Department of Labor Publishes Final Fiduciary Rules:

On April 6, the U.S. Department of Labor (“DOL”) published final rules regarding the definition of “fiduciary” under section 3(21) of the Employee Retirement Income Security Act of 1974 (“ERISA”) and under the Internal Revenue Code’s prohibited transaction provisions. This new guidance, which replaces the DOL’s 2010 and 2015 proposals, addresses circumstances under which someone who provides investment advice to an employee benefit plan or IRA will be considered an ERISA fiduciary. The guidance focuses on preventing conflicts of interest that can arise when investment advisors provide advice that is not in retirement plan or IRA participants’ best interests (e.g., by steering them into an investment option mainly because that option pays the advisor more than another viable option). The final rules consist of more than 1,000 pages, as they take the form of a final regulation, two prohibited transaction exemptions, and amendments to several existing prohibited transaction exemptions.

Overall, the final rules treat people who provide investment advice for a fee or other compensation with respect to plan or IRA assets as fiduciaries “in a wider array of advice relationships” than under rules published in 1975 (which these new rules replace). The DOL explains that the final rules are necessary because, unlike in 1975, given that defined contribution plans have largely replaced defined benefit plans, many plan participants are now responsible for making their own investment decisions. However, many participants are “bewildered” because they lack sufficient investment expertise, and they must therefore rely on experts. That is true even though many participants are not able to assess the quality of an expert’s advice, how that individual is being compensated, or whether conflicts of interest exist. That situation can lead to advisors receiving “opaque fees over the life of the investment [that] will reduce [participants’] returns.” In this connection, the DOL states that a participant “could lose 6 to 12 and possibly as much as 23 percent of the value of her savings over 30 years of retirement by accepting advice from a conflicted financial adviser.”

I have provided a summary below of prominent rules under the two main pieces of new guidance: the final regulation and the Best Interest Contract Exemption. (Given that most of my clients and contacts focus on qualified plans rather than IRAs, my summary below focuses on the new guidance’s effect on qualified plans.) The other related new DOL guidance (i.e. another proposed prohibited transaction exemption, and amendments to several existing prohibited transaction exemptions) are beyond the scope of this article.

Final Regulation:  The final regulation describes the types of communications that constitute investment advice and then describes the types of relationships in which such communications invoke fiduciary investment advice responsibilities.

Communications:  The first kind of communication that constitutes investment advice is a recommendation about the advisability of acquiring, holding, disposing of, or exchanging securities or other investments, or a recommendation about how securities or other investments should be invested after they are rolled over, transferred, or distributed from a plan. The second kind of communication here is a recommendation regarding the management of securities or other investments (e.g., recommendations for investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services) or recommendations concerning rollovers, distributions, or transfers from a plan. Note that communications are only fiduciary in this regard if they are provided “for a fee or other compensation.”

Thus, only a communication that fits the regulation’s definition of a “recommendation” establishes the existence of fiduciary investment advice. For this purpose, the term “recommendation” generally means a communication that would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from engaging in a course of action. However, the regulation lists “non-exhaustive examples” of communications that are not “recommendations” and thus are not fiduciary communications:

  • Platform Providers:  Marketing or making available to a plan fiduciary, without regard to the plan’s or participants’ individualized needs, a platform from which a plan fiduciary can select or monitor investment alternatives. The plan fiduciary must be independent of the person who markets or makes the platform available, and such person must disclose in writing to the plan fiduciary that the person is not providing impartial investment advice.
  • Selection and Monitoring Assistance:  Identification of investment alternatives that meet objective criteria specified by the plan fiduciary, where the person identifying the investment alternatives discloses in writing whether the person has a financial interest in any of the identified investment alternatives. In certain cases, the person must identify a sample set of investment alternatives, the current investment alternatives designated under the plan, or both. That must be in writing, and it must disclose whether the person identifying the sample set has a financial interest in any of the alternatives. This also involves providing objective financial data and comparisons with independent benchmarks to the plan fiduciary.
  • General Communications:  Furnishing or making available to a plan fiduciary or participant communications that a reasonable person would not view as an investment recommendation (e.g., newsletters, presentations during a conference). It is acceptable if the communications include certain data, such as market performance, trading volumes, and performance reports.
  • Investment Education:  Furnishing or making available a wide array of investment-related information and materials. This includes certain plan information (e.g., description of plan terms, benefits, the impact of pre-retirement withdrawals on retirement income, and fee and expense information). This also includes general financial, investment, and retirement information such as information addressing general financial and investment concepts, as well as estimating future retirement income needs. Investment education for this purpose also encompasses asset allocation models where illustrations such as pie charts, graphs, or case studies are used to provide a plan fiduciary or participant with asset allocation portfolios for hypothetical individuals with different time horizons for retirement. Finally, investment education includes interactive investment materials, such as questionnaires, worksheets, and software that provide a plan fiduciary or participant with tools to estimate future retirement income needs and to assess the impact of different asset allocations on retirement income.

Relationships:  The final regulation imposes fiduciary status on: (1) investment recommendations by people who acknowledge that they are acting as a fiduciary; (2) advice rendered pursuant to a written or verbal agreement or understanding that the advice is based on the advice recipient’s specific investment needs; and (3) recommendations directed to a specific advice recipient or recipients as to the advisability of a particular investment in a plan. However, except for people who acknowledge that they are acting as a fiduciary, one will not be deemed to be a fiduciary solely because he or she engages in any of the following:

  • Providing advice to a plan fiduciary who is independent of the person providing the advice with respect to an arm’s length transaction related to the investment of securities or other investments. This exception only applies, however, if prior to entering into the transaction, the person providing the advice satisfies certain requirements.
  • Furnishing advice to a plan by someone who is a swap dealer, major swap participant, or a swap clearing firm in connection with a swap or security-based swap, if certain conditions are satisfied.
  • In his or her capacity as an employee of the plan sponsor or as an employee of a plan fiduciary, providing advice to a plan fiduciary, an employee (other than in his or her capacity as a participant or beneficiary of a plan), or an independent contractor of the plan sponsor. However, such person providing the advice cannot receive a fee or other compensation in connection with the advice, other than his or her normal compensation for work performed for the employer.

In addition, as expected, the final regulation specifically addresses brokers and dealers registered under the Securities Exchange Act of 1934. The general rule here is that they will not be deemed to be fiduciaries under ERISA or the Internal Revenue Code’s prohibited transaction provisions with respect to a plan solely because they execute transactions for the purchase or sale of securities on behalf of such plan in the ordinary course of business as a broker or dealer, pursuant to instructions of a plan fiduciary. However, several conditions must be satisfied for that rule to apply. For example, the plan fiduciary’s instructions must contain certain information (e.g., a price range within which a security is to be purchased or sold, and a time span during which such security may be purchased or sold).

The final regulation will be effective as of April 10, 2017. The DOL states that such deadline provides adequate time for plans and their affected financial services and other service providers to “adjust to the basic change from non-fiduciary to fiduciary status.”  Here is a link to the final regulation:

Best Interest Contract Exemption (“BICE”):  In broad terms, if numerous conditions are satisfied, the BICE provides relief for common types of conflicted compensation (e.g., commissions and revenue sharing) that an adviser and his or her employing firm might receive for providing investment advice to plans.

More specifically, the BICE allows “Advisers” and “Financial Institutions” to receive conflicted compensation as a result of their provision of investment advice (within the meaning of ERISA and the Internal Revenue Code’s prohibited transaction provisions) to a “Retirement Investor.” In general, those terms are defined as follows:

  • An Adviser is one who is a plan fiduciary solely because he or she provides investment advice with respect to plan assets. An Adviser is also one who is an employee, independent contractor, agent, or registered representative of a Financial Institution.
  • A Financial Institution is an entity that employs an Adviser (or retains such individual as an independent contractor, agent or registered representative) and that is: (1) registered as an investment adviser under the Investment Advisers Act of 1940 or under applicable state law; (2) a bank or similar financial institution; (3) an insurance company satisfying certain requirements set forth in this guidance; or (4) a broker or dealer registered under the Securities Exchange Act of 1934.
  • A Retirement Investor is: (1) a plan participant with authority to direct the investment of assets in his or her plan account; or (2) a Retail Fiduciary with respect to a plan. (The term “Retail Fiduciary” includes plan sponsor employees who are fiduciaries and Board members who are fiduciaries, as opposed to parties such as banks, insurance companies, investment advisors and broker-dealers.)

Advisers and Financial Institutions seeking to rely on the BICE must adhere to “Impartial Conduct Standards” when providing investment advice. (Financial Institutions must also adopt policies and procedures designed to ensure that their Advisers adhere to those conduct standards, disclose important information relating to fees, compensation, and conflicts of interest, and retain records demonstrating compliance with the BICE.) Under those conduct standards, the Financial Institution must state that it and its Advisers will adhere to the following, and they must actually adhere to the following:

  • When providing investment advice to a Retirement Investor, the Financial Institution and the Adviser must provide advice that is in the best interest of the Retirement Investor. This means the advice must reflect the care, skill, and prudence that a prudent person acting in a like capacity and familiar with such matters would use in this regard. Also, the advice must consider the Retirement Investor’s investment objectives, risk tolerance, and financial circumstances, without regard to the financial or other interests of the Financial Institution or Adviser.
  • No recommended transaction can cause the Financial Institution or Adviser to receive compensation that is unreasonable.
  • Statements by the Financial Institution and its Advisers to the Retirement Investor about the recommended transaction, fees and compensation, and conflicts of interest cannot be materially misleading.

In addition, to comply with the BICE, Financial Institutions must provide certain warranties and must comply with those warranties (e.g., the Financial Institution has adopted and will comply with written policies and procedures designed to ensure that its Advisers adhere to the Impartial Conduct Standards). When formulating such policies and procedures, Financial Institutions must identify and document their conflicts of interest, and they must adopt measures aimed at preventing such conflicts from causing violations of the Impartial Conduct Standards.

The BICE also requires Financial Institutions to provide detailed written disclosures to a plan prior to or simultaneously with the execution of recommended transactions.

There is no contract requirement for recommendations to Retirement Investors regarding investments in Plans covered by ERISA. But, the Impartial Conduct Standards and certain other requirements of the BICE (e.g., a written acknowledgment of fiduciary status, adoption of policies and procedures) must be satisfied for the BICE’s relief to be available in connection with ERISA plans.

In one controversial provision, the BICE protects a Financial Institution that limits Advisers’ investment recommendations (based on whether the investments are proprietary products or generate third party payments), as well as an Adviser making recommendations subject to such limitations. For that protection to apply, however, several conditions must be satisfied. Those conditions are as follows:

  • Prior to or simultaneously with the execution of a recommended transaction, the Retirement Investor must be clearly informed in writing that the Financial Institution offers proprietary products or receives third party payments with respect to the purchase, sale, or holding of recommended investments.
  • Prior to or simultaneously with the execution of a recommended transaction, the Retirement Investor must be fully and fairly informed in writing of any conflicts of interest that the Financial Institution or Adviser have with respect to the recommended transaction.
  • The Financial Institution must document several items in writing (e.g., its limitations on the universe of recommended investments).
  • The Financial Institution cannot rely on quotas, bonuses, or contests that would reasonably be expected to cause the Adviser to make imprudent investment recommendations or recommendations based on the Adviser’s considerations of factors other than the Retirement Investor’s investment objectives, risk tolerance, and financial circumstances.
  • The amount of compensation anticipated to be paid to the Adviser or Financial Institution for their services regarding the recommended transaction must be reasonable.
  • The Adviser’s recommendation must reflect the care, skill, and diligence that a prudent person would use in this regard, based on the Retirement Investor’s investment objectives, risk tolerance, and financial circumstances.

For the BICE to apply, a Financial Institution must also disclose certain information to the DOL, as well as satisfy certain recordkeeping requirements.

The BICE also applies to a plan or participant who engages in a purchase or sale with a Financial Institution that is a service provider or other party-in-interest or disqualified person to the plan. The DOL explains that this exemption is provided because investment transactions often involve otherwise prohibited purchases and sales involving entities that are a party-in-interest to a plan. The following conditions apply to this exemption:

  • The transaction must be effectuated by the Financial Institution in the ordinary course of its business.
  • The compensation for any services rendered by the Financial Institution must be reasonable.
  • The transaction’s terms must be at least as favorable to the plan or participant as terms generally available in an arm’s length transaction with an unrelated party.

The BICE generally applies to transactions that occur on or after April 10, 2017, although special transition relief delays several requirements until January 1, 2018. Here is a link to the BICE:

Conclusion:  These new rules do not alter ERISA’s fundamental fiduciary duties that apply to plan sponsors. For example, plan sponsors must still prudently select and monitor service providers and investments, and they must still negotiate and understand service providers’ contracts and the compensation paid under those contracts. However, plan sponsors should consider evaluating whether anyone currently providing investment “recommendations” to the plan sponsor and/or to participants are fiduciaries under the new rules. This will involve reviewing contracts and other communications from such individuals and firms.

Plan sponsors might also wish to consider discussing with any non-fiduciary investment advisors whether and when those advisors will transition their plan services to a fiduciary model. A discussion with current advisors as to whether they will aim to comply with the BICE might be appropriate as well.