The Department of Labor s New Fiduciary Regulation Considerations for Mutual Fund Directors

Transcription

1 The Department of Labor s New Fiduciary Regulation Considerations for Mutual Fund Directors September 20, 2016 Copyright 2016 by K&L Gates LLP. All rights reserved. Susan Ferris Wyderko, CEO/President, Mutual Fund Directors Forum Kris Zanotti, Partner, K&L Gates Donald Smith, Partner, K&L Gates Robert Sichel, Partner, K&L Gates

2 TOPICS Background Why Mutual Fund Boards Should Care

3 Background

4 ERISA FIDUCIARY STATUS One can become an ERISA fiduciary by: Discretionary Fiduciaries: Exercising discretionary authority or discretionary control with respect to the management of an employee benefit plan covered by ERISA (e.g., 401(k) plans) or an IRA Investment Advice Fiduciaries: Rendering investment advice to such a plan for a fee or other compensation or having any responsibility to do so; regulations define the scope Status of IRAs

5 NEW DOL REGULATION In April, the Department of Labor issued a new regulation that re-defines when one is acting as an investment advice fiduciary The regulation greatly expands the number of market participants that will be deemed ERISA fiduciaries and will have broad implications for the U.S. retirement landscape The biggest impact will likely be on brokerage firms and other intermediaries that are currently not considered fiduciaries

6 INVESTMENT ADVICE FIDUCIARIES OUT IN Five part test Providing a recommendation can cause one to be a fiduciary A recommendation broadly includes statements that would reasonably be viewed as suggestions to take or refrain from taking a particular course of action Content, context and presentation inform the determination The more individually tailored the communication, the more likely it is a suggestion

7 DOL WAS CONCERNED WITH CONFLICTS According to the DOL Compensation arrangements in the retirement industry have created incentives for advisers to recommend products that pay them or their firms more money rather than products that are in the clients best interests IRAs receiving conflicted investment advice can expect their investments to underperform by an average of onehalf to one percent per year over the next 20 years. This underperformance for IRA front-end-load mutual fund investments alone could cost IRAs between $95B and $189B over the next 10 years

8 IRA ROLLOVERS According to the DOL: As baby boomers retire, they are increasingly moving money from ERISA-covered plans, where the employer has both the incentive and the fiduciary duty to facilitate sound investment choices to IRAs where advice that is conflicted is commonplace Rollover advice will now be considered fiduciary advice This is expected to decrease the rate of rollovers

9 U.S. RETIREMENT SPACE IS EXPERIENCING DRAMATIC CHANGES Traditional defined benefit pension plans 401(k) plans IRAs ~$2.8T in assets ~$6.8T in assets ~$7.4T in assets Beginning to wane as plans are closed, frozen and terminated Experiencing growth Experiencing growth, but may stagnate under the new regulation Cause of changes: Regulatory activity State level activity Litigation Result: Plan sponsors looking for safer investment vehicles for their plans 9

10 IF ONE IS AN ERISA FIDUCIARY There are many complexities to navigate Subject to: Duties of prudence and loyalty Strict prohibited transaction restrictions 10

11 Why Mutual Fund Boards Should Care

12 IN THE CASE OF INVESTMENT COMPANIES The regulation may impact the fiduciary status of any person that makes a recommendation to purchase the fund, including: Distributors Intermediaries Advisers / registered reps The regulation may result in changes to distribution models and product offerings Note, portfolio assets of investment companies continue to not be plan assets

13 WHAT ACTIVITY IS OK (DOES NOT CAUSE FIDUCIARY STATUS)? Having hire me discussions Providing investment education Making general communications Providing recommendations to a sophisticated, independent fiduciary Large plans Intermediaries

14 HIRE ME CONCEPT Rule: Can have a hire me discussion with a prospective client touting the quality of the firm without becoming a fiduciary Limitation: Combining a hire me discussion with a recommendation of a particular product or investment program is fiduciary investment advice 14

15 INVESTMENT EDUCATION Rule: It is not fiduciary investment advice to furnish certain types of investment-related information and materials to a plan, plan fiduciary, plan participant or IRA Limitation: With limited exceptions, the information and materials cannot include recommendations with respect to Specific investment products Specific plan or IRA alternatives Investment or management of particular securities or other investment property 15

16 GENERAL COMMUNICATIONS Rule: It is not fiduciary investment advice to furnish or make available general communications that a reasonable person would not view as an investment recommendation Examples: General circulation newsletters Commentary in publicly broadcast talk shows Remarks and presentations in widely attended speeches and conferences Research or news reports prepared for general distribution General marketing materials General market data, including data on market performance, market indicies or trading volumes Price quotes Performance reports Prospectuses 16

17 SOPHISTICATED FIDUCIARY Rule: It is not fiduciary investment advice for a party to communicate with a sophisticated, independent fiduciary acting on behalf of a retirement investor where there is no expectation of reliance Requirements include: The party providing the advice knows or reasonably believes the fiduciary is a: (i) bank, (ii) insurance company, (iii) RIA, (iv) broker-dealer or (v) party that holds or has under management or control at least $50M in assets The party providing the advice informs the fiduciary that it is not providing impartial investment advice or giving advice in a fiduciary capacity The party providing the advice knows or reasonably believes the fiduciary is a fiduciary under ERISA and/or the Internal Revenue Code with respect to the transaction and is responsible for exercising independent judgment in evaluating the transaction The party providing the advice knows or reasonably believes the fiduciary is capable of evaluating investment risks independently, both in general and with regard to the particular investment 17

18 FIDUCIARIES MUST Ensure fees are reasonable relative to the services provided Act in the client s best interest Avoid ERISA prohibited transactions Absent a prohibited transaction exemption (such as the BIC Exemption), may not provide advice that causes one to receive additional compensation, such as the receipt of a sales load, 12b-1 fee or sub-ta fee

19 BIC Exemption Allows otherwise impermissible compensation 12b-1 fees Commissions Sales loads Revenue-sharing payments But, fees to sales people are limited Compliance burdens: Many, including Compliance with impartial conduct standards Policies and procedures Disclosures Streamlined requirements for level fee fiduciaries

20 POTENTIAL IMPLICATIONS Accelerate movement to lower cost options Passive/index strategies and larger funds Bank collective trusts Increased assets in 401(k) plans vs. IRAs Funds will be disadvantaged that have complex administrative and distribution trail structures expect consolidation of classes Platforms may eliminate many small, expensive and/or poor performing funds Possibly increased litigation risks

21 NEW SHARE CLASSES? Considerations: Can an adviser receive a front-end sales load? Can an adviser receive a contingent deferred sales charge? Can an adviser receive 12b-1 fees? Is the total amount of all fees reasonable?

22 WINNERS AND LOSERS Mutual fund industry being challenged from multiple directions Pressure on fees and profits from DOL rule, litigation and market forces Higher expenses due to more regulatory requirements Scale becomes more important than ever the winners are likely to be the big players. More industry consolidation possible Movement to collective funds expected to increase due to low cost of entry and lower expenses and regulatory burdens

23 Speaker Biographies

24 Robert L. Sichel Partner New York Robert Sichel is a partner in the firm s New York office, where he is a member of the Investment Management practice group and oversees the ERISA Fiduciary practice. He has extensive experience helping financial institutions and corporate retirement plans navigate the complexities of ERISA, as well as issues under the Dodd-Frank Act that pertain to special entities. Mr. Sichel s practice focuses on advising investment managers and other financial institutions on the fiduciary responsibility and prohibited transaction rules of ERISA; assisting investment managers with drafting and implementing ERISA-related policies and procedures; providing training and compliance advice with respect to Department of Labor prohibited transaction exemptions; and drafting and negotiating investment management agreements, fund documents, side letters and trading-related agreements (e.g., ISDAs, clearing agreements, futures agreements, securities lending agreements and prime brokerage agreements) on behalf of financial institutions, investment managers and institutional investors. Mr. Sichel also counsels corporate defined benefit plans and defined contribution plans on investment matters, governance, de-risking and the handling of service providers. Prior to joining K&L Gates, Mr. Sichel held senior positions at several large financial institutions, including most recently as General Counsel of a $20 billion registered investment adviser, where he led a team of legal, compliance and risk professionals. In addition, he was an executive director in the legal department at a global financial services firm, where he was responsible for providing ERISA advice to the derivatives, prime brokerage, advisory and other businesses. Mr. Sichel also served as internal ERISA counsel for a New York-based global investment bank. 24

25 Kristina M. Zanotti Partner Washington, D.C Ms. Zanotti is a partner in the Investment Management practice group, concentrating in the areas of ERISA Fiduciary practice and derivatives transactions. In the ERISA Fiduciary practice, Ms. Zanotti focuses on fiduciary responsibility matters under ERISA, including advising clients regarding ERISA s prohibited transaction restrictions and exemptions. Ms. Zanotti is co-author of the chapter ERISA Issues for Mutual Fund Advisers in the treatise Mutual Fund Regulation (ed. Clifford E. Kirsch) and co-author of the chapter ERISA Issues in the treatise Variable Annuities & Variable Life Insurance Regulation (ed. Clifford E. Kirsch). In the derivatives area, Ms. Zanotti represents financial services clients in connection with swap and other derivatives transactions and in negotiating master agreements, including ISDAs, Master Repurchase Agreements, Master Securities Forward Transaction Agreements, futures agreements, cleared derivatives documentation, and related agreements. Ms. Zanotti is co-vice chair of the American Bar Association s Trust & Investment Services Subcommittee. 25

26 Donald W. Smith Partner Washington, D.C Mr. Smith concentrates his practice on investment management and mutual fund law. He serves as counsel to registered investment companies and their boards of directors, with a particular focus on bank-affiliated investment companies. In addition to providing regulatory and compliance counseling on routine and complex operational issues, he advises registered investment company and investment adviser clients on the impact of the rapidly changing regulatory landscape. His experience also extends to trust and investment management activities of banks and their affiliates, as well as questions arising from the other securities activities of banking institutions. 26