The Long and Winding Road that Leads to the “New” ERISA Fiduciary Rules has Another Detour

May 10th, 2017|By Amy Klein, Esq.

Back in 2010, when I was an attorney in private practice at Bond, Schoeneck & King PLLC, an investment advisory firm that was a client of mine asked me what they needed to do to comply with the newly released Department of Labor proposed rules to change the 1975 ERISA fiduciary rules. The proposal would redefine when a person providing investment advice – a broker, investment consultant, or investment manager – was truly responsible for the advice given. In other words, when that person would become a fiduciary under ERISA.  It also added a number of disclosures that my client would be required to provide to its clients.

I normally don’t like to pay much attention to proposed regulations unless they can be relied upon prior to finalization, which was not true of these 2010 rules. Especially when the proposal is issued in the fourth quarter of the year, which was my super-busy time. I promised my client (DirectAdvisors, which now employs me) that when the rules were finalized I would drop everything, analyze them, and redraft any documents that required changes.

I did not need to jump into action very quickly. Public hearings on the proposed rules were held in May 2011, which resulted in the DOL’s announcement in September 2011 that it would propose new rules. It took until April 2015 for that new proposal to arrive. After a 5-month comment period, four days of public hearings, more than 3,000 comment letters, 300,000 petitions, and more than 100 meetings with stakeholders, the final regulations were published one year later, on April 8, 2016. They were supposed to become applicable on this past April 10th – but on April 7th the application of the new definition of fiduciary was extended by 60 days to June 9, 2017, and the disclosures and other conditions that would apply to avoid a prohibited transaction under the “Best Interests Contract Exemption” (BICE) were delayed until January 1, 2018.

Well, there likely will be another delay – and it will be a long one. On May 4, 2017, the House Financial Service Committee approved the Financial CHOICE Act 2.0 and referred the legislation to the full House of Representatives for consideration. The Act would nullify the DOL’s 2016 fiduciary regulations and the related prohibited transaction exemptions. It would also prohibit the DOL from issuing new regulations on these subjects until 60 days after the Securities and Exchange Commission (SEC) issues a final rule relating to standards of conduct for brokers and dealers. The SEC apparently has not begun such regulations. Any subsequent DOL fiduciary rules must be “substantially identical” to the rules the SEC imposes on brokers, dealers, or investment advisers.

If the Financial CHOICE Act 2.0 is adopted by Congress, and signed by the President, the 1975 fiduciary rules would remain in effect. Let’s review what those rules say:

WHO IS A FIDUCIARY INVESTMENT ADVISOR?
5-Part Test – All parts must be satisfied. Does not apply to Individual Retirement Accounts.
A person who, for a fee or other compensation (direct or indirect):

  1. Gives advice (as opposed to the broader “recommendation”) on the value or advisability of investing in securities or other property…
  2. On a regular basis (not just once)…
  3. Pursuant to a mutual agreement, arrangement, or understanding (written or otherwise), whether or not there is an acknowledgment of fiduciary status…
  4. That the advice will serve as a primary basis for investment decisions; AND
  5. The advice will be individualized based on the particular needs of the plan regarding such matters as, among other things, investment policies or strategy, overall portfolio composition, or diversification.

Result: Before the DOL’s 2016 regulations, many investment professionals, brokers, consultants, and advisers claimed non-fiduciary status and structured their business not to offer advice, as defined by the five-part test. Without fiduciary status, these persons could act in their own self-interest without committing a prohibited transaction. Since the 2016 regulations were published, many (but not all) of such investment professions revamped procedures to satisfy the new rules and accepted fiduciary status.

WHAT MUST A FIDUCIARY INVESTMENT ADVISOR DO?

  1. Act in the best interests of plan participants and beneficiaries
  2. Act prudently (the “prudent expert” standard of care)
  3. Not deal with plan assets in a way that benefits the advisor, for example, by receiving compensation that varies based on the investment advice (without an exemption, this is a prohibited transaction)
  4. Acknowledge fiduciary status in writing, if the intent is to protect the named fiduciary (e.g. plan sponsor or trustee) from fiduciary liability for investment decisions. (Note: the named fiduciary still must prudently select and monitor the investment advisor.)

What if a fiduciary investment advisor breaches one or more of these duties? As a fiduciary, the investment advisor is personally liable to restore the plan to the place it would have been had the breach of fiduciary duty not occurred. This includes restoring lost investment income, unwinding the transaction, etc. If the action was a “prohibited transaction”, an excise tax is also payable.
Do you want to learn more about the ERISA fiduciary requirements? Watch for our upcoming posts, “Fiduciary Fables”.


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