On April 14, 2015, the U.S. Department of Labor (DOL) reissued the long-awaited re-proposal of its regulation expanding the definition of "fiduciary" under the Employee Retirement Security Act of 1974, as amended (ERISA), and prescribing stricter conflict-of-interest rules that will apply to relationships between such fiduciaries and their customers (mainly retirement plans and IRAs). Along with the proposed regulation, the DOL proposed two related Prohibited Transaction Class Exemptions (PTCE) and amendments to six existing PTCEs that will also apply to relationships between fiduciaries and their retirement plan customers (the proposed regulation and the PTCE's together, the "Proposal").
The basic approach taken by the DOL in the Proposal is that persons (and entities) providing advice concerning clients' retirement accounts must put their clients' best interests first. The DOL does this by attempting to close existing loopholes where possible and by expanding the types of advice that will be subject to fiduciary protections. On the other hand, the Proposal continues to distinguish certain functions that do not constitute advice subject to fiduciary protection, such as brokerage services or investment education, and explicitly excludes them from the definition of fiduciary investment advice. The Proposal's PTCEs include a new exemption, known as the "best interest contracts exemption," that can allow fiduciary advisors to contract to continue commonly-used fee and compensation arrangements so long as there is a written contract that includes prescribed protections to ensure that the advice provided is in the clients' best interest. The other new exemption would allow principal transactions between an investment advisor and its plan (or IRA) client, so that the advisor could purchase or sell certain debt securities from or to the plan or IRA, so long as it adheres to certain conditions that are protective of the plan's interests and that are laid out in the PTCE.
For purposes of both ERISA and the Internal Revenue Code of 1986, as amended (the Code), fiduciaries are currently defined, in relevant part, to include persons or entities who provide investment advice "for a fee or other compensation, direct or indirect." (This is the portion of the definition to which the Proposal relates.) Regulations issued by the DOL 40 years ago prescribe the circumstances under which a party will be considered to be providing investment advice for this purpose. Under the current definition, an advisor is considered to be providing investment advice only if it provides advice, individualized based on the needs of the plan, as to the value of securities or other property (or the advisability of investing in, purchasing, or selling such securities or other property) on a regular basis pursuant to an agreement or understanding that its advice would serve as a primary basis for investment decisions under the plan.
The Proposal still requires that investment advice be provided "for a fee or other compensation, direct or indirect," but it makes no difference who pays an advisor's fee; it could be paid directly by the customer or it could be paid by a third party, such as a fund family that compensates the advisor for directing funds to its investments. The advisor could also receive its compensation as a part of the transaction, such as by receipt of 12b-1 fees. Payments such as brokerage or sales commissions are also included within the definition of "fee or other compensation, direct or indirect" for purposes of determining whether an advisor is a fiduciary. Compensation received by affiliates is taken into account as received by the advisor "indirectly."
The Proposal specifies four types of advice that may constitute "investment advice": (1) investment recommendations, (2) investment management recommendations, (3) investment appraisals, and (4) recommendations as to persons to provide investment advice for a fee or to manage plan assets. In addition to furnishing one of the foregoing types of advice, either (A) the advisor acknowledges that it is acting as a fiduciary, or (B) the advice is provided pursuant to an agreement, arrangement, or understanding that it is individualized advice based on the needs of the plan and may be taken into account in making investment or investment management decisions regarding plan assets. (Note that under the Proposal, with respect to clause (B), above, the current "regular basis" requirement would be eliminated, as would the "primary basis" requirement, so an advisor would become a fiduciary if it receives compensation for simply providing advice that is individualized or specifically directed to a particular plan sponsor, plan participant, or IRA owner for consideration in making an investment decision.) In addition, the advice that can result in becoming a fiduciary can also include advice as to whether or not to take a distribution from a plan, or whether to roll over such a distribution to an IRA. The DOL expanded these elements of the definition specifically in order to cover a greater number of service providers as fiduciaries, since the perception is that many advisors, while acting within the rules, have nevertheless been providing biased or self-serving advice. Under the Proposal, in addition to the usual banks and trust companies, a fiduciary can be a broker, a registered investment advisor or any other type of advisor, some of which may also be subject to regulation under federal securities laws and some of which will not be.
Recognizing that the broader definition could hamper various ordinary transactions and relationships that would not need fiduciary protections, the Proposal also carves out numerous functions from the activities that may give rise to fiduciary status. Some of those carve-outs are:
- Retirement/Investment education. Generic education concerning savings and/or investing for retirement will not trigger fiduciary duties. For this purpose, education might consist of general explanations or recommendations regarding the mix of investments that might be appropriate for someone based on their particular age, income bracket, family situation, and other circumstances, but notrecommending specific stocks, bonds, or funds that should comprise that mix. Likewise, information regarding the plan or IRA (or regarding plans or IRAs in general) will not constitute investment advice. Nor will asset allocation models, including interactive materials, provided that prescribed conditions are satisfied.
- Accepting purchase/sale orders. Calling a broker and telling the broker to buy or sell a specific security or securities, without asking for advice, does not cause the broker to have any fiduciary responsibility to the client.
- Counterparties making sales pitches to plan fiduciaries with financial expertise. When large plans (over 100 participants) have managers with financial expertise who are themselves fiduciaries, those managers may enter into transactions to sell or purchase assets where they may receive advice from a counterparty in the transaction. Like any other fiduciary under the Proposal, such a plan fiduciary has a duty to watch out for the participants' best interests, and should understand that the counterparty is trying to make a sale rather than to provide advice in the best interests of the plan and the participants. Therefore, the Proposal carves out such transactions from consideration as investment advice, provided that certain conditions are satisfied. (This would also apply to plan fiduciaries having over $100 million of plan assets under management.)
- Swaps and securities-based swaps entered into with independent plan fiduciaries are exempted if certain requirements under the Securities Exchange Act or Commodities Exchange Act are satisfied.
- Providing an investment "platform," such as that which can be used in the administration of a participant-directed plan, and nothing more, will not be equated with "advice" so as to cause a third-party to become a fiduciary.
- Providing advice as an employee of a plan sponsor for no fee or compensation other than normal compensation for work performed as an employee will not constitute fiduciary advice.
- Providing an appraisal, a fairness opinion or a valuation to an ESOP holding employer securities, to a collective investment fund holding plan assets, or to a plan in order to meet reporting and disclosure requirements will not constitute investment advice for this purpose.
Finally, in addition to being applicable for various purposes under ERISA, the Proposal applies with respect to plans enumerated in sections 4975(e)(1)(A)-(F) of the Code. This includes all tax-qualified plans, whether or not subject to ERISA, and IRAs (both individual retirement accounts and individual retirement annuities) as mentioned above, but also includes Archer MSAs, Health Savings Accounts, and Coverdell Education Savings Accounts. However, the Proposal, by its terms, would have no application to section 403(b) tax-sheltered annuities (including section 403(b)(7) custodial accounts) that are not "pension plans" under ERISA, since those are not "plans" for purposes of section 4975(e)(1) of the Code.