On April 14th, 2015, the U.S. Department of Labor (DOL) released the highly anticipated proposed rule that broadens the scope of advisers who would be fiduciaries under Section 3(21) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) (80 Fed. Reg. 21928-01).  The rule, if adopted, would change the landscape of the retirement services industry by expanding the definition of “investment advice” to cover a broader group of services and make more retirement plan and IRA advisers “fiduciaries” for purposes of ERISA and the prohibited transaction rules under the Internal Revenue Code. Plan sponsors, who have a duty to review and monitor third-party plan fiduciaries, should familiarize themselves with the new rule and the prohibited transaction exemptions released in connection with the rule to understand which service providers may become fiduciaries under the new rules as well as the new obligations the fiduciaries will have when providing investment advice.

Background and Current Rule

Under the current rule, an adviser becomes a fiduciary to an ERISA plan if it provides investment advice for a fee that the parties agree will serve as a primary basis for a plan fiduciary’s investment decisions.  An advisor who becomes a plan fiduciary has the duties of prudence, loyalty and care under ERISA and is prohibited from engaging in certain transactions that may present a conflict of interest.  A fiduciary adviser who violates its duties would be liable to the plan and possibly subject to equitable remedies.  In addition, any prohibited transaction in which a fiduciary adviser engages may be unwound and subject to significant excise taxes under the Internal Revenue Code.

Many advisers, such as broker-dealers and insurance agents, are able to avoid fiduciary status by having the parties agree that the adviser’s recommendations are not a primary basis for the plan fiduciary’s investment decisions.  By avoiding fiduciary status, advisers may receive certain fees, such as commissions, 12b-1 fees and revenue sharing payments, that would otherwise give rise to a conflict of interest if the adviser were a fiduciary.

In addition, under the current rule, a service provider must provide advice on a regular basis in order to be a fiduciary.  Many service providers, such as appraisers, may fall outside of the definition because they provide one-time advice that is not on a “regular basis.”

Significantly, the current fiduciary adviser rules under ERISA apply only to advisers to ERISA retirement plans and not advisers to Individual Retirement Accounts (IRAs).

Proposed Rule

The proposed rule will significantly expand the universe of advisers deemed to be investment adviser fiduciaries to a plan.  In addition, advisers providing certain services to IRA owners will also be treated as fiduciaries for purposes of the prohibited transaction rules under the Internal Revenue Code.  The proposed rule would accomplish this by enumerating certain services provided to retirement plans and IRAs that would be considered “investment advice” for purposes of ERISA. Generally, an adviser providing these enumerated services for a fee will be considered a fiduciary if it either (i) acknowledges its fiduciary status in an agreement with the plan or IRA owner or (ii) renders its advice pursuant to a written or verbal agreement or understanding, which advice is individualized to and directed toward the recipient to assist with making investment or management decisions.

Investment Advice

The general types of services that would be considered “investment advice” under the proposed rule are:

  • a recommendation as to the advisability of acquiring, holding, disposing or exchanging of securities or other property (including whether to take distributions from a plan or rollover assets to another plan or an IRA);
  • a recommendation regarding the management of securities or other property, including a recommendation regarding the management of assets in a rollover or distribution;
  • an appraisal, fairness opinion or similar statement (verbal or written) concerning the value of securities or other property that are the subject of a particular transaction or transactions by a plan or IRA; and
  • a recommendation of a person who will also receive a fee or other compensation for providing the types of advice described above.

Carve-Outs

There are, however, certain services that are carved-out of the definition of “investment advice,” which, if performed, would not cause the service provider to become a fiduciary.  The carve-outs are, generally:

  • certain “sales pitches” made by a service provider to a large plan fiduciary with financial expertise;
  • communications related to swap or security-based swap transactions;
  • recommendations provided by employees of the plan sponsor, so long as the employee does not receive additional compensation for the recommendations;
  • statements made in marketing materials or other general statements made by recordkeepers or third-party administrators offering a platform of investment vehicles that are not tailored to the plan;
  • indentifying investment alternatives or financial data based on objective criteria provided by the plan fiduciary;
  • providing general investment education that is not specifically tailored to the plan or an individual; and
  • appraisals or valuations performed for ESOPs and collective investment funds.

New Prohibited Transaction Exemption for Fiduciaries

Although many service providers, such as broker-dealers and insurance agents, would become investment adviser fiduciaries under the new rule, a new prohibited transaction exemption would allow them to receive certain forms of compensation that would otherwise give rise to a fiduciary breach.  The “Best Interest Contract Exemption” (80 Fed. Reg. 21960-0) permits fiduciary advisors to receive payments, such as commissions, 12b-1 fees and revenue sharing payments, as long as the adviser enters into a written agreement with the plan or IRA owner under which the adviser:

  • acknowledges its status as a investment adviser fiduciary under ERISA;
  • commits to providing advice that is in the best interest of the advice recipient;
  • warrants it has adopted compliance policies designated to mitigate conflicts of interest and ensure advisers comply with the best interest standard; and
  • discloses any material conflicts of interest, all fees related to the investments, payments from third parties and which of its investment options are proprietary products.

The contract may not, however, contain language that disclaims or limits the adviser’s liability for violating the contract’s terms or prevents the client from participating in a class action suit (but the agreement may require arbitration for individual disputes).

Fiduciaries relying on the Best Interest Contract Exemption will also have on-going disclosure requirements related to its available investment options and the fees associated with the investment options.

Considerations for Plan Sponsors

The proposed rules, if adopted, would significantly increase the number of retirement plan and IRA advisers who would be considered fiduciaries for purposes of ERISA.  In addition, advisers who have limited their fiduciary responsibilities to a prescribed set of services may have more services fall under the umbrella of “investment advice” and, therefore, broaden their fiduciary liability.  For example, providing advice regarding distribution planning, which participants often find helpful, would be a fiduciary act under this proposal.  Plan sponsors have a duty to review and monitor any outside fiduciary providing services to a plan.  The increase in the number of advisers who would be considered fiduciaries, as well as the increase in the types of services considered fiduciary acts, would significantly expand the plan sponsor’s responsibilities for reviewing and monitoring outside providers.  Likewise, plan sponsors would have additional responsibilities associated with reviewing and negotiating agreements with advisers to ensure they comply with general ERISA requirements and any prohibited transaction exemptions the advisers intend to use.

The comment period for the proposed rule and the exemptions will be open for 75 days (until July 6, 2015). The DOL indicated it will hold public hearings on the proposals, and will likely re-open the comment period after the hearings.  The final rule would generally become effective eight months after it is released.  Although it may be a while before the final rule becomes effective, and the proposed rule will likely be subject to negotiation and revisions in the interim, plan sponsors should familiarize themselves with the premise and subject matter of the proposed rule to better understand the DOL’s approach to expanding the universe of who serves as a fiduciary to a plan.  Plan sponsors should also evaluate whether they will have to change or renegotiate their arrangements with plan service providers in light of the new rules.