Lindabury, McCormick, Estabrook & Cooper, P.C. Firm News & Events
On April 14, 2015, the Department of Labor, Employee Benefits Security Administration (“EBSA”) released a proposed regulation defining who is a “fiduciary” of an employee benefit plan under the Employee Retirement Income Security Act of 1974 (“ERISA”) as a result of giving investment advice to a plan or its participants or beneficiaries. If adopted, the new regulation would treat individuals who provide investment advice or recommendations to an employee benefit plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owners as fiduciaries under ERISA and the Internal Revenue Code (the “Tax Code”). The proposed rule seeks to increase consumer protection for plan sponsors, participants, beneficiaries and IRA owners by naming financial advisers and their firms as fiduciaries, thus compelling such advisers to abide by certain duties of good faith and loyalty to their clients, subject to specific carve-outs and exceptions.
Under the current statutory and regulatory scheme, fiduciary status is central to protecting the integrity of retirement and other important tax-favored benefits. Generally, a person is a fiduciary to a plan or IRA to the extent that the person engages in specified plan activities, including rendering investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of a plan. ERISA imposes standards of care and undivided loyalty on plan fiduciaries and holds such fiduciaries liable when these duties are violated. IRA and plan fiduciaries are not permitted to engage in “prohibited transactions” which stem from conflicts of interest and endanger the security of retirement, health and other benefit plans.
EBSA’s new proposal expressly expands these duties to financial advisers and their firms, by broadening the definition of fiduciary “investment advice,” subject to specific exceptions or carve-outs for particular kinds of communications that are non-fiduciary in nature. Under the new definition, a person renders investment advice by:
- providing investment or investment management recommendations or appraisals to an employee benefit plan, a plan fiduciary, participant or beneficiary, or an IRA owner or fiduciary, and
- either (a) acknowledging the fiduciary nature of the advice, or (b) acting pursuant to an agreement, arrangement, or understanding with the advice recipient that the advice is individualized to, or specifically directed to, the recipient for consideration in making investment or management decisions regarding plan assets. When this advice is provided for a fee or other compensation, direct or indirect, the person giving the advice is a fiduciary.
The new definition of investment advice could sweep in some relationships that are not appropriately regarded as fiduciary in nature and that EBSA does not believe Congress intended to cover as fiduciary relationships. Accordingly, the proposed regulation includes a number of specific carve-outs to the new general definition. For instance, the regulation draws a distinction between fiduciary investment advice and non-fiduciary investment or retirement education. Likewise, under a new “seller’s carve-out,” the proposed regulation would not treat as fiduciary advice recommendations made to a plan in an arm’s length transaction where there is generally no expectation of fiduciary investment advice, so long as the carve-out’s specific conditions are met. Additionally, the proposed regulation includes specific carve-outs for advice rendered by employees of plan sponsors, platform providers, and individuals who offer or enter into swaps or security-based swaps with plans. All of the proposed rule’s carve-outs are subject to conditions designed to distinguish fiduciary and non-fiduciary communications consistent with ERISA and the Tax Code.
In addition to the new proposal, EBSA is simultaneously proposing a new Best Interest Contract Exemption that would provide conditional relief for common compensation, such as commissions and revenue sharing, that a financial adviser and the financial adviser’s firm might receive in connection advice to retail retirement investors. This new exemption requires the financial adviser and the adviser’s firm to contractually acknowledge fiduciary status, commit to adhere to basic standard of impartial conduct, adopt policies and procedures reasonably designed to minimize the harmful impact of conflicts of interest, and disclose basic information on their conflicts of interest and on the cost of their advice. Integral to this new exemption is the financial adviser’s agreement to meet fundamental obligations of fair dealing and fiduciary conduct.
The proposed regulation also includes a new exemption for “principal transactions,” in which debt securities are sold to plans or IRAs from the financial adviser’s own inventory. In addition, EBSA is seeking public comment on whether it should issue a separate streamlined exemption that would allow financial advisers to receive otherwise prohibited compensation in connection with the plan, participant and beneficiary accounts, and IRA investments in certain high-quality, low-fee investments, subject to fewer conditions. Finally, the proposal carves out general investment education from fiduciary status. Sales pitches to large plan fiduciaries who are financial experts, and appraisals or valuation of the stock held by employee-stock ownership plans, are carved out.
This new regulatory proposal seeks to allow financial advisers and their firms to give advice that is in the best interest of their clients, without disrupting common compensation arrangements under conditions designed to ensure that the financial adviser is acting in the client’s best interest. EBSA will seek comments on the proposed regulation for 75 days following its publication in the Federal Register. The proposal and a number of guidance documents, including information on the proposed exemption for principal exemptions and the best interest contract exemption may be found on the Department of Labor’s website.