Much has been written to speculate what may become of the Department of Labor’s (DOL) fiduciary rule. Recently, the DOL issued a FAQ confirming that the new fiduciary rule will become effective June 9, 2017. Transition exemptions that were previously announced also will go into effect on that date. The DOL also issued non-enforcement guidance that should help mitigate the risk of litigation against fiduciaries who make a good faith attempt to comply with the new rule and applicable prohibited transaction exemptions during the transition period ending on Jan. 1, 2018.
The phased implementation can seem confusing. The bottom line is that many advisers who may not have been fiduciaries in the past will become fiduciaries starting on June 9, 2017. That includes advisers who give recommendations to ERISA plan participants to rollover their accounts to IRAs. Based on common compensation practices, they may need to adhere to requirements of a prohibited transaction exemption starting on that date as well. Until further notice is given, additional requirements (anti-conflicts policies, disclosures, and representations and warranties) for an exemption will apply beginning on Jan. 1, 2018.
Fiduciaries may still have a lot of work to do between now and the end of the year. That is why the DOL’s non-enforcement policy for those acting in good faith to comply with these standards is such welcome relief. As such, we continue to recommend that plan sponsors take the following steps sooner rather than later.
Review all existing advisory relationships to determine which entities will be considered fiduciaries under the new rule.
- Review existing educational materials provided to participants to determine whether they remain non-fiduciary “education,” or whether they are fiduciary investment “advice.”
- Review practices related to rollovers into and out of the plan to determine whether they trigger fiduciary obligations.
- Confirm that in-house employees who provide advice to participants are not being separately compensated for such advice (which will help those employees avoid the new fiduciary requirements).
- Confirm that existing plan investment managers can continue to rely on any needed prohibited transaction exemptions.
- Analyze contractual arrangements with advisers to confirm fiduciary status and compliance with rules and related exemptions. Those who become fiduciaries under this new rule should be providing ERISA 408(b)(2) fee disclosures.
- Confirm that the fee structure and amounts of compensation received by advisers are not prohibited transactions. In particular, ERISA 408(b)(2) fee disclosures should be reviewed to ensure that the disclosures are complete and that the overall arrangement is reasonable in light of the service performed.
We provide an additional overview of the fiduciary rule, prohibited transaction exemptions, and transition guidance below.
As a brief reminder, the DOL’s new fiduciary standard expanded the definition of who is a fiduciary by virtue of providing investment advice to plan sponsors and participants. Essentially, almost any piece of advice that can be considered a recommendation to buy, sell or hold a security makes an adviser a fiduciary. In the FAQs, the DOL confirmed that this standard will become effective June 9, 2017, without further delay.
Prohibited transaction exemptions
The expanded fiduciary definition could make many traditional arrangements prohibited transactions because the payments that advisers receive potentially could be considered to create conflicts of interest. In response to that concern, the final rule published a Best Interest Contract Exemption (BIC Exemption) and a Principal Transactions Exemption. It also amended current Prohibited Transaction Exemption 84-24, which generally applies to sales of annuities.
The BIC Exemption has received the most attention and is expected to be an important new exemption. As such, it will be the focus of this discussion. The BIC exemption allows advisers to receive compensation that otherwise could be prohibited (e.g., 12b-1 fees and revenue sharing payments) so long as they provide advice that is in the “best interest” of the client (essentially a combination of prudence and loyalty concepts). To satisfy this best interest requirement, advisers must (i) develop policies and procedures to avoid conflicts of interest, (ii) disclose information about the services they provide, fees, expenses, and potential conflicts, and (iii) enter into contracts with IRA and non-ERISA plan clients that contain representations and warranties about their adherence to these standards. Advisers whose compensation is based on a level fee (a fixed percentage of assets under management) have fewer disclosures to make under a “BIC Light” exemption, but the DOL has explained that BIC Light will be applied narrowly.
Transition relief for prohibited transaction exemptions
Needless to say, compliance with the BIC Exemption has required a lot of time and effort on the part of fiduciaries. Recognizing this issue, the DOL provided transition relief that allows fiduciaries to comply only with the following requirements through Dec. 31, 2017:
- Adherence to the impartial conduct standards (i.e., the prudence and loyalty requirements of the best interest standard)
- Charging no more than reasonable compensation
- Making no misleading statements about investment transactions, compensation and conflicts of interest
Interestingly, the FAQs add that the DOL “expects” financial institutions to develop policies and procedures that are reasonably determined to ensure that its advisers comply with the impartial conduct standards. That appears to be a new requirement for transition relief.
The DOL also acknowledged that it is continuing to review the fiduciary rule and related prohibited transaction exemptions to determine whether further changes are necessary, as required under a prior executive order of President Trump. The DOL requested information from commenters to determine where further changes should be made.
Non-enforcement policy for good faith attempts at compliance
Finally, the DOL’s non-enforcement policy states that during this transition period, the DOL “will not pursue claims against fiduciaries who are working diligently and in good faith to comply with the fiduciary duty rule and exemptions, or treat those fiduciaries as being in violation of the fiduciary duty rule and exemptions.” So, as long as you are making reasonable efforts to comply with the above requirements, that should safeguard against any potential DOL claims.