Art by Tim BowerThe new fiduciary rule from the Department of Labor (DOL)
expands the definition of investment advice to create a very wide net, covering
many service providers that previously had not considered themselves
fiduciaries. All that is needed to constitute fiduciary advice is to make a
recommendation to follow a particular course of action—e.g., to buy, sell or
hold investment property—geared to the needs of the plan or its participants.
The new definition’s scope also includes making recommendations to take a
rollover from a plan and how to invest rollover assets. Further, the widened
net catches communications relating to investment policies and/or strategies,
plus the selection of investment managers and investment account arrangements
such as the choice between a brokerage and an advisory account.
A communication of this nature becomes fiduciary advice
merely by receipt of a fee by the person making the communication in return for
giving the advice. The regulation adds a “but for” test so that if the same fee
would have been paid irrespective of the recommendation, that will not be
characterized as fiduciary advice. On the other hand, if the recommendation is
viewed as part of a provider’s regular services, for which it earns a fee, the
provider would be deemed a fiduciary.
This wide net would be unworkable and disrupt the delivery
of plan services by providers unwilling to assume fiduciary obligations were it
not strategically narrowed by a half dozen exclusions from the fiduciary
definition. If a provider satisfies the conditions under one of these
exclusions, it will not be deemed a fiduciary even when providing
investment-related recommendations to retirement clients.
Several of these exclusions should be of particular interest
to advisers’ plan sponsor clients. The first exclusion deals with general
communications that a reasonable person would not view as an investment
recommendation such as newsletters, talk shows, speeches, research and news
reports, market data, performance reports and prospectuses. To encourage the
continued flow of information from defined contribution (DC) plan platform
providers, the DOL created another exclusion, which allows for marketing funds
on the platform if this is done without regard to the individualized needs of
the particular plan or its participants. To qualify for the exclusion, the platform
provider would also need to disclose in writing that it was not undertaking to
provide advice—impartial or otherwise.
Plan sponsors should understand, however, that the
exclusions skirt the main purpose of the new rule, which is to restrict
incentives for which fiduciary advisers steer retirement investors, including
plans, plan participants and individual retirement account (IRA) owners, to
more expensive investment products that raise the adviser’s compensation.
Imposing fiduciary status on the group left uncovered by the exclusions means
those advisers will violate the prohibited transaction rules of the Employee
Retirement Income Security Act (ERISA) if they receive variable compensation,
such as commissions, whose amount may increase or decrease depending on the
selected investment. Without expansion of the prohibited transaction system
consisting of roughly 55 class exemptions the DOL has issued, plan investment
activity would be in danger of seizing up.
In response to this need, the final regulatory package
includes a new best interest class (BIC) exemption that allows fiduciary
advisers to continue receiving variable compensation, subject to constraints
that include the adviser’s written commitment to a new fiduciary standard: the
best interest standard. This new standard combines ERISA’s duties of prudence
and loyalty and, most importantly, requires that investment recommendations be
made without regard to the fiduciary adviser’s own financial interests. This is
the heart of the entire regulatory package.
For IRAs and non-ERISA plans, the standard will need to be
reflected in a written contract that will be the basis for a new contract-based
legal action by these retirement investors. For ERISA plans or plans served by
fiduciaries receiving a level fee, the contract requirement is reduced to
providing a written statement of the adviser’s fiduciary status and adherence
to the best interest standard.
Depending on which version of the BIC exemption applies,
qualifying for that will require general disclosures regarding an adviser’s
compensation, transaction disclosures for each recommended investment, and
disclosure of related conflicts of interest, as well as a warranty that the
adviser’s firm has adopted compliance policies to mitigate these conflicts.
An adviser’s failure to meet the best interest
standard or to fulfill the other requirements of the exemption will mean that
he loses his protection, while touching all the substantive and procedural
bases of the exemption will mean that he remains eligible to receive variable
compensation such as commissions.
Marcia Wagner is an expert in a variety of employee benefits and executive
compensation issues, including qualified and nonqualified retirement plans, and
welfare benefit arrangements. She is a summa cum laude graduate of Cornell
University and Harvard Law School and has practiced law for 29 years. She is a
frequent lecturer and has authored numerous books and articles.