After years of political battles, the Department of Labor (DOL) recently issued the highly anticipated final fiduciary rule. As expected, the final rule requires all financial advisors (including broker-dealers, registered investment advisors and insurance agents) to put their clients’ best interests before their own profits when they give retirement investment advice. The final rule applies when advising retirement plans (ERISA and non-ERISA plans) and individual retirement accounts (IRAs).
So what does this mean for plan sponsors? That depends on the type of financial advisor the plan sponsor is using for its pension or 401(k) plan.
Today, registered investment advisors and their representatives are already deemed to be fiduciaries for purposes of federal and state securities laws, but broker-dealers and insurance agents are currently subject to a different “suitability” standard, even though they are often providing similar investment recommendations.
Under the suitability standard, broker-dealers are not required to put their clients’ interests above their own when making investment recommendations. As long as the investment is suitable for the client based on the client’s financial needs, objectives and unique circumstances, it can be recommended to the client, even if the particular investment choice pays the broker-dealer or insurance agent a higher fee, commission or other compensation than a comparable investment product.
New Rule Highlights
The new rule applies the same ERISA fiduciary standard of care to registered investment advisors, broker-dealers, insur-ance agents, banks and other advisors to retirement plans and IRAs.
Fiduciary Definition
An investment fiduciary now includes anyone who gives “covered investment advice,” as described below, with respect to a retirement plan or IRA for a fee or other form of compensation, regardless of whether it is paid directly by the client or indirectly by a third party (e.g., a mutual fund or other investment or insurance product company paying trail commissions, 12b-1 fees, referral or solicitor fees and revenue sharing) and satisfies any one of these three additional conditions:
Covered Investment Advice
The rule describes what is and what is not “covered investment advice.”
Covered investment advice includes:
Covered investment advice does not include: (Note: The rule has a long list of exclusions. We have highlighted below only those exclusions most relevant to plan sponsors.)
Prohibited Transaction Exemptions
Under ERISA and the Internal Revenue Code (Code), fiduciary investment advisors to plans and IRAs are not permitted to receive payments creating conflicts of interest (e.g., compensation that varies based on the investment advice), except as permitted under a prohibited transaction exemption (PTE). The final rule creates two new PTEs and modifies several existing PTEs. The most relevant of these to plan sponsors is the new Best Interest Contract (BIC) PTE. The BIC PTE is not an exemption from the new fiduciary standard of care, just permission to receive fully disclosed conflicted compensation under specified conditions.
Best Interest Contract PTE: The BIC PTE is available to investment fiduciaries (advisors, financial institutions and their affiliates and related entities) providing nondiscretionary advice to plan participants and beneficiaries, IRAs and non-institutional (retail) plan fiduciaries. Generally, the BIC PTE allows nondiscretionary investment fiduciaries to continue their current fee practices (including receipt of commissions, 12b-1 fees and revenue sharing) if certain basic standards set forth in the BIC PTE are satisfied. The BIC PTE is not available to advisors who have discretionary control over the investment of the retirement plan or IRA assets.
Fiduciaries that receive only a “level fee” (i.e., a flat dollar amount or a basis point fee) paid by the client in connection with advisory or investment management services may comply with more streamlined conditions designed to target the conflicts of interest associated with such services. The ongoing receipt of a level fee from the client typically would not raise prohibited transaction concerns. The DOL noted, however, that certain transactions, such as rollover recommendations, could give rise to conflict concerns because of the additional fees and charges resulting from the change.
Transition and Effective Dates
To give investment firms time to come into full compliance, the DOL adopted a phased implementation approach. On April 10, 2017, the broader definition of fiduciary will take effect, including its application to IRA accounts. Full compliance with the BIC PTE will be required on January 1, 2018.
Action Steps for Plan Sponsors
Although lawsuits opposing the rule already have been filed, these cases may or may not delay the rule’s effective dates. So, with less than a year until the first phase of the rule becomes law, plan sponsors should begin to evaluate the impact of the rule on their retirement plans now. Below are some action steps to consider:
And, of course, involve your attorney in these discussions. Our Employee Benefits attorneys are available to answer any questions and concerns surrounding the new DOL fiduciary rule and any other employee benefits matter.
