DOL New Fiduciary Regulation: Seven Action Items for the Next Year
Everyone can take a deep breath. The rule is final. And despite the fact that the rule becomes effective 60 days after the date of publication in the Federal Register, it is not applicable until April 10, 2017. That gives us all a year in which to adjust ourselves to the new fiduciary investment advice landscape. So, at least for a little while, we can take it slowly.
But before we do, plan sponsors and fiduciaries should remember, that the new rule, which may add a few bodies to the count of plan fiduciaries, does nothing to change the basic fiduciary duties that requires fiduciaries to:
1. Act solely in the interest of plan participants and their beneficiaries, with the exclusive purpose of providing benefits to them;
2. Carry out all fiduciary duties prudently – follow a process and document that process;
3. Follow the plan documents (unless they are not consistent with ERISA, in which case, you’ll want to reach out to your trusted employee benefits advisor);
4. Diversify plan investments;
5. Pay only reasonable plan expenses; and
6. Hire plan advisors prudently, and continuously (and reasonably) monitor their performance.
Now, for the newest augmentation of the fiduciary rule, and the “To Do” list it creates for plan sponsors, please see below.
What was the old rule and why did it have to change?
As recounted by the Department of Labor in its 208-page publication of the new rule, the original fiduciary investment advice rule, written in an era when defined benefit plans dominated the retirement plan scene, IRAs were a curious oddity, and retirement wasn’t even a twinkle in the eyes of the vast population of working baby boomers, the DOL issued a five-part test for the definition of fiduciary investment advice. For investment advice to be considered a fiduciary act, the advice had to be:
1. Rendered as to the value of securities or other property, or recommending the advisability of investing in, purchasing or selling securities or other property,
2. On a regular basis,
3. Pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary,
4. That the advice will serve as a primary basis for investment decisions with respect to plan assets, and
5. That the advice will be individualized based on the particular needs of the plan.
The DOL contends that the five-part rule doesn’t reflect the broad fiduciary rules of ERISA in the current era of participant-directed 401(k) plans, the common use of IRAs and the almost obligatory rollover of plan assets from ERISA-protected plans to IRAs.
What is the new rule and when did it come out?
After iterations in 2010 and 2015, the DOL published its final rule on April 8, 2016. In summary, the new rule provides that a person will be considered to be rendering fiduciary investment advice with respect to a plan (described below) or IRA if:
1. such person provides to a plan, plan fiduciary, plan participant or beneficiary, IRA or IRA owner the following types of advice for a fee or other compensation, direct or indirect:
a. a recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, or a recommendation as to how such property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA;
b. a recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, 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, (including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made); and
2. the investment advice recommendation is made either directly or indirectly (e.g., through or together with any affiliate) by a person who:
a. represents or acknowledges that it is acting as a fiduciary within the meaning of ERISA or the Code,
b. 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 advice recipient, or
c. directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.
A “plan” under this rule includes any employee benefit under ERISA and any plan under Code Section 4975(e)(1)(A) that has an investment component (other than a disability, health or term life insurance policy). That means that Health Savings Accounts (HSAs), Archer Medical Savings Accounts, and Coverdell Education Savings Accounts are included.
A “fee or other compensation, direct or indirect,” means any explicit fee or compensation for the advice received by the person (or by an affiliate) from any source, and any other fee or compensation received from any source in connection with or as a result of the recommended purchase or sale of a security or the provision of investment advice services including such things as commissions, loads, finder’s fees, gifts and revenue sharing payments. A fee or compensation is “in connection with or as a result of” a transaction or service if such fee or compensation would not have been paid but for the transaction or service or if eligibility for or the amount of the fee or compensation is based in whole or in part on the transaction or service.
If that’s the rule, why is the DOL’s publication so long?
The balance of the new rule provides carve-outs, clarifications, and definitions in connection with the basic rule above.
First, what is a “recommendation?”
The first regulatory refinement defines “recommendation.” For purposes of this rule, a recommendation is a communication that would reasonably be viewed, on an objective basis, as a suggestion that the advice recipient should engage in or refrain from taking a particular course of action. The determination is based on the content, context, and presentation of the communication. Throughout the DOL’s publication, it refers to this communication as a “call to action.” The DOL concedes that, in general, the more individually tailored the communication to a specific recipient as to a security, investment property or investment strategy, the more likely the communication will be considered a “recommendation.”
Or maybe we should ask: what is not a “recommendation?”
The second refinement explains different types of information that will not be considered a “recommendation” for purposes of the new rule. The DOL sets forth several “carve-outs.”
Platforms. First, simply making available a platform of investment alternatives to a plan fiduciary without regard to the individualized needs of the plan, its participants, or beneficiaries - if the plan fiduciary is independent of the platform provider - would not constitute communications considered to be recommendations under the final rule, provided that the service provider also represents that they are not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity, and such representation is in writing.
Selection and Monitoring Assistance. Certain investment selection and monitoring activities are carved out as non-recommendations. Identifying investment alternatives that meet objective criteria specified by the plan fiduciary, provided that the person identifying the investment alternatives discloses in writing whether the person has a financial interest in any of the identified alternatives (and if so, details the interest) is exempted. Providing objective financial data and comparisons with independent benchmarks to the plan fiduciary is also deemed not to be a recommendation. Finally, in response to an RFI, RFP or similar request on behalf of a plan, 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), is not a recommendation provided that the response is in writing and discloses whether the person has a financial interest in any of the identified alternatives (and if so, details the interest).
General Communications. Communications that a reasonable person would not view as investment recommendation, including general circulation newsletters, commentary in publicly broadcast talk shows, remarks in widely attended conferences or seminars, news reports for general distribution, broadly distributed marketing materials and general market data on market performance, market indices or trading volumes, price quotes, performance reports or prospectuses and similar communications would not constitute “recommendations.”
Education. The DOL states very specifically that education will not be considered a “recommendation” no matter who the educator is (plan sponsor, fiduciary, or service provider), no matter the frequency of the delivery, no matter what form the provision of information takes (via call center, video, computer software, in writing, orally, to an individual or to a large group), provided that the educational information is not combined with recommendations as to investment in or management of particular investment property. The DOL lists common education communications and provides the following required parameters:
Plan information: Descriptions of the terms or operation of a plan, the benefits of IRA or plan participation, the impact of increasing contributions, the impact of preretirement withdrawals, retirement income needs, varying forms of distributions and their characteristics, fee and expense information, investment objectives and philosophies, risk and return characteristics, historical return information or related prospectuses – so long as there is no suggestion that any individual investment alternative or benefit distribution option is more appropriate than another.
General financial, investment and retirement information: Descriptions of general financial concepts including rates of returns, fees, inflation, estimating future retirement income needs, determining investment time horizons, risk tolerance, etc. – so long as there is no reference to a specific plan or IRA investment alternative or distribution options available to the plan participants or IRA owner or to specific investment services outside of the plan or IRA.
Asset allocation models: So long as the models are: (1) based on generally accepted investment theories that take into account historic returns of different asset classes over specified periods; (2) accompanied by all material facts and assumptions (retirement ages, life expectancies, income levels, rates of return, etc.); (3) accompanied by a statement that any plan participant, beneficiary or IRA owner applying the model to themselves must take into account their own assets, income, etc.; (4) exclusive of any specific investment product or alternative available under the plan or IRA, unless it is the designated investment alternative under the plan and subject to oversight by a plan fiduciary independent of the persons who developed or markets the investment alternative and model and meets certain other requirements.
Interactive investment materials: Questionnaires, worksheets, software and similar materials that provide recipients such as a plan fiduciary, plan participant or fiduciary or IRA owner the opportunity to estimate retirement income needs and assess the impact of the different asset allocations or to evaluate distribution options would not be “recommendations” if certain requirements are met, including that: (1) the materials are based on generally accepted investment theories that take into account historic returns of different asset classes over specified periods; (2) there is no objective correlation between the income stream generated by the materials and the information supplied by the recipient; (3) there is no objective correlation between the asset allocations generated by the materials and the data supplied by the recipient; (4) all material facts and assumptions (retirement ages, life expectancies, income levels, rates of return, etc. are clearly set forth; (5) the materials take into account other assets such as income and investments, Social Security benefits, equity in a home, etc., or are accompanied by a statement that any recipient should consider their own such assets; and (6) the materials do not include any specific investment product or alternative available under the plan or IRS, unless it is the designated investment alternative under the plan and subject to oversight by a plan fiduciary independent of the persons who developed or markets the investment alternative and model and meets certain other requirements.
Are there any specific investment transactions an advisor could engage in, and not be considered a fiduciary?
The third major refinement in the rule revolves around investment services or transactions that advisors to a fiduciary of a plan or IRA could engage in, and avoid being considered a fiduciary under the new rule.
Transactions with independent plan fiduciaries with financial expertise (the “seller’s” exemption): Unless an individual represents or acknowledges that they are acting as a fiduciary, an advisor, who is communicating with independent plan fiduciaries, will not be deemed to be a fiduciary under this rule, if the advisor knows or reasonably believes that the independent fiduciary: (1) is a licensed and regulated provider of financial services, such as banks, insurance companies, registered investment advisors and broker-dealers, or that the independent fiduciary has responsibility for the management of $50 million in assets; (2) is capable of evaluating investment risks (which capability the plan or independent fiduciary can represent in writing); and (3) is a fiduciary under ERISA, the Code or both with respect to the transaction (sale, purchase, loan, exchange or other transaction related to the investment of securities or other investment property) and is responsible to exercise independent judgment in assessing the transaction (which facts the plan or independent fiduciary can represent in writing), AND, the independent fiduciary is informed: (a) that the advisor is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with the transaction; and (b) of the existence and nature of the advisor’s financial interests in the transaction. The advisor cannot receive a fee or other compensation directly from the plan, plan fiduciary, plan participant or beneficiary, IRA or IRA owner for the investment advice provided in connection with the transaction.
Swap and Security-Based Swap Transactions: A swap dealer, security-based swap dealer, major swap participant, major security-based swap participant or a swap clearing firm, who gives advice to an ERISA-covered benefits plan will not be considered a fiduciary under the new rule if: (1) the plan is represented by a fiduciary independent of the swap advisor; (2) the swap advisor is not acting as an advisor to the plan as determined under certain securities laws; (3) the swap advisor does not receive a fee or other compensation directly from the plan or plan fiduciary for the investment advice provided in connection with the transaction; and (4) the swap advisor, prior to providing any advice, obtains a written representation from the independent fiduciary that the swap advisor is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity and that the independent fiduciary is responsible to exercise independent judgment in assessing the transaction.
Employees of plan sponsors, affiliates, employee benefit plans, employee organizations or plan fiduciaries: If these employees do not receive any compensation in connection with any advice they give or recommendations they make to a plan sponsor or other named fiduciaries of the plan, beyond their normal pay from the employer, then such advice or recommendations will not make them fiduciaries under the new rule. In addition, unless an employee: (1) is a registered or licensed advisor under securities or insurance laws; (2) their position specifically involves the provision of investment advice or recommendations; or (3) the advice they are giving requires registration or licensing, the employee will not be considered a fiduciary under the new rule when they communicate information to other employees about the plan and distribution options under the plan if they do not receive compensation beyond their normal pay.
And if that’s not enough, what about new prohibited transaction exemptions (PTEs), and amendments to others?
The general rule is that individuals who provide fiduciary investment service to plan sponsors, plan participants and IRA owners are not permitted to receive payments that create conflicts of interest without being covered by a PTE. The DOL issued two new PTEs and is amending a few existing PTEs to reflect the provisions of the new investment advice fiduciary rule.
Best Interest Contract Exemption (BICE): Under the BICE, financial institutions and their advisors are required to acknowledge their fiduciary status. The financial institutions must follow basic standards of impartiality, including providing prudent advice that is in the customer’s best interest, avoiding misleading statements and receiving no more than reasonable compensation. In addition, policies and procedures designed to mitigate damages from conflicts of interest must be in place, and disclosures must be provided regarding fees and charges and any existing conflicts of interest. The financial institution must maintain and regularly update a website that includes information regarding the institution’s business model and the required disclosures above. (Individualized information about a particular advisor’s compensation is not required to be included.) It is important to know that the BICE includes a grandfathering provision so that additional compensation can be received from previously acquired assets. And, as long as it is in the customer’s best interest, the “level fee” provision permits recommendations to roll over assets from an employer plan to an IRA. Generally, there must be a contract in place before the investment advice is provided, which requires the financial institution to acknowledge its fiduciary status in writing, commit to the impartial conduct standards and give certain warranties regarding any conflicts of interest. Please note that individual advisors of an institution do not have to sign the required contract in the case of an IRA or other non-ERISA plan, only the institution need execute the contract. To comply with the BICE, financial institutions must provide notice to the DOL of its reliance of the BICE. Finally, the financial institution must maintain records to support its reliance on the BICE for six years. BICE is effective January 1, 2018.
Principal Transactions Exemption: This PTE permits investment advice fiduciaries to buy or sell certain recommended debt securities and other investments out of their own inventories to or from plans and IRAs. Many of the requirements in the BICE are also required under this PTE.
PTE 84-24 Amendment: PTE 84-24 is being amended to reflect the provisions of the new rule. This PTE permits insurance agents and brokers, and insurance companies, to receive compensation for recommending fixed rate annuity contracts to plans and IRAs.
Other Exemptions being amended: Other exemptions being amended include Class Exemptions 75-1, 77-4, and 80-83 and PTEs 86-128 and 75-1.
So what needs to be done in the next year?
Depending on who you are, there will be a unique “To Do” list that you will need to generate and follow before April 10, 2017. But, for starters, for plan sponsors:
1. Take this opportunity to review fiduciary “best practices” in general, including the duty to monitor the plan’s service providers;
2. Understand that this rule is directed at investment advice, and is not confined to defined contribution plans – HSAs with investment components are subject to this rule;
3. Understand when service providers are and are not acting as fiduciaries – just because an advisor is a fiduciary for these assets or those services, doesn’t mean they are fiduciaries as to the plan or its assets on a global basis;
4. Review any agreements or correspondence from service providers, particularly investment advisors, for statements regarding their fiduciary status, and note where changes may be forthcoming from the providers, including potentially higher fees;
5. Review any educational materials provided by investment advisors to ensure that no inadvertent recommendations are being made;
6. Review any communications to plan participants regarding rollovers and distributions to ensure that no particular recommendations are inadvertently being made; and
7. Review who the employees are (and how they are compensated) who regularly communicate with plan participants and beneficiaries, and educate them about the new rule’s requirements.