Department of Labor releases final conflict of interest rule applicable to retirement investment advice
On April 6, 2016, the U.S. Department of Labor (DOL) released its final rule regarding the scope of individuals who are subject to a fiduciary standard when providing retirement investment advice. Accordingly, individuals providing investment advice for retirement accounts will be subject to a fiduciary standard.
What is retirement investment advice?
Covered investment advice is defined as any recommendation, for a fee or other compensation, direct or indirect, made to a plan, plan fiduciary, plan participant or beneficiary, Individual Retirement Account (IRA), or IRA owner as to (1) the advisability of acquiring, holding, disposing of, or exchanging securities or other investment property, including 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, or (2) the management of securities and other investment property or recommendations with respect to rollovers, transfers or distributions from a plan or IRA.
The central question in determining whether activity constitutes covered investment advice is whether a “recommendation” has occurred. A recommendation is a “communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.” The more tailored a communication is to a particular advice recipient, the more likely the communication will be considered a recommendation.
The DOL’s final rule details certain communications that are generally not considered to be investment advice recommendations, including the following:
- General educational information about retirement savings and investment;
- General communications that would not be regarded by a reasonable person as constituting investment recommendations — for example, newsletters, comments made in speeches, on television shows, at conferences, or general marketing materials;
- Options provided by platform providers — e.g., offering a selection of investment alternatives to plan fiduciaries who choose options that will be made available to participants;
- Transactions with independent plan fiduciaries with financial expertise;
- Swap and security-based swap transactions; or
- Reports and recommendations developed by employees of plan sponsors, affiliates, employee benefit plans, employee organizations or plan fiduciaries.
Expanding the definition of fiduciary
Individuals are subject to fiduciary obligations in making investment advice recommendations if certain relationships exist between the individuals and clients. As such, the final rule broadens the definition of fiduciary to include any person who, directly or indirectly, (1) represents or acknowledges that he or she acts as a fiduciary within the meaning of the Employee Retirement Income Security Act (ERISA) or the Internal Revenue Code; (2) renders investment advice pursuant to a written or verbal agreement that the advice is based upon the particular investment needs of the advice recipient; or (3) directs the advice to a specific advice recipient regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA. Additionally, recommendations only qualify as investment advice if they are provided, directly or indirectly, in exchange for a “fee or other compensation.” Individuals who qualify as fiduciaries are prohibited from engaging in self-dealing and receiving compensation from third parties in connection with transactions involving employee benefit plans and IRAs. Representatives of a registered investment adviser, a bank or similar financial institution, insurance company, or a broker-dealer are all subject to the expanded definition of fiduciary.
Best Interest Contract Exemption
The Best Interest Contract Exemption (BICE) allows individuals and firms to continue receiving “common compensation” such as commissions and revenue sharing, but still requires them to provide advice that is in their clients’ best interests. To qualify for the BICE, a representative and firm must abide by certain conditions. First, the individual and firm must acknowledge their fiduciary status with respect to investment advice to the investor. Second, “Impartial Conduct Standards” must govern the parties’ relationship, including requiring that only advice that is in the best interest of the client is given, that total compensation to the individual and firm will not exceed reasonable compensation, and that misleading statements about investment transactions, compensation, and conflicts of interest are prohibited. Third, the firm must warrant that it has policies and procedures in place that are reasonably and prudently designed to prevent violations of the Impartial Conduct Standards. Fourth, firms must refrain from giving or using incentives for individuals to act contrary to the client’s best interests. Finally, the firm must disclose all fees, compensation and material conflicts of interest associated with the investment advice recommendations.
The Principal Transactions Exemption (PTE) allows investment advice fiduciaries to sell or purchase certain recommended debt securities and other investments out of their own inventories to or from plans and IRAs. In order to be eligible for this exemption, fiduciaries must follow certain Impartial Conduct Standards, including obligations to act in clients’ best interests, avoid misleading statements, and attempt to obtain the best execution reasonably available under the circumstances for the transaction.
The DOL is also working to finalize an amendment to PTE 84-24, which will allow insurance agents, brokers and insurance companies to receive compensation for recommending fixed-rate annuity contracts to plans and IRAs. Additionally, the DOL plans to amend other existing exemptions to ensure that investors are consistently protected by the Impartial Conduct Standards.
To view the final rules in their entirety, see the links below:
- The Final Rule
- The Best Interest Contract Exemption
- The Principal Transactions Exemption
- The Amendment to PTE 75-1, Part V
- The Amendment to PTE 84-24
- The Amendment to PTE 75-1
- The Amendment to Class Exemptions 75-1, 77-4, 80-83, 83-1
Compliance with the final rule will not be required until April 10, 2017. The exemptions will also be available on the final rule’s applicability date; however, a phased implementation approach of the BICE and the PTE will create a transition period from April 2017 until January 1, 2018. During this time fewer conditions apply, including acknowledging fiduciary status, complying with the best interest standard and making basic disclosures of conflicts of interest. Firms must also designate a person responsible for addressing material conflicts of interest and monitoring individuals’ compliance with impartial conduct standards. Full compliance with the exemptions will be required on January 1, 2018.
How does the final rule differ from the proposed rule released in April 2015?
Asset list in BICE: The asset list applicable to the BICE has been eliminated. Now advice to invest in all asset classes is covered by the BICE.
Disclosure requirements: These requirements have been significantly streamlined. Some requirements, such as one-, five-, and ten-year projections or returns and fees at the point of sale and the annual transaction disclosure of fees and costs requirement, have been eliminated in their entirety. The requirement that firms include disclosures on a website remains in a simplified form with the stated purpose of enabling third parties to help customers evaluate firm practices.
Conversion to fee-based accounts: In response to fears that this provision would effectively eliminate commission-based compensation, the final rule provides examples of policies and procedures that are compatible with a commission-based model.
The DOL has provided a more complete list describing how the final rule addresses concerns expressed in the public comments submitted in response to the proposed rule.
If you have any questions about the topics covered above, please contact your regular Greensfelder contact or any member of Greensfelder’s Securities & Financial Services Group.