The U.S. Department of Labor (“DOL”) has issued a sweeping proposal that aims to significantly broaden who is considered a fiduciary for purposes of retirement plans. These new proposed rules were several years in the making.
Fiduciary Definition Expanded
An individual receiving compensation for providing advice to a plan sponsor, plan participant or IRA owner will be deemed a “fiduciary” under the new rule. Actions triggering the fiduciary designation include recommending which assets to purchase or sell and whether to roll over assets from an employer-sponsored retirement plan to an IRA. Those potentially affected would be brokers, registered investment advisers (“RIAs”), insurance agents, administrative service providers and salespeople. Excluded from fiduciary status, however, would be:
- brokers acting strictly as order-takers for customers instructing the broker exactly what to buy or sell without asking for advice;
- financial institutions (intending to act as counterparties) making a “sales pitch” to fiduciaries of large plans with financial expertise;
- providers of non-fiduciary “investment education” only to IRA clients who do not identify specific investment products; and
- providers of valuations for ESOP stocks
What It Means to Be a Fiduciary
Under the proposed rule, fiduciaries must provide impartial advice in their client’s best interest. Furthermore, a fiduciary cannot accept any payment creating a conflict of interest, unless the fiduciary qualifies for an exemption intended to assure that the customer is adequately protected.
One such exemption would be a new “Best Interest Contract Exemption,” allowing fiduciary advisors to set their own compensation or earn “variable compensation” including commissions. The exemption would require the fiduciary advisor to enter into a written contract with the client that provides for the following:
- the firm commits to following the “best interest” fiduciary standard;
- the firm has adopted compliance policies designed to mitigate conflicts (and there is no differential compensation or any other incentive that would tend to encourage individual advisors to make improper recommendations);
- any conflicts have been identified and disclosed (and provide a web address for a web page containing additional compensation disclosures); and
- a private right of action against the firm for contractual breaches (arbitration clauses are permitted so long as the client has the right to bring class action lawsuits).
Supplementing the written contract requirement, the Best Interest Contract Exemption would also require various disclosures to be provided to the customer including:
- a point-of-sale disclosure to the customer that includes the all-in and ongoing costs of the recommended investment;
- annual compensation disclosures that also list the investments purchased or sold during the year;
- a web page with disclosures of all direct and indirect compensation; and
- notice and other related disclosures if the advisor is unable to recommend a sufficiently broad range of investments due to platform-related or other limitations.
The advisor would need to notify the DOL of its intent to utilize the Best Interest Contract Exemption.
The DOL proposal also includes a new “Principal Transactions Exemption” that would give a financial institution the ability to recommend certain fixed income securities and sell them from its inventory, and proposed revisions to a number of current prohibited transaction exemptions to be consistent with the proposed changes.
The DOL is asking for comments on whether it should establish a “Low-Fee Exemption” with fewer requirements than the Best Interest Contract Exemption, allowing advisors to earn variable compensation when recommending the lowest-fee product in a given product class.
Consequences of Proposed Rule
If adopted, the DOL rules would impose on substantially all retirement advisors, including brokers and insurance agents, the same type of disclosure and compliance policy requirements that are already imposed on RIAs under securities law. The DOL proposal would require conflicts-related disclosures from many advisors who are not currently subject to this requirement, and broker-dealers and insurance firms would have to more closely monitor and limit the levels of variable compensation earned by their registered representatives and agents. Such requirements would almost certainly increase compliance costs for these firms and their retirement businesses.
Public Comment Period
The public may now submit comments through late July. After the close of this period, a public hearing will be scheduled and the public record will be reopened for comments. The DOL intends to finalize the rules at the conclusion of this process.
Given the extensive nature of the proposal, comments are expected to be voluminous. This process will take some time to complete and realistically the new rules will not be effective until sometime in late 2016 at the earliest.
If you have questions about the proposed rules and your current retirement plan situation, please contact any of the members of the Lindquist & Vennum Employee Benefits Group.