DOL Major Changes to Fiduciary Investment Adviser Definition and Prohibited Transaction Exemptions - Part 2
June 1, 2016
Exceptions from the New Investment Advice Fiduciary Definition
By Darcy Norville
and Jessica Morgan
On April 6, 2016, the U.S. Department of Labor (the "DOL") issued final regulations expanding the definition of who is a fiduciary and what constitutes fiduciary advice to ERISA-covered employee benefit plans and individual retirement accounts (IRAs). This is the second in a series of Tonkon Tips addressing the new investment advice fiduciary definition. This Tip focuses on what activities do not
constitute fiduciary advice under the new rule and therefore are not subject to the rule's requirements.
Why the New Definition Matters to Financial Services Providers
Persons who are deemed to be fiduciaries to ERISA plans or IRAs are restricted by prohibited transactions rules from receiving compensation from third parties in connection with a transaction involving the plan or IRA or engaging in transactions that result in the fiduciary receiving increased amounts of compensation. Without a prohibited transaction exemption, a fiduciary cannot provide services to or engage in transactions with an ERISA plan or IRA, or engage in any transaction deemed to present a conflict of interest or self-dealing.
As noted in our first Tip in this series
, if an individual makes any of the following types of "recommendations," for a direct or indirect fee, the individual will be deemed to be a fiduciary to the ERISA plan or IRA:
- Recommendations as to the advisability of acquiring, holding, disposing of or exchanging an investment in the ERISA plan or IRA;
- Recommendations regarding investing proceeds that are rolled over, transferred or distributed from an ERISA plan or IRA;
- Recommendations regarding the management of securities of other investment property, including recommendations regarding:
- Investment policies or strategies or portfolio composition;
- The selection of other persons to provide investment advice or investment management services;
- Rollovers, transfers or distributions from an ERISA plan or an IRA; or
- The selection of investment account arrangements (e.g. brokerage vs advisory).
The rule defines a "recommendation" as a communication that: (i) based on its content, context and presentation would reasonably be viewed as a suggestion that the recipient engage in or refrain from taking a particular course of action; and (ii) is provided by an adviser who either: (1) represents or acknowledges its fiduciary status; (2) renders advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is based on the particular investment needs of the recipient; or (3) directs the advice to a specific recipient regarding the advisability of a particular investment or management decision.
Whether a "recommendation" has occurred is the threshold issue and initial step in determining whether a person is a fiduciary by virtue of providing investment advice. In order to provide some clarification of the DOL's intended meaning of a "recommendation," the final rule provides a non-exhaustive list of examples of communications and activities that are not
considered "recommendations" and therefore not fiduciary advice. Those listed communications and activities are described below.
Communications and Activities that Are Not "Recommendations"
- Platform providers. Service providers such as record-keepers and third party administrators will not be deemed to make recommendations by virtue of offering a "platform" or selection of investment alternatives to participant-directed individual account plans, where a plan fiduciary chooses the specific investment alternatives that will be made available to participants to select for investment of their individual accounts, as long as: (i) the plan fiduciary is independent of the persons who markets or makes available the investment alternatives, and (ii) the person marketing or making available the investment alternatives discloses in writing to the plan fiduciary that they are not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity. Marketing and making available segmented platforms of investment alternatives based on merely identifying investment alternatives based on objective criteria will not result in providing fiduciary advice solely by virtue of the segmentation, for example offering different platforms for small, medium and large plans. If the requirements of the platform provider carve-out are met, the platform provider will be able to receive variable compensation, such as commissions or 12b-1 fees, from investment providers represented on the platform that would otherwise be prohibited.
- Selection and monitoring assistance. Services commonly performed by platform providers to assist plan sponsors in selecting and monitoring a line-up of investment alternatives to be made available to plan participants also will not be deemed "recommendations" if certain requirements are met. Platform providers will not be deemed to be providing recommendations by virtue of providing the following services: (i) identifying investment alternatives as meeting objective criteria specified by the plan fiduciary (e.g., asset type, fund size, or expense ratios); (ii) responding to RFPs; or (iii) providing objective financial data and comparisons with independent benchmarks to the plan fiduciary, such as information on the historic performance of asset classes and of the investment alternatives available through the provider.
In response to concerns that the common practice of providing a sample line-up of investments in a RFP response might be viewed as recommending those investments to a plan, especially in cases where the RFP requires some degree of individualization in the response or where specific representations were included about the quality of services being offered, the DOL clarified in the final rule that a RFP response with a sample line-up of investments is not a "recommendation." Such treatment, however, is conditioned on written notification to the plan fiduciary that the person issuing the RFP response is not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity. Further, the RFP response containing the sample line-up must disclose whether the person has a financial interest in any of the alternatives and, if so, the precise nature of such interest. In effect, a service provider issuing the RFP response can treat the plan's current investment alternatives as a proxy for objective criteria specified by the plan fiduciary, and create a sample line-up, so long as the required disclosures are made.
- Investment education. The final rule describes in detail four broad categories of non‑fiduciary educational information and materials, the provision of which does not constitute making a "recommendation" when provided to plan fiduciaries or plan participants and beneficiaries:
- information and materials that describe investments or plan alternatives without specifically recommending particular investments or strategies (e.g., describing investment objectives and philosophies of plan investment options or mutual fund; risk and return characteristics, historical returns; fees associated with investments; distribution options; contract features; or similar information);
- general financial, investment and retirement information, provided that the adviser does not recommend a specific investment or investment strategy (e.g., standard financial and investment concepts such as diversification; risk and return; tax deferred investments; historic differences in rates of return between different asset classes; effects of inflation; estimating future retirement needs and investment time horizons; assessing risk tolerance; or general strategies for managing assets in retirement);
- asset allocation models, provided that (a) they are based on generally accepted investment theories; (b) the assumptions on which they are based are explained; and (c) specific investments or products are not referred to or recommended; and
- interactive investment materials, (e.g. work sheets, questionnaires, software and similar materials that enable individuals to estimate future retirement needs and to assess the impact of different investment allocations on retirement income). These interactive materials can consider the impact of specific investments, as long as the specific investments are specified by the investor, rather than the firm/adviser.
Persons Not Deemed Investment Advice Fiduciaries – "Carve-Outs"
- General communications and commentaries. The rule excludes from investment advice the furnishing of general communications that a reasonable person would not view as an investment recommendation (e.g. general circulation financial newsletters; television, radio and public media talk show commentary; remarks in widely attended speeches and conferences; research reports prepared for general distribution; general marketing materials; fund menus; general market data; price quotes; performance reports; or prospectuses).
The final rule exempts certain conduct and information that the DOL believes is beneficial for plans, plan fiduciaries, plan participants and beneficiaries and IRA owners, and should not be treated as fiduciary investment advice. The DOL excluded the following transactions and advice from the fiduciary investment advice rule, notwithstanding that they otherwise would fall within the general definition of "recommendations."
- Transactions with independent plan fiduciaries with financial expertise. A person will not be deemed to be a fiduciary solely because of the provision of advice to a person who is a fiduciary of the plan or IRA, with respect to an arm's length sale, purchase, loan, exchange or other transaction involving the investment of securities or other property, if the person knows or reasonably believes that they are dealing with an independent plan fiduciary who is a (i) registered investment adviser, (ii) registered broker-dealer, (iii) insurance carrier, (iv) bank, or (v) independent plan fiduciary who holds, or has under management or control, total assets of at least $50 million.
The exemption requires that the person knows or reasonably believes that the independent fiduciary of the plan or IRA is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies, and that the independent fiduciary is a fiduciary under ERISA or the Code (or both) with respect to the transaction and is responsible for exercising independent judgment in evaluating the transaction. The person may rely on written representations from the plan or independent fiduciary to satisfy those requirements.
The exemption also requires that the person fairly inform the independent plan fiduciary (i) that the person is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity in connection with the transaction, and (ii) of the existence and nature of the person's financial interest in the transaction. The person must not receive a fee or other compensation directly from the plan or plan fiduciary for the provision of investment advice (as opposed to other services) in connection with the transaction. Thus, the person may not charge the plan a direct fee to act as an adviser with respect to the transaction, and then disclaim responsibility as a fiduciary adviser by asserting that he or she is merely an arm's length counterparty.
This so-called "seller's" exemption will apply to many transactions between financial services providers and plan sponsors or trustees, and is premised on the idea that both sides of such transactions understand that they are acting at arm's length, and neither party expects that recommendations will necessarily be based on the buyer's best interests, or that the buyer will rely on them as such.
- Swap and security-based swap transactions. Persons acting as swap dealers and security-based swap dealers do not become investment advice fiduciaries as a result of communications and activities conducted during the course of swap or security-based swap transactions regulated under the Commodity Exchange Act of the Securities Exchange Act of 1934 and applicable implementing rules if the following conditions are met:
- The swap or security swap dealer may not be acting as an adviser to the plan; the plan must be represented by an independent plan fiduciary;
- the person does not receive a fee or other compensation directly from the plan or plan fiduciary for the provision of investment advice (as opposed to other services) in connection with the transaction; and
- the person obtains a written representation from the independent fiduciary that the independent fiduciary (a) understands that the person is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with the transaction, and (b) is exercising independent judgment in evaluating the recommendation.
Scope of Investment Advice Fiduciary Duty
- Employees of plan sponsors, plans or plan fiduciaries. Employees working in a company's payroll, accounting, human resources, benefits, or financial departments who regularly develop reports and recommendations to the company and other named fiduciaries of the sponsor's plans are not investment advice fiduciary if the employee receives no fee or other compensation (direct or indirect) in connection with the such recommendations beyond the employee's normal compensation for work performed for their employer. This exclusion also covers communications between employees about the plan and distribution options in the plan, so long as they are not registered or licensed advisors under securities or insurance laws and receive only their normal compensation for work performed for their employer.
The rule confirms that a person who is a fiduciary with respect to the assets of a plan or IRA by reason of rendering investment advice as described in the final regulation shall not necessarily be deemed to be a fiduciary regarding any assets of the plan or IRA with respect to which that person does not have or exercise any discretionary authority, control or responsibility or with respect to which the person does not have the authority to render such advice. This remains unchanged from the existing regulation.
This client update is prepared for the general information of our clients and friends. It should not be regarded as legal advice. If you have any questions regarding the final regulations discussed in this update, please contact a member of Tonkon Torp's Financial Services practice group