DOL’s new Conflict of Interest regulation in brief

The new DOL regulation (and related rules): (1) re-defines who is an “investment advice fiduciary” under ERISA, expanding those situations in which giving investment advice to an employee benefit plan, plan fiduciary, participant, or IRA owner makes the advice-giver an ERISA fiduciary; and (2) significantly changes what sorts of advice may be given, to whom and in what circumstances. The new rules will probably have their greatest effect on brokers, mutual funds, and certain other financial services providers and on consultants and third party administrators.

For plan sponsors, the new rules matter, first, because sponsors and their participants are, in effect, consumers of advice and, second, because sponsors and sponsor staff may themselves in some cases be investment advice fiduciaries.

We provide detailed discussions of the new regulation and the Best Interest Contract Exemption in articles posted today. In this article we briefly summarize the regulation and exemption.

Who is an investment advice fiduciary under the new regulation?

Generally and oversimplifying somewhat, a person is an investment advice fiduciary if she makes a recommendation to a plan, plan fiduciary, participant or IRA owner about an investment, rollover or distribution, or about investment management (e.g., portfolio composition), and either (1) she acknowledges she is a fiduciary, (2) the advice is pursuant to an “understanding” that it is based on the recipient’s particular needs, or (3) she directs advice about a particular investment to specific recipient.

Who is not an investment advice fiduciary? Certain persons are not advice fiduciaries, because what they do either does not constitute a “recommendation” or is explicitly excluded under the regulation:

Platform providers who market a generic platform from which the plan fiduciary may select or monitor investment alternatives.

Persons producing general communications, e.g., general circulation newsletters.

Persons providing investment education, including for plans (but not IRAs) education that identifies specific investment alternatives as long as other, similar alternatives are identified.

Persons providing advice in an arm’s length transaction to “institutional fiduciaries.” Institutional fiduciaries include banks, insurance carriers, 1940 Act- and state-registered investment advisers, registered broker-dealers and independent fiduciaries that manage total assets of at least $50 million. (This is the institutional “seller’s exception.”)

Certain sponsor employees – plan committee staff and employees who provide casual advice to a colleague.

Persons providing asset valuations – DOL intends to address this issue in another regulation project.

New rules on compensation and disclosure for “retail advice”

Advisers to plan participants and IRAs generally will be fiduciaries. For them to provide that advice while receiving conflicted payments, they and their related Financial Institutions must comply with a new Best Interest Contract Exemption (BICE).

The BICE generally:

Changes how retail advisers are compensated – while Financial Institutions may provide products with, e.g., different profit margins, they may not provide incentives to Advisers (e.g., brokers) to “push” those more profitable products. To qualify for the BICE, the Adviser’s related Financial Institution must: acknowledge fiduciary status; comply with best interest, reasonable compensation and no misleading statements standards; adopt policies and procedures designed ensure Adviser compliance with those standards; and provide extensive general, transaction- and web-based disclosures.

Increases the transparency of the retail retirement investment market – the BICE requires a Financial Institution to maintain a website that provides significant information about its business model, conflicts, third-party incentives, compensation and incentive arrangements with Advisers and any payout or compensation grids. As the DOL explains, “The web disclosure … is publicly available to promote comparison shopping and the overall transparency of the marketplace for retirement investment advice.”

Under the new rules, Financial Institutions whose Advisers are advising plan participants do not have to execute a contract committing to the new standards, but they do have to comply with those new standards as a condition of the exemption.

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Provided certain conditions are met, advisers to institutional advice fiduciaries (e.g., fiduciaries of larger plans) generally get a pass. Advice to plan participants, however, will be subject to the new rules – that is, the adviser will generally be a fiduciary. Advice as to in-plan asset allocation may come within the exception for investment education. And asset allocation outcomes may also be improved by the use of defaults (e.g., to a target date fund).

The significant participant advice problem for plan sponsors will be: who will advise the participant on termination of employment? Critically, who will coach terminating participants on the wisdom of rollovers or of leaving their retirement assets in the qualified plan system? We will have to wait to see if advisers emerge to respond to this need under DOL’s new rules.