Employee Benefits Update – Spring 2016
By Robert Q. Johnson, ESOPs & Employee Benefits
Department of Labor’s New ERISA Fiduciary Rules May Impact Plan Sponsors
The DOL’s newly issued rules could impact a variety of retirement plan relationships by making a broad class of investment advisers “fiduciaries” under ERISA.
- For the first time, many financial advisers working with retirement plans will be held to higher “fiduciary” standards. To avoid personal liability for a prohibited transaction and significant excise taxes, advisers must comply with the new “best interest” standard when making an investment recommendation. This standard parallels the ERISA fiduciary standards and requires advisers to act in the plan’s best interest (without regard to their own fees or compensation) when making an investment recommendation, receive no more than reasonable compensation for their advice, and refrain from making misleading statements. Advisers and their firms must decide whether to begin acting as a fiduciary or limit their involvement to qualify for an exception to the new rules.
- Plan sponsors—or members of the sponsor’s retirement plan committee—should communicate with their advisers to ensure they understand whether their adviser is, or will be, acting as a fiduciary under the new rule. Sponsors should also expect to receive updated agreements and disclosure documents. These changes do not create any new direct obligations for plan sponsors.
- Plan participants will not be directly affected by the new rule.
Implementation of New Rules
On April 8, 2016, the Department of Labor (“DOL”) released the final rules expanding the scope of fiduciary status under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code (the “Code”). The new rules begin to phase in between June 2016 and January 2018.
Current Definition of “Fiduciary”
Broadly speaking, a “fiduciary” includes any person to the extent he or she has or exercises discretionary control over plan assets and administration. The new rules do not change the fiduciary status of those already acting in a fiduciary capacity, such as plan sponsors, retirement plan committees, and investment managers with discretionary authority to manage plan assets. The new rules do not specifically add or modify any responsibilities these fiduciaries already have, but they may require additional action by existing fiduciaries.
The DOL’s prior interpretation of when investment advice constitutes a fiduciary function was issued when defined benefit pension plans prevailed and covered only a limited set of individualized and ongoing investment recommendations that formed the primary basis of the plan’s investments. Given the ubiquity of participant-directed 401(k) plans, the existing interpretation failed to cover most financial advisers servicing these plans. Many investment advisers will find themselves being fiduciaries for the first time, particularly when providing services to 401(k) plans.
New Definition of “Fiduciary”
Under the new rules, an adviser is considered a fiduciary if he or she provides investment advice for a fee (directly or indirectly, from any source, including a third party by way of revenue sharing, loads, commissions, and other forms of direct or indirect payment). Fiduciary investment advice is broadly defined as:
- a recommendation about the advisability of acquiring, holding, disposing of or exchanging securities or other investment property; or
- a recommendation as to the management of securities or other investment property, including a recommendation 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 example, commission-based brokerage v. fee-based advisory).
The crucial determination is whether the adviser is making a “recommendation.” The final rule defines “recommendation” as communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the recipient of the advice engage in or refrain from taking a particular course of action. As is clear, the definition does not provide a bright-line test for what is or isn’t a recommendation. However, the DOL explained that the more individualized and tailored the communication, the more likely it will be deemed a recommendation regardless of the label applied by the adviser.
Certain activities, however, do not rise to the level of a recommendation. The final rule includes a list of examples, including:
- offering an investment platform for participant-directed plans;
- providing generic investment education information and materials to plan participants, including asset allocation models and interactive investment materials for plan participants;
- making general or public recommendations through channels like television shows, newsletters, or other widely distributed communications about investments; and
- employees of the plan sponsor performing administrative functions with respect to the plan.
There are also several administrative exemptions covering specific transactions.
Many advisers will for the first time find themselves classified as fiduciaries under ERISA. As a result, these advisers will have to ensure they are acting in the participants’ best interests when making investment recommendations.
To comply with the new fiduciary standards, advisers must meet the “best interest contract” exemption or face a prohibited transaction with punitive excise taxes. Generally speaking, advisers must act in the best interests of plan participants when making investment recommendations, without regard to any fees or compensation the adviser stands to receive. Advisers must also receive no more than “reasonable” compensation, and must not make any misleading statements about the recommended investments or their compensation.
Plan Sponsor Impact
To the extent an employer is already exercising fiduciary authority over its retirement plan, as most employers are, the new rules do not change that dynamic. Plan sponsors acting as fiduciaries do, however, need to make sure they understand the capacity in which their advisers are acting.
If a plan’s adviser was not previously acting as a fiduciary, they may now be considered fiduciary investment advisors under the new rules. Advisers who currently recommend investment options based on the individualized needs of each plan will be treated as fiduciaries under the new rules. While some advisers will become fiduciaries, others may choose to limit the scope of their services in the future to avoid making a recommendation that would cause them to become a fiduciary. If plan sponsors are unsure whether their advisers were acting as fiduciaries—or will now be acting as fiduciaries—they should ask. Plan sponsors should likewise ensure their service agreements with their advisers accurately reflect the adviser’s capacity and scope of services.
There are consequences for the plan sponsor: Where the fiduciary adviser act violates the fiduciary rules newly imposed on the adviser, that transaction (or the continued retention of the adviser) could result in co-fiduciary liability to the plan sponsor.
Other Impacts on Financial Advisers
Aside from expanding the scope of investment advice subject to a fiduciary standard under ERISA-governed, employer-sponsored retirement plans, the new rules significantly affect the IRA market, including the advice offered to IRA owners as well as a recommendation by an adviser to roll over a 401(k) balance to an IRA. Again, this marks the first time many advisers will be subject to the more stringent fiduciary rules when advising current or prospective IRA owners. While there are similar exceptions for advisers to recommend IRA investment products and receive types of compensation historically permitted, the advisers must put their clients’ interests first when making investment recommendations.
If you have any questions about how these new rules will impact you, please contact a member of the Kaufman & Canoles ESOP & Employee Benefits practice group.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.