New DOL Regulations May Have an Effect on Your Company’s Retirement Plans

On April 6, 2016, the U.S. Department of Labor’s (the “DOL”) Employee Benefits Security Administration issued final regulations addressing conflicts of interest in the provision of retirement financial advice (the “Regulations”). The Regulations are intended to change the way certain financial advisers give advice to their clients. Businesses should take note of the new Regulations since it’s quite possible they could increase their compliance obligations and costs in offering a retirement plan to its employees (such business, a “Plan Sponsor”).

Many articles have been written in the past couple of years regarding the financial adviser industry and the fees that certain financial advisers charge. Some of these fees are upfront and disclosed, but there is a concern that employer plan sponsors and participants are not fully aware of all the fees being charged since some fees are currently not required to be disclosed. Recently some employer plan sponsors have been sued in participant class actions for alleged breach of their fiduciary duties by paying unreasonably high investment management fees, or by failing to provide appropriate investment options (See White et. al. v. Chevron Corporation, Chevron Investment Committee and John Does 1-20, filed on February 17, 2016).

In issuing the Regulations, the DOL has stated it was concerned that not every financial adviser to a plan was legally obligated to act in the best interest of a plan participant. Some financial adviser’s compensation structures may be misaligned with the plan participants’ interests and goals, and could create a strong incentive to direct plan participants into particular financial investment products that may not be among the best investment options available. According to the DOL, the goal of the Regulations is to establish plan participants as “clients” of the financial adviser and to “protect investors by requiring all who provide retirement investment advice to plans and IRAs to abide by a fiduciary standard — putting their clients’ best interest before their own profits.”

While the DOL’s goal appears straightforward, the Regulations provide over 1,000 pages of rules and exceptions to those rules to try to accomplish that goal. The Regulations seek to reduce potential conflicts of interest primarily by 1) expanding the definition of who is a “plan fiduciary”, and 2) permitting certain financial adviser compensation arrangements only by adherence to specific disclosure rules.

Along these lines, the White House has stated that the Regulations ensure retirement savers get advice in their best interest by

  • Requiring more retirement investment advisers to put their client’s best interest first, by expanding the types of retirement advice covered by fiduciary protections;
  • Clarifying what does and does not constitute fiduciary advice; and
  • Enacting an exemption from the prohibition against certain compensation practices to allow firms to accept common types of compensation – like commissions and revenue sharing payments – if they commit to putting their client’s best interest first (the “Best Interest Contract Exemption”).

These changes may require financial advisers to revise their contractual relationship with employer Plan Sponsors in order to be compliant with the Regulations.

The Regulations further expand who is a fiduciary by expanding the definition of “investment advice.” Under the Employee Retirement Income Security Act of 1974 (“ERISA”), a person is a “fiduciary” to a retirement plan to the extent that the person engages in specified activities, including rendering ‘‘investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan . . . [.]” ERISA imposes standards of care and undivided loyalty on plan fiduciaries, and by holding fiduciaries accountable when they breach those obligations. Under those rules, fiduciaries are not permitted to engage in certain ‘‘prohibited transactions.”

The Regulations define someone who provides “investment advice” broadly as anyone “providing for a fee or other compensation, direct or indirect,” the following types of advice:

  • A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan to an IRA.
  • A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., brokerage versus advisory); or recommendations with respect to rollovers, distributions, or transfers from a plan to an IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer or distribution should be made.

Under the Regulations, the threshold question is whether a recommendation has occurred. Generally, a recommendation is deemed to have occurred if there is a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action. Recommendations made in exchange for a fee or other compensation by the following types of persons are generally recommendations that give rise to fiduciary investment responsibilities under the Regulations:

  • Persons who present or acknowledge that they are acting as a fiduciary within the meaning of ERISA or the Internal Revenue Code;
  • Persons rendering advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is based on the particular investment needs of the advice recipient; or
  • Persons who direct the advice to a specific recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

The Regulations do provide exceptions whereby certain communications, such as education or general communications, do not rise to the level of a “recommendation” and are not subject to the Regulations. If a financial adviser does make a recommendation, the Regulations provide that such advice needs to be in “the best interest” of the plan participants and beneficiaries. (Currently many advisers are just held to a “suitability” requirement.) A financial adviser’s failure to offer such advice not only exposes the adviser to ERISA penalties and potential lawsuits by participants and beneficiaries, but also exposes the Plan Sponsor (your company) to the same penalties and potential lawsuits.

In addition to expanding who is a fiduciary by expanding the definition of investment advice, the Regulations also require enhanced disclosure regarding certain compensation arrangements, particularly with respect to advice given to IRA owners and other non-ERISA retirement plans. Generally, plan fiduciaries are prohibited from accepting commission-based compensation unless an applicable exception to the ERISA prohibited transaction rules exists. The Regulations add a “Best Interest Contract Exemption” to the prohibited transaction rules allowing commission-based compensation under certain circumstances. Under the Regulations, in order for a financial adviser to charge commissions or revenue sharing payments for financial advice offered to a non-ERISA plan or an IRA owner, the financial adviser needs to: 1) commit the firm and adviser to providing advice in the client’s best interest, charge only reasonable compensation, and avoid misleading statements about fees and conflicts of interest; 2) adopt policies and procedures designed to ensure that advisers provide best interest advice, and prohibiting financial incentives for advisers to act contrary to the client’s best interest; and 3) disclose any conflicts of interest.

As part of the policies and procedures designed to ensure that advisers provide best interest advice, the Regulations require certain advisers to maintain a website that includes information about the financial institution’s business model and associated material conflicts of interest, a written description of the financial institution’s policies and procedures that mitigate conflicts of interest, and disclosure of compensation and incentive arrangements with advisers.

Certain industry and trade associations have objected to the DOL’s issuance of the Regulations. Numerous lawsuits have been contemplated against implementation of the Regulations. In fact, on June 1, 2016, the U.S. Chamber of Commerce along with others filed suit in the U.S. District Court for the Northern District of Texas claiming, among other issues, that the DOL overstepped its authority in issuing the rules. According to the lawsuit filed by the U.S. Chamber of Commerce1.

“Instead of helping savers plan for retirement, the new rule will unfortunately restrict their access to affordable retirement advice and limit their options for saving. The rule will shackle Main Street financial advisers with extensive new requirements and constant liability, forcing them to limit the options and guidance they provide to retirement savers.”

“Advisers servicing small business plans will similarly be left with no choice but to limit or stop servicing the retirement plans offered by those job-creators, significantly reducing the retirement savings options available to their millions of employees. These consequences collectively reinforce that government officials failed to perform an adequate cost-benefit analysis during the rule’s development.”

These lawsuits are specifically targeting the “private right of action” provision in the Regulations that allows investors and plan participants to file class action lawsuits when they believe an adviser is not working in the best interest of the investor or has otherwise violated a provision in the Regulations. It is too early to determine what effect, if any, the lawsuit will have on the implementation of the Regulations, but we will continue to follow the status of these lawsuits.

The Regulations became effective on June 7, 2016, but include a phased-in implementation period. The broader definition of fiduciary in the Regulations will have an applicability date of April 10, 2017, and the requirements involving the Best Interest Contract Exemption will be gradually phased in from April 10, 2017, through January 1, 2018. During this phase-in period, financial advisers must adhere to an “impartial conduct” standard, provide certain notices to retirement investors, and designate a person responsible for addressing material conflicts of interest and monitoring advisers’ adherence to the impartial conduct standards.

At over 1,000 pages, the Regulations are quite extensive and complex. If you have questions on how the Regulations may impact your organization’s retirement plans, please contact Russell Stein.

This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass & Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.