The final Department of Labor (DOL) fiduciary regulations were published this past April 8. While the rules were generally effective as of June 7, they do not generally apply until April 10, 2017, with a transition period for some portions lasting through January 1, 2018. Plan sponsors should, therefore, consider the impact now. This article addresses some of the issues and uncertainty resulting from the fiduciary rule that plan sponsors should keep in mind.
Q: How is the role of the fiduciary being expanded?
A: The new conflict of interest rule significantly expands the scope of fiduciary responsibility by creating additional lower-threshold requirements for fiduciary standards. Thus, there no longer needs to be a mutual understanding, or for investment advice to be given on a regular basis for a fiduciary relationship to exist. Additionally, the advice does not need to be the primary basis for an investment decision. Instead, the new rules provide that a fiduciary relationship exists where there is a:
- Recommendation of the purchase, sale or retention of an investment;
- Recommendation of someone to provide investment advice; or
- Recommendation about whether or how to take a distribution, rollover or transfer from a plan or individual retirement account (IRA).
However, the fiduciary relationship exists only if the recommendation is based on the particular needs of a plan, participant or beneficiary, or it is directed to a specific recipient, and the person making the recommendation is getting a direct or indirect payment with respect to it or the investment.
Q: How will the new fiduciary rule affect plan sponsors?
A: Plan sponsors can expect to see a shift in how services are provided in light of the new conflict of interest rule. These differences may come in a variety of ways.
The new rules expand what constitutes investment advice and limits how advisers may be paid. Plan sponsors should expect to be contacted if their relationship with their investment adviser/consultant does not fit into the exception outlined below.
The final rule will likely cause many service providers to be deemed fiduciaries under the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (IRC). This means that, among other things, the service provider will be subject to the standards of care and loyalty set forth in those laws, when it makes recommendations. These providers taking on a fiduciary role could result in prohibited compensation and sales practices.
Accordingly, the DOL issued some exemptions that it believes will allow common fee arrangements to continue if the terms of the exemptions are satisfied. The most far-reaching exemption—and one that will or could apply to many plan sponsor relationships—is the Best Interest Contract (BIC) exemption. Generally, this exemption requires that a fiduciary adviser’s financial institution enter into a client contract whereby it agrees to act in the “best interest” of the client. That financial institution, in overseeing the relationship, is required, among other things, to:
- Acknowledge its fiduciary status;
- Give advice that is in the retirement plan investor’s best interests;
- Charge no more than “reasonable compensation”;
- Avoid misleading statements about investments, compensation and conflicts of interest;
- Implement policies and procedures designed to avoid breaches of the impartial conduct standards;
- Avoid providing incentives for advisers to act counter to the customer’s best interests; and
- Accurately disclose the fees, compensation and conflicts associated with any recommendation.
The BIC exemption also contains a streamlined exemption for level fee arrangements under which the adviser’s compensation is not affected by the differing investments chosen. If plan sponsors do not already have a relationship with their service provider that meets the BIC standards, the sponsor should coordinate with the investment adviser to discuss next steps.
Q: Why has investment education become a great concern for plan sponsors?
A: The final rule makes it clear that there is a fine line between providing nonfiduciary education and fiduciary advice. Importantly, if communications are clearly for educational purposes, the content will not be subject to the fiduciary standards—regardless of who supplies the information or how the supplying is done.
As described in the final rule, “investment education” includes:
- Information and materials that describe the terms, features or operation of the plan, without making reference to the appropriateness of any individual investment alternative or benefit distribution option, or a particular plan participant or beneficiary;
- General financial, investment and retirement information that does not address specific investment products, plan investment alternatives or distribution options;
- Certain asset allocation models for hypothetical scenarios; and
- Interactive investment materials—e.g., questionnaires, worksheets, software and similar materials—that enable a participant to estimate future retirement income.
- The DOL has also stated that asset allocation models and interactive investment materials provided to plan participants may include specific investments and still be considered educational materials if:
- The investment is a designated investment alternative under the plan, selected and monitored by a plan fiduciary;
- The models and interactive materials identify all other designated investment alternatives available under the plan that have similar risk and return characteristics, if any; and
- The asset allocation models and interactive investment materials include a disclosure that advises participants of where to obtain additional information on the included investments.
This should be helpful for sponsors that wish to offer education tools
that can guide participants to investment options identified through the
asset allocation model or the interactive material, rather than having
to identify the asset classes generically and leave it to participants
to identify the options under the plan in those asset classes. However, a
plan sponsor should evaluate its investment-education materials to make
sure it is comfortable with the content, in light of the new rules and
While the fiduciary rule will not directly affect plan sponsors, they are advised to work with their plan service providers to understand and clarify how it may affect the operation of the plan as a whole. Additionally, the plan sponsor, bearing the rule in mind, should confirm whether any service provider agreements need to be reworked.
Lisa Barton is a partner in the employee benefits and executive compensation practice at Morgan Lewis. Her work encompasses all aspects of employee benefits and executive compensation arrangements, including the design, drafting and operation of tax-qualified retirement plans, health and welfare plans, nonqualified deferred compensation plans and equity compensation plans. She advises clients with respect to compliance with the Internal Revenue Code, Employee Retirement Income Security Act, COBRA and other federal and state laws affecting employee benefit plans, and often represents clients before the federal agencies responsible for regulation of these programs—e.g., the Internal Revenue Service, Department of Labor and Pension Benefit Guaranty Corporation. If you have any questions about your defined contribution plan that you would like Lisa to answer, please send them to firstname.lastname@example.org.
NOTE: This feature is to provide general information only, does not constitute legal counsel, and cannot be used or substituted for legal or tax advice.