Expanding the Definition of Fiduciary

The Department of Labor’s much-anticipated Final Conflict of Interest Rule is the most significant regulatory undertaking by the DOL since the enactment of ERISA. Greensfelder is releasing a series of client updates to help broker-dealers and registered investment advisors understand, implement and remain compliant in the wake of this new rule. This first installment focuses on the broadened definition of “fiduciary” and what communications constitute “recommendations” as defined by the rule.

The DOL’s Final Conflict of Interest Rule becomes effective on April 10, 2017. Then, communications with retirement investors will become recommendations triggering the “fiduciary” relationship between representative and client. This means firms will need to comply with impartial conduct standards, acknowledge fiduciary status and disclose material conflicts.

The rule includes temporary provisions that apply only from June 7, 2016, to April 10, 2017, and provide a provisional definition of “fiduciary.” The definition states that anyone providing investment advice to an employee benefit plan, if the person provides advice or makes recommendations on buying, and directly or indirectly, has discretionary authority or control of the customer’s account or provides advice on a regular basis pursuant to an agreement with the customer that the recommendations are the customer’s primary basis for investment decisions regarding plan assets is considered a fiduciary under the rule.

A fiduciary is anyone (broker-dealer, registered investment advisor, insurance agent, etc.) who receives compensation for providing certain types of advice, directly or indirectly. Generally, a fiduciary must provide impartial advice that is in the client’s best interest and cannot accept payments creating a conflict of interest unless the payment qualifies for an exemption.

The rule frames the categories of advice as recommendations for retirement investment decisions and sets out types of advice:

  1. Recommendations regarding acquiring, holding, disposing of or exchanging investments in a plan or IRA.
  2. How investments should be invested after a rollover, transfer or distribution from a plan or IRA.
  3. Recommendations on management of investments including investment strategies.
  4. Recommendations regarding rollovers, distributions or transfers from a plan or IRA. For example, the advice to roll over assets from an ERISA plan to an IRA constitutes a “recommendation” and the advice must be in the retirement client’s best interest.

Next, the rule establishes the types of relationships that must exist for the fiduciary investment advice obligations to apply. The rule applies to anyone making recommendations that acknowledges their fiduciary status, provides advice pursuant to a written or verbal agreement or understanding that the advice is based on the individualized investment needs of the customer receiving the advice, and makes recommendations regarding the advisability of a particular investment or management decision.

The rule defines a “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.” The more individualized the communication, the greater the likelihood that it will be a recommendation.

Though the rule further expands the types of retirement advice that will be considered fiduciary in nature, there are carve-outs that describe communications that are not “recommendations” under the rule, and therefore, are not subject to the heightened fiduciary standards. General communications (such as commentaries or financial newsletters) and retirement investment education (including plan information; general financial, investment, financial and retirement advice; asset allocation models; or interactive investment materials) are not recommendations. The rule also excludes situations where a broker executes an order to buy or sell without providing a recommendation — in those circumstances, the transaction does not constitute investment advice and the broker will not be a fiduciary.

Finally, the rule excludes from the definition of fiduciary a person who gives advice to another in an arm’s length transaction if, before providing the advice, she believes:

  1. The plan fiduciary is a bank, insurance carrier, investment adviser, broker-dealer or has at least $50 million in total assets under management;
  2. The plan fiduciary is capable of independently making his or her own evaluation of investment risks;
  3. Disclose to the plan beneficiary that they are not undertaking the task of giving impartial investment advice or as a fiduciary, and disclose their financial interest in the transaction;
  4. The person reasonably believes that the plan fiduciary is a fiduciary to the plan/IRA; and
  5. The person does not receive any compensation directly from the plan/plan fiduciary/plan participant or beneficiary/ IRA for the investment advice connected to the transaction.

Navigating the contours of the rule and its expanded definition of fiduciaries is complex, especially as firms determine what communications are covered and which exemptions may apply to their specific business.