Posted by Tyler Starr
On April 6, 2016, the U.S. Department of Labor (DOL) issued its final rule expanding the definition of investment advice fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA) and modifying the complex list of prohibited transaction exemptions as it relates to the expanded definition. The basic fiduciary rules were created in 1975, following the passage of ERISA, and have not been significantly updated since then. The new Fiduciary Rule will become applicable on April 10, 2017, and here are the important changes:
- The DOL will be significantly expanding the circumstances in which broker-dealers, investment advisors, insurance agents, plan consultants and other intermediaries are treated as fiduciaries to ERISA plans and individual retirement accounts (IRAs), and are therefore precluded from receiving compensation that varies with the investment choices made or from recommending proprietary investment products absent an exemption;
- Providing new exemptions and modifying or revoking a number of existing exemptions, addressing those activities; and
- Retaining the ERISA distinction between non-fiduciary investment education and fiduciary investment advice
These changes will force advisors to examine their compensation structures and adhere to reasonable fee amounts void of conflicts of interests. The new DOL rule does not ban commissions or revenue sharing, but it requires advisors who accept them to have clients sign a best-interest-contract to qualify for the exemption. This contract exemption will require advisors to act in the client’s best interests and only earn reasonable compensation. Because “best interest” and “reasonable compensation” can be subjective criteria, that can be interpreted differently by the recipient of services depending on the performance of the investment selected, these rules give plan participants the opportunity to sue their advisors in court if they believe the advisor did not act in their best interest. The differences between what advisors consider reasonable and what investors expected could result in an increase in litigation.
The new rule will also create more clarity as to who is recognized as a fiduciary. Under the old rule, only Registered Investment Advisers (RIAs) were expected to act as fiduciaries. Previously, brokers would be able to avoid fiduciary standards by only offering education to plan participants, as opposed to advice. The new changes to the fiduciary rule will bridge the gap between RIAs and brokers, creating a uniform standard for anyone giving investment advice to 401(k) plan participants. General educational communications will still be viewed as non-fiduciary, but any recommendations made by advisers will be considered fiduciary investment advice.
In anticipation of the Fiduciary Rule compliance date, employers should examine any advisor relationships to determine whether changes will need to be made to stay compliant with fiduciary duties.