Does your company offer retirement benefits to its employees through a 401(k) or other retirement plan? A recently issued Department of Labor regulation (the “Final Rule”) will dramatically expand the retirement plan service providers considered fiduciaries when it becomes applicable on April 10, 2017, which in turn will limit how those service providers may be paid for their services without violating the law.

Your company (or one or more of its employees) generally serves in a fiduciary capacity to its retirement plan and must, among other things, protect plan participants and beneficiaries by ensuring that plan service provider engagements are reasonable. Because the Final Rule will cause plan service providers to re- examine their services and compensation and possibly seek to alter their arrangements with your retirement plan, your company must take steps to understand the implications of the Final Rule so that it can properly discharge its duties. Failure to do so may create significant risk of liability and penalties for your company and the individuals making decisions for the retirement plan.

This article provides a high-level overview of issues your company should consider.

Regulatory Background

The Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (the “Code”)—the two primary regulatory regimes governing employer-sponsored retirement plans—impose on the company maintaining a retirement plan for its employees (the “Plan Sponsor”) a fiduciary obligation to prudently select and monitor service providers for the plan. Additionally, failure to ensure that services supplied by a plan service provider are necessary and obtained for no more than reasonable compensation constitutes a prohibited transaction which may result in personal liability and stiff penalties.

The Plan Sponsor may also be subject to fiduciary liability for the acts or omissions of other plan fiduciaries in certain circumstances. For example, the Plan Sponsor may be subject to liability if it, through its own noncompliance with its fiduciary responsibilities, enables another fiduciary to commit a fiduciary breach.

The Final Rule

Under ERISA and the Code, a person who, for a fee, provides investment advice regarding assets of a retirement plan is a fiduciary. The Final Rule redefines the types of communications considered investment advice, expanding the definition to include recommendations concerning plan distributions, rollovers, and other service providers who will provide investment advice to the plan or its participants and beneficiaries. At the same time, the Final Rule makes it easier for recommendations to be considered investment advice by eliminating certain formal requirements. For instance, the Final Rule eliminates the requirement that the parties mutually agree that recommendations will serve as the primary basis for investment decisions. Instead, recommendations directed to a specific party may be covered investment advice, even in the absence of a mutual agreement.

As a result of these changes, many services providers will, for the first time, become fiduciaries if they do not alter their current practices. As fiduciaries, these service providers will be subject to the high ERISA fiduciary standards (including the prudent expert standard) and be required to avoid financial conflicts of interest. Because many service providers are currently compensated in ways that create conflicts of interest (for example, if an adviser receives more money if you invest in one investment instead of another, the adviser has a financial incentive to push you into the investment for which it receives more money), they will be forced to (1) change their current practices to avoid fiduciary status, (2) change their practices to comply with the fiduciary standards, or (3) potentially subject themselves (and your company) to significant penalties and liability.

Direct Impact on Plan Sponsors

Plan Sponsors generally are fiduciaries and, as a result, the Final Rule will not change that status. However, the Final Rule provides some welcome relief to Plan Sponsors from inadvertently expanding their fiduciary roles. First, the Final Rule excepts from the definition of investment advice investment education. This exception will permit Plan Sponsors (and others) to provide certain general educational services and information to plan participants and beneficiaries without becoming investment advice fiduciaries. Second, the Final Rule also does not consider certain communications between employees of the Plan Sponsor and (1) the responsible plan fiduciary (i.e., the individuals at the company who make investment and service provider decisions for the company) or (2) plan participants and beneficiaries, to be investment advice. To avoid expanding their fiduciary roles, Plan Sponsors should: 

  • review or seek guidance on potential sources of relief;
  • consider drafting and implementing policies and procedures to utilize available relief;
  • provide training, as necessary, to assure compliance with the policies and procedures; and
  • establish a process to monitor compliance with the policies and procedures.

 Service Provider Selection and Monitoring Implications

In addition to the potential direct impact of the Final Rule, Plan Sponsors must also prudently select, monitor and retain their retirement plan service providers. To do so, Plan Sponsors should:

  • inventory current plan service provider arrangements (including the services provided and compensation related to those services)
  • analyze the potential impact of the Final Rule on their plan service providers, including whether the Final Rule would confer fiduciary status on a plan service provider based on its current services to the plan (i.e., whether the Final Rule creates fiduciary status when none currently exists)
    • if so, understand whether fiduciary status will require changes to the service arrangement which might include limiting the scope of services provided, modifying the compensation structure, or complying with the requirements for relief from prohibited transactions
    • if relief from prohibited conflicts of interest is necessary, understand the requirements of the relief and how the plan fiduciary will monitor compliance with necessary relief
  • carefully review any proposed changes to service agreements to confirm compliance with the Final Rule or applicable relief

Common Arrangements for Further Scrutiny

The following common arrangements should be on your short list for review and consideration.

Record Keepers

Virtually all ERISA retirement plans engage financial institutions to serve as record keepers. Many record keepers serve as platform providers: they make available a universe of investment alternatives the plan may choose to make available to plan participants and beneficiaries. They quite often also provide certain educational services, provide periodic investment reviews to the Plan Sponsor, and recommend IRA rollover solutions to plan participants and beneficiaries. Each of these services should be examined to determine whether the record keepers’ activities trigger application of the Final Rule.

Investment Advisers and Consultants

Many plans also engage the services of professional investment advisers to assist in the selection and monitoring of investment alternatives for plan participants and beneficiaries. While many of these arrangements already constitute fiduciary engagements, some of the currently available relief utilized to address conflicts of interest has been modified and may require adherence to additional requirements. Plan Sponsors should confirm that these requirements will be satisfied by their service providers.

Conclusion

Plan Sponsors must continue to be vigilant in protecting the participants and beneficiaries of their retirement plans. The Final Rule will likely prompt changes to the services provided and fees charged by their retirement plan service providers. Plan Sponsors should take time to understand the changing landscape and be prepared to ensure that both existing and future service arrangements comply with the Final Regulation. As with all fiduciary obligations, an ounce of prevention is worth a pound of cure.