One More Fiduciary Issue for Recordkeepers

This is my 74th article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

In my last four posts, Angles 70 through 73, I discussed issues and opportunities for recordkeepers under the new fiduciary rule and the transition Best Interest Contract Exemption. This post covers a carve-out to the fiduciary definition that probably will not work—or, at least, won’t work effectively—for recordkeepers.

That carve-out to the fiduciary definition is one that allows recordkeepers to provide lists of the investments available on their platforms that satisfy certain criteria specified by the plan sponsor, for example, performance, expense ratios, volatility, etc. Specifically, that provision says that a recordkeeper does not become a fiduciary by:

Identifying investment alternatives that meet objective criteria specified by the plan fiduciary (e.g., stated parameters concerning expense ratios, size of fund, type of asset, or credit quality), provided that the person identifying the investment alternatives discloses in writing whether the person has a financial interest in any of the identified investment alternatives, and if so the precise nature of such interest; . . .”.

At first blush, that raises a practical question of whether plan sponsors who aren’t working with advisors have the ability to select appropriate criteria. Fortunately, the DOL permits recordkeepers to provide information to plan sponsors about generally accepted criteria. So, that hurdle can be cleared.

Similarly, in a FAQ, the DOL permits recordkeepers to use the criteria in an investment policy statement and provide the plan sponsor with the list that those criteria produce, without the recordkeeper becoming a fiduciary for that purpose.

In that regard, the FAQ states:

The recordkeeper would not be treated as making a recommendation for purposes of the Rule if it provided a list of all of the investment alternatives available on the platform that meet the requirements of the plan’s investment policy statement.

The recordkeeper must apply the criteria to all of the investments that are available on its platform and then report the results. As you might imagine, that could, depending on the criteria selected by the plan sponsor, be a list of just a few funds or a list of hundreds of funds.

Unfortunately, if the recordkeeper further winnows the list of investments produced by the application of the generally accepted criteria or the IPS criteria, the recordkeeper could become an investment fiduciary. In that regard, the DOL has said:

However, if the recordkeeper exercises discretion in narrowing the response to a selective list of investment alternatives, in the Department’s view, the communication could constitute an investment recommendation for purposes of the Rule if a reasonable person would view the communication as a recommendation that the fiduciary choose investments from the selective menu screened by the recordkeeper.

My view is that this carve-out may not be particularly helpful . . . because recordkeepers cannot provide selective lists without running the risk of becoming fiduciaries. As a result, recordkeepers that do not want to be fiduciaries are likely to provide investment line-ups to advisors through wholesalers (see Angles #72) and through responses to RFPs and RFIs as described in Angles #73.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Recordkeeper Investment Support for Plan Sponsors

This is my 73rd article about interesting observations concerning the Department of Labor’s (DOL’) fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

In Angles article #70, I discussed three areas where the fiduciary rule is impacting recordkeepers. Those are: acceptance of fiduciary status; non-fiduciary investment services for advisors; and non-fiduciary investment services for plan sponsors. Angles articles #71 and #72 discussed the first two points. This article discusses the third.

In the past, recordkeepers often provided sample line-ups to start-up plans and to existing plans that were transferring to their recordkeeping platform. However, under the new fiduciary definition, a selective list of investments is considered to be fiduciary investment advice, which means that the recordkeeper would need to make prudent recommendations and would be subject to ERISA’s prohibited transaction rules (e.g., for any proprietary investments and revenue sharing). Fortunately, there is an exception in the fiduciary regulation; unfortunately, though, the scope of the exception is limited. Let me explain.

The DOL’s fiduciary regulation—which applied on June 9, 2017—expands the definition of fiduciary advice. However, it also includes “carve-outs,” or exceptions, from the fiduciary definition. One of those exceptions is that fiduciary advice does not include a line-up of investments that is provided:

“ . . . In response to a request for information, request for proposal, or similar solicitation by or on behalf of the plan, identifying a limited or sample set of investment alternatives based on only the size of the employer or plan, the current investment alternatives designated under the plan, or both, provided that the response is in writing and discloses whether the person identifying the limited or sample set of investment alternatives has a financial interest in any of the alternatives, and if so the precise nature of such interest; . . .”

As a result, a recordkeeper can provide a plan sponsor with a sample list of investments (for example, for a 401(k) plan) without becoming an investment advisor fiduciary. However, the investment line-up can only be based on the size of the employer or the size of the plan, the plan’s current investment alternatives (if it is an existing plan), or both. In other words, the line-up cannot be customized for the particular plan (by, e.g., taking into account other factions). If it is customized, that would be fiduciary investment advice.

In addition, the sample line-up must be:

  • In response to a request for information, request for proposal, or similar solicitation by or on behalf of the plan.
  • In a written form which discloses whether the recordkeeper has a financial interest in any of the investments in the line-up and, if so, the precise nature of the interests must be described. That would include any proprietary investments and any investments that pay revenue sharing to the recordkeeper.

The sample list is limited to line-ups that would generally be proposed for plans or employers of a particular size (or be based on the line-up of an existing plan) and, therefore, would be of limited value to many plans, this RFP/RFI exception will likely provide some value to small, start-up plans which are serviced by advisors with little or no 401(k) experience and to plans that do not have advisors.

However, where plans do have advisors (even if they have limited experience with plans), the better approach would probably be the wholesalers exception, which was discussed in a prior post, Angles article #72.

Interestingly, if a recordkeeper goes beyond the limits of the RFP/RFI exception (for example, customizes the investment line-up), the recordkeeper will be a fiduciary to the plan, which implicates both the fiduciary standard of care and the prohibited transaction rules. Since recordkeepers commonly receive revenue sharing from a plan’s investments and, therefore, engage in prohibited transactions, they would need to comply with the transition rules for the Best Interest Contract Exemption. Those rules are: adherence to the best interest standard of care; receipt of no more than reasonable compensation; and not making materially misleading statements. For the duration of the transition period (until July 1, 2019), those requirements do not appear to be insurmountable. As a result, some recordkeepers may decide to provide fiduciary investment advice to plan sponsors, rather than use the RFP/RFI carve-out. To this point in time, though, I haven’t seen a movement in that direction.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Recordkeepers and Financial Wellness Programs

This is my 71st article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

In my last post, Angles #70, I highlighted the three types of work that we are doing for recordkeepers as a result of the DOL’s fiduciary regulation and exemptions. This post goes into more detail about the development of financial wellness programs and the acceptance by recordkeepers of fiduciary responsibility for some of the services.

As background, the goal of financial wellness programs is to provide help to participants in achieving their short-, intermediate-, and long-term financial objectives. Recordkeepers are uniquely suited to provide those services, because of the information they already possess and because of their call centers. The services most often provided cover advice about:

  • Contributions and benefit adequacy.
  • Repayment of indebtedness.
  • Budgeting and management of expenses.
  • Savings for unexpected expenses.
  • Investing their 401(k) accounts.
  • Roll-ins to the 401(k) plan.
  • Rollovers from the 401(k) plan.

Some of that advice is fiduciary and some is not. Let’s take a closer look at that.

Clearly, recommendations about repayment of indebtedness, budgeting and management of expenses, and the accumulation of savings for unexpected expenses is not fiduciary advice. However, the recommendations must be reasonable in light of the circumstances (under the laws of most states). In addition, advice about the level of deferrals to 401(k) plans is not fiduciary advice, so long as it is based on an objective standard. For example, financial wellness programs may recommend that, as a first step, participants defer at least enough to benefit from the full match offered by the employer. In addition, those programs typically recommend at some point in the process that participants defer enough to achieve benefit adequacy at retirement (for example, a 70% income replacement ratio).

On the other hand, investment advice for participants’ accounts and recommendations of roll-ins and rollovers, is fiduciary advice. Those types of recommendations will cause the recordkeeper to become a fiduciary for those purposes. As a result, recordkeepers will need to have prudent processes in place to develop and deliver the recommendations. In addition, where the recordkeeper, or an affiliate, would make more money if a participant agrees to the recommendation, the recordkeeper will need to comply with a prohibited transaction exemption. Usually, that will the Best Interest Contract Exemption, or BICE.

For example, if a recordkeeper recommends that a participant rolls in his or her money from another plan or an IRA, the recordkeeper will need to do a prudent analysis of the relevant facts and then make a prudent and loyal recommendation to the participant. While the DOL has not provided detailed guidance about roll-ins, a reasonable approach would be for the recordkeeper to gather information about the investments, services and expenses in the IRA or old plan; the same type of information about investments, services and expenses in the recordkeeper’s plan; and information about the needs, circumstances and preferences of the participant. (As a general rule, in order to provide prudent advice, a fiduciary must gather the information that a knowledgeable person would consider relevant to making the decision. However, we are left to speculate about the specific information that would be required for a roll-in recommendation.)

In any event, recordkeepers must gather the relevant information and make prudent and loyal recommendations where they provide fiduciary advice under a wellness program. In addition, where a recordkeeper would receive additional compensation if the recommendation is accepted by the participant, the recordkeeper would need to satisfy the conditions of BICE which, in addition to the best interest standard of care, would include a prohibition on compensation in excess of a reasonable amount and would prohibit any materially misleading statements. The recordkeeper should also have written policies and procedures, together with supervision, for the development and delivery of the fiduciary recommendations.

If those conditions are satisfied, recordkeepers could provide so-called “conflicted” advice. (In this context, “conflicted” means that advice that will cause the recordkeeper or an affiliate to receive additional compensation.)

Where the financial wellness program also includes discretionary investment management of participant accounts, the issues are more complex. That is because BICE does not provide an exemption for discretionary investment management. In that case, the recordkeeper will need to either utilize an independent third party investment manager for the discretionary services or will need to use another exception (for example, the Frost Advisory Opinion or Prohibited Transaction Exemption 77-4).

Having worked on programs that offer these services to participants—and, therefore, having given it some thought, I believe that these programs will provide valuable services to employees. The financial world is increasingly complex and young employees are often burdened by substantial student loans. As a result, there is a need for help with financial decisions.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.