After years of political battles, the Department of Labor (DOL) recently issued the highly anticipated final fiduciary rule. As expected, the final rule requires all financial advisors (including broker-dealers, registered investment advisors and insurance agents) to put their clients’ best interests before their own profits when they give retirement investment advice. The final rule applies when advising retirement plans (ERISA and non-ERISA plans) and individual retirement accounts (IRAs). So what does this mean for plan sponsors? That depends on the type of financial advisor the plan sponsor is using for its pension or 401(k) plan. Today, registered investment advisors and their representatives are already deemed to be fiduciaries for purposes of federal and state securities laws, but broker-dealers and insurance agents are currently subject to a different “suitability” standard, even though they are often providing similar investment recommendations. Under the suitability standard, broker-dealers are not required to put their clients’ interests above their own when making investment recommendations. As long as the investment is suitable for the client based on the client’s financial needs, objectives and unique circumstances, it can be recommended to the client, even if the particular investment choice pays the broker-dealer or insurance agent a higher fee, commission or other compensation than a comparable investment product. New Rule Highlights The new rule applies the same ERISA fiduciary standard of care to registered investment advisors, broker-dealers, insur-ance agents, banks and other advisors to retirement plans and IRAs. Fiduciary Definition An investment fiduciary now includes anyone who gives “covered investment advice,” as described below, with respect to a retirement plan or IRA for a fee or other form of compensation, regardless of whether it is paid directly by the client or indirectly by a third party (e.g., a mutual fund or other investment or insurance product company paying trail commissions, 12b-1 fees, referral or solicitor fees and revenue sharing) and satisfies any one of these three additional conditions:
The advisor represents or acknow-ledges he is acting as a fiduciary;
The advisor renders advice pursuant to a written or verbal agreement, arrangement or under-standing that the advice is based on the recipient’s particular investment needs; or
The advisor directs the advice to a specific recipient regarding the advisability of a particular investment or management decision with respect to securities or other property of a retirement plan or IRA.
Covered Investment Advice The rule describes what is and what is not “covered investment advice.” Covered investment advice includes:
Recommendations: A “recommendation” means a communication to a plan fiduciary, plan participant and/or IRA owner 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 certain action with respect to securities or other investment or insurance products. The more individually tailored the communication, the more likely the communication will be viewed as a recommendation. For example, call center employees who are paid only a salary will become fiduciaries if they make specific recommendations to plan participants and IRA owners.
Rollovers: Covered investment advice now also includes recommending rollovers, transfers or distributions from a plan or IRA, including whether, in what amount, in what form and to what destination such a rollover, transfer or distribution should be made.
Covered investment advice does not include: (Note: The rule has a long list of exclusions. We have highlighted below only those exclusions most relevant to plan sponsors.)
Investment Education: Investment education includes general information about the terms and operation of the plan, fee and expense information, risk and return characteristics and historical return information. The exclusion also allows asset allocation modeling and interactive materials, such as questionnaires.
General Communications: General information includes newsletters, commentary in publicly broadcasted talk shows, remarks and presentations in speeches and conferences and research prepared for general distribution.
Employees of Plan Sponsors: Employees working in a company’s payroll, accounting, human resources or finance department who routinely provide reports and recommendations for the company or plan fiduciaries are not investment advice fiduciaries if the employees receive no compensation for such activities beyond their normal wages. This exclusion also covers communications between employees, such as human resources staff members who communicate information about the plan to employees, if they receive only their normal compensation thatis unrelated to investment recommendations or selections.
Prohibited Transaction Exemptions Under ERISA and the Internal Revenue Code (Code), fiduciary investment advisors to plans and IRAs are not permitted to receive payments creating conflicts of interest (e.g., compensation that varies based on the investment advice), except as permitted under a prohibited transaction exemption (PTE). The final rule creates two new PTEs and modifies several existing PTEs. The most relevant of these to plan sponsors is the new Best Interest Contract (BIC) PTE. The BIC PTE is not an exemption from the new fiduciary standard of care, just permission to receive fully disclosed conflicted compensation under specified conditions. Best Interest Contract PTE: The BIC PTE is available to investment fiduciaries (advisors, financial institutions and their affiliates and related entities) providing nondiscretionary advice to plan participants and beneficiaries, IRAs and non-institutional (retail) plan fiduciaries. Generally, the BIC PTE allows nondiscretionary investment fiduciaries to continue their current fee practices (including receipt of commissions, 12b-1 fees and revenue sharing) if certain basic standards set forth in the BIC PTE are satisfied. The BIC PTE is not available to advisors who have discretionary control over the investment of the retirement plan or IRA assets. Fiduciaries that receive only a “level fee” (i.e., a flat dollar amount or a basis point fee) paid by the client in connection with advisory or investment management services may comply with more streamlined conditions designed to target the conflicts of interest associated with such services. The ongoing receipt of a level fee from the client typically would not raise prohibited transaction concerns. The DOL noted, however, that certain transactions, such as rollover recommendations, could give rise to conflict concerns because of the additional fees and charges resulting from the change. Transition and Effective Dates To give investment firms time to come into full compliance, the DOL adopted a phased implementation approach. On April 10, 2017, the broader definition of fiduciary will take effect, including its application to IRA accounts. Full compliance with the BIC PTE will be required on January 1, 2018. Action Steps for Plan Sponsors Although lawsuits opposing the rule already have been filed, these cases may or may not delay the rule’s effective dates. So, with less than a year until the first phase of the rule becomes law, plan sponsors should begin to evaluate the impact of the rule on their retirement plans now. Below are some action steps to consider:
Review the services being provided by current service providers (investment advisors and record keepers). Plan sponsors need to determine whether the services received are fiduciary or non-fiduciary services under the new rule. The first step in this process is to ask the service provider directly. The next step is to review all service provider contracts; the contract should clearly state whether the services are fiduciary or non-fiduciary services. Beware of any disconnect between what the advisor says and the contract language. Determine whether current non-fiduciary services may become fiduciary services under the new rule (e.g., rollover recommendations) and revise the agreement as necessary.
Ask service providers (investment advisors and record keepers) how they intend to address and comply with the new DOL fiduciary rule. If they currently are receiving commissions or other types of non-level compensation, will they be moving to a level fee arrangement? Do they plan to take advantage of the BIC PTE? If they have not yet decided on how they will comply with the new rule, have them clarify their timing for coming into compliance.
Review Plan Education Materials. Review and update, as necessary, all retirement plan educational materials to ensure any information provided does not cross over into covered investment advice.