It’s not every day that a change in the laws governing retirement plans makes front page news, but it’s not every day that the change is as significant as the Department of Labor’s (“DOL”) new “advice rule”. On April 8, 2016 the DOL published its long awaited and controversial regulation that greatly expands the definition of investment advice subject to ERISA’s fiduciary standards and coverage under the prohibited transaction rules of Internal Revenue Code section 4975. By changing the definition of who is a fiduciary as a result of providing investment advice for a fee, the rule will cause many advice providers to become fiduciaries for the first time, and it will likely have a profound effect on the relationships between plans, participants and advisors.
From the DOL’s perspective, the purpose of the rule is to update a regulation that had become very outdated, left behind by changes in the nature of retirement plans and methods of distribution. The fiduciary standards require advisors to act in the best interest of their clients and reduce the possibility that advisors will be conflicted as a result of the compensation they receive. But because of the shift from defined benefit plans to individual account plans such as 401(k) and 403(b) plans and IRAs over the last 40 years, much of the investment advice that is being provided to individual participants is not subject to fiduciary standards.In particular, the DOL has focused on advice relating to IRA rollovers.
On the other hand, critics of the rule object to the additional administrative burden it imposes and suggest that it will result in a reduction of advice available as service providers stop offering advice services to avoid the new rules. They argue that the costs of complying with the rule greatly exceed its benefits, and other regulators are already providing safeguards in this arena.
The current definition of advice, which dates from 1975, included a five-part test that needed to be met before a provider would be a plan fiduciary. The test required a showing that the advice was given on a regular basis and that it was the primary basis for the investment of plan assets.As a result, for example, advice given regarding a rollover would not be included under the definition because it would not be given on a regular basis.
The new definition will apply to a recommendation given for a direct or indirect fee regarding the purchase, sale or management of a plan investment, whether to take a distribution from a plan, whether to roll it over to an IRA, and how to invest it once it is rolled over to the IRA.A “recommendation” is very inclusive, defined as a communication that would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action. Whether an individual is giving advice is to be determined on an objective standard, based on the communication’s content, context, and presentation.
How the Rule Affects Plan Sponsors
The advice rule, along with a number of other changes in the fiduciary rules that were issued in conjunction with it, is very extensive and quite complex. Certain service providers, including investment advisors and brokers, will feel its most far-reaching effects. But there are also potential implications for plan sponsors, and we will describe here some of the rules that may be of greatest immediate interest to them.
There are a number of important exceptions in the advice rule for certain specific types of communications that will not constitute advice of particular interest to plan sponsors:
1. Participant Education
Since 1996, sponsors and service providers have been able to provide participant education that did not constitute advice if limited to certain categories of information. The advice rule continues to allow participant education that provides information and materials that describe plan information; general financial, investment, and retirement information; asset allocation models; and interactive investment materials.But the advice rule extends the scope of the participant education by permitting allocation models and interactive materials to identify a specific investment product or specific alternative available, if the following criteria are met: 1) the specific alternative is an investment choice under the plan; 2) a fiduciary, who is not the person who developed the model portfolio, is responsible for overseeing the investment; 3) the education materials also identify all similar investments available under the plan; and 4) the participant is provided with information about where to obtain more information about those other investment options. Although typically the plan sponsor will be relying on a service provider to offer participant education, it is the plan sponsor’s responsibility to monitor the service provider and to make certain that the education is unbiased and fits within this exception. This expansion of the participant education rule does not apply to education given in connection with the sale of IRAs.
2. Employees of the Plan Sponsor
An employee of the plan sponsor is not an investment advice fiduciary if, in his or her capacity as an employee, the person provides advice to a plan fiduciary or to an another employee (other than in his or her capacity as a participant or beneficiary of a plan) of the plan sponsor. The person must receive no fee or other compensation, direct or indirect, in connection with the advice beyond the employee’s normal compensation for work performed for the employer. Therefore, employees who work on the plan and may provide recommendations to plan fiduciaries without receiving a fee will not be fiduciaries. In addition, human resources staff who provide information about the plan to other employees will not become fiduciaries, even if the communication includes investment advice, as long as they do not receive compensation for the advice and their job responsibilities does not include providing investment advice.
3. Interactions with Service Providers
As noted above, the advice rule will have its biggest impact on certain plan service providers. Consequently, plan sponsors will likely see some changes in how their service providers conduct business. This may result in plan sponsors seeing service providers changing their business models to avoid fiduciary status or providing new and extensive disclosures to meet the requirements of available exemptions.In subsequent newsletters, we will discuss the effect of these changes on plan sponsors in more detail.In the meantime, plan fiduciaries should keep in mind that they are responsible for prudently selecting and monitoring plan service providers and other plan fiduciaries. Plans should evaluate their relationships with their service providers and determine whether the service providers will be fiduciaries under the new rule.
4. Effective Date
The new definition of fiduciary will be effective on April 10, 2017. Certain exemptions under the advice rule will be subject to a transition rule and will be fully in effect on January 1, 2018.