Marcia Wagner(Have all your DOL Rule questions answered by Marcia Wagner LIVE and earn CFP credit. Register to attend the ThinkAdvisor/National Underwriter Co. webinar on August 24, The DOL Fiduciary Rule: What Now? What Next? To register, click here.)

The DOL’s proposal expanding the definition of fiduciary investment advice was published April 20, 2015. Almost a year later, after public hearings and thousands of comment letters were submitted with respect to the proposal, the DOL finalized and published its new fiduciary rule on April 8, 2016. The new fiduciary rule is actually a package of regulatory guidance and separate exemptions comprised of a new definition of fiduciary investment advice and a number of related releases providing relief from ERISA’s prohibited transaction rules for fiduciary advisors necessitated by the dramatically expanded scope of the revised fiduciary definition.

The DOL’s new fiduciary rule is intended to broaden the scope of retirement advisors who are deemed to be fiduciaries under ERISA and the Internal Revenue Code (the “Code”), and it is also designed to address the potential conflicts of interest that arise when they are advising their retirement clients. The scope of the new rule is far-reaching, and it specifically covers and protects IRA clients as well as plan sponsors and participants.

The new fiduciary rule targets broker-dealers, their registered representatives as well as insurance companies and their agents. It will affect virtually all registered representatives with any IRA or plan clients. In order to continue to earn commission-based compensation, advisors will need to comply with one of the new class exemptions. Virtually all IRA advisors will be deemed to be fiduciaries, and the new rule is expected to change the IRA marketplace. The new rule will also impact registered investment advisors (or RIAs) principally in two areas: it will restrict their ability to capture rollovers and it will also impose new restrictions on retail managed account programs that are sponsored by advisory firms.

Scope of Affected Plans

The new definition of fiduciary investment advice applies to ERISA plans maintained by private employers, as well as the tax-qualified arrangements described in Code section 4975 which include sole proprietor plans, such as solo 401(k) plans, IRAs, Archer Medical Savings Accounts, Health Savings Accounts, and Coverdell education savings accounts. Code section 529 plans are not subject to ERISA and they are not listed in Code section 4975, so they are excluded from coverage (see Figure 2.1).

Figure 2.1

Plans Affected by the DOL Fiduciary Rule

Included Plans:

Excluded Plans:

  • Tax-qualified arrangements described in IRC §4975
  • Sole proprietor plans
  • §401(k) plans
  • IRAs
  • Archer medical savings accounts
  • Health savings accounts
  • Coverdell education savings accounts
  • ERISA-covered §403(b) plans maintained by private employers
  • §529 plans
  • Non-ERISA §403(b) plans maintained by individuals or governmental entities
  • Funded §457 (typically government) plans
  • Nongovernmental §457 plans
  • Nonqualified, non-ERISA plans

 

 

 

Codes section 403(b) accounts can be divided into three groups: (1) non-ERISA section 403(b) accounts maintained solely by an individual through salary reductions with little or no employer involvement in administration, (2) non-ERISA section 403(b) plans maintained by a governmental entity, such as a public school or a non-electing church, and (3) ERISA-covered section 403(b) plans maintained by a private employer. The DOL has made it clear that categories (1) and (2) are not subject to ERISA or the new fiduciary rule.

Nongovernmental §457(b) plans are generally structured as unfunded nonqualified deferred compensation plans covering only a select group of management or highly compensated employees and, as such, are exempt from the fiduciary requirements contained in Part 4 of ERISA.  Therefore, these plans and their counterparts under Section 457(f) of the Internal Revenue Code are not covered by the new fiduciary rule.

Effective Date

Although the DOL’s final rule was officially published on April 8, 2016, its effective date was delayed until April 10, 2017. This one-year grace period was designed to give the industry time to adjust to the new rules and be consistent with the DOL’s previously announced commitment to give the industry lead time of at least eight months. The related prohibited transaction exemptions impose numerous conditions and requirements on fiduciary advisors. Some of these requirements will be phased in and become effective on April 10, 2017, but many of the more onerous requirements will not become effective until January 1, 2018, once again giving advisors and other service providers time to adjust to the change from non-fiduciary to fiduciary status.

Fiduciary Definition and “Investment Advice” 

Under the DOL’s existing fiduciary definition for service providers, the provider is deemed to be a fiduciary to the extent it provides “investment advice” relating to plan assets for a fee or other compensation. Once the provider is deemed to be a fiduciary, the provider becomes subject to a higher standard of care under ERISA, as well as particular limitations on the conduct of fiduciaries, i.e., prohibited transaction rules.

Rationale for Repeal of Old Definition – Under the old DOL definition, in order to be a fiduciary providing investment advice, the advisor needed to make recommendations as to investing in securities or other property, or give advice as to their value, on a regular basis. There also had to be a mutual understanding that the advice would serve as a primary basis for the plan’s investment decisions, and that the advice would be individualized to the particular needs of the plan.

Since 2010, when it initially proposed revising the five-factor definition, the DOL has taken the position that this definition is too narrow in today’s world, allowing many advisors to effectively provide advice without having to answer to ERISA’s fiduciary standard of care. For example, an advisor could take the position that its advice is not provided on a regular basis, or that there is no mutual understanding that the advisor’s recommendations will serve as the primary basis for the plan’s decisions. The DOL thought it was too easy for advisors to escape fiduciary status by relying on these components of the old definition which it viewed as going too far in narrowing the definition of a fiduciary. It, therefore, expanded the definition considerably under the new fiduciary rule to include a much broader group of advisors.

Context of Advice – As with the old fiduciary rule, the DOL’s new rule provides that a person furnishing “investment advice” for compensation will still be viewed as a fiduciary. However, under the new rule, there are three different ways or contexts in which an advisor will be deemed to be given investment advice as a fiduciary. First, if the advisor acknowledges that it is acting as a fiduciary under ERISA or the code, its advice will be automatically viewed as fiduciary advice. Second, if there is a written or unwritten understanding that the advice is based on the particular investment needs of the client, the advice will be deemed to be fiduciary in nature. Third, if the advice is directed to a specific person where the advice relates to the advisability of a particular investment decision, the advice will be deemed to be fiduciary advice.

Content of a Fiduciary “Recommendation” – In addition to looking at the context of the advice, it is also necessary to examine the nature of the advice, to determine if it is fiduciary advice. Advice will be deemed to be fiduciary investment advice, only if it includes a “recommendation” for a fee or other direct or indirect compensation, regardless of whether it is paid by the plan or a third party, such as an investment provider. Under the final rule, the threshold question in determining if fiduciary advice has been rendered is whether such a “recommendation” has occurred.

The formal definition of a recommendation, like everything in the final rule, is somewhat complicated, but it can be boiled down to two types of recommendations to plan and IRA clients. First, fiduciary advice includes recommendations on the advisability of investing in a security or other investment property. Second, fiduciary advice also broadly includes recommendations relating to the management of securities or other property. For example, management-related recommendations may include guidance with respect to an investment policy statement, investment strategies or portfolio composition. It may also include recommendations concerning the selection of other persons to provide investment advice or investment management services. Recommendations relating to the type of investment account (such as brokerage versus advisory accounts) are also covered.

A recommendation for the transfer or rollover of assets from a plan or IRA account to a different plan or IRA account is another form of fiduciary advice. The DOL has clarified that under its new fiduciary advice definition, all types of rollover recommendations will be viewed as fiduciary investment advice. Merely recommending a rollover distribution from a plan is viewed as fiduciary advice, even if it does not include an actual investment recommendation as to how to invest the rollover proceeds after the distribution is made from the plan.

Proposed vs. Final Regulations – The final version of the DOL’s new investment advice definition follows the structure of its proposed rule, which was issued in April 2015. However, there are a few noteworthy differences. While the 2015 proposal provided that appraisals and financial valuations of securities would generally be viewed as fiduciary advice, the DOL’s final rule excludes appraisals from the definition of investment advice. The DOL is, however, developing a regulatory amendment that will cover ESOP appraisals in the future. As discussed, the DOL’s final regulations will become effective on April 10, 2017.

For purposes of the final fiduciary definition, the DOL has clarified that an advisor’s fiduciary services may be limited to one-time advice, provided that the advisor communicates that it will not have any ongoing monitoring responsibilities with respect to the recommended investment after its acquisition. However, the DOL has indicated that when there will be no ongoing monitoring, the advisor must ensure that the investment can be prudently recommended in the first place without provision for a monitoring mechanism.

OBSERVATIONS: The new definition broadens the scope of what fiduciary investment advice is by eliminating the regular basis, mutual understanding and primary basis aspects of the old five-factor test. Even one-time advice that is not provided on a regular basis can potentially be viewed as fiduciary advice. Unlike the old definition, there is no need for a “mutual understanding” between the parties for fiduciary advice to be provided. It is enough for a plan or IRA client to unilaterally think that the advisor is providing fiduciary advice, to trigger fiduciary status for the advisor, provided that the advisor’s communication is “reasonably” viewed as investment advice. The advice does not even need to be individualized. A recommendation will be viewed as fiduciary advice if it addresses the particular investment needs of a client, or if it merely addresses a particular investment decision. Also, the advice no longer needs to serve as the “primary basis” for the retirement client’s investment decision as required under the old rule. Under the new rule, the retirement client merely needs to receive the advice.

The old fiduciary investment advice definition clearly covered investment recommendations, but it did not expressly apply to investment management recommendations. Because of the literal wording, certain advisors took the position that recommending investment managers (as opposed to investments) was not a fiduciary act. However, the DOL has now clarified that investment management recommendations are also covered advice.

Further, with respect to recommendations concerning the selection of other persons to provide investment advice or investment management services, the DOL has clarified that the fiduciary advice definition is not intended to include marketing-related statements that an advisor might make when promoting its own services. Therefore, investment advice does not include an advisor’s recommendation to a retirement client to hire the advisor itself. In other words, an advisor that makes a “hire me” recommendation to a plan or IRA client will not be viewed as providing fiduciary advice. This is a helpful clarification, because otherwise, an advisor’s “hire me” recommendation could potentially be viewed as conflicted advice in violation of the prohibited transaction rules.

In response to commentators, the final rule provides that advice as to the purchase of health, disability, term life insurance and similar life insurance policies without an investment component will not constitute fiduciary investment advice. However, the Preamble to the final regulation makes a point of noting that if an advisor effectively has discretionary control over the decision to purchase such insurance, the advisor could potentially come under the management or administration branches of the functional fiduciary definition, even if the advisor was not deemed to have provided investment advice.

Lastly, the final rule purports to follow the definition of a “recommendation” as promulgated by the Financial Industry Regulatory Authority (“FINRA”) meaning that it broadly includes any communication that, based on its content, context and presentation, would be reasonably viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.

(Excerpted from her new book, The Advisor’s Guide to the DOL Fiduciary Rule, published by The National Underwriter Company.)

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(Have all your DOL Rule questions answered by Marcia Wagner LIVE and earn CFP credit. Register to attend the ThinkAdvisor/National Underwriter Co. webinar on August 24, The DOL Fiduciary Rule: What Now? What Next? To register, click here.)