The DOL s New Rules for Retirement Investment Advice Douglas J. Heffernan, Megan E. Hladilek, and Graham P. Widmer Faegre Baker Daniels LLP After years of debate and speculation, the Department of Labor ( Department ) issued its final package of rules regulating individuals and entities that provide investment advice to retirement plans and IRA investors. The Department s final fiduciary regulation and related administrative exemptions aim to curb investment advice practices that, in the Department s view, fail to serve the best interest of retirement investors. Common current practices may be permissible, but are subject to new conditions that may require changes for certain investment advice providers. Investment Advisers as Fiduciaries Key to the Department s final rule is a new definition of investment advice fiduciary under ERISA and the Code which replaces the narrow, five-part test outlined in prior regulations. Under the final regulation s broader definition, a person is an investment advice fiduciary if two conditions are met: 1. The person makes a recommendation for a fee or other compensation, whether direct or indirect, as to: (i) (ii) the advisability of acquiring, holding, disposing of, or exchanging, plan or IRA assets, or a recommendation as to how plan or IRA assets should be invested after the plan or IRA assets are rolled over, transferred, or distributed from the plan or IRA; or the management of plan or IRA assets, including, among other things, recommendations on investment policies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., brokerage versus advisory), or recommendations with respect to rollovers, transfers, or distributions from a plan or IRA regarding what form and to what destination such a rollover, transfer, or distribution should be made. 2. The person must either: (i) (ii) acknowledge its fiduciary status; have an agreement, written or verbal, that the advice is based on the particular investment needs of the advice recipient; or
(iii) direct the advice to a specific advice recipient. The final rule clarifies that a recommendation will include the recommendation of other persons who provide advice or investment management services, but will not include the marketing of oneself or one s services. This clarification is intended to allow responses to requests for proposals and general sales pitch materials. Exceptions to Fiduciary Status Starting from the broad fiduciary definition, the final regulations exclude certain activities from being either recommendations or investment advice. These include: General communications (e.g., newsletters); Investment education (including, subject to certain conditions, asset allocation models and interactive investment materials that may identify specific investment options available under ERISA plans (but not IRAs)); Providing an ERISA plan with an investment platform, defined by the market, and related selection and monitoring of investment options; Providing advice, subject to certain conditions, to an independent fiduciary of a plan or IRA that is either a licensed or regulated provider of financial services or is responsible for the management of at least $50 million in plan and non-plan assets; For swap dealers / participants, acting as a counterparty in a swap or security-based swap transaction with an ERISA plan represented by a fiduciary independent of the counterparty; and For employees of a plan sponsor, making recommendations to a plan fiduciary, without receiving additional compensation. Scope of Plans and IRAs The definition of fiduciary and investment advice is focused on retirement plans and IRAs, including SIMPLE IRAs and SEP IRAs, Archer medical savings accounts (MSAs), health savings accounts (HSAs), Coverdell education savings accounts, and Keogh or HR-10 plans for self-employed individuals. Advice regarding health, disability, and term life insurance policies is explicitly excluded from the scope of the regulation. Administrative Exemptions in the Final Regulatory Package The Department created or amended several prohibited transaction exemptions ( PTEs ) to permit investment advice fiduciaries to engage in transactions that ERISA and the Code would otherwise prohibit, including the receipt of third-party payments and compensation that varies based on the investment advice provided. Without a PTE, common forms of compensation (even if in the best interest of the retirement investor) would trigger the Code s excise tax (generally equal to 15% of the amount involved) and, for ERISA plan transactions, expose the fiduciary to liability under ERISA s civil enforcement provisions.
Best Interest Contract Exemption For investment advice fiduciaries in the retail investment marketplace, the exemption of general applicability is the final Best Interest Contract Exemption ( BIC Exemption ), which generally requires investment advice fiduciaries ( Advisers ) and the registered investment advisers, banks, insurance companies and registered broker-dealers that employ or otherwise retain them ( Financial Institutions ) to adhere to an enforceable fiduciary standard of conduct and take certain steps to mitigate conflicts of interest. Scope of BIC Exemption The Department intends the BIC Exemption to cover variable compensation and third party payments for fiduciary investment advice provided to retail Retirement Investors, which include fiduciaries of small participant-directed plans, but do not include plan or IRA fiduciaries who fall within the exception to fiduciary status for advice to fiduciaries with financial expertise. The BIC Exemption will be available for investment recommendations concerning all investment types and types of fiduciary investment advice, but will not apply to advice provided with respect to the Adviser s or Financial Institution s in-house retirement plans, or where the Adviser exercises discretionary authority or control with respect to the recommended transaction. BIC Exemption Requirements The final BIC Exemption places the burden of compliance squarely on the Financial Institution by requiring it to acknowledge in writing that that both it and its Adviser will act as fiduciaries with respect to investment recommendations. Contract Requirements Consistent with the Financial Institution s acknowledged fiduciary status, the final BIC Exemption saddles the Financial Institution with legal liability for ensuring compliance with the exemption s requirements. ERISA plan participants, beneficiaries and fiduciaries may pursue legal action against the Financial Institution by using the statutory enforcement provisions of ERISA. However, because there is no federal statutory civil cause of action for non-erisa plan investors, with respect to IRA and non-erisa plan transactions only, the final BIC Exemption requires the execution of a Best Interest Contract warranting compliance with the exemption s substantive requirements, which will be enforceable by the Retirement Investor against the Financial Institution. The BIC Exemption protects Retirement Investors right to pursue contractual remedies (or statutory remedies, for ERISA plan investors) by disallowing class action waivers and contractual limitations on the Adviser s or Financial Institution s liability. However, the Retirement Investor may agree to reasonable binding arbitration for individual claims and may waive its right to seek punitive damages or rescission of recommended transactions. The Best Interest Contract is a two-party agreement between the Retirement Investor and the Financial Institution and must be executed by the time the recommended transaction is executed.
Conditional relief is available for circumstances in which a Retirement Investor acts on fiduciary advice notwithstanding the absence of a Best Interest Contract. In addition, transitional relief allows for a negative consent procedure, whereby a Financial Institution may obtain the assent of customers with existing contractual arrangements as of January 1, 2018, by sending a contract amendment that becomes effective if the customer does not terminate the contract within 30 days. Impartial Conduct Standards and Anti-Conflict Policies and Procedures The final BIC Exemption regulates the behavior of Financial Institutions and their Advisers by requiring the Financial Institution to affirmatively state that it and its Advisers will adhere to Impartial Conduct Standards and comply with certain anti-conflict policies and procedure requirements. For IRA and non-erisa plan Retirement Investors, the exemption s substantive standards must be incorporated into the Best Interest Contract, meaning that their violation is an enforceable breach of contract. Financial Institutions transacting with ERISA plan Retirement Investors must also comply with the exemption s substantive standards to avoid civil liability for a non-exempt prohibited transaction under ERISA. The Impartial Conduct Standards require the Financial Institution and its Advisers to act in the Best Interest of the Retirement Investor by providing advice that meets a standard of care similar to the ERISA standard. They must also charge no more than reasonable compensation for their services and refrain from making materially misleading statements about the recommended transactions, fees and compensation, material conflicts of interest, or other matters relevant to the investment decision. One result of the final regulations and the final PTEs is the ERISAfication of IRAs. The Impartial Conduct Standards essentially mirror ERISA s fiduciary standards of conduct, which do not apply under federal statutes to IRAs. However, in order to avoid the excise tax on prohibited transactions with respect to certain IRA transactions, Advisers and their Financial Institutions who wish to rely on the BIC Exemption must agree to be subject to the same fiduciary standards as apply under ERISA. Financial Institutions are required to adopt written anti-conflict policies and procedures to ensure that Advisers adhere to the Impartial Conduct Standards described above. The BIC Exemption specifies how the Impartial Conduct Standards can be satisfied by Financial Institutions that restrict Adviser s investment recommendations to proprietary products or products the generate third party payments. In broad terms, the Financial Institution must reasonably determine that the material conflicts of interest created by its business model will not result in excess compensation or imprudent investment recommendations. Disclosure Requirements The BIC Exemption adopts a two-tier approach to disclosures, requiring Financial Institutions to provide general information in an initial contract disclosure and periodic pre-transaction disclosures, and more specific information in website disclosures or upon request. Agency Notification and Recordkeeping
The Financial Institution must provide advance notification of its reliance on the BIC Exemption to the Department and must maintain certain data accessible to the Department and the Retirement Investor for six years from the transaction date. Level Fee Fiduciaries The BIC Exemption provides streamlined exemption conditions for Level Fee Fiduciaries, which include Financial Institutions and Advisers that receive only a set fee or fees and compensation based on a fixed percentage of the value of assets (rather than a commission or transaction-based fee). Transitional Relief and Grandfathering Provision The full requirements of the final BIC Exemption will not take full effect until January 1, 2018. During the transition period between April 10, 2017 (when the final rule s definition of investment advice fiduciaries takes effect) and January 1, 2018, Financial Institutions will not be required to execute the Best Interest Contract or provide warranties or disclosures regarding anti-conflict policies and procedures. In addition, the BIC Exemption grandfathers certain pre-existing advisory relationships. The grandfather provision removes the need to comply with the BIC Exemption s full requirements for compensation received as a result of investment advice on property purchased before April 10, 2017. Grandfather relief is subject to reasonable compensation and basic best interest requirements. Other Prohibited Transaction Exemptions The final fiduciary rule package creates or amends several other PTEs, the most important of which is PTE 84-24, which, as amended, will be available for plan or IRA purchases of mutual fund shares and insurance or fixed rate annuity contracts. The final PTE 84-24 differs significantly from the 2015 proposal because its will not be available for transactions in fixed indexed annuities. While PTE 84-24 will cover traditional fixed annuities, only the BIC Exemption is available to provide relief for variable annuities and fixed indexed annuities. Moving Forward While the final regulations and the final PTEs have generally been made more workable for financial service providers, much more work and analysis will be required during the transition period. Providers of call center services, investment education services or asset allocation models will need to review the specific conditions for those exceptions. Financial institutions that had relied on a commission or other transaction-based model will need to study what steps need to be taken to satisfy the requirements of the BIC Exemption. And some might consider shifts to a level-fee model rather than undertake the steps needed to rely on the BIC Exemption. The Department has indicated that it intends to work with interested parties on compliance assistance activities and materials and invites stakeholders to identify areas or specific issues where they believe additional clarifying guidance is needed.