The U.S. Department of Labor (DOL) has finalized regulations describing the circumstances in which a person who provides investment advice in connection with a retirement plan or individual retirement arrangement (IRA) acts as a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code.

The regulations, known as the investment advice fiduciary rules, were issued together with a series of proposed amendments to prohibited transaction exemptions. They will significantly alter the landscape for how employee benefit plans, their fiduciaries and participants, and IRA holders receive investment advice. The DOL initially proposed a version of these investment advice fiduciary rules in October 2010, but later withdrew the initial proposal due to concerns raised by the business community and lawmakers from both parties. Proposed regulations were reissued in April 2015

The new investment advice fiduciary rules broadly define a fiduciary to include any individual who provides investment advice for a fee to an ERISA-covered plan, a plan fiduciary, a plan participant or beneficiary, or an IRA holder for consideration in making a retirement investment decision. Under current law, providing investment recommendations to IRA holders was not considered a fiduciary activity. The rules encompass:

  • Recommendations as to the advisability of buying, selling, or holding investments;

  • Recommendations as to the advisability of taking a distribution of assets from a plan, and the investment of those distributed assets;

  • Recommendations as to the management of investments, including the management of assets to be distributed from a plan or IRA; and

  • Recommendations of a person who will receive a fee for any of the functions described above.

The regulations stipulate that a prohibited transaction exists under both ERISA and the Internal Revenue Code where an investment advice fiduciary receives certain types of “conflicted compensation” in connection with the investments that he or she sells to a retirement plan or IRA because of the inherent conflict of interest between the investment advice fiduciary and the plan, plan participants, or IRA holder. These types of conflicted compensation include “commissions, trailing commissions, sales loads, 12b-1 fees, and revenue-sharing payments from investment providers or other third parties” which, by their nature, could vary based on the investment recommended. (Receipt of such compensation previously had constituted a prohibited transaction in connection with retirement plans, unless certain conditions were met.)

In conjunction with the regulations, the DOL issued a new series of prohibited transaction exemptions and amendments to existing prohibited transaction exemptions. Most investment advisers who intend to continue receiving conflicted compensation are expected by the DOL to utilize the “Best Interest Contract” exemption. This provides relief from prohibited transaction restrictions on conflicted compensation received by investment advice fiduciaries as a result of the purchase, sale or holding by a plan or IRA of certain investments.  Among other conditions, the exemption requires the investment advice fiduciary to adhere to basic standards of impartial conduct, which include:

  • Giving advice that is in the client’s best interest;

  • Avoiding misleading statements; and

  • Receiving no more than reasonable compensation.

The basic standards of impartial conduct set forth in the new proposed exemption reflect the standards that already apply under ERISA to advisers who work with employee benefit plans.

The Best Interest Contract exemption also requires that an investment advice fiduciary enter into a contract with the client that acknowledges the adviser’s fiduciary status. It cannot include exculpatory provisions limiting the liability of the fiduciary in the event of a violation of the contract’s terms. A fiduciary who breaches this contract could be subject to a private cause of action for breach of contract. This is especially important in the case of IRAs, whose owners do not currently have a cause of action against investment advisers for breach of fiduciary duties under ERISA. The proposed exemption permits the contract to provide for individual dispute resolution through arbitration, but prohibits any limitation on the right of a plan, participant, or IRA owner to bring or participate in a class action lawsuit to resolve disputes.

The final regulations included some significant changes from the proposed regulations issued in April 2015. The final regulations allow the contract required under the Best Interest Contract exemption to be adopted at the time investments are purchased instead of the time in which they are initially recommended, and eliminate the requirement that a formal contract be required for participants in ERISA-covered plans. Additionally, the final regulations no longer define appraisals and fairness opinions regarding investments, including opinions for valuations of employee stock ownership plans (ESOPs) as fiduciary functions and specifically exempt health and welfare plans, disability plans, and term life insurance policies from complying with its requirements.

Plan sponsors and investment providers are required to comply with these regulations beginning in April 2017, with a phased approach under which fewer conditions apply between April 2017 and January 1, 2018. We can assist plans and investment advisers in reviewing their service agreements to determine how their arrangements will need to be modified to comply with the new regulations and prohibited transaction exemptions.

If you have further questions about the final regulations, please contact the authors of this alert.


Copyright © 2016 by Ballard Spahr LLP.
www.ballardspahr.com
(No claim to original U.S. government material.)

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, including electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the author and publisher.

This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.