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How will the Fifth Circuit’s decision, in Chamber Of Commerce of the United States of America, et al. v. United States Department of Labor, to vacate the Department of Labor’s Fiduciary Rule affect plan sponsors?
In this article we begin with a brief summary of the current situation post the Fifth Circuit decision. We then consider what for many sponsors may be one of the most critical issues: the extent of the obligation of sponsor fiduciaries to monitor call center operators if, as the Fifth Circuit decision orders, the Fiduciary Rule is vacated. In subsequent articles we will consider how the court’s decision may affect participant education and the fiduciary status of sponsor officials and will discuss some of the questions that the voiding of the Fiduciary Rule by the Fifth Circuit raises.
Let’s begin by establishing, so far as possible, what the Fifth Circuit decision does. By its terms, the decision “vacate[s] the Fiduciary Rule in toto.” In this regard, the court defined the Fiduciary Rule as “a package of seven different rules that broadly reinterpret the term ‘investment advice fiduciary’ and redefine exemptions to provisions concerning fiduciaries that appear in the Employee Retirement Income Security Act of 1974.” So the court’s decision to void the Fiduciary Rule also voids the prohibited transaction exemptions included in the Fiduciary Rule package, including the Best Interest Contract Exemption (BICE).
Under court rules, unless there is a request for an en banc hearing, the court’s decision will take effect May 7, 2018. It will then be the “law of the land” – the Fifth Circuit decision does not (as some have suggested) conflict with the Tenth Circuit’s decision in Market Synergy Group, Inc. v. DOL, which was decided on grounds not taken up by the Fifth Circuit.
After the decision was handed down, DOL announced that it would not enforce the rule “pending further review.” It’s not clear what that means – conceivably, after further review, DOL could decide to appeal the decision and begin enforcing it again. In response to the court’s decision, DOL may (1) request an en banc hearing (a reconsideration of the case by the full Fifth Circuit), (2) appeal the Fifth Circuit decision to the Supreme Court, or (3) simply let the court’s decision stand. It is also possible that a third party may find a way to challenge the decision, e.g., in another circuit.
There has also been widespread speculation that the Securities Exchange Commission may take up the issue of broker conduct and that DOL may defer to that process.
The Fiduciary Rule affected plan sponsors in several respects. Critically, it applied a new, fiduciary-based regulatory regime to: (1) recommendations/advice received with respect to the selection and monitoring of investments and fund menu investment options; (2) recommendations/advice to (and education for) participants about plan investments; and (3) recommendations/advice to participants about plan distributions/rollovers. It turned some persons, who had previously simply been sponsor employees, and some, who had previously simply been plan service providers, into ERISA fiduciaries.
We are – until some further development – going assume that the Fifth Circuit decision will stand. We also assume that there will be some follow-on process to address some of the issues raised in connection with the adoption of the Fiduciary Rule, particularly with respect to the conduct of persons interacting with 401(k) plan participants and making “recommendations” to them with respect to investments and distributions.
This is the first of a series of articles evaluating the significance for plan sponsors of these developments – the “voiding” of the Fiduciary Rule package and any follow-on regulatory initiatives. In the remainder of this article we are going to focus on what may be the (metaphorical) ground zero for the regulation of such participant recommendations: call center operators affiliated with financial services organizations that offer rollover IRAs.
How does the Fifth Circuit decision change (or not change) the responsibilities of plan fiduciaries with respect to the activities of these call center operators? We assume the Fifth Circuit decision restores the status quo ante: that whatever rules were in place before the Fiduciary Rule was adopted once again apply.
Consider a call center operator who (1) is affiliated with a financial services company, (2) makes recommendations to plan participants about distributions (which may include a recommendation that the participant take a distribution and roll it over to an IRA product operated by her affiliated financial services company) and (3) receives some sort of fee (a bonus or other consideration) for doing so.
Under the Fiduciary Rule, that call center operator was generally an ERISA fiduciary. Under pre-Fiduciary Rule and post-Fifth Circuit decision law, however, at least if the right disclaimers are made, she generally will not be an ERISA fiduciary.
As DOL explained in Advisory Opinion 2005-23A:
Question 3: Would an advisor who is not otherwise a plan fiduciary and who recommends that a participant withdraw funds from the plan and invest the funds in an IRA engage in a prohibited transaction if the advisor will earn management or other investment fees related to the IRA?
Answer: No. … [A] recommendation by someone who is not connected with the plan, that a participant take an otherwise permissible distribution, even when combined with a recommendation as to how to invest distributed funds, is not investment advice within the meaning of the [ERISA’s definition of “advice fiduciary”], nor is such a recommendation, in and of itself, an exercise of authority or control over plan assets that would make a person a fiduciary …. Accordingly, a person making such recommendations would not be a fiduciary solely on the basis of making such recommendations, and would not engage in an act of self-dealing if he or she advises the participant to roll over his account balance from the plan to an IRA that will pay management or other investment fees to such person. [Emphasis added.]
DOL also stated that “Any investment recommendation regarding the proceeds of a distribution would be advice with respect to funds that are no longer assets of the plan.”
We note that, as stated in the quoted language, the result would be different if the person giving this advice were a plan fiduciary, e.g., an official who sat on a plan fiduciary committee. (We will discuss the implications of the Fifth Circuit decision for such sponsor fiduciaries in a subsequent article.)
Does the fact that, after the Fifth Circuit decision, this call center operator generally is not a fiduciary change the sponsor fiduciary’s responsibilities with respect to the call center operator? No, and yes.
As the Department of Labor said (in the preamble to the final Fiduciary Regulation), sponsor fiduciaries have a duty to monitor the conduct of persons providing services to a plan, whether those persons are fiduciaries or simply service providers:
[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. … “As with any designation of a service provider to a plan, the designation of a person(s) to provide investment educational services or investment advice to plan participants and beneficiaries is an exercise of discretionary authority or control with respect to management of the plan; therefore, 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).” [Quoting Interpretive Bulletin IB 96-1]
As we discussed, the Fiduciary Rule (in effect) transformed this call center operator from a “mere service provider” to an “ERISA fiduciary.” The Fifth Circuit decision (in effect) transformed her back into a mere service provider. But in either case, the sponsor fiduciary who appointed that call center operator (or retained the firm that employs her) has an ERISA fiduciary duty to make that appointment, and to monitor it on an ongoing basis, prudently and solely in the interest of participants.
What does this duty to monitor 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.”
The Fiduciary Rule didn’t change any of this, and neither does the Fifth Circuit decision.
What the Fiduciary Rule did change, however, was the legal character of, and the rules that apply to, the call center operator’s conduct. Specifically, under the Fiduciary Rule (and BICE), during DOL’s June 9, 2017-July 1, 2019 “Transition Period,” advice fiduciaries were required to adhere to Impartial Conduct Standards: to give prudent advice that is in retirement investors’ best interest, charge no more than reasonable compensation, and avoid misleading statements. And, while there was some doubt as to the extent to which other provisions of the BICE would ultimately be made applicable, those rules would have required compliance with the BICE’s written contract, disclosure and pay policy requirements.
All of that would have imposed significant new monitoring duties on plan fiduciaries, not because their role had changed, but because the rules applicable to the person they were monitoring – the call center operator – had gotten significantly more complicated.
This is all a little dense and not particularly intuitive. But it remains the bottom line: the complexity of the sponsor fiduciary’s job (monitoring service provider/fiduciary conduct) ultimately depends on the complexity and “onerous-ness” of the rules applicable to the service provider. The Fiduciary Rule (and the BICE) made those rules more complex/onerous. The Fifth Circuit decision made them (somewhat) less complex/onerous.
Thus, if the Fifth Circuit decision stands, sponsor fiduciaries will generally not be obligated to, e.g., monitor compliance with BICE pay policy standards. Or to determine whether the fees on an ex-participant’s IRA investments are “reasonable.” They will, however, have to monitor, generally, the call center operator’s compliance with “applicable federal and state securities law requirements.”
Thus, the follow-on process to the Fifth Circuit decision – e.g., the possible adoption by the SEC of a new set of broker conduct rules – will (again) change “what the plan fiduciary has to monitor.” Moreover, guidance from DOL could limit or expand the scope of that duty. There is nothing to prevent DOL from, e.g., determining that there are circumstances in which a plan fiduciary might have a duty to “review the specific advice at issue with the investment adviser.”
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Sponsor fiduciaries will want to review any guidance about post-Fifth Circuit decision compliance that DOL or the SEC publishes. They may also want to consider whether, in the absence of Fiduciary Rule legal limits on what call center operators may say, some contractual limits may be appropriate.
Finally, the application of the rules we’ve discussed to any sponsor’s specific facts should only be undertaken with advice of counsel.
We will continue to follow this issue.