Changes AheadEarlier this month, the Department of Labor finally released the long-awaited “Definition of Fiduciary; Conflict of Interest Rule.”

This blog post is intended to do two things:

  1. Provide a brief history of the proposal, and
  2. Provide an overview of the key points of the final rule and how it differs from the 2015 proposal.

For additional materials and information on the Final Rule, visit the DOL webpage. In addition, you can access all 200 plus pages of the final rule here.

I.  The “Conflict of Interest” Rule’s History

Since the adoption of ERISA, the governing regulations have mandated use of a five-part test that dictates whether an individual will be considered an investment advice fiduciary. In order to rise to the level of an investment advice fiduciary, the five-part test required that a person give investment advice: (1) about the value or advisability of investing in securities or other property; (2) on a regular basis; (3) pursuant to an agreement with the plan; (4) individualized to the specific plan; and (5) with the mutual understanding that such advice will serve as a primary basis for investment decisions.

The DOL initially proposed rulemaking to change the definition of an investment advice fiduciary back in October of 2010. The 2010 proposal generally did the following:

  • suggested eliminating the five-part test and, more specifically, the requirement that investment advice be provided on a regular basis;
  • indicated that a paid advisor would have been treated as a fiduciary if the advisor provided one of the three types of advice defined in the proposal and either: (1) represented that s/he was an ERISA fiduciary; (2) was already an ERISA fiduciary to the plan by virtue of having control over plan assets or discretionary authority over plan administration; (3) was already an investment advisor under the Investment Advisers Act of 1940; or (4) provided advice pursuant to an agreement, arrangement or understanding that the advice may be considered in connection with plan investment or asset management decisions and would be individualized.

This 2010 proposal was withdrawn, and the Employee Benefits Security Administration (EBSA) announced in September 2011 that it would repropose the rule.

It wasn’t until spring of 2015 that the DOL released for public comments its revised proposal, which incorporated various comments received on the original 2010 proposal. These resulting changes included a “Best Interest Contract Exemption,” “Principal Transactions Exemption,” a carve-out for investment education provided to IRA owners as well as plan sponsors and plan participants, and a change to focus on the advice rendered when determining who constitutes a fiduciary rather than on title/designation. Despite the many differences from the 2010 proposal, the revised proposal still eliminated the five part test and eliminated the requirement that the advice must be provided “on a regular basis.” Instead, a single act of advising could render an individual an investment advice fiduciary.

As discussed in our two prior posts, the 2015 proposal would include in the definition of fiduciary anyone who (1) receives compensation, directly or indirectly, for the requisite type of advice (e.g., advice, appraisals, or fairness opinions about the value of any investment; recommendations to purchase, hold, or sell any investment; or recommendations as to the management of any investment) and (2) meets one of the following conditions:  (i) is or represents his or herself to be an ERISA fiduciary, or (ii) provides the advice pursuant to an agreement or understanding that the advice may be considered in connection with investment or management decisions with respect to plan assets and will be individualized to the needs of the plan. Accordingly, much if not all of the full-service and discount brokerage services that broker-dealers offer to plan sponsors and plan participants would be subject to a fiduciary duty under the proposed rule.

Like the 2010 proposal before it, the 2015 revised proposal received many comments and concerns. Unlike the 2010 proposal, the 2015 revised proposal was not withdrawn. Instead, a final rule was published in the Federal Register on April 8, 2016.

II. Third Time’s the Charm? The Final Rule

Below we describe some of the key provisions and significant ways in which the Final Rule differs from the 2015 revised proposal.

A.  Applicability Date

Unlike the 2015 proposal which stated that the rules should be applicable eight months following publication, the Final Rule adopts a phased implementation approach. First, the revised definition of fiduciary investment advice as well as the new and amended exemptions become applicable on April 10, 2017. This means that the current five-part test remains in effect for roughly the next year. The Best Interest Contract Exemption and the exemption for the Principal Transactions become fully applicable later as a transition period under which more limited conditions will apply until January 1, 2018.

B.  Fiduciary Investment Advice

1.  Investment Advice Definition

The Final Rule adheres to the general structure of the 2015 revised proposal. It states that individuals provide investment advice if they provide, for a fee or other compensation, certain specified types of information, including:

  • A recommendation as to the advisability of acquiring, holding, disposing of, exchanging, rolling over, transferring, or distributing securities or other investment property of the plan or IRA; or
  • A recommendation as to the management of securities or other investment property including investment, portfolio composition, or recommendations with respects to rollovers, transfers, or distribution from a plan or IRA.

In addition to providing a perquisite type of information, the individual must also (i) represent or acknowledge that they are acting as a fiduciary within the meaning of ERISA or the Internal Revenue Code; (ii) provide advice rendered pursuant to a written or verbal agreement, arrangement, or understanding that the advice is based on the particular investment needs of the recipient; or (iii) provide recommendations directed to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision. Again, the “on a regular basis” requirement is not included in the Final Rule.

A notable difference between the Final Rule and the 2015 revised proposal is that the Final Rule does not consider appraisals, fairness opinions, or similar statements concerning the value of securities or other property to constitute investment advice. All appraisals and valuations, not just those for ESOPs, are excluded from the rule. The DOL has also made it clear that advice regarding “investment property” does not include health, disability, and term life insurance policies and other assets to the extent they do not contain an investment component.

2.  What Constitutes a Recommendation?

The Final Rule makes clear that whether a communication constitutes a “recommendation” depends on its content, context, and presentation. If the content, context, and presentation would reasonably be viewed as a suggestion that the recipient of such advice engage or refrain from taking a particular course of action, then the communication is likely a recommendation. In addition, the more individually tailored the communication, the more likely that it will constitute a recommendation.

The Final Rule also provides a non-exhaustive list of what does not constitute a recommendation. Examples on the list include:

  • marketing or making available to a plan fiduciary a platform of investments;
  • providing selection and monitoring assistance such as identifying investment alternatives (provided that the person identifying the investment alternatives discloses in writing whether the person has a financial interest in any of the identified investment alternatives and the precise nature of such interest) or providing objective financial data and comparisons with independent benchmarks;
  • furnishing or making available general communications to a plan, plan fiduciary, plan participant, beneficiary, IRA, or IRA owner; and
  • furnishing or making available investment education to a plan, plan fiduciary, plan participant, beneficiary, IRA, or IRA owner.

3.  What Constitutes Investment Education?

The Final Rule still recognizes the same general four categories of investment education (plan information, general financial/investment information, asset allocation models, and interactive investment materials).

Unlike the 2015 revised proposal, the Final Rule still allows asset allocation models and interactive investment materials to identify specific designated investment alternatives available under the plan without being considered fiduciary investment advice. However, doing so comes with additional requirements. Specific alternatives may be identified if: (1) the alternative is a designated investment alternative under an employee benefit plan; (2) the alternative is subject to fiduciary oversight by a plan fiduciary who is independent of the person developing/marketing the investment alternative; (3) the asset allocation models and interactive investment materials identify all the other designated investment alternatives available under the plan with similar risk and return characteristics; and (4) the asset allocation models and interactive investment materials are accompanied by a statement that identifies where information on the alternatives included may be obtained.

Since the Final Rule requires that an independent fiduciary have oversight of the specific designated investment alternatives, this exception does not apply to any presentations of asset allocation models or interactive investment materials to IRA owners. Presentations to IRA owners may not include specific alternatives without being considered investment advice.

4.  Carve-Outs

The Final Rule includes a list of additional activities that will not be considered investment advice, even if the activities otherwise meet the recommendation and investment advice criteria. These carve-outs include: transactions with independent fiduciaries with financial expertise, swap and security-based swap transactions, and advice provided by an employee to a plan fiduciary, other employee, or an independent contractor if the advice is provided in connection with the individual’s role as an employee.

C.  The Best Interest Contract Exemption

1.  Who Requires a Contract, and When Must it be Executed?

The Best Interest Contract Exemption requires a financial institution to acknowledge it and its advisors’ fiduciary status in writing in order to receive compensation that would otherwise be prohibited. The contract requirement for ERISA plans has been dropped, but the Final Rule requires an enforceable contract in writing for IRAs and other non-ERISA plans. In addition, the contract also no longer requires a contract signed the customer, financial institution and adviser. Instead, only the financial institution and the customer need to sign the contract.

The Final Rule also allows the contract to be incorporated into other account opening documents. The contract no longer needs to be entered into prior to the time that any advice is provided. Instead, the contract may be entered into before or at the same time the recommended transaction is executed.

2.  Covered Assets

The Final Rule eliminated the list of covered assets included in the 2015 revised proposal. This means that the Best Interest Contract Exemption may be available for any asset type so long as the advisor meets the impartial conduct standards (advice in client’s best interest, avoid misleading statements, receive no more than reasonable compensation) and other conditions of the exemption.

3.  Level Fee Fiduciaries

The Final Rule added a special exemption for level fee fiduciaries. This special exemption covers a recommendation to roll over assets from a plan into a fee-based account, or transfer assets from a commission-based account to an account that charges a fixed percentage of assets under management, if the financial institution and adviser are “level fee fiduciaries” and other conditions are satisfied.

D.  The Principal Transaction Exemption

The Final Rule does not require that the pricing of the principal transaction be at least as favorable as the price offered by two unaffiliated counterparties. Instead, advisers and financial institutions must seek to obtain the best execution reasonably available under the circumstances

The Final Rule also includes a broadened list of the types of assets that may be traded on a principal basis under this exemption. These assets include:

  • purchases by a plan of Certificates of Deposit (CDs), interests in Unit Investment Trusts (UITs), and “debt securities,” and
  • sales by a plan of “securities or other property,” which the DOL indicates corresponds to “the broad range of assets that can be recommended” by fiduciary advisers.

Though the DOL expanded the Principal Transaction Exemption to cover more types of assets, it did not expand the exemption to cover purchases of other types of investments, including municipal securities, currency, asset-backed securities, equities, derivatives, and bank note offerings.