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).
Plans Affected by the DOL Fiduciary Rule
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.
If you’ve got questions about compliance issues related to the new fiduciary standard, you’re not alone. (Photo: iStock)
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.