The U.S. Department of Labor (DOL) published its long awaited and highly controversial final rule on April 6, 2016, which addresses when a person is considered a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA), when providing investment advice to a Plan, its participants and beneficiaries.

Background

Over 40 years ago the DOL issued basic rules defining an investment advice fiduciary under ERISA. While these rules have not changed, the retirement landscape certainly has. Now there are more defined contribution plans, such as 401(k) plans as opposed to defined benefit plans, and the participant has more responsibility for selecting their own investments from the lineup provided. The need for quality investment advice is significant and the DOL in an attempt to protect investors updated the fiduciary definition to help investors make the right decisions.

What does the new rule mean in a nutshell?

The final rule defines who is a fiduciary investment adviser and holds them to a “fiduciary” standard of putting their clients’ best interests before their own.

Key Provisions

Fiduciary Investment Advice

Under the new rule, the kinds of communications that constitute investment advice are highlighted as well as the types of relationships and circumstances that cause this to be fiduciary investment advice. The key to establishing if there is fiduciary investment advice is whether a “recommendation” was provided. A “recommendation” is any communication, based on its content, context, and presentation, that would be reasonably viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.

Investment advice is a recommendation to a plan, plan fiduciary, plan participant and beneficiary or IRA owner for a fee or other compensation, direct or indirect, as to the advisability of buying, holding, selling or exchanging securities or other investment property, including recommendations as to the investment of securities or other property after the securities or other property are rolled over, transferred or distributed from a plan or IRA. It also includes recommendations as to management, investment policies or strategies, portfolio composition, selection of people to provide advice and recommendations with respect to rollovers, transfers or distributions from a plan or IRA.

In order for this investment advice to be considered fiduciary investment advice under the new rule, it must be a recommendation rendered for a fee or other compensation.

Exclusions from Fiduciary Investment Advice

Communications between investment advisors that do not meet the definition of “recommendations” will be excluded from fiduciary investment advice. The rules give the following examples that are specifically excluded from fiduciary investment advice:

  • Education about retirement plans and investments.
  • General communications, e.g. newsletters, conferences, general marketing materials etc.
  • General marketing from service providers offering a selection of investment alternatives to employers, as long as they state in writing that they are not giving advice in a fiduciary capacity.
  • Communications to banks, insurance companies, registered investment advisers, broker-dealers in the capacity of an independent fiduciary.
  • Communications between employees of the plan sponsor including the human resources department.
  • Recommendations to plan fiduciaries who manage, hold or control plan assets over $50 million.
  • Asset allocation models for participants in defined contribution plans that reference only designated investment alternatives in the plan lineup.

The Best Interest Contract (BIC) Exemption

The new rule expands the definition of a fiduciary and therefore there will be many investment consultants and providers that will be considered fiduciaries. Under ERISA, conflicts of interest are prohibited transactions and these fiduciaries providing investment and distribution recommendations for compensation would be considered prohibited transactions. The DOL, created the BIC exemption to allow retirement investors to receive advice in their best interest and allow the advisors to continue to receive commission-based compensation.

Under the BIC exemption, the advice provider must acknowledge fiduciary status for the advice being provided and adhere to basic standards of impartial conduct. Impartial conduct standards include the following:

  • Giving prudent advice in the best interest of the recipient.
  • Avoiding making misleading statements.
  • Receiving no more than reasonable compensation.

Fiduciary advisors must have policies and procedures in place to mitigate impacts of conflicts of interest and must disclose any conflicts and the cost of their advice.

Impact of the new rule for Plan Sponsors

The new rule does not change a plan fiduciary’s responsibilities, and these remain the same under ERISA. However, the new rule does impact the extent of Plan sponsor obligations. Plan sponsors need to understand the new rule and how it affects their relationships with plan service providers.  Investment advice providers will be held to a new fiduciary standard under the new rule and this will impact the nature of the relationships. Plan sponsors will need to look at fees and contracts and select service providers that act in the participant’s best interests. They will need to know whether the investment advisor is a fiduciary under ERISA, how they are compensated and if they fall under the BIC exemption. The fiduciary duty to select a quality service provider and ongoing monitoring still exists but will need to now encompass the impacts of the new fiduciary rule.

Effective Dates

The rule is phased in and effective from April 10, 2017 to January 1, 2018.