The DOL’s proposal expanding the definition of fiduciary investment advice waspublished April 20, 2015.

Almost a year later, after public hearings and thousands ofcomment letters were submitted with respect to the proposal, theDOL finalized and published its new fiduciary rule on April 8,2016.

Related: Check out our DOL Fiduciary Rulepage

The new fiduciary rule is actually a package of regulatoryguidance and separate exemptions comprised of a new definition offiduciary investment advice and a number of related releasesproviding relief from ERISA’s prohibited transaction rules forfiduciary advisors necessitated by the dramatically expanded scopeof the revised fiduciary definition.

Related: 4 versions of the Best Interest ContractExemption

The DOL’s new fiduciary rule is intended to broaden the scope ofretirement advisors who are deemed to be fiduciaries under ERISAand the Internal Revenue Code (the “Code”), and it is also designedto address the potential conflicts of interest that arise when theyare advising their retirement clients. The scope of the new rule isfar-reaching, and it specifically covers and protects IRA clientsas well as plan sponsors and participants.

Related: The key question in NAFA's lawsuit againstthe DOL fiduciary rule

The new fiduciary rule targets broker-dealers, their registeredrepresentatives as well as insurance companies and theiragents.

It will affect virtually all registered representatives with anyIRA or plan clients.

In order to continue to earn commission-based compensation,advisors will need to comply with one of the new class exemptions.Virtually all IRA advisors will be deemed to be fiduciaries, andthe new rule is expected to change the IRA marketplace.

The new rule will also impact registered investment advisors (orRIAs) principally in two areas: it will restrict their ability tocapture rollovers and it will also impose new restrictions onretail managed account programs that are sponsored by advisoryfirms.

Scope of affected plans

The new definition of fiduciary investment advice applies toERISA plans maintained by private employers, as well as thetax-qualified arrangements described in Code section 4975 whichinclude sole proprietor plans, such as solo 401(k) plans, IRAs,Archer Medical Savings Accounts, Health Savings Accounts, andCoverdell education savings accounts.

Code section 529 plans are not subject to ERISA and they are notlisted in Code section 4975, so they are excluded from coverage(see Figure 2.1).

Figure 2.1

Codes section 403(b) accounts can be divided into three groups:(1) non-ERISA section 403(b) accounts maintained solely by anindividual through salary reductions with little or no employerinvolvement in administration, (2) non-ERISA section 403(b) plansmaintained by a governmental entity, such as a public school or anon-electing church, and (3) ERISA-covered section 403(b) plansmaintained by a private employer.

The DOL has made it clear that categories (1) and (2) are notsubject to ERISA or the new fiduciary rule.

Nongovernmental §457(b) plans are generally structured asunfunded nonqualified deferred compensation plans covering only aselect group of management or highly compensated employees and, assuch, are exempt from the fiduciary requirements contained in Part4 of ERISA.

Therefore, these plans and their counterparts under Section457(f) of the Internal Revenue Code are not covered by the newfiduciary rule.

If you've got questions about compliance issues related tothe new fiduciary standard, you're not alone. (Photo:iStock)

Effective date

Although the DOL’s final rule was officially published on April8, 2016, its effective date was delayed until April 10, 2017.

This one-year grace period was designed to give the industrytime to adjust to the new rules and be consistent with the DOL’spreviously announced commitment to give the industry lead time ofat least eight months.

The related prohibited transaction exemptions impose numerousconditions and requirements on fiduciary advisors.

Some of these requirements will be phased in and becomeeffective on April 10, 2017, but many of the more onerousrequirements will not become effective until January 1, 2018, onceagain giving advisors and other service providers time to adjust tothe change from non-fiduciary to fiduciary status.

Fiduciary definition and “investment advice”

Under the DOL’s existing fiduciary definition for serviceproviders, the provider is deemed to be a fiduciary to the extentit provides “investment advice” relating to plan assets for a feeor other compensation.

Once the provider is deemed to be a fiduciary, the providerbecomes subject to a higher standard of care under ERISA, as wellas particular limitations on the conduct of fiduciaries,i.e., prohibited transaction rules.

Rationale for Repeal of Old Definition – Underthe old DOL definition, in order to be a fiduciary providinginvestment advice, the advisor needed to make recommendations as toinvesting in securities or other property, or give advice as totheir value, on a regular basis.

There also had to be a mutual understanding that the advicewould serve as a primary basis for the plan’s investment decisions,and that the advice would be individualized to the particular needsof the plan.

Since 2010, when it initially proposed revising the five-factordefinition, the DOL has taken the position that this definition istoo narrow in today’s world, allowing many advisors to effectivelyprovide advice without having to answer to ERISA’s fiduciarystandard of care.

For example, an advisor could take the position that its adviceis not provided on a regular basis, or that there is no mutualunderstanding that the advisor’s recommendations will serve as theprimary basis for the plan’s decisions.

The DOL thought it was too easy for advisors to escape fiduciarystatus by relying on these components of the old definition whichit viewed as going too far in narrowing the definition of afiduciary. It, therefore, expanded the definition considerablyunder the new fiduciary rule to include a much broader group ofadvisors.

Context of Advice – As with the old fiduciaryrule, the DOL’s new rule provides that a person furnishing“investment advice” for compensation will still be viewed as afiduciary.

However, under the new rule, there are three different ways orcontexts in which an advisor will be deemed to be given investmentadvice as a fiduciary.

First, if the advisor acknowledges that it is acting as afiduciary under ERISA or the code, its advice will be automaticallyviewed as fiduciary advice.

Second, if there is a written or unwritten understanding thatthe advice is based on the particular investment needs of theclient, the advice will be deemed to be fiduciary in nature.

Third, if the advice is directed to a specific person where theadvice relates to the advisability of a particular investmentdecision, the advice will be deemed to be fiduciary advice.

Content of a Fiduciary “Recommendation” – Inaddition to looking at the context of the advice, it is alsonecessary to examine the nature of the advice, to determine if itis fiduciary advice.

Advice will be deemed to be fiduciary investment advice, only ifit includes a “recommendation” for a fee or other direct orindirect compensation, regardless of whether it is paid by the planor a third party, such as an investment provider. Under the finalrule, the threshold question in determining if fiduciary advice hasbeen rendered is whether such a “recommendation” has occurred.

The formal definition of a recommendation, like everything inthe final rule, is somewhat complicated, but it can be boiled downto two types of recommendations to plan and IRA clients.

First, fiduciary advice includes recommendations on theadvisability of investing in a security or other investmentproperty.

Second, fiduciary advice also broadly includes recommendationsrelating to the management of securities or other property. Forexample, management-related recommendations may include guidancewith respect to an investment policy statement, investmentstrategies or portfolio composition. It may also includerecommendations concerning the selection of other persons toprovide investment advice or investment management services.

Recommendations relating to the type of investment account (suchas brokerage versus advisory accounts) are also covered.

A recommendation for the transfer or rollover of assets from aplan or IRA account to a different plan or IRA account is anotherform of fiduciary advice.

The DOL has clarified that under its new fiduciary advicedefinition, all types of rollover recommendations will be viewed asfiduciary investment advice. Merely recommending a rolloverdistribution from a plan is viewed as fiduciary advice, even if itdoes not include an actual investment recommendation as to how toinvest the rollover proceeds after the distribution is made fromthe plan.

Proposed vs. Final Regulations – The finalversion of the DOL’s new investment advice definition follows thestructure of its proposed rule, which was issued in April 2015.However, there are a few noteworthy differences.

While the 2015 proposal provided that appraisals and financialvaluations of securities would generally be viewed as fiduciaryadvice, the DOL’s final rule excludes appraisals from thedefinition of investment advice. The DOL is, however, developing aregulatory amendment that will cover ESOP appraisals in the future.As discussed, the DOL’s final regulations will become effective onApril 10, 2017.

For purposes of the final fiduciary definition, the DOL hasclarified that an advisor’s fiduciary services may be limited toone-time advice, provided that the advisor communicates that itwill not have any ongoing monitoring responsibilities with respectto the recommended investment after its acquisition.

However, the DOL has indicated that when there will be noongoing monitoring, the advisor must ensure that the investment canbe prudently recommended in the first place without provision for amonitoring mechanism.

It's important, under the new DOL law, to understand exactlywhat constitutes "fiduciary advice." (Photo: iStock)

Observations

The new definition broadens the scope of what fiduciaryinvestment advice is by eliminating the regular basis, mutualunderstanding and primary basis aspects of the old five-factortest.

Even one-time advice that is not provided on a regular basis canpotentially be viewed as fiduciary advice. Unlike the olddefinition, there is no need for a “mutual understanding” betweenthe parties for fiduciary advice to be provided.

It is enough for a plan or IRA client to unilaterally think thatthe advisor is providing fiduciary advice, to trigger fiduciarystatus for the advisor, provided that the advisor’s communicationis “reasonably” viewed as investment advice. The advice does noteven need to be individualized.

A recommendation will be viewed as fiduciary advice if itaddresses the particular investment needs of a client, or if itmerely addresses a particular investment decision.

Also, the advice no longer needs to serve as the “primary basis”for the retirement client's investment decision as required underthe old rule. Under the new rule, the retirement client merelyneeds to receive the advice.

The old fiduciary investment advice definition clearly coveredinvestment recommendations, but it did not expressly apply toinvestment management recommendations.

Because of the literal wording, certain advisors took theposition that recommending investment managers (as opposed toinvestments) was not a fiduciary act. However, the DOL has nowclarified that investment management recommendations are alsocovered advice.

Further, with respect to recommendations concerning theselection of other persons to provide investment advice orinvestment management services, the DOL has clarified that thefiduciary advice definition is not intended to includemarketing-related statements that an advisor might make whenpromoting its own services.

Therefore, investment advice does not include an advisor’srecommendation to a retirement client to hire the advisor itself.In other words, an advisor that makes a “hire me” recommendation toa plan or IRA client will not be viewed as providing fiduciaryadvice. This is a helpful clarification, because otherwise, anadvisor’s “hire me” recommendation could potentially be viewed asconflicted advice in violation of the prohibited transactionrules.

In response to commentators, the final rule provides that adviceas to the purchase of health, disability, term life insurance andsimilar life insurance policies without an investment componentwill not constitute fiduciary investment advice.

However, the Preamble to the final regulation makes a point ofnoting that if an advisor effectively has discretionary controlover the decision to purchase such insurance, the advisor couldpotentially come under the management or administration branches ofthe functional fiduciary definition, even if the advisor was notdeemed to have provided investment advice.

Lastly, the final rule purports to follow the definition of a“recommendation” as promulgated by the Financial IndustryRegulatory Authority (FINRA) meaning that it broadly includes anycommunication that, based on its content, context and presentation,would be reasonably viewed as a suggestion that the advicerecipient engage in or refrain from taking a particular course ofaction.

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