A full year after issuing the initial proposal – and six years after the issue was first raised — the DOL has released the controversial new fiduciary rule.
The new rule includes several changes to the proposal employers will need to know.
Compliance date extended
In a nutshell, the bill aims to grant retirement plan participants greater protections by requiring brokers and advisers to act in their clients’ best interest when doling out investment advice.
To ensure this standard, anyone providing investment advice – including brokers and advisers – will be designated as a fiduciary and must disclose any potential conflicts of interest to plan participants.
One change in the rule both brokers and advisers and employers will likely appreciate: an extension of the compliance deadline until Jan. 1, 2018.
The basic rules governing retirement investment advice have not been meaningfully changed since 1975, despite the dramatic shift in our private retirement system away from defined benefit plans and into self-directed IRAs and 401(k)s, DOL officials announced.
The Labor Department said new rule will seek to:
- Require more retirement investment advisers to put their client’s best interest first, by expanding the types of retirement investment advice covered by fiduciary protections. Today large loopholes in the definition of retirement investment advice under outdated DOL rules expose many middle-class families, and especially IRA owners, to advice that may not be in their best interest. Under DOL’s proposed definition, any individual receiving compensation for providing advice that is individualized or specifically directed to a particular plan sponsor (e.g., an employer with a retirement plan), plan participant, or IRA owner for consideration in making a retirement investment decision is a fiduciary.
Being a fiduciary simply means that the adviser must provide impartial advice in their client’s best interest and cannot accept any payments creating conflicts of interest unless they qualify for an exemption intended to assure that the customer is adequately protected.
- Preserve access to retirement education. The Department’s proposal carefully carves out education from the definition of retirement investment advice so that advisers and plan sponsors can continue to provide general education on retirement saving across employment-based plans and IRAs without triggering fiduciary duties.
As an example, education could consist of general information about the mix of assets (e.g., stocks and bonds) an average person should have based on their age, income, and other circumstances, while avoiding suggesting specific stocks, bonds, or funds that should constitute that mix. This carve-out is similar to previously issued guidance to minimize the compliance burden on firms, but clarifies that references to specific investments would constitute advice subject to a fiduciary duty.
- Distinguish “order-taking” as a non-fiduciary activity. As under the current rules, when a customer calls a broker and tells the broker exactly what to buy or sell without asking for advice, that transaction does not constitute investment advice. In such circumstances, the broker has no fiduciary responsibility to the client.
- Carve out sales pitches to plan fiduciaries with financial expertise. Many large employer-based plans are managed by financial experts who are themselves fiduciaries and work with brokers or other advisers to purchase assets or construct a portfolio of investments that the plan offers to plan participants.
In such circumstances, the plan fiduciary is under a duty to look out for the participants’ best interest, and understands that if a broker promotes a product, the broker may be trying to sell them something rather than provide advice in their best interest. Accordingly, the proposed rule does not consider such transactions fiduciary investment advice if certain conditions are met.
What companies need to do to comply
Under ERISA and the Internal Revenue Code, individuals providing fiduciary investment advice to plan sponsors, plan participants, and IRA owners are not permitted to receive payments creating conflicts of interest without a prohibited transaction exemption (PTE).
The proposed rule creates a new type of PTE that is broad, principles-based and adaptable to changing business practices. This new approach contrasts with existing PTEs, which tend to be limited to much narrower categories of specific transactions under more prescriptive and less flexible conditions.
The “best interest contract exemption” will allow firms to continue to set their own compensation practices so long as they, among other things, commit to putting their client’s best interest first and disclose any conflicts that may prevent them from doing so.
To qualify for the new “best interest contract exemption,” the company and individual adviser providing retirement investment advice must enter into a contract with its clients that:
- Commits the firm and adviser to providing advice in the client’s best interest. Committing to a best interest standard requires the adviser and the company to act with the care, skill, prudence, and diligence that a prudent person would exercise based on the current circumstances. In addition, both the firm and the adviser must avoid misleading statements about fees and conflicts of interest. These are well-established standards in the law, simplifying compliance.
- Warrants that the firm has adopted policies and procedures designed to mitigate conflicts of interest. Specifically, the firm must warrant that it has identified material conflicts of interest and compensation structures that would encourage individual advisers to make recommendations that are not in clients’ best interests and has adopted measures to mitigate any harmful impact on savers from those conflicts of interest. Under the exemption, advisers will be able to continue receiving common types of compensation.
- Clearly and prominently discloses any conflicts of interest, like hidden fees often buried in the fine print or backdoor payments, that might prevent the adviser from providing advice in the client’s best interest. The contract must also direct the customer to a webpage disclosing the compensation arrangements entered into by the adviser and firm and make customers aware of their right to complete information on the fees charged.
For further insight, employers can check a Fact Sheet issued by the Obama administration.