Background
Several years ago, the U.S. Department of Labor sought to expand the definition of “fiduciary” under the Employee Retirement Income Security Act (“ERISA”) to more broadly define as fiduciaries those persons who render investment advice to plans and IRAs for a fee. It is no surprise that the proposal has resurfaced. However, the 2015 proposal takes a different approach than the prior rulemaking effort and looks to eliminate conflicts of interest in retirement advice as part of President Obama’s “middle class economics” agenda. U.S. Labor Secretary Thomas Perez has commented: “This boils down to a very simple concept: if someone is paid to give you retirement investment advice, that person should be working in your best interest.” Thus, under the 2015 proposal, a broker, insurance agent, administrative service provider, or salesperson may be deemed an ERISA fiduciary. Presently, such advisers are held to a “suitability” standard, which means that they can recommend products that net higher fees or commissions without yielding better returns for investors so long as the products generally fit an investor’s needs and tolerance for risk. Upon approval of the proposed rule, there would be a shift in focus under ERISA, and such advisers would be required to act in their client’s best interest, which is the standard currently applicable to Registered Investment Advisers under the Investment Advisers Act of 1940.
2015 Proposal on the Fiduciary Standard
Under the 2015 proposal, an individual would be deemed to be a fiduciary if such individual receives compensation for providing advice that is specifically directed to a particular plan sponsor, plan participant, or IRA owner for consideration in making a retirement investment decision. Such decisions can include, but are not limited to, what assets to purchase or sell and whether to rollover from an employer-based plan to an IRA.
However, seven activities are specifically excluded from the definition of fiduciary investment advice and thus would exclude from fiduciary status the person who engages in such activities.
- Statements or recommendations made to a large plan investor with financial expertise by a counterparty acting in an arm’s-length transaction.
- Offers or recommendations to plan fiduciaries of plans covered by ERISA to enter into a swap or security-based swap regulated under the Securities Exchange Act or the Commodity Exchange Act.
- Statements or recommendations provided to a plan fiduciary of an ERISA plan by an employee of the plan sponsor, if the employee receives no fee beyond his or her normal compensation.
- Marketing or making available a platform of investment alternatives to be selected by a plan fiduciary for an ERISA participant-directed account plan.
- The identification of investment alternatives that meet objective criteria specified by a plan fiduciary of an ERISA plan or the provision of objective financial data to such fiduciary.
- The provision of an appraisal fairness opinion or a statement of value to an employee stock ownership plan regarding employer securities, to a collective investment vehicle holding plan assets, or to a plan for meeting reporting and disclosure requirements.
- Information and materials that constitute “investment education” or “retirement education.”
An individual meeting the expanded fiduciary criteria would be required to provide impartial advice that is in the client’s best interest. Further, the fiduciary would be prohibited from accepting any payment that creates a conflict of interest, unless the fiduciary qualifies for an exemption intended to ensure that the customer is adequately protected. For example, the receipt of Rule 12b-1 fees by a fiduciary is prohibited unless the fiduciary satisfies one of the exemptions. In addition to the already existing prohibited transaction exemptions, the 2015 proposal would add two new exemptions, with consideration of a possible third exemption.
2015 Proposed Exemptions
1. “Best Interest Contract Exemption”
The “best interest contract exemption” would permit firms (generally considered to encompass brokerage firms, insurance agencies, administrative service providers, and other firms that employ advisers) to continue to set their own compensation practices or earn variable compensation including commissions so long as they notify the U.S. Department of Labor of the intent to utilize the “best interest contract exemption” and meet a set of stringent requirements. Among other things, the “best interest contract exemption” requires the firm and the individual providing retirement advice to enter into a contract with a client that would:
- Commit the firm and the individual adviser to provide advice in the client’s best interest. Committing to a best interest standard would require the adviser and the firm to act with the care, skill, prudence, and diligence that a prudent person would exercise based on the current circumstances. In addition, both the firm and the adviser would be required to avoid misleading statements about fees and conflicts of interest.
- Warrant that the firm has adopted policies and procedures designed to mitigate conflicts of interest. Specifically, the firm would be required to warrant that it has identified material conflicts of interest and compensation structures that would encourage individual advisers to make recommendations that are not in clients’ best interests and has adopted measures to mitigate any harmful impact on investors from those conflicts of interest.
- Clearly and prominently disclose any conflicts of interest that might prevent the adviser from providing advice in the client’s best interest. The contract would be required to also direct the customer to a webpage that discloses the compensation arrangements entered into by the adviser and firm and make customers aware of their right to complete information on the fees charged.1
2. “Principal Transactions Exemption”
In addition to the new “best interest contract exemption,” the proposal would add a new, principles-based exemption for principal transactions while maintaining or revising many existing administrative exemptions. The “principal transactions exemption” would allow advisers to recommend certain fixed-income securities and sell them to the investor directly from the adviser’s own inventory, as long as the adviser adhered to the exemption’s consumer-protective conditions.
3. Possible “Low-Fee Exemption”
Finally, the proposal asks for comment on whether the final exemptions should include a new “low-fee exemption” that would allow firms, when recommending the lowest-fee products in a given product class, to accept payments that would otherwise be deemed “conflicted,” with even fewer requirements than the “best interest contract exemption.”
Practical Impact on Plan Sponsors of Employee Benefit Plans
Many commentators view the proposed fiduciary rule as beneficial for plan sponsors partly due, to a greater transparency regarding fees and the application of a uniform definition of “fiduciary”. Reliance by plan sponsors on advisers, who are themselves fiduciaries to the plan, provides a degree of safety to plan sponsors when they make their investment decisions (even though they cannot rely implicitly on their advisers). However, because plan sponsors would need to acknowledge in writing all potential conflicts of interest, as well as their full understanding of their adviser’s services and fees, plan sponsors would likely vet their advisers’ offerings more carefully than before and would begin to ask “What potential conflicts of interest exist with the management of our account?” and “Do you adhere to the fiduciary standard of care and always do what is in the best interests of your clients?”
Similarly, the proposed rule will have less impact on Registered Investment Advisers who are already held to the higher “best interest” standard under the Investment Advisers Act. The greater impact would be felt by brokers and insurance agents, who would be subject to increased disclosure and compliance policy requirements and increased cost of compliance.
Next Steps
Practitioners have commented that the U.S. Department of Labor should make the proposed fiduciary requirements less confusing and complex, and address the narrowness of prohibited transaction exemptions and general investment education. The public is invited to submit comments on the proposed rule by July 21, 2015. A public hearing on the proposed rule will be held the week of August 10, 2015, after which the comment period will be reopened for approximately 30 to 45 days
We will keep you informed of the latest developments in the Department of Labor’s proposal to move to a universal fiduciary standard.
If you have any questions, please do not hesitate contact any member of the ERISA/Employee Benefits Team.