On March 15, the Fifth Circuit Court of Appeals issued a ruling vacating the DOL Fiduciary Rule (the “Rule”) in its entirety.1 By the “Rule,” we mean the Obama-era regulation that significantly expanded the definition of “fiduciary” investment advice under ERISA and the Internal Revenue Code. Moreover, also vacated was the package of new and amended prohibited transaction exemptions – including the “Best Interest Contract Exemption” – that were issued to permit newly minted advice fiduciaries to receive sales commissions and other “conflicted” forms of compensation.
The Fifth Circuit’s ruling primarily affects brokers, insurance providers and other financial institutions and advisors. However, plan sponsors should also understand whether or not recommendations that plan participants and fiduciaries receive from vendors constitute “fiduciary” advice, subject to ERISA’s standards of prudence and loyalty.
At the outset, it should be noted that the Fifth Circuit’s ruling applies nationwide – not just within the states in the Fifth Circuit. Also, the ruling is final. The DOL has not appealed, and while we expect that the DOL will go back to the drawing board and propose new guidance later on (likely in conjunction with the SEC), for now the “old” standard for defining fiduciary advice (issued in 1975) is the current standard.
Under the Rule, the definition of “fiduciary” investment advice was very broad. With some exceptions, it included virtually all recommendations about investments and certain insurance products, even those given in a “sales” capacity or on a one-time basis, as well as recommendations about plan distributions and IRA rollovers. The 1975 standard, which now applies again, is narrow. Among other things, to be considered “fiduciary,” advice must be given regularly, under a mutual understanding that the advice is a primary basis for investment decisions and is individualized for the investor’s particular needs.
So, whether or not the Fifth Circuit ruling will affect the fiduciary status of a plan vendor depends on the relationship. In some cases, there may be no effect. For example, where plan sponsors have hired registered investment advisers (RIAs) to provide regular advice under a traditional “direct fee for service” advisory model, the RIAs will still be fiduciaries. In these cases, the advice given will still be considered “fiduciary” under the 1975 standard, and the RIA will generally acknowledge its fiduciary status in writing. Also, discretionary investment managers (3(38) Investment Managers) will still be fiduciaries – managing plan assets on a discretionary basis is, and always has been, a fiduciary service.
In other cases, the effect may not be as clear. For example, broker-dealers can (and sometimes do) provide advice that is “fiduciary” under the 1975 standard, but whether this is the case depends on the specific facts and circumstances. Also, brokers may wish to avoid fiduciary status if possible — particularly depending on what transitional relief (i.e., prohibited transaction exemption(s)) becomes available to permit them to receive commissions and other forms of compensation on account of fiduciary recommendations.
One important area that could be affected is distribution and rollover services. Under the Rule, a recommendation to take a distribution, and/or to roll plan benefits over to an IRA, was deemed fiduciary advice. Following the Fifth Circuit’s ruling, previous DOL guidance relating to IRA rollover recommendations (Advisory Opinion 2005-23A) may again apply. Under that guidance, vendors such as recordkeepers (and their affiliates) who were not already plan fiduciaries were not treated as giving fiduciary advice when recommending IRA rollovers to plan participants; thus, IRA assets could be “captured” without having the recommendations being subject to ERISA’s fiduciary standards. Thus, now may be an opportune time for plan sponsors to revisit this issue with recordkeepers. For example, plan sponsors may wish to find out whether written materials and call center representatives will provide only unbiased educational services about distribution options, or whether rollovers may be recommended and, if so, what safeguards are in place to protect participants’ best interests.