Under ERISA [1] and the Code, [2] a fiduciary to a plan or IRA includes a person who renders investment advice for a fee. ERISA imposes safeguards on a fiduciary by applying standards of care and duties of loyalty and penalizing a fiduciary for breaching them. In 1975, the U.S. Department of Labor (DOL) issued regulations narrowing ERISA’s definition of fiduciary thereby excluding many financial institutions and advisers from liability. On April 8, 2016, the DOL modified these regulations by issuing an updated final rule redefining what it means to be an investment advice fiduciary and bringing these financial institutions and advisers within ERISA’s reach. [3] Retirement arrangements subject to the final rule include not only ERISA plans, but also IRAs and other non-ERISA plans, such as MSAs, HSAs and Keogh plans for self-employed individuals.

Investment Advice

Under the final rule, a fiduciary includes someone who charges a fee for giving a plan, plan sponsor, participant, IRA, or IRA owner “investment advice.” Investment advice is given if

• an adviser makes a “recommendation” [4] about any of the following:
  • buying, holding, or selling an investment;
  • managing investments (e.g., strategy, portfolio composition); or
  • rollovers, distributions, or transfers from a plan or IRA, including the amount, form, and destination of the rollover or transfer; and
• the adviser does any of the following:
  • acknowledges being a fiduciary;
  • gives advice under an agreement that addresses specific needs of an advice recipient; or
  • directs advice to one or more specific advice recipients.

Nonfiduciary Communications and Advisers

Because the final rule so significantly expanded the definition of investment advice, the DOL categorically excluded certain communications and advisers from being considered fiduciaries. The following are not considered recommendations and, therefore, are not investment advice:

General Communications. General communications, e.g., public comments, research or news reports, marketing materials, market data (including performance, trading volume, quotes), and prospectuses.

Investment Education.

• General information about finance, investing, and retirement, e.g., general concepts (risk and return, diversification, compound interest); risk/return differences among asset classes; how fees affect returns; effects of inflation; determining retirement-income needs, investment time horizon, risk tolerance, retirement risks.
• Descriptions of the terms and operation of a plan, benefits of plan participation, impact of withdrawals, forms of distribution, fee information.
• Models of asset-allocation portfolios of hypothetical individuals with different time horizons and risk profiles.
• Materials used to estimate retirement-income needs and assess impact of asset allocation on retirement income.

Platform Providers. Marketing of a platform from which a plan may select and monitor investments or into which participants may invest. Does not apply to IRAs.

Selection and Monitoring. Identifying investment alternatives to meet criteria specified by a plan (e.g., in response to a request for proposal). Does not apply to IRAs.

Appraisals and Fairness Opinions. Appraisals, fairness opinions, and other valuations of investment property are not covered by the final regulations.

Similarly, the following are not investment advice fiduciaries:

Ordinary-Course Securities Transactions. A broker dealer or bank buying or selling securities in the ordinary course of business is not a fiduciary, so long as two conditions are met. First, the broker dealer or bank is not a fiduciary of the plan/IRA. Second, the instructions for the transaction specify (1) the security to buy or sell; (2) a price range; (3) a time span to buy or sell (up to five business days); and (4) the minimum or maximum quantity or value to buy or sell.

Employees. An employee of a plan, plan sponsor, or plan fiduciary (acting in that capacity) who advises a plan fiduciary or an employee of the plan sponsor (not acting as a participant) is not a fiduciary, so long as the advice-giving employee does not receive a fee for the advice. Similarly, an employee of a plan sponsor (acting in that capacity) who advises a plan participant is not a fiduciary, so long as the employee is not employed to give investment advice.

Independent Fiduciaries with Financial Expertise. A person who advises a plan/IRA fiduciary about an arm’s length transaction is not a fiduciary, so long as the adviser:

• reasonably believes that the fiduciary is a bank, insurer, a registered investment adviser, a broker-dealer, or a fiduciary that manages at least $50 million in assets;
• reasonably believes the fiduciary is responsible for exercising independent judgment and capable of evaluating investment risks;
• informs the fiduciary that the adviser is not providing impartial advice; and
• does not receive a fee for the advice.

Independent Swap Dealers. A swap dealer is not a fiduciary, so long as (1) the plan is represented by an independent fiduciary; (2) the swap dealer is not acting as a plan adviser; (3) the swap dealer receives no fee for the advice; (4) the independent plan fiduciary understands that the swap dealer is not providing impartial investment advice about the transaction.

Limited Fiduciaries. An investment fiduciary of a plan/IRA is not considered an investment fiduciary of assets over which the person has no discretionary authority or control.

Best Interest Contract Exemption

In light of the expansion of the types of financial institutions that will now be considered fiduciaries, the final rule would—absent an exemption—prohibit common compensation arrangements between investors and financial institutions and advisers, including commissions and revenue sharing. To permit these arrangements while protecting investor rights, the DOL issued the Best Interest Contract Exemption (the “BICE”) from ERISA’s prohibited-transaction rules. To rely on the BICE, a financial institution and adviser must (among other things):

• acknowledge in writing that they act as fiduciaries when giving investment advice.
• comply with the following “Impartial Conduct Standards”:
  • investment advice, when given is in the best interest of the investor;
  • no relevant statements are materially misleading when made; and
  • no more than reasonable compensation is payable;
• make and comply with warranties regarding (among other things) the adoption of measures to follow the Impartial Conduct Standards and to prevent material conflicts of interest from violating the Impartial Conduct Standards; the absence of employment actions (e.g., quotas) or incentives (e.g., bonuses) expected to cause advisers to make recommendations other than in the best interest of the investor;
• make disclosures in contracts, per transaction, and on the Web site, including (among other things) the best interest standard of care, services provided, how an investor pays for services directly or indirectly through third-party payments, material conflicts of interest, measures adopted to follow Impartial Conduct Standards, and right to receive copies of required warranties and disclosures; and
• include in contracts various requirements of the BICE, including acknowledgment of fiduciary status, Impartial Conduct Standards, required warranties and disclosures.
• Certain conditions of the BICE (e.g., required warranties and disclosures, contract requirements) do not apply to investment advice fiduciaries that only charge fees based on a fixed percentage of asset value or not based on investment recommendations. By contrast, financial institutions that restrict an adviser’s recommendations to proprietary products or investments that generate third-party payments are subject to additional notice and recordkeeping requirements.

Key Takeaways

The final rule goes into effect on June 7, 2016, with a phase-in transition period through January 1, 2018. For example, from April 10, 2017, to January 1, 2018, the BICE is subject to fewer conditions. Accordingly, financial institutions and advisers should review their business models to determine if any actions are necessary to comply with the final rules. In making this determination, they should consider the following takeaways from the final rule:

• Compensation practices that were not previously subject to ERISA’s prohibited transaction rules may now need to comply with the final rules or qualify for an exemption. The application of new exemptions (e.g., the BICE) or existing or modified exemptions to newly classified fiduciaries may change profit margins given the administrative burdens of qualifying for the exemptions. This may well force brokers and other financial institutions to either comply with the BICE (and assume its related legal risks) or move to fixed- or level-fee arrangements.
• Since IRAs (and other non-ERISA retirement plans) will now be subject to the final rules, increased litigation risk to financial institutions may likely factor into the pricing of investment and other services to their retail clients.
• Modification of service contracts will need to be considered. In addition to adjusting fee arrangements, provisions to address the new ERISA requirements may be necessary. Standard language such as arbitration clauses and exculpatory provisions in indemnity clauses may now be problematic.
• Providers of brokerage services need to be especially mindful that certain recommendations may qualify as investment advice subject to the final rules. This will include not only communications initiated by a person but also by a computer software program.
• To the extent possible, client communications not intended to be investment advice should be crafted to comply with those categories clearly identified in the final rule as non-recommendations, e.g., general communications or investment education. Failure to do so may cause the financial institution to be considered a fiduciary, which (among other things) will cause the institution to be subject to ERISA’s prudence and exclusive benefit rules, cause certain of its operations to be restricted by ERISA’s prohibited transaction rules, subject the institution to possible claims by the DOL, other fiduciaries and plan participants, and make it potentially liable as a co-fiduciary.
• The application of the final rules may cause financial institutions to reconsider their range of services, particularly if retail clients are not a core part of their business.
• Although there is news of legislative opposition and court challenges to the final rule, those most affected have begun preparing for compliance rather than expecting a withdrawal of the regulations or a delay in the effective date.

[1] Employee Retirement Income Security Act of 1974, as amended.
[2] Internal Revenue Code of 1986, as amended.
[3] 29 C.F.R. § 2510.3-21 (2016). The DOL also issued, rescinded, and modified prohibited-transaction exemptions coincident with the issuance of the final rule. For convenience, this memorandum uses the term “final rule” to refer to the final regulations and all of related prohibited-transaction exemptions affected by the final regulations.
[4] For purposes of rendering investment advice, a “recommendation” means a communication that, based on content, context, and presentation, would reasonably be viewed as a suggestion to act or not to act.

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.

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