The Department of Labor’s proposed fiduciary rule, which is designed to remove conflicts of interests from advisors to IRAs and most of the country’s 401(k) plans, actually creates a new conflict of interest, according to one analyst.

Aside from the proposal’s explicit carve-outs, such as the best interest contract exemption, seller’s carve out and education carve out, the proposal suggests the DOL is considering another fiduciary exemption.

The “low-fee”exemption, a concept introduced deeper into the proposal’s lengthy layout, would exempt advisors from fiduciary obligations when they recommend cheaper investments to plan sponsors and investors.

The idea’s presumption is that investments with low-fee structures, like passively managed mutual funds, are inherently conflict-free. Because they are cheaper, advisors make less money on them, and therefore they are in the best interest of participants and retirement savers.

Bob Collie, chief research strategist for institutional investing in the Americas at Russell Investments, has a problem with that reasoning.

A low-fee exemption would create a safe harbor for what he calls a “favored category” by the DOL, which, as he writes in the most recent post on the Russell’s fiduciary matters blog, comprises products that are likely to be passively managed.

That would incentivize advisors to recommend passively managed investments, which Collie thinks could be its own conflict of interest.

“The conflict in this case is not based on direct monetary incentive, but on a legal incentive (i.e. exemption from the fiduciary rule), but it’s still a conflict of interest,” writes Collie.

That potential for conflict could result in peril to defined contribution investors.

Collie points to defined benefit plans for explanation as to why. Because defined benefit plans’ investment costs and performance directly impact a sponsor’s funding requirements, sponsors of DB plans are incentivized to invest in the most conceivably efficient way.

And while those sponsors certainly access passively managed funds, they do not do so exclusively.

In fact, defined benefit plans tend to deploy more actively managed investments than defined contribution plans, according to Collie.

The reason? Fiduciaries to 401(k) plans want to reduce the risk of lawsuits.

In other words, the choice to use passively managed funds may be a decision made in the sponsor’s best interest, not the participants’.

That thinking clearly runs afoul of the Employee Retirement Income Security Act, which leaves no ambiguity as to whose interests sponsors must serve.

Collie speculates that the potential for a low-fee exemption is driven by the thinking that passively managed investments are always better for participants.

But that’s not always true, thinks Collie.

“Although passive investment is generally cheap — and it’s often an appropriate route — it’s not always a good way to go,” wrote Collie (emphases his).

He points to the example of broad market fixed income funds, which can include thousands of securities, many of them illiquid.

Those that are passively managed often don’t include independent credit analysis of the underlying investments, which drives their cost down, said Collie.

That also explains, in part, why sponsors of defined benefit plans don’t favor passively managed fixed income funds.

“Few corporate DB plans — even those who lean heavily on passive strategies in their equity portfolios — invest passively in fixed income,” explained Collie.

“That’s why the idea of a low-fee exemption seems to us to be out of place in a regulation intended to make sure that each product is given fair and equal consideration, and to remove incentives from advisors that might bias their recommendations,” he said.

“The suitability of passive products needs to be judged using the same standards as for other products,” added Collie.

Instant Insights /

Analyst says DOL creates new conflict in its conflict of interest rule

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