DOL attempts again to expand range of investment advisors subject to ERISA as fiduciaries


The Department of Labor has issued a long-awaited restatement of proposed rules that are intended to protect plan participants from potentially conflicted investment advice by subjecting a broad range of retirement and investment advisors to ERISA’s fiduciary requirements. Although many retirement advisors would be newly subject to the fiduciary standards, the DOL has also proposed a “best interest contract” PT Exemption, which would allow brokers and other investment firms to continue to retain current forms of compensation, including commissions and revenue sharing, as long as they mitigated the risk of conflicts of interest and disclosed such conflicts.

Current rules allow for conflicts of interest

Current regulations, ERISA Reg. §2510.3-21(c), issued in 1975, define the circumstances under which a person renders “investment advice.” A person who renders investment advice under the regulations, and receives a fee or other compensation, direct or indirect, for doing so, is considered a fiduciary under ERISA §3(21)(A)(ii).

Under ERISA Reg. §2510.3-21(c)(1), a person renders investment advice if the following requirements are satisfied.

(1) The person renders advice to the plan regarding the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property.

(2) The person rendering the investment advice either directly or indirectly, (a) has discretionary authority or control (whether or not pursuant to an agreement) over the purchase or selling of securities or other property, or (b) renders any advice with respect to the value of securities or the advisability of investing in, purchasing, or selling securities or other property (whether or not pursuant to discretionary authority or control) on a regular basis pursuant to a mutual agreement, arrangement, or understanding (written or otherwise) between such person and the plan or fiduciary which stipulates that such advice will serve as the primary basis for investment decisions with respect to plan assets and that the person will render individualized advice to the plan based on the particular needs of the plan.

ERISA Reg. §2510.3-21 has effectively limited fiduciary status to investment advisers who satisfy each element of the above test. As a consequence, the DOL has claimed that it is not able to hold investment advisers accountable for even the most abusive advice unless each element of the test can be established. In addition, the DOL has noted, service providers may be structuring their relationship with plans in order to avoid being treated as a fiduciary under the conditions of ERISA Reg. §2510.3-21. For example, a service provider that offers investment recommendations may include a provision in the contract that states that the investment recommendations are not intended to be the primary basis for plan investment decisions. A service provider may also present investment fund options to a plan at the time the plan is established, but maintain that it is not a fiduciary because the plan sponsor is responsible for selecting the funds that are actually included in the plan, even if the funds have paid the provider (through 12b-1 fees and or sale loads) to be included in the options offered to the plan.

The DOL has expressed concern that such arrangements invite a conflict of interest from which the service provider is shielded from liability because it may not be a fiduciary under ERISA Reg. §2510.3-21. Heightening the DOL concern is the fact that plan sponsors (especially sponsors of small plans) and participants may further assume that the service providers that are providing investment assistance are actually subject to ERISA as fiduciaries. Thus, plan sponsors may rely on recommendation or other advice without being aware of a service provider’s financial incentives (e.g., sales commissions) for recommending the adoption of select investment funds as plan investment options.

Proposed rules issued in 2010 withdrawn. The DOL issued proposed rules in October 2010 that would have addressed the perceived conflicts of interest by significantly expanding the definition of a fiduciary under ERISA. Significantly, the proposed rules would have defined investment advisers as fiduciaries even if they did not provide advice on a regular basis or pursuant to a mutual understanding that the advice would be the primary basis for plan investment decisions.

The proposed rules generated over 260 written public comments and precipitated considerable consternation among brokers and other service providers. Financial professionals specifically charged that the proposed rules would increase costs and discourage service providers from furnishing investment advice. Deferring to the outcry and acknowledging that the proposed rules “may inappropriately limit the types of investment advice relationships that give rise to fiduciary duties on the part of the investment advisor,” the DOL announced in 2011 that it would withdraw the rules. Anticipating a restatement of the rules, EBSA indicated at the time that any reconfigured rules would address the concerns of brokers and advisers regarding the continued applicability of exemptions that allow brokers to receive commissions in connection with mutual funds, stocks, and insurance products.

The newly proposed rules, four years in the making, represent a thorough effort to accommodate the needs of investors and advisors. However, the labored history of the rules would suggest that the process is long from completion.

Retirement advice subject to ERISA fiduciary rules

The proposed rules would generally expand the definition of a fiduciary under ERISA Reg. 2510.3-21 to include any individual receiving compensation for providing advice (whether or not provided on a regular basis or as the primary basis for an investment decision) that is individualized or specifically directed to a particular plan sponsor (e.g., an employer with a retirement plan), plan participant, or IRA owner for consideration in making a retirement investment decision. Such decisions, the DOL explains, may include, but are not limited to, what assets to purchase or sell and whether to rollover assets from an employer-based plan to an IRA.

Specifically, under proposed ERISA Reg. Sec. 2510.3-21, a person would render investment advice with respect to moneys or other property of a plan or IRA by:

(1) Providing, directly to a plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner the following types of advice in exchange for a fee or other compensation, whether direct or indirect:

(i) A recommendation as to the advisability of acquiring, holding, disposing or exchanging securities or other property, including a recommendation to take a distribution of benefits or a recommendation as to the investment of securities or other property to be rolled over or otherwise distributed from the plan or IRA;

(ii) A recommendation as to the management of securities or other property, including recommendations as to the management of securities or other property to be rolled over or otherwise distributed from the plan or IRA;

(iii) An appraisal, fairness opinion, or similar statement whether verbal or written concerning the value of securities or other property if provided in connection with a specific transaction or transactions involving the acquisition, disposition, or exchange, of such securities or other property by the plan or IRA;

(iv) A recommendation of a person who is also going to receive a fee or other compensation for providing any of the types of advice described in paragraphs (i) through (iii); and

(2) Either directly or indirectly (e.g., through or together with any affiliate):

(i) Representing or acknowledging that it is acting as a fiduciary with respect to the advice described above; or

(ii) Rendering the advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is individualized to, or that such advice is specifically directed to, the advice recipient for consideration in making investment or management decisions with respect to securities or other property of the plan or IRA.

Uniform standard of fiduciary conduct. A fiduciary, under the proposed rules, could be a broker, registered investment adviser, insurance agent, or other type of adviser. Thus, the rules would eliminate the separate treatment of registered investment advisors and other parties offering investment advice, such as brokers and insurance agents.

Rules preserve access to retirement education

Redressing a concern that the proposed rules would prevent brokers and advisors from furnishing plan participants with general investment advice, the DOL has provided an exemption from the definition of retirement investment advice for education. Accordingly, advisors and sponsors would be able to continue to provide general education on retirement saving across employment-based plans and IRAs without triggering fiduciary duties. For example, an advisor could provide general information about the mix of assets (e.g., stocks and bonds) an average person should have based on their age, income, and other circumstances, while avoiding suggesting specific stocks, bonds, or funds that should constitute that mix. However, DOL cautions that references to specific investments, including the value of securities or property, would constitute advice subject to fiduciary duty.

Note: DOL Interpretive Bulletin 96-1 has allowed plan sponsors and advisors to provide general plan information; general financial information; asset allocation models; and interactive investment materials, such as worksheets, calculators, and risk questionnaires without incurring liability as investment advisors. The extent to which the rules as proposed would allow advisors to continue to provide such models and interactive materials (even without reference to specific products) without being subject to fiduciary constraints may need clarification.

Lifetime income information. The proposed rules would clarify that general information that helps an individual assess and understand retirement income needs past retirement and associated risks (e.g., longevity and inflation risks), or explains general methods for the individual to manage those risks within and outside the plan would not result in fiduciary status.

Rules allow for current business practices

The proposed rules acknowledge certain current practices as not involving fiduciary activity. Specially, the rules continue to treat “order-taking” as a non-fiduciary activity. Thus, as under current rules, when a customer calls a broker and tells the broker exactly what to buy or sell without asking for advice, that transaction does not constitute investment advice. Under such circumstances, the broker has no fiduciary responsibility to the client.

Similarly, the proposed rules allow for sales pitches to plan fiduciaries with financial expertise. the DOL acknowledges that many large employer-based plans are managed by financial experts who are fiduciaries and work with brokers or other advisers to purchase assets or construct a portfolio of investments that the plan offers to plan participants. Under such circumstances, the plan fiduciary is under a duty to look out for the participants’ best interest, and understands that if a broker promotes a product, the broker may be trying to sell them something rather than provide advice in their best interest. The proposed rules do not treat such transactions as fiduciary investment advice if certain conditions are met.

Note: Additional “carve-out” exemptions are provided for: swaps regulated by the SEC or CFTC; employees of the plan sponsor; investment platform providers; and ESOP appraisals.

Prohibited transaction exemptions

In order to minimize compliance costs and to allay concerns about the possible elimination of brokerage commissions, the proposed rules create a new type of Prohibited Transaction Exemption that the DOL describes as “broad, principles-based and adaptable to changing business practices.”
Best interest contract exemption. The “best interest contract exemption” will allow firms to continue to set their own compensation practices so long as they commit to putting their client’s best interest first and disclose any conflicts that may prevent them from doing so. Compliance with the exemption will allow for the continuation of compensation practices common in the financial services industry, such as commissions, revenue sharing, and 12b-1 fees, whether paid by a client or a mutual fund.

In order to comply with the “best interest contract exemption,” investment advisors and their firms must acknowledge fiduciary status and must enter into a contract with clients that satisfy the following conditions.

(1) Commits the firm and adviser to providing advice in the client’s best interest. Committing to a best interest standard, the DOL advises, requires the adviser and the company to act with the care, skill, prudence, and diligence that a prudent person would exercise based on the current circumstances. In addition, the DOL cautions, both the firm and the adviser must avoid misleading statements about fees and conflicts of interest.

(2) Warrants that the firm has adopted policies and procedures designed to mitigate conflicts of interest. Specifically, the DOL explains, the firm must warrant that it has identified material conflicts of interest and compensation structures that would encourage individual advisers to make recommendations that are not in clients’ best interests and has adopted measures to mitigate any harmful impact on savers from those conflicts of interest.

(3) Clearly and prominently discloses any conflicts of interest, such as hidden fees, which the DOL suggests, may be buried in the fine print or backdoor payments and may prevent the adviser from providing advice in the client’s best interest.

(4) The contract must direct the customer to a webpage disclosing the compensation arrangements entered into by the adviser and firm and make customers aware of their right to complete information on the fees charged.

Principles-based exemption. The DOL is also proposing a new “principles-based exemption” for principal transactions that would allow advisers to recommend and sell certain fixed-income securities to investors directly from the adviser’s own inventory. The advisor, however, would need to comply with stipulated consumer protections requirements that mirror those under the best interest contact exemption.

Possible “low-fee” exemption. The DOL has asked for comment on a “low fee exemption” that would allow firms to accept otherwise conflicted payments when recommending the lowest-fee products in a given product class. The low fee exemption would require compliance with fewer conditions than the best interest contract exemption.

Private rights of action authorized

Under current rules, consumers have limited recourse under ERISA and the Internal Revenue Code to redress conflicts of interest. The proposed rules are designed to ensure that retirement advisors are held accountable to their clients if they provide advice that is not in their clients’ best interest. Specifically, the “best interest contract exemption” empowers customers to hold fiduciary advisers accountable for providing advice in their best interest by authorizing a private right of action for breach of contract.

Arbitration requirement allowed. The DOL notes that investment firms can still require that individual disputes be handled through arbitration. However, the contract must allow clients the right to bring class action lawsuits in court if a group of people are harmed.

Consultation with SEC

The DOL indicated that it consulted extensively with the Securities and Exchange Commission (SEC) and other federal stakeholders. Specifically, the DOL coordinated with the SEC and the Commodity Futures Trading Commission (CFTC) regarding a carve-out for swaps and security-based swaps. The provision would not treat some persons involved in swaps transactions as ERISA fiduciaries when they perform duties required under applicable swaps and derivatives laws and implementing rules.

Note: The Dodd-Frank Act empowers the SEC to adopt a rule that brings the duty of care for broker-dealers into line with the standard for investment advisers. SEC Chair, Mary Jo White, has indicated to the House Financial Services Committee that she believed the SEC should move towards adopting a uniform fiduciary standard for brokers who give personalized securities advice to retail investors. White said any regulations would need to carefully define key terms, leave room for agency guidance, and be enforceable. She also confirmed that the SEC had provided “technical assistance” to the DOL regarding ERISA’s definition of “fiduciary.” However, White has not indicated a specific time frame during which the SEC will propose its own fiduciary duty rule. The DOL proposed rules could, thus, be finalized before the SEC takes actions.

It is important to note that the DOL proposal is limited to advice offered to participants in ERISA-governed retirement plans. By contrast, the SEC rules would cover brokers who also provide advice outside of the retirement plan context. Thus, the DOL has cautioned that it cannot take into account all possible conflicts with securities regulations or other laws because of these laws’ varied duties and remedies. Still, in the DOL’s view, its proposal “neither undermines, nor contradicts the provisions or purposes of the securities laws, but instead works in harmony with them.” However, investors, plan administrators, and advisors may have a legitimate concern that they may be subject to potentially conflicting rules from different federal agencies.

Projected cost savings

An exhaustive regulatory impact analysis accompanying the DOL proposal (lacking in the 2010 proposal) estimates that the rules and related exemptions would save investors over $40 billion over ten years. The real savings from the proposal, the DOL suggests, however, may likely be much larger as conflicts and their effects are both pervasive and well hidden.

Note: A White House Council of Economic Advisers analysis found that conflicts of interest in the retirement plan marketplace result in annual losses of about 1 percentage point for affected investors, resulting in losses of $17 billion per year. The Investment Company Institute has challenged the research underlying the DOL’s estimate of cost savings as “fatally flawed,” charging that claim individual plan participants pay “billions of dollars a year” in excess costs “does not stand up to the facts.” The costs of conflicted advice and the savings projected to be realized under the proposed regulations will, presumably, be a ripe subject for dispute during the comment period.

Source: 80 FR 21927, April 20, 2015.

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