For the past several years, the U.S. Department of Labor (the “DOL”) has been in the process of revising the “investment advice” regulations that govern “fiduciary” status under the Employee Retirement Income Security Act of 1974 (“ERISA”). Revising these ERISA rules has been a high priority of President Obama’s administration for quite some time, and was the centerpiece of a policy speech by the President on February 23, 2015. These rules had not been meaningfully revised since 1975, notwithstanding the dramatic shift in the retirement market from defined benefit plans to defined contribution plans (such as “401(k)” plans) and individual retirement accounts (“IRAs”).
The DOL first issued proposed rules affecting investment advice in 2010, but, in an unusual step, subsequently withdrew the proposal following significant concern and comments from the ERISA community and the marketplace generally. In April of 2015, the DOL re-issued the proposed rules, with a number of changes intended to address concerns that had been expressed to the DOL.
Earlier today, April 6, 2016, the DOL, to much fanfare, released the final fiduciary rules together with certain accompanying prohibited transaction exemptions. The final rules, which will take effect in April 2017 (with a phase-in of certain exemption provisions through the end of 2017), are expected to have significant impact on the market for investment advice to retirement accounts.
We have previously addressed the 2015 proposal here.1 We have long been suggesting that, while the basic tack of the rules from the 2010 proposal through to the final rules seemed unlikely to change, substantial and significant changes were likely to be made in connection with a wide range of applicable details. That, indeed, seems to have occurred, and many of the changes seem intended to be responsive to legitimate concerns that have been expressed by the market. This Newsflash will provide a high-level overview of some of the significant aspects of the final rules. We expect to be communicating with you on this topic in greater detail in the future.
Examples of the types of provisions that have now been included in the final rules are:
- Adviser recommendations generally. Information is not generally fiduciary in nature unless in the nature of a “recommendation.” The final rules define “recommendation”, include examples of communication that would not rise to the level of a recommendation and thus would not be considered advice, and generally indicate the more individually tailored a communication is to a specific advice recipient, the more likely it would be viewed as a recommendation.
- Marketing by advisers. The DOL has clarified that, under certain circumstances, a person or firm can recommend that the customer hire the adviser (or its affiliate) for advisory or asset-management services without having the recommendation be a fiduciary recommendation.
- Selling proprietary products. The DOL has made clear in the Best Interest Contract Exemption (the “BICE”) that advisers may sell proprietary products, and has provided specific guidance on how proprietary products can be permissibly sold under the new rules.
- Seller’s “carve-out” expanded. The seller’s “carve-out” from fiduciary status is available to any plan that is represented by an independent fiduciary with financial expertise that satisfies specified criteria (e.g., is a bank, insurance carrier, registered investment adviser or U.S. SEC-registered broker-dealer) or has US$50 million in assets under management.
- Clarifying the investment education provision. The final rules permit asset-allocation models and interactive investment materials to identify specific designated investment alternatives under ERISA-covered plans if certain conditions are met without triggering a fiduciary relationship. (However, it should be noted that this exception is permitted (i) for asset-allocation models only with respect to ERISA-covered plans, since in the IRA context there is no independent plan fiduciary to review and select investment options; and (ii) for interactive investment materials, only as stated in the foregoing clause (i) or if the investment alternative is specified by the plan participant, beneficiary or IRA owner, in the case of an IRA.)
- Certain contract requirements only apply to IRAs and other non-ERISA plans. The BICE eliminates the contract requirement for ERISA plans; the contract requirement only applies to IRAs and other non-ERISA plans.
- Timing of the BICE contract. The DOL has adjusted the BICE’s contract requirement to make it clear that, where applicable, it can be incorporated into other account opening documents and can be entered into either before or at the same time the recommended transaction is executed.
- “Negative consent” to BICE contract permissible. The BICE provides a special “negative consent” procedure for existing clients to obtain the new protections. In other words, the firm can send out a notification to its clients informing them of proposed contract amendments to comply with the BICE requirements. If the client does not terminate the amended contract within 30 days, the amended contract is effective.
- The BICE is available to small plans. The BICE is now available to small plans of all types, including those sponsored by small businesses.
- The BICE’s “asset list” has been eliminated. The DOL has eliminated the “asset list” so that advice to invest in all asset classes is potentially covered by the BICE. Certain segments of the market involved with the sales and marketing of private funds (nonpublic business develop companies, real estate investment trusts, etc.) and certain other assets, such as futures, options and non-U.S. securities had expressed particular concern regarding the applicability of the proposed exemption only to specified asset classes. The elimination of this issue will come as a welcome change to those who could have been affected.
- BICE disclosure requirements relaxed. The DOL has significantly streamlined the disclosure requirements under the BICE.
- BICE data retention requirements relaxed. The data retention requirements have been removed, and firms must only retain the records that show they complied with the law.
- Commission arrangements permitted under certain circumstances. The DOL provides examples of policies and procedures that are compatible with commission-based models.
- No “lowest-fee” requirement. The DOL clarifies in the preamble to the final rules that the adviser is not required to recommend the lowest fee option if another product is better for the client.
- Phased implementation of the final rules. The DOL has extended the first phase of implementation to one year after publication of the final rules. In addition, the DOL has adopted a “phased” implementation approach for certain exemptions so that firms will have more time to come into full compliance.
As noted, we expect to be communicating further in the future regarding the fiduciary rules as we proceed to analyze them. We note that the fiduciary rules could have an impact even outside of the retirement context, particularly for those organizations with robust and long-standing internal processes, policies and procedures that have a desire for internal standardization.