Included in the definition of a fiduciary in Section 3(21) of the Employee Retirement Income Security Act ("ERISA") is someone who provides investment advice for a fee. Regulations issued in 1975 by the U.S. Department of Labor ("DOL") included a five-part test for determining whether someone is a fiduciary under this provision of ERISA. However, in response to developments since 1975, e.g., the growth of participant-directed defined contribution plans ("DC Plans") and individual retirement accounts ("IRAs"), the DOL concluded that the 1975 regulations were outdated and did not adequately address conflict of interest considerations.
After many years of back and forth (including two sets of proposed regulations), the DOL issued final regulations on April 6, 2016 that changed the definition of fiduciary by way of the provision of investment advice. These regulations are expected to change key aspects of the retirement benefits landscape, especially for those who advise, provide services or engage in transactions at the retail or institutional level with IRA owners, defined contribution or defined benefit plans or their participants or internal fiduciaries.
The purpose of this Alert is to summarize the newly proposed rules and to discuss the impact of these proposed rules on plans and plan sponsors. Further Alerts in this series will discuss the impact on participants and on service providers.
Summary of New Definition of Fiduciary
The final regulations (the "Regulations") set out a core definition of an "advice" fiduciary. The regulations then identify a number of situations that are not investment advice for this purpose and include several exceptions.
The general rule is that a person is a fiduciary if he or she provides recommendations or advice for a fee to a plan, a plan fiduciary, plan participant or IRA owner regarding:
- the advisability of acquiring, holding, disposing or exchanging
plan or IRA assets;
- the investment of assets after those assets are rolled over,
transferred or distributed form a plan or IRA;
- the management of such assets, including recommendations on
investment policies or strategies, portfolio composition, and the
selection of persons providing investment advice or investment
management services and investment account arrangements; or
- the management of assets rolled over or otherwise distributed from a plan or IRA to another plan or an IRA.
provided the person, directly or indirectly, represents or acknowledges acting as an ERISA fiduciary in furnishing such advice OR furnishes this advice pursuant to a written or verbal agreement, arrangement or understanding that this advice is "individualized" OR directs the advice to a specific advice recipient.
The new definition differs materially from the DOL's 1975 final regulations. Significantly, it no longer requires that the advice be provided on a regular basis, or that the advice be provided according to a mutual understanding that it will serve as the primary basis for decision making.
Under the Regulations, the threshold question is whether there has been a recommendation. For this purpose, a recommendation is a communication that would reasonably be viewed as a suggestion that the recipient take or refrain from a particular action. The DOL also provided examples of situations that would not constitute a recommendation for this purpose.
- Employees. An employee of a plan sponsor who,
while working in an employee capacity and receiving no fee other
than normal compensation for work performed as an employee,
provides advice to a plan fiduciary is not considered a
For example, when employees of a plan sponsor provide advice and services to a plan's investment committee, those employees will not be deemed to be fiduciaries (assuming no compensation in excess of their regular compensation was paid for that work).
- Platform Provider. A person who merely markets
and makes available to a plan (without regard to the plan's or
its participants' individualized needs) a platform that
provides a menu of available investment alternatives from
which a plan fiduciary can select/monitor investment alternatives
made available for participant-directed investments is not
considered a fiduciary, if the platform provider discloses to the
plan fiduciary in writing that it is not providing impartial
investment advice or giving advice in a fiduciary capacity.
- Selection and Monitoring Assistance. A person
who,in connection with platform provider-related services, merely:
(i) identifies investment alternatives that meet objective criteria
set by the plan fiduciary; or (ii) provides the plan fiduciary with
objective financial data and comparisons with independent
benchmarks for investment alternatives, will not be considered a
fiduciary. (It is likely that providers will modify their
agreements and disclosures to ensure they fit within this
- Investment Education. Persons who make available investment education materials generally are not considered fiduciaries. To be considered investment education, the information provided must not be individualized or specific to a participant's needs and situation. Such information falls into four categories:
a. Plan Information: provides information regarding the plan or IRA operation, rules, distribution options and related advantages and disadvantages, etc. without reference to the appropriateness of any specific investment alternative, or of any distribution option.
b. General Financial, Investment and Retirement Information: provides general financial/investment education (e.g., asset classes, risk tolerance, etc.) without addressing specific investment products, IRA alternatives or distribution options.
c. Asset Allocation Models: provides models of asset allocation portfolios of hypothetical individuals with different time horizons and risk profiles based on generally-accepted investment theories; provided that: (i) all material facts and assumptions on which the models are based are disclosed; and (ii) the models are accompanied by a statement that application of a particular asset allocation model to an individual situation also needs to take into account the individual's other assets, income and investments.
d. Interactive Investment Materials: materials that provide a means for an individual to estimate retirement needs and retirement income, such as questionnaires, worksheets and software, subject to similar requirements as to asset allocation models (i.e., utilize generally accepted investment theories, objective correlation between asset allocation and projected retirement income stream, disclosure of material facts and assumptions, and materials that either reflect other assets or advise as to need for the individual to consider other assets).
These rules are not materially different than the old rules regarding non-fiduciary investment education.
The following situations are excluded from the definition of fiduciary:
- Counterparty or Swap Dealer with respect to a
Transaction with a Plan Fiduciary with Financial
Expertise. A person acting as a counterparty to a
plan and also providing information or materials that could be
considered advice to a fiduciary who is independent of such person
and who is exercising control with respect to an arm's length
transaction between the plan and the counterparty, will not be
considered a fiduciary if certain requirements are satisfied.
First, the independent fiduciary must satisfy certain status
requirements (e.g., the fiduciary is a bank, insurance company,
registered advisor, broker-dealer). Second, the counterparty
must reasonably believe that the fiduciary has sufficient expertise
to evaluate the transaction. Third, the counterparty
reasonably believes that the independent plan fiduciary exercises
control as to the management of the plan's assets and is
responsible for exercising independent judgement in evaluating the
transaction. This requirement can be satisfied by receiving a
written representation from the plan or independent
fiduciary. Fourth, the counterparty may not receive a fee for
providing this advice. There are similar provisions for swap
transactions. While counterparty documentation may be changed
to incorporate some of these requirements, in our experience
sophisticated plan fiduciaries generally are not counting on the
counterparty to be a fiduciary. Thus, the relationships
essentially will not change.
- Execution of Securities Transactions. A person
who executes buy/sell securities transactions (e.g., a broker or
dealer, reporting broker or a bank) is not considered a fiduciary
solely by reason of executing these transactions in the ordinary
course of its business if: (i) the fiduciary providing the
instructions is not such broker, dealer or bank; and (ii) the
instructions specify the price range for the purchase or sale of
the security, the time span (not more than five days) within which
the transaction is to be effected, and the minimum or maximum
quantity of the security to be purchased or sold.
A broker, dealer or bank that has discretionary authority is a fiduciary with respect to the assets over which it has the requisite authority or control.
Valuations and Appraisals
The definition of fiduciary in the 2015 proposed regulations included providers of appraisals, fairness or similar statements of the value of an asset. In response to comments, the DOL decided that issues related to valuations were more appropriately addressed in a separate, future, initiative. The DOL did reiterate in the preamble to the Regulations its position that a proper valuation of "hard-to-value" assets is the "single most important factor in determining the prudence of the transaction."
New Class Exemptions and Amendments to Existing Class Exemptions
The Regulations will confer fiduciary status on certain persons who previously were not fiduciaries. As a result, the DOL also has also finalized two new prohibited transaction class exemptions and amendments to several existing class exemptions to enable DC plans and IRA owners to receive services without giving rise to a prohibited transaction.
- "Best Interest Contract" Exemption: The
purpose of this exemption is to broadly allow financial
institutions, advisers, and their respective affiliates and related
parties to receive compensation that would otherwise give rise to
prohibited transactions as a result of advice to DC Plan
participants, beneficiaries and certain fiduciaries (including
small DC Plan sponsors), and IRA owners. The exemption
requires that the financial institution and/or adviser undertake
certain protective measurements, which include acknowledgement of
fiduciary status and compliance with impartial conduct
standards. The financial institution must enter into an
enforceable written contract with IRA owners providing for the
required protective conditions. (With respect to ERISA plans
and ERISA fiduciaries, the DOL does not require an enforceable
written contract because these parties have a cause of action under
ERISA.) Finally, the financial institution must notify the
DOL regarding its intention to rely on the exemption.
- "Principal Transaction" Exemption: The
purpose of the exemption is to allow principal transactions or
riskless principal transactions in debt securities, certificates of
deposit or interests in a unit investment trust, between an adviser
or financial institution and a plan, participant or beneficiary
account, or IRA. Financial institutions and advisers seeking
to rely on the exemption must acknowledge fiduciary status; adhere
to impartial conduct standards; disclose material conflicts of
interest; adopt certain policies and procedures and retain certain
records. For principal transactions and riskless principal
transactions involving IRAs and plans not covered by Title I of
ERISA, a written contract will be required.
- Certain current Prohibited Transaction Class Exemptions were also amended to bring them into conformity with the Regulations.
Impact of Regulations on Plans and Plan Sponsors
While the definition of "fiduciary" in the Regulations is broader, the impact on plans and plan sponsors may not be as great as might appear at first glance. The key impact will fall on investment consultants, advisers and brokers, some of whom have taken the position that they are not fiduciaries. Except for some changes to the documentation for relationships between plans and their service providers, the current relationships between plans and their service providers will stay essentially the same.
One area that plan sponsors will now need to review in a different light includes investment education materials that are provided to participants, in particular to ensure that the materials continue to constitute education rather than investment advice.
The bigger impact of the Regulations in the DC Plan community will fall on those persons (e.g., brokers) who provide direct investment advisory services to DC Plan participants and IRA owners; or who try to market to participants who are contemplating a distribution from plans. These "retail-oriented" service providers, who traditionally have avoided characterization as fiduciaries, would become ERISA fiduciaries and subject to ERISA's fiduciary standards and prohibited transactions.
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.