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Fiduciary Status Under The New DOL Rule — Frequently Asked Questions
On April 6, 2016, the U.S. Department of Labor (DOL) released its final regulation (DOL Rule) defining fiduciary, which expands the circumstances under which financial professionals become fiduciaries for purposes of ERISA and the prohibited transaction provisions of the Internal Revenue Code, as a result of providing investment advice. The DOL also issued two new prohibited transaction class exemptions and modified certain existing prohibited transaction exemptions.
In the preamble to the DOL Rule, the DOL stated that the previously existing regulation (enacted in 1975) was adopted before the existence of participant-directed 401(k) plans, significant use of Individual Retirement Accounts (IRAs) and frequent rollovers from ERISA-protected plans to IRAs. The DOL expressed concern that advisers to plans and IRAs may be providing conflicted advice that furthers their own interests rather than the interests of plan participants and IRA owners. The DOL expressed the view that a broader definition of “fiduciary” would be appropriate to better protect the interests of plans, plan participants, plan beneficiaries and IRA owners from possible conflicts of interest, imprudence or disloyalty.
Frequently Asked Questions:
Definition of Fiduciary Investment Advice
Q.1. How has the DOL Rule expanded the definition of fiduciary investment advice to address the concerns noted above?
A.1. A person will be deemed to be providing fiduciary investment advice under the DOL Rule if, in exchange for a fee or other compensation, that person provides to a plan, plan fiduciary, plan participant or IRA owner, a recommendation as to investments or a recommendation as to the management of investments and the recommendation is made by a person who:
- represents or acknowledges that the person is acting as a fiduciary; or
- renders the advice based on an agreement or understanding that the advice is based on the particular needs of the advice recipient; or
- directs the advice to a specific recipient regarding the advisability of a particular investment or management decision with respect to securities or other investment property of a plan or IRA.
Persons Impacted by the DOL Rule
Q.2. Given the breadth of the new fiduciary investment advice definition, who within the financial services industry will be impacted by the DOL Rule?
A.2. Financial professionals who provide any of the recommendations referenced above with respect to retirement accounts can expect to be impacted. Thus, broker-dealers, investment advisers, banks, insurance companies and each of their representatives, agents and employees who provide investment advice as fiduciaries, will be impacted.
Information Excluded From the Definition of Fiduciary Investment Advice
Q.3. What types of information are excluded from the definition of fiduciary investment advice?
A.3. Subject to certain conditions and disclosure requirements, a platform provider will not be deemed to be acting as a fiduciary.
A person does not act as a fiduciary if he or she provides general communications that are not directed to any specific individuals, such as newsletters, speeches provided to groups of people or general marketing materials.
Certain categories of investment-related guidance provided to retirement investors will be treated as investment education and excluded from the definition of fiduciary investment advice. Included among those categories are (i) information about the terms or operation of a plan or IRA, (ii) information about the benefits of participating in a plan or IRA, (iii) general financial, investment and retirement information, (iv) asset allocation models, and (v) interactive investment materials that provide a means for estimating future retirement needs. With respect to asset allocation models, specific investment alternatives can be identified for plan models but not for IRA models.
In addition, advice from persons dealing with financially sophisticated plan fiduciaries, advice provided by swap dealers to an ERISA plan and advice from a plan sponsor employee to the plan sponsor may also be excluded from the definition if certain conditions are met.
Q.4. For those persons providing fiduciary investment advice, what transactions would be prohibited in the absence of exemptive relief?
A.4. Among other things, the receipt of certain forms of compensation would be prohibited in the absence of an exemption to applicable prohibited transaction rules. For transactions resulting in the receipt of variable compensation (i.e., transaction-based compensation that varies depending upon the product or service being recommended), a fiduciary will need to rely on a prohibited transaction exemption (PTE). Examples of variable compensation include sales loads, Rule 12b-1 fees, trailing commissions and revenue sharing payments made by product sponsors.
In addition, exemptive relief would be needed for fiduciaries who receive a level fee (Level Fee Fiduciaries) if the investment advice provided could give rise to a conflict of interest. As examples, the DOL has made reference to:
- a recommendation that a plan participant roll money out of a plan into a fee-based account that generates ongoing fees for the Level Fee Fiduciary; and
- a recommendation that a client switch from a low-activity commission-based account to an account that charges a level fee.
Exceptive Relief for Prohibited Transactions
Q.5. What type of exceptive relief is available?
A.5. The best interest contract exemption (BIC Exemption or BICE) is the primary vehicle for such relief with respect to retail retirement clients. However, depending on the investment advice that is provided, certain other PTEs may apply. The following retirement investor clients are covered under the BIC Exemption:
- any IRA client;
- any participant in an ERISA or other tax-qualified retirement plan; or
- any “retail” plan client with assets of less than $50 million (including but not limited to defined contribution plans with participant-directed investments).
As a practical matter, given the business models and compensation arrangements that currently exist and, given the different scenarios under which “conflicted advice” may be provided, it is expected that the BIC Exemption will be relied upon in some form by a great number of providers of fiduciary investment advice.
If fiduciary investment advice is provided to IRA owners or non-ERISA plans, the advice provider’s firm must enter into a best interest contract with the retirement investor. Included among the requirements for such a contract are: (i) an acknowledgment by the firm of fiduciary status, (ii) a representation that the firm and its representatives will operate under a “best interest” standard of care, (iii) a representation that certain impartial conduct standards will be adhered to, (iv) the inclusion of warranties relating to the adoption of certain compliance policies, and (v) the inclusion of certain disclosures related to the best interest standard, services to be provided, conflicts of interest and fees and charges.
If fiduciary investment advice is provided to ERISA plans a best interest contract is not required. However, a statement of fiduciary status and certain disclosures must be provided to the retirement investor at or before the time a recommended transaction is executed. The client disclosures mirror the disclosures described above. The firm and the adviser must adhere to the impartial conduct standards described above and will need to adopt the same compliance policies and procedures regarding the impartial conduct standards and conflicts of interest that would have been required if the best interest contract conditions applied in full.
Exceptive Relief for Level Fee Fiduciaries
Q.6. In A.4. above, there is a reference to investment advice provided by Level Fee Fiduciaries that would require exemptive relief (see the examples provided in A.4.). What type of exceptive relief would be needed?
A.6. A variation of the BIC Exemption, sometimes referred to as “BICE Lite,” allows advice providers who receive a level fee (i.e., a set fee that does not vary) to provide investment advice under circumstances that could, according to the DOL, give rise to a conflict of interest. With fewer conditions than those that would apply under the full-blown BIC Exemption, this version requires Level Fee Fiduciaries that provide potentially conflicted advice to provide certain disclosures, adhere to impartial conduct standards and provide documentation explaining the reasons for making certain recommendations.
Effective Date; Delayed Applicability; Transition Period for Compliance with Certain BIC Exemption Requirements
Q.7. What is the effective date of the DOL Rule?
A.7. The DOL Rule became effective on June 7, 2016; however, this is subject to a delay in its applicability and a transition period for compliance with certain conditions under the BIC Exemption.
Applicability of the DOL Rule will be delayed until April 10, 2017 in order to afford fiduciaries who provide investment advice to retirement accounts ample time to prepare. Moreover, the time for compliance with certain BIC Exemption conditions will be extended as follows:
- During the transition period from April 10, 2017 through December 31, 2017 (Transition Period), firms will need to provide written notice prior to the execution of a recommended transaction (i) acknowledging the adviser’s fiduciary status, (ii) promising compliance with the BIC Exemption’s Impartial Standards, and (iii) disclosing any materials conflicts of interest. The notice will also need to disclose whether proprietary products or investments generating third party payments are being recommended and the limitations this places on the universe of investment recommendations. In addition, the firm will need to designate a BIC Officer to monitor compliance and comply with BIC Exemption recordkeeping requirements by the start of the Transition Period.
- By Januaryl, 2018, firms and their advisers will be required to meet all the requirements for the BIC Exemption, including the preparation of contracts, where required, and implementation of policies and procedures mitigating conflicts.
Grandfathering of Pre-Existing Transactions
Q.B. Will pre-existing transactions be grandfathered?
A.8. Yes, subject to certain requirements being met. Firms and their advisers may continue to receive variable compensation with respect to investment products acquired by IRA or plan clients prior to April 10, 2017 if the following requirements are met:
- the compensation is received under an arrangement that was entered into prior to April 10, 2017 and that has not expired or come up for renewal;
- the client’s initial acquisition of the investment product did not trigger a non-exempt prohibited transaction;
- the compensation is not related to a client’s investment of additional amounts under the previously acquired investment product (e.g., additional premium payments under an annuity) unless the purchases were made under an arrangement established before April 10, 2017;
- the compensation is reasonable; and
- any advice provided after April 10, 2017 (including a hold recommendation) with respect to the investment product is in accordance with the Best Interest fiduciary standard.
As the various DOL Fiduciary Rule deadlines approach, your firm must assess its current business lines, investment offerings, compliance program and determine what changes will have to be made and how to best implement and monitor those changes. For some firms, compliance with the rule will be an enormous undertaking, taxing firm resources. For others, implementation may mean making minor changes to policies and procedures. If your firm has limited capacity to manage the necessary assessments, implementation, and monitoring, Oyster can supplement your staff. We can help to manage and guide your project to successful completion.
Whether you are looking to change from self-clearing to fully-disclosed (or vice-versa), exploring your clearing options or starting a broker-dealer, Oyster can assist with the assessment, analysis, vendor selection and conversion processes.Download