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Make Principles, Not Rules

In embracing a principles-based, rather than rules-based standard for advisors to ERISA plans, the Department of Labor moved down a road less traveled. On the other road, our government promulgates increasingly-detailed rules and regulations, Congress promulgates laws that are filled with specific rule-based behaviors, the tax code is filled with tens of thousands of pages of minutia, and everybody-businesses and individuals alike-complain about the growing amount of paperwork and complexity in our lives.

Is it possible that there’s an alternative?

Imagine if the government regulators were to shift their focus from all these rule-detailed specifications to broad principles. Instead of the Environmental Protection Agency defining how much a business can emit of what into the atmosphere or dump into a river, it replaced thousands of pages of paperwork with a simple rule: You must not introduce into the planet’s global ecosystem any chemical, gas or other material that has known harmful effects to the biosphere, human or animal life.

Based on that principle, greenhouse gases that produce global warming would have to be scrubbed or otherwise recycled, rather than released into the air. Cars would have to be manufactured with converters, as they are now, but with far less oversight. It would be immediately clear that dumping toxic waste into the nearest river is patently illegal.

When government contracts are issued, the principle replacing thousands of pages of rules might say something like: The issuer must ask for good faith bids from the community of potential service providers, and choose the one that could reasonably be said to make the most sense from a cost and benefits standpoint. No hoops to jump through, no required language for the proposal process. You just have to play fair.

Yes, I realize that it can’t be quite as simple as that, and if we’re holding up an example, perhaps a 1,200 page document, with 204 primary pages, more than 350 pages on one aspect of the rule and hundreds of pages of addenda might not be a perfect poster child. But the concept is: instead of laying out every single possibility that people on the government payroll with way too much spare time can think of, let’s consider streamlining our rules and regulations by articulating what we want to happen. We want less pollution, advisors to act in the best interests of their clients and customers, fair up-front disclosure of prices and costs before any good or service is sold, fairness and honesty in contract negotiation and hiring practices-and maybe (am I getting too far out here?) a fiduciary society where we are all responsible for behaving fairly toward others.

If we shifted from rules to principles, then enforcement would require common sense rather than a close reading of minutia.

Did the car dealer who failed to disclose the engine problems in the used car adhere to basic principles of fairness? (Under a rules-based system, maybe he got the customer to sign a contract whose fine print absolved him of having to make those disclosures. Under a principles-based system, he clearly defrauded the customer.)

Did the broker who almost exclusively recommended high-commission non-traded REITs to his customer really have the customer’s best interests in mind? (Under a suitability standard, he gets a pass. Under the fiduciary standard, his activities are clearly predatory.)

Did the company whose smokestacks belched out smelly toxins utilize available technology to scrub those toxins out of the emissions? (Under EPA rules, the toxins may not yet be on the updated list of prohibited pollutants. Under the principles-based standard, the firm is clearly in violation.)

Did the brokerage firm that sold derivative investments to customers and then bet against those investments treat its customers fairly? (In a suitability world, apparently this behavior gets a pass. In a world governed by principles, it’s a terrible transactional atrocity.)

If this vision of our governing future is even possible, then the recent DOL Rule is a very small step. It is primarily principles-based, but with many, many too many pages of explanations that look like rules. A happy vision that I hope others like me could find ourselves sharing is that this rule will become for our nation-like our profession-a kind of milestone, a start of something better, leading to a future where the messy, growing paperwork of life is pushed aside in favor of simple principles that can be articulated in a few sentences, replacing millions of pages of rules.