Participant communications and the Conflict of Interest regulation

May 10, 2016

For plan sponsors, one of the most important questions raised by the new conflict of interest regulation is: how will it affect participant communications? In this article we sketch out some provisional answers to that question.

We note that the new regulation is still “fresh,” that it has a long implementation period (it is not fully effective until January 2018), and that a number of elements of it are still unclear. Over the next year and a half our understanding will, necessarily, improve, as sponsors and providers work with the new rule and the Department of Labor provides clarification. This article is simply an attempt to identify issues and provide a preliminary discussion of how DOL seems to be envisioning new, “post-regulation” participant communications. (For general background on the new rule, please see our article DOL finalizes re-definition of ERISA “investment advice fiduciary.)

401(k) participant communications generally

In the context of current 401(k) administrative practice, the most important participant communications will generally be those concerning asset allocation and distributions. And communications in three different contexts will be most significant – advice/recommendations made: (1) by call center operators; (2) by enrollment meeting leaders; and (3) in “non-personal” communications (e.g., SPDs, asset allocation software, and related investment education materials).

We begin by discussing how asset allocation communications in these different contexts will be affected by the new regulation.

The fiduciary status of communications about asset allocation – what is said

Let’s begin by reviewing how participant communications about asset allocation may be handled under the new rule. Clearly a generic statement – e.g., a description of the plan’s fund menu – does not constitute fiduciary advice. What more can be said? Consider three statements about the wisdom of investing in a plan’s target date fund:

1. “An unsophisticated investor generally should put all her assets in the plan’s target date fund.” This is a communication “regarding the advisability of a particular investment” (the plan’s target date fund). If it is directed “to a specific advice recipient or recipients” (and the adviser is receiving compensation) then it will generally be fiduciary advice. Whether it is so directed will depend on the context. One can imagine situations in which it is (arguably at least) not directed “to a specific advice recipient or recipients” – e.g., enrollment meeting leaders are told to open every meeting with this statement. Clarification of this issue would be helpful.

2. In response to a question about asset allocation from a participant who says he knows nothing about investing, a call center operator says: “You should put all your assets in the plan’s target date fund.” This statement would clearly be fiduciary advice, because it is directed to a specific participant about a particular investment.

3. What if, in response to the question described in 2, a call center operator repeats the first statement: “An unsophisticated investor generally should put all her assets in the plan’s target date fund.” This also is probably fiduciary advice, because it is about a particular investment, and it is (given the context) directed to a specific participant.

We’ve used a fairly specific statement – a recommendation that an unsophisticated investor invest in the plan’s target date fund – as an illustration. But even recommendations about portfolio composition may be fiduciary advice. Thus, a statement that a specific participant should “invest 60% in equities and 40% in fixed income” would generally be fiduciary advice.

The fiduciary status of participant communications – who says it

The fiduciary status of advice will also turn on who provides it. Again, consider three cases:

The sponsor. Sponsor communications – even if directed to a specific participant about a particular investment – generally will not constitute fiduciary advice because the sponsor generally does not receive compensation for providing the advice. So, for instance, even if the sponsor, in a targeted communications program, selects specific participants to whom to deliver the message “you should invest in the plan’s target date fund,” the sponsor is not a fiduciary. Here’s what the preamble to the regulation says in this regard:

In the Department’s view, since only investment advice for a fee or compensation falls within the fiduciary definition, the fact that employers do not generally receive compensation in connection with their educational communications provides employers with a high level of confidence that their educational activities would not constitute investment advice under the rule. In that regard, the Department does not believe that incidental economic advantages that may accrue to the employer by reason of sponsorship of an employee benefit plan would constitute fees or compensation within the meaning of the rule. For example, the Department does not believe that an employer would be receiving a fee or compensation under the rule merely because the plan is structured so the employer does not pay plan expenses that are paid out of an ERISA budget account funded with revenue sharing generated by investments under the plan.

(We note that, while the sponsor will not be a fiduciary with respect to this sort of advice, it will remain a fiduciary in other respects.)

Sponsors will want to consider reviewing their arrangements with the plan and providers to determine if any might be considered as providing more than an “incidental advantage.”

A provider. The same communication – the message “you should invest in the plan’s target date fund” targeted at specific participants – generally would constitute fiduciary advice if delivered by, e.g., a call center operator employed by a provider (who does receive compensation for providing this advice).
Sponsor employees. It also appears that, e.g., a sponsor employee (e.g., an investment professional) who is employed to lead enrollment meetings at which one of her duties includes giving this sort of advice (e.g., telling participants who are unsophisticated investors that they should put all their plan assets in the target date fund) will be an advice fiduciary. Further clarification of the status of sponsor employees would be helpful.

Critical importance of the exception for investment education

As illustrated above, the new definition of “fiduciary advice” under the regulation will sweep in a lot of current participant communications. This puts stress on the one exception provided under the new regulation that is generally available for “investment education.”

The point here is subtle. Under the rules that apply until the new regulation takes effect, strict compliance with the investment education exception (provided in Interpretive Bulletin 96-1) is less important because it is relatively easy to avoid being an advice fiduciary (e.g., by explicitly stating that the advisor does not agree that the advice will serve as a primary basis for investment decisions with respect to plan assets). After the new regulation takes effect, those “easy-outs” from fiduciary status will no longer be available, and the only viable alternative will be (“strict”) compliance with the (now somewhat narrower and in some respects more burdensome) exception for investment education.

We discussed the investment education exception in detail in our article Investment education under the Conflict of Interest regulation. Here we just want to note a couple of features of it that bear on the issue of asset allocation:

Asset allocation advice may only be provided in models and interactive materials. It appears that asset allocation recommendations – including, even, generic recommendations such as “invest 60% in equities and 40% in fixed income” – qualify as investment education (and not fiduciary advice) only if they are provided in asset allocation models or interactive materials. If, for instance, a participant directly asks a call center operator or the leader of an enrollment meeting about asset allocation, it may be possible to frame a response within one of those exceptions, by saying something like: “The asset allocation models suggest that a person 50 years old should invest 50% in equities and 50% in fixed income.” Although just how far the adviser may go here is not at all clear.

The sponsor may provide asset allocation advice directly. As discussed above, however, the sponsor generally may provide such advice – e.g., in materials distributed at an enrollment meeting – directly to participants without triggering fiduciary status, because it is not receiving compensation.

The fiduciary status of communications about distributions

The line between fiduciary/non-fiduciary communications about distributions is generally similar to the line drawn for communications about asset allocation. Consider three statements about the wisdom of a participant leaving assets “in the system” after termination of employment:

1. “Terminating participants should consider leaving assets in the plan or rolling them over into an IRA.” This is a recommendation of a particular distribution strategy. Whether it is directed “to a specific advice recipient or recipients” will depend on the context/facts and circumstances, based on an analysis similar to the one discussed above with respect to asset allocation.

2. In response to a participant question about what to do on termination, a call center operator says: “You should consider leaving assets in the plan or rolling them over into an IRA.” This statement would be fiduciary advice, because it is directed to a specific participant about a particular distribution strategy.

3. What if, in response to the question described in 2, a call center operator repeats the first statement: “Terminating participants should consider leaving assets in the plan or rolling them over into an IRA.” Again, this statement would (because of the context) likely be treated as fiduciary advice.

Direct communications from sponsors generally allowed. As with asset allocation advice, direct communications from the sponsor – even if they are directed to a specific participant and recommend a particular distribution strategy – generally would not be fiduciary advice because the sponsor is not receiving compensation.

No exception for models/interactive materials. Generic communications about distributions (e.g., “these are your distribution options under the plan”) are “investment education” and not fiduciary advice. But there is no parallel for distributions to the exception that allows particular asset allocation advice to be characterized as “education” if it is provided in a model or interactive materials.

Consequences of fiduciary status

Let’s finally note that fiduciary status will have a different significance for different persons. ERISA fiduciaries are generally subject to duties of loyalty and prudence. Further, under ERISA’s prohibited transaction rules, a fiduciary may not (i) engage in self-dealing, (ii) have, or act for a person who has, an adverse interest, or (iii) receive a “kickback.” Finally, a fiduciary is an ERISA “party in interest,” prohibited from dealing with a plan in many respects.

If the sponsor or sponsor employees are considered fiduciaries, then they will have to comply with ERISA’s duty of loyalty and prudence requirements. It is possible to conceive of situations in which the sponsor or a sponsor employee will have, e.g., a self-dealing or prohibited transaction issue, but (at this point at least) it looks like those situations will be the exception. For providers, self-dealing and prohibited transaction issues will, in contrast, be typical. Thus, fiduciary status may present greater problems for providers than for sponsors or sponsor-employees.

* * *

We emphasize (again) that 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.

In our view, for sponsors, two questions are critical. The first question has been the subject of this article: Which sorts of participant communications by the sponsor, sponsor employees and providers will be “fiduciary advice,” and what can still be said to participants without triggering fiduciary status? For sponsors and fiduciaries concerned to avoid fiduciary status, the new rules will in effect narrow the sort of asset allocation and distribution recommendations/advice/education that may be provided to participants.

Our next article will discuss the second question: What is the scope and substance of the sponsor-fiduciary’s duty to monitor participant communications by providers?