The new Department of Labor (“DOL”) Rule changes the definition of “fiduciary” under the Employee Retirement Income Security Act (“ERISA”), expanding the universe of financial professionals who would be deemed to be fiduciaries.
Most of the Rule’s requirements become effective April 10, 2017. The full disclosure provisions, the policies and procedures requirements, and the contract requirement do not go into full effect until January 1, 2018.
Under the DOL’s Rule, any individual receiving compensation for providing advice for an individual or specifically directed to a particular plan sponsor (e.g., an employer with a retirement plan), plan participant, or IRA owner for consideration in making a retirement investment decision is a fiduciary. The types of retirement investment advice that would be covered by the fiduciary standard include, but are not limited to, (i) advice concerning which assets to purchase or sell, and (ii) advice regarding whether to roll over assets from an employer-based plan to an IRA.
To ensure the customer is adequately protected, being a fiduciary would mean any financial adviser, including an entity who, among other things, is a representative of an RIA, a bank or similar financial institution, an insurance company, or a broker-dealer, must provide impartial advice in the client’s best interest, and generally excluding commissions and revenue sharing. These types of traditional charges may be used under the Best Interests Contract Exemption (BICE). The BICE essentially allows for conflicted forms of compensation (i.e., commissions and revenue sharing) as long as the compensation is “reasonable,” adequately disclosed, acknowledges the Financial Institution and its Adviser(s) are fiduciaries under ERISA, and does not lead to biased recommendations in any way. .
The DOL’s proposal carefully excludes education from the definition of retirement investment advice so that advisers and plan sponsors can continue to provide general education on retirement saving across employment-based plans and IRAs without triggering fiduciary duties. This exclusion is similar to previously issued guidance to minimize the compliance burden on firms, but clarifies that references to specific investments would constitute advice subject to a fiduciary duty.
IMPACT ON INVESTMENT ADVISERS
The DOL’s fiduciary standard is not the same as the standard enforced by the Securities and Exchange Commission (the “SEC”). Since RIAs currently follow the SEC standard, the DOL’s proposal would force them to comply with two separate fiduciary regimes.
Broadly speaking, the SEC standard requires advisers to disclose conflicts of interest up front to clients through Form ADV, and to minimize the impact of conflicts and manage them properly. Within this context, it is up to individual clients and advisers to decide whether they can work together given any existing conflicts.
The DOL standard is much more restrictive, in large part prohibiting advisers from engaging in transactions that, in the Department’s view, present a conflict of interest. These conflicts cannot be cured merely through disclosure. Under the current proposal, some of these transactions would be permissible through a best interest contract exemption – or BICE – that would require clients to enter into a highly complex contractual agreement with the adviser.
While RIAs who do significant business in the 401(k) market have experience in complying with ERISA and DOL requirements, the vast majority of RIAs – who may advise only on IRAs for individuals – could find themselves scrambling to comply with new reporting and regulatory requirements.