On April 6, 2016, the Department of Labor (DOL) released its long-awaited final fiduciary rule (the “Fiduciary Rule”) under the Employee Retirement Income Security Act of 1974 (ERISA).  Along with the final rule, the DOL also released the new Best Interest Contract (BIC) Exemption and several amendments to other exemptions.  Compliance with the new rule will be phased in over an extended time frame.  In particular, the revised definition of “fiduciary” and certain provisions relating to the BIC Exemption will apply in April 2017, and the balance of the rule will apply on January 1, 2018.

The ostensible intent of the Fiduciary Rule is to protect 401(k), IRA and other retirement investors by mitigating conflicts of interest.  While the final Fiduciary Rule may impact many different types of investment advisers and financial professionals, it will likely impact financial advisers and broker-dealers to the greatest extent.

Set forth below is a high-level explanation of some key provisions of the Fiduciary Rule and its potential impact on various segments of the financial services and asset management industries.

Expanded “Fiduciary” Definition

Under law prior to the final Fiduciary Rule—and still in effect until April 2017–a “fiduciary” generally includes persons who have management and control over plan assets as well as persons who provide “investment advice” on a regular basis with respect to plan assets; “investment advice” generally results from a mutual understanding that the advice will be the primary basis for the client’s investment decisions and tailored to the client.

Under the final Fiduciary Rule, a person is a “fiduciary” if he or she provides the following types of advice to a plan, plan fiduciary, plan participant/beneficiary, IRA or IRA owner for compensation:

  • A recommendation as to various transactions in securities or other property, including a recommendation to take a distribution of benefits or as to the investment of “rollovers”;
  • A recommendation as to the management of securities or other property, including a recommendation as to the management of “rollovers”; or
  • A recommendation of another person to give any of the advice described above

and the person represents that he or she is a fiduciary in providing the advice; the person provides the advice under a written or verbal arrangement or understanding that the advice is individualized; or the person directs advice to a specific recipient for consideration in making investment or management decisions. This new definition significantly expands the situations in which a person might be deemed a fiduciary, because there is no longer a requirement that there be any regularity or recurrence in the advice nor is there a requirement of any mutual understanding; as such, fiduciary status is much more likely to attach to discrete, one-time interactions with a client.

Exclusions and “Carve-Outs”

The final Fiduciary Rule carves out a number of transactions/categories from “fiduciary” status, the most notable of which are:

  • “Seller’s Exception” — With appropriate disclosures and other conditions, transactions with and advice to fiduciaries of large plans (i.e., at least $50 million in plan assets) are not considered within the “fiduciary” definition.
  • Platform Providers and Monitoring Assistance — With appropriate disclosures, fiduciary status will not apply to providers of platforms that allow plan fiduciaries to select and monitor investment alternatives offered to participants. Likewise, platform providers can avoid fiduciary status if they merely identify investment alternatives that meet objective criteria (e.g., expense ratios, size of fund, asset type, etc.).
  • Investment Education—Consistent with current law, the final Fiduciary Rule permits providing plans, participants and IRA owners with plan information; general financial, investment and retirement information; asset allocation models; and interactive investment materials, without these activities being deemed “investment advice.” The final Fiduciary Rule also permits interactive materials and asset allocation programs for plans and participants, but not for IRA owners, to mention specific investment products under certain conditions.

“Best Interest Contract” (BIC) Exemption

Given the broad expansion of the “fiduciary” definition in the final Fiduciary Rule, many financial advisers and broker-dealers who receive various types of compensation (e.g., commissions, Rule 12b-1 fees and revenue sharing, among others) would violate ERISA in the absence of an exemption.  For this purpose, the final Fiduciary Rule includes a BIC Exemption which permits these types of compensation, but also requires unconflicted investment advice provided in the best interest of plan participants and beneficiaries, IRA owners and small plans.  Unfortunately, the BIC Exemption is complicated and, in some cases, onerous.

To rely on the BIC Exemption, an adviser must meet several requirements, most notably:

  • Acknowledge fiduciary status — The adviser must acknowledge its fiduciary status with respect to any recommendations.
  • Agree to adhere to “impartial conduct standards” in rendering advice — Under these standards, the adviser must provide advice in the “best interest” of the retirement investor, which means with the care, skill, prudence and diligence that a prudent person would exercise in similar circumstances and without regard to financial or other interests of the adviser or other related parties, financial institutions or affiliates. In addition, the adviser’s compensation from a recommendation must be limited to reasonable compensation.
  • Adopt policies and procedures designed to mitigate the dangers posed by material conflicts of interest — These procedures must identify material conflicts of interest and measures to prevent them from causing violations of the “impartial conduct standards.”
  • Disclose important information relating to fees, compensation and conflicts — The adviser must disclose any material conflicts of interest as well as the retirement investor’s right to obtain complete information regarding fees.

Revisions to Other Prohibited Transaction Class Exemptions

As part of its rulemaking, the DOL also amended a number of other prohibited transaction class exemptions (including 75-1, 77-4, 84-24 and 86-128) to conform certain requirements to those in the Fiduciary Rule and Best Interest Contract Exemption.


 

This article is adapted from content in Lemke & Lins, ERISA for Money Managers (Thomson West, 2016 ed.).  In addition, the topics discussed in this article are will also be covered more extensively in the forthcoming 2016 edition of Lemke & Lins, Regulation of Financial Planners and 2017 edition of Lemke & Lins, Regulation of Investment Advisers.


 

This post was written by Gerald T. Lins, General Counsel of Voya Investment Management (formerly ING U.S. Investment Management), which manages a broad array of investment strategies and products. Mr. Lins has also been the head lawyer overseeing legal matters for other asset management institutions and fund complexes, and during several years of private practice, concentrated on general corporate and securities law matters, including the regulation of investment advisers, investment companies and broker-dealers. Prior to that Mr. Lins served in the Office of the Chief Counsel of the SEC Division of Investment Management.

Mr. Lins is co-author of Regulation of Investment Advisers with Thomas P. Lemke.Mr. Lemke and Mr. Lins have also co-authored Hedge Funds and Other Private Funds: Regulation and Compliance, Soft Dollars and Other Trading Activities, ERISA for Money Managers, and Mutual Fund Sales Practices, all published by Thomson West or its affiliate, Glasser Legal Works.