In April, the Department of Labor (the “DOL”) issued controversial proposed regulations that would broaden the category of service providers who become fiduciaries under the Employee Retirement Income Security Act of 1974 (“ERISA”) as a result of giving investment advice to ERISA plans or plan participants or IRA owners. Plan sponsors may expect significant changes in retirement plan service providers' business practices and offerings if the final regulations, which the DOL is expected to issue before President Obama leaves office, are similar to the proposed regulations.
Current Definition of Investment Advice Fiduciary
Under ERISA, a person who renders (or has authority or responsibility to render) investment advice for a fee with respect to the assets of an ERISA plan is a fiduciary of that plan. (In general, ERISA fiduciaries must act in the best interest of the plan and its participants and beneficiaries and may not engage in transactions involving the plan on behalf of a party whose interests are adverse to those of the plan or its participants and beneficiaries.) Current regulations provide that an adviser does not render "investment advice" unless advice is given or recommendations made on a regular basis and pursuant to a mutual agreement, arrangement or understanding with the plan or plan fiduciary that the advice will serve as a primary basis for investment decisions with respect to plan assets and will be individualized based on the particular needs of the plan.
Proposed Definition of Investment Advice Fiduciary
The proposed regulations would replace the current definition of “investment advice” with a much broader definition under which an investment-related recommendation or asset appraisal is investment advice if the adviser renders the advice pursuant to a verbal or written agreement, arrangement or understanding that the advice is individualized for, or specifically directed to, the advice recipient for consideration in making investment or management decisions with respect to securities or other property of the plan or IRA. (An adviser that directly or indirectly represents or acknowledges that it is acting as an ERISA fiduciary would also be an investment advice fiduciary.) According to the preamble to the proposed regulations, this new definition of fiduciary investment advice “better reflects the broad scope of the statutory text and its purposes and better protects plans, participants, beneficiaries, and IRA owners from conflicts of interest, imprudence, and disloyalty.”
The proposed regulations establish a number of exemptions from the broad new category of investment advice (which apply only if the adviser does not represent that it is acting as a fiduciary):
- The “seller's carve-out” for advice provided to a plan fiduciary with financial expertise – Advice with respect to an arm's length counterparty transaction provided by the counterparty or a representative of the counterparty to an independent plan fiduciary who exercises authority or control with respect to the management or disposition of plan assets is not investment advice if the adviser does not receive direct compensation for providing the advice and certain other requirements are met. If the independent plan fiduciary manages less than $100 million in plan assets, the adviser must obtain a representation that the plan has 100 or more participants and must know or reasonably believe that the independent plan fiduciary has sufficient expertise to evaluate the transaction and determine whether it is prudent and in the best interest of plan participants.
- Advice provided to a plan fiduciary with respect to a swap transaction – Advice provided by certain swap transaction counterparties to an independent plan fiduciary is not investment advice if the counterparty obtains a written representation from the independent plan fiduciary that it will not rely on the counterparty’s recommendations.
- Advice provided to a plan fiduciary by an employee of the plan sponsor – Statements or recommendations made by an employee of a plan sponsor to a plan fiduciary are not investment advice as long as the employee does not receive compensation beyond the employee's normal compensation in connection with the advice.
- Platform provider services – A platform provider does not provide investment advice if it markets or provides a platform of investment alternatives to a plan "without regard to the individualized needs" of the plan or its participants and provides a written disclosure to the plan fiduciary that it is not providing impartial investment advice or giving advice in a fiduciary capacity. A platform provider that also provides selection and monitoring assistance to the plan does not provide investment advice if it “merely identifies investment alternatives that meet objective criteria specified by the plan fiduciary” or “merely provides objective financial data and comparisons with independent benchmarks to the plan fiduciary.”
- Valuations – Appraisals, fairness opinions and statements of value do not constitute investment advice when they are provided to an ESOP or a fund that has investments or plan assets from unaffiliated plans or if they are provided solely for purposes of compliance with reporting and disclosure requirements.
- Investment Education – If no specific investment products or alternatives are identified, asset allocation models and interactive investment materials that meet certain methodology and disclosure requirements and certain kinds of general plan and investment information are not considered investment advice.
These proposed exemptions are narrow and would not keep many brokers and other retirement plan service providers from becoming fiduciary investment advisers under the expanded definition of investment advice. The exemptions for platform provider services and investment education are particularly narrow and would not cover much of the information and services commonly provided by recordkeepers to individual account plan sponsors and participants. Recordkeepers are likely to curtail such services if those two carve-outs are not broadened in the final regulations.
New Prohibited Transaction Exemptions
Along with the proposed regulations, the DOL published two proposed prohibited transaction exemptions that would allow advisers and financial institutions that become fiduciaries under the investment advice definition to continue to receive compensation for certain services provided to plans and IRAs. Both exemptions would require the adviser and financial institution to enter into a contract with the plan sponsor, plan participant or beneficiary or IRA owner (the “retirement investor”) that discloses any material conflicts of interest and provides that the adviser and financial institution are fiduciaries and will provide investment advice that is in the retirement investor's best interest.
- The Best Interest Contract Exemption would allow advisers and financial institutions to receive compensation for services provided in connection with the purchase, sale or holding of certain assets as a result of investment advice given to plan participants or beneficiaries, IRA owners or sponsors of non-participant-directed plans with fewer than 100 participants. (Advisers to larger plans may take advantage of the seller’s carve-out.) In addition to entering into a contract with the retirement investor prior to providing investment advice, the adviser and financial institution would have to comply with complicated disclosure and recordkeeping requirements.
- The Principal Transaction Exemption would allow advisers and financial institutions to buy or sell certain debt securities in a principal transaction with a retirement investor. The debt securities would have to be liquid and have a credit risk that is “no greater than moderate,” and the adviser and financial institution would have to believe that the purchase or sale price is at least as favorable to the retirement investor as that available in a transaction that is not a principal transaction. In addition to entering into a contract with the retirement investor prior to engaging in the transaction, the adviser and financial institution would have to comply with complicated disclosure and recordkeeping requirements.
Effective Date and Comment Period
Given that proposed investment advice regulations were also issued in 2010 and that finalizing the regulations appears to be a priority for the Obama administration, it would not be surprising if the final regulations are similar to the proposed regulations in some important respects and take effect within a relatively short timeframe. (The preamble to the proposed regulations indicates that the final rule will apply eight months after its publication.) Plan sponsors should be prepared for changes in the services and contracts offered by recordkeepers, particularly with respect to investment education services.