Chao & Company’s Position Post DOL Fiduciary Redefinition

On April 6, 2016, the DOL issued the final and much debated and anticipated regulation in redefining who is an ERISA “fiduciary” of an employee benefit plan as a result of giving investment advice to a plan or its participants or beneficiaries and IRA.  This is the first time since 1975 when ERISA regulation was adopted that the fiduciary definition has been updated. Since 2010, the DOL has attempted to tighten the definition so that more investment advisers would be deemed fiduciaries with significant push-back by the brokerage and insurance industries which were subject to a less buyer-beware FINRA suitability standard.  Moreover, the resistance to change is rooted in retaining the commission compensation structure and multiple revenues derived from asset managers and not to be subject to fiduciary liabilities.

The final regulation that redefines the meaning of an ERISA fiduciary and the associated group of exemptions does not in any material way affect our firm’s service to you and your organization.  Under a written agreement, we acknowledge our fiduciary position, and we serve as an investment co-fiduciary with the Committee in delivering advice solely in the best interest of the Plan participants and beneficiaries.  Moreover, the agreement clearly states that we are compensated strictly on a fixed fee basis and we do not accept or in any way are remunerated in cash or in kind by a third party, directly or indirectly. We have been serving as a fiduciary to ERISA plans on a fee basis since 2000, and we do not provide participant level advice as a fiduciary nor do we seek clients on an individual basis from any retirement plans we serve as a fiduciary.

Under ERISA and the Code, if these advisers are not fiduciaries, they may operate with conflicts of interest that they need not disclose and have limited liability under federal pension law for any harms resulting from the advice they provide. Non-fiduciaries may give imprudent and disloyal advice; steer plans and IRA owners to investments based on their own, rather than their customers’ financial interests; and act on conflicts of interest in ways that would be prohibited if the same persons were fiduciaries. The DOL is focused on not only causing more advisers to become ERISA fiduciaries but to apply the fiduciary duties to retail investors.

With over 1,000 pages of text, the final regulation along with a number of class exemptions will become applicable to the retirement advice industry on April 10, 2017.

The final regulation treats persons who provide investment advice or recommendations for a fee or other compensation with respect to assets of a plan or IRA as fiduciaries in a wider array of advice relationships. The new definition states that a person shall be deemed to be rendering investment advice (thus deemed a fiduciary) if:

1. Such person provides to a plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner the following types of advice for a fee or other compensation, direct or indirect:
   1. A recommendation as to the advisability to take action or non-action with investment property to be invested after the investment property are rolled over, from the plan or IRA;
   2. A recommendation as to the management of investment property, or recommendations with respect to rollovers to an IRA; and
2. With respect to the investment advice, the recommendation is made either directly or indirectly (e.g., through or together with any affiliate) by a person who:
   1. Represents or acknowledges that it is acting as an ERISA fiduciary;
   2. Renders the advice pursuant to an agreement or understanding that the advice is based on the particular investment needs of the advice recipient; or
   3. Directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

The new regulation carved out the following specific duties or service providers from being deemed fiduciary if the specified conditions are all met (primarily is when the information and communication is not individualized and not deemed to be a recommendation, and significant amount of disclosures):

1. Platform providers
2. Investment education
3. Asset allocation models
4. Interactive investment materials
5. Seller of financial assets e.g. “swap” dealers
6. Employees (investment advice is not part of their function)

Please refer to the attached more detailed summary, “DOL Redefined an ERISA Fiduciary”, prepared by this firm on April 11, 2016.

The DOL has also sought to preserve various business models for delivery of investment advice by separately publishing new exemptions from ERISA’s prohibited transaction rules that would broadly permit firms to continue to receive many common types of fees, as long as they are willing to adhere to applicable standards aimed at ensuring that their advice is impartial and in the best interest of their customers. As In conjunction with the new regulation, DOL published a new exemption – the Best Interest Contract Exemption (“BICE”) that would provide conditional relief for common compensation, such as commissions and revenue sharing, that an adviser and the adviser’s employing firm might receive in connection with investment advice to retail retirement investors.

With the use of BICE, variable compensations that were deemed to be prohibitive are now exempted and the advisers may receive variable compensation, sell proprietary products, and apply a limited product universe and then be deemed a fiduciary, provided the compensation is “reasonable” and the advice is prudent.

Please refer to the more detailed summary, “DOL Best Interest Contract Exemption (BICE)” prepared by this firm on April 19, 2016.