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On April 14, 2015, the Department of Labor released its long-awaited re-proposal of a regulation re-defining ‘fiduciary’ under ERISA. In connection with that proposal it also proposed two new prohibited transaction exemptions (PTEs) and amendments (and revocations) of certain prior PTEs.
With this proposed regulation ‘package’ DOL is expanding those situations in which giving investment advice to an employee benefit plan, plan fiduciary, participant or beneficiary, IRA, or IRA owner makes the advice-giver an ERISA fiduciary (hereafter, an ‘investment advice fiduciary’).
The proposal, if finalized, would significantly change what sorts of advice may be given, to whom and in what circumstances. It will probably have its greatest effect on brokers, mutual funds, and certain other financial services providers and on consultants and third party administrators. The proposal does not just cover 401(k) plans – it covers any employee benefit plan or IRA. Arguably, its most drastic effects would be on IRAs and persons advising IRA-holders.
Our focus, however, will be exclusively on the effect the proposal would have on retirement plan sponsors. For plan sponsors, DOL’s proposal matters, first, because sponsors are, in effect, consumers of advice. Either directly, when, for instance, a consultant advises them about which funds to put in a fund menu. Or indirectly, on behalf of participants, when, for instance, they retain persons (educators, investment advisors or even call center operators) who advise their participants.
It also matters (second) because sponsors and sponsor staff may be directly affected, that is, they may themselves in some cases be investment advice fiduciaries under the proposed rule.
For retirement plan sponsors, three areas will be critical: (1) advice received with respect to the selection and monitoring of investments and fund menu investment options; (2) advice to (and education for) participants about plan investments; and (3) advice to participants about plan distributions/rollovers.
In this article we are going to review the proposal generally. We will provide follow on articles dealing with a number of specific issues raised by the regulation package.
We begin with a very brief review of current rules.
Under current rules, it is fairly hard to become an ‘investment advice fiduciary’ (that is, to be an ERISA fiduciary merely because you have given a plan or plan participant investment advice). Generally, to trigger fiduciary status, you must: (a) render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property (b) on a regular basis (c) pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary that (d) the advice will serve as a primary basis for investment decisions with respect to plan assets, and that (e) the advice will be individualized based on the particular needs of the plan.
Under these rules an adviser generally can prevent fiduciary status by, for instance, simply disclaiming agreement that her advice will serve as a primary basis for investment decisions.
DOL is dissatisfied with the narrowness of this definition and is proposing to radically expand it.
Under the proposal, a person would be an investment advice fiduciary if, for a fee or other compensation, he, she or they:
provide investment or investment management recommendations or appraisals to an employee benefit plan, a plan fiduciary, participant or beneficiary, or an IRA owner or fiduciary, and
either
acknowledge the fiduciary nature of the advice, or
act pursuant to an agreement, arrangement, or understanding with the advice recipient that the advice is individualized to, or specifically directed to, the recipient for consideration in making investment or management decisions regarding plan assets.
Let’s unpack some of the concepts DOL is introducing.
A person cannot be an investment advice fiduciary unless he, she or they are compensated for the provision of advice. ‘Compensation’ is construed broadly. It includes, for instance, compensation received by affiliates. And it includes the ordinary compensation that a call center operator receives.
This concept includes: investment recommendations; investment management recommendations; and recommendations of investment advisers. A ‘recommendation’ is defined as:
[A] communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.
In this regard, DOL is asking for comments on whether it should adopt the standards developed by Financial Industry Regulatory Authority (FINRA) for what constitutes a ‘recommendation.’
Recommendations with respect to rollovers would be broadly covered, including:
[A] recommendation to take a distribution of benefits or a recommendation as to the investment of securities or other property to be rolled over or otherwise distributed from the plan or IRA … [and] recommendations as to the management of securities or other property to be rolled over or otherwise distributed from the plan or IRA.
In the (withdrawn) 2010 version of this proposal, many regarded DOL’s position on when an appraisal or valuation report constituted ‘investment advice’ and triggered fiduciary status as too broad. In the new proposal this concept is significantly narrowed, covering:
An appraisal, fairness opinion, or similar statement … concerning the value of securities or other property if provided in connection with a specific transaction or transactions involving the acquisition, disposition, or exchange, of such securities or other property by the plan or IRA.
In addition, the following are excluded from the definition:
ESOP valuations.
Certain valuations with respect to investment funds (e.g., collective trusts and pooled separate accounts) involving more than one unaffiliated plan.
Valuations provided solely for purposes of compliance with the reporting and disclosure provisions of Federal or state law.
While ‘advice’ to the general public (e.g., in a newsletter) would not trigger fiduciary status, “the parties need not have a meeting of the minds on the extent to which the advice recipient will actually rely on the advice …,” they simply must “agree or understand that the advice is individualized ….” DOL goes on to explain: “Under the proposal, advisers could not specifically direct investment recommendations to individual persons, but then deny fiduciary responsibility on the basis that they did not, in fact, consider the advice recipient’s individual needs or intend that the recipient base investment decisions on their recommendations.”
The design of the regulation is to define fiduciary advice broadly and then to provide ‘carve outs’ for communications “that are best understood as non-fiduciary in nature.” (These carve outs generally do not apply to a person who represents that she is acting as a fiduciary.)
The following are the key carve outs for plan sponsors:
This carve out excludes from the definition of investment advice fiduciary a counterparty (the ‘seller’) that provides advice to an independent plan fiduciary (e.g., a plan sponsor), in connection with an arm’s length sale, purchase, loan or bilateral contract if, before the transaction, one of the following two alternatives is met:
Alternative 1 (knowledge the plan fiduciary has expertise) – this alternative is satisfied if:
Plan fiduciary representations. The plan fiduciary represents: (1) that it “exercises authority or control with respect to the management or disposition of” plan assets; (2) that the plan has 100 or more participants; and (3) that it “will not rely on the [seller] to act in the best interests of the plan, to provide impartial investment advice, or to give advice in a fiduciary capacity.”
Seller representation: The seller informs the plan fiduciary of “the existence and nature of the [seller’s] financial interests in the transaction.”
No fee for advice. The seller “[d]oes not receive a fee or other compensation directly from the plan, or plan fiduciary, for the provision of investment advice (as opposed to other services) in connection with the transaction.”
Plan fiduciary expertise. The seller “[k]nows or reasonably believes that the independent plan fiduciary has sufficient expertise to evaluate the transaction and to determine whether the transaction is prudent and in the best interest of the plan participants ….” The seller may rely on a written representation made by the plan or plan fiduciary for this purpose.
Alternative 2 (plan fiduciary manages at least $100 million) – this alternative is satisfied if:
$100 million in plan assets. The seller “[k]nows or reasonably believes that the independent plan fiduciary has responsibility for managing at least $100 million in employee benefit plan assets.” For this purpose the seller may rely on the information in the plan’s most recent Form 5500. In the case of an independent plan fiduciary that is acting as an asset manager for multiple plans, the seller may rely on representations from the independent plan fiduciary.
Seller representation: The seller informs the plan fiduciary that it “is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity.”
No fee for advice. The seller “[d]oes not receive a fee or other compensation directly from the plan, or plan fiduciary, for the provision of investment advice (as opposed to other services) in connection with the transaction.”
It will take some time before all the issues presented by the proposal are fleshed out. But, on first reading, this carve out seems to provide a usable framework for the provision of advice to large plans and large plan sponsors.
The seller’s carve out is, in effect, for institutional advice recipients, e.g., the sponsor of a large plan. A separate and to some extent complementary PTE (the “Best Interest Contract Exemption”) has been proposed (as part of the package) for (1) plan participants, (2) IRA owners and (3) sponsors of non-participant-directed ERISA plans that have fewer than 100 participants. This exemption imposes, in effect, duties of prudence and loyalty on persons providing advice to these ‘retail’ advice recipients. It also imposes extensive disclosure and compensation practice requirements.
In this proposed exemption DOL also floats the idea of a separate ‘streamlined exemption’ for certain ‘high-quality low-fee investments.’ (DOL did not formally propose this streamlined exemption because, as it said in the preamble to the Best Interest Contract Exemption, it could not ‘operationalize’ it.)
The Best Interest Contract Exemption is likely, if finalized, to provide the basic rules for the provision of advice to plan participants (including participants in large plans). Again, it will take time to identify all the issues raised by this exemption. Briefly: this proposal/PTE is clearly intended to disrupt advice practice involving persons with conflicts – for instance, a call center operator that works for or is affiliated with a mutual fund organization or a broker that receives a fee from such an organization. It also doesn’t cover certain transactions that are not covered by the seller’s carve out, e.g., sponsors of participant-directed plans with less than 100 participants and sponsors of plans with 100 or more participants where the sponsor fiduciary does not have expertise.
We will review the Best Interest Contract Exemption in our next article on this topic.
Under the new proposal, a person on sponsor staff is excluded from the definition of advice fiduciary so long as he “receives no fee or other compensation, direct or indirect, in connection with the advice beyond the employee’s normal compensation for work performed for the employer or employee organization.” This is an important improvement over the 2010 proposal, which some read as making such persons fiduciaries.
With respect to, e.g., a participant-directed 401(k) plan in which a plan fiduciary must choose investment alternatives available in the fund menu, a person may, without becoming an investment advice fiduciary, market or make available “such investment vehicles, without regard to the individualized needs of the plan or its participants and beneficiaries, as long as they disclose in writing that they are not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity.”
Those persons (that is, those persons involved marketing and making available investment vehicles for fund menus) may also “(i) [m]erely identif[y] investment alternatives that meet objective criteria specified by the plan fiduciary …; or (ii) [m]erely provid[e] objective financial data and comparisons with independent benchmarks to the plan fiduciary.”
Oversimplifying, this carve out in effect limits the ‘advice’ that platform providers (with conflicts) can give to generic asset allocation recommendations (unless they are covered by, e.g., the Best Interest PTE).
The new proposal would, if finalized, supersede DOL Interpretive Bulletin on Investment Education (IB 96-1). We will be doing a separate article reviewing in detail the proposed changes to investment education practice. For the moment, we note that the proposal would treat “advice or recommendations as to specific investment products, specific investment managers, or the value of particular securities or other property” as investment advice (triggering fiduciary status). IB 96-1, currently permits “the use of asset allocation models that refer to specific investment products …, as long as those references to specific products are accompanied by a statement that other investment alternatives having similar risk and return characteristics may be available.”
This new approach would significantly change participant education practice where the education is being provided by a person with a conflict (e.g., someone affiliated with a mutual fund organization).
We discussed the carve out for appraisals and valuations above. There are a number of special purpose ‘carve outs’ that we are not going to review in this article.
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DOL’s proposal package is a truly massive undertaking. Its effect on large plan sponsors as direct consumers of advice is relatively limited, generally to the terms of the seller’s exemption and how that rule will in practice be administered. Its effect on participants will be much more significant. Broker-based/commission funded advice practices – with respect to, e.g., 401(k) plan investment and, probably most critically, rollovers – would be radically transformed.
To repeat: it will take some time to fully digest these consequences. We can expect a vigorous response to the proposal from the affected communities, e.g., brokers and mutual funds. We intend to provide a number of articles on specific provisions of the proposal and the responses of those communities, with, as always, a focus on the consequences for sponsors.