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Labor Department Raises Standards for Advisors to Retirement-Plan Participants

On April 6, 2016, the Department of Labor (DOL) released the final version of its highly anticipated Conflict of Interest Rule, which imposes a fiduciary standard on investment professionals rendering investment advice to participants in retirement plans subject to Employee Retirement Income Security Act (ERISA), 401(K) plans, and Individual Retirement Accounts (IRAs). The rule is intended to expand the definition of fiduciary and, among other purposes, protect individual investors from conflicts of interest that arise when an investment professional receives greater compensation for placing clients into one investment product over another, often at the investor’s expense.   

The ERISA standard for investment professionals who provide investment advice to participants in retirement plans had not changed since the original enactment of ERISA in in 1975. Under the old rules, some advice investment professionals provided to individuals was not considered fiduciary advice.

Definition of ‘Fiduciary Advice’ Expanded

Under the new rule, the definition of “fiduciary advice” is expanded so that advisors more often will be held to the higher fiduciary standard that requires them to act in the “best interests” of their clients. The advisors must also either avoid payments that create conflicts of interest (most commonly commission-based compensation) or comply with the protective terms of an exemption issued by the DOL.

The rule applies to any person or entity that provides an investment recommendation for a fee or compensation with respect to an ERISA retirement plan or IRA. It does not apply to non-retirement related assets. Under the rule, investment advice will be deemed rendered (and required to meet the fiduciary standard) if it contains a recommendation, which is defined as a communication that “would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.” [Rule Section 2510.3-21 (b)(1)]

Exceptions to the Rule

Acknowledging that not all financial-advisor communications will rise to the level of a recommendation DOL specifically identified the following exceptions:

  • Educational materials about retirement savings.
  • General communications to investors.
  • Communications by platform service providers that offer a selection of investment options to an independent plan fiduciary that independently decides which options are offered to the investors.
  • Communications with an independent plan fiduciary with financial expertise, such as a bank, insurance company, registered investment advisor (RIA), broker dealer, or an independent fiduciary with assets of at least $50 million.
  • Communications by a swap dealer or swap participant with the independent fiduciary of a plan.
  • Communications with a plan beneficiary or plan fiduciary by an employee of the plan or plan sponsor in the normal course of employment.

If the advice is subject to the rule, the advisor “must either avoid payments that create conflicts of interest or comply with the protective terms of an exemption issued by the DOL,” according to the DOL. The practical impact of this would be to prohibit such advisors from receiving commission-based compensation absent compliance with an exemption.

Exemptions Enable Advisors to Continue to Receive Commissions

To allow advisors to continue to receive commissions, the DOL has issued two exemptions:

1.  Best Interest Contract (BIC) Exemption:  Parties must enter into a contract in which the advisor acknowledges its role as a fiduciary, agrees to adhere to basic standards of impartial conduct, and implements policies and procedures designed to mitigate the negative impacts of any conflict and provide transparency of commissions and fees and any potential conflicts.

2.   Principal Transactions Exemption: Allows the advisor to sell or purchase plan investments out of its own product inventory, subject to similar restrictions as the BIC exemption.

The final version of the rule changed considerably from what the DOL originally released in April 2015. During the initial public comment period, the DOL received thousands of comments, and it appears to have taken many of these suggestions into account.

Some of the changes include:

  • Eliminating any restrictions on which products would qualify for the BIC exemption. Now all products are eligible.
  • Eliminating the need to have existing clients sign a new contract to comply with the BIC exemption; the advisor can issue notices complying with transparency requirements.
  • Amending the educational communication exception to allow asset allocation models and other interactive materials to identify specific investment products.
  • Amending the independent plan fiduciary communication exception to lower the asset threshold from $100 million to $50 million.
  • Increasing the implementation period from eight months to one year to allow advisors more time to transition clients into best-interest contracts.
  • Streamlining the disclosure requirements under the BIC exemption.

While many in the industry have applauded the DOL’s efforts to temper the rules, there are still many who oppose it. Trade and commerce groups, including the US Chamber of Commerce, are mulling legal challenges to the rule and certain members of Congress have proposed legislation to countermand it.

Measures Financial Firms Should Consider

The changes under the rule go into effect in April 2017.  Some of the steps that financial firms should consider include:

  • Reviewing disclosure and transparency policies and procedures regarding fees and commissions and rectifying them, where necessary.
  • Evaluating all account relationships to determine if any fiduciary obligations under the rule have been triggered.
  • Reviewing fee and commission schedules. Some broker/dealers already have lowered their fees and commissions in anticipation of the rule.
  • Revisiting fee-based versus commission-based compensation arrangements on an account-by- account basis to determine what is in clients’ best interests.
  • Reviewing their professional liability insurance contracts to ensure there are no exclusions pertaining to fiduciary obligations.

Industry concerns over the rule include increases in compliance and client-servicing costs and a heightened exposure to lawsuits. While broker/dealers will see the most significant changes under the rule, it likely will significantly impact other areas of the financial services industry.

The insurance industry is directly impacted by the specific inclusion of the sale of variable annuities as a transaction that may implicate fiduciary obligations.  And while registered investment advisors have long been subject to a fiduciary standard of care when dealing with retirement assets, they nonetheless will have to comply with the rule’s additional requirements on top of the existing regulatory scheme.

There surely is more to come on this front in the year leading up the rule’s implementation in April 2017.

(Note: Statements concerning legal matters should be understood to be general observations based solely on Marsh’s experience as insurance brokers and risk consultants and should not be relied upon as legal advice, which we are not authorized to provide.)