New rules for ERISA Plan investment advisors
On June 29, 2020, the Department of Labor (the Department) released a technical amendment (Technical Amendment) that implements the Fifth Circuit’s decision to vacate the Department’s controversial 2016 Final Regulation on Definition of Fiduciary, Conflict of Interest Rule – Retirement Investment Advice1 and two related prohibited transaction exemptions (2016 Rule) under the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code of 1986 (Code)2.
The Technical Amendment summarily wipes out 2016 Rule, and its two related prohibited transaction exemptions, and returns the applicable regulations and prohibited transaction exemptions back to where they were prior to the 2016 Rule. The Technical Amendment also clarifies and confirms standards for participant education with respect to investments. It is effective immediately, without any notice and comment period, and is discussed below.3
On the same date, the Department also released a proposed prohibited transaction exemption4 (Proposed Exemption) that addresses self-dealing and conflicts of interest under ERISA and the Code for financial institutions and investment professionals in providing “investment advice”5 to plans and participants in plans with self-directed investments. The Proposed Exemption applies primarily to registered investment advisors (RIAs), insurance company employees and agents, and broker-dealers (Investment Professionals6) who are themselves ERISA fiduciaries or who perform services for banks, investment houses, insurance companies and other financial institutions (Financial Institutions7) and their Affiliates8. While the Proposed Exemption addresses many of the same rules made mandatory in the 2016 Rule, the Proposed Exemption would provide relief from the prohibited transaction rules on an “as needed” basis, as determined by a Financial Institution or Investment Professional. The Department has requested comments on almost every significant provision of the Proposed Exemption.
A. Proposed Exemption
Plan fiduciaries are prohibited from engaging in self-dealing under ERISA. Absent an exemption, a fiduciary may not use the assets of a Plan or IRA in the fiduciary’s own interest or for its own account. ERISA also prohibits a fiduciary from causing a plan to pay an additional fee to a party-in-interest that could impermissibly influence the fiduciary from acting in the Retirement Investor’s9 best interest. The Proposed Exemption is primarily intended to address conflicts of interest that may arise when an investment fiduciary (including its affiliates or related entities) gives investment advice to Retirement Investors in a Plan that allows participant-directed investments and then receives additional compensation for executing transactions relating from that advice.10 An understanding to of “affiliates” is an important aspect of the Proposed Exemption.11
The Proposed Exemption’s stated objective is to protect Retirement Investors, while preserving wide availability of investment advice arrangements and products. Some Financial Institutions and Investment Professionals changed or eliminated business practices and investment products to comply with the 2016 Rules.
The Proposed Exemption covers all types of compensation, but specifically mentions three prevalent compensation structures for Financial Institutions and Investment Professions:
- For broker-dealers (or affiliates): execution fees based on a transaction implementing investment advice, including 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs, and revenue sharing payments from investment providers or third parties;
- For insurance Investment Professionals: commissions when the Retirement Investor buys an insurance product from the insurance company (or an affiliate) related to the Investment Professional’s advice; and
- For a Registered Investment Advisor (RIA): fees for investment advice based on assets under management or for a fixed fee that does not vary with asset levels. These types of fees may not even be prohibited transactions. However, if the RIA (or an affiliate) providing the investment advice causes itself (or an affiliate) to receive the level fee, then even a level fee might be a prohibited transaction requiring an exemption.
The Department has determined that one compensation structure does not fit all. Thus, the Proposed Exemption is available to various business models and compensation structures, provided that the Financial Institution and/or an Investment Professional satisfy impartial conduct standards intended to mitigate conflicts of interest12 (Impartial Conduct Standard). The Impartial Conduct Standard means:
- The advice is in Retirement Investors’ best interest,
- The compensation structure constitutes “reasonable compensation”, and
- No materially misleading statements are made about the investment transaction and other relevant matters.
The adoption of the ‘best interest’ standard is intentionally consistent with the Regulation BI issued by the Securities Exchange Commission (SEC) as well as best interest rules adopted by state insurance (New York) and securities (Massachusetts) regulators. The proposal provides that Advice is in a Retirement Investor’s “Best Interest” if such advice reflects the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, and does not place the financial or other interests of the Investment Professional, Financial Institution or any affiliate, related entity, or other party ahead of the interests of the Retirement Investor, or subordinate the Retirement Investor’s interests to their own.
In addition, the Impartial Conduct Standard requires a Financial Institution and its Investment Professionals to:
- Obtain the “best execution” of the investment transaction reasonably available, as required by the Securities Exchange Commission,
- Acknowledge in writing that the Financial Institution and Investment Professional are acting as ERISA fiduciaries when providing investment advice to a Retirement Investor. The writing must also describe the services to be provided, and any material conflicts of interest,13 and
- Adopt policies and procedures “prudently designed” to ensure compliance with the Impartial Conduct Standards and require a retrospective review of compliance.
The Proposed Exemption will not apply to situations already covered by other provisions of ERISA, including situations where the employer of the employees covered by the Plan; a named fiduciary; or a fiduciary who selects a plan administrator and other service providers, are not independent of the Financial Institution, Investment Professional and their Affiliates. The Proposed Exemption also does not cover “robo” advice generated solely by an interactive website providing investment advice based on personal information that the Retirement Investor enters into the website without any personal interaction with an Investment Professional; or Investment Professional acting in a fiduciary capacity other than as an investment advice fiduciary.14
Of particular interest is the Proposed Exemption’s treatment of rollovers from an ERISA Plan to an IRA, or from an IRA to another IRA. Investment advice to Retirement Investors on whether to rollover Plan benefits out of the Plan was a major focus of the 2016 Rule. In the Proposed Exemption, the Department recognizes that such Retirement Investors may be exposed to greater costs and lose important ERISA protections, including the benefit of a Plan fiduciary representing their interests in selecting investment options or structuring investment advice relationships, and the right to sue to protect their interests.
For these reasons, the Proposed Exemption prohibits an investment advice fiduciary from receiving a fee for investment advice provided to a Retirement Investor to rollover Plan benefits, unless certain conditions are satisfied. Such investment advice must satisfy the Impartial Conduct Standards, and, notably, the Financial Institution would be required to document the reasons that the advice to roll over was in the Retirement Investor’s best interest (as required under SEC rules).
The Proposed Exemption also would provide relief to Financial Institutions that engage in covered “principal transactions” with Plans and IRAs, provided certain conditions are satisfied.15 If an investment advice fiduciary engaging in a principal transaction is on both sides of the transaction, the firm has a clear conflict of interest. However, the Proposed Exemption would permit relief for “Covered Principal Transactions” in which a Financial Institutions and Investment Professional could receive compensation, provided that any compensation received is “reasonable”16 and certain other conditions are satisfied.
B. Technical amendment
Under ERISA section 3(21)(A)(ii), a person is considered a fiduciary with respect to an employee benefit plan to the extent that person “renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority to do so. . . . .” According to the Technical Amendment, the following information does not constitute the rendering of “investment advice”, regardless of who provides it (i.e., plan sponsor, fiduciary, service provider); how often it is provided; the form of delivery (e.g., on an individual or group basis, in writing or orally, or via video or computer software); or whether it is furnished alone or in combination with other information and materials.
This type of information includes:
- Educational information or materials about the benefits of participating in the plan, increasing of plan contributions, the impact of preretirement withdrawals on retirement income, and the terms of plan operation; and
- General investment information, such as investment philosophies, general financial and investment concepts; historic differences in rates of return between different asset classes (e.g., equities, bonds, or cash) based on standard market indices and other factors; assessment of risk tolerance and other factors explained in the Technical Amendment.
This information does not give rise to ERISA fiduciary liability, as long as it does not refer to the appropriateness of any individual investment option for a particular participant or beneficiary under the plan.
The asset allocation models generally available to all plan participants, such as pie charts, graphs or case studies, involving hypothetical individual’s investment portfolio; the historic returns of different asset classes (e.g., equities, bonds or cash); the model’s underlying facts and assumptions (e.g., retirement ages, life expectancies, income levels, financial resources and other factors) will not give rise to fiduciary liability. The model hypothetical investment portfolio produced by the asset allocation model must be accompanied with a statement that other investment alternatives with similar risk characteristic may be available under the plan (and how to obtain information about them); and that participants should consider their other personal assets, income and investments (e.g., equity in a home, IRA investments, savings accounts and interests in other qualified and non-qualified plans) in choosing plan investment options.
Questionnaires, worksheets, software and similar materials that allow participants to estimate future retirement income needs and to assess different asset allocations do not constitute “investment advice” or a “recommendation”, provided that they reflect certain requirements listed in the Technical Amendment are satisfied.
The plan sponsor’s or plan fiduciary’s selection of a service provider, including investment managers and advisors, for purposes of providing investment educational services or investment advice to plan participants continues to be a fiduciary act under ERISA. For example, the plan sponsor or fiduciary must consider such factors as the service provider’s qualifications, investment philosophy, credentials, track record and other factors.
Plan sponsors should be on the lookout for an acknowledgement in writing that the Financial Institution and Investment Professional are acting as ERISA fiduciaries when providing investment advice to a Retirement Investor, including rollovers out a Plan. The writing must describe the services to be provided, and disclose any material conflicts of interest.
182 Fed. Reg. 16902 (April 4, 2016)
2The 2016 Rule made significant changes to the definition of “investment advice” and “recommendations” to include many participant communications not previously thought of as advice, including certain marketing materials, an investment asset allocation calculator on a service provider’s website, participant investment education, and even oral conversations with bank branch employees regarding whether to roll over. Significantly, the 2016 Rule extended these fiduciary rules to IRAs.
3For purposes of the exemption, a Plan means any employee benefit plan described in ERISA section 3(3) and any plan described in Code section 4975(e)(1)(A). Code section 4975 defines a plan as an IRAs and a health savings accounts (HSA) – as well as an Archer medical savings account, and a Coverdell education savings account
4Prohibited Transaction Application No. D-12011
5The Department defines investment advice for this purpose under a 1975 regulation’s “five-factor” test. 29 CFR 2510.3-21(c)(1), 40 FR 50842 (Oct. 31, 1975). A financial institution or investment professional who is not otherwise a fiduciary must render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property (2) on a regular basis (3) pursuant to a mutual agreement, arrangement, or understanding with the Plan, Plan fiduciary or IRA owner that the advice will (4) serve as a primary basis of investment decisions with respect to Plan or IRA assets, and that (5) the advice will be individualized based on the particular needs of the Plan or IRA. A financial institution or invest professional that meets this five-part test, and receives a fee or other compensation, direct or indirect, is an “investment advice” fiduciary under ERISA and the Code.
6An Investment Professional is an individual who: (1) Is a fiduciary of a Plan or IRA who provides investment advice described in ERISA section 3(21)(A)(ii) or Code section 4975(e)(3)(B), (2) Is an employee, independent contractor, agent or representative of a Financial Institution; and (3) Satisfies the federal and state regulatory and licensing requirements of insurance, banking, and securities laws. See Proposed Exemption, section V.
7A Financial Institution means an entity employing or retaining the services of an Investment Professional, and that is: (1) a registered investment adviser under the Investment Advisers Act of 1940 or under state laws, (2) A U.S. bank or similar financial institution, or a savings association under FDIC rules; or (3) An insurance company that satisfies applicable licensing and other requirements. See Proposed Exemption, section V.
8For purposes of the exemption, an Affiliate would include: (1) Any person directly or indirectly through one or more intermediaries controls or is controlled by, or under common control with the Investment Professional or Financial Institution.
9A Retirement Investor means (1) A participant or beneficiary of a Plan with authority to direct the investment of assets in his or her account or to take a distribution; (2) The beneficial owner of an IRA acting on behalf of the IRA or (3) A fiduciary of a Plan or IRA. Proposed Exemption, section V
10Under ERISA, “a fiduciary may not use the authority, control or responsibility which makes such a person a fiduciary to cause a plan to pay an additional fee to such fiduciary (or to a person in which such fiduciary has an interest) which may affect the exercise of such fiduciary’s best judgment as a fiduciary) to provide a service.” 29 CFR § 2550.408b-2(e)(1).
11For example, Ace Investment Management Services may advise a Retirement Investor to rollover a plan benefit to an IRA, and Ace National Bank receives a fee for establishing and providing on-going management services for the IRA.
12A Conflict of Interest is an interest that might incline a Financial Institution or Investment Professional - consciously or unconsciously - to make a recommendation that is not in the Best Interest of the Retirement Investor.
13Interestingly, the exemption provides that Financial Institutions and Investment Professionals must police themselves in applying the Impartial Conduct Standard, rather than requiring an independent party.
1429 CFR 2510.3-21(c)(1)(i) and (ii)(B) or 26 CFR 54.4975-9(c)(1)(i) and (ii)(B) setting forth the test for fiduciary investment advice.
15A principal transaction may include the purchase from, or sale to, a Plan or IRA, of an investment, on behalf of the Financial Institution’s own account or the account of a person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the Financial Institution.
16Including the payments from a “riskless transaction” or the receipt of a mark-up, mark-down or other payments