DOL Issues First Wave of Fiduciary Rule Guidance

November 3, 2016

Last week, the U.S. Department of Labor (DOL) issued long-awaited guidance in the form of answers to 34 frequently asked questions (the FAQs) on its final rule (the Rule) for determining when a party is a fiduciary, by virtue of providing investment advice for a fee, as to an ERISA retirement plan or an individual retirement account (IRA). The FAQs, which cover a broad range of topics under the Rule, mark the DOL’s first substantive guidance on the Rule following its release in April.


The 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 now will be treated as fiduciaries and will therefore become subject to ERISA’s fiduciary responsibility requirements (and certain related tax rules applicable to IRAs).

In connection with this change, the DOL has 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 engage in certain transactions without violating applicable prohibited transaction rules. For more information on the Rule, see our earlier WorkCite.

Despite the broad-ranging implications for financial service providers — as well as for employers, plan fiduciaries and IRA owners who contract for their services — the DOL has been slow in providing much-needed guidance on application of the new and amended exemptions. This past July, the DOL issued technical corrections and clarifications on the Rule, but these lacked any meaningful insight. Accordingly, the FAQs represent the first wave of substantive guidance. Following are highlights of some of the guidance contained in the FAQs.

Compliance Dates

BIC Exemption and Principal Transactions Exemption

The FAQs indicate that the Best Interest Contract (BIC) Exemption and Principal Transaction Exemption, both of which were issued at the same time as the Rule, will become available to fiduciary advisers at the same time the Rule becomes effective — April 10, 2017. At that time, however, a transition period extending until Jan. 1, 2018, will apply, requiring satisfaction of fewer conditions. The transition period is intended to give fiduciary advisors additional time to prepare for full compliance while providing basic safeguards to protect retirement investor interests.

During this transition period, each financial institution and adviser must: (i) comply with the impartial conduct standards under the exemptions; (ii) provide a notice which, among other things, acknowledges fiduciary status and discloses material conflicts of interest; and (iii) designate a person responsible for addressing material conflicts of interest and monitoring advisers’ adherence to the impartial conduct standards. When the transition period ends Jan. 1, 2018, full compliance with all of the exemptions’ requirements will be required.

Pre-existing Exemptions Amended by the Rule

As mentioned in our previous WorkCite, the Rule amended several pre-existing PTEs (75-1, 77-4, 80-83, 83-1, 84-24, and 86-128) to require compliance with the impartial conduct standards, and, in some cases, to more tightly restrict their availability. Generally, compliance with the new restrictions is effective April 10, 2017. An additional transition period is provided, however, for certain transactions under PTE 86-128.

BIC Exemption Guidance

The FAQs provide guidance on a broad range of topics related to the availability of, and compliance with, the BIC Exemption.

Availability of the BIC Exemption

The FAQs reiterate the DOL’s intent that the BIC Exemption serve as the primary exemption for investment advice transactions involving retail investors, including recommendations as to all categories of assets, advice to roll over plan assets, and recommendations on persons a customer should hire to serve as investment advisers or managers. The term “retail investor” in the FAQs refers to plan participants and beneficiaries and IRA owners.

Observation:  The BIC Exemption uses the term “retirement investor,” which has a precise definition, rather than “retail investor.”  The definition of “retirement investor” in the BIC Exemption includes certain fiduciaries of plans and IRAs as well as plan participants who can direct the investment of their accounts and IRA owners who act on behalf of their IRAs.

In order for fiduciary status to arise under the Rule, there must be (i) an investment recommendation; and (ii) the receipt of compensation, direct or indirect, as a result of such recommendation. The FAQs clarify that the BIC Exemption is therefore not required in the absence of an investment recommendation, such as when transactions are executed at the direction of a client. Similarly, even if a person recommends a particular investment, the person is not a fiduciary unless he or she receives compensation as a result of such recommendation.

Discretionary Fiduciaries

The BIC Exemption generally prohibits relief for advisers that have or exercise any discretionary authority or control as to the recommended transaction. However, the FAQs explain that the BIC Exemption is available to discretionary fiduciaries for:

  • investment advice to roll over a participant’s account, even if the adviser serves as a discretionary fiduciary as to the plan or that participant’s account and will provide fiduciary investment advice following the rollover; and
  • investment advice to roll over a plan account into an IRA, even if the adviser or financial institution will subsequently serve as a discretionary investment manager as to the IRA.

In both cases, however, the BIC Exemption is available so long as the adviser does not have or exercise any discretionary authority or control as to the decision to roll over, and the other applicable conditions of the exemption are satisfied.

In confirming that the BIC Exemption is unavailable to provide relief for a recommended transaction if the adviser has or exercises any discretionary authority or control as to the transaction, the FAQs indicate that several of the DOL’s existing exemptions may nonetheless provide relief for conflicted compensation.

Compensation Practices Under the BIC Exemption

The BIC Exemption provides generally that financial institutions cannot “use or rely upon quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause Advisers to make recommendations that are not in the Best Interest of the Retirement Investor.”

The FAQs provide guidance on compensation practices under the BIC Exemption as to adviser awards and bonuses, escalating pay grids and price discounting practices.

            Adviser Awards and Bonuses

The FAQs draw a distinction between adviser awards that are “front-end” awards, such as recruitment incentives or signing bonuses, and “back-end” awards, such as awards or bonuses that are expressly contingent on the adviser’s achievement of certain sales or asset targets.

According to the FAQs, front-end awards are permissible under the BIC Exemption because such payments do not turn on the adviser’s particular recommendations or create inappropriate incentives to give advice that is not in the customer’s best interest. Conversely, back-end awards are prohibited under the BIC Exemption, because such awards commonly result in large amounts of income to the adviser that are paid on an “all-or-nothing” basis contingent on the adviser’s satisfaction of certain revenue or asset targets. The DOL is concerned that such disproportional amounts of compensation significantly increase the conflicts of interest for advisers making recommendations to investors, particularly as the adviser approaches the target. Accordingly, a financial institution generally may not enter into back-end award arrangements under the BIC Exemption.

To the extent any back-end award arrangements predate the FAQs, the financial institution may continue to rely on the BIC Exemption for transactions involving the adviser, provided it adopts special policies and procedures specifically aimed at engaging in stringent oversight of the adviser during the period of the arrangement.

            Escalating Pay Grids

The FAQs confirm that the use of an escalating pay grid, under which the percentage of a commission paid to an adviser increases based on volume, is not categorically precluded under the BIC Exemption. The DOL cautioned, however, that special care must be taken in developing and monitoring compensation systems to ensure that they do not run counter to the fundamental obligation to provide advice in the customer’s best interest. The FAQs provide a list of factors that should be considered when designing pay grids to ensure that such incentive structures are not misaligned with the interests of retirement investors.

            Price Discounting Practices

The FAQs verify that the BIC Exemption does not prohibit the practice of discounting prices paid by customers for services (e.g., to attract new clients or reward longstanding clients), provided such discounts are not used in a manner that reintroduces conflicts of interest.

Rollovers and Streamlined Relief for Level-Fee Fiduciaries

The FAQs confirm that streamlined relief under the BIC Exemption is available for “level-fee” fiduciaries who receive compensation for providing investment advice to retirement investors. As defined in the BIC Exemption, a “level fee” is a fee or compensation that is provided on the basis of a fixed percentage of the value of the assets or a set fee that does not vary with the particular investment recommended, rather than a commission or other transaction-based fee. The FAQs note that while level-fee fiduciaries do not typically experience the same sorts of conflicts that give rise to prohibited transactions requiring an exemption, there are two areas in which a substantial conflict may arise, specifically when an adviser recommends that a participant:

  • roll money out of a plan into a fee-based account generating ongoing fees for the adviser that he or she would not otherwise receive; or
  • switch from a commission-based account to an account where a fixed fee of assets under management is charged on an ongoing basis.

The FAQs state that under the streamlined BIC Exemption, the level-fee adviser with assets under management may receive only a level fee in connection with the investment management services provided to the plan or IRA, which must be disclosed in advance. In addition, the FAQs verify that the streamlined BIC Exemption conditions described below must also be met:

  • Furnishing the retirement investor with a written acknowledgement of the adviser’s fiduciary status
  • Satisfaction of the impartial conduct standards in the exemption
  • Documentation of the reasons why the advice was considered to be in the best interest of the retirement investor (which would include an analysis concerning the alternative of leaving money in an employer plan rather than rolling it into an IRA) 

This streamlined relief for level-fee fiduciaries is not available for level-commission type structures.

The documentation requirement referenced above may be relaxed, but only if, despite diligent and prudent efforts, the financial institution or adviser is unable to obtain (or the investor is unwilling to provide) the necessary information, in which case the adviser may rely on alternative reliable data sources (e.g., Form 5500 or other benchmarks), subject to additional requirements.

Also as to level-fee fiduciaries, the FAQs explain the following:

  • Compliance with the streamlined BIC Exemption provisions is simply an alternative compliance method for such fiduciaries; they may always comply with the full BIC Exemption.
  • The streamlined BIC Exemption is not limited to the level-fee fiduciary who offers only level-fee advisory services, but if the adviser offers commission-based and level-fee arrangements, he or she must nevertheless satisfy the full BIC Exemption as to such commission-based arrangements. The FAQs verify that a retirement investor may invest under both types of arrangements, but cautions that care should be taken to ensure that any recommendations comply with the impartial conduct standards and are not intended to evade the requirements of the BIC Exemption.
  • A financial institution may rely on the level-fee provisions in the BIC Exemption to recommend a rollover from an employer plan to an IRA even though the adviser will become a discretionary manager, so long as the adviser does not exercise any discretionary authority as to the rollover decision. Additional requirements may apply as to any potential conflicts of interest arising from the manager’s conduct after the assets are rolled into a discretionary account.
  • Assets that generate third-party payments (e.g., 12b-1 fees and revenue-sharing payments) are not considered level-fee compensation. If an adviser or financial institution recommends products that generate third-party payments, compliance with the more rigorous provisions of the full BIC Exemption, as well as the strict requirements applicable to third-party payments under Section IV of the BIC Exemption, will be necessary.
  • Level-fee provisions are not available for commission- or transaction-based compensation arrangements or for compensation structures that are limited to the sale of proprietary products. If an adviser recommends only proprietary products, it must comply with the more stringent provisions of the full BIC Exemption as well as those portions of Section IV of the BIC Exemption that apply to proprietary products.

DOL Enforcement

The FAQs indicate that the DOL intends to help stakeholders come into compliance with the Rule and related prohibited transaction exemptions, rather than citing violations and imposing penalties.

Other Guidance

In addition to the topics highlighted above, the FAQs also provide guidance on the following:

  • Bank networking arrangements
  • PTE 84-24, which was amended at the time the Rule was issued and which allows fiduciaries and other service providers to receive compensation in connection with plans’ and IRAs’ purchases of insurance contracts and fixed-rate annuity contracts, and also provides relief for the receipt of compensation in connection with ERISA plans purchasing securities of investment companies registered under the Investment Company Act of 1940
  • Certain grandfathering provisions
  • The Principal Transactions Exemption

For further information, please contact either of the authors, Robert B. Wynne  and Maria P. Rasmussen, or any other member of the McGuireWoods employee benefits team.