The final rule has implications for plan sponsors and may impact certain relationships with service providers.
On April 6, after a long (and some might say tortured) process, the US Department of Labor (DOL) issued a final rule revising the definition of who is considered a fiduciary under the Employee Retirement Income Security Act of 1974, as amended (ERISA) and Section 4975 of the Internal Revenue Code (the Code) by virtue of providing investment advice to covered plans and accounts. The final rule is the culmination of a nearly seven-year undertaking by the DOL and US President Barack Obama’s administration to expand the universe of retirement plan advisers who are subject to the fiduciary standards of ERISA and the prohibited transaction provisions of Section 4975 of the Code.
The final rule will have a significant impact on the financial services community and will affect how many retirement plans receive investment advice from financial services institutions. While the rule’s most dramatic effects are likely to be on IRAs and their investment providers, ERISA plan fiduciaries need to be cognizant of the provisions directed towards them and the actions they will need to take given the sea change in this area.
The final rule will expand significantly on who is considered an investment advice fiduciary under ERISA and Section 4975 of the Code. Specifically, under the current DOL regulations (adopted more than 40 years ago), an adviser would only be considered a fiduciary if the advice arrangement meets a five-part test focused on, among other things, the advice being ongoing in nature, specifically directed to the plan recipient, and pursuant to a mutual understanding of the nature of the relationship. At the time the original changes were proposed in 2010, the DOL expressed the view that this regulation allowed many financial professionals to avoid fiduciary status by drafting their contracts specifically to rebut a conclusion that there was a mutual understanding or that the advice was ongoing in nature. The final rule attempts to address this perceived evasion of ERISA’s coverage.
Under the new definition, a person will be considered to provide investment advice to a plan or IRA (or their respective participants, beneficiaries, fiduciaries, or owners) if he or she provides either
Further, the above-described recommendation types must be made by a person who either directly or indirectly
Notably, this definition removes the requirements that the arrangement be ongoing in nature and/or pursuant to a mutual understanding. As such, it may be more difficult for financial service providers to use disclaimers to avoid fiduciary status. Additionally, the final rule will now specifically treat advice related to rollovers and distributions from plan accounts as fiduciary in nature. This is a reversal of the DOL’s prior position as outlined in the Deseret advisory opinion, where the DOL opined that such advice would not, in itself, render the adviser a fiduciary under ERISA or Section 4975 of the Code.
Given the broad definition of what constitutes a “recommendation” for purposes of the final rule, the DOL clarifies that the following types of specified activities will not be considered recommendations:
Additionally, the DOL created certain additional exceptions that will not be treated as investment advice where the person does not represent or acknowledge that it is a fiduciary:
|certain registered investment advisers,
|broker-dealers registered with the US Securities and Exchange Commission (SEC), and
|independent plan fiduciaries with at least $50 million under their management or control.
The financial professional transacting with these sophisticated fiduciaries must know or reasonably believe that the independent fiduciary is capable of evaluating investment decisions of the type involved in the transaction. Further, the “seller” must disclose any known conflicts and its financial interest in the transaction. Finally, the adviser may not receive a fee directly from the plan for providing advice in connection with the transaction or otherwise represent that it is a fiduciary of the plan in connection with the transaction. The Independent Fiduciary Exception, therefore, allows the adviser to receive fees in connection with products it sells to a plan provided that a fiduciary with financial expertise is making the decision on behalf of the plan to purchase a product. Notably, the exception does not apply advice that may be provided in the course of selling a product to IRA owners and/or individual plan participants.
Even with the exceptions described above, the final rule will cause many service providers to be deemed fiduciaries under ERISA and Section 4975 of the Code. For ERISA covered plans, this means that the service provider would be subject to, among other things, the standards of care and loyalty found in Section 404 of ERISA and the prohibited transaction rules set forth in Section 406 of ERISA. Advisers to IRAs would become subject to the prohibited transaction rules set forth in Section 4975 of the Code. The application of these provisions to many advisers could cause common compensation and sales practices to result in prohibited transactions under ERISA and/or the Code if the advice provided leads to additional compensation to the adviser. Accordingly, the DOL simultaneously issued a series of exemptions that the DOL believes will allow many common fee arrangements to continue if the terms of the exemptions are met. The most far-reaching exemption is the Best Interest Contract (BIC) exemption. Additionally, many commonly used existing exemptions have been modified to include some of the concepts contained in the BIC exemption.
Generally, the BIC exemption requires that a fiduciary adviser’s financial institution enter into a client contract whereby it agrees to act in the “best interest” of the client. The financial institution overseeing the relationship is required, among other things, to
The BIC exemption also contains a streamlined exemption for level fee arrangements under which the adviser’s compensation is not affected by the differing investments chosen.
Given the administrative complexities associated with the BIC exemption, it remains to be seen how financial services firms will need or want to revise their existing practices to comply with the final rule.
As noted above, one area of import for plan sponsors is providing investment education to plan participants. The final rule makes it clear that there is a fine line between providing non-fiduciary education and providing fiduciary advice. Importantly, if communications are viewed as education, the content will not be subject to the fiduciary standards—regardless of who provides the information, how often it is shared, or the manner in which it is provided. The final rule incorporates much of the DOL’s prior guidance in setting forth this distinction.
As described in the final rule, “investment education” includes
In a change from the proposal, and consistent with prior guidance, the DOL has stated that asset allocation models and interactive investment materials provided to plan participants may include specific investments and still be considered educational materials if
This should be helpful for sponsors that wish to offer participant education tools that can guide participants to investment options identified through the asset allocation model or interactive material, rather than having to identify the asset classes generically and leave it to participants to identify the options under the plan in those asset classes. Notably, this is not the case for asset allocation models and interactive materials for IRA owners. For IRA owners, any model or materials that identify specific investments will be viewed as fiduciary investment advice rather than non-fiduciary investment education.
The revised definition of “fiduciary investment advice” and the new and amended exemptions do not become “applicable” until April 10, 2017. Until then, the current definition of fiduciary investment advice will remain in effect. Moreover, the BIC and other new exemptions include a transition period under which more limited conditions will apply until January 1, 2018.
During the next year, plan fiduciaries and sponsors will have much to do in anticipation of the new rule. In light of the final rule, plan sponsors and fiduciaries may wish to do the following:
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Lisa H. Barton
Craig A. Bitman
 29 CFR 2510.3–21 (1975).
 The final rule utilizes what is described as an objective test to define a “recommendation” for these purposes. Specifically, a “recommendation means a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.”
 Advisory Opinion 2005–23A (Dec. 7, 2005).
 Some examples that could potentially violate the prohibited transaction rules, according to the DOL, depending on the specific facts and circumstances, include advising a client to (i) transfer from a lower cost investment to a higher cost investment; (ii) roll over his/her plan account to an IRA along with a recommendation of how to invest that IRA; and (iii) switch from commission-based brokerage to a wrapped fee arrangement.