As anybody reading this should be aware, the DOL has issued a delay of the applicability date of its Fiduciary Rule which was slated to take effect on April 10, 2017. The DOL has pushed the applicability date out 60 days, until June 9, 2017. The DOL has indicated that it is highly unlikely to issue any further extension.
The DOL did provide some additional relief in the form of some new transitional exemptions.
A Little Background
Under ERISA, it is considered a prohibited transaction to receive a fee for providing fiduciary investment advice that creates a conflict of interest. This has been the rule since ERISA became effective in 1975 and, will continue to be the rule after June 9, 2017.
What Happens on June 9?
On June 9, the definition of the term “Fiduciary Investment Advice” changes. Specifically, the following activities will be considered to be fiduciary acts on June 9 and thereafter:
Making a recommendation to an ERISA Plan, participant or IRA owner on:
- The selection of investments.
- Specific investment strategies.
- Purchases of insurance or annuities.
- The hiring of a specific investment manager.
- Whether to take a distribution (and in what form: lump-sum, rollover, transfer)
Up until this point, investment advice was only considered to be fiduciary in nature if it satisfied five very specific criteria:
- The advice provided as to the value of securities or other property.
- The advice was provided on a regular basis.
- The advice was provided pursuant to a mutual agreement.
- The advice serves as the primary basis for investment decisions.
- The advice provided is individualized.
If all five criteria were not met, the advice was not considered to be fiduciary in nature. Clearly, the new definition of fiduciary investment advice casts a much wider net.
You Will Probably Be a Fiduciary
If you were providing investment related services to qualified retirement plans, participants or IRA owners prior to June 9, 2017, whether you considered yourself to be a fiduciary or not, you will likely be considered to be a fiduciary on June 9, if you continue to provide those services.
Many fiduciary advisors use a level-fee compensation structure to avoid potential conflicts of interest in dealing with plans and participants. This continues to be a viable strategy with the new definition. But, you will need to understand how the new rules impact any activities involving distribution and rollover advice being provided. Even absent a relationship to a plan or its participants; the provision of advice relative to taking a distribution, in any form, will be considered fiduciary investment advice.
Wait, IRAs Are Not Subject to ERISA
Recommendations to ERISA plans and participants will continue to be subject to ERISA’s prudent man rule and duty of loyalty. Breaches of fiduciary duty will be enforceable as ERISA claims, enforceable by the Department of Labor’s Employee Benefit Security Administration (EBSA). However, IRAs fall outside of ERISA and, up until now, outside of the DOL’s jurisdiction. The new definition of fiduciary investment advice and, more importantly, the types of activities that give rise to a prohibited transaction give the DOL rulemaking authority over IRAs, to an extent.
Pursuant to an inter-departmental coordination agreement, the DOL has all rulemaking authority as it relates to prohibited transactions under section 4975 of the Internal Revenue Code. However, IRS retains enforcement responsibilities as it pertains to compliance for non-ERISA arrangements (IRAs). So, we find ourselves now with a rule that subjects investment advice providers to potential prohibited transactions as a result of apparent conflicts of interest that are created by decades old compensation arrangements.
How Can Prohibited Transactions Be Avoided?
The easiest way to avoid any conflict of interest while providing fiduciary investment advice is to eliminate any conflicts of interest. Unfortunately, that which is so easy to say is near impossible to accomplish.
Certainly, moving to a level-fee arrangement for investment advisory services helps eliminate many issues, but a number still remain. To help deal with these remaining conflicts of interest, DOL provides the Best Interest Contract Exemption (BICE).
The BICE allows an investment advice provider to offer advice that may inherently carry specific conflicts of interest, provided that prior to, or at the time of, providing the advice, the advice provider and the customer enter into an agreement with an enforceable contract that spells out specific conditions, namely:
- The advice provider acknowledges fiduciary status.
- Adheres to Impartial Conduct Standards that requires a firm to:
- Provide prudent investment advice.
- Charge only reasonable compensation.
- Make no misleading statements about investments, compensation or any potential conflict of interest.
- The firm implements policies and procedures that are reasonably designed to prevent violations of the impartial conduct standards,
- Refrain from awarding financial incentives to advisors to act contrary to the customer’s best interest.
- Fairly discloses fees, compensation and material conflicts of interest.
Any investment advice provider planning to make use of the BICE would need to notify DOL of their intention, prior to doing so. In addition, there is an obligation to retain certain records associated with the advice provided.
One of the more unappealing aspects of the BICE is the fact that it creates a private right of action for IRA owners. Without an enforceable contract, DOL would have promulgated a ruling without much real enforceability outside of ERISA. However, many in the industry see the potential for class-action litigation to be a tough pill to swallow.
What About Those New “Transitional Exemptions?”
To help the industry deal with the new definition of fiduciary investment advice, DOL has provided some additional transitional exemptive relief. This transitional relief is available through December 31, 2017. For advice related to registered securities (not insurance), DOL provides us with a new best interest contract transition exemption (“Transitional BICE”).
In order to satisfy the Transitional BICE, a fiduciary investment provider will need to comply with the three requirements of the Impartial Conduct Standards as described above.
The Presidential Memorandum of February 3, 2017
On February 3, President Trump issued a memorandum to the DOL to review its Fiduciary rule to ensure that the rule is “consistent with the policies of” his administration. Given the scope and the required time to complete such a review, the transitional exemptions help the industry become comfortable with a new definition of fiduciary investment advice. What final exemptive relief we end up with by year-end is anybody’s guess.