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AdvisorNews - October, 2016


A Brave New World for Investment Advisors Following Issuance of Final Rule

On April 8, 2016, the Department of Labor (DOL) released the much anticipated final regulation to broaden the scope of fiduciary status under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986, as amended (Code).  While the final rule will become officially effective on June 7, 2016, its requirements are not applicable until April 10, 2017.  The DOL explained that the purpose in making the rule officially effective right away and yet not applicable until next year was to provide certainty that the rule is indeed final and not subject to modification without additional public notice and comment.  Thus, parties affected by the final rule may therefore begin planning for compliance with assurance of the provisions.

The final rule replaces a long-standing regulatory interpretation of the term “fiduciary” as it relates to the provision of investment advice for employee benefit plans and other tax-advantaged accounts, such as individual retirement accounts and health savings accounts (collectively referred to herein as IRAs).  Since the issuance of the prior interpretation, there has been significant utilization of participant-directed plans, more rollovers of retirement plan assets, and increased sophistication of financial products.  Due to these changes in the marketplace, the DOL concluded that the final rule was necessary, particularly, to protect the interests of participants, beneficiaries, IRA owners, and small plan sponsors (collectively referred to herein as retail investors).  The results of the final rule are far reaching.  Traditional investment advisors, as well as broker-dealers, insurance brokers, banks, and employers, will be interested in how this rule affects them, and the guidance will undoubtedly continue to develop over the coming months.

This news alert is intended to provide you a general summary of the final rule.  Additional news alerts will be distributed to address each component of the final rule and applicable exemptions in detail.

Background of Current Law
Under current law, ERISA imposes standards of care that the United States Supreme Court characterizes as the “highest known to the law.”  Fiduciaries that violate these standards of care are personally liable for losses to the applicable plan.  Additionally, ERISA prohibits fiduciaries from engaging, directly or indirectly, in prohibited transactions, including self-dealing transactions where conflicts of interest may be present.  While similar prohibited transaction rules are prescribed under the Code (and would apply to IRAs, for instance), there is no fiduciary standard of care imposed under the Code with respect to these accounts.  Violations of the prohibited transaction rules under either ERISA or the Code can result in significant excise taxes (of up to 100% of the amount involved) being imposed upon the parties and payable to the IRS; however, there is no right on the part of retail investors to pursue any action against an investment advisor for breach of fiduciary duty.

For purposes of ERISA and the Code, the term “fiduciary” is defined on a functional basis to include any person, to the extent, he has or exercises certain discretionary authority, responsibility, or control with respect to plan assets and administration.  The final rule does not change the fiduciary status of such persons.  For example, administrative committees of plans, investment managers with discretionary authority to manage plan assets and, to some extent, plan sponsors, will continue to be fiduciaries following the release of this rule.
In addition, however, a person is a fiduciary under ERISA and the Code to the extent he renders investment advice for a fee or other compensation (whether direct or indirect) with respect to plan assets, or has any authority or responsibility to do so.  Notwithstanding the expansive statutory language describing this latter group, the DOL issued a regulatory interpretation in 1975 that greatly constricted the scope of the definition of “fiduciary” for investment advisors.  Several conditions had to be met under this interpretation in order for the advisor to be considered a fiduciary with respect to such advice.  Specifically, the advice had to be provided on a regular basis to the plan, there had to be a mutual understanding of the parties that the advice would serve as the primary basis for investment decisions with respect to plan assets, and the advice had to be individualized based on the particular needs of the plan.

If any factor of this regulatory test was not satisfied, the person rendering the advice would not be considered a fiduciary by virtue of providing such advice.  Under this rule, persons who provided one-time advice, like recommendations for a rollover from a qualified plan or investment of a rollover into an insurance or annuity product, were not fiduciaries.  Noteworthy, the regulatory interpretation included exceptions for the execution of transactions for the purchase or sale of securities on behalf of a plan in the ordinary course of business if certain conditions are met.  This regulatory exception remains largely intact under the final rule, except for some clarifying changes.
New Definition of “Fiduciary”

Under the final rule, a person is considered a fiduciary by virtue of rendering investment advice (and is referred to herein as a fiduciary investment advisor) with respect to ERISA plan assets or IRA assets if the person provides to a plan, plan fiduciary, plan participant or beneficiary, or IRA or IRA owner, for a fee or other compensation:

1.    a recommendation about the advisability of acquiring, holding, disposing of or exchanging securities or other investment property, or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA; or

2.    a recommendation as to the management of securities or other investment property, including a recommendation on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g. commission-based brokerage v. fee-based advisory), and recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer or distribution should be made.

The final rule does not cover the issuance of an appraisal, fairness opinion or similar statement concerning the value of securities or other investment property.  Instead, the DOL intends to issue separate guidance with respect to these activities.

In order to be treated as a fiduciary investment advisor, the recommendation must be made directly or indirectly by a person who:
1.    Represents or acknowledges that it is acting as a fiduciary within the meaning of ERISA or the Code,
2.    Renders the advice pursuant to a written or verbal agreement, arrangement 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(s) regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

For these purposes, an investment advice fiduciary is not limited to a person registered under the Investment Advisers Act of 1940. On the other hand, not all persons who provide investment advice will be considered fiduciaries under the final rule. Rather, the person must satisfy each of the requirements prescribed in the final rule in order to be considered a fiduciary investment advisor and, further, not be covered by an applicable exception to the rule (as described below).

At the crux of the analysis is whether the advice involves a recommendation.  The final rule defines “recommendation” as a 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.  Certain activities, however, do not rise to the level of a recommendation.  The final rule includes a non-exhaustive list of examples, including certain activities related to the offering of an investment platform for participant-directed plans; the provision of investment education information and materials to plan participants or IRA owners, including asset allocation models and interactive investment materials for plan participants; and general or public communications, provided, in each instance, that certain conditions are met.

Absent the advisor’s receipt of a fee or other compensation, however, the fact that the advisor makes a recommendation will not, by itself, result in the advisor being a fiduciary.  Satisfaction of this condition is not limited to a direct payment of fees by the recipient of the advice.  Rather, it includes the advisor’s receipt of any fee or compensation received from any source in connection with or as a result of the recommended purchase or sale of a security or the provision of investment advice services.  Meaning, the compensation could be paid, among others, as commissions, loads, finder's fees, revenue sharing payments, shareholder servicing fees, marketing or distribution fees, underwriting compensation, payments to brokerage firms in return for shelf space, recruitment compensation, gifts and gratuities, and expense reimbursements. Consequently, an advisor will not escape fiduciary status merely because it has not directly charged the recipient for the recommendation.

Even if the advisor receives a fee or other compensation in connection with the recommendation, it will not be a fiduciary investment advisor if any one of three regulatory exceptions applies.  The first regulatory exception covers certain transactions, such as sales pitches, that are part of an arm’s length transaction with a sophisticated plan fiduciary where neither side assumes that the counterparty to the plan is acting as an impartial or trusted advisor.  The second regulatory exception is for certain communications and activities conducted during the course of swap or security-based swap transactions.  The third regulatory exception is for certain advice provided by employees of the plan sponsor (or an affiliate).

With the expanded definition of “fiduciary”, new groups of persons will now find themselves being regarded as fiduciaries under ERISA and/or the Code. Advisors often receive compensation for advice through a variety of arrangements that may implicate the prohibited transaction rules prescribed under ERISA and the Code.  Further, if the person provides advice to an ERISA-governed plan, it will become subject to the standards of care prescribed under ERISA and can be held personally liable for failures to act prudently and solely in the interests of plan participants.

To address this former concern, the DOL, simultaneously with the publication of the final rule, issued a new prohibited transaction exemption referred to as the “Best Interest Contract Exemption.”  The Best Interest Contract Exemption is specifically designed to address the conflicts of interest that exist as a result of various compensation arrangements utilized by fiduciary investment advisors in connection with advice provided to retail investors.  In addition, a new “Principal Transactions Exemption” has been issued to permit fiduciary investment advisors to sell or purchase certain debt securities and other investments out of their own inventories to or from plans and IRAs. These exemptions require, among other things, that the advisors contractually agree to adhere to certain impartial conduct standards, which include fundamental obligations of fair dealing and fiduciary conduct such as obligations to act in the customer’s best interest, avoid misleading statements, and receive no more than reasonable compensation. The DOL also amended existing prohibited transaction exemptions to ensure uniform application of the impartial conduct standards. The incorporation of these standards into the prohibited transaction exemptions effectively provide IRA owners a contractual right to protections similar to those prescribed under the fiduciary responsibility rules of ERISA.

The new and amended exemptions supplement existing statutory exemptions and previously adopted class exemptions, as well as previously issued guidance in the form of advisory opinions.  Fiduciary investment advisors may continue to rely on these existing exemptions and guidance to avoid a prohibited transaction.  In short, reliance on the Best Interest Contract Exemption is not the sole method for avoiding a prohibited transaction with respect to compensation received in connection with the provision of investment advice.
What does this mean for investment advisors?

To the extent an investment advisor is already exercising fiduciary authority or retains fiduciary responsibility with respect to the management of assets of a retirement plan or IRA, nothing in this final rule changes that status. Such advisor must avoid prohibited transactions under ERISA and/or the Code, as applicable. Where the advice is being provided with respect to an ERISA-governed plan, the advisor retains the duty to comply with fiduciary standards of care under ERISA.  For example, investment managers to ERISA-governed plans (or their participants) remain obligated to act in the sole interests of plan participants and make prudent investment decisions for the plan.
Investment advisors who are not already considered fiduciaries under ERISA or the Code, however, will need to carefully review their service arrangements and determine whether they will be considered fiduciary investment advisors under the final rule. The final rule is broad and covers many standard relationships, including the provision of investment platforms to participant-directed accounts and investment education programs, unless specific conditions are met.  On the other hand, some services are not considered investment advice or are specifically excepted from the final rule.

As a fiduciary investment advisor to an ERISA-governed plan, the person will become subject to the fiduciary standards of care under ERISA and could be personally liable for losses resulting from the recommendations given to the plan or participants.  It is irrelevant whether the plan to which the advice is provided is a participant-directed plan under ERISA Section 404(c).  Although fiduciaries are not generally liable under an ERISA 404(c) plan for investment losses that are the direct and necessary result of the participants’ directions, that protection does not extend to advice that is provided to the participants imprudently or that implicates a prohibited transaction.
Furthermore, as a fiduciary investment advisor, the person will become subject to the prohibited transaction rules of ERISA and/or the Code.  If the compensation arrangement implicates the prohibited transaction rules, the advisor can modify the compensation arrangement to avoid a conflict of interest or retain the existing compensation arrangement and satisfy the Best Interest Contract Exemption or another available prohibited transaction exemption to avoid the imposition of excise taxes.  Reliance on the Best Interest Contract Exemption and other prohibited transaction exemptions, however, can result in additional recordkeeping and retention requirements for the advisor.
Depending on the decision made, the fiduciary investment advisor will likely need to renegotiate and amend service agreements for various reasons, such as:
1.    To change the scope of investment advice or education provided to the plan, participants or IRA owners;
2.    To revise compensation arrangements to ensure that no prohibited transaction occurs by virtue of the receipt of such compensation,
3.    To provide necessary disclosures or acknowledgments to ensure the arrangement fits within an applicable exception to the final rule, and
4.    To incorporate required provisions under the newly issued Best Interest Contract Exemption or other applicable prohibited transaction exemptions and advisory opinions to avoid exposure to possible excise taxes.

Additionally, the fiduciary investment advisor should contact its professional liability insurer. As a fiduciary under ERISA and the Code, the advisor could be exposed to additional liability and may desire to increase its liability coverage.


DOL issues final fiduciary rule on investment advice

June 27, 2016
By Puneet Arora and Lynn Cook
Under final regulations from the Department of Labor (DOL), certain types of advice provided to retirement plans, plan fiduciaries, participants, beneficiaries and individual retirement accounts (IRAs) or IRA owners in exchange for direct or indirect compensation constitute “investment advice” subject to ERISA’s fiduciary standards. The rules were proposed in 2010 and again in 2015.1
The DOL lists the following types of communications as “investment advice” potentially subject to the rule:
1.     A recommendation to acquire, hold, dispose of or exchange securities or other investment property, or advice on how to invest securities or other property after a plan or IRA distribution
2.     A recommendation for managing securities or other investment property, including recommendations on investment policies or strategies; portfolio composition; selection of investment advisors or managers; selection of investment account arrangements (e.g., brokerage versus advisory); and the amount, form and destination for a rollover or other distribution

A recommendation is a communication that — based on content, context and presentation — would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from an action. According to the DOL, determining whether a recommendation has occurred is an objective rather than subjective inquiry. The more individually tailored a communication is to its recipient, the more likely it is to be viewed as a recommendation. For example, providing a list of securities deemed appropriate for an investor would be a recommendation. It makes no difference whether the communication is initiated by a person or computer software.

Under the new definition of investment advice, more advisors who make recommendations to plans, participants or beneficiaries for managing investments and the timing of distributions will be considered investment advice fiduciaries subject to ERISA. More recommendations could give rise to a prohibited transaction, potentially subjecting the plan sponsor to the associated 15% penalty tax. To minimize disruption to the retirement industry, the DOL finalized some relief through the new “best interest contract” (BIC) exemption. Those who provide investment advice to plans, plan sponsors, fiduciaries, plan participants, beneficiaries, and IRAs and IRA owners must either avoid payments that create conflicts of interest or comply with the terms of an approved exemption.

The final rule is silent on whether appraisals, fairness opinions and statements of value are investment advice as the DOL plans to address these in a separate regulatory initiative. While the final regulations are generally applicable as of April 10, 2017, there is a longer transition period (to January 1, 2018) for the BIC exemption and the prohibited transaction exemption for principal transactions.

The final regulation describes the types of relationships that must exist for investment advice to give rise to fiduciary responsibilities. To be considered fiduciary investment advice, the recommendation must be made either directly or indirectly (e.g., through an affiliate) by someone who meets at least one of three conditions:
1.     Represents or acknowledges that he or she is acting as a fiduciary
2.     Renders the advice under a written or verbal agreement, arrangement or understanding that the advice is based on the recipient’s investment needs
3.     Advises a specific recipient on the advisability of making investment or management decisions on securities or other investment property of the plan or IRA


The DOL excluded some services, communications and materials from the rule, including marketing by platform providers, assistance in selecting and monitoring platform providers, general communications, plan information and investment education. The DOL also identified activities that involve investment advice but do not make the involved party a fiduciary, unless he or she acknowledges acting as a fiduciary under ERISA or the tax code.

According to the DOL, a fiduciary designation does not apply to the normal activity of marketing oneself or an affiliate as a potential fiduciary, without making an investment recommendation covered by the final rule. However, a communication that results in a rollover or investment recommendation would be subject to the rule.

A platform provider offers access to a selection of investment funds. Marketing (or making available) a platform of investment alternatives (including qualified default investment alternatives) for plan participants to a plan fiduciary who is independent of the platform provider is not a recommendation if the provider informs the plan fiduciary (in writing) that the advice is not impartial or given in a fiduciary capacity. Platform providers marketing directly to plan participants, beneficiaries or their relatives may not rely on this provision.


Providing assistance to plan fiduciaries who select and monitor investments offered through platforms or similar mechanisms is not making recommendations, provided the service is limited to identifying investments that meet objective criteria specified by the fiduciary, such as required expense ratios, fund size, asset type or credit quality.

Furnishing or making available general communications that a reasonable person would not view as an investment recommendation — such as newsletters, talk show commentary or conference presentations — is not giving investment advice.

Providing or offering certain educational materials is not considered investment advice. The final regulation classifies investment education into four categories: (1) plan information; (2) general financial, investment and retirement information; (3) asset allocation models; and (4) interactive investment materials.

Plan information. Comparative information about forms of distribution is not a recommendation as long as it is not individualized. Information about the benefits of participating or contributing more; the effect of preretirement withdrawals on retirement income; and general descriptions of the plan’s investment options, fees and expenses are not recommendations. However, information related to the appropriateness of an individual benefit distribution option for the plan or IRA, or a particular participant, beneficiary or IRA owner would constitute investment advice.

General financial, investment and retirement information. Information and materials on retirement-related risks, and general methods and strategies for managing assets in retirement are not investment advice.

Asset allocation models. Model asset allocation portfolios, such as pie charts, graphs and case studies of hypothetical individuals are not investment advice. The models must be based on generally accepted investment theories that reflect historical returns and disclose material facts and assumptions, and be accompanied by a statement advising readers to consider their other income and investments before allocating their assets. Asset allocation models may identify a specific investment alternative if it is a designated investment alternative subject to oversight by an independent plan fiduciary, and any other designated investment alternatives with similar risk and return characteristics are also described.

Interactive investment materials. Interactive materials that allow a plan fiduciary, participant or beneficiary, or IRA owner to evaluate distribution options, products or vehicles described in the sections above are not recommendations, as long as the materials are based on generally accepted investment theories, and there is an objective correlation between the income stream generated by the materials and the information and data supplied by the participant, beneficiary or IRA owner. Under the final rule, a designated investment alternative may be included or identified in interactive investment materials under the same conditions discussed in the asset allocation model section above.


The final regulations also address three categories of activities that are not fiduciary investment advice under ERISA or the tax code unless the person represents or acknowledges acting as a fiduciary.

Seller’s exception. Advice to a plan fiduciary with financial expertise by a counterparty acting in an arm’s-length transaction (e.g., sale of an interest in a common collective trust) is not fiduciary investment advice if five conditions are met:
1.     The independent fiduciary is a bank, insurance carrier, investment advisor, broker-dealer or independent fiduciary that manages or controls assets of at least $50 million.
2.     The counterparty must reasonably believe that the independent fiduciary is capable of evaluating investment risks independently.
3.     The counterparty informs the independent fiduciary that the advice is not impartial or provided in a fiduciary capacity, and fully discloses any financial interests in the transaction.
4.     The counterparty reasonably believes that the independent fiduciary is responsible for exercising independent judgment in evaluating the transaction.
5.     All fees paid in connection with the transaction are for services or products other than investment advice.

All plan and non-plan assets being managed may count toward the $50 million threshold. Furthermore, the counterparty giving advice may rely on written representations from the plan or independent fiduciary that the $50 million threshold has been met, and the independent fiduciary is a fiduciary under ERISA or the tax code and is capable of evaluating investment risks.

Swap and security-based swap transactions. Advice provided to an employee benefit plan to enter into a swap or security-based swap that is regulated under the Securities Exchange Act or the Commodity Exchange Act is not fiduciary advice as long as the plan is represented by another independent ERISA fiduciary, and the swap dealer neither acts as an advisor nor receives a fee from the plan or plan fiduciary for the advice. The plan fiduciary must provide certain written representations in advance of any recommendations.

Employees. Advice provided to the plan fiduciary by the sponsor’s employees is not fiduciary investment advice, provided the employee receives no additional compensation for the advice. Additionally, an employee who inadvertently recommends an investment to another employee — such as an HR employee communicating with another employee— is not an investment advice fiduciary, as long as the advice-providing employee: (1) is not a licensed or registered investment advisor under state or federal law, (2) is not employed by the employer or an affiliate to provide investment recommendations to other employees, and (3) does not receive any additional compensation for the inadvertent advice.


Advice for purchasing health, disability and term-life insurance policies is not subject to these rules as long as the policies have no investment component. However, the rule does apply to health savings accounts (HSAs), medical savings accounts (MSAs) and Coverdell education savings accounts (ESAs). As the DOL notes, these accounts receive tax preferences; HSAs may have associated investment accounts; and HSA funds may be put in IRA-approved investments, such as bank accounts, annuities and mutual funds. Furthermore, HSA trust or custodial agreements may include permissible investments, such as specific investment funds, and HSAs are subject to the prohibited transaction rules.

The DOL has publicly stated that it does not intend to extend fiduciary status to an employer who provides or contracts with a vendor who administers the HSA, but that stance is not in the final rule. Previous guidance has stated that the DOL generally does not consider HSAs to be covered under ERISA, suggesting that HSA sponsors would not be ERISA fiduciaries.


The BIC exemption provides a way for investment advisors and financial institutions to work with participants and beneficiaries who are eligible to roll over a plan distribution to an IRA, or provide advice (versus education) on investing a defined contribution (DC) account. The exemption permits fiduciary advisors and financial institutions and their affiliates to receive variable (including additional) compensation for investment advice provided to plan participants, beneficiaries and plan fiduciaries (other than banks, insurers, registered investment advisors and broker-dealers) who hold, manage or control assets of less than $50 million.

For an ERISA plan, the exemption generally requires an investment advisor or the advisor’s financial institution to acknowledge fiduciary status and meet basic standards of impartial conduct. Unless compensation is level, the advisor must also warrant that it has adopted policies and procedures to mitigate any harmful impact of conflicts of interest, and disclose any conflicts of interest and the cost of the advice. All fiduciaries must retain records demonstrating compliance with the exemption. In general, required disclosures may be made electronically. 

Advisors must adhere to ERISA’s “prudent expert” standard of conduct, and base investment recommendations on the investment objectives, risk tolerance, financial circumstances and needs of the participant or beneficiary, disregarding their own or anyone else’s financial interests. This portion of the impartial conduct standards is also called the “best interest” standard. The compensation received must be appropriate and be based on the reasonable compensation rules under ERISA, and advisors may not make materially misleading statements.

The DOL also streamlined compliance for level-fee fiduciaries. In addition to acknowledging fiduciary status and complying with the impartial conduct standards, a level-fee fiduciary also must consider (and document): (1) the participant’s or beneficiary’s alternatives to a rollover, including leaving the money in the employer plan if permitted, and the different fees and expenses associated with both the plan and the IRA; (2) whether the employer pays some or all of the plan’s administrative expenses; and (3) the different levels of services and investments available under each option.

Some of this information is generic to DC plans or generally available in the plan’s fee disclosures. Robo-advice providers (financial advisors that provide online portfolio management with minimal human intervention) must charge level fees to qualify for the BIC exemption. Fiduciaries who are not level-fee advisors are generally not required to perform an analysis of rollover alternatives, but are subject to extensive requirements designed to make any conflicts of interest transparent. Advisors that limit options to proprietary products must also make additional disclosures that increase transparency.

The exemption for variable compensation generally permits advisors to receive brokerage or insurance commissions. However, the rules prohibit certain incentive compensation practices, including quotas, appraisals, performance or personnel actions, bonuses, contests and special awards. Generally, any differential compensation that does not demonstrably align with the interest of the advice recipient is suspect.

The BIC exemption applies to transactions on or after April 10, 2017, but until January 1, 2018, only the best interest standard, the reasonable compensation requirement, the prohibitions on materially misleading statements, and requirements related to certain disclosures of material conflicts of interest and third-party payments apply.

Under a grandfather rule — subject to certain conditions — the prohibited transaction rules do not apply to compensation attributable to advice for (1) investments made before April 10, 2017, or (2) investments made pursuant to advice on a systematic purchase program established before that date. Compensation attributable to any advice regarding grandfathered investments after April 10, 2017, must meet the best interest standard.

To avoid prohibited transactions, insurance and financial services advisors and brokers who sell retirement investment advice and products to small plans, plan participants and IRA owners will likely have to satisfy the conditions of a prohibited transaction class exemption. Plan sponsors, plan participants and IRA owners will benefit, since the rules make conflicts of interest considerably more transparent.
Plan sponsors may wish to:
•         Review contracts and arrangements with investment advice providers to ensure the advice either does not constitute a “recommendation,” or acknowledges fiduciary status and liability for the products or services offered or provided.
•         Review vendors’ contracts and arrangements to determine their fiduciary status, identify any conflicts and confirm they are properly disclosing fees.
•         Review DC plan investment education programs and update as necessary to provide clear guidelines to plan fiduciaries.
o    Determine whether asset allocation models use specific designated investment alternatives and, if so, monitor whether such models are unbiased.
o    Review general communications and confirm that they do not inadvertently provide investment advice.
o    Discuss the implications of this final rule on DC plan recordkeepers, especially to the extent they provide investment education materials, such as asset allocation models and interactive investment materials.
•         Ensure that plan fiduciaries are fully advised of their obligations.
•         Monitor the impact of the changes on employees, particularly those nearing retirement.
•         Review HSA agreements with vendors to insure that the employer remains insulated from the new DOL fiduciary/conflict of interest standards.
•         Confirm that fiduciary liability insurance coverage is adequate.
o    Beware of ancillary exposures. The new, broader interpretation of both advisor and advice may increase exposure for the investment industry. For example, a provider of lists and reviews of third-party investment products could be characterized as a fiduciary if the plan invests in one of the listed products, and the financial professional services policy might not cover that ancillary exposure.
o    Reconsider the impact of indemnification and align it to coverage terms. The higher risk of co-defendants may present a corresponding risk of triggering indemnification rights. Ensure that insurance coverage for these risks is adequate.
o    Review limits adequacy. Given the likelihood of more litigation and higher costs, sponsors might want to buy more fiduciary or professional liability insurance coverage. Be wary of peer review as a foundation of that assessment, as where exposure is increasing materially, as it is here, peer analysis may fall short.

Tips For Drafting Best-Interest Contracts Under DOL Rule

Law360, New York (June 29, 2016, 11:53 AM ET) --
The best-interest contract (BIC) exemption is the centerpiece of the U.S. Department of Labor’s regulatory package regarding fiduciary conflicts of interest, which includes an expanded DOL definition of fiduciary investment advice and corollary exemptions. When dealing with individual retirement accounts (IRAs), a written contract is required and serves as the critical element for relief under the BIC exemption. The contract can be a stand-alone document or its terms may be folded into a broker-dealer’s customer account agreement. In either format, a BIC contract must meet many requirements. But there is latitude in how the required language is presented. This article is intended to identify and discuss practice considerations for attorneys drafting BIC contracts. Operational Issues Contract Parties. The IRA owner and the financial institution (FI) (and not the individual representative or adviser) will be the parties to the BIC contract. The FI is the entity to which the representative/adviser is associated and that is (1) registered as an investment adviser under the Investment Advisers Act, (2) a bank, similar financial institution or savings association, (3) an insurance company that meets certain qualifications, (4) a broker or dealer registered under the Securities Exchange Act of 1934, or (5) any entity that the DOL determines is a financial institution in a future exemption. The IRA account owner signs the contract manually or electronically. Telephone assent is not permitted. The FI is not required to sign the contract so long as the BIC contract is enforceable against the FI. Contract Execution and Assent. The contract, which may be executed at the time of other account-opening documentation and other agreements, is required to be executed prior to or at the same time the recommended transaction is executed. Until Jan. 1, 2018, existing IRAs may be amended by negative consent so that the contract requirements may be satisfied by sending the IRA customer a written notice including the contractual undertakings and requirements. Contract Terms Fiduciary Acknowledgment. The BIC exemption requires the FI to state in writing that it and its representatives/advisers act as fiduciaries with respect to the investment advice subject to the contract.

The DOL has indicated that the fiduciary acknowledgement can be limited to investment recommendations subject to the contract. The acknowledgement does not in and of itself impose on the FI or the representative/adviser an ongoing duty to monitor the investment that was recommended, but the DOL notes that there may be some investments that cannot be prudently recommended without ongoing monitoring. If an investment will be monitored, however, specified disclosures are required as discussed below. Consistent with past practice, a careful and specific articulation of the undertakings for which fiduciary status is acknowledged would ordinarily be good practice. For example, investment “education” under the new definition or advice within the grandfather rule of the BIC exemption should be outside the scope of the fiduciary acknowledgement. Impartial Conduct Standards. The BIC contract must state that the FI and its advisers comply with and will adhere to impartial conduct standards and that (1) they will provide advice that is in the best interest of the retirement investor (discussed below) at the time of the recommendation; (2) they will not cause the FI, adviser, affiliates or related entities to receive compensation for their services that would exceed reasonable compensation within the meaning of the Employee Retirement Income Security Act; and (3) statements about the recommended transaction, fees and compensation, material conflicts of interest, and any other matters related to the retirement investor’s investment decisions will not be misleading at the time they are made. A material conflict of interest exists when an FI or adviser has a financial interest that a reasonable person would conclude could affect the exercise of its best judgment as a fiduciary in providing advice to an IRA account owner. Warranties. The BIC contract must also warrant that (1) the FI has adopted and will comply with written policies and procedures reasonably and prudently designed to ensure that advisers adhere to the impartial conduct standards; (2) that in formulating the policies and procedures, the FI identified and documented any material conflicts of interest and adopted measures to prevent the material conflicts of interest from causing violations of the impartial conduct standards, with a designated person responsible for addressing and monitoring these issues; and (3) that the FI’s policies and procedures require that neither the FI nor (to the best of its knowledge) affiliates use or rely on 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 not in the best interest of the retirement investor (although differential compensation that is not counter to the retirement investor’s best interest is allowable). Predispute Arbitration. A BIC contract may require predispute binding arbitration of disputes with the FI or representative/adviser, provided that a chosen venue is not distant and does not unreasonably limit the ability of the investor to assert claims against the FI or the adviser. The retirement investor’s right to bring a class action or other representative action in court must be preserved. Note that some customer account agreements include predispute arbitration provisions. Consideration should be given to whether the BIC contract version of the provision should follow or differ from the provision in the base agreement. Waivers. The contract may include a waiver of the investor’s right to obtain punitive damages under contract law or rescission of recommended transactions based on a violation of the contract if such waivers are permitted under applicable state or federal law. A BIC contract does not require waivers of certain claims or jury trials, forms, time limits on claims, punitive damages or costs, and attorneys’ fees. Notwithstanding, standard contractual language designed to limit liability and minimize expenses associated with litigation might be appropriate; there is no policy reason for litigation outcomes under a BIC contract to differ due to vagaries in state law. The language may limit causes of action to a particular jurisdiction, but note that the BIC exemption prohibits venue selections that are distant from the customer or that unreasonably limit the ability of the customer to assert claims. Exculpatory Provisions. Provisions disclaiming or limiting liability of the FI or adviser for a violation of the contract’s terms or of the fiduciary rules under the ERISA are expressly precluded from inclusion in a BIC contract. Consideration should be given, however, to including provisions to limit liability. The contracting parties may not agree to an amount representing liquidated damages for breach of the contract. However, the exemption expressly permits the parties to knowingly agree to waive the retirement investor’s right to obtain punitive damages or rescission of recommended transactions to the extent such a waiver is permissible under applicable state or federal law. Care should be taken to ensure that this language does not conflict with language in a customer account agreement or any other account documentation. Terminating the Contract. Language permitting either party to terminate the contract with prior notice is not required by the BIC exemption but it will be helpful. In addition, setting forth the obligations of the IRA owner and the FI upon termination is worthwhile. Governing Law. The BIC exemption does not require the contract to include a provision stating which jurisdiction’s laws will govern its interpretation where ERISA and Code rules do not apply. Such language may provide a helpful measure of certainty, without regard to choice-of-law provisions in other account-related documents. Headings. Language regarding the significance of headings terminology in the contract is not required by the BIC exemption, but is standard contractual language designed to avoid interpretive questions. Severability. A provision stating that if parts of the contract are held to be illegal or otherwise unenforceable, the remainder of the contract will still apply is not required by the BIC exemption, but is standard contractual language designed to avoid interpretive questions. Disclosures In the BIC contract or in a separate single written disclosure provided with the contract, the FI must clearly and prominently make certain disclosures. The content of the disclosures will be subject to customization to the FI’s particular circumstances. As they apply to IRAs, a few of the disclosures are redundant to other contract terms. So long as the required information is provided clearly and prominently, a single disclosure of particular information is sufficient. The disclosures must be promptly amended or supplemented, and promptly delivered to the IRA owner, to reflect any material changes or additions. The disclosures must:
• State the best-interest standard of care and describe how the retirement investor will pay for services, and describe the FI’s material conflicts of interest and any fees and compensation that the FI, its affiliates and its advisers expect to receive. (This may be done by reference to web disclosures).

• Inform the retirement investor of his or her right to obtain copies of the FI’s written policies and procedures and specific disclosures of costs, fees and compensation associated with the recommended transaction. 

• Provide a link to its website and inform the retirement investor that the website includes model contract disclosures and copies of the FI’s policies and procedures to ensure that its advisers are meeting the best-interest standard of care.
• Must state whether the FI offers proprietary products or receives third-party payments.
• Provide contact information for a representative of the FI describing whether or not the adviser and FI will monitor the recommended investments. (Ongoing monitoring of recommended investments is not required but may be agreed to by the parties.) The terms of the contract or disclosure, along with other representations, agreements or understandings between the financial adviser, the FI and the IRA account owner, will govern whether the nature of the relationship between the parties is ongoing or not.
Conclusion Practitioners drafting the BIC contract will need to take care to ensure the contract not only satisfies the DOL fiduciary rule’s requirements, but also conforms to the firm’s related customer agreements and disclosures and also employs conventional terms that are designed to provide protections to the firm, where appropriate.



Change is coming to the field of financial advice and it’s going to be disruptive

3 industry trends converging, says J.D. Power study
Jul 04, 2016 | By Marlene Y. Satter

Retiring advisors and advisors starting their own firms are some of the reasons the investment advisory business is in for a sea-change, says a J.D. Power study.

Change is coming to the field of financial advice, and it’s going to be disruptive.

That’s according to the "J.D. Power 2016 U.S. Financial Advisor Satisfaction Study," which found that traditional investment advisory services are likely to be transmogrified in a confluence of retiring advisors, the rise of the robo-advisor or automated investment-picking algorithm, and the lower fees of independent advisory shops.

The study measures advisor satisfaction — both for employees and independents — and uses seven factors to determine how content (or otherwise) advisors are. The factors are client support; compensation; firm leadership; operational support; problem resolution; professional development support; and technology support.

Satisfaction is measured on a 1,000-point scale. Among employee advisors — those who work for an investment services firm — overall satisfaction averages 722; that’s up 21 points from 701 in 2015.

Among independents — those affiliated with a broker-dealer but operating independently — satisfaction averages 755; that’s down 18 points from last year’s average of 773.

Retirement and going independent are main factors
The study pointed to several impending changes that will have far-reaching changes for the field. First is the potential for retirement among advisors on a large scale.

Nearly a third (31 percent) are poised to retire in the next 10 years. Between 2014 and 2016, the number of advisors indicating they plan to retire in the next 1–2 years has risen to 3 percent from 2 percent.

Then there’s the trend for advisors to jump ship, or to strike out as independents.

The percentage of employee advisors, in particular, who indicate that they’re likely to go independent in the next 1–2 years has doubled since 2014, when it was 6 percent. Now it’s 12 percent. And another 12 percent of advisors say they’re likely to join or start an independent registered investment advisor practice in the next 1–2 years, up from 7 percent.

Retain advisors, retain profits
Between retirements and other departures, firms could stand to lose billions, according to the study.

At the current expected rate of attrition due to retirement and firm switching, it said, a firm with 10,000 financial advisors could have more than half a billion (approximately $585 million) in annual revenue at risk during the next 1–2 years. That emphasizes how critical it can be to retain top producers and to effectively manage succession planning to transition assets to newer advisors.

Keeping advisors happy could be the key; the study found that among employee advisors who are highly satisfied (overall satisfaction scores of 900 and above), only 1 percent say they “definitely will” or “probably will” leave their firm in the next 1–2 years, compared with 46 percent of dissatisfied employee advisors (scores of 600 and below) who say the same. The same trend holds true for independent advisors (2 percent and 45 percent, respectively).



Hundreds of thousands of 401(k)s up for grabs after DOL fiduciary rule

Morningstar to offer automated small plan advisory tool that provides 3(38) fiduciary services for plan sponsors
Aug 15, 2016 | By Nick Thornton

Small 401(k) plans aren't cost-effective to service but leaving them to a generalist advisor can be risky for a broker-dealer. (Photo: Getty)
If and when the U.S. Department of Labor’s fiduciary rule survives several legal challenges, the small and midsize 401(k) plan market stands to be revolutionized.

The rule requires all advisors to 401(k) plans with less than $50 million in assets to serve as fiduciaries. Under the Employee Retirement Income Security Act, all plan sponsors assume fiduciary obligations upon offering a defined contribution strategy, irrespective of plan size.
But those sponsors were not required to hire fiduciary advisors prior to finalization of the Labor Department's rule.

The Department of Labor’s fiduciary rule may restrict assets in 401(k) plans from flowing to IRA accounts, says Cerulli Associates....
Critics of the Labor Department's rule have argued that requiring advisors to serve as fiduciaries to the small and midsize plan market will negatively affect access to 401(k) plans at a time when policymakers at the federal and state level are crafting and passing legislation intended to broaden access to retirement savings for employees of small employers.

Requiring all plan advisors to serve as fiduciaries will impose new regulatory costs and expose both advisors and sponsors to new liabilities, argue opponents of the Labor Department rule.

That will disincentivize advisors from servicing the massive segment of small and midsize plans, potentially motivate some existing sponsors to drop their plans, and discourage other small employers not offering a plan from doing so in the future, say the rule’s opponents.

The Labor Department and its advocates obviously disagree with that analysis. In imposing a fiduciary standard of care on all plan advisors, smaller sponsors will be relieved of liability, as advisors will be contractually obligated to serve plan participants’ best interests under the rule.

With fiduciary advisors at the helm, sponsors and participants will benefit from improved plan design and investment options with lower costs, as advisors will be prohibited from designing plans loaded with higher costing options that are not in a plan’s best interest.

How many plans will be affected?

At least one court will consider the potential impact of the Labor Department rule on the small and midsize plan market in determining whether the agency overstepped its statutory authority in crafting the rule.

The U.S. Chamber of Commerce, which has argued the rule will negatively impact small and midsized plans throughout the rulemaking process and after, is part of a consolidated lawsuit in the U.S. District Court for the Northern District of Texas.

If the rule survives legal challenges, the question will be how many 401(k) plans will be affected by the rule.

Consolidated data is hard to come by, according to several sources that consolidate data on the 401(k) market.

Recent data from Judy Diamond Associates, a provider of 401(k) analytic tools, shows there are about 481,000 plans with a median balance at or below $58 million in assets.

And there are nearly 469,000 plans with a median value at or below $5.2 million in assets, according to Judy Diamond, a business unit of ALM Media, the parent company of BenefitsPRO.

In 2015, analysts at Cerulli Associates set out to examine the impact of 401(k) specialist advisors on the 401(k) market.

Nearly half of the $1.3 trillion advisor-sold defined contribution market is controlled by what Cerulli calls “retirement specialists,” which the firm defines as advisors that generate at least half of their revenue from defined contribution retirement plans.

While their reach and influence on the 401(k) market is powerful, Cerulli says retirement plan specialists comprise only 5 percent of the total advisor population. Furthermore, within that small segment, 45 percent of those plan specialists do not offer services as an ERISA fiduciary.
By Cerulli’s numbers, less than 3 percent of the total advisor universe operated as an ERISA fiduciary plan specialist prior to finalization of Labor Department's fiduciary rule.

Broker-dealers weigh options
James Smith, head of workplace strategy and business development at Morningstar, says many broker-dealers are taking a proactive approach to measuring the rule’s impact on their 401(k) advisory business, and not waiting for courts to determine the Labor Department rule’s fate.

“We don’t have hard numbers on just how many plans stand to be impacted, but some of the bigger broker-dealers have up to 30,000 plans under advisement,” said Smith. “Right now, industry is focused on what their risks are, and what practices they will need to change to comply with the rule.”

By January of 2017, several months before the rule’s first April 10th compliance deadline, Morningstar is slated to roll out Morningstar Plan Advantage, an automated small 401(k) plan advisory tool that provides 3(38) fiduciary services for plan sponsors.

The technology will use Morningstar’s existing fiduciary advisory capability, offered through Morningstar Investment Management LLC, a registered investment advisor subsidiary of Morningstar Inc. that services 13,000 plan sponsors.

The platform is designed to address the tens of thousands of small plans serviced by nonspecialist broker-dealer advisors.

At this point, Morningstar is not hoping to compete for all 401(k) plans under the Labor Department's $50 million threshold, but is thinking in smaller terms, said Smith.

“As we talk to industry, we’re finding that different broker-dealers have different definitions of ‘small plan’,” said Smith. “Most broker-dealers already have 401(k) plan specialist advisors. And they are going to be in very high demand.”

The question for broker-dealers, says Smith, is what to do with small plan sponsor clients that are serviced by generalist wealth managers.
Often, successful wealth managers will have a handful of small 401(k) plans in their book, typically acquired as a result of relationships with wealthy retail clients that are business owners.

Those sponsor clients tend to have 401(k)s with less than $10 million in assets, and often substantially less, said Smith. The plans are not pure profit drivers within retail wealth managers’ businesses, but are worth servicing to retain the sponsors that are also high net-worth retail clients.

“For the plan advisor specialists, plans that small are not cost-effective to service,” said Smith. “But leaving them to a generalist advisor opens the broker-dealer up to compliance risk.”

Simply walking away from small, or micro plan clients in order to avoid that risk once the rule is implemented is not a good option for broker-dealers, added Smith, because the risk of losing the associated high net-worth sponsors as retail clients is too great.

Smith said the Plan Advantage platform’s user interface is still being built. Sponsors will have an “expansive” number of recordkeepers to choose from, and the option to stay with existing service providers. “The platform will not favor a single recordkeeper, nor will we be recommending a recordkeeper,” he explained.

The value for broker dealers is a no-brainer, thinks Smith.

“This moves a lot of liability off their plate. If I’m a broker-dealer with 8,000 generalists, I have to make sure everyone is complying with the DOL rule. With the Plan Advantage platform, now all they have to do is monitor us,” he said.