The fiduciary rule issued by the Department of Labor (DOL) is one of the major developments in employee benefits law in recent years. The rule aims to reduce and regulate conflicts of interest related to paid investment advice to ERISA-covered retirement plans and to IRAs. When the rule became applicable on June 9, 2017, a significant number of investment professionals became subject to ERISA’s stringent fiduciary standards and the prohibited transaction provisions of ERISA and the Internal Revenue Code (Code).
Although not intended to impact investments in private investment funds or separately managed accounts, the fiduciary rule is nonetheless implicated when an ERISA plan or IRA considers becoming an investor in such a fund or account — even if the total investment by benefit plan investors is less than 25 percent of each class of the fund or account’s equity interests.*
Background
The fiduciary rule revamps the standards for determining when a party is a fiduciary as to an ERISA plan or IRA by virtue of providing investment advice for a fee. Because the rule substantially expands existing standards, a broader range of brokers, insurance agents, advisers and financial service providers are now treated as fiduciaries and are therefore subject to ERISA’s fiduciary responsibility requirements and prohibited transaction rules. In connection with the rule, the DOL also issued new and revised prohibited transaction class exemptions (PTEs) which permit providers of fiduciary investment advice to continue to receive certain forms of compensation and to engage in certain transactions.
The rule treats a party as providing fiduciary “investment advice” if it renders any of several categories of “recommendations” for a fee, including:
For these purposes, a “recommendation” is broadly defined as any “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.”
Impact on Investment Managers
As a result of the rule’s expanded definition of fiduciary investment advice, and lack of guidance from the DOL, certain marketing, offering and other related activities commonly provided by private investment funds and separately managed accounts to prospective and/or current ERISA or IRA investors may now be considered “recommendations.” They therefore also may be considered “investment advice,” such that the manager or advisor would become an ERISA fiduciary, even if benefit plan investors own less than 25 percent of each class of equity securities offered by the fund. Absent an exception under the rule or the satisfaction of a PTE, the receipt by such manager or advisor of any fee or compensation could result in a prohibited transaction.
Example: Under ERISA and the Code, it is a prohibited transaction for a plan fiduciary to receive any consideration for its own personal account from any party dealing with the plan (such as an investment fund) in a transaction involving the plan’s assets (such as the plan’s purchase of shares in such fund).
A prohibited transaction would trigger excise taxes under the Code as to ERISA plans and ERISA fiduciary violations that would result in personal liability for any loss to the investing plan on account of such “investment advice.” Moreover, under the Code, if the owner or beneficiary of an IRA engages in a prohibited transaction with the account, the account ceases to qualify as an IRA.
Following is a list of considerations for fund managers and/or investment advisors who accept investments from ERISA plans and IRAs:
1. The advice provider must know or reasonably believe that the independent fiduciary of the plan or IRA is a bank, insurance carrier, registered investment adviser, registered broker-dealer or an independent fiduciary that has responsibility for managing at least $50 million in total assets. All plan and nonplan assets under management are included in determining whether this threshold is met. In its recent request for information, the DOL noted that some commenters have requested that it expand the scope of this exception.
2. The advice provider must know or reasonably believe that the independent fiduciary is capable of independently evaluating the investment risks associated with the transaction.
3. The advice provider must inform the independent fiduciary that the advice provider is not providing impartial investment advice or giving advice in a fiduciary capacity, and must disclose its financial interests in the transaction.
4. The advice provider must know or reasonably believe that the independent fiduciary is a fiduciary under ERISA or the Code and is responsible for exercising independent judgment in evaluating the transaction.
5. The advice provider cannot receive a fee or other compensation directly from the plan, plan participant, IRA or owner for the provision of the investment advice in connection with the transaction.
The advice provider can meet the second and fourth conditions by obtaining written representations from the plan or the independent fiduciary.
Non-Enforcement Policy for Diligent Fiduciaries
As it stands today, the fiduciary rule’s future remains far from certain. Although the new definition of fiduciary investment advice became applicable June 9, most of the requirements for the new and amended PTEs have been delayed until Jan. 1, 2018. Moreover, the DOL is in the middle of conducting a new regulatory impact analysis of the rule, as required by President Trump, which could result in further changes. In the meantime, the DOL has released a new non-enforcement policy. Specifically, from June 9, 2017, until Jan. 1, 2018, the DOL:
In light of the DOL’s non-enforcement policy, fund managers and investment advisors who market their products and services to ERISA plan and IRA investors should take steps to document their efforts to comply with the rule. Doing so may permit them to take advantage of the non-enforcement policy.
In addition, because the rule is likely subject to further revision, fund managers should continue to closely follow related developments.
To stay apprised of new developments or for more information concerning the fiduciary rule, please contact any of the authors of this article — Robert B. Wynne, G. William Tysse, Maria P. Rasmussen and Jeffrey R. Capwell — or any other member of the McGuireWoods employee benefits team.
*Under ERISA and the DOL’s plan asset rule, unless an exception applies, if benefit plan investors (IRAs and non-governmental retirement plans) own 25 percent or more of the total value of each class of equity interest issued by a private investment fund, then: