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April 21, 2016
ERISA & Investment
THE DEPARTMENT OF
What You Need to Know!
year after being proposed and after public hearings and thousands of
comment letters, the U.S. Department of Labor ("DOL") has
finalized its regulation redefining and broadening the meaning of
fiduciary investment advice rendered to retirement plans and IRAs.
The regulatory package also includes new and revised class exemptions
necessitated by the scope of the revised fiduciary definition. The
DOL considers these changes necessary to make the fiduciary concept
relevant to changes in the retirement plan marketplace over the last
40 years. While retaining the overall structure of the proposal, the
final package includes changes addressing a number of concerns raised
final regulation is widely viewed as the most comprehensive revision
of rules affecting the retirement industry since the enactment of
ERISA and will affect substantially all advisers, even if they do not
have plan clients, because of the regulation's reach to IRA assets.
Advisers who have nothing to do with plan assets, but who have high
net worth clients with IRA money, will be profoundly impacted by this
change. The new rule will also impose significant compliance costs on
broker-dealers and insurance agencies that may need to qualify under
the rule's so-called BIC exemption. These are only a few of the
reasons many people are referring to the finalized regulation as a
discussion will highlight the primary features of the final rule,
including its sweeping expansion of the fiduciary concept and the
detailed requirements of the numerous exemptions and exclusions that
will need to be complied with in order to continue providing
investment advice to retirement client.
FINAL DEFINITION OF THE TERM FIDUCIARY
Fiduciary Definition. Like the
proposal, the final regulation significantly enlarges the definition
of fiduciary advice. The finalized definition of fiduciary investment
advice covers recommendations relating to the holding, acquisition
and sale of securities or other property and, as under the proposal,
recommendations to take rollovers from a plan, as well as investment
recommendations for rollover assets. For now, the final regulation
eliminates the proposal's inclusion of financial valuations,
appraisals and fairness opinions as covered fiduciary
recommendations, but the DOL has indicated it is developing an
amendment that will cover ESOP appraisals.
final regulation also follows the proposal by covering
recommendations relating to the investment management of plan or IRA
assets, including rollover assets, so that recommending an investment
manager would have fiduciary implications. The final rule clarifies
that investment management recommendations can also include
communications relating to investment policies or strategies,
portfolio composition and the selection of investment account
arrangements, such as the choice of a brokerage or advisory account.
response to commentators, the final rule provides that advice as to
the purchase of health, disability, term life insurance and similar
life insurance policies without an investment component will not
constitute fiduciary investment advice. However, the preamble to the
final regulation makes a point of noting that if an adviser
effectively has discretionary control over the decision to purchase
such insurance, the adviser could potentially come under the
management or administration branches of the functional fiduciary
definition, even if the adviser was not deemed to have provided
Conditions for Fiduciary Advice.
Under the old definition of fiduciary advice, there needed to be a
mutual understanding between the parties that the advice would serve
as a primary basis for plan investment decisions. The proposal
eliminated these requirements, and the final version of the
definition maintains this position, by providing that there only
needs to be an understanding that a recommendation is based on the
particular investment needs of the retirement investor receiving it
or directed to a specific recipient regarding the advisability of a
particular investment or management decision with respect to plan or
IRA assets. The point of this language, as revised under the final
rule, is to distinguish specific investment representations to an
individual from recommendations to the general public. The final rule
contains a new provision to make clear that such general communications
are not fiduciary advice.
the final rule, the threshold question in determining if fiduciary
advice has been rendered is whether a "recommendation" has
occurred. Following the FINRA definition of the term, the final rule
clarifies that a "recommendation" means a communication
that, based on its content, context and presentation, would be
reasonably viewed as a suggestion that the advice recipient engage in
or refrain from taking a particular course of action. The DOL views a
number of the proposed rule's so-called carve-outs from the fiduciary
advice definition as being outside the scope of a recommendation.
Accordingly, the carve-outs for platform providers and investment
education are now treated as exceptions to the definition of a
recommendation, so that complying with the terms of one of these
exceptions will avoid fiduciary status.
fiduciary advice rule consists of a five-part test, one component of
which is that investment advice recommendations be furnished on a
regular basis. As under its proposed version, the final regulation
eliminates this requirement, so that a one-time recommendation
directed to a plan or IRA (e.g., one-time advice on a large,
complex plan investment or a rollover recommendation to an IRA owner)
may be treated as fiduciary advice. Nevertheless, the preamble to the
final rule indicates that, in certain circumstances, the BIC
exemption contract, discussed below, may be permitted to clarify that
the adviser's services will be limited to one-time advice so that the
adviser will not have any ongoing monitoring responsibilities with
respect to a recommended investment after its acquisition. This may
be limited, however, to investments that can be prudently recommended
in the first place without provision for a monitoring mechanism.
on Certain Adviser Referrals. An
unanswered question under the proposed regulation was whether certain
incidental communications could amount to fiduciary investment
advice. For example, some commentators thought a literal reading of
the proposal could result in a third party administrator, call center
or other service provider becoming an inadvertent fiduciary if it
responded to a question from a retirement plan client about available
investment advisers or managers, even though the respondent's fee was
not related to or contingent on the response. One of ERISA's
statutory requirements is that fiduciary status applies to a service
provider only if it receives compensation in connection with its
referral or recommendation.
finalized regulation deals with incidental advice by redefining the
requisite fee so there would be fiduciary advice when an amount is
explicitly received for particular advice, if a fee is paid that
would not have been paid but for the advice, or if eligibility for or
the amount of the fee is based in whole or in part on the advice.
Accordingly, if a plan service provider can show that a referral or
recommendation with respect to investment advisory services was
purely an extra for which no fee was received, the recommendation
should be non-fiduciary in nature. On the other hand, if the
recommendation is deemed to be a part of its regular services, for
which it earns a fee, the helpful service provider could potentially
be viewed as a fiduciary adviser.
EXCEPTIONS FROM FIDUCIARY DEFINITION
Provider Exception. The final
rule retains an exception enabling third party administrators and
recordkeepers marketing or offering an investment platform to
retirement investors to maintain their non-fiduciary status. This
relief is conditioned on the provision of written disclosure that, in
making the platform available, the provider is not purporting to give
impartial investment advice or to render advice in a fiduciary
capacity. To qualify under this exception, the platform provider's
assistance in selecting and monitoring investments on the platform
would need to be performed without regard to the individualized needs
of the particular plan or its participants. However, the preamble to
the final rule allows some level of customization (referred to as
"segmentation") so that winnowed bundles of investment
options may be offered to different general types of plans
differentiated by objective criteria (e.g., small, medium and
large plans). Nevertheless, the preamble warns that, if a platform
provider communicates that a particular platform is
"appropriate" for a given plan, the communication will
likely constitute a fiduciary recommendation.
communications and activities related to providing an investment
platform that are considered exempt recommendations under the final
rule include identifying investment alternatives meeting objective
criteria specified by a plan fiduciary, such as investment funds of a
certain size or with expense ratios below a particular threshold. A
provider can also respond to requests for identification of
investment alternatives with a particular type of asset or credit quality.
The exception for these activities is conditioned on the provider's
written disclosure of any financial interest it may have in the
alternative investments and the precise nature of this interest. In
addition, the provider would be permitted to furnish, on an exempt
basis, objective financial data for investment alternatives, as well
as independent benchmarks.
final regulation also permits responding to an RFP or similar plan
solicitation by identifying a limited sample set of investment alternatives
based on the size of the employer plan or the current investment
alternatives designated under the plan, provided the response is in
writing and discloses the provider's financial interest in these
investments, if any.
platform provider exception will not apply to communications made to
plan participants or IRAs. The rationale for the DOL's decision in
this regard is that these communications are typically not subject to
review by an independent plan fiduciary interacting with the platform
Investment Services. The
preamble to the final regulation also addresses the status of related
services frequently bundled with investment platforms, such as
elective managed account programs, qualified default investment
alternatives, investment adviser/ manager options, and non-affiliated
RIA services. The preamble to the final rule states the DOL's belief
that investment recommendations within the meaning of the fiduciary
rule would not include "much" of the information a platform
provider would convey to plan clients in explaining these
features. However, the regulation offers no practical
guidance with respect to identifying the type of information that
might have fiduciary implications. The preamble indicates the final
regulation did not make any changes reflecting comments on this
Education Exception. The final
regulation contains a liberalized version of the proposed
regulation's carve-out for investment education. Consistent with DOL
Interpretive Bulletin 96-1, there are four categories of
investment-related guidance that service providers may render to
retirement investors without triggering fiduciary status: (i) plan
information, (ii) general financial, investment and retirement
information, (iii) asset allocation models, and (iv) interactive
investment materials. Unlike the interpretive bulletin, the proposed
and final regulations cover information furnished to plan sponsors,
plan fiduciaries and IRA owners, as well as participants and
rule prohibited educational materials from referring to specific
investment alternatives, based on the fear that this could encourage
conflicts of interest. However, the final rule lifts this restriction
with respect to plans, but not IRAs. Thus, plan investment
alternatives can be used in asset allocation models if: (i) the
investment's inclusion on the investment platform is subject to
oversight by a plan fiduciary independent from the person who
developed or markets the investment alternative or the model, (ii)
the model identifies all other investments available under the plan
having similar risk and return characteristics to the investment
referred to in the model, and (iii) the model is accompanied by a
statement indicating that these other investments have similar
characteristics to those included in the model and identifying where
information on them can be obtained. Similar restrictions apply where
plan investment alternatives are referred to in interactive
Carve-Out. The final rule
liberalizes the counterparty exception from the definition of
fiduciary advice under which a person acting as a counterparty in an
arm's-length transaction (e.g., a purchase, sale or loan
between the plan and the counterparty) may provide advice without
being deemed to be an investment advice fiduciary if certain
conditions are met. Under the proposal, the plan sponsor or another
plan fiduciary independent of the counterparty would have been
required to provide a written representation that the plan had at
least 100 participants, that it had sufficient expertise to evaluate
the transaction, and that it would not rely on the counterparty to
act as a fiduciary. This written representation was not required if
the plan fiduciary had at least $100 million of assets under
non-institutional advisers, the final rule eliminates the qualifying
condition of 100 participants and reduces the $100 million threshold
for applicability of the seller's exception to $50 million. The $50 million
threshold is based on the FINRA definition of an institutional
account and indicates the exemption's underlying rationale that a
financially sophisticated plan fiduciary can correctly evaluate sales
communications made by a counterparty without the need to classify it
as fiduciary advice. Consistent with this reasoning, the final rule
extends the counterparty exception to regulated banks, insurance
companies, registered investment advisers and registered
broker-dealers with no minimum size requirement.
the essence of this exemption is the existence of a non-advisory
relationship, the counterparty may not receive a fee from the plan,
plan sponsor, a plan participant or an IRA owner. Therefore, unlike
many of the exceptions to the fiduciary rule, the seller's exception
does not sanction commissions or variable compensation. A
counterparty could, however, charge a fee for rendering non-fiduciary
services unrelated to a sale covered by the seller's exception.
for Advice from Employees of Plan Sponsor. As under the proposed rule, advice from an
employee to the plan sponsor will not be fiduciary advice, provided
the employee does not get paid additional compensation for such
advice, and certain other conditions are met. A corresponding
exception from the fiduciary rule with similar conditions applies to
advice from a human resources employee to plan participants.
carryover from the proposed rule relates to advice from a swap dealer
to an ERISA plan. This advice will not be fiduciary advice if the
plan client provides a written representation that it understands the
swap dealer is not providing impartial advice as a fiduciary and
certain other conditions are met.
for Self-Marketing. An adviser
may market and tout the services of itself or an affiliate without
being viewed as a fiduciary adviser when making "hire me"
recommendations. But if any investment recommendations are included
with the "hire me" recommendation (e.g., whether to
roll assets into an IRA or how to invest assets if rolled over), they
will be viewed separately as fiduciary advice.
BEST INTEREST CONTRACT EXEMPTION
Interest Contract ("BIC") Exemption - General. As a practical necessity, the broad scope of
the new fiduciary definition requires exemptive relief to avoid
subjecting all plan advisers to undue restrictions on traditional
business models and compensation arrangements. The BIC exemption is
the primary vehicle for such relief with respect to retail retirement
clients. Qualifying under the terms of this exemption, which at a
minimum requires acknowledging fiduciary status, allows an adviser
classified as a fiduciary to earn all types of variable compensation
in connection with advice provided to plan and IRA clients.
exemption, however, does not cover variable compensation that arises
as a result of discretionary advice. Nevertheless, the DOL has
clarified that the exemption can still provide relief for advisers
who are in the business of providing discretionary advice, as long as
the discretionary advice itself does not generate variable
compensation. For example, a fiduciary adviser may make a
recommendation for a participant to roll over his or her plan account
to an IRA, where the fiduciary adviser would then provide investment
management services for the rollover IRA for a fee. As long as
the fiduciary adviser does not have discretion over the rollover
decision, the BIC exemption (specifically, the "Level Fee
Fiduciary" rule, as discussed below), would be available to
provide relief for the rollover advice. As illustrated in this
example, relief under the BIC exemption is available, even though the
adviser is in the business of providing discretionary investment
the proposed fiduciary rule, the relief provided by the BIC exemption
was restricted to certain listed investments. The finalized BIC
exemption will cover transactions involving all types of securities
and property (including, but not limited to, non-traded REITs,
options, security futures and private equity).
following retirement investor clients are covered under the BIC
● any participant
in an ERISA or other tax-qualified retirement plan; or
"retail" plan client with assets of less than $50 million
(including but not limited to DC plans with participant-directed
Contract Requirement under BIC Exemption. The core requirement for the BIC exemption
under the proposed rule was a written contract between a fiduciary
adviser and a retirement client that needed to be executed before
advice could be rendered. The contract had to provide that the advice
would be in the best interest of the retirement investor and
consistent with ERISA's prudent man standard of care. The agreement
also had to provide that the adviser was limited to reasonable
compensation and warrant the adviser would make certain disclosures,
avoid misleading statements and adopt compliance policies mitigating
conflicts of interest.
final rule relaxes many of the requirements necessary to qualify for
the BIC exemption. For example, with respect to ERISA plans, it
eliminates the contract requirement, the source of much anxiety and
potential paperwork, although advisers wishing to qualify for the
exemption must still provide written acknowledgement of their
fiduciary status no later than the time the recommended transaction
is executed. Operationally, advice to an ERISA plan must meet the
"Best Interest" standard, the recommended transaction must
not cause amounts to be earned in excess of reasonable compensation
and the adviser must avoid statements that are materially misleading.
Further, the adviser will have to adopt the same compliance policies
and procedures regarding conflicts that would have been required if
BIC conditions applied in full. The policies must be designed to
prevent violations of the impartial conduct standard. Where the
written contract requirement does not apply, as would be the case
with ERISA plans, there will be no new private right of action for
breach of contract, although, in accordance with current law, an
investment advice fiduciary would still be subject to lawsuits for
breaches of fiduciary duty.
written contract requirement remains in place for IRAs and non-ERISA
plans. IRA clients will now have written BIC contractual provisions
that they can enforce. Similar to the FINRA rule and as
provided under the proposed rule, they will have a right to
participate in class actions. Mandatory arbitration is still permitted,
but the final rule clarifies that arbitration provisions with an
unreasonable forum are not. Also, the BIC contract can require
the client to waive the right to punitive damages and rescission
awards if permitted under applicable law. As under the proposed rule,
however, the contract may not disclaim or limit liability for an
adviser's violation of its terms.
advice to non-ERISA plans and IRA owners that would be subject to the
contract requirement, the timing of the contract can be synchronized
with the paperwork opening the account, although the contract must
cover any advice rendered before its execution. The contract may be
signed electronically. Existing clients can agree to the new
contractual provisions by negative consent. Moreover, the final rule
reduces the contract requirement to a bilateral agreement between a
retirement investor and the advisory firm, thereby eliminating the
requirement that personnel actually rendering the advice be parties
to the contract.
specialized requirements for the BIC contract, as further described
below, illustrate that the BIC exemption has splintered into several
different exemptions applicable to various types of fiduciaries, each
with its own rules.
of the BIC Contract. Where a
full-blown BIC contract is required to be in writing for IRAs and
non-ERISA plans, the following provisions must be included in its
of Fiduciary Status.
Conduct Standard. The contract must state that: the firm and its
advisers will provide investment advice that is in the "Best
Interest" (as defined below) of the retirement investor, the
recommended transaction will not result in unreasonable compensation
for the firm or advisers, and statements relevant to the transaction
(e.g., concerning compensation or conflicts of interest) will not be
Relating to Compliance Policies.
(i) The firm's
policies are reasonably designed to ensure its advisers will meet the
Impartial Conduct Standards.
(ii) All conflicts are
identified and documented in the formulation of the policies.
The policies are designed to prevent violations of the Impartial
A responsible person or persons ("BIC Officer") will be
designated for monitoring compliance and addressing conflicts of
(v) Individual advisers may
earn differential compensation only if the policies are reasonably
designed to avoid a misalignment of client's interests with adviser's
(vi) The DOL has indicated that
differential compensation is only permitted to the extent it reflects
"neutral factors" relating to differences in services, such
as the time or expertise needed to sell particular categories of
investments (such as variable annuities). An individual adviser may
not receive a higher payout from a particular investment, simply
because the product generates higher commission-based compensation
for the firm.
Client Disclosures. The
following disclosures must appear in the BIC contract itself or in a
separate single written disclosure statement provided to the
retirement investor along with the contract.
(i) A description of
the Best Interest standard of care owed by the individual adviser and
firm. This new fiduciary standard, which appears to blend ERISA's
prudent man standard of care and the duty of loyalty, requires an
adviser to provide investment 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 like character
and with like aims based on the investment objectives, risk
tolerance, financial circumstances, and needs of the Retirement
Investor, without regard to the financial or other interests of the Adviser...
(ii) Information regarding
services to be provided.
(iii) An explanation of how the
client will pay for services (e.g., direct or third party payments,
commissions or fees, etc.).
(iv) Disclosure of all conflicts.
(v) General information on
fees and charges, including third party payments from investments
must be disclosed.
(vi) Information with respect to
the client's right to obtain a description of compliance policies
within 30 days (or prior to the transaction if an upfront request is
(vii) Information that the client has a
right to obtain specific compensation information (dollar amount or
formula) for any recommended transaction within 30 days (or prior to
the transaction if an upfront request is made).
(viii) Disclosure that model BIC
contracts and compliance policies are posted on a website and
provision of a link.
(ix) Disclosure of any
proprietary products or investments generating third-party payments,
and the extent to which recommendations are limited to such products
(x) Provision of contact
information for the firm's representative who can address concerns
relating to services.
(xi) If applicable, an
explanation of how regulatory information may be available on FINRA's
BrokerCheck or IARD.
(xii) A description of if (and how
often) the client's investment will be monitored for recommended
contractual provisions, however, may not be included in the BIC
contract. These include:
(i) Limits on
the liability of the individual adviser or firm for contractual
(ii) Limitation of the
client's right to participate in class action lawsuits.
(iii) Mandatory arbitration
clauses with an unreasonable venue.
as previously discussed, waivers of the right to receive punitive
damages or rescission awards are permitted.
Exemption - ERISA Plans. As
noted above, there is no need to enter a written BIC contract if a
plan client is subject to ERISA. However, a statement of Fiduciary
Status and a single written document with certain disclosures must be
provided to the client before or when a recommended transaction is executed.
The required Fiduciary Status document must state that the individual
adviser and the firm will be acting as fiduciaries with respect to
the advice. The client disclosures mirror the New Client Disclosures
described above that would otherwise be incorporated in the BIC
the firm and adviser must comply with the Impartial Conduct Standard
of the BIC contract. In addition, the firm will need to prepare an
internal document reflecting the same compliance policies and
procedures regarding the Impartial Conduct Standard and conflicts of
interest that would have been required if the BIC conditions applied
in full. Any contract that the parties do enter into cannot contain
the contractual provisions that are prohibited from being included in
the BIC contract, such as limits on liability or the right to
participate in class actions.
Exemption - Simplified Requirements for Level-Fee Fiduciaries. Another softening of the BIC conditions applies
to advisers whose compensation is a level fee (i.e., a fixed
percentage of assets under management or a set fee that does not
vary). As under the relaxed requirements for ERISA plans, this group
will also be entitled to rely on the BIC exemption without entering a
contract if the advisory firm furnishes a written statement no later
than execution of the transaction that the firm and the individual
adviser will be acting as a fiduciary with respect to the advice. The
firm and the adviser must also comply in practice with the Impartial
Conduct Standard, described above. Finally, in the context of a
rollover transaction from a plan to an IRA, the adviser will need to
document specific reasons why the rollover recommendation was
considered to be in the Best Interest of the client. This should include
a description of the client's alternatives, as well as differences in
fees, services and available investments. Where the
recommended transaction is a rollover from one IRA to another or a
switch from a commission-based account to a level-fee arrangement,
the reasons for the change must be documented with consideration of
the services that will be provided for the fee.
connection with rollover advice, it should be noted that all rollover
recommendations will be viewed as fiduciary advice, even if they do
not include investment recommendations. Further, level-fee
fiduciaries offering rollover advice will need to comply with the BIC
exemption even if there has been no pre-existing relationship with
the plan. They will also need to comply with the BIC exemption if
they are already providing plan-level services for a fee, to the
extent that they will earn a higher fee rate on rollover IRA assets.
However, it appears that qualifying for the exemption will not be
necessary when the rate of rollover IRA-related compensation is no
greater than the adviser's existing rate of plan-related
compensation, since there is no financial gain to the adviser as a
result of the rollover.
Disclosures. For BIC exemption
purposes, plan and IRA clients must receive the following disclosures
before or when each recommended transaction is executed:
A description the Best Interest standard of care owed by the
individual adviser and firm;
description of all conflicts of interest;
regarding the client's right to obtain a description of compliance
policies within 30 days (or prior to the transaction if an upfront
request is made);
regarding the client's right to obtain specific compensation
information (dollar amount or formula) for any recommended
transaction within 30 days (or prior to the transaction if an upfront
request is made); and
that model BIC contracts and compliance policies are posted on a
website and the availability of a link.
these disclosures are required for each investment recommendation,
they do not need to be renewed for subsequent recommendations for the
same investment product made within one year unless there are
material changes. In addition, they do not need to be provided if the
adviser is a level-fee fiduciary or with respect to certain advice
made under a bank networking arrangement.
firms seeking to qualify under the BIC exemption must also post the
following information on the firm's public website, updating it on a
description of the firm's business model and its associated
schedule of typical fees and charges;
BIC contracts (for non-ERISA plans and IRAs) or model BIC exemption
disclosures (for ERISA plans), which must be reviewed on a quarterly
basis and updated within 30 days;
description of firm compliance policies;
list of all product sponsors that make third party payments, and an
explanation of such arrangements;
of compensation and incentive arrangements for individual advisers,
and provision of a "full and fair description" of payout
grids (without referring to a specific adviser's payout); and
request, provision of a copy of the firm's compliance policies.
disclosures may use dollar amounts, formulae or reasonable ranges of
value to describe the firm's arrangements with product sponsors and
individual advisers. Such disclosures must enable clients to make an
informed judgment about the significance of the firm's compensation
practices and conflicts. Further, they may cross-reference and link
to other public disclosures, such as the ADV brochure. The Web
Disclosures are not required for level-fee fiduciaries or bank
final rule also provides relief by simplifying certain disclosures
required as a condition of BIC relief, such as eliminating the need to
make performance projections.
BIC Changes - Proprietary Products.
Other provisions clarify how the BIC exemption applies to advice
rendered with respect to proprietary products which otherwise might
be seen as impeding the best interest of the retirement investor.
Thus, if a firm limits the individual adviser's recommendations to
proprietary products or investment products that generate third party
payments, the following additional requirements will apply:
Statement for Client. Before or when the recommended transaction
is executed, the client must receive a statement that explains how
the recommendations are limited to such investment products.
Documentation. The firm must document its limitations on the
universe of recommended investments, its related conflicts, and any
services it will provide to product sponsors for third party
payments. It must conclude that any related compensation is
reasonable and any conflicts will not cause imprudent advice, and it
must document the basis for its conclusions.
Recordkeeping and Reporting and Compliance. The advisory firm must make a one-time filing
to notify the DOL of its intention to rely on the BIC exemption. In
addition, the firm must maintain all relevant records for 6 years.
Such records must be made available to plan and IRA clients, but a
client may not examine records of other clients. If the firm refuses
a request for any records, it must provide a written notice with
reasons for its refusal within 30 days. Finally, the firm must
designate a BIC officer to monitor compliance with the Impartial
Conduct Standards and address conflicts of interest.
REVISED PTE 84-24 FOR INSURANCE AND MUTUAL FUNDS
Transaction Exemption 84-24. PTE
84-24 has traditionally permitted fiduciary investment advisers to
receive commissions and certain other forms of variable compensation
in connection with the purchase and sale of insurance products and
mutual fund shares by plans and IRAs. Going forward, this exemption
will be revised so that the adviser's acting in the best interest of
a plan, participant or IRA will be a condition for receiving
commissions on these products, similar to that which would be
required under the BIC exemption, except that it will not be
necessary for the adviser to enter a written agreement with the plan
or IRA or adopt formal policies and procedures to mitigate conflicts
should be noted that, with respect to insurance products, PTE 84-24
only applies to commissions; it does not permit the receipt of
sales-based or asset-based revenue sharing payments, administrative
fees or marketing payments from insurance companies. In the case of
mutual funds, the exemption covers commissions and sales loads, but does
not apply to the receipt of 12b-1 fees, revenue sharing payments,
administrative fees or marketing fees.
its proposed revision, PTE 84-24 would not have covered variable
annuities or mutual fund shares sold to IRAs, so that relief from
ERISA's prohibited transaction rules with respect to variable
compensation involving these transactions would need to be sought
under the more stringent BIC exemption. The final revision of PTE
84-24 also makes the exemption inapplicable to fixed index annuities
which, like variable annuities, tie returns to an investment index
and fail to guarantee a minimum interest rate. Thus, for transactions
involving IRAs, the 84-24 exemption will only apply to fixed rate
annuity contracts and life insurance policies.
exemption and PTE 84-24 differ not only with respect to the products
they cover, but also as to the plans to which these products are
sold. On one hand, the product range under PTE 84-24 is significantly
limited compared to the BIC exemption. In contrast to the BIC
exemption, however, PTE 84-24 is not restricted to transactions with
plans having less than $50 million of assets that are not represented
by an independent institutional fiduciary. This means that advisers
operating under PTE 84-24 can potentially receive commissions on
insurance, annuity products and mutual funds sold to these large
plans, as well as to smaller plans.
to Qualify under PTE 84-24. As
under the BIC exemption, compensation received pursuant to a
transaction covered by PTE 84-24 must be reasonable, and an adviser
will need to disclose material conflicts of interest that could affect
the exercise of its best judgment as a fiduciary in rendering advice.
In addition, the BIC exemption and PTE 84-24 share the same impartial
conduct standard, and the terms of sales transactions under both
exemptions must meet an arm's-length standard. Relevant statements
made by the individual adviser and firm must not be materially
a sale under PTE 84-24, certain details regarding the transaction
will need to be disclosed to the client, including:
Whether the adviser's ability to recommend annuity contracts is
limited by any agreement with the insurer or, if they are affiliates,
the nature of the limitation and relationship must be disclosed;
The individual adviser's commission must be expressed as a flat
dollar figure to the extent feasible. Otherwise, it must be expressed
as a percentage of the premiums for the first year and renewal years.
The net commission for the individual adviser and the override
payable to the firm (which is the remaining portion of gross dealer
concession) must be separately disclosed; and
Any charges or penalties (such as surrender charges) that may be
imposed in connection with the purchase, holding or sale of the
annuity contract must be disclosed.
these disclosures, a plan fiduciary or IRA owner must acknowledge in
writing that it has received the disclosures and that it is approving
the annuity sale on behalf of the plan or IRA. In the case of
additional purchases through ongoing deposits under the same
contract, new transaction disclosures must be provided annually.
Similar disclosures and acknowledgments must be made with respect to
sales of mutual fund shares, both at the time of the sales
transaction and annually.
qualify under PTE 84-24, the selling firm (e.g., the insurance
company or principal underwriter of the mutual fund) must maintain
all relevant records for six years. As in the case of the BIC
exemption, these records must be made available to plan or IRA
clients, as well as regulators at the DOL and IRS, but a client may
not examine records of other clients. If the firm refuses a request
for any records, it must provide a written notice with reasons for
its refusal within 30 days.
COVERED PLANS AND EFFECTIVE
Subject to the Fiduciary Rule.
The new fiduciary regime covers ERISA plans that are maintained by
private employers as well as the tax-qualified arrangements described
in Section 4975 of the Internal Revenue Code, which include sole proprietor
plans, such as solo 401(k) plans, IRAs, Archer Medical Savings
Accounts, HSAs and Coverdell education savings accounts. 529
plans are not subject to ERISA and they are not listed in Section
4975, so they are excluded from coverage.
plans are excluded from ERISA and the new fiduciary rule.
Funded 457 plans (with plan assets) by their nature are most
typically governmental plans, so they would be excluded.
accounts can be divided into three groups: (1) non-ERISA 403(b)
accounts maintained by an individual, and not an employer, (2) ERISA
403(b) plans maintained by a private employer, and (3) non-ERISA
403(b) plans maintained by a governmental entity, such as a public
school. The DOL has made it clear that categories (1) and (3)
are not subject to ERISA or the new fiduciary rule.
Effective Dates. The effective
date of the new rule is 60 days after its formal publication on April
8, 2016. Although this means that the fiduciary regulation will take
effect on June 7, 2016, its applicability will be delayed until April
10, 2017 which is somewhat longer than the eight months lead time the
DOL originally signaled. Moreover, the need to comply with many of
the conditions necessary to qualify for various exemptions under the
new prohibited transaction exemption guidance will not apply until
January 1, 2018.
with certain BIC requirements will be required during the transition
period from April 10, 2017 through December 31, 2017. Prior to
execution of a recommended transaction during this period, financial
institutions will need to provide (electronically or by mail) written
notice acknowledging the adviser's fiduciary status, promising
compliance with the BIC exemption's impartial conduct standards and
disclosing any material conflicts of interest. The notice will also
need to disclose whether proprietary products or investments
generating third party payments are being recommended and the
limitations this places on the universe of investment
recommendations. Further, the firm will need to designate a BIC
officer to monitor compliance and comply with BIC exemption
recordkeeping requirements by the start of the transition period.
the transition period, financial institutions and advisers will be
required to meet all the requirements for the BIC exemption, such as
preparation of contracts, where required, and implementation of
policies and procedures mitigating conflicts. For example, negative
consent to the amendment of an investment advisory arrangement that
qualifies as a BIC contract should be in effect by this date.
for Pre-Existing Transactions. An individual adviser and firm may
continue to receive variable compensation with respect to investment
products acquired by plan or IRA clients prior to April 10, 2017 (or
a systematic purchase program established prior to such date), if the
following requirements are met:
The compensation is received under an arrangement that was entered
into prior to April 10, 2017 and that has not expired or come up for
client's initial acquisition of the investment product did not
trigger a non-exempt prohibited transaction;
compensation is not related to a client's investment of additional
amounts under the previously acquired investment product (such as
additional deposits under an annuity) unless the purchases are made
under an arrangement established before April 10, 2017;
compensation is reasonable; and
advice provided after April 10, 2017 (such as hold recommendations)
with respect to the investment product is in accordance with the Best
Interest fiduciary standard.
have arisen as to what this rule will mean for separately managed
account ("SMA") program sponsors who receive variable
compensation from SMA managers they recommend (or advisers select)
within a wrap program. Unfortunately, the DOL did not clarify how its
new rule would apply to these retail managed account programs.
Some have assumed that if a plan or IRA client pays a level fee, such
as an asset-based program fee, there is no prohibited transaction
issue under ERISA, but this assumption may not be correct for many
prohibited transaction rules are fundamentally concerned with whether
an adviser has an improper financial incentive to steer a retirement
investor client to a particular investment solution. If advisers have
an incentive to steer clients to a particular SMA manager, because
the individual adviser or the firm can earn a higher level of net
compensation, a prohibited transaction may be triggered. Of
course, the DOL's Best Interest Contract exemption will allow
advisers to earn this type of variable compensation, but advisers
would need to modify their managed account programs to conform with
the exemption's requirements. Many firms may not realize that
if they want to continue advising their IRA and plan clients for a
fee, significant changes may need to be made to their managed account
programs. Fortunately, the DOL has simplified many of the
conditions necessary to qualify for the BIC exemption.
manager fees or model fees are charged on top of the investment
advisory program fee, the question becomes whether the program fee
constitutes variable compensation. In this situation, a program
sponsor might be paid 1% while the model managers may be paid
separate fees that vary by manager. Assuming pricing is transparent
and the adviser earns the same net compensation regardless of which
SMA manager is selected, the adviser has level compensation and there
is no prohibited transaction. The retirement client will pay an
all-in-fee that varies with whichever SMA manager is
recommended. If a more expensive SMA manager is recommended by
the adviser, this gross fee will be higher for the client. However,
the adviser will not have an improper financial incentive to
recommend one SMA manager over another, since the adviser's net
compensation will not vary with the recommendation.
other hand, revenue sharing payments made to program sponsors by SMA
managers could be problematic, since they are viewed as third party
payments and a fiduciary adviser is not permitted to benefit
financially from any third party payments received in connection with
its advice, because of the conflict this entails. However, if the
program sponsor complies with the requirements of the BIC exemption,
it would be permitted to receive revenue sharing from SMA managers or
rule will effectively require retail managed account providers to
change their advisory programs either by levelizing their net
compensation, or operating their advisory programs in compliance with
the BIC exemption. Given the broad spectrum of SMA managers
with varying investment strategies, it would be virtually impossible
to standardize their compensation so that every SMA manager is paid
the same amount. As a result, standardization of compensation paid to
or received from managers is unlikely. Even if retail managed
account providers opt to rely on the BIC exemption rather than levelizing
their compensation, they will be required to mitigate their financial
conflicts. This, in turn, will pressure them to increase fee
transparency so that the SMA manager's fee is separately disclosed
and charged on top of the program fee.
the question of whether model managers that do not actively implement
their strategies could become an ERISA fiduciary under the final
investment advice fiduciary rule remains unanswered. In many
instances, the model provider will provide its advice to the program
sponsor, without even knowing the identify of any end investors.
However, a model provider potentially may be viewed as a fiduciary to
the extent that it is deemed to be providing advice
"indirectly" to retirement clients through an adviser.
The jury is still out, but if the DOL ultimately decides to adopt an
expansive interpretation of the final rule, model providers could
potentially be viewed as fiduciaries.
Standard. The DOL's ultimate
goal is to impose a universal "Best Interest" fiduciary
standard on all types of advisers to plan sponsors, participants and
IRA owners. There is a certain irony to this endeavor, since if it is
successful, there will be a new regime that effectively creates two
classes of fiduciary advisers, those earning variable compensation
and those that do not.
on Plan Sponsor. Plan sponsors
now must understand how their providers are affected by the new
rules, lest their compensation be a prohibited transaction for which
the plan sponsor could be jointly liable. Sponsors need to reach out
to their vendors to inquire whether and how the plan's fee structure
and amount might be affected as well as their contractual
relationship. This, in turn, may require reevaluation of the fee's
reasonableness, an always difficult task.
of whether a written BIC contract will be required, sponsors should
be prepared for the likelihood that vendors will present them with
new or modified documentation, as the vendors seek to qualify under
one of the now finalized regulatory regime's exceptions or exemptions
or to clarify their fiduciary status. Sponsors should be aware that
such changes could take the form of a negative consent requiring no
affirmative action by the sponsor.
Effect on Providers. The
compliance measures required by the expansion of those who are
investment advice fiduciaries and the new and complicated system of
exceptions and exemptions from fiduciary status will also have major
effect on plan investment and service providers. Broker-dealers and
their registered representatives will need to acknowledge their
fiduciary status and qualify for an exemption if they choose to
continue receiving variable compensation. Registered representatives
and RIAs will be limited in their ability to capture rollovers, and
the structure of managed account programs sponsored by advisory firms
will also be impacted.
* * * * * * * * * *
rule's ramifications will be significant for all who deal with
retirement plans, in ways predictable and unpredictable, with
intended and unintended consequences.
tuned as The Wagner Law Group keeps you posted on what you need to
know and please reach out to us for assistance and advice.