As we indicated in October 2010, the DOL's proposed regulations substantially broadening the term "fiduciary" under ERISA regulations were fraught with controversy. The withdrawal of these proposed regulations was not unexpected.
The proposed regulation had promised to significantly broaden the definition of who is treated as fiduciary under ERISA by reason of providing "investment advice." Currently, the definition of investment advice is governed by a five-part test that had existed since 1974. The proposed regulation replaced this five-part test by a new test that made fiduciary status practically automatic for SEC-registered investment advisers in certain circumstances and caused considerable concern among plan sponsors and the financial community with respect to the regulation's co-ordination with other legislation, such as the Dodd-Frank Act. In particular, there was concern that the interaction between regulations issued under the Dodd-Frank Act and the proposed regulation would have the effect of prohibiting plans from entering into derivative contracts, including swaps (an important tool used by defined benefit plans to manage volatility), and bank-provided stable value contracts (an important tool used by defined contribution plans to offer a capital preservation investment option to plan participants).
Further, if the regulations had been finalized as proposed, plan sponsors were concerned that the service provider marketplace would shrink, since the broad definition could unnecessarily sweep certain service providers who do not have the business model to support fiduciary status into the category of fiduciary. Fiduciary status is costly, and requires compliance support and insurance. For example, most appraisers do not currently agree to fiduciary status. Appraisers who provide services to plans (for example, by appraising employer securities), would have had to revamp their business model at considerable cost in order to continue in business as fiduciaries. As well, for many consultants who do not provide investment advice under current rules, but recommend and assist with plan design, asset allocation, RFPs, manager retention and other consulting projects, fiduciary status and attendant potential liability would have meant substantial additional cost. If plan clients were not willing or able to pay additional fees, these service providers might have ceased doing business with plans. Further, for broker-dealers not engaged in providing investment advice under the current five-part test, fiduciary status would have meant considerable difficulty receiving fees and commissions from plans in connection with principal transactions, a key aspect of the broker-dealers’ business model.
The proposed regulation received several hundred comments and the DOL held two days of hearings on it. Over the summer, several members of Congress, from both sides of the aisle sent letters to the DOL encouraging the DOL to reconsider certain aspects of it. Finally, on September 19, 2011, the DOL announced that it would withdraw the regulation and expected to re-propose it in "early 2012."
In its press release announcing the withdrawal, the DOL indicated that it would revise "provisions of the rule, including but not restricted to, clarifying that fiduciary advice is limited to individualized advice directed to specific parties, responding to concerns about the application of the regulation to routine appraisals and clarifying the limits of the rule's application to arm's length commercial transactions, such as swap transactions. Also anticipated are exemptions addressing concerns about the impact of the new regulation on the current fee practices of brokers and advisers, and clarifying the continued applicability of exemptions that have long been in existence that allow brokers to receive commissions in connection with mutual funds, stocks and insurance products."
These comments indicate that the DOL is aware of the concerns of plan sponsors with respect to swaps and stable value contracts, and will address these concerns in a re-proposed regulation. We expect that the DOL will provide that any re-proposed regulation is not intended to limit plans’ access to swaps used to manage plan volatility and to stable value contracts. Further, while the comments in the DOL’s press release may not entirely quell plan sponsors’ concerns about the effect of a broad definition of “investment advice” on the service provider marketplace, the comments do indicate that any re-proposal will provide exemptions with respect to fees and commissions of brokers and advisers.
It is notable that the DOL has stated that it expects to re-propose the regulation in 2012, which is an election year. Election years can have the effect of delaying the proposal of controversial regulations; therefore we will continue to monitor closely the regulatory activity of the DOL.