Background
The long-anticipated and often-delayed new fiduciary rule under
the Employee Retirement Income Security Act of 1974, as amended
(ERISA) finally went into effect on June 9, with transition relief
blunting its impact until January 1, 2018. In announcing the
transition relief and relaxed enforcement standards at the end of
May, the secretary of labor essentially acknowledged that –
like so many other items on the Trump agenda – eliminating
the new rule was going to be more complicated and harder than
expected. Not only does the Department of Labor (DOL) have to run
the gauntlet of the Administrative Procedures Act, which sets out
detailed and time-consuming requirements for amending or
eliminating a significant regulation, but it also has to accomplish
that task with a seriously depleted staff.
For private funds, the main concern under the new rule is that
behavior previously considered basic marketing without any
fiduciary implications could now be considered investment advice
with potential liability under ERISA's high standard of care
and conflict prohibitions for fiduciaries. Covered investment
advice under the new fiduciary rule is defined as a recommendation
to a plan, plan fiduciary, plan participant (including a
beneficiary), IRA or IRA owner for a fee or other direct or
indirect compensation. A "recommendation" is a
communication that, based on the surrounding facts and
circumstances, a reasonable person would consider to be a
suggestion that the recipient engage in or refrain from taking a
particular course of action relating to investing, whether buying,
holding or selling a particular investment or managing investments
or investment accounts. The more tailored the communication is to a
particular investor or investors the more likely the communication
will be considered a recommendation. Although general
communications in newsletters, widely attended conferences, media
reports, general market data and general marketing materials may
fall outside the new fiduciary rule, it may not take much targeting
to land on the wrong side of the line dividing general
communications from fiduciary advice.
Relief is available where the ERISA plan or IRA invests using an
independent fiduciary (who cannot be the IRA owner or, in the case
a small plan, company insiders). To use this exception, the fund
manager (1) must know or reasonably believe that the independent
fiduciary (a) is a U.S. bank or insurance company, a U.S.
registered investment adviser or broker-dealer, or a fiduciary that
holds, manages or controls at least $50 million in assets, (b) is
capable of independently evaluating investment risks and (c) is the
ERISA or Code fiduciary responsible for exercising independent
judgment with respect to the transaction; (2) must inform the
independent fiduciary that it is not an undertaking to provide
impartial investment advice or to give advice in a fiduciary
capacity with respect to, and discloses to the independent
fiduciary the existence and nature of its financial interests in,
the transaction; and (3) must not receive a fee or other
compensation directly from the benefit plan investor or independent
fiduciary for the provision of investment advice (as opposed to a
fee for other services) in connection with the transaction. These
requirements can be satisfied by representations and covenants in
the investment management agreement, subscription agreement, side
letter or comparable documentation executed by the benefit plan
investor in connection with the transaction.
New Developments Since June 9
At the same time it announced that the new rule would go into
effect as scheduled on June 9, the DOL indicated that it would
implement a temporary enforcement policy until Jan. 1, 2018, and
would not pursue claims against fiduciaries who are working
diligently and in good faith to comply with the new rule and the
related exemptions (although it should be noted that the DOL's
forbearance would not prevent action by an ERISA investor itself).
It also indicated that reliance on the independent fiduciary
exception can be based on negative consent to a written
representation.
Since the rule became effective, there have been related
developments, both from the Labor Department and other sources,
outlined below.
- On August 30 the DOL formally
proposed an extension of the transition relief for prohibited
transaction exemptions adopted or modified in connection with the
fiduciary rule until July 1, 2019. Primarily affected is the Best
Interest Contract Exemption, which is available on a relaxed basis
during the transition period as long as the adviser only provides
advice that is in the best interest of the plan, receives no more
than reasonable compensation, and refrains from making materially
misleading statements regarding a recommended investment, the
adviser's conflicts of interest or other relevant matters. The
Department had previously signaled its intention to take this
action in a recent court filing.
- In another lawsuit specifically
challenging the new rule's ban on arbitration provisions, the
DOL referred to the issue becoming "moot," suggesting
future action to remove the ban; the DOL had previously said it
will no longer defend the ban in court.
- The DOL has also issued a new set of
frequently asked questions (FAQs) regarding the fiduciary rule,
primarily reconciling the disclosure requirements under the
service-provider exemption under ERISA Section 408(b)(2), which
requires self-identification as a fiduciary, and the fiduciary rule
transition relief, which permits silence regarding fiduciary
status. According to the FAQs a covered service provider that is or
could be considered to be providing investment advice as a result
of the new fiduciary rule can satisfy the 408(b)(2) disclosure
requirements by accurately and completely describing its services
to the plan, including those services constituting or arguably
constituting investment advice under the new rule, without labeling
itself as a "fiduciary" until the transition relief
expires and its status under the new rule is clear. The FAQs
further provide that an affirmative disclaimer of fiduciary status
(as opposed to silence) by a service provider that is providing or
reasonably expects to provide investment advice within the meaning
of the new rule as currently applicable would not satisfy the
408(b)(2) disclosure requirements until the affirmatively incorrect
statement is corrected or removed with a revised service contract
or disclosure. The new FAQs also confirm that advice regarding
efforts to increase plan participation is not fiduciary
advice.
- A Nevada law became effective on July
1, requiring investment advisers, broker-dealers and sales
representatives doing business in Nevada to act in accordance with
fiduciary standards in advising all investors in the state.
Covering both retirement and non-retirement accounts, the state law
is potentially broader than the ERISA fiduciary rule, and could be
a model for other states to follow if the Trump administration
rolls back the fiduciary rule.
- Republican-backed legislation has
passed the House, and additional bills have been introduced,
effectively killing the fiduciary rule, but passage through the
Senate is doubtful in the face of likely Democratic
filibusters.
- The SEC has issued an informal invitation for public comment on a possible fiduciary rule that the SEC could adopt to protect retail investors.
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