THE DOL’S NEW FIDUCIARY PROPOSAL
A POTENTIAL GAME CHANGER FOR
RETIREMENT INVESTMENT SERVICES
June 2015
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INTRODUCTION
The DOL fiduciary proposal
Broadens scope of advisors deemed to be fiduciaries
Agenda
• History and Existing Rules
• Proposed Fiduciary Definition
• Proposed Exemption
• Impact of DOL Proposal on IRA Markets
• Timeline for DOL Fiduciary Rule
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HISTORICAL BACKGROUND
ON FIDUCIARY RULES
Different standards based on advisor type
• Brokers subject to suitability standard under FINRA rules
• Registered investment advisers (RIAs) have fiduciary duty under
Investment Advisers Act or state law
ERISA fiduciary standard
• Fiduciary status triggered by advice (and not advisor type) under
Employee Retirement Income Security Act (ERISA)
• Providers of “investment advice” for compensation are fiduciaries
• RIAs (and not brokers) customarily acknowledge ERISA fiduciary status
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EXISTING ERISA FIDUCIARY DEFINITION
ERISA fiduciary status of advisor
Triggered if “investment advice” is provided for compensation
Existing definition of “investment advice” (5-prong test)
• Recommending plan investments
• Regular basis
• Mutual understanding
• Primary basis for plan’s decisions
• Individualized to plan’s needs
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BACKGROUND ON DOL
FIDUCIARY PROPOSAL
DOL’s initial proposal
• Proposed in 2010
• Withdrawn amid controversy
DOL’s new fiduciary proposal
• DOL releases new proposal on April 20, 2015
• Intended to represent flexible approach in regulating retirement advisors
• Promoted and supported by White House
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DOL’S PROPOSED FIDUCIARY DEFINITION
Proposed definition of “investment advice” (4-prong test)
• Making covered recommendations
o
recommending investments (including rollovers),
o
recommending investment managers,
o
giving appraisals, or
o
recommending other advisors who do any of above
• Understanding (does not need to be mutual)
• Individualized or specifically directed to retirement client
• Considered by client (even if not primary basis for decision)
Questions for DOL regarding its defined terms
• Meaning of “recommendation” and “specifically directed”
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ACKNOWLEDGING FIDUCIARY STATUS
Deemed investment advice fiduciaries
• Advisor makes covered recommendations
• Acknowledges that it is a fiduciary with respect to such advice
• No written acknowledgement is required
• Fiduciary status applies automatically, even if proposed
4-prong definition is not met
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PROPOSED CARVE-OUT
FOR INVESTMENT EDUCATION
Existing safe harbor for non-fiduciary education (I.B. 96-1)
• Plan Information
• General Financial/Retirement Information
• Asset Allocation Models
• Interactive Investment Materials
Modifications under proposed carve-out
• Expanded to include retirement income guidance
• Must not reference plan’s specific investments
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IMPLICATIONS OF DOL
FIDUCIARY PROPOSAL
Fiduciary status more easily triggered for advisors
• No carve-out for one-time advice
• Client merely needs “understanding” that advice will
be “specifically directed” for client’s “consideration”
• Brokers making covered recommendations highly likely
to be viewed as fiduciaries
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CRITICAL NEED FOR EXEMPTION
UNDER DOL PROPOSAL
Broader fiduciary definition and prohibited transactions
• Prohibited transaction rules ban fiduciary advisors from earning variable
compensation (commissions)
• Advisors making covered recommendations and receiving commissions (brokers)
would be fiduciaries
• Exemption from prohibited transaction rules would be required for brokers,
including advisors to IRAs
Best interest contract exemption
Released by DOL along with its fiduciary proposal
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BEST INTEREST CONTRACT
(BIC) EXEMPTION
Purpose of exemption
• Enables fiduciary advisors to earn variable compensation
• Brokers serving as fiduciaries would be able to earn commissions
• Firm must eliminate incentives for advisors to provide improper advice (and
further clarification expected from DOL)
• Relief for advisors to IRAs and small retail plans (<100 participants)
• Currently covers small, non-participant-directed plans only
(but relief for small, participant-directed plans also expected)
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OVERVIEW OF BIC EXEMPTION
General requirements under exemption
• Written contract with mandatory terms
• Comprehensive disclosures
• Range of investments (reasonably necessary asset classes)
• Advice limited to covered investment products only
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BIC EXEMPTION — WRITTEN CONTRACT
Mandatory terms for written contract
• Must include fiduciary status of advisor
• No liability limit permitted for contract violations
(but arbitration permitted)
• Must include “impartial conduct standard”
• Must include required warranties
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BIC EXEMPTION — WRITTEN CONTRACT
(IMPARTIAL CONDUCT STANDARD)
“Impartial conduct standard” for advisor
• Advice must be in “best interest” of client
• “Best interest” standard is similar to customary
“prudent man” standard for fiduciaries under ERISA
• Services must be provided for reasonable compensation only
• Must not make any misleading statements
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BIC EXEMPTION — WRITTEN
CONTRACT (WARRANTIES)
Required warranties from advisor
• Will comply with law
• Firm has adopted compliance policies reasonably
designed to mitigate conflicts
• Firm has eliminated incentives for advisor to provide
improper advice in violation of “best interest” standard
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BIC EXEMPTION — DISCLOSURES
Four types of required disclosures
• Up-front disclosures with cost of investing for 1-, 5- and 10-year periods
• Annual disclosures covering investment and fee activity during each period
• Webpage disclosures with full compensation, sources of compensation,
and how amounts would vary by investment
• Written contract must identify conflicts, any proprietary products
or third-party payments, and other disclosures
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BIC EXEMPTION —
RANGE OF INVESTMENTS
Full range of investment products available through advisor
Must be broad enough to allow advisor to make recommendations
in all reasonably necessary asset classes
Requirements triggered for limited range
• Written finding that limited range does not interfere with
“best interest” standard for advice
• Reasonable compensation for services
• Written notice of limited range
• Must notify if recommended investments are not sufficiently
broad for client’s needs
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BIC EXEMPTION — COVERED
INVESTMENT PRODUCTS
Scope of covered investment products under BIC exemption
• Bank deposits and CDs
• Mutual funds, ETFs, CIFs and insurance/annuity products
• Publicly traded securities are also generally covered
Excluded investment products
• BIC Exemption does not cover non-traded REITs or alternative investments
• Retirement advisors may be unable to sell excluded products for
commission-based compensation to plans and IRAs
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RECAP OF BEST INTEREST
CLASS EXEMPTION
BIC exemption requirements
• Written contract with mandatory terms
• Comprehensive disclosures
• Range of investments (reasonably necessary asset classes)
• Advice limited to covered investment products only
Observations
• Impacts brokers and insurance agents, but not advisors earning level
compensation (such as RIAs)
• Higher compliance costs may encourage advisors to stop serving retirement
clients, or migrate to RIA service model
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IMPACT OF DOL PROPOSAL
ON IRA MARKETS
Limited reach of DOL’s current fiduciary rule
• ERISA generally does not apply to brokers (non-fiduciary advisors)
recommending investments for IRAs
• IRA recommendations are subject to same suitability standard
as for regular brokerage accounts
• Under DOL proposal, brokers (fiduciary advisors) would no longer
be able to treat IRAs like regular brokerage accounts
• DOL proposal would affect advisors without plan clients
(who merely have clients with IRAs)
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ANTICIPATED EFFECT ON IRA ADVISORS
Regulation of brokers as IRA fiduciaries
• To earn commissions, brokers would need BIC Exemption
• Firm’s policies would presumably limit advisor’s ability to steer
IRA clients to improper investments with higher payouts
• Cannot sell non-traded REITs or alternative investments
• Certain advisors may stop offering brokerage services to IRAs,
or switch to advisory services (RIA model)
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BIC EXEMPTION AND IRA
ENFORCEMENT AUTHORITY
DOL’s lack of IRA enforcement authority
• DOL has power to define fiduciary status for brokers serving
as IRA advisors
• But DOL cannot enforce prohibited transaction rules
against fiduciary advisors to IRAs
• Only IRS may impose excise tax on IRA fiduciaries
New enforcement mechanism under DOL proposal
Empowers IRA clients to enforce fiduciary standards through
disclosures and contractual rights
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TIMELINE FOR DOL FIDUCIARY RULE
Comment period (extended from 75 days to 90 days)
• Comment period from April 20, 2015 to July 21, 2015
• Public hearings during week of August 10, 2015
• Acceptance of additional comments after public hearing
• DOL will consider all comments before finalizing fiduciary rule
Delayed rollout after finalization
• Final rule effective 60 days after published by DOL
• Compliance generally not required until eight months
after final rule is published
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OUTLOOK FOR DOL FIDUCIARY RULE
Support from Obama administration
• White House has promoted importance of new fiduciary rule
• Committed to finalizing before end of second term (January 2017)
• Congress is unlikely to be able to delay final rule,
by forcing coordinated rule-making with SEC
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CONCLUSIONS
Moving to universal fiduciary standard
• DOL seeking to impose fiduciary status on all types
of retirement advisors
• Fiduciary advisors earning commissions would be subject
to BIC Exemption (and higher compliance costs)
• Significant impact on IRA markets
Following up
• Stay abreast of DOL’s rule-making process
• Discuss how DOL fiduciary rule may impact services provided
on behalf of plans or IRAs (and related fees)
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THE DOL’S NEW FIDUCIARY RULE:
A potential game changer for retirement investment services
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The Wagner Law Group has prepared this presentation on behalf
of Legg Mason & Co., LLC. Future legislative and regulatory
developments may significantly impact the legal analysis provided
herein. Please be sure to consult with your own legal counsel
concerning such future developments. This presentation is intended
for general informational purposes only, and it does not constitute
legal, tax or investment advice on the part of The Wagner Law Group
or Legg Mason & Co., LLC and its affiliates. Financial advisors should
consult with their own legal counsel to understand the potential impact
of the U.S. Department of Labor’s new fiduciary proposal on the
services they provide to plan and IRA clients and the nature and
scope of their responsibilities under ERISA and other applicable law.
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