After much controversy and criticism, the Department of Labor (DOL) issued a final conflict of interest rule on April 6th (the “Final Rule”) which expands the definition of a fiduciary for an “employee benefit plan,” as defined under Section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974 (ERISA) and Section 4975(e)(3)(B) of the Internal Revenue Code of 1986. The definition of fiduciary is important because any person or entity that is considered a fiduciary is subject to fiduciary responsibility and standard of care, and if found in breach of the fiduciary standard can be subject to personal liability. Both plan sponsors and investment advisers should be aware of the Final Rule, given its focus on retirement plan investment advice.  

As way of background, the old fiduciary rule was issued in 1975, before the popularity and availability of 401(k) plans and IRAs.  Investment advisers were typically not subject to the fiduciary standard imposed under ERISA on plan sponsors and employers.  Under the old rule, a person or institution was considered a fiduciary adviser only if a five-part investment advice test was satisfied. Without a fiduciary obligation, advisers could potentially give imprudent advice or steer investment decisions towards products that would benefit the adviser rather than the best interests of the plan or participant.  

Due to the shift from traditional pension plans to 401(k) plans and IRAs, where employees rather than employers are responsible for directing investments, the DOL issued proposed rules updating the definition of “fiduciary” and “conflict of interest” in 2015.  The proposed rules were considered overly broad by the investment community. The DOL took into consideration these concerns and developed the Final Rule with a goal of safeguarding retirement savings from conflicted investment advice without deterring investment institutions from providing recommendations to plans and participants.

What Is New in the Final Rule?

The Final Rule departs from the previous five-part test and considers a person or entity a fiduciary if he or she provides investment advice for a fee to an employee benefit plan or its participants. Investment advice may be direct or indirect and fit into certain categories of advice:

• Recommendation as to the advisability of acquiring, holding, disposing of, or exchanging securities (i.e., investments), including whether or not to rollover funds from an employer-sponsored plan to an IRA.
• Recommendation as to the management of securities or other investment property.
• Recommendation of another person to provide investment advice or investment management.

In order to trigger fiduciary responsibility, the recommendation must:

• Represent or acknowledge that the adviser is acting as a fiduciary;
• Be pursuant to a written or verbal agreement, arrangement, or understanding that the advice is based on the particular investment needs of the recipient; or
• Be directed to a specific recipient regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

Communications that Are Not Recommendations

Because the Final Rule defines what counts as an investment recommendation so broadly, the DOL provided nonexhaustive examples of certain types of communications that generally are not recommendations and, therefore, are not fiduciary communications, including the following:

• General communications would not ordinarily constitute an investment recommendation. Examples include general marketing materials, general market data (including performance reports, price quotes, and prospectuses), and presentations in widely attended speeches or conferences. Whether or not a communication is “general” or “specific” is an objective determination that depends of the facts and circumstances of each situation.
• Investment education describing the benefits of plan participation, the terms or operation of a plan, retirement income needs, and forms of distributions (including rollovers) are not investment recommendations. Similarly, information and materials on financial, investment, and retirement matters that do not address specific investment alternatives are not fiduciary communications.
• A response to a plan’s request for proposal (RFP) with a sample line-up of investments is not a recommendation under the Final Rule.
• Communications about an arm’s length transaction involving the investment of securities or other property are not considered an investment recommendation so long as the parties have a high degree of financial sophistication.

In addition to the above, the Final Rule also makes clear that a plan sponsor’s human resources personnel or plan service providers who have no power to make decisions as to plan policy (including actuaries, accountants, and attorneys) are not considered investment advice fiduciaries with respect to the plan.

BIC Exemption

Coincident with the issuance of the Final Rule, the DOL published a new exemption from the prohibited-transaction rules that prohibit an investment fiduciary from charging non-level fees. The Best Interest Contract Exemption (or “BIC Exemption”) permits current investment fee arrangements between plan sponsors and financial institutions acting as advisers to continue, as long as there are the additional “best interest” assurances.  Plan sponsors should understand the BIC Exemption when negotiating such fee structures.  In order to qualify for the BIC Exemption, a financial institution serving as an investment fiduciary must:

• Acknowledge its fiduciary status;
• Give prudent advice that is in the best interest of the advice recipient;
• Avoid misleading statements; and
• Receive no more than reasonable or level-fee compensation.

Investment fiduciaries who charge level fees are permitted under the BIC Exemption to comply with a streamlined process that requires:

• A written statement of fiduciary status;
• Compliance with standards of impartial conduct; and
• Documentation of the specific reason for the level-fee arrangement.

Takeaways for Plan Sponsors

The Final Rule does not go into effect until June 7, 2016, with a phase-in transition period through January 1, 2018. Accordingly, plan sponsors have time to work with their investment advisers to determine if any actions are necessary to comply with the Final Rules. In making this determination, plan sponsors should consider the following takeaways from the Final Rule:

• A plan sponsor’s existing fiduciary duties are unaffected by the Final Rule.
• Brokers are the most likely to be affected by the Final Rule.  Some of them who are not currently considered investment fiduciaries will be once the Final Rule becomes effective.
• Plan sponsors have no obligation to ensure that their investment adviser complies with the Final Rule, but it is their best interests to work with their adviser to ensure compliance.
• A plan sponsor should consider asking its service providers (including brokers, advisers, and recordkeepers) if they are affected by the Final Rule as a way to inventory which ones consider themselves investment fiduciaries.
• Expect some service providers to renegotiate their contracts, and review these new contracts with ERISA counsel.

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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