United States: Fiduciary Rule Update – September 2017

Last Updated: September 6 2017
Article by Christine Lutgens


The long-anticipated and often-delayed new fiduciary rule under the Employee Retirement Income Security Act of 1974, as amended (ERISA) finally went into effect on June 9, with transition relief blunting its impact until January 1, 2018. In announcing the transition relief and relaxed enforcement standards at the end of May, the secretary of labor essentially acknowledged that – like so many other items on the Trump agenda – eliminating the new rule was going to be more complicated and harder than expected. Not only does the Department of Labor (DOL) have to run the gauntlet of the Administrative Procedures Act, which sets out detailed and time-consuming requirements for amending or eliminating a significant regulation, but it also has to accomplish that task with a seriously depleted staff.

For private funds, the main concern under the new rule is that behavior previously considered basic marketing without any fiduciary implications could now be considered investment advice with potential liability under ERISA's high standard of care and conflict prohibitions for fiduciaries. Covered investment advice under the new fiduciary rule is defined as a recommendation to a plan, plan fiduciary, plan participant (including a beneficiary), IRA or IRA owner for a fee or other direct or indirect compensation. A "recommendation" is a communication that, based on the surrounding facts and circumstances, a reasonable person would consider to be a suggestion that the recipient engage in or refrain from taking a particular course of action relating to investing, whether buying, holding or selling a particular investment or managing investments or investment accounts. The more tailored the communication is to a particular investor or investors the more likely the communication will be considered a recommendation. Although general communications in newsletters, widely attended conferences, media reports, general market data and general marketing materials may fall outside the new fiduciary rule, it may not take much targeting to land on the wrong side of the line dividing general communications from fiduciary advice.

Relief is available where the ERISA plan or IRA invests using an independent fiduciary (who cannot be the IRA owner or, in the case a small plan, company insiders). To use this exception, the fund manager (1) must know or reasonably believe that the independent fiduciary (a) is a U.S. bank or insurance company, a U.S. registered investment adviser or broker-dealer, or a fiduciary that holds, manages or controls at least $50 million in assets, (b) is capable of independently evaluating investment risks and (c) is the ERISA or Code fiduciary responsible for exercising independent judgment with respect to the transaction; (2) must inform the independent fiduciary that it is not an undertaking to provide impartial investment advice or to give advice in a fiduciary capacity with respect to, and discloses to the independent fiduciary the existence and nature of its financial interests in, the transaction; and (3) must not receive a fee or other compensation directly from the benefit plan investor or independent fiduciary for the provision of investment advice (as opposed to a fee for other services) in connection with the transaction. These requirements can be satisfied by representations and covenants in the investment management agreement, subscription agreement, side letter or comparable documentation executed by the benefit plan investor in connection with the transaction.

New Developments Since June 9

At the same time it announced that the new rule would go into effect as scheduled on June 9, the DOL indicated that it would implement a temporary enforcement policy until Jan. 1, 2018, and would not pursue claims against fiduciaries who are working diligently and in good faith to comply with the new rule and the related exemptions (although it should be noted that the DOL's forbearance would not prevent action by an ERISA investor itself). It also indicated that reliance on the independent fiduciary exception can be based on negative consent to a written representation.

Since the rule became effective, there have been related developments, both from the Labor Department and other sources, outlined below.

  • On August 30 the DOL formally proposed an extension of the transition relief for prohibited transaction exemptions adopted or modified in connection with the fiduciary rule until July 1, 2019. Primarily affected is the Best Interest Contract Exemption, which is available on a relaxed basis during the transition period as long as the adviser only provides advice that is in the best interest of the plan, receives no more than reasonable compensation, and refrains from making materially misleading statements regarding a recommended investment, the adviser's conflicts of interest or other relevant matters. The Department had previously signaled its intention to take this action in a recent court filing.
  • In another lawsuit specifically challenging the new rule's ban on arbitration provisions, the DOL referred to the issue becoming "moot," suggesting future action to remove the ban; the DOL had previously said it will no longer defend the ban in court.
  • The DOL has also issued a new set of frequently asked questions (FAQs) regarding the fiduciary rule, primarily reconciling the disclosure requirements under the service-provider exemption under ERISA Section 408(b)(2), which requires self-identification as a fiduciary, and the fiduciary rule transition relief, which permits silence regarding fiduciary status. According to the FAQs a covered service provider that is or could be considered to be providing investment advice as a result of the new fiduciary rule can satisfy the 408(b)(2) disclosure requirements by accurately and completely describing its services to the plan, including those services constituting or arguably constituting investment advice under the new rule, without labeling itself as a "fiduciary" until the transition relief expires and its status under the new rule is clear. The FAQs further provide that an affirmative disclaimer of fiduciary status (as opposed to silence) by a service provider that is providing or reasonably expects to provide investment advice within the meaning of the new rule as currently applicable would not satisfy the 408(b)(2) disclosure requirements until the affirmatively incorrect statement is corrected or removed with a revised service contract or disclosure. The new FAQs also confirm that advice regarding efforts to increase plan participation is not fiduciary advice.
  • A Nevada law became effective on July 1, requiring investment advisers, broker-dealers and sales representatives doing business in Nevada to act in accordance with fiduciary standards in advising all investors in the state. Covering both retirement and non-retirement accounts, the state law is potentially broader than the ERISA fiduciary rule, and could be a model for other states to follow if the Trump administration rolls back the fiduciary rule.
  • Republican-backed legislation has passed the House, and additional bills have been introduced, effectively killing the fiduciary rule, but passage through the Senate is doubtful in the face of likely Democratic filibusters.
  • The SEC has issued an informal invitation for public comment on a possible fiduciary rule that the SEC could adopt to protect retail investors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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