DOL Reproposes Fiduciary Rule for ERISA Plans and IRAs | Practical Law

DOL Reproposes Fiduciary Rule for ERISA Plans and IRAs | Practical Law

On April 14, 2015, the Department of Labor (DOL) issued a proposed rule defining the term fiduciary for investment advisers and brokers providing investment advice to participants or beneficiaries of ERISA-governed employee benefit plans and individual retirement accounts (IRAs). The DOL also issued several new and amended versions of prohibited transaction exemptions in connection with the proposed rule.

DOL Reproposes Fiduciary Rule for ERISA Plans and IRAs

Practical Law Legal Update 6-609-1270 (Approx. 12 pages)

DOL Reproposes Fiduciary Rule for ERISA Plans and IRAs

by Practical Law Employee Benefits & Executive Compensation
Published on 17 Apr 2015 • USA (National/Federal)
On April 14, 2015, the Department of Labor (DOL) issued a proposed rule defining the term fiduciary for investment advisers and brokers providing investment advice to participants or beneficiaries of ERISA-governed employee benefit plans and individual retirement accounts (IRAs). The DOL also issued several new and amended versions of prohibited transaction exemptions in connection with the proposed rule.
On April 14, 2015, the Department of Labor (DOL) issued a proposed rule that replaces the existing regulatory interpretation of fiduciary investment advice under ERISA Section 3(21) (80 Fed. Reg. 21928 (Apr. 20, 2015)). This reproposal follows the DOL's initial proposal and subsequent withdrawal of the original proposed fiduciary rule in 2010 and 2011 in response to significant backlash from the brokerage industry regarding the potential impact of the proposed rule, particularly regarding IRAs. Comments on the proposed rule are due to the DOL by July 21, 2015.
In connection with this reproposed rule, the DOL also issued a new proposed prohibited transaction exemption (PTE) and several amendments to existing PTEs currently used throughout the financial industry for certain investments made by ERISA plans, including PTEs 75-1, 86-128, 77-4 and 84-24.

Existing Definition of Fiduciary Investment Advice

The existing regulation interpreting the scope of fiduciary investment advice under ERISA Section 3(21) (29 U.S.C. § 1002(21)) and Section 4975(e)(3)(B) of the Internal Revenue Code (Code) was issued by the DOL in 1975.
Under the existing regulation, for advice to constitute "investment advice," an adviser who does not have discretionary authority or control regarding the purchase or sale of securities or other property of the plan must render advice about the value of securities or other property, or make recommendations about the advisability of investing in, purchasing or selling securities or other property:
  • On a regular basis.
  • Under a mutual agreement, arrangement or understanding with the plan or fiduciary that the advice will:
    • serve as the primary basis for investment decisions for plan assets; and
    • be individualized based on the particular needs of the plan.
(29 C.F.R. §2510.3(21)(c)(1).)
DOL Advisory Opinion 76-05A further limited this definition by providing that valuations of employer securities in connection with employee stock ownership plan (ESOP) purchases is not considered fiduciary advice (see Practice Note, Employee Stock Ownership Plans (ESOPs)).
There are significant potential consequences attached to an investment adviser's status as a fiduciary. Both ERISA and the Code broadly prohibit investment advisers from engaging in prohibited transactions on behalf of a plan that may create conflicts of interest. Fiduciaries who engage in a prohibited transaction may be subject to:
  • Civil penalties under ERISA Section 502(i) (29 U.S.C. § 1132(i)) of up to 5% of the amount involved for each year (or part of a year) that the prohibited transaction continues.
  • Criminal penalties.
  • Excise taxes under the Code.
For more information, see Practice Note, Prohibited Transactions and Exemptions under ERISA and the IRC.

2010 Proposed Regulations

In light of the growth of participant-directed 401(k) plans and IRAs in an increasingly complex financial marketplace, the DOL in 2010 proposed an amendment to the existing regulation significantly broadening the scope and application of the fiduciary investment advice definition under ERISA Section 3(21)(A)(ii) (29 U.S.C. § 1002(21)(A)(ii)) and Code Section 4975(e)(3)(B) (26 U.S.C. § 4975(e)(3)(B)).
This proposed regulation elicited many comments and significant backlash from the financial services industry due to its breadth, particularly because:
  • Broker-dealers providing investment advice to IRA owners would be considered fiduciaries and subject to the prohibited transaction provisions.
  • There was little coordination between the provisions of the 2010 proposed rule with the other federal agencies, especially the Security and Exchange Commission's (SEC) standards of care for providing investment advice and the Commodity Futures Trading Commission's (CFTC) business conduct standards for swap dealers under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
As a result, in September 2011, the DOL withdrew the proposed rule but announced its intention to repropose the rule after further consideration.

Major Provisions of the Reproposed Rule

The proposed rule broadens the types of advice that constitutes fiduciary investment advice. The rule applies to both ERISA-governed employee benefit plans and IRAs under ERISA Section 3(21)(A)(ii) (29 U.S.C. § 1002(21)(A)(ii)) and Code Section 4975(e)(3)(B) (26 U.S.C. § 4975(e)(3)(B)), subject to specific carve-outs for particular types of communications that are non-fiduciary in nature. These carve-outs are accompanied by a new proposed prohibited transaction exemptions (PTEs) as well as revisions to several existing PTEs (see Prohibited Transaction Exemptions).
The DOL's reproposal retains the essential framework of the 2010 proposal, including its broad application to broker-dealers in connection with their advice to IRA owners. It provides, subject to certain carve-outs (see Carve-outs and Exclusions), that a person renders fiduciary investment advice with respect to ERISA plan assets or IRA assets if the person provides to a plan, plan fiduciary, plan participant or beneficiary, or IRA or IRA owner, any of the following four types of advice for a fee or other compensation:
  • A recommendation about the advisability of acquiring, holding, disposing or exchanging of securities or other property, including a recommendation to:
    • take a distribution of benefits; or
    • rollover securities or other property from a plan or IRA.
    (See Rollovers and Distribution Advice.)
  • A recommendation regarding the management of securities or other property, including a recommendation regarding the management of assets in a rollover or distribution (see Voting Proxies).
  • An appraisal, fairness opinion or similar statement (verbal or written) concerning the value of securities or other property that are the subject of a particular transaction or transactions by a plan or IRA (see Appraisals).
  • A recommendation of a person who will also receive a fee or other compensation for providing the types of advice described above (see Recommendations of Investment Managers or Advisers).
In addition, to be a fiduciary, the person must either:
  • Represent or acknowledge that it is acting as a fiduciary within the meaning of ERISA or the Code regarding this advice.
  • Render the advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is individualized or specifically directed to the recipient for consideration in making investment or management decisions regarding securities or other property of the plan or IRA.
(80 Fed. Reg. 21929 (Apr. 20, 2015).)
In a departure from the 2010 proposal, the reproposed regulation does not automatically attribute fiduciary status to investment advisers registered under the Investment Advisers Act of 1940.

Rollovers and Distribution Advice

The reproposal applies to recommendations regarding plan and IRA rollovers. This would supersede DOL Advisory Opinion 2005-23A, which concluded that these recommendations did not constitute fiduciary investment advice (Advisory Opinion No. 2005-23A, (Dec. 7, 2005)).
However, the preamble to the proposal provides that simply providing plan or IRA participants with information about plan distribution options (including the tax consequences associated with those distribution options) does not constitute fiduciary investment advice.

Voting Proxies

Individualized or specifically directed advice and recommendations on the exercise of proxy or other ownership rights is fiduciary investment advice under the prong that defines investment advice to include management of securities or other property.
In response to comments received from the 2010 proposal, the DOL clarifies in the preamble that the following would not constitute fiduciary investment advice:
  • Guidelines or other information on voting policies for proxies that are provided to a broad class of investors:
    • regardless of a client's individual interests or investment policy; and
    • that are not directed to a plan or IRA as a recommended policy to adopt.
  • A recommendation by an issuer addressed to all shareholders in a proxy statement.

Appraisals

The reproposal retains the 2010 proposal's inclusion of appraisals and valuation reports as fiduciary investment advice, but narrows this provision in response to comments by expanding the carve-out for ESOPs, collective investment funds and plans for reporting and disclosure purposes (see ESOPs and Collective Investment Funds).

Recommendations of Investment Managers or Advisers

The reproposal treats recommendations on the selection of investment managers or advisors as fiduciary investment advice (see Practice Note, Selecting and Hiring an Investment Manager), provided they are made for a fee and satisfy certain requirements.
The selection of investment managers or advisors includes recommendations of persons to perform asset management services or make investment recommendations. However, it would not include:
  • General qualitative and quantitative criteria to consider in hiring an investment manager.
  • Trade journal endorsements of an investment manager.
  • Recommendations of administrative service providers, property managers or other providers who do not provide investment services.

Defining Recommendation

The reproposal is structured so that communications from an investment adviser must constitute a "recommendation" to fall within the scope of fiduciary investment advice (excepting the prong concerning appraisals and valuations). After consulting with staff from other federal agencies charged with rulemaking authority over broker-dealers and investment advisers, the DOL:
  • Believes that FINRA's standards defining communications that rise to the level of a "recommendation" provides useful guideposts for distinguishing investment education from investment advice (see FINRA Regulatory Notice 11-02, 12-25 and 12-55).
  • Is specifically soliciting comments on whether it should adopt some or all of these standards.
(See Investment Education.)

Carve-outs and Exclusions

The reproposal includes carve-outs and exclusions for persons who do not represent that they are acting as ERISA fiduciaries. Subject to specific conditions, these carve-outs apply to:
  • Statements or recommendations made to a large plan investor with financial expertise by a counterparty acting in an arm's length transaction (see The Seller's Exception).
  • Offers or recommendations to ERISA plan fiduciaries to enter into a swap or security-based swap that is regulated under the Securities Exchange Act or Commodity Exchange Act (see Swap Transactions).
  • Statements or recommendations provided to an ERISA plan fiduciary by an employee of the plan sponsor provided that no additional fees beyond normal compensation are received (see Employees of Plan Sponsors).
  • Marketing or making available a platform of investment alternatives from which an ERISA plan fiduciary selects for an ERISA participant-directed plan (see Platform Providers).
  • Identifying investment alternatives or providing objective financial data that satisfy objective criteria specified by an ERISA plan fiduciary (see Platform Providers).
  • Providing an appraisal, fairness opinion or statement of value to ESOPs, collective investment funds and plans for the purpose of reporting and disclosure (see ESOP and Collective Investment Funds).
  • Information that constitutes "investment education" or "retirement education" (see Investment Education).
None of these carve-outs apply if the adviser represents that it is a fiduciary regarding a type of investment advice specifically covered under the proposed regulations. Advisers who represent in service provider agreements that they are fiduciaries "to the extent they act as fiduciaries as defined under ERISA" might need to renegotiate these provisions to disclaim fiduciary status to be eligible for these carve-outs.

The Seller's Exception

The reproposal provides a carve-out for investment advice provided in connection with an arm's length sale, purchase loan or bilateral contract between an expert plan investor and the adviser, if the advice is provided to a plan fiduciary independent of the adviser who exercises authority and control regarding the management of the plan's assets regarding this transaction. This exception is limited to "expert plan investors" and does not extend to recommendations made to retail investors and small plan providers.
There are two separate sets of conditions, depending on whether the plan has 100 or more participants (see Plans with 100 or More Participants) or the plan has $100 million or more in assets (see Plans with At Least $100 million in Assets).

Plans with 100 or More Participants

Before providing any recommendation regarding the transaction, the adviser must:
  • Obtain a written representation from the fiduciary that:
    • he is a fiduciary who exercises authority or control with regard to the plan's assets under ERISA Section 3(21)(A);
    • the plan has 100 or more covered participants; and
    • the fiduciary will not rely on the person to act in the best interests of the plan, provide impartial investment advice or give advice in a fiduciary capacity.
  • Fairly inform the plan fiduciary of the existence and nature of his financial interests in the transaction.
  • Not receive a fee or other compensation directly from the plan or plan fiduciary for investment advice rendered for the transaction. This does not preclude the adviser from receiving fees or compensation for other services relating to the transaction.
  • Know or reasonably believe that the independent plan fiduciary has sufficient expertise to evaluate the transaction and determine whether it is prudent and in the best interest of the plan. A written representation from the plan or the plan fiduciary will satisfy this condition.

Plans with At Least $100 Million in Assets

Before providing any recommendations, the adviser must:
  • Fairly inform the independent plan fiduciary that it:
    • is not providing impartial investment advice;
    • is not providing investment advice in a fiduciary capacity; and
    • cannot receive a fee or other compensation from the plan or plan fiduciary for the provision of investment advice in connection with the transaction.
  • Reasonably believe that the independent plan fiduciary has sufficient expertise to prudently evaluate the transaction.
To determine whether plans have more than $100 million in assets, a person may rely on the most recent Form 5500 Annual Report. For independent fiduciaries that represent several plans, an adviser may rely on representations from the independent plan fiduciary.

Swap Transactions

The reproposal carves out swap dealers, security-based swap dealers, major swap participants (MSPs) and major security-based swap participants who make recommendations to plans from becoming ERISA investment advice fiduciaries when they act as counterparties to a swap or security-based swap transaction. This was done due to the extensive regulation of these entities under the Dodd-Frank Act.
To be eligible for the carve-out:
  • The swap dealer may not act as an adviser to the plan (within the meaning of the CFTC or SEC business conduct standards).
  • The person providing the recommendation must obtain a written representation from the independent plan fiduciary that the fiduciary will not rely on the recommendations provided by that person.
In addition to these requirements, these entities must comply with the requirements under the Commodity Exchange Act for swap dealers or MSPs that act as counterparties to ERISA plans (see Practice Note, The Dodd-Frank Act: Final External Business Conduct (EBC) Rules for Swap Dealers and MSPs: Swaps with Special Entities).

Employees of Plan Sponsors

There is a carve-out for employees of a plan sponsor of an ERISA plan, such as members of a human resources department. These individuals would not be considered investment advice fiduciaries regarding the advice they provide to plan fiduciaries so long as they do not receive any compensation for that advice, beyond the normal compensation they receive as employees.

Platform Providers

There is a carve-out for service providers, such as recordkeepers and third-party administrators (TPAs) that offer a "platform" or selection of investment vehicles to participant-directed plans under ERISA (see Practice Note, Fee and Investment Disclosure Requirements for Participant-Directed Plans).
Under this carve-out, the mere marketing of or making investment alternatives available to a plan (without regard to the individualized needs of the plan or participants or beneficiaries) would not be considered fiduciary investment advice, provided:
  • The plan fiduciaries choose the specific investment alternatives to be made available to plan participants.
  • The recordkeeper or TPA discloses in writing that they are not providing impartial investment advice or giving advice in a fiduciary capacity.
Similarly, platform providers who identify investment alternatives that satisfy objective criteria specified by the plan fiduciary or financial data regarding those alternatives would not be considered fiduciary investment advisers on that basis.
This carve-out is available for Code Section 403(b) plans, but is not available to platform providers recommending investments to IRA owners.

ESOP and Collective Investment Funds

The proposal provides a carve-out from fiduciary treatment for appraisal and fairness opinions or statements of value to:
This is an expansion of the carve-out from the 2010 proposed rule for compliance with reporting and disclosure requirements to additionally exclude appraisals and fairness opinions for ESOPs. The DOL stated in the preamble to the reproposal that while it remains "concerned" about valuation advice concerning an ESOP's purchase of employer stock, it concluded that those concerns raise unique issues that are best addressed in a separate regulatory initiative.

Investment Education

The final carve-out distinguishes fiduciary investment advice from the provision of investment education. Under the carve-out, making available the specified categories of information and materials to a plan, fiduciary, beneficiary or IRA owners does not constitute fiduciary investment advice, regardless of:
  • Who provides the information.
  • The frequency with which the information is shared.
  • The form in which the information is provided.
  • Whether an identified category of information and materials is made available alone or combined with other categories of investment or retirement plan information and materials.
  • The type of plan or IRA involved.
This is similar to the conditions required by the DOL Interpretative Bulletin (IB) 96-1, which would be replaced by this reproposed regulation.
There are several changes from the conditions imposed by IB 96-1, including:
  • The information and materials must not include advice or recommendations as to specific investment products, investment managers or the value of other securities or property.
  • The distinction between non-fiduciary education and fiduciary advice applies equally to information provided to plan fiduciaries and to information provided directly to plan participants, beneficiaries and IRA owners.
  • Asset allocation models that refer to specific investment products available under the plan or IRA are not permitted to be included with educational materials, regardless of whether they have a disclaimer attached to them stating that other investment alternatives are available.

Prohibited Transaction Exemptions

Together with the reproposal, the DOL proposes certain administrative class PTEs and proposed amendments to existing PTEs. The intent of these exemptions is to allow broker-dealers, insurance agents and others that act as investment advice fiduciaries to continue to receive a variety of common forms of compensation that would otherwise violate the prohibited transaction rules of ERISA and trigger excise taxes under the Code.
The PTEs include:
  • A new Best Interest Contract Exemption. A new proposed Best Interest Contract PTE would provide broad and flexible relief from prohibited transaction restrictions on compensation received by investment advice fiduciaries as a result of a plan or IRA's purchase, sale or holding of specifically identified investments. This PTE would apply to advisers and the firms that employ them. Among other requirements, it generally requires the firm and the adviser to contractually:
    • acknowledge fiduciary status;
    • commit to adhere to basic standards of impartial conduct;
    • warrant that they will comply with applicable federal and state laws governing advice and that they have policies and procedures reasonably designed to mitigate any harmful conflicts of interest; and
    • disclose basic information on their conflicts of interest and on the cost of their advice.
    For more information, see Legal Update, Proposed Best Interest Contract Prohibited Transaction Exemption.
  • A new Principal Transactions Exemption. A new proposed principal transactions exemption would permit principal transactions in certain debt securities between a plan or IRA owners and an investment advice fiduciary, under certain circumstances. The conditions would include the contractual requirements of the Best Interest Contract Exemption, but would also include specific conditions related to the price of the debt security. For more information, see Legal Update, Proposed Principal Transactions Prohibited Transaction Exemption.
  • Amendments to PTE 86-128. The DOL is proposing to amend PTE 86-128 (67 Fed. Reg. 64137-01 (Oct. 17, 2002) to require all fiduciaries relying on the exemption to adhere to the same conduct standards required by the Best Interest Contract Exemption and to eliminate relief for investment advice fiduciaries to IRA owners. It is also proposing that PTE 86-128 extend to a new covered transaction for fiduciaries who sell mutual fund shares out of their own inventory (acting as principals) to plans and IRAs to receive commissions for doing so.
  • Amendments to PTE 75-1. The DOL is proposing several changes to PTE 75-1 (71 Fed. Reg. 5883-02 (Feb. 3, 2006), including revoking those provisions that provide relief for non-fiduciary services to plans and IRAs. The DOL would instead require persons in these transactions to rely on the statutory exemptions of ERISA Section 408(b)(2) and Code Section 4975(d)(2) (26 U.S.C. § 4975(d)(2)). It is also proposing to revoke Part II(2) of PTE 75-1 in its entirety and to provide relief in the amended version of PTE 86-128.
  • Amendments to PTE 84-24. The DOL is proposing to amend PTE 84-24 to require all fiduciaries relying on this exemption to adhere to the same conduct standards required by the Best Interest Contract Exemption. It also proposes to revoke PTE 84-24 in part so that investment advice fiduciaries to IRA owners would not be able to rely on PTE 84-24 for certain transactions but would instead be required to rely on the Best Interest Contract Exemption.
The DOL is also requesting comments on another streamlined exemption that would apply to compensation received in connection with investments by plans, participants and beneficiaries and IRA owners in certain high-quality, low-fee investments that would be subject to fewer conditions than the Best Interest Contract Exemption.

Effective Date

The proposed regulation will be published in the Federal Register on April 20, 2015. Comments are due by July 21, 2015. The final rule would be effective 60 days after publication in the Federal Register and the requirements of the final rule would generally become applicable eight months after publication of a final rule, with potential exceptions. There will be an administrative public hearing within 30 days of the close of the comment period.

Practical Implications

This reproposal dramatically broadens the definition of what it means to be a fiduciary providing investment advice to ERISA-governed employee benefit plans and to IRAs. It will likely be the subject of intense debate and negotiation over the coming months. However, employers sponsoring these plans should be familiar with this new proposed structure and should consider whether changes to their contracts and arrangements with service providers will need to be renegotiated and changed to accommodate this new fiduciary structure.