Monitoring advice providers under the new Conflict of Interest regulation

May 17, 2016

One question the new Conflict of Interest regulation has raised with sponsors is: how will it affect their obligation to monitor persons providing fiduciary, or, for that matter, non-fiduciary, advice/education to plan participants?

In this article we review that issue in detail, but let’s begin with our bottom line: While the new rule doesn’t change the plan fiduciary’s legal obligation under ERISA to monitor the prudence of the appointment of a (fiduciary or non-fiduciary) service provider, the new requirements applicable to the provider will be stricter and more complicated. And reviewing the provider’s compliance with those requirements will make the plan fiduciary’s obligation more burdensome.

(The focus of this article is the scope and substance of the plan fiduciary’s duty to monitor; we do not address, e.g., the steps a plan fiduciary must take if it discovers that an advice fiduciary has violated ERISA’s prohibited transaction rules.)

The first step: inventory relationships

As a preliminary matter, most sponsor-fiduciaries will want to consider inventorying their provider relationships and identifying which ones will, under the new rule, involve a change in status from “non-fiduciary service provider” to “advice fiduciary.” This process will, of necessity, involve a discussion of the issue with providers. Typically, some service providers will modify the services they provide to avoid fiduciary status under the new rule; others may have to modify their services in order to comply with the new rule.

With respect to service providers who will under the new rule take on fiduciary status, the sponsor fiduciary will want to understand what new duties the service provider-as-advice-fiduciary will now have. One critical question: will the “new” fiduciary be complying with the Best Interest Contract Exemption (BICE), and if yes, how?

At the end of this process the sponsor-fiduciary should have a general picture of which of the plan’s providers will be fiduciaries and what those provider-fiduciary’s duties will be under the new rule.

The duty to monitor advisers – generally

Now let’s turn to the plan fiduciary’s duty to monitor, and let’s begin with what the Department of Labor said (in the preamble to the final regulation) about that duty: “whether the service provider renders fiduciary advice or non-fiduciary education, the final rule does not change the well-established fiduciary obligations that arise in connection with the selection and monitoring of plan service providers.” DOL continued, quoting paragraph (e) of Interpretive Bulletin 96-1, “[a]s with any designation … [the] persons making the designation must act prudently and solely in the interest of the plan participants and beneficiaries, both in making the designation(s) and in continuing such designation(s).”

Thus, from one point of view, the new rule doesn’t change the sponsor’s monitoring obligation. The appointment of a person to provide services to a plan is a fiduciary act, regardless of whether those services are “fiduciary” or “non-fiduciary.” Theoretically at least, the fact that a service provider (e.g., a call center operator) who, under current (pre-Conflict of Interest regulation) law, is not a fiduciary will, under the new regulation, be a fiduciary should not change the appointing fiduciary’s ongoing duty to monitor the service provider’s conduct.

The substance of the duty to monitor

What does the duty to monitor in this context – monitoring the conduct of an investment advice fiduciary – look like? In a related context, in Field Assistance Bulletin 2007-1, DOL described that duty as follows:

In monitoring investment advisers, we anticipate that fiduciaries will periodically review, among other things, the extent to which there have been any changes in the information that served as the basis for the initial selection of the investment adviser, including whether the adviser continues to meet applicable federal and state securities law requirements, and whether the advice being furnished to participants and beneficiaries was based upon generally accepted investment theories. Fiduciaries also should take into account whether the investment advice provider is complying with the contractual provisions of the engagement; utilization of the investment advice services by the participants in relation to the cost of the services to the plan; and participant comments and complaints about the quality of the furnished advice. With regard to comments and complaints, we note that to the extent that a complaint or complaints raise questions concerning the quality of advice being provided to participants, a fiduciary may have to review the specific advice at issue with the investment adviser.

This language is pretty straightforward. The monitoring fiduciary should review: (1) any changes (since the initial selection), including compliance with applicable securities laws and conformity to “generally accepted investment theories;” (2) compliance with contractual provisions; and (3) participant comments/complaints. The monitoring fiduciary, however, has “no duty to monitor the specific investment advice given by the investment advice provider to any particular recipient of the advice.”

(We note that FAB 2007 is nearly 10 years old. It would be helpful for DOL to give updated guidance on the scope and substance of a plan fiduciary’s monitoring obligation with respect to advice fiduciaries.)

But – the substance of what the service provider is doing has changed

So the change of the provider’s status from “mere” service provider to fiduciary advice provider does not change the formal monitoring standard. But the standards applicable to the advice provider will change (when the fiduciary standard becomes applicable). How far must the plan fiduciary go in monitoring the provider’s compliance with the new Conflict of Interest regulation? That’s a good question.

Consider the situation in which a call center operator/advice fiduciary is giving advice about distributions to plan participants – “You should consider leaving assets in the plan or rolling them over into an IRA.” Because the call center operator is affiliated with a mutual fund company that offers rollover IRAs, in order to give this advice the operator and her related Financial Institution must comply with the BICE. And in order to comply with the BICE, the Financial Institution must, among other things, adopt and enforce policies and procedures “reasonably designed to mitigate any harmful impact of conflicts of interest.”

How far must the plan fiduciary go in monitoring compliance with these requirements? Mere reliance on a representation from the advice fiduciary/Financial Institution (e.g., that it complies with the BICE) will probably not be enough. Must the plan fiduciary review the policies and procedures? Must it do due diligence on the call center operator’s compliance with them? On the Financial Institution’s general compliance with them? The answers to these questions are, at this point, unclear. Guidance from DOL would be useful.

Moreover, we note that, even with respect to service providers who are not fiduciaries, the monitoring fiduciary will have some obligation (how much is unclear) to determine that they in fact are not fiduciaries under the new rule, e.g., that they are complying with whatever requirements take them out of the rule. For instance, if call center operators will limit communications about distributions to investment education, the plan fiduciary will probably have some obligation to review whether those communications are in fact so limited. Again, how far that review must go is unclear.

Thus, as we said at the beginning of this article: The new rule doesn’t change the plan fiduciary’s legal obligation – it must, e.g., review the continuing prudence of using the advice provider whether that provider is a fiduciary or not. But the requirements applicable to the provider will be stricter and more complicated. And reviewing the provider’s compliance with those new requirements (as a fiduciary or non-fiduciary) will be more burdensome.

Co-fiduciary liability

The change of an adviser from non-fiduciary service provider to advice fiduciary will produce one formal change – plan fiduciaries will now have possible “co-fiduciary” liability with respect to fiduciary breaches by the advice fiduciary that they did not have with respect to the non-fiduciary service provider.

Generally, a fiduciary (e.g., a sponsor-fiduciary) has co-fiduciary liability with respect to the breach of another fiduciary (e.g., an advice fiduciary) where:

1. The fiduciary participates knowingly in, or knowingly undertakes to conceal, a co-fiduciary’s breach, knowing that it is a breach.

2. By failing to act prudently and diligently, the fiduciary enabled the co-fiduciary to commit the breach.

3. The fiduciary has knowledge of the breach and does not make reasonable efforts to correct it.

With regard to the new regulation, issue 2 will probably be most significant for sponsor-fiduciaries. As a general matter, the sponsor’s co-fiduciary responsibility/possible liability here will look a lot like the duty to prudently select and monitor, discussed above. That is, the most likely co-fiduciary breach would be a failure to adequately monitor the conduct of the advice-fiduciary.

* * *

We repeat what we said in our last article (Participant communications and the Conflict of Interest regulation): we are all still learning about what the new rule requires; we expect further guidance on and clarification of a number of these issues; and therefore the foregoing discussion is provisional.

We will continue to follow this issue.

October Three Consulting, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

Through effective plan design strategies October Three believes successful financial outcomes are achievable for employers and employees alike. A critical element of those strategies is the ReDB® plan design. The ReDefined Benefit Plan® represents an entirely new, design-based approach to retirement and to the management of both the employer’s and the employee’s financial risk, focusing on maximizing financial efficiency and employee value.

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