Advice for Investment Advisers

Transcription

1 Advice for Investment Advisers Risk Management Considerations for the Department of Labor s Final Fiduciary Rule September 2016 Lockton Companies Announcements about new rules from the Department of Labor (DOL) don t normally receive attention from HBO comedy shows or become subject to congressional votes or presidential vetoes all in the span of only six weeks. But the final fiduciary DON GLAZIER Vice President Claims Counsel donald.glazier@lockton.com rule change has the potential for significant impact on certain segments of the investment advice community. The tumult began on April 8, 2016, when the DOL issued its final rule regarding who is now considered a fiduciary under Employee Retirement Income Security Act (ERISA). Last updated in 1975, the rule needed to reflect that investors increasingly need to make independent investment decisions. There is also a great focus on fees charged by investment professionals. The Department s goal in making the rule change was to better protect retirement plans, plan participants, beneficiaries, and now individual retirement account owners from undisclosed conflicts of interest or imprudence or disloyalty in the management of retirement assets. These changing risks warrant a review of investment advisers operations as well as risk management methods, including insurance protections. L O C K T O N C O M P A N I E S

2 The final rule issued in April clarifies the timeline for compliance. Within the first 12-month phase, those providing advice to retirement investors will need to adhere to a higher standard in connection with their advice as well as acknowledge their fiduciary status. Organizations are given more time in phase two, until January 1, 2018, to implement the disclosure, documentation, and other policy and procedure changes to support the exemption requirements and new advice standards. PHASE ONE PHASE TWO JANUARY 1, 2018 Full compliance needed. The announcement has prompted discussion and activity on the ramifications of the rule change both in favor and against. Favoring the rule change, comedian John Oliver recently devoted 20 minutes of his HBO show, Last Week Tonight, to a topic not commonly the subject of comedy. Oliver focused on what he called hidden charges in 401(k) plans that reduce retirement savings and on the need to impose fiduciary responsibilities on financial advisers who, he argued, do not always put their clients interests first. Taking an alternate view of the rule change, some members of the Republican-controlled House described it as Obamacare for financial planning and passed a resolution to block its implementation. Not surprisingly, when the resolution reached President Obama s desk for signature, he vetoed it. Some insurance groups that sell annuities as retirement investments have filed suit against the DOL to try to block the implementation of the rule change. Similar litigation has been initiated by financial and business trade groups that claim that the rule will increase costs for annuities and worsen retirement investors options. 2

3 September 2016 Lockton Companies The new rule is getting attention because it changes the standard that many investment professionals will now need to maintain in connection with the services they provide to their investor clients. Depending upon the services provided, many advisers are held to a suitability standard while others are held to a higher fiduciary standard. Suitability Standard Advisers held to the suitability standard must offer investment recommendations that are only suitable for the client. This standard applies to advisers who are typically compensated on a commission basis. Advisers can meet this standard even if their fees or commissions associated with the investment options are higher when compared to others. In addition, the suitability standard does not require the level of conflict disclosures that are obligatory with a fiduciary duty. Fiduciary Standard Other advisers, including Registered Investment Advisers (RIAs), must comply with the higher fiduciary standard, advisers to act in their clients best interest and disclose any potential conflicts of interest as well as compensation received for services. The new DOL rule greatly expands the number of investment professionals who will be held to the higher fiduciary rule, changing what had been the standard for more than 40 years FIDUCIARY RULE Under the long-standing five part test, created by the 1975 regulations, advisers are deemed fiduciaries if they render advice: 1. As to recommended investments through purchasing or selling securities or other property. 2. On a regular basis. 3. Subject to contract or other agreement with the client. 4. That is understood to serve as a primary basis for investment decisions. 5. Which has been customized to meet the client s needs. Any advisers who did not meet the five-part test needed their recommendations to only satisfy the lower suitability test, whose standard did not require the same level of compensation disclosure. 3

4 NEW DOL FIDUCIARY RULE Under the new broader rule, advisers, whether brokers, RIAs, insurance agents, or anyone else compensated by a fee, who render investment advice, will be held to ERISA s fiduciary standard if they provide the following to investors, including individuals: 1. Recommendations regarding procuring and the disposition of securities or other investment property, or investment advice relating to securities or other property following an IRA or plan distribution. 2. Recommendations for handling investments, including those in connection with investment strategies, portfolio elements, hiring advisers or managers, and decisions related to rollover distributions. What Activities Constitute Investment Advice? The new rule extends fiduciary obligations well beyond the existing 1975 rules and certainly leaves many questions unanswered regarding whether specific activities constitute investment advice or a recommendation. These questions will most likely be answered through litigation as investors assert that advisers breached their fiduciary duty in certain activities. To provide some clarity with the introduction of the new rule, the DOL states that some communications are not considered investment advice, including: General communications, such as newsletters, marketing materials, and certain educational materials about retirement savings and general investments. Offering investment alternatives as a fund platform provider. BIC EXEMPTION Recognizing that the new rule could have an adverse impact on many smaller investors, the DOL included the Best Interest Contract (BIC) Exemption to the broad rule change. The BIC Exemption allows many current forms of compensation and fee practices to continue, even though they would otherwise constitute prohibited transactions. To qualify, the adviser must obtain written acknowledgment of their fiduciary role, comply with standards of impartial conduct, disclose details regarding their compensation, and maintain a website making this information readily available. 4

5 September 2016 Lockton Companies RISK MITIGATION STEPS AND E&O INSURANCE COVERAGE Assuming that the DOL s rule change survives the current legal and any future legislative efforts to derail its implementation, claims from investors or the DOL asserting a breach of fiduciary duty are undoubtedly going to increase. In light of that increase in exposure, advisers can take steps to mitigate these exposures, including: 1. Review contracts and arrangements to assess whether the advice constitutes a recommendation, or acknowledges fiduciary status and liability for the investments offered, and properly discloses fees. 2. Determine whether asset allocation tools or interactive investment materials use specific investment alternatives and, if so, ensure that they are unbiased. 3. Review general communications and investment education programs to confirm that they do not inadvertently provide investment advice. 4. If offering insurance and financial services to small plans, plan participants, and IRA owners, seek protection with the BIC Exemption. 5. Obtain and review any insurance coverages in place to ensure that they will respond to these new exposures. 5

6 ERRORS AND OMISSIONS (E&O) COVERAGE E&O coverage is the policy that warrants the closest examination. Fiduciary liability insurance seems relevant to this discussion, but typically the coverage is limited to liability stemming from an ERISA fiduciary s activities on behalf of its own company plan, not for others. The elements of E&O coverage that should be reviewed include: Adequacy of limits. It is important to regularly consider limits adequacy in light of internal changes, such as number of employees, revenues, and other metrics. External changes in exposure, such as the DOL rule change, also warrant considering an increase in E&O limits purchased. Policy terms regarding coverage for indemnity claims. Claims by potential codefendants for indemnification rights should be clearly addressed in the policy terms. The policy s definition of professional services to ensure that it meets the broader interpretations of both adviser and advice. The definition should be broad enough to respond with coverage for an insured that, for example, is held to the fiduciary standard in offering lists of investment options with commentary on those investments. The E&O policy may contain exclusionary language that was not previously concerning, but with the new broader fiduciary exposure facing the adviser, the provision may need closer scrutiny. Pricing for E&O coverage is driven by the insurer s actual or expected loss experience. Carriers are anticipating an increase in the exposure to investment advisers with the implementation of the DOL fiduciary rule. Premium costs could increase to address this increased exposure. The DOL rule change is going to take some time to implement fully. However, now is the time to consider the impact that it may have on the risk management and insurance you currently have in place. Lockton strives to be ahead of the curve on new risk developments and welcomes the opportunity to assist you in mapping strategies for dealing with this latest one. 6

7 September 2016 Lockton Companies NOTES 7

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