ERISA Fiduciary Definition April 21, 2015 On April 14, 2015, after 43 months in development, the U.S. Department of Labor (DOL) released its reproposal to expand the investment advice fiduciary definition under the Employee Retirement Income Security Act of 1974, as amended (ERISA), which was published in the Federal Register on April 20, 2015. The DOL s original October 2010 proposal on this subject was withdrawn, as announced in September 2011 in the face of substantial criticism from the regulated community and Capitol Hill, and, as expected, was replaced with a reproposal that: Recedes on the October 2010 proposal to treat the valuation of employee stock ownership plan (ESOP) stock as fiduciary activity; Significantly expands the circumstances in which broker-dealers, investment advisers, insurance agents, plan consultants and other intermediaries would be treated as fiduciaries to ERISA plans and individual retirement accounts (IRAs), and therefore precluded from receiving compensation that varies with the investment choices made or from recommending proprietary investment products absent an exemption; Provides new proposed exemptions and modifies or revokes a number of existing exemptions addressing those activities; and Retains the ERISA distinction between non-fiduciary investment education and fiduciary investment advice, with important modifications. The reproposal remains the most politicized and controversial rulemaking ever undertaken by DOL in its administration of ERISA. DOL made a legitimate effort, from its frame of reference, to address a number of criticisms of the earlier proposal made formally during the 2010-2011 rulemaking process and informally during the intervening years. For example, the reproposal is plainly more fully developed than the 2010 proposal, the institutional retirement market is distinguished from the retail market in helpful ways, and DOL specifically invites comments on a range of critical points implicated by this rulemaking. On balance, however, there is substantial reason to question both the justification for and the execution of the reproposal. At bottom, the reproposal does not target bad actors for reform. Instead, it would materially modify otherwise permissible practices in the affected industries and impose substantial compliance costs, uncertainties and exposure on good actors. Consequently, important interests of plan sponsors, participants, IRA owners, financial services providers and the retirement system as a whole are in play. Related People/Contributors Peter J. Anderson Eric A. Arnold Brian Barrett Keith J. Barnett Frederick R. Bellamy Bruce M. Bettigole Thomas E. Bisset Adam B. Cohen Olga Greenberg Michael A. Hepburn Dodie C. Kent Clifford E. Kirsch Michael B. Koffler Susan S. Krawczyk Neil S. Lang Paul R. Lang Carol T. McClarnon Alice Murtos S. Lawrence Polk Stephen E. Roth Brian L. Rubin Vanessa A. Scott Holly H. Smith W. Mark Smith William J. Walderman John H. Walsh Bryan M. Ward Carol A. Weiser Mary Jane Wilson-Bilik
Key Dates DOL proposed an aggressive timetable for consideration and implementation of the reproposal, which is posted on its website. Close of comment period: July 6, 2015. For a proposal of this magnitude, an extension may be necessary and appropriate. Hearing: Within 30 days after close of the comment period, with the record open for additional written comments after the hearing. Effective date: 60 days after publication of final rules. Applicability Date: Compliance would be required eight months after publication of final rules, which is patently insufficient and will draw requests for extension. Background ERISA imposes a famously comprehensive and reticulated 1 scheme of regulation for the terms of employee benefit plans, particularly retirement plans, and for plan reporting and disclosure. For the management of plans, however, ERISA instead relies primarily on a standards-based form of regulation, and at the core of that regulation is the concept of a fiduciary to the plan. Such fiduciaries are charged with carrying out their duties for the plan in accordance with unusually rigorous fiduciary standards (ERISA 404) and are barred from engaging in certain prohibited transactions (ERISA 406). For example, acting with a conflict of interest generally would be contrary to these fiduciary standards, absent an exemption. Fiduciaries for ERISA plans can be personally liable for losses suffered by a plan resulting from a non-exempt violation of these standards, as well as for excise taxes, civil penalties and other remedies. Fiduciaries for IRAs, on the other hand, generally are subject to only the 406 prohibited transaction standards (through Internal Revenue Code 4975) and are liable to the IRS for excise taxes, but not to IRA owners, for violations of those standards, but not to IRS owners. ERISA 3(21) provides that three classes of persons are fiduciaries for these purposes, generally: Persons with discretionary authority or responsibility for the administration of the plan ( plan administration fiduciaries ); Persons who provide investment advice for a direct or indirect fee or other compensation with respect to the moneys or other property of the plan ( investment advice fiduciaries ); and Persons who manage plan assets on a discretionary basis ( discretionary asset management fiduciaries ).
In 1975, shortly after the enactment of ERISA, DOL promulgated a regulation specifying the circumstances in which a person providing investment advice becomes a fiduciary. For an adviser who does not have discretionary management authority, the 1975 regulation provides that the adviser is a fiduciary only if she satisfies a five-part test, specifically, if for a direct or indirect fee or other compensation (which, in DOL s longstanding view, includes insurance or securities commissions or similar amounts) she: 1. Renders advice as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing or selling securities or other property 2. On a regular basis 3. Pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary, that 4. The advice will serve as a primary basis for investment decisions with respect to plan assets, and that 5. The advice will be individualized based on the particular needs of the plan. DOL now seeks to replace that five-part test with a more expansive definition, supported by a revised set of exemptions dealing with various investment activities. DOL s Justification for an Expanded Fiduciary Definition The reproposal remains a solution in search of a problem. This is no small matter. With current assets of approximately $19.5 trillion, 2 the U.S. private retirement system provides substantial equity and debt capitalization for the U.S. economy. When the question of the ERISA investment advice fiduciary definition was first considered following the enactment of the statute in 1974, the Securities and Exchange Commission (SEC) expressed on the record its serious concern about the risk of disruption to the U.S. capital markets if ERISA fiduciary status was overextended. DOL carefully crafted its five-part fiduciary definition against this background and, in the years since, has sought to balance the uncompromising requirements ERISA imposes on fiduciaries with the structure of and national policies served by the U.S. investment markets as governed by their primary regulators. Any such balance is missing from DOL s reproposal. Indeed, the unstated but fundamental premise of the reproposal is that the primary regulation of investment markets by Congress, state legislatures, the OCC, SEC, FINRA, and other federal or state banking, insurance and securities regulators is inadequately protecting the interests of at least retail retirement plan investors. Thus, the banking, insurance and securities industries, as they participate in the retirement market, are to be restructured by the Labor Department under the auspices of the federal pension
law, rather than by the authorities with the direct responsibility and the competence for those industries. And since DOL s mission under ERISA includes no expertise in or responsibility for the health of those industries or the functioning of the distribution systems that support them, an ERISA regulatory proposal proceeding from that fundamental premise will inevitably lack balance. Moreover, it is plainly right that the ongoing evolution of the private retirement system, and in particular the shift to reliance on defined contribution plans and IRAs for retirement security, creates a pressing need for plan participants and IRA owners to receive qualified, professional financial services with respect to retirement investments. In addition, investment intermediaries play an instrumental role in bringing plan sponsors, participants and IRA owners into the retirement system and keeping them in the retirement system. Those intermediaries essentially function as the missionaries for the retirement system. In that respect, some sponsors and individuals require more time and attention than others and, if the price for that additional service is a commensurately higher fee reflected in their retirement savings, as opposed to having no retirement savings at all, that incremental cost is money well spent. Accordingly, constraints on the availability of investment services that could result from the DOL's reproposal, particularly for smaller plans or individual retirement investors, can undermine the retirement system in various ways. Finally, meaningful regulatory changes always create cost and uncertainties. In this case, both would be a tax on the retirement system. And to the extent retirement advisers would face unsettled compliance requirements and thus exposure, those risks would be shared with the plan sponsors or other fiduciaries who engage those advisers. Given the stakes, then, it would be well that any regulatory restructuring of retirement advice arrangements be based on documented and serious problems arising under existing law, to which the solution least likely to produce adverse or unintended consequences has been tailored. There will be respected commentators in the regulated community who will support the reproposal and the justifications offered by DOL for it some of which have carried over from 2010 and some of which are new. In the end, however, those justifications do not bear the weight of a proposal as consequential as the proposed expansion of ERISA fiduciary status. In the reproposal, DOL does not empirically substantiate any systemic abuse of retirement plans or participants or IRA owners by conflicted advisers. Our perspective is that the existing pattern of ERISA regulation of retirement advice (even with its various compromises), coupled with the heavy regulation of investment intermediaries under other federal and state laws, has substantially succeeded in protecting retirement plan investors and provided effective remedies in bad actor cases (even if they are not always DOL remedies).
Indeed, in the preambles to the reproposal, DOL recognizes that most retirement advisers well serve the interests of their retirement investors. Instead, DOL essentially rests its reproposal on a different argument that in light of the expectations and competencies of retirement investors, the retirement system should not permit conflicted advice otherwise allowed under applicable law. The conclusion then follows in a circular manner fiduciaries are barred from providing conflicted advice, so all retirement advisers should be fiduciaries. DOL does attempt to square its reproposal with the statute, by arguing the investment advice fiduciary definition in ERISA 3(21)(a)(ii) is broad. To the contrary, the statute by its terms is neither broad nor narrow; it merely provides that investment advice for a fee is fiduciary activity. The statute supplies no definition of or content for what it means to provide investment advice. Thus, DOL again assumes the result in making this argument. DOL also suggests that the tax benefits afforded retirement plans justify a more rigorous regulation than applies to retail investments. By limiting the application of ERISA to employee benefit plans, which generally do not include IRAs, Congress has already delineated the circumstances in which that argument would or would not be controlling. DOL does refer to academic literature and government reports that support its position and speculates about the quantitative benefits to the retirement system from its reproposal. As the commentary to be submitted on the reproposal no doubt will show, however, there is more to that record, which will provide a more nuanced perspective on these points than DOL cities in its advocacy. And in the end, even DOL rejects the logical conclusion of its own arguments that conflicted advice should be banned in the retirement market in favor of rules conditionally allowing such advice in a variety of circumstances. We summarize below the principal elements of that reproposal.
Arrangements in Scope of the Reproposal Taking into account, among other things, the expected transfer of savings from retirement plans to IRAs during the baby boomer retirement years, DOL was not persuaded by the arguments that different fiduciary regulatory structures should apply to ERISA plans and IRAs. Accordingly, the reproposal in all of its aspects the expanded fiduciary definition and the restructured complex of exemptions would apply not only to ERISA plans (including those 403(b) programs and employersponsored IRAs subject to ERISA), but also, by reason of IRC 4975(e)(1), to the following non-erisa arrangements: Traditional IRA accounts and annuities Roth IRAs Archer medical savings accounts Health savings accounts Coverdell education savings accounts The proposed ERISAfication of IRAs, discussed below, thus would extend to a number of arrangements beyond both (i) DOL s regulatory purview and expertise, remarkably including Coverdell accounts, and (ii) any meaningful consideration in the justifications or regulatory impact analysis proffered for the reproposal. The Reproposed Fiduciary Definition Under the reproposal, the five-part investment advice fiduciary test would be replaced by a greatly expanded definition subject to several carve-outs, as follows: Services A person is a fiduciary if: That person, for a fee, provides directly to a plan, plan fiduciary, plan participant or beneficiary, IRA or IRA owner: 1. A recommendation a communication that, based on its content, context and presentation, would reasonably be viewed as a suggestion that the recipient engage in or refrain from a particular course of action (a concept modeled on FINRA guidance) as to the advisability of a plan investment holding or transaction, including a recommendation to take a distribution or as to the investment of a rollover of that distribution; 2. A recommendation as to the management of securities or other property, e.g., proxy voting; 3. A verbal or written appraisal, fairness opinion or similar statement concerning the value of securities or other property in connection with a specific transaction; or 4. A recommendation of a person to provide, for a fee, any of the above services.
Status Carveouts And Such person directly or indirectly (e.g., through or together with any affiliate): 1. Represents or acknowledges that is he or she is acting as a fiduciary; or 2. Renders the advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is EITHER (a) individualized or (b) specifically directed to the recipient for consideration in making investment or management decisions with respect to plan or IRA securities or other property. Unless, but only if Status #2 applies, Such person: 1. Is a counterparty in a transaction with an ERISA plan where an independent fiduciary has financial expertise, namely either: A mid-size plan with 100 or more participants where an independent fiduciary has the expertise to evaluate the transaction under ERISA standards, or A large/mega-plan with more than $100 million in plan assets, where financial expertise is presumed, and follows specified procedures that vary by plan size, including fairly informing an independent plan fiduciary of the adviser s non-fiduciary status; 2. Is a counterparty to a specified swap or securities-based swap with an ERISA plan; 3. Is an employee of an ERISA plan sponsor who provides advice to a plan fiduciary and receives only normal compensation for the work performed; 4. Is a platform provider for ERISA plans that markets and makes available its investment platform without regard to individualized plan/participant needs, if the platform provider discloses that it is not undertaking to act as a fiduciary; 5. Provides selection and monitoring assistance (a screen of options meeting the plan fiduciary s specifications, or objective financial or benchmark information) with respect to investments available on such a platform; 6. Provides an appraisal, fairness opinion or statement of value to (a) an ESOP, (b) a pooled investment fund in which more than one plan has an interest or which holds the plan assets of more than one plan, or (c) a plan, fiduciary, participant or beneficiary, IRA or IRA owner solely for purposes of ERISA/IRC/other federal or state law/self-regulatory organization reporting or disclosure requirements; or 7. Provides investment education under a revised articulation of the distinction between non-fiduciary education and fiduciary advice (discussed below). Carve-outs 1-5 are not available with respect to non-erisa IRAs.
For this purpose, and consistent with DOL s prior position, a fee would include any direct or indirect fee or other compensation (i) for the advice received by the person (or an affiliate) from any source or (ii) received incident to the transaction for which the advice has or will be rendered, including brokerage fees and mutual fund or insurance sales commissions. As under the existing rule, the revised definition would go on to provide that: Even where the adviser acknowledges fiduciary status, that status is limited to the assets or other matter for which the adviser is acting as a fiduciary and not for any other assets or matter (subject to the co-fiduciary liability provisions of ERISA 405), and The execution of a securities transaction specified by another fiduciary is not itself fiduciary activity. The revised fiduciary definition is the core of the reproposal. The reproposal would take a more refined path to largely the same result as the 2010 proposal that many if not most interactions between investment intermediaries and plans, participants or IRA owners would constitute fiduciary investment advice and would expressly bring IRA rollover advice into the fiduciary definition even if an investment recommendation is not provided. While registered investment advisers would not automatically be investment advice fiduciaries under the reproposal, it appears intended that in most cases they would functionally have that status. The preambles contemplate that any client-facing personnel of a financial services provider, including in a call center, may be fiduciaries. To the extent an adviser was not previously treated as a fiduciary, that change in status may obligate it to, for example, start providing ERISA 408(b)(2) disclosures by the Applicability Date. Conceptually, the most fundamental disruption arising from the expanded definition is its conversion of salespeople into trustees for retail investors. The purpose in the financial system of broker-dealers and insurance agencies, among others, is to distribute investment and insurance products; their function is to be selling firms, and they are subject to both innate regulation and legal obligations to that end. In addition, some companies that manufacture investment products for the retirement market sell their own (i.e., proprietary) products through their own sales force. It is one thing to require selling firms and product manufacturers to engage in fair dealings with their customers. It is something very different to make them legally liable as impartial fiduciaries to their customers, much less to subject them to fiduciary
standards that are the highest known to the law. 3 The reproposal may make progress on the extent to which valuations are fiduciary activity the intent appears to be that advice about valuation of an asset in the context of a purchase or sale transaction would be fiduciary investment advice, but, the posting in plan records or statements by a trustee or recordkeeper of asset values (of even hard-to-value assets) on valuation dates, for example, would not although more clarification may be required on this point. The preamble describes the counterparty carve-out as a seller s exception for the institutional market where the plan has financial expertise as determined under the specified factors. This is a significant improvement from the 2010 proposal. Consideration might also appropriately be given to extending the carve-out to plans with fewer than 100 participants, at least where the sponsor either is a business akin to those described in SEC Rule 180 (a law firm, accounting firm, investment banking firm, pension consulting firm, or investment advisory firm, the nature of whose business requires a familiarity with financial matters) or separately has a different, trusted adviser on which it would rely. Similarly, the statement of the ERISA plan platform carve-outs has been improved from the 2010 proposal. The absence of a carve-out for IRA platforms, however, creates an inadvertent fiduciary problem the point at which the marketing of the platform crosses into fiduciary investment advice cannot be determined in advance with certainty for which the proposed complex of exemptions may not provide a workable solution. The Moving Line between Investment Education and Fiduciary Advice Current law Interpretive Bulletin (IB) 96-1, as codified by DOL regulation acknowledges the importance of enabling plan sponsors and service providers to provide participants and beneficiaries with investment educational materials without subjecting them to rigorous fiduciary standards and potential liability. The preamble to IB 96-1 explains that the distinctions between investment education and investment advice were developed after a review of actual investment educational materials. DOL then circulated a draft of proposed guidance to plan sponsors and service providers and released IB 96-1 because [b]oth plan sponsor and service provider representatives unequivocally agreed that the guidance as drafted would strengthen participant investment education, and urged the Department to proceed as expeditiously as possible to adopt the interpretive bulletin. The proposed regulation would supersede IB 96-1, replace it with a carve-out in the revised fiduciary definition, and substantially modify its content in several respects.
The proposal would narrow the types of information that can be provided to participants expanded to include IRA owners as investment education. The most notable change is that investment education materials could not include information, standing alone or in connection with other materials, on specific investment products, investment managers or the value of particular securities or other property. Asset allocation models and interactive investment models would still be permissible but must preclude the identification of plan investment alternatives. The inevitable result, of course, is that the education available to individuals (before triggering fiduciary regulatory compliance) will less effectively help them understand retirement plan and IRA investment options. On the other hand, the proposal also contains helpful additions with regard to educational materials on retirement plan distribution forms and retirement risks, such as longevity risk. These additions were drawn from comments solicited by DOL and the Treasuary Department on the use of lifetime income options in defined contribution plans and are consistent with developing policy encouraging the use of these types of investments. Major differences between current law and the proposed regulation as to the meaning of investment education are as follows: Category of Investment Education Plan Information Significant Changes in Proposal May not include reference to appropriateness of individual benefit distribution options for the plan or an IRA but may include descriptions of varying forms of distributions (including rollovers, annuitization and other forms of lifetime payment options (e.g., immediate annuity, deferred annuity or incremental purchase of deferred annuity), advantages, disadvantages and risks of different forms of distribution. Observations This new provision would coordinate with DOL s revocation of its current position on when rollover information becomes fiduciary investment advice. Permitted description of distribution forms is intended to permit education on lifetime income options.
Category of Investment Education General Investment Information Asset Allocation Models Significant Changes in Proposal Could not include information on specific investment products, plan alternatives, or distribution options, or specific alternatives or services outside of the plan. May provide information about retirement-related risks (e.g., longevity, market/interest rates, inflation, and health care), general methods and strategies for managing assets in retirement, including outside the plan. May not include or identify any specific investment product or alternative available under the plan. Observations Current rule provides that information may have no direct relationship to investment alternatives available under a specific plan or to individual participants or beneficiaries. Current practice of providing material on specific investment options, together with disclosure that other investment alternatives with the same risk/return characteristics are available, would no longer be permissible. Permitted information on retirement-related risks was added in response to comments on encouraging lifetime income options in plans. Presumably it would be up to the participant or IRA owner to determine which offerings under the plan or IRA are, for example, moderate risks vs. higher risk funds. The efficacy of the material would become largely dependent on an individual s degree of investment sophistication. Interactive Investment Materials May not include or identify any specific investment alternative / distribution option available, unless such option is specified by the participant. Permissible to evaluate distribution options, products or vehicles (based on plan information supplied by participant and general financial, investment and retirement information) and estimate income stream that could be generated by an actual or hypothetical account balance. Current rule permits material to include specific investment alternatives available under the plan, if accompanied by statement indicating that other investment alternatives having similar risk and return characteristics may be available under the plan (including where to find such information). Tools to evaluate distribution options would be expressly permitted.
DOL expressly recognized that the proposal represents a significant change in the information that may constitute investment education and invited comments on the appropriateness of these changes. The Restructured Complex of The proposed expansion of the investment advice fiduciary definition would be accompanied by the most substantial reworking of prohibited transaction exemptions ever undertaken by DOL. The absence of correlative prohibited transaction relief was a major gap in the 2010 proposal, and DOL deserves credit for giving extensive consideration to these matters in the reproposal. Best Interest Contract Exemption (BICE 4 ). The proposed BICE is the centerpiece of the restructured complex of exemptions. It is intended as the generally applicable exemption (and for rollover and other assistance to IRA owners involving many types of investments, the exclusively available exemption) for retail advice provided: To a Retirement Investor Defined as: ERISA plan participants and beneficiaries in participant-directed plans (including, according to the preamble, 403(b) plans); IRA owners; and The sponsor of an ERISA-defined benefit plan (or other plan not directed by participants) with fewer than 100 participants, where the sponsor (or its director, officer or employee) has fiduciary responsibility for investment decisions. For the usual reasons, the 100-participant cap would cause complications with respect to plans whose participant headcount vacillates in the vicinity of 100. If a fiduciary other than the sponsor is acting for the plan, as well as for plan-level advice for 401(k) and other participantdirected plans, resorting to other exemptions apparently would be required. By an Adviser Defined as an individual who is an investment advice fiduciary employed by or representing a Financial Institution and is appropriately licensed under applicable law for the advice to be given. Financial Institutions are limited to: Investment advisers registered under federal or state law; A bank or similar institution supervised by the U.S. or a state, that is subject to periodic federal or state examination and review, but only if the advice is provided through its trust department; An insurance company qualified to do business by a state with an active certificate of authority from its domiciliary jurisdiction (which must require annual actuarial review and reporting of reserves) and that undergoes either annual CPA examinations or a triennial financial examination by the state s insurance commissioner; or A broker-dealer registered with the SEC. The stated requirements for banks and insurance companies are more limiting than is typical under ERISA exemptions.
With respect to Assets Unless certain exceptions apply Assets are defined in a specified list of investment products commonly held in plans and IRAs. The exceptions relate to plans affiliated with or for the account of the Adviser or Financial Institution, roboadvice, or situations where the Adviser is a plan administration or discretionary asset management fiduciary (as well as an investment advice fiduciary). The proposed exemption is intended to provide principles-based relief for compensation (which is not prescriptively defined) received by the Adviser, Financial Institution or certain related entities for services provided in connection with the purchase, sale or holding of an Asset as a result of the Adviser s and Financial Institution s advice, provided all of the following conditions are satisfied (which, as the preamble makes clear, apply only to in-plan advice and not to any advice or asset outside the plan or IRA). BICE Condition Contract Requirement Terms Prior to making a recommendation, the Adviser and Financial Institution enter into an enforceable contract with the Retirement Investor that includes all the terms specified below. 1. The Adviser and Financial Institution are fiduciaries under ERISA, the IRC or both; Inadvertent fiduciary problems therefore could not be resolved through the BICE. 2. The Adviser and Financial Institution will comply with Impartial Conduct Standards, i.e., they will provide advice in the Best Interest of the Retirement Investor (discussed below) and will not recommend an Asset if the total compensation to the Adviser, Financial Institution and certain affiliates and related entities would exceed reasonable compensation for the total services provided. 3. The Adviser s and Financial Institution s statements about the Asset, fees, Material Conflicts of Interest (discussed below) and any other matters related to the Retirement Investor s investment decisions will not be misleading. 4. The Adviser and Financial Institution warrant (a) they will comply with all other applicable federal and state law, (b) the Financial Institution has adopted written policies and procedures reasonably designed to mitigate the impact of Material Conflicts of Interest and to ensure that Advisers adhere to Impartial Conduct Standards (discussed below), (c) in formulating the policies and procedures, the Financial Institution identified any Material Conflicts of Interest and adopted
BICE Condition Contract Requirement Terms measures to prevent the Material Conflicts of Interest from causing violations of the Impartial Conduct Standards, (d) neither the Financial Institution nor (to its knowledge) its affiliates engage in HR or compensation practices tending to encourage Advisers to make recommendations not in the Best Interest of the Retirement Investor (although differential compensation that is not counter to the Retirement Investor s Best Interest is allowable). The preamble suggests any of the following compensation structures could satisfy these warranties: (i) differential compensation if the advice is generated by independently certified computer models; (ii) level, assetbased compensation; (iii) level compensation achieved through a fee offset mechanism; (iv) differential compensation supported by neutral factors (e.g., the time and effort required to advise about different types of products); and (v) compensation structures that align with the interests of the Retirement Investor, e.g., bonuses for Best Interest advice. While not included in the text of the proposed exemption, the preamble also recommends, in granular detail, compliance processes and procedures derived from a 2013 FINRA report on conflicts of interest. The preamble also suggests the violation of the warranty about compliance with other applicable laws would not void the exemption unless it rose to a violation of the Best Interest standard or some other condition although it would constitute an actionable breach of contract. 5. The contract must (a) identify and disclose any Material Conflicts of Interest and (b) advise the Retirement Investor of its right to complete information about all fees currently associated with the Assets in which it is invested, and (c) disclose whether the Financial Institution offers proprietary products or receives indirect compensation from third parties and the website described below. 6. The contract may not contain (a) exculpatory provisions disclaiming liability for a violation of contract terms or (b) any waiver or qualification of the Retirement Investor s right to bring or participate in a class action against the Adviser or Financial Institution. The contract may provide for arbitration of individual claims.
BICE Condition Contract Requirement Material Conflict of Interest Transaction Disclosure Annual Disclosure Terms The timing requirement for the contract and the breadth of the recommendation concept may well require the contract to be provided and executed before any substantive discussion of investments, or even before the Retirement Investor has determined to engage the Adviser, which will produce very strange dynamics. The contract would create ERISA standards and a private right of action that previously did not exist under federal law for IRA owners. Because the BICE as proposed would not provide relief from the prohibition against services from a fiduciary or other party-in-interest, advance 408(b)(2) plan-level fee disclosures would be necessary in the ERISA plan context, as applicable, in addition to the multiple disclosures required by the BICE. A Material Conflict of Interest exists when an Adviser or Financial Institution has a conflict of interest that could affect the exercise of its best judgment as a fiduciary in providing advice to the Retirement Investor. This formulation, including the could affect language, would set forth a broad and uncertain standard. Prior to execution of an Asset purchase, the Adviser furnishes a chart of the dollar amount of projected Total Cost to the Retirement Investor (calculated in a specified manner) for one-, five- and 10-year periods (unless the chart for that Asset has been provided in the prior 12 months and Total Cost has not materially changed). Because cost projections are usually predicated on performance projections, it will be necessary to consider whether this aspect of the proposal would require approval from other financial services regulators. Within 45 days after year end, the Adviser or Financial Institution provides a succinct single disclosure for the year of (a) each Asset purchased or sold with the transaction price, (b) the total amount of fees and expenses with respect to each Asset, and (c) the total amount of all direct and indirect compensation received by the Adviser and Financial institution as a result of each Asset. The systems of many retirement advisers do not currently capture all this information.
BICE Condition Webpage Disclosure Range of Investment Options Terms The Financial Institution must maintain a webpage, open to the general public and updated at least quarterly, showing in a machine-readable format (a) the direct and indirect compensation payable to the Adviser, Financial Institution and affiliate for each Asset available to plans, participants and IRAs within the last 365 days and (b) the source of the compensation and its variation among Assets. Financial services companies have traditionally treated this information as proprietary and confidential, and may have legal obligations to do so. From that perspective, this sort of publication raises very different concerns than the specific client-facing disclosures required under 408(b)(2) or PTE 84-24, for example. Either: 1. The Financial Institution must offer, and the Adviser make available, a broad range of investment options enabling the Adviser to make recommendations with respect to all asset classes reasonably necessary to serve the Retirement Investor s Best Interest; or 2. If the Financial Institution limits the available options for any reason, including to just proprietary products or products that provide indirect compensation, (a) the Financial Institution makes a written finding that the limitation on Assets does not prevent the Adviser from providing Best Interest advice or adhering to the Impartial Conduct Standards, (b) any compensation received does not exceed reasonable compensation, (c) before giving Recommendations, the Adviser or Financial Institution notifies the Retirement Investor in writing of the limitations, and (d) the Adviser notifies the Retirement Investor if the Adviser does not recommend a sufficiently broad range of Assets to meet the Retirement Investor s needs. At least for proprietary product providers that are disinclined to offer their competitors products, or for advisers that undertake only a limited rather than a comprehensive role for a plan or IRA the adviser for the fixed-income sleeve of a small defined benefit plan, for example, or the insurance agent who only offers lifetime income products there should be a more certain way to meet this condition. If the Adviser and Financial Institution did not provide advice about an ERISA plan s investment menu and are only providing participant-level advice about the allocation of accounts among designated investment options, this requirement is inapplicable.
BICE Condition Disclosure to DOL Recordkeeping and Access DOL Data Request Best Interest standard Terms Before receiving compensation in reliance on the BICE, the Financial Institution must provide a one-time notification to DOL of its intent to rely on the exemption. The Financial Institution must maintain certain records for six years and provide unconditional access during normal business hours to designated persons, including (a) DOL or IRS and (b) participants or IRA owners (or their representatives). DOL and IRS would have access to trade secrets and privileged commercial or financial information. On request from DOL, the Financial Institution must produce within six months the following data for the preceding six years: For each Asset by quarter, (i) the aggregate shares/units bought, the aggregate purchase price and investor cost of those purchases, the revenue received by the Financial Institution and affiliates, and the identity of each revenue source; (ii) comparable information for sales; and (iii) comparable information for holdings; and At the Retirement Investor level, (i) the identity of the Adviser, (ii) quarterly return information for the Retirement Investor s portfolio, and (iii) external cash flows in and out of the portfolio by date. The DOL reserves the right to publicly disclose this information, aggregated at the Adviser level and without any identifiable financial information regarding Retirement Investor accounts. This aspect of BICE is unprecedented. Advice is in the Best Interest of the Retirement Investor if it meets a prudent investor standard without regard to the financial interest of the Adviser or Financial Institution, certain affiliates or related entities, or any other party. The prudent investor standard is formulated slightly differently than the ERISA 404 prudent expert standard, to which Advisers to ERISA plans would also be subject. The preamble glosses the Best Interest standard as requiring the Adviser to put the Retirement Investor s interest ahead of its own, which at least as an evidentiary matter is very different from the articulation in the proposed exemption. The preamble also suggests a familiar ERISA procedural prudence process to support Best Interest determinations.
Because of it is central to the reproposal, the proposed BICE will no doubt draw substantial attention in the commentary. At a high level: As a principles-based exemption, the BICE is probably the most conditional exemption ever developed by DOL. The system and compliance costs to satisfy the exemption would be considerable, and compliance with at least some conditions could not be assured in advance. For example, the recordkeeping, disclosure and (functionally, under the data request requirement) reporting required at the individual participant/ira owner level would exceed current systems capabilities in many cases. The BICE in form keeps DOL s promise that commission and other current compensation practices would be allowed. It remains to be seen whether that promise has been kept in substance; unless a Financial Institution utilizes a level fee or fee offset structure, compliance uncertainties about compensation that varies by, for example, product type may create unacceptable risks. The BICE materially departs from the statutory structure by, through the contract requirement, extending ERISA prudence and loyalty principles to IRAs and by providing a private right of action for IRA owners which Congress specifically did not do when it created IRAs in ERISA. With respect, while DOL has the authority to determine the conditions for administrative exemptions it grants, this ERISAfication of IRAs strikes us as a stunning rewriting of the statute. In a variety of ways, DOL took pains to create class action and reputational exposure for Advisers and Financial Institutions, apparently intending that risk to incent compliance with the conditions of the BICE. The warranty with respect to compliance with other applicable law may burden the settlement of enforcement investigations by the SEC, FINRA, the OCC, and other federal and state banking, insurance, and securities regulators. Financial Institutions rationally will take into account exposures under the BICE in considering whether to enter into such settlements and on what terms. Also, DOL s notions about the consequences of less substantial violations of other laws may not be binding on a court in the event of private litigation. Finally, it is unclear whether state law claims preempted by ERISA could nonetheless be brought by reason of the contract. DOL also proposed in the BICE conditional relief for (i) the purchase of insurance or annuity products where the insurer is a party-in-interest, and (ii) compensation received after the Applicability Date in connection with Assets previously
purchased, held or sold pursuant to a preexisting arrangement, provided no further advice is provided. Finally, DOL invited comment on the possibility of promulgating a less conditional exemption for advice relating to low-cost, high quality investments. Other Revisions to the Complex of. The reproposal would also add, revise or revoke a number of other prohibited transaction class exemptions (PTE) dealing with investment activities, as follows: Exemption Covered Activity Proposed Changes PTE 75-1, Part II(2) PTE 75-1, Parts III, IV PTE 75-1, Part V New PTE Sales of nonproprietary mutual funds by broker-dealer Underwritings Market Making Extension of credit to a plan/ira in connection with a securities transaction Principal sales in cash of Rule 10b- 10(d)(4) debt securities between plan/ira and fiduciary Revoked, and now covered in PTE 86-128. Incorporates Impartial Conduct Standards from the BICE (without the warranty); serious violations of other applicable law may void the exemption under these standards. Revised to permit investment advice fiduciaries to receive compensation on arm s-length credit extended to avoid a failed securities transaction (other than a failure caused by the fiduciary s action or inaction) if Rule 10b-16 or comparable disclosure is provided in advance. Available for Advisers and Financial Institutions under the BICE, other than insurance companies. Debt security must be, subject to additional conditions, (i) registered, U.S. dollar denominated corporate debt, (ii) an agency debt security under FINRA Rule 6710(l) or (iii) a U.S. Treasury security under FINRA Rule 6710(p). Incorporates written contract and warranty, Impartial Conduct Standards and certain disclosures from the BICE; violation of the other applicable law warranty does not void the exemption unless it rises to a violation of Best Interest or other conditions, but is an actionable breach of contract. Other conditions include pricing that (i) the Adviser and Financial Institution believe is at least as favorable as an agency transaction and (ii) is at least as
Exemption Covered Activity Proposed Changes New PTE Principal sales in cash of Rule 10b- 10(d)(4) debt favorable as two price quotations from unaffiliated parties for a contemporaneous agency transaction. securities between plan/ira and fiduciary If applicable, compliance with ERISA 408(b)(2), including disclosures, would be required. The usual practices of bond trading desks would require serious modification to satisfy the proposed exemption. PTE 77-4 PTE 80-83 PTE 83-1 PTE 84-24 Allocation by discretionary asset management fiduciary to proprietary mutual funds Use of proceeds from sale of securities to reduce or retire indebtedness Mortgage pool investment trusts Commissioned sales of insurance/annuity products and proprietary mutual funds Incorporates Impartial Conduct Standards from the BICE (without the warranty); serious violations of other applicable law may void the exemption under these standards. This PTE has always required an explanation to an independent fiduciary as to why the proprietary investment is appropriate. Incorporates Impartial Conduct Standards from the BICE (without the warranty); serious violations of other applicable law may void the exemption under these standards. Revoked for IRAs, other than with respect to insurance or annuity products that are not securities under federal law. Incorporates Impartial Conduct Standards from the BICE (without the warranty); serious violations of other applicable law may void the exemption under these standards. Limits permissible compensation for insurance and annuities to initial, renewal and trail commissions paid by the insurance company, and would not include other indirect compensation including from funds underlying variable contracts.
Exemption Covered Activity Proposed Changes PTE 84-24 Commissioned sales of insurance/annuity products and proprietary mutual funds Limits permissible compensation for mutual funds to a commission or sales load paid by the plan or mutual fund for effecting or executing the transaction, and would not include 12b-1 fees (even under a distribution plan), revenue sharing payment, administrative or marketing fee. Relief continues to be provided for product-level revenues. PTE 86-128 Commissions for the execution of securities transactions by a fiduciary; agency cross-transactions Revoked for IRAs. Clarifies that 408(b)(2) relief and disclosures may be required in addition to PTE 86-128 compliance. Revised to provide that relief is available only for compensation to the fiduciary or a related entity in the form of a brokerage commission or sales load paid by the plan/ira for executing the transaction; no relief for any form of indirect compensation. Adds relief for principal transactions in nonproprietary mutual funds; only compensation permitted is the commission (sales load) disclosed by the mutual fund; retains conditions from PTE 75-1 and adds the PTE 86-126 antichurning requirement. Incorporates Impartial Conduct Standards from the BICE (without the warranty); serious violations of other applicable law may void the exemption under these standards. Provides clarifications with respect to the recapture of profits by trustees. The fiduciary rather than the plan must satisfy recordkeeping requirements. With respect to these revisions, and in addition to the observations above regarding the BICE as applicable: DOL did not keep its promise to preserve existing commission and other compensation practices. Although the status of certain indirect compensation practices under existing exemptions was not clear, DOL would specifically disallow such compensation under PTE 84-24 and, as to principal transactions in nonproprietary mutual funds, PTE 86-128. Given (i) the prevalence of these