Considerations for Broker-Dealers and Investment Advisors Under the New ERISA “Fiduciary Advice” Regulations

In April 2016, the U.S. Department of Labor (“DOL”) issued final regulations that address when a person is a “fiduciary” of an employee benefit plan subject to the Employee Retirement Income Security Act (“ERISA”) or a non-ERISA “plan,” as defined in theInternal Revenue Code (the “Code”) – for example, an individual retirement account (“IRA”) -- as a result of providing investment advice (“the Fiduciary Advice Rule”). In connection with these regulations, the DOL issued new prohibited transaction exemptions and updated some existing exemptions.

This summary highlights some key points that broker-dealers and investment advisors may need to deal with under the Fiduciary Advice Rule. While the effective date of the Fiduciary Advice Rule is April 10, 2017, financial professionals may have already started reviewing their business models and documentation to determine how the new rule may impact how they advise and service clients. There are numerous open questions under the new rule, and the DOL has stated that it will be issuing additional guidance. The Fiduciary Advice Rule is complex, so this summary is only a general overview, and is not to be regarded as advice on any particular situation.

The Fiduciary Advice Rule is Triggered by “Recommendations”

The Fiduciary Advice Rule provides,in general,that if a person provides any of the following types of advice to a plan or its participants and/or beneficiaries, or to an IRA owner (any of which is a “retirement investor”), for a fee or other compensation (direct or indirect), then the person is providing “investment advice for a fee” and is therefore a fiduciary to the retirement investor. The types of advice that can create such a relationship are:

  • Recommendations 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;
  • Recommendations 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,
  • types of investment account arrangements (brokerage vs. advisory), or
  • recommendations with respect to rollovers, transfers or distribution from a plan, including whether in what amount, in what form and to what destination such a rollover, transfer or distribution should be made.

The definition of “recommendation” is broad: it includes advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is based on the particular investment needs of the retirement investor or specific advice regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA to a retirement investor. For example, providing a selected list of securities as “appropriate” for a retirement investor is a “recommendation.”

Is Every Communication to a Retirement Investor a “Recommendation”?

In general, the following are not “recommendations” that trigger fiduciary status under the Fiduciary Advice Rule:

  • non-fiduciary investment education (as described in the regulation);
  • general communications (such as market reports, prospectuses or general marketing materials); or
  • marketing or giving general advice about a menu of investment alternatives not tailored to a particular retirement investor activities (“platform provider” activity).

What are Possible Consequences for a Firm or Representative thatProvides “Recommendations” so that it is a Fiduciary?

ERISA and the Code generally prohibit fiduciaries from receiving compensation that varies based on the advice they give, or from receiving compensation from third parties in connection with transactions involving plan assets. Commissions, sales loads, 12b-1 fees, revenue sharing, and other such payments can constitute such compensation. Examples of activities that could be prohibited as a result of the Fiduciary Advice Rule are a recommendation that a 401(k) plan participant roll over a distribution from the plan to an IRA which will generate fees or commissions, or steering an IRA client to products or services that pay a higher fee or commission when comparable, lower-cost options are available.

If the Fiduciary Advice Rule is applicable to a Firm or Representative, are there Available Exemptions from Potential Prohibited Transactions?

There are certain statutory exemptions under ERISA and the Code that exempt certain transactions that would otherwise be prohibited transactions through application of the Fiduciary Advice Rule. In conjunction with the Fiduciary Advice Rule, the DOL amended some existing DOL exemptions to harmonize them with the new rule and added new exemptions. The most important exemptions in many situations may be the new “best interest contract exemption,” or “BIC Exemption.” The BIC Exemption provides fiduciaries who provide recommendations with an exemption from the ERISA and Code prohibited transaction provisions to permit them to receive certain variable compensation. Even with the BIC Exemption, though, the compensation received by the

firm or representative must be “reasonable” under the circumstances.

The BIC Exemption is fairly complex and may require significant contractual requirements and obligations, depending on the type of compensation to be received. For arrangements like IRAs and Keogh plans, the BIC Exemption requires that its standards be set forth in an enforceable contract with the retirement investor. For ERISA plans and plan participants, the same disclosures and materials are required, but need not be included in a contract. The level of compliance and disclosure required to comply with the BIC Exemption can vary with the type of advice given and the nature of the variable compensation.

“Level fee fiduciaries,” whose only fees received in connection with advisory or investment management services to retirement investors are a level fee that is disclosed in advance, are not subject to most of the BIC Exemption requirements described below. A “level fee” is a fee or compensation that is provided on the basis of a fixed percentage of the value of the assets, or a set fee that does not vary with the particular investment recommended, rather than a commission or other transaction-based fee.

Some of the key BIC Exemption requirements include:

  • Fiduciary acknowledgement. Affirmative acknowledgementof fiduciary status under ERISA or the Code (or both) with respect to recommendations covered by the agreement.
  • Impartial Conduct Standards. Adoption and compliance with “impartial conduct standards” to provide advice that reflects the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the recipient of such recommendation, without regard to the financial or other interest of the advisor or any of its affiliates or related parties.
  • Do not mislead. Statements about the recommended transaction, fees, material conflicts of interest and other matters that are relevant to the retirement investor’s investment decision must not be materially misleading at the time they are made.
  • Warranties and policies and procedures. Must warrant and comply with written policies and procedures reasonably and prudently designed to ensure that it: (i) adheres to the impartial conduct standards (described above); (ii) has identified and documented its “material conflicts of interests” (i.e., when an advisor has a financial incentive that a reasonable person would conclude could affect the exercise of its best judgment as a fiduciary in rendering advice to an investor) and adopted measures to prevent such material conflicts of interest; and (iii) has designated a person(s) responsible for addressing material conflicts of interest.
  • No incentives for conflicted advice. A financial firm must not use or rely upon quotas, differential compensation, or other actions or incentives that would reasonably be expected to result in recommendations that do not adhere to the “best interest of the retirement investor” (generally means to act with the care, skill, prudence, and diligence under the circumstances that a prudent person would use based on the investment objectives, risk tolerance, etc., without regard to the financial interests of the advisor). Importantly, the DOL has stated that differential compensation based on neutral factors such as the differences in services delivered with respect to different types of investments, as opposed to differences in the amounts of third party payments to the advisor, may be received.
  • Disclosures. Written disclosures that describe: (i) the “best interest of the retirement investor” standard (above); (ii) the services provided to the retirement investor; (iii) how the retirement investor will pay for services (i.e., directly or through third-party payments); (iv) material conflicts of interest; (v) any fees or charges imposed upon the investor or the investor’s account; (vi) the type of compensation expected from third parties in connection with investments recommended.
  • Website link. The financial firm must maintain a website that includes additional disclosures, including: (i) a discussion of its business model and any material conflicts of interest associated with it; (ii) a schedule of typical account or contract fees and service charges; and (iii) a list of investment product providers with whom it maintains arrangements and third party providers with respect to specific investment products or classes of investments recommended to retirement investors.
  • Proprietary products and limitations. Disclosures as to whether proprietary products are offered or third-party payments received with respect to any recommended investments and whether investment recommendations are limited (in whole or in part) to proprietary products or investments that generate third-party payments.
  • Prohibited provisions include exculpatory provisions disclaiming or otherwise limiting the firm’s or representative’s liability, waiver or qualification of the retirement investor’s right to bring or participate in a class action, and agreements to arbitrate or mediate claims in venues that are distant or that otherwise unreasonably limit the ability of the retirement investor to assert claims safeguarded by the BIC Exemption.

Where can I find out More About the Fiduciary Advice Rule and the BIC Exemption?

The Fiduciary Advice Rule can be found at:

The BIC Exemption can be found at:

A DOL summary of the Fiduciary Advice Rule can befound at:

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