions of the Internal Revenue Code, thus encompassing investment advice for previously unaffected IRA plans. Finally, the rule would create a new contract between investors and advisors that would expressly incorporate the best-interests rule, thus opening the door for breach-of-contract lawsuits by investors. Overall, the DOL's proposed rule is a response to the transition over the past forty years from large, employer-managed pension plans to a significantly larger number of individually managed 401(k) and IRA plans. The DOL cited major concerns with the 1975 five-part test's limitation of fiduciary standards to advisors who offer opinions on a regular basis for the primary purpose of influencing investment decisions. Discussing a number of areas of potential and past abuse, the DOL asserted that the proposal will ensure that advisors who are expected to have an impartial view on investment decisions adhere to their clients' best interests before looking to personal gain. The Financial Industry Regulatory Authority ("FINRA") and the Securities Industry and Financial Markets Association ("SIFMA") spoke out last week in opposition to the proposed rule, joining a growing chorus of contentious debate on both sides of the issue. The central concern from the industry appears to be that the DOL's proposed rule creates a patchwork effect by subjecting advisors to multiple statutory obligations and potential grounds for liability. As FINRA stated, the proposal would shift a significant amount of litigation power to the persons being advised, while SIFMA raised concerns of the illogical failure to consolidate enforcement powers in one agency (the Securities and Exchange Commission ("SEC")) rather than in multiple agencies. FINRA and SIFMA's concerns do not stem from the best-interests aspect of the new rule itself. Indeed, and as has been reiterated by both organizations, advisors have already largely been subject to a similar rule. For example, and as I've seen personally, many FINRA arbitrations already concern fiduciary-duty claims. These types of claims arise frequently in the context of retirement planning, IRA roll-overs, and annuity investing, and they are often coupled with the full panoply of other claims, including suitability, breach-of-contract, and similar claims. Apart from the long-term effects of having multiple sources of enforcement pressure, the proposal includes significant costs to industry participants. The DOL itself recognized that the rule would require several billions of dollars to implement, but justified those costs by the expected benefits for investors that will ostensibly profit from non-conflicted transactions. The DOL also estimated legal costs of millions of dollars to industry participants in drafting and implementing the new best-interests contract. However, and as was not entirely set out in the proposal, the expected cost of litigating suits based on the breach of these new contracts-including by the DOL and by the plan participants themselves-will significantly alter participants' strategies and incentives for offering securities advice in the first instance. Moreover, on a broader scale, the future effects of these new claims remain unclear as to the longstanding limitation of ERISA remedies to largely equitable relief. At the very least, creative plaintiffs' attorneys could seize this opportunity to formulate new arguments for monetary relief in the ERISA context, thus greatly increasing the expected litigation cost of the proposed rule. The proposal clearly raises significant cost and compliance issues for entities engaged in offering retirement advice. The approach undertaken in giving the DOL enforcement authority in this area is intriguing: although the DOL states that statutes forbid adoption of identical definitions between ERISA and the statutes governing the SEC's work, it would certainly seem that the SEC and FINRA's substantial institutional experience would better serve rule-making in this area. In any event, given the DOL's past willingness to reevaluate its most-recent fiduciary-duty proposal from 2010, there is still a strong potential that industry participants' flurry of protests could lead to meaningful and well-thought-out alterations to the DOL's proposed rule. Regardless, the result will almost certainly be a broader definition of fiduciary-duty responsibilities for financial advisors, and, thus, a greater need for firms to ensure compliance with the latest developments. Sources: Proposed Rule Proposed Best Interest Contract Exemption "UPDATE 5-Wall St watchdog says Labor Dept. broker rule 'not the way to go'," Reuters "Statement from SIFMA CEO Kenneth E. Bentsen, Jr. in Response to Remarks By FINRA Chairman and CEO Richard Ketchum on a Best Interest Standard;" sifma.org "White House presses ahead with contentious financial adviser rule," The Hill "FINRA's Ketchum Blasts DOL Fiduciary Plan; White House Says 'Work With Us'," Think Advisor "Bipartisan Policy Center: "Champions, Critics and Consequences of a New Fiduciary Standard" Closing Remarks," sifma.org "FINRA CEO Criticizes DOL Fiduciary Proposal," welthmanagement.com