Department of Labor Finalizes Rule to Address Conflicts of Interest in Retirement Advice

On April 6, 2016, the U.S. Department of Labor (DOL) issued a final rule addressing conflicts of interest in retirement advice. The new rule requires those who provide retirement investment advice to abide by a fiduciary standard and put their clients’ best interest before their own profits. The rule also prohibits fiduciaries to plans, plan participants, and individual retirement account (IRA) owners from receiving payments creating conflicts of interest unless they comply with conditions designed to minimize the potential effects of a conflict.

According to a White House press release, the rule defines fiduciary investment advice, while the accompanying exemptions allow advisers and their firms to continue to receive common forms of compensation if they put their clients’ best interest first. The rulemaking package also includes a regulatory impact analysis outlining the monetary harm caused to retirement investors from conflicted advice and the expected economic impacts of the rule.

Who Is a Fiduciary?

Under the rule, a person is a fiduciary if he or she receives compensation for providing advice with the understanding it is based on the particular needs of the person being advised or that it is directed to a specific plan sponsor, plan participant, or IRA owner. Such decisions can include what assets to purchase or sell and whether to rollover from an employment-based plan to an IRA. The fiduciary can be a broker, registered investment adviser, or other type of adviser, some of whom are subject to federal securities laws and some of whom are not. Additionally, under the rule’s updated definition of fiduciary investment advice, advisers to plan participants and sponsors are required under the Employee Retirement Income Security Act (ERISA) to provide investment advice in their client’s best interest. Likewise, under the rule and the associated prohibited transaction exemptions, advisers to IRA savers are required to put their client’s best interest first when recommending investments if they wish to continue receiving payments creating conflicts of interest. Those that provide investment advice to plans, plan sponsors, fiduciaries, plan participants, beneficiaries, and IRAs and IRA owners must either:

  • Avoid payments that create conflicts of interest; or
  • Comply with the protective terms of an exemption issued by the DOL.

Under the rule, firms are obligated to acknowledge their status and the status of their individual advisers as fiduciaries. Firms and advisers will also be required to:

  • Make prudent investment recommendations without regard to their own interests, or the interests of those other than the customer;
  • Charge only reasonable compensation; and
  • Make no misrepresentations to their customers regarding recommended investments.

Recommendations Are Fiduciary Investment Advice

Not all communications with financial professionals are fiduciary investment advice. If the communications do not meet the definition of a “recommendation,” the communications will be considered non-fiduciary. Investment advice covered by the rule are recommendations that meet the following elements:

  • That are made to a plan, plan fiduciary, plan participant and beneficiary, and IRA owner for a fee or other compensation, direct or indirect;
  • As to the advisability of buying, holding, selling, or exchanging securities or other investment property; and
  • Include recommendations as to the investment of securities or other property after the securities or other property are rolled over or distributed from a plan or IRA.

Covered investment advice also includes the following recommendations:

  • Recommendations as to the management of securities or other investment property.
  • Recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (for instance, brokerage versus advisory).
  • Recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made.

Fiduciary responsibilities are triggered when recommendations are made, either directly or indirectly, by any person who:

  • Represents or acknowledges that they are acting as a fiduciary within the meaning of ERISA or the Internal Revenue Code;
  • Renders advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is based on the particular investment needs of the advice recipient; or
  • Directs the advice to a specific recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

Examples of what is not covered investment advice are education about retirement savings and general financial and investment information, general communications that a reasonable person would not view as an investment recommendation, platform providers, transactions with independent plan fiduciaries, and swap and security-based swap transactions. Additionally, employees working in a company’s payroll, accounting, human resources, and financial departments who routinely develop reports and recommendations for the company and other named fiduciaries of the sponsors’ plans are not investment advice fiduciaries.

Exemptions

Under the best interest contract exemption, firms (and their individual advisers) can continue to receive the most common forms of compensation for advice to retail customers and small plan sponsors to invest in any asset so long as the firms:

  • Commit the firm and adviser to providing advice in the client’s best interest, charge only reasonable compensation, and avoid misleading statements about fees and conflicts of interest.
  • Adopt policies and procedures designed to ensure that advisers provide best interest advice, and prohibiting financial incentives for advisers to act contrary to the client’s best interest.
  • Disclose conflicts of interest. The firm must direct the customer to a webpage disclosing the firm’s compensation arrangements and make customers aware of their right to complete information on the fees charged.

Common forms of compensation, such as commissions, revenue sharing, and 12b-1 fees, are permitted under this exemption, whether paid by the client or a third party such as a mutual fund, provided the conditions of the exemption are satisfied. This exemption is available to advisers that advise IRA savers, individual plan participants, and small plans.

The principal transaction exemption allows advisers to recommend investments, such as certain debt securities, and sell them to the customer directly from the adviser’s own inventory, or purchase investment property from the customer, as long as the adviser adheres to the exemption’s consumer-protective conditions.

When Is Compliance Required?

The new protections and responsibilities are not effective immediately. Plans and their affected financial services, and other services providers, must change from non-fiduciary status to fiduciary status by April 2017. Technically, the law states, “compliance with the new requirements will not begin to be required until one year after the final rule is published in the Federal Register.” The applicable Federal Register was published Friday, April 8, 2016 and one year later is Saturday, April 8, 2017. However, when a date falls on a weekend or holiday, the next federal business day is used; therefore the effective date should be April 10, 2017. (1 CFR 18.17).

A phased implementation approach has also been adopted for the best interest contract exemption and the principal transactions exemption. Both exemptions provide for a transition period, from the April 2017 applicability date to January 1, 2018, under which fewer conditions apply to give financial institutions and advisers time to prepare for compliance with all the conditions of the exemptions while safeguarding the interests of retirement investors. During this period, firms and advisers must:

  • Adhere to the impartial conduct standards.
  • Provide a notice to retirement investors that, among other things, acknowledges their fiduciary status and describes their material conflicts of interest.
  • Designate a person responsible for addressing material conflicts of interest and monitoring advisers’ adherence to the impartial conduct standards.

Full compliance with the exemptions will be required as of January 1, 2018. Read more about the final rule here.

About Samantha Yurman, JD

Samantha Yurman is one of ThinkHR's legal editors. She is a licensed attorney in California and Florida with over 16 years of experience researching and analyzing human resources legislation and law. Samantha uses her expertise to translate highly technical legal topics into usable information for our clients.