The Times Are Changing: A First Look At The DOL’s New Fiduciary Paradigm - Employee Benefits & Compensation

On April 14, 2015, the US Department of Labor (the "DOL") issued its proposed rule clarifying when individuals and institutions providing advice to employee benefit plans and individual retirement accounts ("IRAs") will be fiduciaries for purposes of the Employee Retirement Income Security Act of 1974 ("ERISA") and the prohibited transaction provisions of the Internal Revenue Code (the "Code"). This detailed DOL proposal tackles the relationship between individuals who invest through IRAs, small plans and participant-directed plans and the investment professionals who provide advice and products to this growing segment of the market. It is being rolled out with considerable support from the White House, which signals that significant portions of the proposal may be adopted substantially as proposed.

Under the DOL's new paradigm, a broader array of advice and services will result in investment professionals being fiduciaries for purposes of ERISA. Most significantly, the proposal will expand the reach of ERISA's fiduciary duties and remedies by giving investment professionals the option, as a condition to relief from ERISA and the Code's prohibited transaction rules, to agree to have ERISA's fiduciary standards and remedies apply to them by contract in situations where they might not otherwise apply by statute.

The DOL's proposal will require financial institutions to rethink the way they and their investment professionals are compensated and will require a careful assessment of the costs and benefits of complying with the new requirements for prohibited transaction relief.

This client publication discusses the key aspects of the proposal and diagrams the key elements of each of the proposal's main components. Future client publications will analyze in greater detail key aspects of the proposal and suggest areas that may be appropriate for comment.

The Key Components of the Proposal

The DOL's proposal consists of the following three components:

A new proposed rule defining when persons providing investment advice to employee benefit plans and IRAs are so-called "advice fiduciaries" for purposes of ERISA and the Code.¹
Two new proposed prohibited transaction exemptions offering relief for certain fee and other commercial practices applicable to fiduciaries. The more important of the two is the proposed Best Interest Contract Exemption (the "BIC Exemption") that, among other things, conditions relief on an agreement to have ERISA's fiduciary standards apply by contract to advisers to IRAs and certain covered plans.²
Amendments, revisions or the actual repeal of portions of existing prohibited transaction exemptions to conform to the impartial conduct standards in the BIC Exemption or to prior DOL regulatory initiatives.³

If adopted in their present form, the DOL's new proposed rule and proposed exemptions will expand the types of interactions with employee benefit plans and IRAs that result in fiduciary status. The expansion of fiduciary status will require the substantial alteration of common compensation and other commercial practices of the investment professionals who advise IRA, small plan and participant directed investors.

The Paradigm Shift in the Proposal

The proposal embraces a major paradigm shift in the way that ERISA applies to investment professionals who advise and offer investment products to the retail employee benefit plan and IRA market. The key elements of this shift are the following:

The proposed rule aims to have ERISA fiduciary rules apply broadly to those who advise IRAs, small employee benefit plans and participants in self-directed plans.
The proposed rule enumerates specific types of advice to employee benefit plans and IRAs that will result in fiduciary status, in situations where the advice giver receives a fee or other direct or indirect compensation in connection with rendering the advice. The advice does not need to be on a regular basis, and there does not have to be an understanding that the advice will form the primary basis for the investment decision, as long as the advice is individualized or directed to the advice recipient for consideration in making investment decisions.⁴
If advice givers acknowledge that they are fiduciaries, all categories of advice listed in the proposed rule will result in fiduciary status.
Advice to take a plan distribution or to effect a rollover to an IRA is included in the categories of advice that will result in fiduciary status.
The proposed rule will make it difficult, if not impossible, to continue compensation arrangements for advisers to IRAs and employee benefit plans where the amount of compensation or fee income, direct or indirect, varies based on security or product selection, unless the advisers and financial organizations comply with the BIC Exemption.
The BIC Exemption is broad and principles-based. It has, at its core, "impartial conduct standards" that essentially condition relief from ERISA's prohibited transaction rules on the agreement by individual advisers to IRAs or employee benefit plans (and the financial organizations that employ these advisers) to have ERISA fiduciary standards apply by contract to them.

Effective Date and Comment Period

The DOL will accept written comments on or before July 6, 2015. The DOL plans to hold a public hearing during the 30-day period following the close of the comment period. Following the hearing, the DOL will accept additional written comments for a limited period of time.

The final DOL rule will be effective 60 days after its publication in the Federal Register, and the requirements of the final rule will generally become applicable eight months after publication in the Federal Register. The BIC Exemption will be available eight months after publication of the final rule and the other new and amended exemptions will be effective at that same time.

Next Steps

Now that the proposal has been published, you should consider how this new paradigm could affect your business. You may wish to submit a comment letter to the DOL or attend the public hearing. The following pages contain a set of charts designed to illustrate the application of the proposal.

Charts 1-3: These charts explain the general application of the proposal, focusing on how one becomes an investment advice fiduciary, the four different types of advice that would qualify as fiduciary investment advice under the proposal, and the various carve-outs from the concept of fiduciary investment advice that could apply. They may be most useful for those seeking to understand the general scope of the proposal.
Charts 4-8: These charts describe the requirements for satisfying certain specific carve-outs. They should prove useful in ascertaining the impact of the proposal on individual businesses and persons.
Charts 9-10: These charts explain the parameters of two new exemptions, the BIC Exemption and the Principal Transaction Exemption. They may be most useful to attorneys seeking to understand the application of these exemptions.
Chart 11: This chart depicts the changes to existing prohibited transaction exemptions imposed by the proposal, and may be most useful to attorneys who are familiar with the existing exemptions.
Note that, in the charts, outward-pointing arrows indicate conjunctive requirements, all of which must be established to satisfy the requirement in the center of the chart (see charts 1, 4-10). Inward-pointing arrows indicate alternative options (see charts 2-3).

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Footnotes

1. The proposed rule may be found at: http://www.gpo.gov/fdsys/pkg/FR-2015-04-20/pdf/2015-08831.pdf.

2, The proposed exemptions may be found at: http://www.gpo.gov/fdsys/pkg/FR-2015-04-20/pdf/2015-08832.pdf (Best Interest Contract

Exemption) and http://www.gpo.gov/fdsys/pkg/FR-2015-04-20/pdf/2015-08833.pdf (Principal Transaction Exemption).

3. The amendments and revisions may be found at: http://www.gpo.gov/fdsys/pkg/FR-2015-04-20/pdf/2015-08836.pdf; http://www.gpo.gov/fdsys/pkg/FR-2015-04-20/pdf/2015-08837.pdf; http://www.gpo.gov/fdsys/pkg/FR-2015-04-20/pdf/2015-08839.pdf; and http://www.gpo.gov/fdsys/pkg/FR-2015-04-20/pdf/2015-08838.pdf.

4. Under the current DOL regulations, a person provides investment advice as a fiduciary if he (1) provides advice as to the value of securities or other property or makes investment recommendations, (2) on a regular basis, (3) pursuant to a mutual agreement, arrangement or understanding with a plan fiduciary that (4) the advice will serve as the primary basis for investment decisions with respect to plan assets and that (5) the advice will be individualized based on the particular needs of the plan or IRA.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.