With this week's "surprise" presidential election victory of Donald Trump over Hillary Clinton, combined with the success of the Republicans holding both the Senate and the House of Representatives, the question arises as to whether the Republican clean sweep in Washington spells an imminent demise for the Republican-opposed Department of Labor fiduciary rule. What is the likely fate of the fiduciary rule once the change in power occurs next January?
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, I discuss why I actually do not think that the Republican victory is going to lead to an immediate and total repeal of the Department of Labor fiduciary rule.
Because the reality is that while the rule will not be enforced until next April - after President Trump takes office - the regulation itself became official this past April. And the President doesn't have the power to just immediately enact a massive change to an existing regulation. Remember, it took President Obama's Department of Labor nearly 6 years just to get the prior fiduciary rule changed to what it is now becoming! If President Trump tried to halt it immediately, the fiduciary advocates would have their own opportunity to sue the Department of Labor, and would likely be successful!
Of course, the reality is that even if President Trump would have trouble eliminating the rule, he could "defang" it by directing the Department of Labor to only minimally enforce it, akin to the SEC's similar failure to enforce the existing provisions of the Investment Advisers Act of 1940 that already requires brokers who give substantive investment advice to register as fiduciary investment advisers. Which would mean the fiduciary rule is still on the books. But the Department of Labor wouldn't be much of a threat for those who didn't follow it.
On the other hand, the existence of the fiduciary rule's requirement that consumers must retain the right to a class action lawsuit against a financial institution for breaching its fiduciary duty (across a large number of advisors) means the threat of DoL fiduciary enforcement remains, even if the Department of Labor itself isn't funded to do it. Which means perhaps the most likely Republican "fix" to the rule will simply be to pass a law that eliminates the class action provision, which doesn't kill the DoL fiduciary rule but does drastically reduce its threat.
In addition, while President Trump would be limited in just issuing an Executive Order to kill the DoL fiduciary rule, Congress itself could pass a law to end the rule altogether (as opposed to just its class action provision). However, it's not clear how politically feasible this actually is. The Republicans still don't have enough votes to overcome a filibuster in the Senate, and with so many major firms already implementing changes to adjust to the DoL fiduciary rule, some previously anti-fiduciary foes may now become fiduciary advocates to keep the rule (because they believed they're more prepared than their competition to succeed if it sticks around). And with President Trump having already put a lot of other rule changes on his agenda for his first 100 days in office... and the DoL fiduciary rule enforcement beginning just 80 days after the change in power in January... it's entirely possible that by the time Congress is even ready to take the issue up, it will be a moot point because the Department of Labor's fiduciary rule will already be fully implemented and enforced!
(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)
#OfficeHours with @MichaelKitces Video Transcript
Welcome, everyone! Welcome to Office Hours with Michael Kitces!
With the news that not only has Donald Trump won the election for the White House, but Republicans now have a clean sweep with the Senate and the House of Representatives as well, there are lots of questions about what policy is going to look like going forward out of Washington. And in the context of us as financial advisers, the question that's coming up immediately is about the likely fate of the DoL Fiduciary rule. So I thought I would tackle the question head-on this morning.
First and foremost, it's important to recognize how the DoL fiduciary rule happened. The Department of Labor is under the Executive Branch (under the President), and the DoL fiduciary rule was pushed forward as an explicit priority from the White House (from President Obama). You may even recall there was a brief point where Labor Secretary Perez was actually acknowledged as a potential running mate for Hillary Clinton.
Not surprisingly, since this rule was driven by the Executive Branch (controlled by the Democrats), objections to the rule were pretty consistently split on party lines. Republicans strongly objected to it, and Democrats generally affirmed it (or at least, were not willing to fight the White House on the issue). So as long as President Obama was in the White House, and Republicans didn't have enough votes to override a presidential veto, there was no way to stop or legislatively block the Department of Labor's actions.
However, with Donald Trump winning the presidency and Republicans having control of both the House of Representatives and the Senate, the landscape has shifted... and now it really raises questions regarding the future of the DoL fiduciary rule. We have had many proposals from Congress in the past to kill the DoL fiduciary rule, and now that Republicans have control in Washington, does that mean DoL Fiduciary is toast?
What It Takes To Change DoL Regulations And The Administrative Procedures Act [Time - 1:55]
It's important to recognize that a lot actually has to happen in order for the DoL fiduciary rule to get unwound.
First and foremost, the biggest challenge to unwinding the DoL fiduciary rule is that it's a "done deal", at least as far as regulations go. The enforcement date isn't until next April 10th (when you have to actually do all the compliance with the rules), but the rule itself was made final as an official Department of Labor regulation this past April. We're past the "effective date" of the new regulation.
That's really important, because it means that President Trump can't just arbitrarily undo the rule at this point by executive action. It's a published Department of Labor regulation. Now, if the Department of Labor wants to change it, that requires a new rule-making process under the Administrative Procedures Act.
And we've seen how long that takes! The process to create the current version of DoL fiduciary rule started in 2010. It took almost six years to make the rule, and even then, fiduciary opponents have sued the DoL claiming that it was a "hasty" rule and didn't sufficiently consider the issues.
Which means if President Trump comes in and tries to kill the rule through executive action (or tries to substantively change the regulations what from are already effective), he'd actually have the same problem. If he just came in and changed the regulations, the fiduciary side could sue the Department of Labor for a capricious rule change – and they could probably win, if President Trump did it too quickly! Many court cases regarding government regulation have been successfully overturned when government acts too hastily.
It's worth noting, however, that President Trump certainly can push the DoL to be lax on enforcement of the rule. This is a popular strategy that both sides of the political aisle have used over the years to "defang" rules and regulations that they don't like (i.e., reduce the severity of their potential bite).
In point of fact, technically, there's already a rule on the books that says, "Any broker who gives investment advice beyond just being solely incidental to the sale of brokerage products, has to register as an investment adviser and be a fiduciary." In other words, a rule already exists that says you have to be a fiduciary when you give investment advice. It was part of the Investment Advisers Act of 1940, and would make the entire DoL fiduciary rule moot! But the SEC hasn't enforced it for decades now.
That's an example of an existing fiduciary rule that isn't fully enforced. President Trump effectively could direct the DoL in a similar matter. Not repeal the rule or eliminate the rule, but just direct the Department of Labor not to substantively enforce it. The President could direct the Labor Secretary: "Okay, there are 300,000 financial advisers, and we'll have one examiner whose job it is to enforce it. Good luck with that." The end result of insufficient enforcement staff is a lax rule.
So we could substantively defang the rule, even if we don't eliminate it entirely. But that's different because the rule is not gone, it just might not be enforced for a while.
However, the caveat to the lax enforcement strategy is that the DoL Fiduciary rule also contains the requirement that consumers have to have the right to a class action lawsuit. Which means even if President Trump were to defang the DoL Fiduciary rule by stripping back enforcement, consumers en masse could still sue financial institutions for fiduciary breaches. As a result, even the DoL not enforcing the rule actually doesn't fully eliminate the risk of it being enforced.
But the key point here is to recognize that part of the checks and balances of our government system is that the President can't implement regulatory changes this broad and sweeping without going through a process. We went through a process to get the current rule, and it is a published and final rule. It's not a rule that is still in limbo because it hasn't taken effect until next April. It was a final rule as of last April, so the President can't just directly order the new Labor Secretary to just kill it the first day that he shows up in office.
A Legislative “Fix” To The DoL Fiduciary Rule [Time - 5:28]
There is a second option that could result in DoL fiduciary getting overturned: Congress.
Congress can override DoL regulations by passing a new law. That's again part of our checks-and-balances system of government. Congress can pass laws to override the Executive Branch. This has actually been the strategy many of the opponents of DoL fiduciary have tried all along. They wanted Congress to block the rule by passing a law, but they couldn't get it done because even if the law passed, everybody knew that President Obama was going to veto it.
With a clean of sweep for Republicans, though, a legislative change to kill DoL Fiduciary is certainly much more feasible. They could pass legislation that really would kill the rule, because Congress does have the power to override the Department of Labor.
The caveat to that is it's not entirely clear how much of a priority that really is going to be for President Trump and the Republican legislature. Trump hasn't actually taken a strong position on the issue either way over the past six months since the rule took effect, even though Hillary Clinton announced from the campaign trail that she was for it.
In the meantime, Trump has been very vocal about prioritizing other rule changes (e.g., rolling back parts of Dodd-Frank, repealing the Affordable Care Act, corporate tax reform, and individual tax reform) so it's not really clear where DOL fiduciary is on the radar screen, or even what the President's position is. The DoL fiduciary rule will start to be enforced 80 days after the President takes office, and eliminating it is nowhere on his first-100-days plan.
It's also worth noting that President Trump has had a number of positions that are not entirely in line with the Republican establishment, so no one actually knows where he stands on the issue. It's entirely possible he's not as opposed to it as the Republicans in Congress have been.
So given Republican opposition historically, and Republicans now controlling Washington, it's certainly a possibility that we see a law passed in early 2017 to stop the fiduciary rule. And I'm sure some of the lobbyists that fought the fiduciary rule all along are already creating their plans to make a lobbying push for the new Congress to take this up when they first meet in January. But there's a lot that President Trump has already put on his plate for his first 100 days, so it really isn't clear whether this gets done anytime soon or not (or at all).
Will The Industry Fight To KEEP The DoL Fiduciary Rule? [Time - 7:22]
So even if there's a clear legislative potential to kill the rule, it's still not entirely clear it's going to happen when we get to the change in power in January.
The situation is further exacerbated by the fact that so many major firms have begun to enact the changes that would be needed to comply with the rule. In fact, if you're a broker-dealer firm that's been out ahead on this rule (and is more ready to comply than the rest of your competition), you actually want the rule to go through and stay because that helps your competitive position.
For instance, big firms like Merrill Lynch and Commonwealth Financial already stepping forward to say they're ready to comply and that they're going to strip out all commissions and be level fee fiduciaries in all retirement accounts. Which means from a competitive marketplace perspective, they want the rule to stay at this point, to differentiate themselves from other wirehouses and independent broker-dealers who haven't!
As a result of these shifts that have already happened, the lobbying environment around DoL fiduciary may be very different in 2017 than it was in 2016 and 2015. Because now there are going to be some major firms that will actually support the rule and want it to stay. Even if it's a tough transition for them, if it's harder for everyone else, it's still a win for them to keep the rule that's on the books.
So while there may be lobbyists that push Republicans to enact the law that stops the rule, there are (or at least can be) more lobbyists than last time that actually push for it to stay, too. And between conflicted lobbying, and ambiguity about President Trump's position and where it is on the priority list, any potential change could take a while.
Which matters because the longer it takes for change to happen, the more firms there are with systems in place to comply, the more the rule is in place and fully entrenched, and the harder it is to walk the rule back. Firms can't realistically wait until February to see if Congress implements a quick rule change, because if Congress doesn't act, then they've got less than two months to comply with the rule – and that's a serious problem. But if they keep preparing for it to happen, then by the time all the changes are made... well,who wants to eliminate a rule after you've put all the money into building the systems and the structure and the oversight in order to handle it?!
Given all of this, my gut is that the rule is probably going to stick around. I really don't think it's going to get repealed. I can't state unequivocally that it's not, and Republicans do have the power to repeal the rule, but I would not automatically assume that the rule is actually going to get repealed. Given where we are with respect to the timing, the implementation, the fact that it is an official regulation on the books (so it would require an active Congress for a hasty fix), and the fact that Congress has a lot of stuff they are talking about doing – DoL fiduciary is just not a high priority right now. At worst, the April 10th enforcement date could get halted a month or few, but even then, it's not clear that Congress will have the time or attention to take up a substantive "kill" to eliminate it.
De-Fanging The DoL Fiduciary Rule’s Class Action Lawsuit Provision [Time - 9:50]
That being said, the rule was so unpopular with Republicans that I cannot imagine it's going to remain exactly as it is going forward. My gut is that we're not going to see the rule eliminated, but we're going to see enforcement of the rule get gutted.
And I think the number one thing that you probably will see change in the DoL fiduciary rule in the next year is that the industry is going to lobby Congress to kill that class action lawsuit provision, and allow all financial institutions to bind clients to mandatory arbitration again (which is what the industry has "always" done for decades now). They're going to push for everything to go back to arbitration.
That eliminates the risk of a major class-action lawsuit, and that means the DoL Fiduciary rule can stay, because now it's actually not nearly as threatening to financial institutions. It's still out there, and they still have to at least deal with it in arbitration, but they can deal with those small scenarios one adviser at a time. It doesn't pose the same kind of institutional risk to the firm that class action lawsuits do.
Unfortunately for those of us who advocate on the fiduciary side, that does undermine the rule's consumer protections, quite significantly. It dramatically brings down the threat and consequences of enforcement. Even above and beyond the fact that a Republican-controlled Department of Labor isn't likely to enforce the rule aggressively either.
Nonetheless, I really would not be banking on the total elimination of the fiduciary rule here – even with the Republicans sweeping Washington. It is a possibility, but don't underestimate how far the industry has already come in changing to meet the rules, and how the competitive landscape has shifted, with prior fiduciary opponents who now might support it. Given that this is an official regulation and it does have a looming implementation date (which is actually not that far out, barely 80 days after President Trump takes office), the industry still has had no choice but to prepare.
In other words, the Department of Labor's tactic to get the rule done while President Obama was still in office appears to have worked. We may just be a little bit too far along now. Which means the most politically feasible path may be to just eliminate some key line items – defanging the DoL Fiduciary rule so it's less threatening and has fewer financial consequences for financial institutions that violate it.
But if that's all that changes, you still need to be preparing to follow the rule! Even if the class action lawsuit provision gets eliminated, you as an individual adviser won't want to lose an arbitration case for breach of fiduciary duty. A watered down fiduciary rule is less threatening to a big financial institution, but if it's not repealed it's still something advisors must adhere to!
So I hope that helps a little as food for thought regarding the election results. This is Office Hours with Michael Kitces. Normally 1 p.m. East Coast time on Tuesdays, but I thought this was an issue too important not to tackle first thing Wednesday morning here after Election Day. Thanks for joining us today, and have a great day, everyone!
So what do you think? Will President Trump kill the DoL fiduciary rule? Will Congress seek to eliminate or defang the rule? What changes to the DoL fiduciary rule do you think are most likely? Please share your thoughts in the comments below!