As the Office of Management and Budget considers a proposed 18-month delay of the fiduciary rule by the Labor Department, some inindustry are holding out hope that the rule will be rescinded, ifnot gutted to the point of effective extinction.

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Neither is likely, says Aron Szapiro, director of policyresearch at Morningstar.

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“I’ve been saying that since last year’s election,” Szapiro toldBenefitsPRO. “And I’m more confident in that belief now thanever.”

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From the specificity of questions raised in Labor’s request forinformation in support of its review of the rule, to the tone takenby Sec. Alexander Acosta in his Wall Street Journal op-edannouncing that the rule’s impartial conduct standards would not befurther delayed, Szapiro says the tea leaves are clear: Anyoneexpecting the rule to die a slow death is making the wrong bet.

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“At this point industry is not having an argument about the needfor a fiduciary standard,” he said. “We’re having an argument aboutenforcement.”

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In the comment letter Szapiro recently penned on behalf ofMorningstar, he and the firm offered substantive support for therule alongside hard details on how to improve it.

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Questions in the RFI indicate that Labor isconsidering new, streamlined exemptions to soften the Best InterestContract Exemption—specifically the prohibited transactionexemption’s warranties and private right of action, which theObama-era Labor Department designed as the rule’s enforcementlevers.

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Morningstar and others have said the threat oflawsuits under the BIC have been a motivating force behindindustry’s efforts to comply with the rule.

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Those advocating changes to the rule are targeting the privateright of action. Many stakeholders have argued the provision wouldleave even those firms committed to giving best interest advicesubject to the ambitions of the trial bar.

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Consumer advocates say stripping the privateright of action would leave a fickle rule in place. Without thethreat of class-action lawsuits, some firms would be tempted tosidestep the best interest standard.

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Morningstar thinks it has a way to appease both industry andconsumer advocates.

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The solution: Replace Big Law’s role as enforcer with BigData.

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“If Labor designs a new exemption to give relief from potentiallawsuits, you still would need an enforcement mechanism,” saidSzapiro, who added that he is suspicious of both those that see therule as a panacea, and those that say it will price smallerinvestors out of the advice market.

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Morningstar envisions what it calls an “auditable big-datasystem,” implemented by a neutral third-party, which would holdinformation on all of a firm’s client’s portfolios.

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Each portfolio would be scored on the quality and cost ofinvestments, the appropriateness of asset allocation relative to aspecific investor’s needs, and the value and extent of personalizedadvice given.

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By sourcing the scores from thousands of portfolios, technologycould green-light when a portfolio is constructed in the bestinterest of a client. Moreover, the database could be applied todetermine if a 401(k) rollover recommendation satisfies thefiduciary rule’s impartial conduct standards.

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Szapiro said it is not Morningstar’s intention to be theindependent third-party auditor, but that the firm could supplydata and the methodology for scoring portfolios.

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“The idea came out of what we were seeing in the marketplaceanyway,” said Szapiro. “Companies are interested in leveragingtechnology for monitoring their recommendations.”

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Morningstar thinks the data approach would provide a moreuniform application of a fiduciary standard for individual clientsthan enforcement by private right of action.

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Szapiro describes the alternative as a way to “pre-emptivelyprove” compliance.

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“Provided there was a standard of prudence and reasonableness, afinancial institution could at any time provide that its entirebook of business was either compliant or being brought intocompliance,” writes Szapiro in Morningstar’s comment letter.

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He is hoping regulators are aware of the emerging datacapabilities.

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“A lot of this technology is in place,” said Szapiro.Morningstar has already developed a best-interest score card, basedon the rule’s impartial conduct standards, to assist in theevaluation of rollovers.

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“This doesn’t present a tech problem, but a policy problem.Labor would have to come up with a workable way to incorporate thisinto an exemption that satisfies the major parties. But once youhave the regulation, it would only be a matter of months to standthis up.”

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Easier than clean shares

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Obtuse as the big-data solution may seem to the technologicallychallenged, Szapiro says it would be a less complicated fix to thefiduciary rule than clean shares.

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A handful of firms have filed new clean share mutual fundclasses with the Securities and Exchange Commission.

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Clean shares allow money managers to strip distribution fees,which have been traditionally used to compensate brokers andadvisors, from the expense ratio of a fund.

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With a clean share, brokers and advisors attach their ownadvisory charges on top of expense ratios. Potential conflicts infund selection are neutered because different clean shares wouldnot have variable advisor compensation embedded in the funds.

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But the Labor Department will have to clearly define whatconstitutes a clean share if it intends to write a new exemptionbased on their use, said Szapiro.

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Client memorandums from law firm K&L Gates have interpretedan SEC determination letter to mean clean shares can include SubTransfer Agent fees, which are embedded costs paid to funddistributors to record keep investments.

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Morningstar adamantly opposes the notion thatclean shares can include Sub TA fees and still be clean.

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“There is a real dispute going on over clean shares and sub TAfees,” said Szapiro.

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In stripping 12b-1 fees, clean shares address conflicts at theadvisor level. But sub TA fees create a conflict at thedistributing firm level, says Szapiro.

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Szapiro calls sub TA fees the elephant in the room. Labor isdefinitely getting input from some stakeholders saying the feesshould be allowed in clean shares, he says

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Morningstar’s bottom line: if Labor allows clean shares to carrysub TA fees, they would be leaving the door open to conflictedadvice.

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“Once you strip out loads and 12b-1 fees, the problem of sub TAfees is exacerbated,” added Szapiro. ““We would be taking a stepback if Labor allows clean shares to include sub TA fees.”

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Related: See more coverage and analysis of the DOLfiduciary rule

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