On April 6, 2016, the Department of Labor (DOL) released in final form its massive package of rules, exemptions and amendments to existing exemptions that comprise its Fiduciary Rule. The objective of the Fiduciary Rule is to significantly broaden the scope of persons who are considered fiduciary advisers to plans, plan participants and individual retirement account (IRA) owners; and to impose on fiduciary advisers heightened disclosure, reporting, procedural and other requirements under the Employee Retirement Income Security Act of 1974 (ERISA) and comparable provisions of the Internal Revenue Code of 1986. The final version of the Fiduciary Rule addresses many of the technical issues raised by commentators on the April 2015 proposal, which was discussed in a previous Mayer Brown legal update. However, the final version essentially retains the proposal’s framework.

It will take some time for the industry to sort out the full implications of the final version. This is due to its significant expansion of the scope of services and dealings with plans that trigger fiduciary status under ERISA, the scope and complexity of the Fiduciary Rule and the myriad of services, products and investments used by ERISA plans and IRAs. This legal update provides a first look at the final Fiduciary Rule’s aspects that are most immediately relevant to plan fiduciaries and services providers.

When does the Fiduciary Rule go into effect? The Fiduciary Rule is effective on June 7, 2016. However, it will be implemented in phases. The expanded definition of “fiduciary” will not apply until April 10, 2017. Until then, fiduciary status will continue to be determined under the current regulation. In addition, DOL’s new “best interest contract exemption” (BICE) provides simplified exemptive relief that essentially grandfathers investments made under arrangements entered into before April 10, 2017 that may become prohibited as a result of the service provider’s new status as an ERISA fiduciary. But new investments made on and after April 10, 2017 generally will not be grandfathered, even if made under a pre-existing arrangement. In addition, compliance with the various conditions of BICE is transitioned in phases between April 10, 2017 and January 1, 2018.

How does the final Fiduciary Rule change the definition of “fiduciary” under ERISA? Like the proposed rule, the final Fiduciary Rule significantly expands the definition of a fiduciary adviser to include persons who make recommendations for a fee or other compensation (direct or indirect) to a plan fiduciary or participant or IRA owner with respect to: (i) the acquisition, sale or holding of securities or other property; (ii) distributions from a plan or IRA or decisions to roll over a plan account to an IRA; (iii) general investment management decisions; or (iv) the selection of investment managers or advisers for the plan or IRA. Fiduciary status is triggered if the adviser represents or acknowledges its fiduciary status, enters into an oral or written agreement or understanding that the advice is based on the particular investment needs of the plan or IRA, or merely directs the recommendation to a particular recipient.

Does the final Fiduciary Rule include carve-outs or other exceptions from fiduciary status? The final Fiduciary Rule allows carve-outs from fiduciary status for (i) dealings with sophisticated plan fiduciaries, (ii) swap transactions and (iii) plan sponsor employees. In response to comments, changes have been made to the carve-outs that make them significantly more useful. There are still limitations to the carve outs—most notably the carve-out for dealings with sophisticated persons excludes dealings with IRA owners or small plan fiduciaries (less than $50 million) and direct dealings with plan participants, no matter how sophisticated the individual may be. In response to proposal commentators’ concerns that any direct communication with a plan, participant or IRA owner about an investment matter would cause the person communicating to become a fiduciary regardless of the intent or circumstances, DOL acknowledged that a communication would not trigger fiduciary status unless it constitutes a “recommendation.” And DOL modified the definition of “recommendation” to clarify that the determination of whether a recommendation has been made is an objective, rather than subjective, inquiry. This leaves the door open for direct communications that are carefully crafted to avoid fiduciary status, even if not covered by a specific carve-out. Consistent with this approach, certain areas included as carve-outs in the proposal are included in the final Fiduciary Rule as non-exclusive examples of communications that do not trigger fiduciary status. These include investment education, general investment information and asset allocation models. In addition, DOL clarified that a person may sell his or her own investment services or the services of an affiliate without triggering fiduciary status. DOL also confirmed in the BICE preamble that, because of the limitations on the activities of banks and their employees in making referrals, in most cases the referrals will not constitute a “recommendation” within the meaning of the Fiduciary Rule.

What is the consequence of becoming a fiduciary? Among other things, in the absence of an exemption, ERISA prohibits fiduciaries from providing advice to a plan client under circumstances that involve a conflict, including receipt of contingent compensation and compensation from third parties. ERISA conflicts may not be cured through disclosure or waiver. Fiduciaries also may not engage in principal, extension of credit or other transactions with a plan client, without an exemption.

What are the conditions of BICE? Although the final version of BICE addresses some of the technical issues raised by commentators to the proposed rule and is now available to a broader range of investments, the final BICE continues to include the conditions that were the most troubling to the commentators, such as:

  1. an affirmative agreement to be a fiduciary:
  2. warranties to adopt and comply with policies and procedures reasonably and prudently designed to eliminate conflicts despite receipt of contingent compensation or compensation from third parties;
  3. prohibitions on a financial institutions using quotas, bonuses, special awards, contests or other incentives that are intended or would reasonably be expected to cause individual advisers to make recommendations that are not in a client’s best interests;
  4. prohibitions on use of contractual exculpation provisions or waivers of rights to bring or participate in class action lawsuits;
  5. the requirement of a written contract covering the mandatory provisions with IRA and other non-ERISA plan clients;
  6. website disclosures of fees, compensation and incentive arrangements for employees, sources of third-party payments, conflict policies and procedures, and a description of the mandatory contract terms; and
  7. delivery of notice to DOL that the financial institution is receiving compensation in reliance on BICE.

Given the continuing concerns with BICE, we expect that many in the financial and plan services industries will opt to limit their communications with plans, plan participants and IRA owners to avoid fiduciary status or will revisit other possible exemptions, such as the statutory exemption for participant investment advice under Section 408(b)(14) of ERISA.

How does the final Fiduciary Rule affect other common class exemptions? As with the proposal, the final Fiduciary Rule includes amendments to other class exemptions commonly relied on in the financial industry to address fiduciary conflicts involving plan investments and transactions, including Prohibited Transaction Class Exemption (PTE) 77-4 for investments in affiliated mutual funds, PTE 86-128 for securities and affiliated brokerage arrangements, PTE 75-1 for securities transactions effected through a broker and PTE 84-24 for the sale of insurance contracts. In general, the amendments aim to add new conditions that mirror BICE and to better align these conditions with the objectives of the Fiduciary Rule. Firms that rely on these exemptions will need to conform their compliance procedures by April 10, 2017.

Where can I find the final Fiduciary Rule? The final Fiduciary Rule is available on the DOL website.