Introduction

On April 6 2016 the Department of Labour (DOL) released its final regulation defining 'fiduciary', which expands the circumstances under which consultants, advisers and others become fiduciaries for purposes of the Employee Retirement Income Security Act of 1974 (ERISA), as amended, and the prohibited transaction provisions of the Internal Revenue Code of 1986, as amended, as a result of providing investment advice.

In addition to the final regulation, the DOL released two new prohibited transaction class exemptions and amended and partially revoked several existing prohibited transaction exemptions. In general, the DOL issued these exemptions and amendments to existing exemptions in order to permit existing compensation practices to continue even if financial institutions become fiduciaries under the regulation. However, to continue these business practices, significant new conditions must be satisfied by the applicable fiduciaries.

Affected parties

Parties that could be affected by the new rules include:

  • securities brokers that advise individual retirement accounts (IRAs) or plans as to investments;
  • insurance brokers that advise IRAs or plans as to investments, including insurance products;
  • banks that advise IRAs or plans as to investments;
  • distributors that advise IRAs or plans regarding investments including interests in commodity funds, hedge funds, mutual funds or other investment products;
  • plan record keepers or other parties that advise plan participants or IRA owners regarding distributions from plans or IRAs; and
  • plan fiduciaries that rely on certain prohibited transaction exemptions in connection with the management of plan assets.

In general, under the new regulation, a party's activities relating to the marketing of investment products to plans and IRAs, where that party receives compensation in connection with those activities, can for the first time give rise to fiduciary status under ERISA and the Internal Revenue Code.

Statutory definition of 'fiduciary'

ERISA defines a fiduciary as including a party that:

  • exercises discretionary authority or control with respect to the management of an ERISA plan or the disposition of its assets; or
  • renders investment advice for a fee or other compensation, or has authority to do so.

Under the second part of this definition, a party can be a fiduciary to an ERISA plan even if it cannot cause the plan to take any action with respect to an investment recommendation. The new definition of fiduciary only affects the second part of this statutory definition.

Five-part test under existing regulation

The 'investment advice' prong of ERISA's definition of 'fiduciary' is the subject of a DOL regulation issued in 1975. Under the existing regulation, a party is treated as a fiduciary by reason of providing investment advice, if the party:

  • renders advice as to the value of securities or other property or makes recommendations as to the advisability of investing in, purchasing or selling securities or other property;
  • does so on a regular basis; and
  • does so pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary, that the advice will:
    • serve as a primary basis for investment decisions with respect to plan assets; and
    • be individualised, based on the particular needs of the plan.

Stated reasons for change

The preamble to the regulation explains that the existing regulation had not been updated since 1975 and that the regulation was adopted before the existence of participant-directed 401(k) plans, significant investments by IRAs and the frequent rollovers from ERISA-protected plans to IRAs. The preamble states that the DOL is concerned that advisers to plans and IRAs may give disloyal advice that furthers the advisers' own interests, rather than the interests of plan participants and beneficiaries or IRA owners. In the DOL's view, a change to the definition of fiduciary is appropriate to protect the interests of plans, participants, beneficiaries and IRA owners from these conflicts of interest, imprudence and disloyalty.

New definition

Under the regulation, a party is a 'fiduciary' if that party:

  • provides to a plan, plan fiduciary, plan participant or beneficiary, IRA or IRA owner the type of advice or recommendations described below in exchange for a fee or other compensation, whether direct or indirect; and
  • meets one of the conditions described below.

Types of advice or recommendation

The types of advice or recommendation include the following:

  • Recommendations regarding investments - these include:
    • the advisability of acquiring, holding, disposing of or exchanging securities or other property; or
    • how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred or otherwise distributed.

One of the biggest changes included in the regulation is the imposition of fiduciary status on parties that meet one of the conditions below and provide recommendations as to the investment of assets to be rolled over or otherwise distributed from a plan or IRA. Under the existing law, those parties would not be considered to be fiduciaries.

  • Recommendations regarding management of investments - these include the management of securities or other investment property with respect to:
    • investment policies or strategies;
    • portfolio composition;
    • selection of other parties to provide investment advice or investment management services;
    • selection of investment account arrangements; or
    • rollovers, transfers or distributions from a plan or IRA.

The preamble explains that a party does not become a fiduciary merely by marketing itself, an affiliate or a third party as a fiduciary to be selected by a plan fiduciary or IRA without making an investment recommendation. It clarifies that when the recommendation to hire an adviser includes a recommendation on how to invest plan or IRA assets, it becomes a fiduciary recommendation.

Conditions

The recommendation must be made directly or indirectly by a party that:

  • represents or acknowledges that it is acting as a fiduciary within the meaning of ERISA;
  • renders the advice pursuant to a written or oral agreement, arrangement or understanding that the advice is based on the particular investment needs of the recipient; or
  • directs the advice to a specific recipient regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

The preamble indicates that if a party represents that it is a fiduciary, it may not later disclaim that representation and none of the exclusions discussed below will apply to it. With respect to the second condition above, the preamble states that the parties are not required to have a "meeting of the minds" regarding whether the plan or IRA will rely on the advice, "but the circumstances surrounding the relationship must be such that a reasonable person would understand that the nature of the relationship is one in which the adviser is to consider the particular needs of the advice recipient".

Recommendation

Definition

The regulation defines the term 'recommendation' as "a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action".

Providing a selective list of securities as appropriate to the advice recipient is a recommendation, even if no recommendation with respect to any one security is made.

Exceptions

The following information does not constitute a recommendation.

Certain information and materials from providers of investment platforms

A party does not act as a fiduciary if it merely makes available to a plan fiduciary or plan – without regard to the individual needs of the plan, its participants or beneficiaries – a platform from which a plan fiduciary may select or monitor investment alternatives, provided that:

  • the plan fiduciary is independent of the party that makes the platform available; and
  • the party discloses in writing to the plan fiduciary that it is not undertaking to provide impartial advice or give advice in a fiduciary capacity.

Selection and monitoring assistance by a platform provider

A party does not act as a fiduciary if, in connection with the marketing and maintenance of a platform, it merely:

  • identifies investment alternatives that meet objective criteria specified by the plan fiduciary, provided that the party discloses in writing whether it has a financial interest in any of the alternatives and the nature of that interest;
  • identifies a limited or sample set of investment alternatives in response to a request for proposal based only on the size of the employer or plan and/or the existing investments under the plan (provided that the party discloses in writing whether it has a financial interest in any of the alternatives and the nature of that interest); or
  • provides objective financial data and comparisons with independent benchmarks to an independent fiduciary.

General communications

A party does not act as a fiduciary if it provides general communications that a reasonable person would not view as an investment recommendation, such as:

  • newsletters;
  • commentary in talk shows;
  • presentations in widely attended speeches;
  • general marketing materials;
  • general market data;
  • price quotes;
  • performance reports; or
  • prospectuses.

Investment education

A party does not act as a fiduciary if he or she furnishes or makes available certain categories of investment-related information and materials to a plan, plan fiduciary, plan participant, IRA or IRA owner, provided that the information and materials (with certain exceptions) include no recommendations regarding:

  • specific investment products or recommendations or specific plan or IRA alternatives; or
  • the investment or management of a particular security or other investment property.

The regulation describes the types of information that constitutes investment education, including:

  • information about the terms or operation of the plan or IRA;
  • information about the benefits of participating in the plan or IRA;
  • general financial, investment and retirement information;
  • asset allocation models; and
  • interactive investment materials that provide the means for estimating future retirement needs.

Exclusions from fiduciary status

The regulation specifically excludes certain parties from being fiduciaries, provided that they do not represent or acknowledge that they are acting as a fiduciary to a plan or IRA. Excluded parties are those that engage in the following activities.

Transactions with independent fiduciaries with financial expertise

The exclusion applies to a party providing advice to an 'expert fiduciary' of a plan or IRA (including to a fiduciary of a plan assets fund) that is independent of the advice provider with respect to an arm's-length transaction related to the investment of investment property, provided that the advice provider:

  • knows or reasonably believes that the expert fiduciary is:
    • a US-regulated bank;
    • a US-regulated insurance carrier;
    • a federal or state-registered investment adviser;
    • a US-registered broker-dealer; or
    • any independent fiduciary that holds or has under management and control total assets of at least $50 million;
  • knows or reasonably believes that the expert fiduciary can evaluate investment risks independently;
  • fairly informs the expert fiduciary:
    • that it is not undertaking to provide impartial investment advice or give advice in a fiduciary capacity; and
    • of the existence and nature of its financial interests;
  • knows or reasonably believes that the expert fiduciary is a fiduciary under ERISA or the Internal Revenue Code with respect to the transaction and is responsible for exercising independent judgment; and
  • receives no compensation for providing investment advice in connection with the transaction.

This exclusion is intended to exclude from fiduciary status a party engaging in an arm's-length transaction with a plan, where the party is not generally expected to provide fiduciary investment advice. The final regulation clarifies that the exclusion applies to advice to the fiduciary of an investment product or fund (eg, a bank collective investment fund) that contains plan assets if the manager of that product or fund is described above.

Swap and security-based swap transactions

The exclusion applies to a swaps entity (ie, swap dealer, security-based swap dealer, major swap participant, major security-based swap participant or swap clearing firm) providing advice to a fiduciary of a plan subject to ERISA in connection with a swap or security-based swap, provided that:

  • the plan is represented by an ERISA fiduciary that is independent of the swaps entity;
  • the counterparty, if a swap or security-based swap dealer, is not acting as an adviser to the plan in connection with the transaction;
  • the swaps entity does not receive compensation directly from the plan or plan fiduciary for the provision of investment advice in connection with the transaction; and
  • before providing any recommendations regarding the transaction, the swaps entity obtains a written representation from the independent plan fiduciary that it:
    • understands that the swaps entity is not undertaking to provide impartial investment advice or advice in a fiduciary capacity; and
    • is exercising independent judgment.

The preamble notes that the Dodd-Frank Act regulates swaps and securities-based swaps and explains that Congress did not intend for ERISA to regulate swap transactions with employee benefit plans. Therefore, the regulation confirms that swap entities do not become ERISA fiduciaries as a result of swap activities conducted in accordance with the Dodd-Frank Act and the business conduct standards of the Securities and Exchange Commission and the Commodity Futures Trading Commission. The preamble clarifies that the exclusion for swaps applies to cleared and uncleared swaps because both types of transaction are regulated under the Dodd-Frank Act and the business conduct standards. The exclusion does not apply to swap transactions involving IRAs.

Employees

The exclusion applies to advice by an employee of a plan sponsor, an employee benefit plan, an employee organisation or a plan fiduciary to a plan fiduciary, to an employee or an independent contractor of such plan sponsor, affiliate or plan, provided that the employee receives no compensation for that advice beyond his or her normal compensation. Further, an employee who provides advice in his or her capacity as a participant or beneficiary of the plan is excluded from fiduciary status, provided that:

  • his or her job responsibilities do not involve the provision of investment advice or recommendations;
  • he or she is not required to be registered under federal or state securities or insurance laws; and
  • he or she does receives no compensation for that advice beyond the employee's normal compensation.

Execution of securities transactions

The regulation establishes the conditions under which a registered broker-dealer, reporting dealer or US bank will not be considered to be a fiduciary for executing securities transactions for a plan in the ordinary course of its business, pursuant to the instructions of a fiduciary of a plan or IRA. The conditions are that:

  • the broker-dealer, dealer or bank is not the fiduciary or an affiliate of the fiduciary; and
  • the fiduciary's instructions specify:
    • the security to be purchased or sold;
    • a price range within which the security will be purchased or sold;
    • a timespan during which the transaction may occur; and
    • the minimum or maximum quantity of the security that may be purchased or sold.

Effective date, new exemptions and changes to existing exemptions

The regulation will be effective 60 days after the date of publication in the Federal Register (April 8 2016); however, all provisions other than that relating to securities executions apply from April 10 2017. The best contract exemption and principal transaction exemption provide for a transition period until January 1 2018, during which fewer conditions apply. The full disclosure provisions, policies and procedures requirements and contract requirement do not go into full effect until January 1 2018, although certain disclosures are required during the transition period.

On the same day that the DOL released the regulation changing the definition of fiduciary, it also issued:

  • a new prohibited transaction class exemption, the 'best interest contract exemption'; and
  • a new prohibited transaction class exemption that permits principal transactions in certain debt securities.

Further, the DOL issued amendments to and partial revocations of several existing exemptions.

Best interest contract exemption

Relief

The exemption permits advisers, financial institutions and their affiliates and related entities to receive compensation as a result of the provision of investment advice to retirement investors. In contrast to what was originally proposed, the final best interest contract exemption is not limited to transactions involving a specific list of assets, but instead applies to transactions involving all assets and other advice transactions, such as recommendations regarding distributions from plans and IRAs.

An 'adviser' is defined generally as an employee, independent contractor, agent or registered representative of a financial institution who is a fiduciary of a plan or IRA solely by reason of providing investment advice.

A 'financial institution' is the entity that employs the adviser or otherwise retains such individual; it must be a registered investment adviser, bank, insurance company, US-registered broker-dealer or any other financial institution described in an individual exemption issued after the date of the best interest contract exemption.

A 'retirement investor' is defined as:

  • a participant in or beneficiary of a plan that has authority to direct the investment of his or her plan assets or to take a distribution;
  • an IRA owner acting on behalf of the IRA; or
  • a fiduciary of a plan or IRA that is not an expert fiduciary as described in the regulation.

The preamble to the best interest contract exemption is clear that advisers and financial institutions (and their affiliates and related entities) may receive brokerage or insurance commissions, 12b-1 fees and revenue-sharing payments, provided that the conditions of the best interest contract exemption are satisfied. Specifically, the preamble states:

"[I]n response to comments, the exemption makes clear that it does not ban commissions or mandate rigid fee-leveling (e.g., by requiring identical fees for recommendations to invest in insurance products as to invest in mutual funds)."

Limitation on relief provided

The relief does not apply to:

  • ERISA plans for which the adviser, financial institution or any affiliate is the plan sponsor or a named fiduciary or plan administrator that was selected to provide advice to the plan by a non-independent fiduciary;
  • compensation received as a result of a principal transaction with the retirement investor;
  • compensation received by an adviser or financial institution as a result of investment advice that is generated solely by an interactive website without personal interaction or advice from an adviser (ie, robo-advice); or
  • advisers who have full discretionary authority and do not merely provide investment advice.

Conditions for relief

The best interest contract exemption contains many conditions in order for the relief to apply.

Written contract for IRAs

If the advice is provided to an IRA (or other plan described in Section 4975 of the Internal Revenue Code and not subject to ERISA), the adviser and financial institution must enter into a written contract with the retirement investor that:

  • affirmatively states that the adviser and financial institution are fiduciaries;
  • requires the adviser and financial institution to comply with the impartial conduct standards (described below);
  • contains warranties from the adviser and financial institution that the financial institution:
    • has adopted and will comply with written procedures that are reasonably designed to ensure that its advisers comply with the impartial conduct standards;
    • has identified a person responsible for addressing material conflicts of interest and monitoring the adviser's adherence to the impartial conduct standards; and
    • has not established financial incentives or quotas that encourage an adviser to make recommendations that are not in the best interest of the retirement adviser (as defined below);
  • states the best interest standard of care owed by the adviser and financial institution, informs the IRA of the services provided and describes how the IRA will pay for the services (eg, directly or through third-party payments, such as commissions);
  • discloses material conflicts of interest;
  • states that the IRA has the right to receive the financial institution's written description of its policies and complete information about all the fees associated with the investments being recommended;
  • states whether the financial institution offers proprietary products or receives payments from third-parties with respect to investments; and
  • includes:
    • the address of the website required by the best interest contract exemption;
    • contact information for a financial institution representative that can address concerns; and
    • a description of whether the adviser and financial institution will monitor the IRA's investment.

The written contract may not:

  • contain any exculpatory provisions that disclaim or limit the liability of the adviser or financial institution for violating the terms of the contract;
  • contain a waiver or limitation on the retirement investor's right to bring or participate in a class action involving the adviser or financial institution; or
  • require arbitration or mediation in venues that are distant or that otherwise unreasonably limit the ability of the IRA to bring claims.

The contract requirement does not apply to investment advice provided to an ERISA plan.

The 'impartial conduct standards' referenced above require that the adviser and financial institution:

  • provide investment advice that is in the best interest of the retirement investor (as defined below);
  • make no investment recommendations that would result in more than reasonable compensation being paid to the adviser or financial institution; and
  • provide disclosures (described below) that are not misleading.

The term 'best interest of the retirement investor' means that the advice provided by the adviser and financial institution:

"reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party."

This standard closely follows the 'prudent man' standard established in ERISA. The DOL has indicated that it intends to hold investment advice fiduciaries to a prudent investment professional standard. This standard requires fiduciaries of IRAs, which are not generally subject to ERISA, to comply with this prudent person standard and gives IRA owners a contractual cause of action against fiduciaries that breach this standard.

The preamble notes that many commenters objected to the "without regard to the financial or other interests" language but the DOL decided to retain it, since it ensures that the advice will not be tainted by self-interest. The preamble explains that this language should:

"be given the same meaning as the language in ERISA section 404 that requires a fiduciary to act 'solely in the interest of' participants and beneficiaries, as such standard has been interpreted by the Department and the courts. Therefore, the standard would not, as some commenters suggested, foreclose the Adviser and Financial Institution from being paid."

Disclosures for ERISA plans

The contract requirement does not apply to ERISA plans. Instead of a contract, the ERISA plan must receive a written statement of the financial institution and adviser's fiduciary statuses, as well as certain disclosures that must be included in the contract for an IRA. In addition, the financial institution must:

  • adhere to the impartial conduct standards;
  • maintain and comply with the policies and procedures described above, which must apply to ERISA plans; and
  • not disclaim any fiduciary duty under ERISA or purport to prevent an ERISA plan from participating in a class action or require arbitration or mediation in venues that are distant or that otherwise unreasonably limit the ability of an ERISA plan to bring claims.

General disclosure requirements

Before or when the retirement investor makes a recommended investment, the financial institution must deliver a written disclosure that sets out the best interest standard of care and material conflicts of interest and informs the retirement investor of the items that will be provided on request, including the policies that the financial institution must maintain under the best interest contract exemption and the specific disclosure of costs, fees and other compensation.

The disclosure must also contain a link to a website that the financial institution must maintain. The financial institution's public website must contain:

  • a discussion of the financial institution's business model and material conflicts of interest;
  • a schedule of the typical account or contract fees and service charges;
  • a model contract and required disclosures;
  • a written description of the financial institution's policies;
  • if applicable, a list of all product manufacturers and other parties with which the financial institution maintains arrangements that provide third-party payments, as well as a description of the arrangements; and
  • disclosure of the compensation and incentive arrangements with advisers.

Proprietary products and third-party payments

The best interest contract exemption states that a financial institution may restrict its advisers' investment recommendation, in whole or in part, to 'proprietary products' or to investments that generate payments from third parties, if the following conditions are satisfied:

  • The retirement investor is clearly informed in writing:
    • that the financial institution offers proprietary products or receives third-party compensation and is informed of the restrictions on investment products that the adviser can offer;
    • of material conflicts of interest; and
    • that the financial institution and adviser complies with the disclosure requirements described above;
  • The financial institution documents in writing its limitation on investments, the material conflicts of interest and the services it will provide to retirement investors in exchange for third-party payments. It documents its conclusions that these limitations and conflicts will not cause it or the adviser to receive more than reasonable compensation or recommend imprudent investments;
  • The financial institution maintains certain policies and incentive practices;
  • The compensation received by the financial institution or adviser does not exceed reasonable compensation; and
  • The adviser's recommendation reflects a prudent man standard and is not based on the adviser's consideration of any factors or interests other than the investment objectives, risk tolerance, financial circumstances and needs of the retirement investor.

Disclosures to DOL

The financial institution must provide advance notice to the DOL that it will rely on the exemption. Further, the financial institution must maintain certain records and provide information to the DOL on request.

Other relief

The exemption also provides relief for purchases and sales of investment products and for pre-existing transactions, provided that certain conditions are satisfied.

Complex, illiquid, hard-to-value or risky investments

The preamble indicates that although the list of assets permitted under the proposed exemption has been eliminated, the DOL expects advisers and financial institutions to exercise special care when recommending investments that are complex, illiquid, hard to value or particularly risky, or that have a lack of transparency, high fees or commissions or tax benefits that are unnecessary. The preamble states that financial institutions must give special attention to the policies concerning these investments and their oversight of advisers' recommendations. Financial institutions must ensure that advisers are trained to understand these products fully and ensure that customers are advised of the risks. The preamble also states that the financial institution and adviser should document the bases of their recommendations and compliance with the impartial conduct standards. Consideration also should be given to whether these types of investment can be recommended without the provision of ongoing monitoring of the investment.

Special relief for level fee fiduciaries

The best interest contract exemption provides a special provision for investment advice provided by 'level fee fiduciaries' (ie, those that receive a set fee rather than a commission or other type of transaction-based fee). The DOL believes that the ongoing receipt of a level fee would not typically raise prohibited transaction concerns for the adviser or financial institution, and such compensation aligns the interest of the retirement investor and the adviser and financial institution. However, the preamble notes that certain advice transactions could give rise to a conflict of interest. For example, there would be a conflict of interest if an adviser recommended that a participant roll money out of a plan into a fee-based account that would generate ongoing fees for the adviser. Further, a conflict could arise where the recommendation was a switch from a low-activity commission-based account to one that charged a level fee.

Most of the conditions of the best interest contract exemption do not apply to recommendations of a level fee fiduciary. Instead, only the following conditions apply:

  • Before or at the time of execution of the recommended transaction, the financial institution must provide the retirement investor with a written statement of the financial institution and its advisers' fiduciary statuses;
  • The financial institution and adviser must comply with the impartial conduct standards;
  • In the case of a recommendation to roll over from an ERISA plan to an IRA, the financial institution must document the specific reasons why the recommendation is in the best interest of the retirement investor. This documentation must include consideration of the retirement investor's alternatives to a rollover and must take into account:
    • the fees and expenses associated with both the plan and the IRA;
    • whether the employer pays for some or all of the plan's administrative expenses; and
    • the different levels of services and investments available under each option;
  • In the case of a recommendation to roll over from another IRA or switch from a commission-based account to a level fee arrangement, the level fee fiduciary must document the reasons that the arrangement is in the best interest of the retirement investor, including the services that will be provided for the fee; and
  • If applicable, the conditions relating to proprietary products must be satisfied.

Principal transaction exemption for debt securities

Relief

This new exemption permits purchases and sales of certain debt securities between a plan, a plan participant or beneficiary account or an IRA, and a fiduciary that provides investment advice to it. With respect to purchases, the exemption is specifically limited to:

  • corporate debt denominated in US dollars and issued by a US company that is offered pursuant to a registration statement under the Securities Act of 1933;
  • agency and government sponsored enterprise-guaranteed asset-backed securities;
  • asset-backed debt guaranteed by an agency or government sponsored enterprise;
  • certificates of deposit;
  • US treasury securities;
  • unit investment trusts; and
  • other investments with respect to which an individual exemption is granted after the effective date of the exemption

Regarding sales, the exemption is available with respect to securities and other investment property. As a result, the exemption applies to principal transactions involving sales of all investment property, provided that the conditions of the exemption are satisfied. This permits a sale to an advice fiduciary when no reasonable price is available from an independent party.

The preamble notes that both this exemption and the best interest contract exemption are available for purchases and sales of investment property in riskless principal transactions (ie, transactions where the financial institution purchases or sells a security for its own account to fill an order by a retirement investor).

Limit on relief provided

The relief does not apply if:

  • the adviser has full discretionary authority and is not only providing investment advice; or
  • the plan is an ERISA plan for which the adviser, financial institution or any affiliate is the plan sponsor or a named fiduciary or plan administrator that has been selected to provide investment advice to the plan by a non-independent fiduciary.

Conditions for relief

The exemption contains many conditions for the application of the relief, which are similar to the conditions applicable to best interest contract exemption. Unlike the best interest contract exemption, this exemption defines retirement investors to include all plans and IRAs, including those managed by an expert fiduciary.

Written contract for IRAs: The written contract, which applies only to IRAs (and other plans described in Section 4975 of the Internal Revenue Code that are not subject to ERISA) must meet the same conditions as under the best interest contract exemption, except that the contract must:

  • disclose the circumstances under which the adviser and financial institution may engage in principal transactions and the material conflicts of interest and compensation associated with these transactions;
  • contain the retirement investor's affirmative written consent to these transactions, on a prospective basis;
  • state that the consent is terminable at any time with no penalty;
  • inform the retirement investor of the right to receive certain information about the debt security; and
  • describe whether the adviser and financial institution will monitor the investments acquired under the exemption.

Disclosures for ERISA plans: The contract requirement does not apply to ERISA plans. Instead of a contract, the ERISA plan must receive a written statement of the financial institution and adviser's fiduciary statuses, as well as certain disclosures that are required in the contract for an IRA. Further, the financial institution must:

  • adhere to the impartial conduct standards;
  • maintain and comply with the above policies and procedures which apply to ERISA plans; and
  • not disclaim any fiduciary duty under ERISA or purport to prevent an ERISA plan from participating in a class action or require arbitration or mediation in venues that are distant or that otherwise unreasonably limit the ability of an ERISA plan to bring claims.

General conditions: These conditions are as follows:

  • With respect to a purchase, the debt security must:
    • not be issued by the financial institution or any affiliate;
    • not be purchased in an underwriting in which the financial institution or any affiliate is the underwriter or a member;
    • not have a greater-than-moderate credit risk; and
    • be liquid;
  • The transaction must not be designed to evade compliance with ERISA or the Internal Revenue Code or affect the value of the security; and
  • The purchase or sale must be for cash.

General disclosure requirements: Before the transaction, the adviser or financial institution must provide written or oral disclosure to the retirement investor of the capacity in which the financial institution may act with respect to the transaction. After the transaction, the financial institution must provide written confirmation of the transaction and thereafter provide annual written disclosure regarding the principal transactions, including:

  • a statement that the consent is terminable at will; and
  • a declaration of the rights of the retirement investor to obtain on request information about the debt securities.

Further, the financial institution must maintain written policies that describe conflict mitigation and incentive practices that must be posted on its website and be available to the DOL on request.

Amendments of PTCEs

Amendment and partial revocation of PTCE 84-24

Prohibited Transaction Class Exemption (PTCE) 84-24 provides relief for certain plan transactions involving insurance agents and brokers, pension consultants, insurance companies and investment company principal underwriters. Specifically, the exemption allows fiduciaries to receive compensation when plans and IRAs enter into certain insurance and mutual fund (and other registered investment company) transactions recommended by the fiduciaries, as well as certain related transactions.

The most significant change in the final guidance relating to the exemption is that PTCE 84-24 no longer covers all transactions involving variable annuity contracts, indexed annuity contracts and other annuity contracts that are 'securities'. As amended, the only insurance products now covered by PTCE 84-24 are fixed annuity products. Further, PTCE 84-24 no longer covers purchases and sales of mutual fund shares by IRAs. Transactions by plans and IRAs involving insurance products not covered by PTCE 84-24 and transactions by IRAs involving mutual fund shares are now within the scope of the best interest contract exemption.

The amendment requires that fiduciaries to all plans and IRAs relying on the relief provided by the exemption satisfy the impartial conduct standards of the best interest contract exemption. Further, clarifications and changes were made to the disclosure requirements.

Amendments to Part III and IV of PTCE 75-1, PTCE 77-4, PTCE 80-1 and PTCE 83-1

The amendments to these PTCEs require fiduciaries to comply with the impartial conduct standards of the best interest contract exemption. However, these new conditions apply to all transactions covered by these exemptions – not only to transactions involving the so-called 'retail investors' (ie, plan participants, IRA owners and plans and IRAs not managed by an expert fiduciary). The amendments are as follow:

  • Part III of PTCE 75-1 provides relief for purchases of securities during an underwriting when the fiduciary is also a member of the syndicate.
  • Part IV of PTCE 75-1 provides relief for principal transactions between a plan and a fiduciary that is a market maker.
  • PTCE 77-4 provides relief for investments in open-end mutual funds (and other registered investment companies) where the adviser to the mutual fund is also the fiduciary to the plan or affiliated with the fiduciary.
  • PTCE 80-83 provides relief for the purchase of a security when the proceeds of the securities issuance may be used to retire or reduce indebtedness to the fiduciary or an affiliate.
  • PTCE 80-1 provides relief for certain sales of certificates by the sponsor of a mortgage pool to a plan or IRA when the sponsor, trustee or insurer of the mortgage pool is a fiduciary to the plan or IRA.

Amendment to Part V of PTCE 75-1

Part V of PTCE 75-1 provides relief for the extension of credit to a plan or IRA by a broker-dealer in connection with the purchase or sale of securities (eg, to permit the normal settlement of securities transaction and in connection with short sales). This exemption does not permit the receipt of compensation for an extension of credit by broker-dealers that are fiduciaries with respect to the assets involved in the transaction.

The amendment permits investment advice fiduciaries (but not fiduciaries with investment discretion) to receive compensation when they extend credit to plans and IRAs in order to avoid a failed securities transaction. For the relief to apply, the following conditions must be satisfied:

  • The potential failure of the securities transaction may not be a result of the action or inaction of the fiduciary;
  • The terms of the extension of credit must be at least as favourable as the terms available in an arm's-length transaction; and
  • Advance written disclosure must be made to the plan or IRA regarding the interest rate or other fees charged for the extension of credit.

Amendment and partial revocation of PTCE 86-128 and Parts I(b), I(c) and II(2) of PTCE 75-1

PTCE 86-128 permits a fiduciary to cause a plan to pay compensation to it or any of its affiliates for executing securities transactions directed by it, provided that the conditions of the exemption are satisfied. Under the existing PTCE, most of these conditions need not be satisfied for securities execution transactions involving IRAs. PTCE 86-128 also provides relief for certain agency cross-transactions (where the fiduciary acts as an agent both for the plan or IRA and for another party) if the conditions of the exemption are satisfied.

The amendment requires all fiduciaries to comply with the impartial conduct standards of the best interest contract exemption, in addition to the existing conditions of the exemption. Further, regarding fiduciaries of IRAs that exercise discretion (rather than merely provide investment advice), the amended exemption requires all of the conditions of the exemption to be satisfied with respect to transactions involving IRAs. The exemption will no longer be available to fiduciaries of IRAs that provide investment advice (rather than exercising discretion); instead, investment advice fiduciaries to IRAs will have to rely on the best interest contract exemption for these transactions.

Further, the exemption adds a new section that permits a broker-dealer fiduciary to use its authority to cause a plan or IRA to purchase mutual fund shares from the broker-dealer – acting as principal – and receive commissions, where the transactions are not excessive in amount or frequency and the other conditions of the exemption are satisfied. The relief does not extend to the plan's or IRA's sales of mutual fund shares because the DOL does not believe that it is necessary for the sale to be in a principal transaction.

The amendment makes certain additional changes including adding a definition of 'commission' and adding record-keeping requirements.

Part I(b) of PTCE 75-1 provides relief for the effecting of securities transactions – including clearance, settlement or custodial functions – by parties that are not fiduciaries. Part I(c) of PTCE 75-1 provides relief for the furnishing of non-fiduciary advice regarding securities or other property to a plan or IRA. The amendment revokes these two parts of PTCE 75-1 because, according to the DOL, these exemptions are duplicative of statutory exemptions. Specifically, the DOL has indicated that fiduciaries may rely on the necessary services exemption under Section 408(b)(2) of ERISA to exempt these transactions.

Part II(2) of PTCE 75-1 contains an exemption for mutual fund share purchases between fiduciaries and plans or IRAs and requires that the fiduciary not be a principal underwriter for, or affiliated with, the mutual fund. The amendment also revokes this part of PTCE 75-1 because, as described above, the amendments to PTCE 86-128 include relief for these transactions.

For further information on this topic please contact Beth J Dickstein at Sidley Austin LLP by telephone (+1 312 853 7000) or email (bdickstein@sidley.com). The Sidley Austin website can be accessed at www.sidley.com.

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