Compliance August 1, 2017

Can States Pick Up DOL Fiduciary Enforcement Slack?

There are certainly states that are attempting to do so, but it’s unclear whether ERISA’s preemption of state law will render their efforts toothless. 
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A Client Alert shared by Stradley Ronon, penned by ERISA attorneys George Michael Gerstein, Jessica Burt, and James Severs, warns that several states are in the process of debating and potentially adopting their own legislation relating to the fiduciary responsibilities of broker/dealers and investment advisers.

The laws could make for some interesting and challenging legal circumstances in the future, the alert warns, given that the Employee Retirement Income Security Act (ERISA) is generally understood to preempt state law. In recent years this generally meant that the Department of Labor (DOL) could enforce more rigorous conflict of interest standards on behalf of retirement investors than the individual regulators in more conservative states were apt to do. However, now that Republicans have regained control of Congress and the White House and are aiming at relaxing the recently expanded fiduciary rule the Obama administration sought to establish under ERISA, some states are considering what powers they have to pick up the slack.

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Among the states debating/implementing their own conflict of interest rules are Connecticut, New Jersey and New York. Effective July 1, according to the Stradley Ronon attorneys, broker/dealers and investment advisers operating in Nevada became subject to the state’s financial planner statue, known as NRS 628A, “making them fiduciaries to their clients and requiring them to submit to a rigorous disclosure regimen.” 

Similar to the approaches being take elsewhere, in Nevada, the newly adopted legislation removes existing exemptions for broker/dealers, investment advisers and their respective representatives from the definition of a “financial planner.” The statutory fiduciary duty specifically requires financial planners to “disclose to a client, at the time advice is given, any gain the financial planner may receive such as profit or commission, if the advice is followed.”

The statutory fiduciary duty also requires financial planners, through a “diligent inquiry of each client,” to make an initial determination of suitability of the advice to be given to each client as well as to evaluate such suitability on an ongoing basis. As the attorneys note, in making such determinations of suitability, the financial planner should consider “the client’s financial circumstances and obligations and the client’s present and anticipated obligations to and goals for his or her family.”

“Broker-dealers, investment advisers and their respective representatives will be financial planners under Nevada law if they advise others for compensation upon the investment of money or upon provision for income to be needed in the future, or if they hold themselves out as qualified to perform either of these functions,” the attorneys explain. “As financial planners, they will now be subject to Nevada’s statutory fiduciary duty with respect to advice that they provide to Nevada clients.”

Crucial to note, the attorneys argue, whether or not advisers/brokers registered with the U.S. Securities and Exchange Commission are exempt from the Nevada laws on federal preemption grounds “is an open question.” It will be an important question to answer, given that the legislation also grants to the clients of financial planners a statutory right of action if the financial planner violates any element of the fiduciary duty, is grossly negligent in the provision of advice to the client, or violates any state law in the provision of investment advice.

The full client alert can be downloaded here. 

Client Service August 1, 2017

DB Plan Sponsors Using Different Strategies for Cost, Funding Measures

PwC finds some DB plan sponsors are using multiple discount rates, and some have moved to mark-to-market accounting.
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For defined benefit (DB) plans included in a PwC study, the 2016 median discount rate decreased 20 basis points since 2015 (from 4.30% to 4.10%) and has decreased more than two full percentage points since 2007 (from 6.25%), reflecting the low interest rate environment of the past decade.

PwC’s Pension/OPEB 2017 Assumption and Disclosure Study, which represents an analysis of the 2016 year-end assumptions and disclosures of DB plans and analyzed data for 100 companies, comprising Fortune 100 and other large and established companies with a December 31 fiscal year-end, also found the 2016 median expected long-term rate of return on pension plan assets decreased 25 basis points since 2015 (from 7.25% to 7.00%) and 130 basis points since 2007 (from 8.30%), reflecting less optimistic capital markets outlooks of investment professionals.

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The 2016 median salary scale assumption decreased 17 basis points since 2015 (from 3.97% to 3.80%) and has decreased 45 basis points since 2007 (from 4.25%).

Median plan funding levels remained unchanged from 2015, with pension plan assets equal to approximately 82% of the projected benefit obligation (PBO) in 2016 and 2015. In 2007, the median funded ratio was 100%. If interest rates were to return to 2007 levels, PwC estimates the median funded ratio would increase to roughly 110%.

Median deferred losses for pension plans in the study remained unchanged at 33% of the projected benefit obligation at the end of both 2015 and 2016. Of the 89 companies that defer recognition of gains/losses, 87 were in a loss position at 12/31/2016.

Median 2016 asset allocations for pension plans in the study were generally consistent with 2015 allocations at 40% equity, 39% debt/fixed income, and 16% other in 2016, compared to 39% equity, 40% debt/fixed income, and 15% other in 2015. In 2007, the median values were 64% equity, 29% debt/fixed income, and 5% other.

NEXT: Changing trends in DB plan measurements

According to the study report, until recently, most companies used a single discount rate approach—a single weighted average discount rate determined from measurement of the projected benefit obligation was also used to measure the interest cost and service cost components of benefit cost. However, beginning in 2015, many companies adopted an alternative approach, with separate measurement of the projected benefit obligation, interest cost, and service cost. Under this approach, individual spot rates from a yield curve are matched with the respective future cash flows. This results in different weighted average discount rates for the projected benefit obligation, interest cost and service cost.

Of the 100 companies in the study, 36 disclosed adopting a multiple discount rate method at year-end 2016, an increase from year-end 2015 when 25 companies disclosed using such method.

PwC says another key component of net benefit cost is the gain or loss resulting from changes in assumptions or actual experience different from assumptions (for example, mortality, returns on plan assets, discount rates). Most companies defer recognition of these gains and losses through accumulated other comprehensive income and amortize them to income over future periods.

However, PwC found over the last few years, some companies have elected instead to immediately recognize these gains and losses in income (sometimes referred to as a mark-to-market approach). Of the 100 study companies, eight disclosed using a full mark-to-market approach, in which all gains or losses are recognized in income in the year they occur. Further, three companies disclosed using a partial mark-to-market approach, in which gains or losses only in excess of a corridor (10% of the greater of beginning of year PBO and asset values) are recognized immediately. The number of companies using a mark-to-market approach is consistent with the prior year.

The study also found the number of companies that had frozen their funded pension plans has been increasing each year. Based on information disclosed in the study data collected, in 2007 only one company had disclosed a frozen plan or plans, compared to 20 companies in 2015 and 21 companies in 2016. PwC concedes that these numbers may be understated, since for some companies in the study it was unable to determine based on their disclosures whether the company had frozen one or more pension plans.

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