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The DOL Fiduciary Rule: Part 1 - An Overview

In this Series, we're going to be exploring the Department of Labor's Fiduciary Rule which was published in April.  This Series will not only explore the legislation itself, but also its impact.  Join us for our launch into the world of blogging with this controversial piece of legislation.  Welcome the the KLF Employee Benefits Blog.

 

On April 6, 2016, the Department of Labor (DOL) publicly announced its final conflict of interest rule, or the fiduciary rule, as more often referenced, and published the rule in the Federal Register two (2) days later, on April 8, 2016.  The release of the final rule has been a tumultuous and controversial ride, to say the least.  The DOL first proposed the new rule in October of 2010, which was the first proposed amendment to the term "fiduciary" since the inception of the Employee Retirement Income Security Act of 1974, as amended (ERISA).   More specifically, the DOL proposed a broadening of the fiduciary definition which impacted persons providing investment advice to employee benefit plans for a fee or other compensation. However, this 2010 proposal was withdrawn in 2011 after the rule was met with much push-back from the financial industry.  

On February 23, 2015, President Obama announced his support for the DOL's "re-proposal" of the fiduciary rule.  On the same day, the DOL submitted a proposed rule to the Office of Management and Budget (OMB) for an inter-agency review. On April 14, 2015, the DOL re-proposed to amend the definition of "fiduciary" under ERISA and subsequently published such re-proposal in the Federal Register.  

Under this new re-proposed definition, more investment advisors would be subject to the ERISA investment advice fiduciary rules, thus subjecting these advisors to a heightened ERISA fiduciary status.  ERISA fiduciary standards are considered the highest in the industry, where advisors must act prudently, must act in the best interests of the participants and beneficiaries, and must disclose all conflicts of interests.  

Under ERISA, a fiduciary is defined as the following:  

A person is a fiduciary with respect to a plan to the extent:

(i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets,

(ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or

(iii) he has any discretionary authority or discretionary responsibility in the administration of such plan. Such term includes any person designated under section 1105(c)(1)(B) of this title.  

The "re-proposed" fiduciary rule focuses on (ii), those rendering investment advice for a fee or other compensation.  

Since early Spring of 2015 until the close of the comment period on September 24, 2015, the DOL received 3,530 public comments on the new legislation.  The DOL received ten (10) times more comments on the "re-proposed" rule than on the original 2010 rule.  Two hundred eighty-one (281) members of Congress raised concerns regarding the re-proposed rule.   Additionally, a four (4) day hearing on the legislation occurred from August 10 - 13, 2015.  

On January 28, 2016, the DOL sent the re-proposed rule to the OMB for an inter-agency review.  On April 6, 2016, the DOL publicly announced the final fiduciary rule, along with the Best Interest Contract Exemption (collectively, the "Final Rule"), and published the Final Rule in the Federal Register two (2) days later, on April 8, 2016. 

COVERED PLANS

The Final Rule impacts more than just ERISA retirement plans.  It also impacts individual retirement accounts (IRAs), health savings accounts (HSAs), Archer Medical Savings Accounts, Coverdell Education Savings Accounts, ERISA-covered 403(b) plans, Simple IRA plans, Simplified Employee Pension Plans (SEPs), and certificates of deposit (CDs).  The Final Rule does not cover welfare plans, such as health plans, disability plans and term life insurance plans to the extent that they do not include an investment component. 

FIDUCIARY COMMUNICATIONS

As stated above, the Final Rule defines an investment advice fiduciary as any individual who renders investment advice to a plan, fiduciary, participant, beneficiary, IRA, IRA owner, HSA, HSA owner, or any other covered plan for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so.  The Final Rule describes the types of communications and activities that would give rise to "investment advice" and further describes the types of relationships that would invoke "fiduciary investment advice responsibilities,"  or in other words, would qualify a person as a fiduciary under the Final Rule.

Investment Advice

The Final Rule provides that person(s) provide investment advice if they provide for a fee or other compensation certain categories or types of investment recommendations. The listed types of advice are—

  • A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA; and
  • A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services; selection of investment account arrangements (e.g., brokerage versus advisory); or recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer or distribution should be made.  

The Final Rules states that a ‘‘recommendation’’ means 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. The determination of whether a ‘‘recommendation’’ has been made is an objective rather than subjective inquiry. In addition, the more individually tailored the communication is to a specific advice recipient or recipients about, for example, a security, investment property, or investment strategy, the more likely the communication will be viewed as a recommendation. It also makes no difference whether the communication was initiated by a person or a computer software program. 

Fiduciary Investment Advice Responsibilities

The Final Rule also establishes the types of relationships that must exist for such recommendations to give rise to fiduciary advice responsibilities.  Individuals will be considered a "fiduciary" in connection with a recommendation under the Final Rule if the recommendation is made either directly or indirectly (e.g., through or together with any affiliate) by a person who gives recommendations and:

  • Represents or acknowledges that they are acting as a fiduciary with the meaning of ERISA or the Internal Revenue Code;
  • Renders advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is based on the particular investment needs of the advice recipient; or
  • Directs the advice to a specific recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan, IRA or other covered plan.

COMMUNICATIONS NOT COVERED UNDER THE FIDUCIARY UMBRELLA

The Final Rule describes the types of information and activities that constitute non-fiduciary investment communications, or simply communications that are not covered under the Final Rule.  For example, if communications do not meet the definition of a "recommendation" as described above, then such communications will be considered non-fiduciary communications and not covered by the Final Rule.  The Final Rule also specifically addresses other types of communications that are considered non-fiduciary communications, and thus do not fall under the Final Rule.

Education

The Final Rule describes that general educational investment information, including such information as risk and return, the difference between a stock and a bond, and the differences in distribution types, is not considered fiduciary investment communications. Additionally, this information can be presented in asset allocation models based upon age, dates of retirement, and risk, as long as such models are generalized and not specific to one participant or beneficiary.  Further, the Final Rule states that providing information and materials that describe plan investments without recommending any particular investment is not considered a fiduciary investment communication, or fiduciary investment advice.

Platform Providers

Additionally, service providers who offer a platform of investment alternatives are not providing fiduciary investment advice by offering such platform as long as  the information provided does not incorporate individualized needs of participants, beneficiaries or account holders.  To qualify for this exemption, the service provider must be independent from the plan fiduciary and must disclose in writing that it is not providing fiduciary investment services. Notwithstanding the above, IRAs and brokerage accounts cannot qualify for this exemption as no independent plan fiduciary who interacts with the service provider.  

Transactions with Independent Plan Fiduciaries with Financial Expertise

Advisors will be exempt from the Final Rule when providing advice in connection with a sale, purchase, loan, exchange, or other investment transaction with independent plan fiduciaries if the advisor knows or reasonably believes that the independent fiduciary is a licensed and regulated provider of financial services or those that have responsibility for the management of $50 million in assets, in addition to other conditions.

Swap and Security-Based Swap Transactions

Advisors will be exempt from the Final Rule when communicating to ERISA-covered employee benefit plans in swap and security-based swap transactions if, among other things, the advisor obtains a representation that the plan fiduciary understands that he or she is not receiving impartial advice.  This provision was coordinated with both the Securities Exchange Commission and the Commodity Futures Trading Commission.

Employees of Plan Sponsors, Employee Benefit Plans, Plan Fiduciaries

Employees working in a company's payroll, accounting, human resources, and financial department who routinely develop reports and recommendations for the company, and who further communicate about plan information both internally and externally (e.g., with plan third party administrators), are not investment advice fiduciaries if these employees receive no fee or other compensation in connection with any such recommendations beyond their normal compensation for work performed by their employer.

General Communications

General communications, such as those made in newsletters, to the media, or other corporate communications, are not considered "recommendations" under the Final Rule if "a reasonable person would not view [such general communication] as an investment recommendation."  

EFFECTIVE DATES

The Final Rule goes into effect on April 10, 2017.  However, with respect to the Best Interest Contract Exemption, only part of the exemption goes into effect next April.  Advisors will be required next April to comply with acknowledging their fiduciary status, adhering to the best interest standard, and making basic disclosure of conflicts and interest.  The remainder of the rule will go into full effect on January 1, 2018.

We'll explore the Best Interest Contract Exemption, among other pertinent issues, in depth in subsequent blog posts on the DOL Fiduciary Rule in the coming weeks.  

 

 

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