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  • Home>Practice Management>Fiduciary Focus>The Reason for the DOL Rule: IRAs

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    The Reason for the DOL Rule: IRAs

    The primary reason for the Department of Labor's fiduciary rule doesn't involve protecting qualified retirement plans but rather unsuspecting IRA owners.

    W. Scott Simon, 11/03/2016

    W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award.


    Since 2010, the U.S. Department of Labor (DOL) has sought to fashion a fiduciary rule that will mitigate conflicts of interest arising from advisors' receipt of variable compensation--commissions, 12b-1 fees, revenue-sharing, etc.--when rendering investment advice to retirement investors. The result, on April 8, 2016, was issuance by the DOL of (among other items) its long-awaited Rule titled: "Definition of the Term 'Fiduciary'; Conflict of Interest Rule--Retirement Investment Advice."

    1974 to Now
    When the Employee Retirement Income Security Act (ERISA) was enacted in 1974, defined benefit plans were about the only kind of retirement plan around. The fiduciaries of DB plans sponsored by companies made all the decisions and bore all the risks of investing for the plans. Individual Retirement Accounts (IRA) were nonexistent since they had just been created by ERISA. IRAs were intended to provide individuals not covered by a retirement plan at work with a tax-advantaged savings program. In addition, they were meant to complement work-related plans by allowing rollover of assets at retirement or when employees changed jobs. 

    In 2016, the retirement landscape is obviously much more complex. Now, 401(k) and other defined contribution plans as well as IRAs dominate the retirement marketplace. Now, investors themselves--not others such as fiduciaries of DB plans--must make the decisions and bear the risks of investing for their retirement. Now, there are countless more and increasingly complex investment products such as target date funds (TDFs), exchange-traded funds (ETFs), hedge funds, private-equity funds, real estate investment trusts (REITs), and insurance products such as fixed indexed annuities. Now, in addition to traditional IRAs, there are Roth IRAs, SEP-IRAs, SARSEP IRAs, and SIMPLE IRAs.

    Many of these investment products are marketed directly to plan participants and IRA owners by non-fiduciaries that enjoy a vast asymmetric information advantage within a caveat emptor environment. The result is that many plan participants and IRA owners today have little ability to assess the value of investment advice or potential conflicts of interest intelligently and are therefore at the mercy of these non-fiduciaries.

    The Reason for the Rule: IRAs
    The primary reason for issuance of the Rule doesn't involve qualified retirement plans. Although litigation over the last decade has shown that hidden--and therefore high--costs exist even in multibillion-dollar 401(k) plans sponsored by giant corporations (e.g., Braden v. Wal-Mart), the $4.7 trillion held in 401(k) plans is relatively better regulated and incurs relatively lower costs than the $7.4 trillion held in IRAs. (Many likely would say that 401(k) plans hold far more in assets than IRAs do, but in fact, IRAs hold more than 50% greater assets than 401(k) plans.)

    The real reason for issuance of the Rule is to mitigate what the DOL regards as the bad effects resulting from the practices of some advisors providing conflicted investment advice and products to unsuspecting IRA owners. The HR director at a plan for which our RIA was the investment manager pursuant to ERISA section 3(38) referred to those engaged in such practices as "circling sharks" waiting for plan participants to retire so they could place them in high-priced investment products.

    W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understandingis the definitive work on modern prudent fiduciary investing.

    Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

    For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

    The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.