The DoL Fiduciary Rule: How does investor comprehension fit in?

Apr 12, 2017 3:26:04 PM


The relationship between financial advisors and their customers can be complicated. And just like any relationship, trust must be built between the two parties for the whole thing to work.  Investors must trust that the advisor understands their situation and goals, has disclosed the rules of engagement, and is working in their best interest.  The advisor trusts that the investor not only received but understands the disclosures associated with risks, terms, expenses, fees, and how returns are calculated.  In general, consumers assume that the advisor is acting in a fiduciary manner – in their best interest – with a duty to disclose and a duty to ensure comprehension.

What is expected of a fiduciary?

Section 404(a) of ERISA sets forth some of the core duties including: the duty of loyalty, the duty of prudence, the duty to diversify plan assets, and the duty to administer plan assets in accordance with its terms.  ERISA did not set forth ALL duties required under common law of trusts, but in some cases the courts have imposed an interpretation which has become part of the common law of ERISA. One of these is the “duty to disclose,” which includes the responsibility to share material information.

Most recently, the U.S. Department of Labort (DoL) introduced specific Fiduciary Rules that add more clarity to the types of information that should be shared with consumers and provided more clear definitions of the fiduciary responsibility that all advisors should have if they are providing retirement investment advice.

Are written disclosures enough?

Today, advisors and brokers rely heavily on written disclosures to explain the terms and conditions of retirement savings plans.  But as anyone who holds a mortgage or credit card knows, written disclosures are rarely (if ever) read – much less understood.  And to make matters worse, studies show that most Americans cannot pass a basic financial literacy test and that the percentage of those who can pass a five-question quiz on basic financial terminology has fallen since the financial crisis of 2009.  The situation is even worse for consumers who are lesser educated.  One research survey of online fee disclosures for the financial services industry found that investments commanding the highest fee structures used the most complex language in their agreements (grade level 14) while those with lower fees used more understandable language (grade level 8) [Muller, L.A. & Turner, J.A. (2016). “Strategic Complexity in Investment Management Fee Disclosures.” Financial Services Review 25(3): 215-234.  and Celerier, C. & vallee, B. What Drives Financial Complexity? A Look into the Retail Market for Structured Products.  Working Paper.].   The U.S. Securities and Exchange Commission (SEC) has even tried to make disclosures more understandable by publishing a handbook for creating clear disclosure documents in “plain English” so that consumers can understand terms and conditions and it hasn’t helped much.

Can written disclosures really build trust, protect consumers and reduce the risk of litigation to firms?

The answer lies in how written disclosures are viewed.  Consumers and advisors view disclosure very differently too.  Consumers view disclosures as an effort toward transparency by advisors.  Firms, however, use them to mitigate risk.  These two very different understandings of the purpose of written disclosures set up a misunderstanding of the true nature of the relationship.  Written disclosures are designed to protect the firm, not necessarily the consumer.  But based on recent rulings, courts are not allowing firms to simply use written disclosures as a defense.  The fiduciary “duty to ensure comprehension” is viewed as equally important.  In one case, a judgement suggested that plan sponsors who knew that investors did not understand the terms of the agreement did not execute on their duty to inform [Bixler v. Central Pa. Teamsters Health and Welfare Fund, 12 F. 3d. 1292 (3rd Cir. 1993)].  While the case law is somewhat mixed on the topic, other courts have clearly stated “the most important ways in which the fiduciary complies with its duty of care is to provide accurate and complete explanation of benefits” [Kenseth v. Dean Health Plan, Inc.  610 F. 3d. 462(7th Cir. 2010)].

Can firms disclose terms and conditions, ensure comprehension, and be protected from lawsuits and regulatory investigations – all while building trust with consumers?

The good thing is the answer is YES!  Precedence has already been set in another regulated industry.

In 1996, in response to a practice called “slamming and cramming” whereby operators would illegally switch a consumer’s phone service or add charges for services without a consumer’s permission, the Federal Trade Commission and the Federal Communications Commission enacted rules (Section 258 of the Telecommunications Act of 1996) that requires all providers of wired voice communications lines to obtain reliable proof that a consumer requested a change of service or ordered new service.  Acquiring this proof proved quite difficult given that most of these types of transactions happen over the phone.

Therefore, the FTC and FCC allowed phone verifications to be legally binding, if recordings are: captured by a third party who does not have interest in the transaction, are available for audit for a minimum of 24 months, and that the identity of the authorizing person must be verifiable (i.e. by social security number, driver's license number, date of birth, etc.). 

For more than 15 years, Istonish has helped cable and telecommunications companies capture “evidence of comprehension” by acting as a neutral third party to verify disclosure of legal terms and conditions, pricing agreements, and capture voice recordings of the entire conversation.

To learn more about how third party verification can help you build trust and capture “evidence of comprehension,” download the white paper I co-authored with Marcia S. Wagner, Esq. from The Wagner Law Group.  It's titled, “Evidence of Comprehension: Managing Litigation and Regulatory Compliance Risks Under the New DOL Fiduciary Rule and ERISA.”


Annette Quintana

Written by Annette Quintana

Annette Quintana is the CEO of Istonish Holding Company, a privately held, Native American- and Latino-owned information technology services company established in 1990. Headquartered in Denver, Colorado, Istonish helps organizations, individuals and communities to be great through innovative technology solutions. Annette’s unique capacity to inspire her team to deliver successful results stems from her enthusiastic commitment to this vision. Under Annette’s leadership, Istonish has grown and evolved to serve government agencies, private companies large and small, and mission-driven not-for-profit organizations throughout the Mountain West.

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