Conflict of interest or fiduciary rule: A plan sponsor’s Q&A
After years of proposed regulation issuance, comment periods, drafting and anticipation, the Department of Labor (DOL) finally published new final guidance regarding the definition of “fiduciary” on April 8, 2016. It is important for plan sponsors to understand the reasoning behind, and the scope of, the final rules. The following Q&A is meant to assist you in understanding the regulations and how they pertain to you, your plan and your participants.
Why did the DOL issue these new rules?
The definition of “fiduciary” for purposes of providing investment advice dates back decades, predating the advent of 401(k) and other defined contribution plans. Prevalent thought within the retirement industry was that the definition was due for an update to reflect the evolution of the retirement plan landscape and to bring more parties under the scope of the Employee Retirement Income Security Act of 1974 (ERISA) standard of care for fiduciaries.
Who are the primary targets of the new rules?
The primary targets of the new rules are providers of retirement plan services and products. Advisors, consultants, recordkeepers and third-party administrators are those most affected by the new rules. The primary objective of the regulations is to sweep into the definition of “fiduciary” more individuals and organizations who may influence plans, plan sponsor fiduciaries and participants in regards to investing-related activities. In so doing, these individuals and their organizations will be held to the highest standard of care in providing investment advice and recommendations under the terms of the ERISA.
In a nutshell, what do the new rules say?
Essentially, the new rules provide that an individual and organization will be a fiduciary under ERISA if they make a recommendation to a plan, plan sponsor fiduciary (e.g., a plan committee) or plan participant (or beneficiary) regarding investment products and services, distributions or rollovers, and they receive a fee for doing so. “Recommendation” is defined as a communication that can reasonably be viewed as a suggestion that the recipient of the information take (or refrain from taking) some course of action.
In the past I recall hearing that certain providers could not be a fiduciary, does that remain true?
In the past, service providers that received uneven, or “conflicted” compensation, would not agree to serve in a fiduciary capacity because they could affect, or influence, their compensation which would have resulted in a prohibited transaction.
Under the new rules, a best interest contract exemption (the BIC exemption) has been created to account for such scenarios. Additionally under the new rules, all individuals and organizations meeting the definition of fiduciary are going to be treated as fiduciaries, regardless of the design of their compensation. In order to avoid a prohibited transaction, fiduciaries receiving conflicted compensation (such as commissions) can continue such compensation design as long as they meet certain requirements, one of which is to commit to providing recommendations that are in the best interests of the recipient of services and recommendations.
Does our plan fall under the new rules?
All ERISA-covered plans that have an investment element will be covered. In essence, 401(k), 403(b), profit sharing, money purchase pension and defined benefit plans will all be covered. Interestingly, recommendations for taking a distribution or rolling over to an IRA will also be covered. And an unexpected surprise for most plan sponsors is that health savings accounts (HSAs) are also covered.
The proposed rules seemed to have a heavy emphasis on participant education. Did that carry over to the final rules?
The new rules explicitly state that plan sponsors and service providers may provide general plan information, general financial, investment and retirement information, notional asset allocation models and interactive investment tools without becoming a fiduciary. The proposed rules were going to prohibit use of specific investments in plans being used in models or interactive tools if the provider wished to avoid fiduciary status. The new final rules allow for identification of specific investments if the following conditions are met:
- The models and tools only identify designated investment alternatives (DIAs) in the plan that are monitored by fiduciaries that are independent from the individual or organization that developed or marketed the investment alternative
- Other DIAs, with similar risk and return characteristics, that are not used in the model or tool are identified
- A statement that those other DIAs are similar
- Identification of where participants and beneficiaries can get additional information regarding those similar DIAs
Are my employees (employees of the plan sponsor) going to be considered fiduciaries under these rules?
Typically, no. If the employees aren’t receiving a fee (not considering their wages) for providing either of the below-listed recommendations, they will not be considered a fiduciary under the rules:
- Work in human resources or finance departments and provide recommendations to the plan committee
- Communicate information regarding the plan and/or distribution options to participants
When can I (plan sponsor) expect a plan’s service provider to be considered a fiduciary under the new rules?
The new rules will sweep quite a few additional individuals and organizations within the definition of fiduciary due to the types of activities that will now be considered recommendations leading to “investment advice.” Under the new rules, even many sales and marketing actions will be considered fiduciary in nature. That said, there are a few common instances where communication between the sponsor and the service provider will not be fiduciary in nature. These include (but are not limited to):
- Requests for proposals (RFPs) – Service providers may provide investment lineups if they are responding to an RFP for services. This is common with RFPs for recordkeeping services, and occasionally with RFPs for advisory services. The proposed investment lineup may be based on plan size, or the plan’s current investment menu. However, for this type of communication to avoid straying into the fiduciary realm the service provider must disclose any financial interest it may have (if any) in any of the investments. This would be common if the recordkeeper is also a fund company that offers proprietary offerings.
- Independent plan fiduciaries – Service provider recommendations that are made to plan fiduciaries, independent of the advisor, may also not give rise to fiduciary status. In this instance, the independent fiduciary must possess “financial expertise” which is considered present if they are a registered investment advisor, or holds, manages or controls (in the aggregate) at least $50 million in assets. In these instances the advisor needs to have made a number of determinations regarding the independent fiduciary, in addition to the fact that they possess financial expertise.
- Marketing – As long as a service provider does not market an investment platform as meeting individualized needs of a plan, and the provider states that it is not providing impartial advice or acting in a fiduciary capacity, the marketing of the platform is not a fiduciary action.
Will the new rules affect my (plan sponsor) relationship with my plan’s service providers?
The answer depends upon the service providers’ current engagements with the plan and plan sponsor. For service providers presently serving in a fiduciary capacity role, little may change. It is possible that they move from a broker-dealer engagement to a registered investment advisory relationship to make the engagement cleaner and more transparent. But that likely will not affect the services, compensation or fiduciary nature of the engagement.
Service providers receiving “conflicted,” or uneven compensation, will have to decide if they wish to continue under that design, and meet the BIC exemption rules, in which case you will receive a great deal more disclosure and the advisor will have to meet more arduous requirements (duties of prudence and loyalty, disclose their conflict of interest policies, etc.) than those to which they are accustomed. Or they may alter their engagement to a fee-level or RIA engagement. Either way, they will most likely have to live up to ERISA’s high fiduciary standard of care moving forward