The Department of Labor (“DOL”) released the final version of its new fiduciary rule on Wednesday April 6, ending months of widespread speculation and apprehension in the financial services industry. The DOL appears to have heard the thousands of public comments asking for more clarification and simplification, particularly as related to the Best Interests Contract (“BIC”) exemption. The final rule contains some notable deviations from the proposed rule.
As we discussed in an earlier blog post, the former definition of fiduciary for providing investment advice to a covered employee benefit plan under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code of 1986 (“Code”) stated that financial advisers were generally only fiduciaries if such investment advice was given on a regular basis and pursuant to a mutual understanding that the advice would serve as the primary basis for investment decisions and would be individualized to the particular needs of the plan. This definition typically encompassed only financial advisers in established and ongoing relationships with their clients, such as investment advisers who provided investment advice to covered plans. Meanwhile, broker-dealers and insurance agents were generally excluded, and broker-dealers were only held to the same suitability standard for retirement plans that applies to their recommendations made to non-retirement plans.
Under DOL’s final fiduciary rule, the definition of fiduciary investment advice under ERISA and the Code includes persons providing investment recommendations for compensation to employee benefit plan sponsors or participants and Individual Retirement Account (“IRA”) owners when the person represents or acknowledges that it is acting as a fiduciary or renders the advice pursuant to an agreement or understanding that the advice is based on the particular investment needs of the investor. This new definition includes investment advice to rollover IRAs, which the DOL had previously stated in an advisory opinion was not fiduciary investment advice. The new definition also removes the requirements that the advice be given on a regular basis or pursuant to a mutual understanding, significantly expanding the types of investment advice relationships that can give rise to fiduciary duties under ERISA and the Code.
Investment advisers to retirement plans must either avoid receiving payments that create conflicts of interest or fall under a prohibited transaction exemption. Certain common forms of compensation that involve conflicts of interest include commissions, 12b-1 fees, and revenue sharing payments. In order to enable investment advice fiduciaries to continue to receive these common forms of compensation, the DOL enacted a new prohibited transaction exemption which allows for the receipt of conflicted compensation so long as advisers adhere to certain standards intended to ensure that their advice is impartial and in the best interest of investors.
This exemption is the BIC exemption, which provides that fiduciaries may continue to receive common forms of compensation such as commissions so long as the fee is reasonable and the fiduciary acknowledges in writing that it is a fiduciary and that it will adhere to the Impartial Conduct Standards. The Impartial Conduct Standards include the duty to act in the best interest of the retirement investor and to render advice using the care, skill, prudence, and diligence that a prudent person would use, based on the investment objectives, risk tolerance, financial circumstances, and needs of the investor.
The fiduciary must also make certain warranties and ongoing disclosures. Under the final rule, fiduciaries must warrant that the firm has adopted policies and procedures reasonably designed to ensure that advisers adhere to the Impartial Conduct Standards. In addition, they must make detailed disclosures regarding the services provided by the adviser, how the adviser is paid, and any material conflicts of interest, among others. Fiduciaries must also make ongoing transaction disclosures and web disclosures which must be updated no less than quarterly. Records of compliance with the BIC exemption must be maintained for a period of six years in a manner that is reasonably accessible for examination.
For ERISA plans and participants, there is no formal contract requirement; advisers must only acknowledge their fiduciary status in writing and adhere to the standards of fiduciary conduct, along with making the required warranties and disclosures. Of course, other law, including some state securities laws, may require the fiduciary to have a written contract with the client. For IRAs and other plans not covered by ERISA, the fiduciary must enter into an enforceable contract stating that it is a fiduciary and that it will adhere to the Impartial Conduct Standards.
The final DOL fiduciary rule contains provisions simplifying the mechanics of the BIC contract formation. Only the financial institution must execute the contract, rather than each of the individual advisers who provide advice to the plan or IRA. The contract must only be entered into prior to or at the same time as the execution of an investment recommendation, as opposed to at the start of conversations with a retirement investor. For new customers, the required contract terms may simply be incorporated into account opening documents and other commonly used agreements. In addition, advisers may rely on a negative consent process for existing contract holders by delivering the proposed amendment and required disclosures to the investor and considering failure to terminate the amended contract within 30 days as assent.
Of particular interest to investment advisers, the DOL also added a streamlined compliance provision to the final rule for level fee fiduciaries who recommend rollovers from a plan to an IRA with a level fee arrangement. Level fee fiduciaries are defined as investment advice fiduciaries that provide ongoing advice for a fee based on a fixed percentage of assets under management. These fiduciaries do not have to enter into a BIC contract, and must only provide a written statement of fiduciary status and adherence to the Impartial Conduct Standards. They must also keep documentation showing why a recommendation to roll over from a plan or IRA to a level fee arrangement was in the customer’s best interest.
The DOL also amended PTE 84-24, an exemption widely used by investment advisers which allows insurance agents, insurance brokers and pension consultants who are investment advice fiduciaries to receive commissions for selling insurance or annuity contracts to plans and IRAs. The DOL revised this PTE to require fiduciaries that rely on the exemption to adhere to the Impartial Conduct Standards outlined in the BIC exemption as a condition to relief. In addition, it limited coverage of insurance products to “Fixed Rate Annuity Contracts” as defined in the exemption. This term does not include variable annuities, indexed annuities, or similar annuities; investment advisers who wish to recommend these products to plans or IRAs must proceed under the BIC exemption.
The final DOL rule is effective 60 days after date of publication in the federal register. However, it will not be applicable until April 10th of 2017. In addition, to allow firms additional time to get in compliance, the DOL adopted a phased implementation process for the BIC Exemption. Under this phased implementation process, the full disclosure provisions, the policies and procedures requirements, and the contract requirement go into full effect on January 1, 2018. It is important that investment advisers start assessing clients and compensation models now to determine which transactions will soon be prohibited by the DOL fiduciary rule and will require compliance with the BIC exemption.
Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our website for more information.