Under ERISA and the Internal Revenue Code, a person is a fiduciary to the extent he or she conducts certain plan-related activities including rendering "investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan. . ." On April 14, 2015, the Department of Labor ("DOL") proposed new regulations that expand the definition of plan "fiduciary" as a result of giving investment advice to a plan or its participants or beneficiaries. These proposed regulations (if later finalized) would amend the DOL's current regulations that were issued in 1975 and replace the DOL's 2010 proposed regulations that were heavily criticized.
In issuing the proposed rule, the DOL acknowledges that today's retirement plan environment is very different from where it was 40 years ago when the current regulations were issued – prior to the existence of participant-directed 401(k) plans, widespread investments in individual retirement accounts ("IRAs"), and the now commonplace rollover of plan assets from fiduciary-protected plans to IRAs. With this regulatory action, the DOL seeks to better protect plans, participants, beneficiaries, and IRA owners from conflicts of interest, imprudence, and disloyalty by replacing the 1975 regulations with a definition of fiduciary investment advice that it believes better reflects the broad scope of the statutory text and its purpose.
In 1975, the DOL issued the current regulations that narrowed the breadth of the statutory definition of fiduciary "investment advice" by creating a five-part test. Under the current regulations, for advice to constitute investment advice, an adviser who is not otherwise a fiduciary must render advice:
- as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property;
- on a regular basis;
- pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary;
- that will serve as a primary basis for investment decisions with respect to plan assets; and
- that will be individualized based on the particular needs of the plan or IRA.
Under the test, an adviser is a fiduciary with respect to any particular instance of advice only if the person meets each and every element of the five-part test with respect to the particular advice recipient or plan at issue.
Proposed Definition of "Fiduciary"
The 2015 proposed rule expands the definition of fiduciary investment advice but adds some specific carve-outs for particular types of communications that are best understood as non-fiduciary in nature. Under the proposed definition, a person renders "investment advice" and is therefore a "fiduciary" when the person:
- provides investment or investment management recommendations or appraisals to an employee benefit plan, a plan fiduciary, participant or beneficiary, or an IRA owner or fiduciary, including advice regarding rollovers and distributions from ERISA plans and IRAs;
- for a fee or other direct or indirect compensation; and
- either (a) acknowledges the fiduciary nature of the advice, or (b) acts pursuant to an agreement, arrangement, or understanding with the advice recipient that the advice is individualized to, or specifically directed to, the recipient for consideration in making investment or management decisions regarding plan assets.
The proposed rule would eliminate the current rule's requirements that the advice be provided on a "regular basis" and pursuant to a "mutual understanding" with the broader standard of an "understanding" that the advice is "individualized to, or specifically directed to, the recipient for consideration in making investment or management decisions." Moreover, the expanded definition specifically includes advice regarding rollovers from ERISA-covered plans (such a 401(k) plans) to IRAs.
Standing alone this change could sweep in some relationships that are not appropriately regarded as fiduciary in nature and that the DOL does not believe Congress intended to cover as fiduciary relationships. In addition, the DOL sought to preserve beneficial business models for delivery of investment advice by separately proposing new exemptions from ERISA's prohibited transaction rules that would broadly permit firms to continue common fee and compensation practices, as long as they are willing to adhere to basic standards aimed at ensuring that their advice is in the best interest of their customers. Rather than create a highly prescriptive set of transaction-specific exemptions, the DOL instead proposed a set of exemptions that it believes flexibly accommodate a wide range of current business practices, while minimizing the harmful impact of conflicts of interest on the quality of advice.
Best Interest Contract Exemption
In particular, the DOL proposed a new exemption called the "Best Interest Contract Exemption" that would provide conditional relief for common compensation, such as commissions and revenue sharing, that an adviser and the adviser's employing firm might receive in connection with investment advice to retail retirement investors. Generally, the exemption requires the firm and the adviser to:
- contractually acknowledge fiduciary status;
- commit to adhere to basic standards of impartial conduct;
- adopt policies and procedures reasonably designed to minimize the harmful impact of conflicts of interest; and
- disclose basic information on their conflicts of interest and on the cost of their advice.
Central to the exemption is the adviser and firm's agreement to meet fundamental obligations of fair dealing and fiduciary conduct—to give advice that is in the customer's best interest; avoid misleading statements; receive no more than reasonable compensation; and comply with applicable federal and state laws governing advice. The DOL believes this principles-based approach better aligns the adviser's interests with those of the plan participant or IRA owner, while leaving the adviser and employing firm with the flexibility and discretion necessary to determine how best to satisfy these basic standards in light of the unique attributes of their business.
Under the proposal, there are additional carve-outs for persons who do not represent that they are acting as ERISA fiduciaries. Subject to specified conditions, these carve-outs cover:
- statements or recommendations made to a "large plan investor with financial expertise" by a counterparty acting in an arm's length transaction;
- offers or recommendations to plan fiduciaries of ERISA plans to enter into a swap or security-based swap that is regulated under the Securities Exchange Act or the Commodity Exchange Act;
- statements or recommendations provided to a plan fiduciary of an ERISA plan by an employee of the plan sponsor if the employee receives no fee beyond his or her normal compensation;
- marketing or making available a platform of investment alternatives to be selected by a plan fiduciary for an ERISA participant-directed individual account plan;
- the identification of investment alternatives that meet objective criteria specified by a plan fiduciary of an ERISA plan or the provision of objective financial data to such fiduciary;
- the provision of an appraisal, fairness opinion or a statement of value to an ESOP regarding employer securities, to a collective investment vehicle holding plan assets, or to a plan for meeting reporting and disclosure requirements; and
- information and materials that constitute "investment education" or "retirement education."
The DOL is accepting written comments on the proposed regulations until approximately the end of June and plans to hold hearings in July 2015. If and when the proposed rules are finalized, they are expected to become effective eight months after publication of the final rule.