On April 7, 2017, the Department of Labor (DOL) published a final rule delaying the applicability date of the “Fiduciary” rule and certain related “Prohibited Transaction Exemption” rules (the Rules) until June 9, 2017. Although there was speculation as to whether the DOL would further delay the applicability date of the Rules, on May 22, 2017, the DOL issued Field Assistance Bulletin 2017-02 and Conflict of Interest FAQ (the May 2017 Guidance) confirming that the applicability date will remain June 9, 2017. In addition, in a recent Wall Street Journal op-ed, Secretary of Labor Alexander Acosta reiterated that the applicability date of the Rules is fixed. Specifically, Secretary Acosta stated that “[w]e have carefully considered the record in this case, and the requirements of the Administrative Procedure Act, and have found no principled legal basis to change the June 9 date while we seek public input. Respect for the rule of law leads us to the conclusion that this date cannot be postponed.”
Accordingly, the Fiduciary rule, the “Best Interest Contract Exemption” (BICE), and the Principal Transactions Exemption rules will take effect on June 9, 2017. However, during the transition period from June 9, 2017, until January 1, 2018, fiduciaries relying on the BICE and Principal Transactions Exemption rules for covered transactions must only adhere to the ‘‘best interest’’ standard and the other “Impartial Conduct Standards”. The Impartial Conduct Standards generally require that fiduciary advisers and financial institutions that provide investment advice do so in the investors’ best interest, receive no more than reasonable compensation, and avoid material misrepresentations when recommending transactions to investors. The transition period will end January 1, 2018, after which fiduciaries will need to comply with all exemption requirements based on current regulatory guidance.
Non-Enforcement Policy by DOL and IRS during the Transition Period
In the May 2017 Guidance, the DOL restated that during the transition period between June 9, 2017, until January 1, 2018 the DOL will not pursue claims against fiduciaries “ ... who are working diligently and in good faith” to comply with the Rules. This non-enforcement policy represents the DOL’s focus on “compliance assistance” over enforcement during this transition period. Similarly, the Internal Revenue Service (IRS) issued IRS Announcement 2017-4 stating that the IRS will not apply Internal Revenue Code Section 4975 (which provides excise taxes relating to prohibited transactions) and related reporting obligations to any transaction or agreement to which the DOL’s temporary non-enforcement policy applies.
The DOL’s Ongoing Examination of the Fiduciary Rule
In the May 2017 Guidance, the DOL emphasized that it will continue to examine the Fiduciary rule as required by the presidential memorandum issued by President Trump on February 3, 2017. The DOL maintained that although it delayed implementation of the Rules in order to conduct a complete review, President Trump’s directive did not prejudge the outcome of the DOL’s review or dictate specific changes to the applicability dates. To this end, the DOL expects to issue a request for information seeking additional public input regarding the January 1, 2018 applicability date for all of the Rules. Specifically, the DOL is interested in whether an additional delay beyond January 2018 would reduce burdens on financial services providers and benefit retirement investors. The DOL is aware that after the Fiduciary rule and Prohibited Transaction Exemptions were issued, financial institutions began to develop new business models and innovative products to mitigate conflicts of interest. The DOL’s request for information will seek public comment on whether it is likely to take more time to implement these new approaches than what the DOL envisioned when it set January 1, 2018 as the applicability date for full compliance. The DOL will be interested in information regarding: novel fee structures currently under development, the projected time to implement such fee structures, and ideas for new exemptions or regulatory changes based on market developments.
Notably, the DOL has identified “clean shares” as a fee structure that may mitigate conflicts of interest and aid financial advisers and institutions in complying with the Rules. Clean shares are a new mutual fund share class that does not provide for any commission, 12b-1, or sub transfer agent fees. This means that fund distributors selling clean shares are not compensated by the mutual fund in the form of a commission. Instead, the financial institution could set its own commission levels uniformly across the different mutual funds that advisers may recommend, substantially insulating advisers from conflicts of interest among different mutual funds. Clean shares were recently approved by the Securities and Exchange Commission in a January no-action letter. Much remains to be seen as to how this fee structure will influence the Fiduciary rule. However, the DOL appears to encourage the financial industry’s exploration of innovative fee and service models as it continues to analyze the Rules.
Not All Participant Communications Constitute Fiduciary Investment Advice
In the DOL’s May 22, 2017 Conflict of Interest FAQs, the DOL made clear that not all communications sent by plan sponsors, advisers or financial institutions to retirement plan participants constitute fiduciary investment advice under the Rules. The DOL explained that furnishing or making available plan information and general financial, investment and retirement information is not investment advice covered by the Fiduciary rule irrespective of the following: (i) who provides or makes available the information and materials (e.g., plan sponsor, investment adviser, financial institution, service provider), (ii) the frequency with which the information and materials are provided, the form in which the information and materials are provided (e.g., on an individual or group basis, in writing, via call center, video, computer software), or (iii) whether an identified category of information and materials is furnished or made available alone or in combination with other categories of information and materials, provided that the information and materials do not include (standing alone or in combination with other materials) recommendations with respect to specific investment products or specific plan or IRA alternatives, or recommendations with respect to investment or management of a particular security or securities or other investment property. However, the DOL FAQ examples are not particularly helpful in providing illustrations of these facts.
The Future of the Fiduciary Rule Remains Uncertain
In the coming months, the DOL will perform a full review of the Fiduciary rule. Additional DOL guidance is expected.
The DOL’s confirmation of the June 9, 2017 applicability date suggests that it may not use the formal rule-making process to repeal or modify the Rules. Instead, the DOL may wait for resolution in various court cases or an act of Congress before taking action. The DOL has successfully defended the Rules against legal challenges in Texas, Washington, DC, Kansas, and Minnesota. Plaintiffs in those cases, including the U.S. Chamber of Commerce, alleged that the DOL ignored comments from stakeholders and failed to properly analyze the costs and benefits of the Fiduciary rule, that the BICE undermines the Federal Arbitration Act by granting investors a private right to sue in federal court, and that the Fiduciary rule violates the First Amendment right to free speech by restricting advisers’ ability to advise clients. The plaintiffs in the Texas case currently have an appeal of the district court’s decision pending before the Fifth Circuit Court of Appeals. Oral arguments are scheduled for late July. Interestingly, the plaintiffs in the Minnesota case have filed an amicus brief in the Texas case. If the Fifth Circuit Court of Appeals were to hold for the plaintiffs in the Texas case and against the DOL, then the DOL could potentially discontinue enforcement of the Rules permanently without going through the formal regulatory process or be required by the Court to modify some or all of the Rules. Plaintiffs in the Washington, DC, case appealed an order denying an injunction against enforcement of the Fiduciary rule. Additionally, the Financial CHOICE Act, the Dodd-Frank replacement bill passed in the House of Representatives on June 8, 2017, includes a broad repeal of the Fiduciary rule. If this Act or something similar is passed by the Senate, the DOL would then not be able to enforce the Rules.
Despite the ongoing legal proceedings challenging the Rules and the DOL’s regulatory actions and inactions, many service providers, financial institutions, plan sponsors, and plan fiduciaries have already taken substantial steps to comply with the new requirements. Even if the outcome of the cases challenging the Rules or the DOL’s review the Rules results in a repeal of the Rules, service providers and financial institutions may continue to implement new service models and procedures designed to comply with the Rules. For example, some service providers have already amended their service contracts with plan sponsors and plan fiduciaries to provide that the service provider will provide “fiduciary” investment advice to plan participants, particularly in the context of retirement distribution options. These changes to the contracts generally modify the conflict of interest standards applicable to these services and specifically provide that the service provider will act in plan participants’ best interests when providing fiduciary investment advice.
Plan Fiduciary Action Required
Plan fiduciaries should take immediate action to determine if their service providers provide fiduciary investment advice under the Rules and, if so, that the service providers comply with the Rules. Named fiduciaries, such as benefit committees, must act prudently and monitor the actions of their co-fiduciaries, including financial institutions, record keepers, and other service providers who provide investment advice services under the Rules.
We recommend plan fiduciaries take the following steps:
- Analyze whether service providers such as financial institutions and recordkeepers, trigger the Rules through provision of investment advice.
- Carefully and thoughtfully review service agreements with those service providers to ensure compliance with the Rules. Consult with counsel and other benefits advisers regarding required amendments and best practices.
- Monitor communications sent by service providers to plan participants on an ongoing basis.
- Periodically request and review reports from service providers regarding investment advice and education provided to plan participants.
- Continue to monitor the status of the Rules. Consider submitting a response to the DOL’s request for information.
We will continue to monitor the implementation of the Rules and provide an update as it becomes available. For further information about the Rules, including information about conflicts of interest and BICE, please see our prior Client Alerts dated May 8, 2015, and April 28, 2017, and the Summer 2016 issue of Perspectives.
(*Note Benjamin T. Gibbs is a summer Intern, not licensed to practice law.)