In April 2016, the U.S. Department of Labor (DOL) released the final version of the so-called fiduciary conflict rule. More than six years in the making, this rule represents perhaps the most significant regulation from the DOL during the Obama administration.
The fiduciary conflict rule expands the definition of fiduciary to cover, with certain exceptions, all investment advice provided to a retirement plan (like a 401(k) plan, defined benefit pension plan or an IRA), or to a retirement plan participant or beneficiary. It imposes fiduciary status on a broad category of professionals, including many broker-dealers who previously had taken the position that they were not investment advice fiduciaries based on a regulation that had been in place since 1975.
The new regulation has an international reach—foreign advisers, whether recommending investments in U.S. or foreign assets, will be subject to the fiduciary rule if the recommendation is made regarding assets of a U.S. retirement “plan” (as defined in the regulation to include the types of plans listed previously).
In contrast to the sweeping changes it imposes on investment advice professionals, the fiduciary conflict rule will have a far more modest effect on actuaries, and the employers and plan administrators for whom they work. Unlike its impact on broker-dealers and other investment professionals, the rule generally will not confer investment fiduciary status on actuaries or employers. Nevertheless, the rule has important implications for actuaries and employers that sponsor retirement plans:
- Actuaries who provide nontraditional services, such as advising on group annuity purchases, risk falling within the rule’s definition of fiduciary.
- By regulating the distribution of benefits from employer-sponsored retirement plans, the fiduciary conflict rule may have the practical effect of slowing the outflow of assets from those plans and thereby increasing the amount of assets they otherwise hold.
- Employers and plan administrators may need to create new procedures to monitor their service providers’ compliance with the fiduciary conflict rule.
Architecture of the Fiduciary Conflict Rule
The fiduciary conflict rule applies a broad, functional test to define fiduciary investment advice as it relates to a retirement plan or investor. Specifically, a person takes on fiduciary status with respect to a retirement plan or investor if he or she:
- provides one of the following types of advice for a fee or other compensation:
- recommendations regarding acquiring, holding, disposing of, or exchanging securities or investment property of a retirement plan;
- recommendations regarding how securities or investment property should be invested after the assets are distributed from the retirement plan; or
- recommendations regarding investment management, such as recommendations on investment policies, strategies or portfolio composition; on selection of other persons to provide investment services or of investment account arrangements; or with respect to rollovers, distributions or transfers from a retirement plan.
- also meets one of the following conditions:
- represents that he or she is acting as a fiduciary;
- provides advice pursuant to an agreement, arrangement or understanding that the advice is based on the particular needs of the advice recipient; or
- directs the advice to a specific recipient.
The rule also specifies certain situations in which a person will not be treated as an investment advice fiduciary, regardless of whether the person might otherwise meet the rule’s definition. These include investment education, communications to a general audience, marketing of a platform of investment options, certain communications by employees of a plan sponsor and, generally, communications by counterparties in negotiations with fiduciaries of large plans.
If a person is an investment advice fiduciary under the new definition (and is not otherwise excluded), his or her investment advice will be subject to the “prohibited transaction” rules. Absent a “prohibited transaction exemption,” these rules prohibit receipt of commissions or any other compensation that varies based on the nature of the investment advice.
Best Interest Contract Exemption
In conjunction with the fiduciary conflict rule, the DOL issued a “Best Interest Contract” prohibited transaction exemption that would allow advisers to retain such variable compensation. The Best Interest Contract exemption generally requires:
- Acknowledgment of fiduciary status.
- Adherence to an “Impartial Conduct Standard” that requires the adviser to provide advice that is in the investor’s best interest, avoid misleading statements and charge no more than reasonable compensation.
- The financial institution employing the adviser to implement policies and procedures designed to prevent violations of the Impartial Conduct Standard.
- Disclosures concerning fees and potential conflicts of interest.
The first and second of these requirements are of particular significance for IRA owners. Unlike participants in most employer-sponsored retirement plans, IRA owners do not have a statutory right to bring suit against fiduciaries under the Employee Retirement Income Security Act (ERISA). Thus, the Best Interest Contract exemption, if used, would provide IRA owners with a direct contractual right—not available under any statute—to seek a remedy for certain breaches that violate prohibited transaction rules or the adviser’s obligations as a fiduciary.
Key Takeaways for Actuaries and Employers
1. ACTUARIES WHO PROVIDE NONTRADITIONAL SERVICES SHOULD CLOSELY SCRUTINIZE WHETHER THEY FALL WITHIN THE NEW DEFINITION OF “FIDUCIARY.”
In nonbinding commentary published in connection with the fiduciary conflict rule, the DOL stated it is not its intent for actuaries to become investment fiduciaries “merely because they provide professional assistance in connection with a particular investment transaction.” Rather, the DOL would view actuaries as being subject to the fiduciary definition only if they “act outside their normal roles.”
Accordingly, as actuaries’ activities shift to less traditional roles, it is important for actuaries to be mindful of the expanded definition of an investment advice “fiduciary.” For example, actuaries who recommend or advise on the selection of a particular insurer to provide a group annuity contract in the context of a de-risking transaction or a defined benefit plan termination may risk being subject to the rule. Likewise, actuaries providing comprehensive services for smaller plans, such as providing recommendations concerning the composition of a pension plan portfolio, also may be covered.
Actuaries who are investment advice fiduciaries must adhere to ERISA’s fiduciary standard, which requires recommendations to be prudent and to be made with undivided loyalty to the plan and its participants. They also must not engage in nonexempt prohibited transactions. Violations of ERISA fiduciary duties or the prohibited transaction rules may subject the actuary to personal liability for the breach. Additionally, excise taxes may be imposed for violations of the prohibited transaction rules.
Ultimately, whether advice from nontraditional actuaries falls within the fiduciary definition depends on individualized facts and circumstances. Actuaries acting in nontraditional roles should consider seeking legal counsel to determine whether their communications with plans or plan participants are subject to the fiduciary standard and, if so, about how best to manage fiduciary obligations and prohibited transaction considerations.
2. THE RULE’S COVERAGE OF IRA ROLLOVER AND OTHER DISTRIBUTION RECOMMENDATIONS MAY LEAD TO INCREASED ASSETS REMAINING IN EMPLOYER-SPONSORED PLANS.
In one of the most significant departures from previous DOL guidance, recommendations on distributions, including rollovers into an IRA or transfers to another plan, can constitute fiduciary investment advice under the new rule.
An adviser must use the Best Interest Contract exemption (or another prohibited transaction exemption, if available) if he or she is to receive any direct or indirect compensation as a result of the distribution. The Best Interest Contract exemption likely requires, in this context, that the adviser acknowledge fiduciary status and document his or her reasons for why it is in the participant’s best interest to take a distribution from the plan rather than leaving the assets in the plan.
Some financial advisers and institutions may view the compliance costs and legal risks associated with the Best Interest Contract exemption as being too great—and cease advising participants regarding plan distributions. Others may find it difficult to document that a distribution is in their client’s best interest, particularly in the context of a distribution from a large employer 401(k) plan that permits participants to invest in preferential “institutional” share classes (or similarly advantageous investment options) to an IRA or other individual investment account that charges higher “retail” fees.
In either case, the practical result may be that fewer participants will take distributions from their employer-sponsored retirement plans. If that occurs, employer-sponsored plan assets will grow over time, as money is retained in the plans for longer durations.
With larger than projected assets, employer-sponsored 401(k)-type plans may have increased bargaining power to negotiate more favorable investment options and other terms for their participants. If these negotiations are successful, the employer may find itself in a virtuous cycle in which the employer-sponsored plan becomes a more attractive option for participants’ retirement assets, thereby providing the plan with more leverage to negotiate even better investment options.
3. EMPLOYERS AND EMPLOYEES LIKELY WILL NOT BE INVESTMENT ADVICE FIDUCIARIES UNDER THE RULE BUT WILL UNDERTAKE NEW MONITORING OBLIGATIONS.
The fiduciary conflict rule and the DOL’s related commentary provide several assurances that employer plan sponsors and their employees will not be investment advice fiduciaries under the rule, absent unusual circumstances.
For example, the rule contains a broad exclusion for nearly all communications between co-workers, including HR employees. Additionally, the DOL has clarified that because ordinarily neither the employer nor the employee receives fees or other compensation in connection with providing advice, any “investment advice” from an employer or employee likely would not be subject to the fiduciary definition because the advice was not provided for the required “fee or other compensation.”
Even if they are not investment advice fiduciaries under the new rule, plan sponsors and administrators have other fiduciary obligations. They maintain a separate—and preexisting—fiduciary duty to monitor their service providers. The fiduciary conflict rule will affect this obligation, particularly with respect to service providers that take measures to remain outside the scope of the rule. For example, employers and administrators must monitor service providers that intend to provide nonfiduciary “investment education” advice. Such education commonly takes the form of asset allocation models and interactive investment materials designed to assist participants in 401(k)-type plans in selecting investment options. The DOL has emphasized that employers and administrators will need to evaluate and periodically monitor these materials to ensure they are “unbiased and not designed to influence investment decisions toward particular investments” that may result in higher compensation for the service provider.
The fiduciary conflict rule will not be applicable until April 10, 2017. While this transitional time primarily is in place to allow broker-dealers and other investment professionals to adjust from nonfiduciary to fiduciary status, the delayed applicability date also should benefit actuaries and employers. Particularly, in light of additional guidance from the DOL expected to be announced in the coming weeks and months, actuaries and employers should monitor developments in the fiduciary conflict rule and closely analyze how the rule will impact their operations.
The information presented is not legal advice and is not to be acted on as such. Please contact your legal counsel to obtain advice on your particular issue or question.