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U.S. Department of Labor Issues Final Rule Redefining ERISA’s Definition of “Fiduciary” for Certain Types of Investment Advice


April 26, 2016

By Daniel R. Salemi and Trevor W. Holmes

On April 6th, the U.S. Department of Labor (DOL) released a final rule (the “Fiduciary Rule”) that expands the types of retirement investment advice that will be subject to the fiduciary duty rules of the Employee Retirement Income Security Act (ERISA).  The Fiduciary Rule primarily affects the investment advice that investment advisers, consultants, broker-dealers, and similar third parties provide to retirement plans, plan sponsors, and individual participants in retirement plans and IRAs.  In general, the Fiduciary Rule requires those advisers to provide investment advice that is in the best interest of the recipient of investment advice.  

Background on the Rule

With the transition from defined benefit to defined contribution retirement plans and the associated shift of retirement investment responsibilities to individual employees, the DOL sought to expand the fiduciary protections of ERISA to cover additional types of retirement investment advice.  Specifically, the new rule confers ERISA fiduciary status to those who provide “recommendations” that constitute “investment advice.”  Under the new rule, an individual will be an ERISA fiduciary when, for a direct or indirect fee, the individual makes:

  • a recommendation that involves the acquiring, holding, or selling of securities or other investment type property in a retirement plan or an IRA; or
  • a recommendation regarding the management of securities or other investment property, such as advice regarding investment portfolio composition or a recommendation regarding a rollover from a workplace retirement plan to an IRA.

Whether an individual has made a recommendation depends on the context and presentation of the information.  In other words, if the recipient of the information would reasonably view the information as advice to take a particular course of action with respect to retirement investments, it likely constitutes a recommendation. The more specific and tailored the advice, the more likely that it will fall within the scope of the final rule.

In addition to the type of advice, an adviser must also:

  • acknowledge that he or she is acting as an ERISA fiduciary; or
  • affirm that the advice is made pursuant to a written or verbal agreement that the advice is based on the recipient’s particular investment needs; or
  • direct the advice to a recipient or group of recipients with respect to the advisability of investing in a particular investment product or offer advice regarding the management of investment property.

The rule also carves out certain activities from the definition of investment advice. Specifically, subject to certain limitations, an adviser’s assistance to a participant or plan fiduciary in identifying investment alternatives, or making available a platform of investment alternatives for a defined contribution plan will not be considered a recommendation. General communications and investment education to individuals or plan sponsors also fall outside the scope of the rule, provided that the adviser meets certain criteria laid out in the rule. For now, proposals regarding valuations of ESOPs are also excluded from the rule’s coverage.

The BIC Exemption

Along with the Fiduciary Rule, the DOL issued a companion prohibited transaction exemption, called the “best interest contract” exemption, or “BIC” exemption. The exemption responds to the investment advisory industry’s concerns about the impact the Fiduciary Rule would have on the industry’s current compensation practices. Specifically, the BIC exemption will allow certain categories of financial advisers and the financial institutions that employ them to continue common industry practices, including the recommendation and sale of investment products with 12b-1 fees, revenue sharing payments, and similar forms of variable compensation, provided that those advisers and their financial institutions take certain steps to ensure that the recommendations that they make are in the best interest of their clients. 

The BIC exemption is important for small employer-sponsored retirement plans, defined as plans with less than $50 million in assets, because it will require advisers and financial institutions to take additional steps to ensure that the advice that those advisers and institutions provide (such as investment option recommendations in 401(k) plan investment lineups) is in the best interest of the plan. These additional protections require the financial institution to:

  • Provide clients with written acknowledgment by the adviser that it is a fiduciary; and
  • Issue initial and ongoing disclosures to the client that detail the adviser’s standard of care, compensation practices (including compensation that it receives from third parties), as well as provide access to a website with more detailed disclosures.

Financial institutions relying on the BIC exemption must also adopt and adhere to internal policies and procedures designed to limit conflicts of interest in the investment recommendations that its advisers make.  Among other things, a financial institution must implement policies that prevent the payment of certain types of compensation (e.g., bonuses) that might have the result of steering the adviser to recommend investments that fall below the “best interest” standard set forth in the rule. It is likely that many advisers to smaller plans will be relying on this exemption, rather than fully complying with the Fiduciary Rule in providing investment advice to plan sponsors.

Effective Date and Future Guidance

The Fiduciary Rule becomes initially effective on April 10, 2017 with respect to certain provisions, and becomes fully effective on January 1, 2018. The rule has proved controversial, as it may have profound implications over how various players in the financial advice industry provide investment recommendations to both ERISA-covered retirement plans and IRAs that receive rollovers from such plans. The DOL is expected to issue further guidance on the scope of the Fiduciary Rule and its various exemptions before it becomes initially effective on April 10, 2017.  

Next Steps for Plan Sponsors

Although the full impact of the Fiduciary Rule on plan sponsors will not be known for some time, we believe the final Fiduciary Rule and its companion BIC exemption may ultimately be a positive development for sponsors of small plans in particular, as it will increase the likelihood that these plan sponsors will receive unbiased advice from investment advisers and brokers.

In light of the BIC exemption, sponsors of small retirement plans should expect to receive new paperwork and disclosures from their investment consultants and similar service providers.  These materials should outline the service provider’s status as a fiduciary as well as details regarding its fee practices. Plan fiduciaries, as part of their ongoing duty to monitor service providers and similar professionals, will need to carefully review these new disclosures to ensure that they understand the adviser’s fee practices and determine whether those fee practices are in the best interest of the plan and its participants.

All plan sponsors should undertake a review of their service agreements with any service provider that provides investment advice or education, to determine whether any modifications are needed in light of the final Fiduciary Rule.  Many service providers are likely to propose contractual changes to plan sponsors, due to the BIC exemption or the overall heightened compliance burden imposed by the final Fiduciary Rule.  

Finally, all plan sponsors should take a close look at the investment education that is provided to employees and plan participants/beneficiaries, to ensure that the investment education qualifies as education (rather than advice) under the Fiduciary Rule.

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