The U.S. Department of Labor's (DOL) final rule significantly expanding when a person is considered to be a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (Code) as a result of providing investment advice is set to become applicable at 11:59 PM (local time) on June 9, 2017. The expanded final rule might cover certain marketing and other related activities common to the investment management industry (including the private investment fund industry).
The final rule was initially set to become applicable on April 10, 2017, but the DOL delayed the final rule's applicability date for sixty days, until June 9, 2017.[1] Although the DOL has since indicated that it will not further delay the applicability date of the final rule,[2] the DOL has also issued a new temporary enforcement policy for the transition period commencing on June 9th and ending on December 31, 2017. During the transition period, the DOL will not pursue claims against fiduciaries who are working diligently and in good faith to comply with the final rule and the related exemptions.[3]
The following is a high-level executive summary of certain material aspects of the final rule as it relates to private investment fund managers and other investment advisers, followed by a list of potential action items to consider. To review a more fulsome summary of the final rule, please see our prior client alerts (available here and here).
Executive Summary
- The final rule affects common marketing and other related
activities involving ERISA plan and/or individual retirement
account (IRA) investors, prospective investors, clients and/or
prospective clients (Targeted ERISA/IRA Parties).
- Certain common marketing or offering activities for private
investment funds and separately managed accounts involving ERISA
plans and/or IRAs could be considered "investment advice"
under the final rule.
- Similarly, some fund managers' and investment advisers'
periodic newsletters could be viewed as a
"recommendation" to remain invested in a fund or continue
a separately managed account arrangement.
- Discussions with Targeted ERISA/IRA Parties might be considered
"investment advice" and fiduciary in nature if they are
considered tantamount to a "recommendation" to invest (or
maintain an investment) in the fund or establish (or maintain) a
separately managed account arrangement, even though, in the case of
a prospective investor or client, a fee will not be charged until
after the investor invests in the fund or the separately managed
account is established.
- If such marketing materials, pitch practices and/or periodic
distributions are considered a "recommendation", such as
a recommendation to purchase or hold a security (e.g., an equity
interest in a private investment fund) or continue a separately
managed account arrangement, then the fund manager or investment
adviser would most likely be considered to be providing fiduciary
"investment advice" to Targeted ERISA/IRA Parties to
purchase or continue to hold an interest in the fund manager's
or adviser's own funds and/or establish or continue a
separately managed account arrangement with the fund manager or
adviser (and to pay any related management or other fees), as the
case may be. This advice could be treated as
"conflicted," resulting in a violation of fiduciary duty
and/or a prohibited transaction absent an exemption.
- Certain common marketing or offering activities for private
investment funds and separately managed accounts involving ERISA
plans and/or IRAs could be considered "investment advice"
under the final rule.
- A request to "hire me" to provide investment
management services by touting the quality of an individual's
or entity's advisory or investment management services that is
not combined with a "recommendation" on how to invest or
manage ERISA plan or IRA assets might not constitute
"investment advice." Unfortunately, the line
between "hire me" communications and advice that triggers
fiduciary obligations is not clear. The "hire me"
exception generally will not work for marketing of specific funds
and preset investment strategies.
- Fund managers and other investment advisers might be able to
avail themselves of an "expert fiduciary exclusion" when
dealing with most ERISA-covered investors and clients.
However, this exclusion is not available for
recommendations to IRA owners, small plan fiduciaries or plan
participants and beneficiaries that are not separately advised by
fiduciaries. This "expert fiduciary exclusion" will
generally apply if the fund manager or investment adviser:
- knows or reasonably believes that the independent fiduciary of
the ERISA plan or IRA is a US-regulated bank, a US-regulated
insurance carrier, a registered investment adviser, a registered
broker-dealer, or an independent fiduciary that holds, or has under
management or control, total assets of at least $50 million (and it
may rely on written representations to satisfy this
requirement);
- knows or reasonably believes that the independent fiduciary of
the ERISA plan or IRA is capable of evaluating investment risks
independently, both in general and with regard to particular
transactions and investment strategies (and it may rely on written
representations to satisfy this requirement);
- fairly informs the independent fiduciary that it is not
undertaking to provide impartial investment advice, or to give
advice in a fiduciary capacity, in connection with the transaction
and fairly informs the independent fiduciary of the existence and
nature of its financial interests in the transaction;
- knows or reasonably believes that the independent fiduciary is
a fiduciary under ERISA or the Code, or both, with respect to the
transaction and is responsible for exercising independent judgment
in evaluating the transaction (and it may rely on written
representations to satisfy this requirement); and
- does not receive a fee or other compensation directly from the ERISA plan, ERISA plan fiduciary, ERISA plan participant or beneficiary, IRA, or IRA owner for the provision of investment advice (as opposed to a fee for other services) in connection with the transaction.
- knows or reasonably believes that the independent fiduciary of
the ERISA plan or IRA is a US-regulated bank, a US-regulated
insurance carrier, a registered investment adviser, a registered
broker-dealer, or an independent fiduciary that holds, or has under
management or control, total assets of at least $50 million (and it
may rely on written representations to satisfy this
requirement);
Potential Action Items
- Private investment fund managers and other investment advisers
that determine that their typical marketing activities would (or
could) be treated as "investment advice" under the final
rule should decide whether or not to continue to pitch their
products to IRAs or small plans, or to alter such activities so as
to not constitute "investment advice".
- Similarly, managers and advisers of open-end, liquid private
investment funds and separate accounts that have IRAs or small plan
investors should determine whether to permit such investors to
remain in their funds or whether to continue such separate account
arrangements.
- The BICE might be available in certain cases to permit the
status quo for IRAs and small plans, but the conditions for the
exemption may prove too complicated or impractical (even with
certain requirements of the BICE not applicable until January 1,
2018).
- Similarly, managers and advisers of open-end, liquid private
investment funds and separate accounts that have IRAs or small plan
investors should determine whether to permit such investors to
remain in their funds or whether to continue such separate account
arrangements.
- With respect to any commitments to be accepted from, or
separate account arrangements to be entered into with, large
institutional ERISA investors after June 9th, fund managers and
investment advisers should determine whether or not to revise any
offering materials and/or require additional written
representations from such investors. For example, fund
managers and investment advisers might want to confirm the
availability of the "expert fiduciary exclusion" with
respect to any potential "investment advice" that may be
provided to such investors in connection with the
commitment/engagement and/or throughout the term of the
investment/engagement.
- With respect to open-end, liquid private investment funds that
have large institutional ERISA investors and existing separate
account arrangements with large institutional ERISA investors, fund
managers and investment advisers should consider requiring the
ERISA investors to make additional written representations to
confirm the availability of the "expert fiduciary
exclusion" with respect to ongoing communications. For
example, the representations would confirm the understanding that
communications to such ERISA investors about performance and
developments is not intended to be fiduciary advice to remain
invested in the fund or account.
- With respect to closed-end, illiquid private investment funds that are no longer fundraising as of June 9th, fund managers and investment advisers should determine whether any action is necessary under those circumstances.
[1] When the DOL issued the final rule it also issued new prohibited transaction exemptions (including the Best Interest Contract Exemption or "BICE") and amendments to existing prohibited transaction exemptions, which were aimed at easing the potential prohibited transaction impact of the final rule. The DOL also delayed the applicability date for most of the new requirements of the BICE and such other new and amended exemptions until January 1, 2018. However, the BICE's "impartial conduct" standard (acting in the client's best interest) is still set to apply as of June 9th.
[2] The DOL has noted that it is continuing to review the final rule and the related exemptions, and it is possible that changes thereto may be issued prior to the end of the transition period, including potentially further delaying the January 1, 2018 applicability date of the delayed exemption requirements. The DOL intends to issue a Request for Information in the near future for additional public input on specific ideas for possible new exemptions, other regulatory changes, and as to whether an additional delay of the January 1, 2018 applicability date of the delayed exemption requirements is appropriate.
[3] The temporary enforcement policy also includes confirmation from the Treasury Department and the Internal Revenue Service that Section 4975 of the Code (which provides excise taxes relating to prohibited transactions) and related reporting obligations will not be applied during this transition period with respect to any transaction or agreement to which the DOL's temporary enforcement policy would apply.
DOL's Fiduciary Rule To Apply June 9th, Investment Managers and Advisers May Want to Take Action Now
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.
