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.*
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:
- recommendations as to the advisability of buying, holding or selling investments;
- recommendations as to the management of investments; and
- recommendations as to the selection of persons to provide investment advice or investment management services.
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:
- Managers and advisors should review their marketing and/or offering activities — including any private placement memoranda, newsletters or pitch books — to determine whether such communications constitute “investment advice” under the fiduciary rule, and if so, to revise them accordingly. The rule provides that “hire me” communications to provide investment-related services that are not combined with a “recommendation” would not constitute investment advice. However, satisfying the “hire me” exception may not be practical, as the line between “hire me” communications and advice that triggers a fiduciary obligation is not at all clear.
- The rule provides an exception for investment advice provided to “expert fiduciaries” — certain independent plan and IRA fiduciaries with financial expertise. To satisfy this exception, several criteria must be met. Importantly, however, this exception is not available for investment advice provided to IRA owners and small plan fiduciaries. To satisfy this exception, each of the following requirements must be met:
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.
- Managers and advisors should consider revising their fund or account documents to include representations consistent with an intention to avoid fiduciary treatment. For example, consideration should be given to representations that the ERISA and/or IRA investor satisfies the conditions of the “expert fiduciary” exception or that the manager or advisor has not rendered any “investment advice” in connection with the fund investment or account establishment.
- Given that the “expert fiduciary” exception may not be available for small IRAs and ERISA plans, managers and advisors may decide not to offer investments to such entities altogether. Alternatively, they may decide to offer investments to such entities and to satisfy one of the new PTEs under the fiduciary rule, most notably the Best Interest Contract Exemption. However, compliance with that exemption will be difficult, as it mandates significant disclosure obligations as well as a requirement that adherence to the exemption be memorialized in an enforceable, written contract.
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:
- will not pursue claims against fiduciaries who are working diligently and in good faith to comply with the rule and its exemptions;
- will not treat those fiduciaries as being in violation of the rule and its exemptions; and
- has confirmed that the IRS has extended prohibited transaction excise tax relief to any transaction or agreement to which the DOL guidance applies.
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:
- the assets of each such investor is considered to be both its equity interest in the fund as well as an undivided interest in each of the fund’s underlying assets; and
- any person who exercises authority or control as to the management or disposition of such underlying assets (such as the general partner of the fund), and any person who provides investment advice as to such assets for a fee (direct or indirect), such as the fund’s investment manager, is a fiduciary of such investor.