On April 6, 2016, the Department of Labor released the final version of its highly anticipated fiduciary rule. The rule is the culmination of six years of study, commentary and revisions after it was originally proposed in 2010, withdrawn and then re-released in 2015.
The rule will impose a fiduciary standard of care on brokers and investment advisors who provide investment advice to retirement plan investors. Generally, a fiduciary must deal fairly with, and act in the best interests of, its client, avoid misrepresentations, receive only reasonable compensation and is prohibited from engaging in any conflict of interest transaction with that client, absent full disclosure of the conflict and advance client consent to the transaction.
The essence of the rule — to subject more retirement plan accounts advisers to the fiduciary standards of ERISA — remains unchanged, but the Department of Labor made several exemptions and modifications to ease the burden on advisers.
Who is now a fiduciary?
The final rule expands those who are considered a fiduciary to retirement accountholders, including employee benefit plan participants and IRA accountholders. A fiduciary now includes a person who provides certain specified types of “investment advice.”
“Investment advice” includes any “recommendation” regarding:
- The prudence of buying or selling investments
- How assets should be invested after they are rolled over, transferred or distributed from a retirement plan or IRA to an accountholder or to another retirement plan or IRA
- Management of investments in a retirement plan account
A “recommendation” is broadly defined as a communication in exchange for compensation that would reasonably be seen as a suggestion that the advisee take (or not take) a particular action. The more narrowly tailored the advice to a particular investor, the more likely the communication will be considered a recommendation. Specific educational asset allocation models and interactive investment materials, if provided to multiple plan participants and beneficiaries, are not considered recommendations. If the same materials are provided to individuals, they may be seen as recommendations. However, certain activities related to marketing, such as advertising available investment options, and hosting investment or retirement education seminars, specifically are not considered recommendations.
Providing investment advice will give also rise to a fiduciary duty when:
- The person providing recommendations represents that such person is a fiduciary under ERISA or the Internal Revenue Code
- The advice is given pursuant to a written or verbal agreement or understanding that the advice is tailored to the investment needs of the individual
- The recommendation is made to one or more particular individuals on the prudence of a particular investment decision regarding the plan’s or IRA’s investment options
Exceptions from fiduciary duty
The new rule provides two important exemptions:
- Best Interest Contract Exemption. Brokers and advisors may receive commissions or 12b-1 payments (which would otherwise be a prohibited conflict of interest for a fiduciary) if the broker or adviser signs a contract with the accountholder acknowledging its fiduciary status.
- Principal Transactions Exemption. Fiduciaries may buy and sell certain investments to and from their own accounts to retirement plan investors. For example, a broker can sell a bond from its inventory to a retirement plan account advised by an affiliated adviser.
Differences from the 2015 proposed rule
The Department of Labor made some important concessions in the final rule to allay concerns raised during the comment period, including:
- The Best Interest advisory contract can be signed after the client has decided to open an account (with other required paperwork) instead of at the first meeting.
- Advisers relying on the Best Interest Contract Exemption will not be required to provide one-, five- and ten-year projections of their fees to clients, as originally proposed, and other disclosure requirements were streamlined.
- The new definition of fiduciary will now begin to be effective April 10, 2017, with full compliance with certain requirements for the new exemptions delayed until January 1, 2018. There is some industry speculation that a new presidential administration might reverse or revise the fiduciary rule, or that legal action could be taken alleging that the DOL does not have authority to regulate broker-dealers and advisers.
- The final rule clarifies that any type of investment product may be recommended or sold, provided that the adviser complies with the Best Interest Contract Exemption. Some commentators had expressed concern that certain investments, such as variable annuities or non-traded REITs, would no longer be permitted investments for retirement accounts.