Nearly a year after it was proposed, the DOL has finalized its regulation redefining and broadening the meaning of fiduciary investment advice, as well as new and revised class exemptions from prohibited transactions potentially affecting the expanded class of fiduciaries. As predicted, the effective date of the new rule is 60 days after its formal publication on April 10, 2016. Although this means that the fiduciary regulation will take effect on June 9, 2016, its applicability will be delayed until April 10, 2017 which is somewhat longer than the eight months lead time the DOL originally signaled. Moreover, the need to comply with many of the conditions necessary to qualify for various exemptions under the new prohibited transaction guidance will not be required until January 1, 2018.
Expanded Fiduciary Definition. As under the proposed fiduciary rule, the final regulation significantly enlarges the definition of fiduciary advice. As would be expected, the finalized definition covers recommendations relating to the holding, acquisition and sale of securities or other property, but as under the proposed revision, it will also cover recommendations to take rollovers from a plan, as well as investment recommendations for rollover assets. The final regulation drops the proposal’s inclusion of financial valuations, appraisals and fairness opinions as covered fiduciary recommendations but signals that the DOL is developing an amendment that will cover ESOP appraisals.
The final regulation also follows the proposed fiduciary advice definition by covering recommendations relating to the investment management of plan or IRA assets, including rollover assets, so that recommending an investment manager can have fiduciary implications. The final rule clarifies that investment management recommendations can also include communications relating to investment policies or strategies, portfolio composition and the selection of investment account arrangements, such as the choice of a brokerage or advisory account.
Non-fiduciary Adviser Referrals. An issue that particularly concerned NIPA membership was whether certain incidental communications could come within the definition of fiduciary investment advice. Some thought a literal reading of the proposal could result in a third party administrator (“TPA”) becoming an inadvertent fiduciary if it responded to a question from a retirement plan client about available investment advisers, even though the TPA’s fee was not related to or contingent on the response. As required by statute, fiduciary status only applies to a service provider if it receives compensation in connection with its referral or recommendation.
The finalized fiduciary regulation attempts to deal with incidental advice rendered with respect to investment advisers by redefining the requisite fee or other compensation either as an amount explicitly received for particular advice or a fee that would not have been paid but for the advice or if eligibility for or the amount of the fee is based in whole or in part on the advice. Accordingly, if a TPA can show that a referral or recommendation with respect to an investment adviser was purely an extra for which no fee was received, the recommendation should be non-fiduciary in nature. On the other hand, if the recommendation is deemed to be a part of its regular services, for which it earns a fee, the TPA could potentially be viewed as a fiduciary adviser.
Additional Conditions for Fiduciary Advice. Under the old definition of fiduciary advice, there needed to be a mutual understanding between the parties that the advice would serve as a primary basis for plan investment decisions. The proposal eliminated these requirements and under the final version of the definition, there only needs to be an understanding that a recommendation is based on the particular investment needs of the retirement investor receiving it or directed to a specific recipient regarding the advisability of a particular investment or management decision with respect to plan or IRA assets.
Under the final rule, the threshold question in determining if fiduciary advice has been rendered is whether a “recommendation” has occurred. Of particular relevance to recordkeeping platforms (“recordkeepers”) that offer a platform of investment vehicles to their 401(k) plan clients is the final regulation’s statement that, “[p]roviding a selective list of securities to a particular advice recipient as appropriate for that investor would be a recommendation as to the advisability of acquiring securities even if no recommendation is made with respect to any one security.” This reflects the DOL’s longstanding view, as reflected in the preamble to the final rule that “specific recommendations as to underlying investments on a platform would continue, of course, to be fiduciary investment advice.”
Platform Provider Exception. Fortunately, the final regulation retains the proposed rule’s concept of a platform provider carve-out from the fiduciary definition enabling recordkeepers to maintain their non-fiduciary status on the condition the recordkeeper provides written disclosure that in offering an investment platform it is not purporting to provide impartial investment advice or to give advice in a fiduciary capacity. To qualify under this platform provider rule, which now takes the form of an exception to the activities that the final fiduciary rule treats as fiduciary recommendations, the recordkeeper would also need to market the platform without regard to the individualized needs of the particular plan or its participants. However, the preamble to the final rule indicates that some level of customization (referred to as “segmentation”) will be allowed so that winnowed bundles of investment options may be offered to different general types of plans differentiated by objective criteria (e.g., small, medium and large plans). Nevertheless, the preamble warns that if a recordkeeper communicates that a particular platform is “appropriate” for a given plan, the communication will likely constitute a fiduciary recommendation.
Other communications and activities related to providing an investment platform that are considered exempt recommendations under the final rule include identifying investment alternatives meeting objective criteria specified by a plan fiduciary, such as investment funds of a certain size or with expense ratios below a particular threshold. A provider can also respond to requests for identification of investment alternatives with a particular type of asset or credit quality. These exemptions are conditioned on the platform provider’s written disclosure of any financial interest it may have in the alternative investments and the precise nature of this interest. In addition, the provider would be permitted to provide on an exempt basis objective financial data for investment alternatives, as well as independent benchmarks.
To these exempt recommendations, which would have been permitted under the proposed rule, the final regulation adds the ability to respond to an RFP or similar plan solicitation by identifying a limited sample set of investment alternatives based on the size of the employer plan or the current investment alternatives designated under the plan provided the response is in writing and discloses the provider’s financial interest in these investments, if any.
Bundled Investment Services. The preamble to the final regulation also addresses the status or related services frequently bundled with investment platforms, such as elective managed account programs, qualified default investment alternatives, investment adviser/manager options, and non-affiliated RIA services. The preamble states the DOL’s belief that “much” of the information a platform provider would convey to plan clients in explaining these would not involve investment recommendations within the meaning of the fiduciary rule, but does not provide practical guidance with respect to identifying the type of information that might have fiduciary implications. The preamble indicates the final regulation did not make any changes reflecting comments on this matter.
Investment Education Exception. A modified version of the proposed regulation’s carving out investment education from the definition of fiduciary conduct continues in the final regulation. Consistent with DOL Interpretive Bulletin 96-1, there are four categories of investment-related guidance that TPAs and other service providers may render to retirement investors without triggering fiduciary status: (i) plan information, (ii) general financial, investment and retirement information, (iii) asset allocation models and (iv) interactive investment materials. Unlike the interpretive bulletin, the proposed and final regulations cover information delivered to plan sponsors, plan fiduciaries and IRA owners, as well as participants and beneficiaries.
The proposed rule prohibited educational materials from referring to specific investment alternatives based on the fear that this could be used as a marketing tool. Reverting to the position taken in the interpretive bulletin, however, the final rule lifts this restriction with respect to plans, but not IRAs, subject to restrictions. Thus, a plan’s specific investment alternatives can be referred to in asset allocation models if (i) the investment’s inclusion on the investment platform was subject to oversight by a plan fiduciary independent from the person who developed or markets the investment alternative or the model, (ii) the model identifies all other investments available under the plan having similar risk and return characteristics to the investment referred to in the model and (iii) the model is accompanied by a statement indicating that these other investments have similar characteristics to those included in the model and identifying where information on them can be obtained. Similar restrictions apply where plan investment alternatives are referred to in interactive investment materials.
Best Interest Contract Exemption. As a practical necessity, the broad scope of the new fiduciary definition requires exemptive relief to avoid subjecting all plan advisers to undue restrictions on traditional business models and compensation arrangements. The best interest class (“BIC”) exemption is the primary vehicle for such relief with respect to retail retirement clients. Under the proposed BIC exemption, this relief was restricted to certain listed investments.
Under the proposed rule, the core requirement for the BIC exemption was a written contract between a fiduciary adviser and a retirement client that needed to be executed before advice could be rendered. The contract had to provide that the advice would be in the best interest of the retirement investor and consistent with ERISA’s prudent man standard of care. The agreement also had to provide that the adviser was limited to reasonable compensation and warrant the adviser would make certain disclosures, avoid misleading statements and adopt compliance policies mitigating conflicts of interest.
The final rule relaxes many of the requirements necessary to qualify for the BIC exemption. For example, it eliminates the list of assets and makes the exemption available to all asset classes. In addition, the contract requirement will be eliminated for ERISA plans, although advisers wishing to qualify for the exemption must still provide written acknowledgement of their fiduciary status. Disclosures required under the contract would be simplified and eliminate the need to make certain performance projections. Special provisions clarify how the BIC exemption applies to advice rendered with respect to proprietary products which other wise might be seen as impeding the best interest of the retirement investor.
Advisers to IRAs whose compensation is a level fee (i.e., a percentage of assets under management) will also be entitled to rely on the BIC exemption without entering a contract. For advice to IRA owners that would be subject to the contract requirement, the timing of the contract can be synchronized with the paperwork opening the account, although the contract must cover any advice rendered before its execution. Existing clients can agree to the new contractual provisions by negative consent. Moreover the final rule reduces the contract requirement to a bilateral agreement between a retirement investor and the advisory firm, thereby eliminating the requirement that personnel actually rendering the advice be parties to the contract.
NIPA members should monitor further developments with respect to the final fiduciary rule, particularly as to dates when its various provisions become applicable.