On April 6, 2016, after more than five years of anticipation, the Department of Labor (DOL) issued the final fiduciary rule and related guidance. The final fiduciary rule amends and expands the definition of a fiduciary that provides “investment advice” to reflect changes in the financial industry and the state of investment advice as it exists today. The final rule focuses on “conflicts of interest,” and serves to sweep in a large number of investment advisers who were not previously treated as fiduciaries under the Employee Retirement Income Security Act of 1974 (ERISA). To temper the scope and impact of the final rule, the DOL also issued two new prohibited transaction exemptions (along with certain amendments to existing exemptions). This guidance is intended to address concerns of these investment advisers with respect to certain prohibited transactions under ERISA and the Internal Revenue Code (the Code), while still protecting retirement plans and participants.

Part I: The Final Rule – Fiduciaries, Investment Advice, and Recommendations

Who is a Fiduciary? Under the final rule, the definition of a “fiduciary” with respect to investment advice is revised to include, broadly, any person who renders investment advice in exchange for direct or indirect compensation. The final rule defines investment advice as a recommendation as to:

• the advisability of acquiring, holding, disposing of, or exchanging securities or investment property, or how securities or other investment property should be invested after it is rolled over, transferred, or distributed from the plan or IRA; or
• the management of the securities or other investment property of a plan or IRA, including recommendations that relate to investment policy or strategy; portfolio composition; selection of other persons to provide investment advice, investment management services, or investment account arrangements (e.g., brokerage or advisory); or with respect to rollovers, distributions, or transfers from the plan or IRA (including whether, in what amount, in what form, and to what destination).

The inclusion of advice related to rollovers, distributions, or transfers from the plan or IRA is a reversal of the DOL's position in 2005, and reflects the DOL’s current focus on advice given when participants and beneficiaries decide whether and when to take a rollover.

What is a Recommendation? The final rule defines a “recommendation” in the context of investment advice as any communication that, based on its “content, context, and presentation,” would reasonably be viewed as a suggestion that the recipient of the advice engage in or refrain from taking a particular course of action. Whether a recommendation occurs in any particular instance is a facts and circumstances determination. The DOL has indicated that the more individually tailored the communication is to a specific individual or plan, the more likely it is a recommendation. In addition, a series of direct or indirect actions that may not constitute recommendations when viewed individually, may amount to a recommendation when considered in the aggregate.

The DOL has carved out of the final rule certain types of recommendations that would otherwise constitute investment advice, but for the carve-out. These include communications that occur in specific types of arms-length transactions with plan fiduciaries who are licensed financial professionals (e.g., broker-dealers, RIAs, banks, insurance companies) or independent plan fiduciaries that hold, or have under management or control, total assets of at least $50 million. In addition, advisers who provide actuarial, accounting, or legal services are not treated as fiduciaries merely because they provide professional assistance in connection with particular investment transactions (unless acting outside their normal roles and recommending specific investments in connection with particular investment transactions). Finally, appraisals and valuations have not been included in the scope of the final rule, but the DOL has noted that they will be the subject of a separate regulatory initiative.

What is NOT a Recommendation? Non-fiduciary communications that do not constitute recommendations would not be covered by the final rule. This exception is intended to cover generalized communications and investment “education,” which encompasses plan information, general financial, investment, and retirement information, asset allocation models, and interactive investment materials. A recommendation also generally does not include an investment adviser’s “hire me” presentation; however, if the adviser includes an investment recommendation in his or her “hire me” presentation, that recommendation would be evaluated separately to determine if it falls within the scope of the final rule. A recommendation does not necessarily include “referrals” for an investment adviser, such as might be provided by a plan’s recordkeeper, although whether a referral rises to the level of a recommendation would depend on the content, context, and presentation in which it was made. Similarly, a service provider’s platform of investment offerings will not necessarily be construed as investment advice to the extent that the platform offerings are not particularized for the plan.

Although the final rule is effective as of June 7, 2016, its applicability date is April 10, 2017, in order to allow time for full compliance.

Part II: Two New Class Exemptions, and Amendments to Existing Exemptions

Because the definition of fiduciary under the final rule is expected to sweep in many investment professionals who are not currently considered fiduciaries with respect to the retirement plans and IRAs with which they work, the DOL has issued two new class exemptions; one of which is intended to permit ongoing flexibility in how investment advisers are compensated (the Best Interest Contract or “BIC” Exemption), and the other allowing these investment advisers to continue to engage in certain principal transactions with the retirement plan investor or IRA (the Principal Transactions Exemption), while preserving the interests of the plan and participants.

What is the BIC Exemption? The BIC Exemption covers advice to “Retirement Investors,” defined as plan participants or beneficiaries, IRA owners, and “retail” fiduciaries (i.e., fiduciaries who are not banks, insurance companies, RIAs or broker-dealers, or who do not manage at least $50 million in assets). It is also intended to offer relief to investment advisers whose scope of recommendations is limited to proprietary product offerings.

Fiduciaries who would otherwise be engaging in a prohibited transaction under ERISA and the Code because their compensation is affected by the investment product(s) selected by the advice recipient, such as through commissions, 12b-1 fees, revenue sharing, or other similar arrangements, may receive relief under the BIC Exemption. Also, advisers who receive level fees (i.e., those advisers whose fees would not normally vary based on the advice they provide) may seek relief under the BIC Exemption if their advice would move an investor out of a commission-based arrangement to a level fee arrangement, or would trigger a fee where none would otherwise exist (such as when rolling money out of an employer-sponsored plan into an IRA).

In order to qualify for the exemption, fiduciaries must meet specific disclosure and notice requirements. The DOL substantially streamlined the structure of the disclosure requirements that accompany the BIC Exemption from the proposed version of the exemption. To comply with the BIC Exemption, the investment adviser must (a) acknowledge that it is a fiduciary with respect to the investment advice it is providing; (b) adhere to the standards of conduct prescribed under the exemption; (c) enter into an enforceable contract with respect to IRAs and non-ERISA plans (however, no contract is required with respect to ERISA-covered plans because relief is available under ERISA); (d) receive no more than “reasonable” compensation for the transaction; and (e) provide detailed disclosures upon demand to Retirement Investors. In addition, the investment adviser wanting relief under the exemption must notify the DOL in advance, and retain certain records that can be made available to the DOL and to Retirement Investors for evaluating compliance with the exemption.

The BIC Exemption is applicable to transactions that occur on or after April 1, 2017, while the contract and disclosure requirements are delayed until January 1, 2018. For an investment adviser’s existing clients, the exemption permits negative consent, under which the Retirement Investor will be deemed to have consented to the terms of Best Interest Contract (or an amendment to an existing contract to bring it into compliance with the BIC Exemption) if he or she does not object within 30 days of receiving the contract or amendment. For new clients, the contract may be entered into before or concurrent with implementation of investment advice. Where a client works with more than one investment adviser at a given financial institution, only one contract, between the Retirement Investor and the institution, is required. The terms of the BIC Exemption can be integrated into existing contracts; a separate contract is not required.

What is the Principal Transactions Exemption? Fiduciaries who otherwise would be engaging in a prohibited transaction under ERISA and the Code because they are engaging in purchases and sales of certain investments with Retirement Investors out of their own inventory (principal transactions), such as with proprietary products, may receive relief under the Principal Transactions Exemption. The Principal Transactions Exemption permits plans and IRAs to purchase certain fixed income investments from advisers who are fiduciaries, which are limited to certificates of deposits, interests in Unit Investment Trusts, and certain debt securities. (The DOL will consider permitting other investments under individual prohibited transaction exemptions.) The exemption permits plans and IRAs to sell a broad range of investments to advisers who are fiduciaries, including any securities or other investment property that are within the range of assets that can be recommended by fiduciary advisers under the final rule. An exemption is also available under the Principal Transactions Exemption for “riskless” principal transactions, which occur when a financial institution, after receiving an order to buy or sell a security from a Retirement Investor, purchases or sells the investment for its own account to offset the contemporaneous transaction.

Similar to the BIC Exemption, and with the same effective dates, the investment adviser must provide the Retirement Investor with a written statement acknowledging its status as a fiduciary with respect to advice related to the principal transaction, adhere to the standards of conduct prescribed under the exemption, and, in the case of IRAs and non-ERISA plans, enter into an enforceable contract that includes the necessary exemption provisions (negative consent also applies with respect to these contracts).

What are the Changes to Existing Exemptions? In addition to the new exemptions, the DOL has amended certain existing prohibited transaction exemptions (PTEs) for consistency with the final rule. In particular, the amendments revise the PTEs to:

• permit fiduciary broker-dealers to receive compensation when lending money or extending credit to plans or IRAs to prevent the failure of a purchase or sale or a security, subject to the conditions prescribed in the amendment;
• permit fiduciaries under the final rule to receive compensation for their recommendations that plans or IRAs invest in fixed rate annuity contracts (as that term is defined under the amendment) or insurance contracts;
• include “Impartial Conduct Standards;” and
• increase the safeguards related to the exemptions provided in connection with certain securities transactions entered into by plans and IRAs.

Part III: Action Steps for Retirement Investors

Many of the investment advisers with whom plan sponsors and IRA owners work now will be considered fiduciaries under the final rule. Although the effective dates of the final rule and the exemptions are delayed to allow time to come into compliance, it is important that plan sponsors and IRA owners begin the process of determining whether any of their investment advisers who are not currently designated as fiduciaries to the plan or IRA will become fiduciaries under the new rule. If an investment adviser is a fiduciary under the new rule, plan sponsors will want to ensure that they receive the required statements of fiduciary status and, if the plan is not an ERISA plan, a contract (or amendment to an existing contract) by the effective dates set forth in the final rule and exemptions.