DOL Issues Final Fiduciary Rule on Investment Advice By Puneet Arora, Lynn Cook, Rich Gisonny, Ben Lupin and Rob Yellen*

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1 Legislative and Regulatory Update This information was prepared by RIC Technical Services. April 15, DOL Issues Final Fiduciary Rule on Investment Advice By Puneet Arora, Lynn Cook, Rich Gisonny, Ben Lupin and Rob Yellen* Summary The Department of Labor (DOL) has issued a package of final guidance, significantly changing the fiduciary definition of investment advice under section 3(21)(A)(ii) of the Employee Retirement Income Security Act (ERISA) and section 4975(e)(3)(B) of the Internal Revenue Code (Code). The issuance of these final regulations and a set of prohibited transaction exemptions (which will be addressed in a separate memo) culminates a lengthy process, with the DOL having first issued proposed regulations in 2010 that were withdrawn in 2011 due to pressure from industry groups. A re-proposed package of guidance was issued in April of While the final regulations and exemptions carry some notable changes from the re-proposed regulations, the concerns expressed by large plan sponsors, specifically with respect to the provision of investment education to participants, have been addressed in a favorable manner. Under the new rules, more advisors who provide recommendations or advice related to investments that are directed to a plan, participant or beneficiary or IRA holder would be treated as investment advice fiduciaries subject to ERISA. This includes recommendations on investment management, as well as recommendations to take a distribution from a plan, whether or not rolled over to an IRA. Under the new definition, many recommendations will give rise to a prohibited transaction, potentially subjecting them to the 15% excise tax on prohibited transactions in employee benefit plans, individual retirement accounts (IRAs) and annuities, and health savings accounts (HSAs). To limit this affect and to attempt to limit the disruption this will cause to the retirement industry, the DOL finalized relief available through a new proposed class exemption, referred to as the Best Interest Contract Exemption (BIC exemption or BICE). Covered Plans and Advice Recipients The new rules affect qualified retirement plans ( plans ), all types of IRAs (including, within the term IRA, HSAs, Archer Medical Savings Accounts (MSAs) and Coverdell Education Savings Accounts (ESAs), as well as the participant, beneficiaries and owners of such plans and accounts. They also affect group trusts, bank collective trust funds, insurance company separate accounts and certain other entities whose underlying assets are ERISA plan assets. The rules do not apply to governmental plans, nonelecting church plans or welfare benefit plans that do not contain an investment component. Key Action Items 1. Consultants should familiarize themselves with the final rule as it has been touted by some as the most substantial change in the retirement plan industry since the passage of ERISA. 1

2 2. Review the to-do list at the end of this memo and discuss with clients, if appropriate. Timing The final regulations are effective 60 days after publication in the Federal Register. However, in order to provide adequate transition time, the rule does not become applicable until April 10, Additionally, the new Best Interest Contract Exemption and prohibited transaction exemption for principal transactions include a transition period under which many of the conditions that must be met will not fully apply until January 1, General Discussion and Observations Background ERISA Sec. 3(21)(A)(ii) and Code Sec. 4975(e)(3)(B) provide that a person is a fiduciary with respect to a plan to the extent he renders investment advice for a fee or other compensation, direct or indirect, with respect to plan assets or has any authority or responsibility to do so. [1] Prior to the issuance of these final regulations, the DOL regulation (issued in 1975) defined providing investment advice as: (1) Making recommendations for investing in, purchasing or selling securities or other property, or giving advice as to their value (2) on a regular basis (3) pursuant to a mutual agreement, arrangement or understanding, written or otherwise, between such person and a plan or plan fiduciary (4) that the advice will serve as a primary basis for investment decisions with respect to plan assets, and (5) will be individualized based on the particular needs of the plan regarding such matters as, among other things, investment policy or strategy, overall portfolio composition or diversification of plan assets. In initiating this guidance project and drafting these regulations, the DOL has expressed that that the fivepart test in the 1975 regulation was created in a different context, prior to the existence of participant directed 401(k) plans, widespread investments in IRAs, and the now commonplace rollover of plan assets from fiduciary-protected plans to IRAs. To that end, the final regulations essentially eliminate the requirements that advice be given on a regular basis, pursuant to a mutual understanding that the advice serve as a primary basis for investment decisions. What is investment advice under the final regulation? Under 3(21)(A)(ii) of ERISA, a person providing investment advice with respect to plan assets, for direct or indirect compensation (which would include any fee linked to a transaction from any source, such as brokerage fees, mutual fund fees and insurance sales commissions), is a fiduciary. Thus, as a threshold matter, to be a fiduciary subject to ERISA s heightened standards, the person must provide investment advice. Under these final regulations, a person will be treated as providing investment advice if, with respect to moneys or other property of a plan or IRA, the person provides a recommendation of a type described below directly to a plan, plan fiduciary, plan participant, plan beneficiary, IRA, or IRA owner, in exchange for direct or indirect compensation. The recommendation must be of a type described in one of these two categories: (i) A recommendation as to the advisability of acquiring, holding, disposing or exchanging securities or other investment property, or a recommendation as to the investment of securities or other investment property after they are rolled over or otherwise distributed [1] ERISA Sec. 3(21)(A) and Code Sec. 4975(e)(3) provide: a person is a fiduciary with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan. Such term includes any person designated under section 405(c)(1)(B). (Section 405(c)(1)(B) refers to persons to whom named fiduciaries have delegated fiduciary responsibilities (other than trustee responsibilities) in accordance with a plan s written procedures.) The final regulation only provides guidance with respect to (ii), i.e., persons who render investment advice for a fee, and, although not mentioned in subparagraph (ii), persons who acknowledge fiduciary status under Sec. 3(21)(A)(ii). 2

3 (ii) from the plan or IRA; or A recommendation as to the management of securities or other investment property, including recommendations on investment policies or strategies, portfolio composition, selection of persons to provide investment advice or management, selection of investment account arrangements (e.g. brokerage versus advisory) or recommendations with regard to whether, in what amount, form and to what destination a rollover or other distributions from a plan or IRA should be made. The term recommendation is defined as a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action. The text of the regulation expounds on the general definition and explains that the determination of whether a recommendation has been made is an objective rather than subjective inquiry and that the more individually tailored a communication is to the specific advice recipient, the more likely it is to be viewed as a recommendation. For example, providing a selective list of securities to an advice recipient as appropriate for that investor would be recommendation even if not with respect to any one security. In addition, a series of actions, directly or together with an affiliate that may not constitute a recommendation individually, may amount to a recommendation when considered in the aggregate. Finally, for purposes of the rule, it makes no difference whether the communication was initiated by a person or computer software. What else must be present for advice to be fiduciary investment advice under the final regulations? To be fiduciary investment advice, the recommendation must be made either directly or indirectly (e.g., through or together with any affiliate, including one who is not an individual) by a person who: (i) (ii) (iii) Represents or acknowledges that it is acting as a fiduciary with respect to the advice; or Renders the advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is based on the particular investment needs of the recipient; or Directs the advice to a specific recipient regarding the advisability of making investment or management decisions with respect to securities or other investment property of the plan or IRA. Why does it matter if the person is providing investment advice is a fiduciary under ERISA or the Code? Someone acting as a fiduciary must discharge his or her duties solely in the interest of participants and beneficiaries, and with the care, skill, prudence and diligence that a prudent expert would exercise under similar circumstances. The fiduciary must not engage in prohibited transactions while acting as a fiduciary, unless an exemption applies. What activities, communications or materials are excluded from the definition of fiduciary investment advice under the final regulations? Acknowledging that the broader definition could result in fiduciary status in situations that should not be treated as fiduciary investment advice, the DOL identified a series of carve-outs in the proposed rules. The DOL received comments indicating that classifying the items as carve-outs implied that unless a communication fell within one of the carve-outs, it would necessarily constitute fiduciary investment advice, which was not always the case or aligned with the DOL s intent. Accordingly, in the final rule, the DOL eliminated the term carve out, reclassified the proposed carve-outs as services or materials that are not recommendations for purposes of the rule, and identified two categories of activities that will not give rise to coverage as fiduciary investment advice under ERISA. First, the DOL addresses a group of services, communications and materials that are not recommendations under the final regulation, provided certain conditions are met. This group of activities is comprised of marketing by platform providers, selection of platform providers and monitoring 3

4 assistance, general communications, plan information and investment education. Second, the DOL identifies certain activities that may involve investment advice under the definition in the final regulations, but will not cause a person to be a fiduciary with respect to such advice, unless the person has represented or acknowledged that they are acting as a fiduciary under ERISA or the Code. What activities, communications or materials are not recommendations? Under the final regulations, the following are not recommendations that would result in the provision of fiduciary investment advice. Note that these exclusions are not conditioned on the absence of a fiduciary representation or acknowledgement. (1) Platform providers A platform provider marketing or making available a platform or similar mechanism from which a plan fiduciary may select and monitor investment alternatives into which participants may direct the investment of assets in their accounts (including qualified default investment alternatives (QDIAs)) to a plan fiduciary who is independent of the platform provider is not a recommendation. Such marketing must not be directed toward the individualized needs of the plan, or its participants and beneficiaries and the platform provider must disclose in writing to the plan fiduciary that it is not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity. A platform provider is a person that provides access to securities or other property through a platform or similar mechanism. This exclusion is not available for marketing by platform providers to a plan participant, beneficiary or relative of either. (2) Selection and monitoring assistance Assistance provided by service providers to plan fiduciaries who select and monitor investment alternatives provided through platforms or similar mechanisms (as discussed above), provided such activities are restricted to identifying investment alternatives that meet objective criteria specified by the plan fiduciary (e.g., stated parameters concerning expense ratios, size of fund, type of asset, credit quality), are not recommendations under the final rule. Furthermore, a written response to a solicitation by a plan (e.g., request for information, request for proposal, etc.) identifying a limited or sample set of investment alternatives based on only the size of the employer or plan, the current investment alternatives designated under the plan, or both, do not constitute investment advice, subject to a disclosure requirement. The written response must disclose whether the person providing the selection and monitoring assistance has a financial interest in any of the alternatives, and if so the precise nature of such interest. Finally, providing objective financial data and comparisons with independent benchmarks to the plan fiduciary is not investment advice and does not require a disclosure of financial interest. (3) General Communications Furnishing or making available general communications to a plan, fiduciary, participant or beneficiary, or IRA that a reasonable person would not view as an investment recommendation, including general circulation newsletters, commentary in talk shows, presentations at conferences, research and news for general distribution, marketing materials, market data (general and on market performance), market indices, trading volumes, price quotes, performance reports or prospectuses do not constitute investment advice under the final rule. In the preamble, the DOL explained that simply placing a label on a communication identifying it as one that is on the list of general communications will not be determinative as to whether it is or is not investment advice. The requirement that a reasonable person would not view it as a recommendation must be met without regard to whether the label is present or not. However, the DOL indicates that they are not suggesting that all general communications always present a question about whether a reasonable person could fairly view the communication as an investment recommendation. For example, if an on-air personality makes suggestions to buy or sell stocks or engage in particular investment courses of action, those suggestions would not constitute recommendations within the meaning of the rule. (4) Investment education Furnishing or making available certain educational materials to a plan, fiduciary, participant or beneficiary, or IRA irrespective of who provides the information and materials (e.g., plan sponsor, fiduciary or service 4

5 provider), the frequency with which the information and/or materials are provided, the form in which such information or materials are provided (e.g., individual or group basis, written or oral, and via call center, video or computer software) or whether the specific category of information or materials are provided alone or in combination with another category of information or materials. In general, this covers general plan, financial, investment and retirement information, information regarding assets allocation models, and other common types of investment and distribution-related information which participants find useful. Except with respect to certain asset allocation models and interactive investment materials (discussed below), such educational materials may not include recommendations (alone or in combination with other materials) for specific investment products, plan or IRA alternatives or recommendations for the investment or management of a particular security or securities. Prior to the issuance of these final regulations, the types of activities and communications that constitute investment education were addressed in Interpretative Bulletin 96-1 (IB 96-1). Although the final regulation is based largely on IB 96-1, it is replaced by the final regulation. The final regulation classifies investment education in four categories: (1) plan information, (2) general financial, investment and retirement information, (3) asset allocation models, and (4) interactive investment materials. (i) Plan information Information and materials about varying forms of distributions, including rollovers, annuitization and other forms of lifetime income payment options (e.g., immediate annuity, deferred annuity, or incremental purchases of deferred annuity), advantages, disadvantages and risks of different forms of distributions that are not individualized are not recommendations under the final regulation. Furthermore, information about the benefits of participation or increasing contributions in a plan or the impact of preretirement withdrawals on retirement income, as well descriptions of product features, investor rights and obligations, fee and expense information, trading restrictions and investment objectives philosophies, return characteristics, historical return information or related prospectuses that are not individualized are not recommendations. However, information related to the appropriateness of any individual benefit distribution option for the plan or IRA, or a particular participant or beneficiary or IRA owner would constitute investment advice. (ii) General financial, investment and retirement information Information and materials on retirement-related risks (e.g., longevity risks, market/interest rates, inflation, health care and other expenses); and general methods and strategies for managing assets in retirement (e.g., systematic withdrawal payments, annuitization, guaranteed minimum withdrawal benefits), including those offered outside the plan or IRA. Information on the management or value of a particular security or securities or specific investment products, specific plan or IRA alternatives or distribution options available to the plan or IRA or to participants, beneficiaries and IRA owners, or specific alternatives or services offered outside the plan or IRA constitute investment advice. (iii) Asset Allocation Models Model asset allocation portfolios (e.g., pie charts, graphs or case studies) of hypothetical individuals with different time horizons which may extend beyond the individual s retirement date. The models must be based on generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time, disclose material facts and assumptions on which the models are based and should be accompanied with a statement that an individual should consider other assets, income and investments (if not taken into account) before applying any asset allocation to their own situation. The proposed regulation provided that models that include or identify any specific investment product or specific alternative available under the plan or IRA would constitute investment advice. However, in the final regulation, the DOL altered their stance, differentiating between asset allocation models associated with an employee benefit plan versus an IRA. Asset allocation models associated with an employee benefit plan may identify a specific investment alternative under the plan if it is a designated investment alternative under DOL regulations that is subject to oversight by a plan fiduciary independent of the entity that develops or markets the alternative, and the materials include a statement that the plan has other designated investment alternatives with similar risk and return characteristics (if any). The DOL did not extend the same to treatment for purposes of IRAs, because in such circumstance there is no plan fiduciary responsible for selecting and monitoring investments. 5

6 Note also, the preamble to the final regulations provide that while a responsible plan fiduciary has a duty under ERISA to monitor plan service providers, they have additional responsibilities if the plan uses specific designated investment alternatives in asset allocation models. The evaluation should include an evaluation of whether the models and materials are in fact unbiased and not designed to influence investment decisions towards particular investments that result in higher fees or compensation being paid to parties that provide investments or investment-related services to the plan. (iv) Interactive Investment Materials Interactive materials that allow a plan fiduciary, participant or beneficiary, or IRA owners to evaluate distribution options, products or vehicles described in the Plan Information or General Financial, Investment or Retirement Information sections above are not recommendations, provided the materials are based on generally accepted investment theories and there is an objective correlation between the income stream generated by the materials and the information and data supplied by the participant, beneficiary or IRA owner. The proposed regulation provided that interactive materials that include or identify any specific investment alternative available or distribution option available under the plan or IRA, unless such alternative or option is specified by the participant, beneficiary or IRA owner would constitute investment advice. In the final regulations, a designated investment alternative (as defined in DOL regulations) provided under a plan may be included or identified in interactive investment materials under the same conditions discussed in the asset allocation model section above. Does the rule help in terms of employers providing investment education to their employees? Since the principles of IB 96-1 are retained essentially intact, it s unlikely that this rule moves the dial with regard to an employer s provision of investment education. There are certain limited changes as discussed above, but for the most part they are just helpful clarifications. In the preamble, the DOL indicates that it received comments expressing concern that the proposed rules may result in employers refraining to provide education about their plans to their employees. However, since generally only investment advice for a fee or compensation falls within the fiduciary definition, and employers do not generally receive compensation in connection with their educational communications the DOL indicated that employers should have a high level of confidence that their educational activities would not constitute investment advice under the rule. Furthermore, in response to other comments that incidental economic advantages that may accrue to the employer by reason of sponsorship of an employee benefit plan (e.g. plan expenses that are paid out of an ERISA budget account funded with revenue sharing generated by investments under the plan), DOL confirmed that it does not believe those would constitute fees or compensation within the meaning of the rule. Additionally, DOL received comments that employers may no longer engage service providers to provide investment education to their plan participants and beneficiaries because of concern that the vendors may be investment advice fiduciaries under the rule, and the employers would have fiduciary obligations or co-fiduciary liability in connection with the activities of those vendors. The commentators advocated for a blanket carve-out for plan sponsors and service providers that operate call centers to assist participants and IRA owners, indicating that otherwise, educational assistance or similar participant outreach would be dramatically reduced or eliminated because, notwithstanding appropriate training and supervision, the plan sponsors and service providers could not be certain that individual communications would not carry potential fiduciary liability if individuals crossed the line to give fiduciary investment advice. The DOL did not agree with the commentators, noting that plan sponsors already have fiduciary obligations in connection with the selection and monitoring of plan service providers (both fiduciary and non-fiduciary service providers), including service providers that provide educational materials and assistance to plan participants and beneficiaries. What activities or communications are not fiduciary investment advice unless acknowledged as such? The final regulations also address a three categories of activities that, unless the person represents or acknowledges that he is acting as a fiduciary, will not be deemed to be fiduciary investment advice within the meaning of ERISA or the Code: (1) Seller s exception 6

7 Advice (statements or recommendations) made to plan fiduciary with financial expertise by a counterparty acting in an arms-length transaction are not fiduciary investment advice, if: (i) (ii) The independent fiduciary is (1) a bank under section 202 of the Investment Advisers Act, (2) an insurance carrier, (3) an investment adviser under the Investment Advisers Act, (4) a broker-dealer registered under the Securities Exchange Act of 1934, or (5) an independent fiduciary that holds or has under management or control total assets of at least $50 million. The person providing the advice must know or reasonably believe that the independent fiduciary is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. (iii) (iv) The person fairly informs the independent fiduciary that the person is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with the transaction and fairly informs the independent fiduciary of the existence and nature of the person s financial interests in the transaction. The person knows or reasonably believes that the independent fiduciary of the plan or IRA is a fiduciary under ERISA or the Code, or both, with respect to the transaction and is responsible for exercising independent judgment in evaluating the transaction. (v) All of the fees paid in connection with the transaction must be in exchange for services or products other than investment advice. In the preamble the DOL indicates that the $50 million threshold for a plan is not required to be attributable to only one plan, but rather allows all the plan and non-plan assets under management to be included in determining whether the threshold is met. Furthermore, the person providing the advice may rely on written representations from the plan or independent fiduciary that it has $50 million of assets under management, that he or she is capable of evaluating investment risks and that the person is a fiduciary under ERISA or the Code. It is unclear to what extent the exception applies when a seller submits a proposal to enter into a contract to provide investment services and does not receive any compensation from incidental advice provided in connection with the proposal. This is an item that may require additional formal or informal guidance from the DOL. (2) Swap and security-based swap transactions Advice provided to an employee benefit plan to enter into a swap or security-based swap that is regulated under the Securities Exchange Act or the Commodities Exchange Act is not fiduciary if the plan is represented by another ERISA fiduciary who is independent of the swap dealer, the swap dealer is not an advisor the plan and does not receive a fee or other compensation the plan or plan fiduciary for investment advice in connection with the transaction. The plan fiduciary must provide certain written representations in advance of any recommendations. (3) Employees Advice provided to the plan fiduciary, by employees of the plan sponsor, provided the employee receives no fee or other compensation, direct or indirect, in connection with the advice beyond the employee s normal compensation for work performed for the employer or employee organization. Additionally, an employee of a plan sponsor who inadvertently makes an investment recommendation to another employee of the plan sponsor (e.g., HR employee communicating with another employee) is not an investment advice fiduciary even if the advice relates to the other employee s plan benefits, if certain conditions are satisfied. The advice-providing employee must not be a licensed or registered investment advisor under state or federal law, is not in fact employed by the employer or an affiliate to provide investment recommendations to other employees and does not receive additional compensation, direct or 7

8 indirect, from any source for the inadvertent advice. Note, the exception for inadvertent advice does not appear to apply if the advice recipient is no longer an employee of the plan sponsor and it is unclear if it applies to participants currently employed by an affiliate or unrelated employer in a controlled group or multiple employer plan. Is there anything else that the final rule changed? Under the proposed regulation, appraisals, fairness opinions, and statements of value provided to an ESOP or a common collective trust fund, or solely for purposes of compliance with reporting and disclosure provisions required under a Federal, state or self-regulating agency s laws, rules or regulations were carved-out from the definition of fiduciary investment advice. The final regulations do not address appraisals, fairness opinions, or statements of value in any way as the DOL will address such matters is a separate regulatory initiative. Additionally, the DOL stated that it was not its intent for a person to become a fiduciary merely by engaging in the normal activity of marketing oneself or an affiliate as a potential fiduciary to be selected by a plan fiduciary or IRA owner, without making an investment recommendation covered by the final rule. However, if the communication results in a rollover or investment recommendation, those would still be subject to the provisions of the rule. Does the final rule apply to health plans, disability plans, term life plans and/or HSAs? The DOL makes it clear in the preamble that it was not the intent of the final fiduciary/conflict of interest rule to treat advice as to the purchase of health, disability, and term life insurance policies as subject to the rules if the policies do not have an investment component. Instead, the DOL believes it would not be within the plain and natural reading of the term investment advice to conclude that recommendations to purchase group health and disability insurance constitute investment advice subject to the final rule. In this regard, the rule was clarified to exclude from the definition of covered investment property health or disability insurance policies, term life insurance policies or other similar assets to the extent that they do not have an investment component. However, the DOL takes a different position in the final rule on HSAs under Code section 223. The final rule retains the provision from the proposed rule that the requirements will apply to HSAs, as well as MSAs and ESAs. The DOL notes that all of these accounts are given tax preferences, similar to IRAs (which are subject to the final rule). In addition, HSAs may have associated investment accounts that can be used as long term savings accounts for retiree health care expenses, and HSA funds may be put in investments approved for IRAs (e.g., bank accounts, annuities, certificates of deposit, stocks, mutual funds, or bonds). Furthermore, HSA trust or custodial agreement may restrict investments to certain types of permissible investments (e.g., particular investment funds), and HSAs also are expressly defined by Code section 4975(e)(1) as plans that are subject to the Code s prohibited transaction rules. Therefore, the DOL has concluded that the owners of these accounts and the persons for whom these accounts were established are entitled to receive the same protections from conflicted investment advice as IRA owners. As a result, vendors/trustees who administer HSAs generally will be subject to the new standards in the final rules, particularly where the vendor/trustee provides investment advice. It is our understanding that the DOL has publicly stated that it does not intend for this rule to extend fiduciary status to an employer who provides or contracts with a vendor who administers the HSA. However, that position articulated by the DOL was not included in the final rule, and we will continue to monitor whether any clarification of this issue will be included in future guidance. In previous guidance (FAB ; ), the DOL confirmed that HSAs generally are not considered ERISA-covered plans, which implies that an employer generally would not be considered an ERISA fiduciary to an HSA. Specifically, FAB provides that even where an employer selects an HSA provider to which it will forward contributions that offers a limited selection of investment options, the employer would not be considered to be making or influencing an employee's investment decisions, and thus would not give rise to an ERISA-covered plan, so long as employees are afforded a reasonable choice of investment options and employees are not limited in moving their funds to another HSA.. However, according to the guidance, if an employer receives a discount on another product from a selected HSA vendor, that fact would constitute the employer receiving a payment or compensation in connection with an HSA, which would also give rise to 8

9 fiduciary and prohibited transaction issues. What are the implications for plan sponsors? A plan sponsor or fiduciary would have no fiduciary responsibility or liability with respect to the actions of a third party selected by a participant or beneficiary to provide education or investment advice where the plan sponsor or fiduciary neither selects nor endorses the educator or advisor, nor otherwise makes arrangements with the educator or advisor to provide services. On the other hand, the designation of a person(s) to provide investment educational services or investment advice to plan participants and beneficiaries is an exercise of discretionary authority or control with respect to management of the plan; therefore, persons making the designation must act prudently and solely in the interest of the plan participants and beneficiaries, both in making the designation(s) and in continuing such designation(s). The table below describes whether certain activities might constitute fiduciary investment advice under the DOL s final rule. Activity Recommendations on the selection of investment managers who will also receive a direct or indirect fee for providing investment advice. Recommendations to participants and beneficiaries to take a distributions or a recommendation as to the investment of securities or other property to be rolled over or otherwise distributed from the plan or IRA. One-on-one investment counseling. Fiduciary Investment Advice if Other Conditions are Met Yes. Yes Yes Comments The DOL indicates that this type of advice is already covered by the current regulation, and they are only revising the text to remove any possible ambiguity. The DOL provides that general advice as to the types of qualitative and quantitative criteria to consider in hiring an investment manager would not rise to the level of a recommendation. The DOL s current guidance under Advisory Opinion A provides that such recommendations do not constitute fiduciary investment advice. That guidance is superseded. One-on-one investment consulting services service constitutes advice that is directed to a specific recipient for making investment decisions for a fee. Lifetime Income Planning Yes Lifetime income planning often involves advice that is directed to a specific recipient for making investment decisions (e.g., an individual retirement annuity purchase) for a fee. Valuations of hard-to-value assets. No Under the proposed rule, appraisals, fairness opinions, or statements of value that relate to a particular transaction would have constituted fiduciary investment advice with certain carveouts provided for valuations performed to comply with reporting and disclosure rules. However, in the final rule, the DOL indicated that these issues will be addressed in a separate guidance project. 9

10 Asset liability modeling studies. Yes An ALM study is investment advice if it is directed to a specific recipient for making investment decisions for a fee. [2] Liability driven investment strategy consulting. Yes An LDI strategy is investment advice if it is directed to a specific recipient for making investment decisions for a fee. Annuity purchase recommendations. Yes Annuity purchase recommendations constitute advice that is directed to a specific recipient for making investment decisions for a fee. Investment Education No The final rule provides that investment education is not fiduciary advice. General advice as to the types of qualitative/quantitative criteria to consider in hiring an investment manager. Recommendations of administrative service providers, property managers, or other service providers who do not provide investment services. General public or industry statements made with respect to investments. No No No The rule provides that such activities do not constitute fiduciary investment advice. Such activities are not considered fiduciary investment advice. The preamble provides that recommendations made to the general public, (i.e., newsletters, television talk show commentary, or remarks made in speeches and presentations at financial industry education conferences) are exempt from being considered fiduciary investment advice. How does the Best Interest Contract (BIC) Exemption apply to ERISA Plans? Plan sponsors can gleam from the Best Interest Contract (BIC) exemption how investment advisors and financial institutions will comply with the final rule when they work with participants and beneficiaries who are eligible to rollover a plan distribution to an IRA, or provide advice (versus education) regarding the investment of a participant s or beneficiary s defined contribution account. The exemption permits fiduciary advisors and financial institutions and their affiliates to receive variable (including additional) compensation for investment advice provided to plan participants, their beneficiaries (if the participant is deceased) and plan fiduciaries (other than banks, insurers, registered investment advisors and brokerdealers) who hold, manage or control total assets of less than $50 million. In the context of an ERISA plan, the exemption generally requires an investment adviser or the advisor s financial institution to acknowledge fiduciary status and commit to adhere to basic standards of impartial conduct. Unless the compensation received is level (regardless of the particular investment recommended), the advisor must also warrant that it has adopted policies and procedures designed to mitigate any harmful impact of conflicts of interest, and disclose information on any conflicts of interest and on the cost of their advice. All fiduciaries must retain records demonstrating compliance with the exemption. In general, required disclosures may be made electronically in accordance with specific rules. In order to satisfy the impartial conduct standards, an advisor s conduct must, among other conditions, [2] See ERISA Advisory Opinion 84-03A. (An insurance company s investment consulting service designed to assist plan fiduciaries in formulating an investment strategy and implementing the plan's investment strategy to maximize the plan's investment performance was assumed to be investment advice as defined in section 3(21)(A)(ii) of ERISA and regulation 29 CFR (c) because the services it provided to a plan on a regular basis, although not including specific recommendations with regard to the acquisition or retention of specific investment vehicles or managers, would in fact be relied upon as a primary basis for either the longer range strategic decisions or the more immediate allocation decisions that are made by the plan, or by the plan's fiduciary. However, to the extent that such services provided no more than quantitative measurements and rankings of a plan's investment portfolio and/or management performance, based on objective, reasonable and relevant criteria that were uniformly applied, the insurer would not be a fiduciary under section 3(21)(A)(ii) with respect to the portion of the services that monitored the performance of the plan s investment managers.) 10

11 adhere to ERISA s prudent expert standard of conduct, and any investment recommendations must be based on the investment objectives, risk tolerance, financial circumstances, and needs of the participant or beneficiary, without regard to the financial interests of the advisor or any other party. This portion of the impartial conduct standards is also referred to as the best interest standard. Advisors have significant flexibility to determine how they will meet the best interest standard in their interactions with advice recipients and their approaches will in most cases differ. The remaining requirements of the best interest standard are that the total compensation received for the services provided must be reasonable, based on the reasonable compensation rules generally applicable to service providers under ERISA Sec. 408(b)(2), and any statements made by the advisor on relevant matters may not be materially misleading. In addition to an acknowledgement of fiduciary status and compliance with the impartial conduct standards, a level fee fiduciary must consider (and document) (1) the participant s or beneficiary s alternatives to a rollover, including leaving the money in his or her current employer s plan, if permitted, and the different fees and expenses associated with both the plan and the IRA; (2) whether the employer pays for some or all of the plan s administrative expenses; and (3) the different levels of services and investments available under each option. Some, but not all of this information is generic to defined contribution plans or generally available in the plan s participant fee disclosures. Note that robo-advice providers may charge only level fees in order to qualify for the BIC exemption. Fiduciaries who are not level fee advisors are generally not required to perform an analysis of rollover alternatives, but are subject to other extensive requirements designed to make any conflicts of interest transparent to participants and beneficiaries. Advisors that limit options to proprietary products must also make additional disclosures that increase transparency of conflicts of interest. As indicated, the exemption for variable compensation generally permits advisors to receive brokerage or insurance commissions. However, certain incentive compensation practices are explicitly prohibited, including quotas, appraisals, performance or personnel actions, bonuses, contests, and special awards. In general, any differential compensation is suspect, unless it is demonstrably in alignment with the interests of the advice recipient. The BIC exemption does not provide ERISA plan participants and beneficiaries with a private right of action for breach of contract. However, an adviser s failure to comply with the conditions of the exemption would result in a non-exempt prohibited transaction and would likely constitute a fiduciary breach. As a result, a plan, plan participant or beneficiary would be able to sue under ERISA section 502(a)(2) or (3) to recover any loss in value to the plan (including the loss in value to an individual account), or to obtain disgorgement of any wrongful profits or unjust enrichment. The exemption may not be used to avoid a prohibited transaction with respect to compensation received by a fiduciary to whom a participant or beneficiary has delegated discretionary authority or control over an account, or to compensation received in connection with the advisor or financial institution s own employee benefit plans. The BIC exemption applies to transactions occurring on or after April 10, 2017, but until January 1, 2018, only the best interest standard, the reasonable compensation requirement, the prohibitions on materially misleading statements, and requirements related to certain disclosures of material conflicts of interest and third-party payments apply. Under a special grandfather rule, subject to certain conditions, the prohibited transaction rules do not apply to compensation attributable to advice with respect to (1) investments made before April 10, 2017, or (2) investments made pursuant to advice on a systematic purchase program established before April 10, Compensation attributable to any advice regarding grandfathered investments after April 10, 2017, must meet the best interest standard. Thus, an advisor may advise a participant after April 10, 2017 on an investment made before that date without violating the prohibited transaction rules, as long as the recommendation satisfies the best interest standard. What should plan sponsors consider doing? Insurance and financial services advisors and brokers who sell retirement investment advice and products to small plans, plan participants and IRA owners are most likely to be affected by the regulations. To avoid prohibited transactions, they will likely have to satisfy the conditions of a proposed prohibited transaction class exemption. Plan sponsors, plan participants and IRA owners will benefit, since the rules make conflicts of interest considerably more transparent. 11

12 Plan sponsors may wish to: Review contracts and arrangements with investment advice providers to ensure the advisor either provides only the type of advice that is not a recommendation under the final rule or acknowledges fiduciary status and liability for the products or services offered or provided. Meet with vendors and review contracts and arrangements with providers to determine their fiduciary status, understand any conflicts and confirm they are properly disclosing fees. Review defined contribution plan investment education programs and, if necessary, update to provide clear guidelines to the plan s fiduciaries. Determine whether asset allocation models use specific designated investment alternatives, and if so, monitor whether such models are unbiased Review general communications and confirm that they are not inadvertently providing investment advice. Discuss the implications of this final rule on DC plan recordkeepers, especially to the extent they are the provider of certain investment education materials (i.e. asset allocation models and interactive investment materials) and consider the impact of any forthcoming changes. Conduct fiduciary education with the plan s fiduciaries after assessing and considering the items above to ensure fiduciaries are fully advised of an investment advice fiduciary s obligations. Begin to monitor the impact the changes may have on the organization s employees, particularly those who are close to retirement. Review HSA agreements with vendors to insure that the employer remains insulated from the new DOL fiduciary/conflict of interest standards set forth in the final rule. Review any fiduciary liability insurance coverage to confirm it provides adequate coverage. (For more information on this topic, contact *Rob Yellen) Beware of Ancillary Exposures: The new, broader interpretation of both advisor and advice may result in greater exposure for the investment industry. For example, a provider of lists and reviews of third-party investment products could be characterized as a fiduciary if the plan invests in one of the listed products. It is possible that the financial professional services policy would not be broad enough to cover that ancillary exposure. Reconsider The Impact of Indemnification And Align It To Coverage Terms: With the increased risk of co-defendants, there is likely a corresponding risk that indemnifications rights will trigger. Review the commitments made to you, when they trigger, the ability of the counterparty to pay, and whether those commitments (or the associated risks) are covered by insurance. Review Limits Adequacy: With more litigation likely and the associated costs likely to increase, it may be time to buy more fiduciary or professional liability insurance coverage. Be wary of peer review as a foundation of that assessment. Where exposure is increasing materially, as it is here, peer analysis may fall short. * Robert Yellen is Executive Vice President, D&O and Fiduciary Liability Insurance Product Leader for Willis Group FINEX North America This update has been prepared for Willis Towers Watson associates. It is for informational purposes only and may not be used or relied upon as legal advice Willis Towers Watson. All rights reserved. 12