In its proposed rule requiring that all advisors to retirement plans act as “fiduciaries,” the U.S. Department of Labor includes a “best interest contract exemption.” In my view, this exemption is as significant — if not more so — than the proposed rule itself.

Background of the fiduciary rule. Few retirement plan participants are aware their trusted advisors may not be “fiduciaries.” The securities industry has done a brilliant job of obfuscating the difference between the fiduciary standard, which carries a legal obligation to act in the best interest of the client, and the much lower “suitability” standard, which brokers and insurance agents owe to plan participants.

Plan sponsors historically have not understood this difference, either. And brokers tend to trivialize this vital distinction by glossing over it. It’s only when a plan sponsor is sued by a plan participant (which is happening with increasing frequency) over the investment options in a retirement plan that the harsh reality of this difference sets in.

While true fiduciaries — which include all registered investment advisors — accept the liability for the selection and monitoring of investment options in a retirement plan, brokers and insurance companies beat a hasty retreat if legal proceedings are initiated. In their business model, because the plan sponsor technically makes the final decision about the lineup of investment options, the sponsor retains liability for that decision, even though it relied heavily on the advice of the broker or insurance company.

It’s worse for plan participants. An advisor governed by the “suitability” standard can (and often does) populate the investment options in a retirement plan with expensive, actively managed funds, even though lower-cost index funds, with higher expected returns, are readily available.

The broker is financially incentivized to place its interests first because it receives what are euphemistically known as “revenue sharing” and other payments from mutual funds that want to be included as investment options in a plan. Fiduciaries can’t accept these payments because they represent a conflict of interest with plan participants.

While the securities industry often attempts to justify these payments with convoluted rationalizations about reducing costs, the reality is that nonfiduciary advisors routinely place their own interests above those of the plan participants they are supposed to serve.

Compelling reasons for requiring advisors to be fiduciaries. I can think of no sound reason why any plan participant would want to rely on the advice of an advisor that does not have a legal obligation to place that participant’s interest above its own.

This is especially true because the nature of 401(k) plans often makes participants very vulnerable. They shoulder the responsibility for choosing among an often dizzying array of investment options. In their time of need, they turn to the plan advisors for guidance. Unfortunately, relying on a nonfiduciary advisor is akin to asking the fox to guard the hen house.

According to the White House Council of Economic Advisers, participants who received conflicted advice from nonfiduciary advisors lost about $17 billion per year compared with the returns they would have earned from nonconflicted advice.

The proposed DOL rule imposing a fiduciary obligation on all advisors to retirement plans is long overdue. While you can expect the securities industry to fight any such rule to the bitter end, as it did successfully in 2010, hopefully fairness, logic and decency will prevail this time.

The hidden provision. While most of the focus and attendant publicity has been on the aspect of the rule requiring all advisors to place the interest of plan participants above their own, there is a provision in the DOL’s accompanying “best interest contract exemption” that has profound implications.

Buried at page 21978 (of the pdf version) is the following language:

“If it could be constructed appropriately, a streamlined exemption for high-quality low-fee investments could be subject to relatively few conditions, because the investments present minimal risk of abuse to plans, participants and beneficiaries, and IRA owners. The aim would be to design conditions with sufficient objectivity that Advisers and Financial Institutions could proceed with certainty in their business operations when recommending the investments.”

What does this mean? The DOL believes advisors who recommend portfolios consisting of low-management-fee index funds, passively managed funds or exchange-traded funds presumptively could be deemed to be acting in a manner consistent with their fiduciary obligation, since these investment options “present minimal risk of abuse.”

The DOL justifies this position by noting it is “consistent with the prevailing (though by no means universal) view in the academic literature that posits that the optimal investment strategy is often to buy and hold a diversified portfolio of assets calibrated to track the overall performance of financial markets.”

Why this is important to you. If investing in a globally diversified portfolio of low-cost, index-based funds meets the fiduciary standard for advice given to retirement plan participants, perhaps it should be the basis of your individual investing as well. Remember: Even if the proposed rule passes, unless the Securities and Exchange Commission takes similar action, your broker will still be free to recommend investments that are not in your best interest.

For both your retirement plan funds and your personal investments, your interests should always come first. They would be best served by adhering to the investment philosophy set forth in the exemption proposed by the DOL.

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The Hidden Provision in the Department of Labor’s Proposed Fiduciary Rule originally appeared on usnews.com