The Department of Labor (DOL) on April 6, 2016, issued the highly anticipated final fiduciary rule. While the essence of the final rule remains the same as the rule proposed last year, it has been tweaked to address, or eliminate, some of the most controversial requirements. As expected, the final rule requires all financial advisers (including broker‑dealers, registered investment advisers and insurance agents) to put their clients’ best interests before their own profits. The final rule applies to retirement plans (ERISA and non‑ERISA plans) and individual retirement accounts (IRAs).
Today, investment advisers and their representatives are already deemed to be fiduciaries for purposes of federal and state securities laws, but broker-dealers and their representatives are subject to a different “suitability” standard, even though they are often providing similar investment recommendations. Under the suitability standard, broker-dealers are not required to put their clients’ interests above their own. So long as the investment is suitable for the client, based on the client’s financial needs, objectives, and unique circumstances, it can be recommended to the client, even if the particular investment choice pays the broker‑dealer or insurance agent a higher fee, commission or other compensation than a comparable investment product.
The DOL issued its first proposal in 2010 and its second proposal in April 2015. Both the financial industry and many members of Congress (from both parties) strongly opposed both proposals. Concerns primarily centered on the potential loss of investment advisery services to smaller retirement plans and, in particular, to IRA account holders.
The final rule and related prohibited transaction exemptions reflect the extensive feedback received since April 2015 from industry advocates, Congress, federal and state regulators, and others. The DOL took this input into account when refining the new rule’s requirements. Revisions to the proposed rule should reduce the anticipated compliance burden for many advisers, while still protecting retirement savers. Nonetheless, the rule will apply to all advisers.
Highlights of New Rule
For purposes of ERISA and its now expanded scope, a fiduciary is broadly defined to include persons who give investment advice for a fee, regardless of whether that fee is paid directly by the customer or indirectly by a third party (for example, a mutual fund or other investment or insurance product company that compensates the adviser for recommending its investment products). The new rule applies the same ERISA fiduciary standard to investment advisers, broker‑dealers, and insurance agents.
Covered Investment Advice
The rule describes what is and what is not “covered investment advice.”
Covered investment advice includes:
- Recommendation: A “recommendation” to a plan, plan fiduciary, plan participant and beneficiary, and IRA owner to engage in, or refrain from taking, a certain action with respect to securities or other investment or insurance products. The more individually tailored the communication, the more likely the communication will be viewed as a recommendation.
- Rollovers: Covered investment advice now also includes recommending rollovers, transfers or distributions from a plan or IRA, including whether, in what amount, in what form and to what destination such a rollover, transfer or distribution should be made. (The final rule overturns the DOL guidance issued in 2005 that stated it was not fiduciary advice to recommend taking a rollover, even if accompanied by an investment recommendation.)
Covered investment advice does not include:
- Education: General information and material about the terms or operation of the retirement plan or IRA, the available distribution options, fee and expense information, risk and return characteristics and historical return information are not recommendations. The education exclusion also allows specific investment alternatives to be included as examples in presenting hypothetical asset allocation models or in interactive investment materials so long as these are designated investment alternatives selected and monitored by an independent plan fiduciary. In the IRA context, however, asset allocation models and interactive tools (sometimes referred to as “robo advisers”) referencing specific investment alternatives would not be “education” because there is no independent fiduciary for IRA accounts.
- General Communications: Newsletters, commentary in publicly broadcast talk shows, remarks and presentations in speeches and conferences, research prepared for general distribution, general marketing materials, and general market data are not recommendations. Specific investment or insurance products cannot be identified.
- Platform Providers: Marketing or making available a platform of investment alternatives, without taking into account the individualized needs of a plan or participants, are not recommendations, if the provider represents in writing to the plan fiduciary that it is not undertaking to provide impartial advice or to give advice in a fiduciary capacity.
- Selection and Monitoring Assistance: Identifying investment alternatives that meet objective criteria specified by the plan fiduciary, identifying investment alternatives in a response to a request for proposal, providing objective financial data and comparisons with independent benchmarks to the plan fiduciary, are not recommendations. (This provision only applies to retirement plans, not IRAs.)
- Plan Fiduciaries with Financial Expertise: If the adviser knows or reasonably believes the independent plan fiduciary is a licensed and regulated provider of financial services (banks, insurance companies, registered investment advisers, broker-dealers) no ERISA fiduciary obligations are imposed on the adviser. In addition, the ERISA fiduciary rule does not apply to communications with an independent fiduciary who has responsibility for the management of $50 million in plan assets (called the “large plan” exception).
- Employees of Plan Sponsor: Employees working in a company’s payroll, accounting, human resources, and financial departments who routinely develop reports and recommendations for the company and plan fiduciaries are not investment advice fiduciaries if the employees receive no fee or compensation for such activities beyond their normal compensation. In addition, this exclusion also covers communications between employees such as the human resources department staff, who communicates information about the plan to other employees, provided they are not registered or licensed advisers and receive only their normal compensation that is unrelated to investment recommendations or selections.
Prohibited Transaction Exemptions
Under ERISA and the Internal Revenue Code, advisers to plans and IRAs are not permitted to receive payments creating conflicts of interest (i.e., receiving compensation that varies based on the investment advice), without a prohibited transaction exemption (PTE). The final rule creates two new PTEs and modifies several existing PTEs. The new proposed Best Interest Contract (BIC) PTE is summarized below. This is not an exemption from the new fiduciary duty obligations, just an exemption allowing receipt of fully disclosed conflicted compensation under specified conditions.
Best Interest Contract PTE: The BIC PTE applies to investment fiduciaries providing advice to plan participants and beneficiaries, IRAs and non-institutional (retail) plan fiduciaries. The BIC PTE would allow investment fiduciaries to continue their current fee practices (including receipt of commissions, 12b‑1 fees and revenue sharing), provided they adhere to certain basic standards set forth in the BIC PTE. The new BIC PTE requires advisers to enter into a client contract with content mandated by the new rule. Transition rules simplify the BIC PTE’s implementation.
The BIC PTE permits firms to continue to rely on many current compensation and fee practices, such as commission-based compensation, provided specific conditions intended to mitigate conflicts of interest are satisfied and their investment advice is in the best interests of their customers. Failure to adhere to the BIC PTE’s standards will give rise to a breach of contract claim (for IRAs and other non-ERISA plans) or statutory claims under ERISA (for ERISA plans, participants and beneficiaries).
To qualify for the BIC PTE under the final rule, advisers must:
- Adhere to specific conduct standards in rendering advice regarding retirement investments;
- Adopt policies and procedures designed to ensure that individual advisers adhere to the impartial conduct standards;
- Disclose certain information relating to fees, compensation and material conflicts of interest; and
- Retain records demonstrating compliance with the exemption. Fiduciaries that will receive only a level fee (flat dollar or basis point fee) in connection with advisery or investment management service must comply with more streamlined conditions designed to target the conflicts of interest associated with such services.
Before receiving any compensation in reliance on the BIC PTE, the adviser also must notify the DOL of the intention to rely on the BIC PTE. The notice would remain in effect until revoked in writing. The notice would not need to identify any plan or IRA. (This disclosure requirement will not apply to level-fee advisers, however.) This notice will enable the DOL to monitor the types of advisers relying upon the BIC PTE and will facilitate the DOL’s audit and compliance assistance programs.
Other Exemptions: In addition to the BIC PTE, the DOL issued a Principal Transactions Exemption which permits investment fiduciaries to sell or purchase certain recommended debt securities and other investments out of their own inventories to or from plans and IRAs. The DOL also amended other existing exemptions, including PTE 75‑1 (added a new Part V permitting the extension of credit to a plan or IRA by a broker-dealer in connection with the purchase or sale of securities); PTE 86‑128 (amended to permit certain fiduciaries to receive a fee directly from a plan for effecting or executing agency securities transactions and agency cross-transactions); PTEs 75‑1 (Parts III and IV), 77‑4, 80‑83 and 83‑1 (amended to incorporate the impartial conduct standards that require fiduciaries to act in the best interest of plans and IRAs, charge no more than reasonable compensation and make no misleading statements to the plan or IRA); and PTE 24‑24 (amended and partially revoked to cover only fixed rate annuity contracts).
To give firms time to come into full compliance, the DOL adopted a phased implementation approach. On April 10, 2017, the broader definition of fiduciary will take effect, but to take advantage of the BIC PTE, firms will only be required to comply with more limited conditions, including acknowledging their fiduciary status, adhering to the best interest standard and making basic disclosures of conflicts of interest. Full compliance with the exemption will be required on January 1, 2018.
Investment Advisers, Broker‑Dealers and Insurance Agents
- Begin evaluating in earnest how the new rule will impact current services and operations. Litigation challenging the DOL’s new rule may or may not occur and, even if filed, may or may not delay the rule’s effective dates. The new rule’s impact will be substantial on most advisery firms and implementation will take significant time and resources.
- Review and revise, as applicable, client services contracts and compliance policies and procedures.
- Review and update, as necessary, all retirement plan educational materials to ensure that the information provided fits within the scope of the new rule. In particular, plan sponsors want to be sure any information provided does not cross over into investment advice.
- Review the services being provided by current service providers. Plan sponsors need to determine whether current services currently identified as non-fiduciary could be defined as fiduciary services under the new rule. In particular, plan sponsors will want to make sure that providers offering or counseling vested terminated participants on IRA rollovers change their processes to comply with the new rule, including acknowledging their fiduciary status in writing.
- Review and update service provider contracts, as necessary, particularly with respect to rollover counseling.
Link to Final Rule and Exemptions
The full text of the final rule and the exemptions is available on the DOL website at: http://www.dol.gov/ebsa/regs/conflictsofinterest.html .
If you have any questions about the new DOL fiduciary rule and the corresponding BIC PTE and other exemptions, please contact Lisa Zimmer at firstname.lastname@example.org  or 248.784.5191, or any member of the Funds and Investment Services or Employee Benefits/Executive Compensation Practice Groups.
Lisa Zimmer is a Partner at the law firm Warner Norcross & Judd , with more than 26 years of experience in employee benefits. She counsels employers in the design, documentation, implementation and compliance of their 401(k) plans, pension plans, and nonqualified deferred compensation arrangements. She has successfully represented clients with matters before the Internal Revenue Service, Department of Labor, and Pension Benefit Guaranty Corporation. See Lisa’s profile here: http://www.wnj.com/lisa_zimmer .