United States: Legal Alert: DOL Fiduciary Rule Changes Landscape For Investment Providers, Plan Sponsors And IRA Investors

The U.S. Department of Labor (DOL) has issued its long-anticipated final fiduciary rule. The final rule establishes more stringent fiduciary standards for investment advisers and consultants who provide services to employer-sponsored retirement plans and IRAs. By offering additional protection to retirement plan participants and IRA owners, the final rule extends the ERISA fiduciary standard to many investment professionals, consultants, and advisers who previously were not subject to ERISA's fiduciary standards or to the related prohibited transaction rules.

General Structure of the Final Rule

Under the final rule, an investment adviser or consultant who makes a "recommendation" to a plan or IRA for a fee or other compensation that is customized for or specifically directed at the plan or IRA may be a fiduciary. Under the final rule, a "recommendation" includes providing advice with regard to:

  • buying, holding, selling, exchanging, or rolling over securities or other investment property; or
  • management of securities or other investment property, investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or services, selection of investment account arrangements, and recommendations with respect to rollovers, distributions, or transfers from a plan or IRA.

Accordingly, an investment adviser or consultant who makes an investment recommendation and receives compensation in connection with such advice may not engage in a prohibited transaction unless (1) one of the specified exceptions, or "carve-outs," from the rule applies, or (2) the adviser/consultant complies with the "Best Interest Contract" exemption requirement.

Carve-Outs From Fiduciary Definition

The final rule contains specific carve-outs that identify common situations in which an adviser will not be considered a fiduciary. These include:

  • Providing a retirement plan with an investment platform, provided that the record-keeper or platform provider notifies the plan that it is not providing investment advice or serving as a fiduciary.
  • Identifying investment options that satisfy the pre-established investment criteria of an independent plan fiduciary (e.g., expense ratios, size of fund, type of asset, etc.) and/or providing benchmarking information to the independent plan fiduciary.
  • Providing general investment communications that under the circumstances a reasonable person would not view as investment advice (e.g., newsletters, public presentations and broadcasts).
  • Providing investment education, including plan information and general financial, investment, and retirement information.
  • Selling investments to a fiduciary who has the requisite investment background and who is properly informed that the broker is not undertaking to impartially advise the plan. This carve-out generally only applies to larger retirement plans with at least $50 million in assets.
  • Marketing for purposes of retaining business, or recommending that an individual hire the adviser for advisory or asset management services. Although, once hired, the adviser would no longer be subject to the carve-out.

Best Interest Contract Exemption

If none of the carve-outs are applicable, an adviser may continue to receive compensation by satisfying certain requirements. The "Best Interest Contract" exemption provides relief from prohibited transaction restrictions on compensation received by fiduciaries as a result of the purchase, sale, or holding by a plan or IRA of certain investments. Generally, the exemption requires the adviser fiduciary to abide by the basic standards of impartial conduct, including giving advice that is in the client's best interest, avoiding misleading statements, and receiving reasonable compensation. There are detailed requirements to meet the exemption.

Increased Investor Protection

In accordance with the DOL's stated consumer protection goals, the final rule is designed to ensure that adviser recommendations are fiduciary in nature.  In theory, the fiduciary standard (that advisers act with the care, skill, prudence, and diligence that a prudent person would exercise in the current circumstances) provides more protection to investors than the suitability standard (that advisers need only have a reasonable basis to believe that a recommended transaction or investment strategy is suitable for the customer, based on information obtained through reasonable diligence). Investors may take action against an adviser who breaches his or her fiduciary duty.

Impact on Retirement Plan Sponsors

As a retirement plan sponsor, an employer is already a fiduciary to its own 401(k) or retirement plan, and is required to understand the nature of its relationships with all of the plan's service providers. As the new fiduciary rules become effective, employers need to:

  • Understand whether the plan's investment adviser is currently acting as a fiduciary.
  • If the adviser has not been acting as a fiduciary, develop a timeline for when and how the adviser will transition its services to a fiduciary investment adviser model. 

Transitioning an existing adviser relationship to an investment fiduciary-based model may require more than just receiving and reviewing new account documents and disclosure statements. In many cases, in order for the adviser to meet the impartial conduct standards, more substantive changes, such as transitioning from a commission-based to a fee-based arrangement, may be necessary.

The new standards will likely require changes to the business models of many firms providing services to 401(k) and other retirement plans. Requiring a plan's investment adviser to act as a fiduciary, while potentially cumbersome for plan sponsors in the short-term (having to review new documents, etc.), should be beneficial to both plan sponsors and participants over time.

Effective Date

Although the new guidance is technically effective just 60 days after publishing in the Federal Register (which would be June 8, 2016), there is a longer transition period before advisers must operate within the confines of the final rule and accompanying exemptions. As of April 10, 2017, investment firms and advisers will be governed by the conduct and disclosure rules. An additional transition period from that date to January 1, 2018 will apply to the Best Interest Contract.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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