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SponsorNews - October, 2016

Employer Action Required 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.
3.    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.
4.    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 employers who sponsor ERISA-governed plans?

To the extent an employer (including an authorized delegate) is already exercising fiduciary authority or retains fiduciary responsibility with respect to the administration or management of its retirement plan or assets, nothing in this final rule changes that status or the duty to comply with fiduciary standards of care under ERISA and avoid prohibited transactions under ERISA and the Code.  As such duty relates to the engagement of investment advisors, employers remain obligated under ERISA to carefully select and monitor all (fiduciary and non-fiduciary) service providers and to pay no more than reasonable compensation to such advisors.

Some advisors engaged by the employer may now be considered fiduciary investment advisors under the final rule.  For example, some advisors may select investment alternatives based on the specific needs of the plan and will be treated as having made a recommendation under the final rule.  Similarly, some advisors may continue to provide model investment allocations based on actual investment alternatives under the plan, which is also considered a recommendation under the final rule unless certain conditions are satisfied.

Assuming that the selection and ongoing engagement of the advisor satisfies the applicable standard of care under ERISA, the designation of an advisor as a fiduciary does not adversely affect the plan.  For example, the employer may continue to rely on the protections of ERISA Section 404(c) for participant-directed investments, where applicable, and will not be liable for losses that are the direct and necessary result of the participants’ directions.  However, where the fiduciary investment advisor acts imprudently or in violation of the prohibited transaction rules in providing advice to the participants, the ongoing engagement by the employer of that advisor may give rise to co-fiduciary liability under ERISA.

Employers should review applicable service agreements with their advisors, paying particular attention to provisions governing limitations of liability, insurance requirements and indemnification. Employers should also expect that advisors may want to renegotiate their service arrangements for various reasons, such as:
1.    To change the scope of investment advice or education provided to the plan or its participants,
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.

Noteworthy, the DOL explained that many administrative functions performed by employers will not implicate the final rule.  For example, employees of the plan sponsor who routinely develop reports and recommendations for the employer and other fiduciaries of the plan will not generally become fiduciary investment advisors as a result of these activities.  Furthermore, the provision of general retirement and investment education by employees of the plan sponsor, including an explanation of required distributions under the plan, is not generally considered investment advice under the final rule.  Nonetheless, communications between the employer (or its authorized employees) and the plan participants continue to be subject to general fiduciary duties under ERISA and misrepresentations can result in fiduciary liability to the employer.

The DOL's New Fiduciary Rules for Retirement Investment Advice


Douglas J. HeffernanMegan E. HladilekGraham P. Widmer

After years of debate and speculation, the U.S. Department of Labor (DOL) issued its final package of rules to regulate individuals and entities that provide investment advice to retirement plans and IRA investors. The DOL’s final “fiduciary” regulation and related administrative exemptions aim to curb investment advice practices that, in the DOL’s view, fail to serve the best interests of retirement investors. Common current practices may be permissible, but are subject to new conditions that may require changes for certain investment advice providers.

Investment Advisers as “Fiduciaries”

Key to the DOL’s final rule is a new regulation that determines when an investment adviser is a “fiduciary” under the Employee Retirement Income Security Act (ERISA) and the prohibited transaction excise tax rules under the Internal Revenue Code (Code). Effective April 10, 2017, the regulation replaces the current five-part test for fiduciary status with a substantially broader definition. The new definition generally covers any person who provides a “recommendation” to a retirement plan investor for a fee.

The new “fiduciary” definition has two essential components. First, to be a “fiduciary,” a person must make a recommendation for a fee or other compensation, whether direct or indirect, as to either:
•    The advisability of acquiring, holding, disposing of, or exchanging, plan or IRA assets, or a recommendation as to how plan or IRA assets should be invested after the plan or IRA assets are rolled over, transferred or distributed from the plan or IRA; or
•    The management of plan or IRA assets, including, among other things, recommendations on investment policies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., brokerage versus advisory); or 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.

Second, with respect to the recommendation, the person must either:
•    Acknowledge its fiduciary status;
•    Have an agreement, written or verbal, that the advice is based on the particular investment needs of the advice recipient; or
•    Direct the advice to a specific advice recipient.

In applying the new fiduciary definition, a critical threshold question is whether a communication is a “recommendation.” Borrowing from FINRA’s definition, the final regulation 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.” The DOL also borrowed from select SEC and FINRA interpretations about recommendations regarding the degree of individually tailored communications, lists of securities, aggregating communications, and disregarding whether the source is a person or a computer.

The final rule clarifies that a “recommendation” will include the recommendation of other persons who provide advice or investment management services, but it will not include the marketing of oneself or one’s services. This clarification is intended to allow responses to requests for proposals and general sales pitch materials.

No “magic words” are needed to acknowledge fiduciary status, and the DOL cautioned affiliates about trying to use a “bait and switch” tactic between related entities that may or may not be fiduciaries. However, the preamble includes an example clarifying that a trustee that acknowledges fiduciary status for a purpose other than investment advice would not be considered acknowledging fiduciary status for an affiliate with respect to an affiliate’s investment-related communications.

Exceptions to Fiduciary Status

Starting from the broad “fiduciary” definition, the final regulations exclude certain activities from being either “recommendations” or “investment advice.”


Investment education is not considered a recommendation, and therefore does not subject the education provider to fiduciary status. The scope of permitted investment education is mainly based on DOL Interpretive Bulletin 96-6. One key change from the 2015 proposed regulation is that asset allocation models and interactive investment materials may identify specific investment options available under ERISA plans (but not IRAs), subject to certain conditions, without being considered a recommendation

General Communications

Suze Orman can rest easy – the DOL does not consider her general communications, or the communications of columnists or on-air personalities, to be a recommendation, and therefore they are not subject to a fiduciary standard. In addition, the final rule clarifies that general communications, like newsletters, are not recommendations.

Platform Provider and Selection and Monitoring Assistance

Providing an ERISA plan with an investment platform, defined by the market, and related selection and monitoring of investments, are deemed to not be recommendations. Platform providers may also include a proposed list of investments in an RFP response without making a fiduciary recommendation.

Advice to an Independent Fiduciary

The previous “seller’s carve-out” of the 2015 proposed regulations has morphed into an exception for advice provided to an independent fiduciary of a plan or IRA if that independent fiduciary is either a licensed or regulated provider of financial services or is responsible for the management of at least $50 million in assets if certain conditions are met. The DOL intended to capture true arm’s length transactions in which the independent fiduciary is not relying on the other party to provide impartial advice. The $50 million threshold is based on FINRA’s institutional account concept and allows all plan and non-plan assets under management to be included in meeting the threshold.


Due to the protections provided by the Dodd-Frank Act’s business conduct standards, the final regulations exempt swap dealers and swap participants acting as a counterparty in a swap or security-based swap transaction with an ERISA plan represented by a fiduciary independent of the counterparty.


Employees of a plan sponsor who make recommendations to a plan fiduciary, without receiving additional compensation, are not considered investment advice fiduciaries.
The only exceptions described above that are available with respect to IRAs are general communications, investment education without identifying specific investments, and possibly the independent fiduciary exception. The independent fiduciary, swap, and employee exceptions do not apply to a fiduciary if fiduciary status has been acknowledged.  

Scope of Plans and IRAs

The definition of fiduciary and investment advice is focused on retirement plans and IRAs. Advice with respect to health, disability, and term life insurance policies are explicitly excluded from the scope of the regulation. The advice applies whether it is at a plan level or at the participant level. Plans include any ERISA plan and any plan under Code Section 4975I(1)(A), which includes: IRAs (including SIMPLE IRAs and SEP IRAs), Archer medical savings accounts (MSAs), health savings accounts (HSAs), Coverdell education savings accounts, and Keogh or HR-10 plans for self-employed individuals.

Administrative Exemptions in the Final Regulatory Package

As a result of the expanded definition of an investment advice fiduciary under the final regulations, many of these newly-minted investment advice fiduciaries who receive variable compensation (e.g., commissions) resulting from their investment advice might otherwise be engaging in a self-dealing prohibited transaction. The DOL’s final regulatory package establishes a number of prohibited transaction exemptions (PTEs) that are designed to permit investment advice fiduciaries to engage in transactions that ERISA and the Code would otherwise prohibit, including the receipt of third-party payments and compensation that varies based on the investment advice provided. Without a prohibited transaction exemption, common forms of compensation (even if in the best interest of the retirement investor) would trigger the Code’s excise tax (generally equal to 15% of the amount involved) and, for ERISA plan transactions, expose the investment advice fiduciary to liability under ERISA’s civil enforcement provisions.

The remainder of this article provides a detailed overview of the final package’s primary PTE, the Best Interest Contract Exemption, and a brief summary of the final package’s other PTEs for specific types of transactions.

Best Interest Contract Exemption

The final Best Interest Contract Exemption (BIC Exemption) is the exemption of general applicability for investment advice fiduciaries in the retail investment marketplace. Using a “standards-based” approach, the BIC Exemption generally requires individuals who provide fiduciary investment advice (advisers) and the investment advisers, banks, insurance companies and registered broker-dealers that employ or otherwise retain them (financial institutions) to adhere to an enforceable fiduciary standard of conduct and take certain steps to mitigate conflicts of interest. The final BIC Exemption retains the core requirements of the proposed exemption announced in 2015, but it has been substantially revised to ease implementation and improve the exemption’s workability.

Scope of BIC Exemption

The DOL intends that the BIC Exemption will cover variable compensation and third party payments for fiduciary investment advice provided to retail “retirement investors,” regardless of plan-type. “Retirement investors” do not include plan or IRA fiduciaries who fall within the exemption for advice provided to fiduciaries with financial expertise (namely, fiduciaries who are licensed or regulated financial service providers or responsible for the managing at least $50 million in assets), but it does include fiduciaries of small participant-directed plans, who were excluded from the 2015 proposal.

The BIC Exemption will be available for investment recommendations concerning all investment types, rather than for the limited list of assets set out in the 2015 proposal. The exemption is likewise available for all types of fiduciary investment advice, including recommendations to take a distribution, roll over assets from a plan or IRA, or utilize services such as managed accounts and advice programs.

The exemption will not apply to advice provided with respect to the adviser’s or financial institution’s in-house retirement plans, or where the adviser exercises discretionary authority or control with respect to the recommended transaction. The exemption also does not cover “robo advice” providers receiving non-level compensation or principal transactions other than “riskless” principal transactions.

BIC Exemption Requirements

The final BIC Exemption places the burden of compliance squarely on the financial institution. As an essential requirement, the financial institution must acknowledge in writing that both it and its adviser will act as fiduciaries with respect to investment recommendations.  In some circumstances, the financial institution might not otherwise be considered a fiduciary because the adviser providing fiduciary investment advice acts independently from the financial institution (for example, where an adviser recommending an annuity product is an independent insurance agent). Nevertheless, the DOL indicated that a financial institution must accept fiduciary responsibility for the recommendations of the adviser as a condition of the exemption, because the financial institution’s role in supervising individual advisers is a key safeguard of the exemption.

Contract Requirements

Consistent with the financial institution’s acknowledgement of fiduciary status, the final BIC Exemption saddles the financial institution with the legal liability for ensuring compliance with the exemption’s requirements. ERISA plan investors, including ERISA plan participants, beneficiaries and fiduciaries, may pursue legal action against the financial institution by using statutory enforcement provisions of ERISA § 502. There is no pre-existing, federal statutory enforcement mechanism for IRA and non-ERISA plan investors, apart from the Code’s excise tax on prohibited transactions. To fill that gap, with respect to IRA and non-ERISA plan transactions only, the final BIC Exemption requires the execution of a “Best Interest Contract” that warrants compliance with the exemption’s substantive requirements, which must be enforceable by the retirement investor against the financial institution.

The BIC Exemption protects retirement investors’ right to pursue contractual remedies (or statutory remedies, for ERISA plan investors) by disallowing class action waivers and contractual limitations on the adviser’s or financial institution’s liability. However, the retirement investor may agree to reasonable binding arbitration for individual claims and may waive its right to seek punitive damages or rescission of recommended transactions.

The final BIC Exemption relaxes some of the 2015 proposal’s requirements related to the form and execution of the Best Interest Contract. Under the final exemption, the Best Interest Contract is a two-party agreement between the retirement investor and the financial institution, rather than a three-party agreement including the adviser. The Best Interest Contract does not need to be executed before any recommendation is made; instead, the contract’s execution may wait until the time the recommended transaction is executed, provided that it covers prior advice. The Best Interest Contract may be a master contract covering multiple recommendations; it may be incorporated into an account opening document or similar document; and it may be signed either by hand or electronically. However executed, the financial institution must maintain an electronic copy of the contract on a website accessible by the retirement investor.

Conditional relief is available for circumstances in which a retirement investor acts on fiduciary advice notwithstanding the absence of a Best Interest Contract, such as where the retirement investor does not open an account after receiving a recommendation. In addition, the exemption provides significant transitional relief by removing the need to obtain signatures from existing customers who make additional purchases after the BIC Exemption becomes effective. Under a “negative consent” procedure, a financial institution may obtain the assent of customers with existing contractual arrangements as of January 1, 2018, by sending a contract amendment, as long as the customer does not terminate the contract within 30 days.

Impartial Conduct Standards and Anti-Conflict Policies and Procedures

The final BIC Exemption regulates the behavior of financial institutions and their advisers by requiring the financial institution to affirmatively state that it and its advisers will adhere to “Impartial Conduct Standards” and warrant compliance with certain anti-conflict policies and procedure requirements. For IRA and non-ERISA plan retirement investors, the exemption’s substantive standards must be incorporated into the Best Interest Contract, meaning that their violation is an enforceable breach of contract. Financial institutions transacting with ERISA plan retirement investors must also comply with the exemption’s substantive standards to avoid civil liability for a non-exempt prohibited transaction under ERISA.

The Impartial Conduct Standards require the financial institution and its advisers to act in the “Best Interest” of the retirement investor by providing advice that “reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor, without regard to the financial or other interests of the adviser, financial institution or any Affiliate, Related Entity, or other party.”  The financial institution and adviser must also charge no more than “reasonable compensation” for their services and refrain from making materially misleading statements about the recommended transactions, fees and compensation, material conflicts of interest, or other matters relevant to the investment decision.  

One result of the final regulations and the final PTEs is the “ERISAfication” of IRAs. The Impartial Conduct Standards essentially mirror ERISA’s fiduciary standards of conduct, which do not apply under federal statutes to IRAs. However, in order to avoid the excise tax on prohibited transactions with respect to certain IRA transaction, advisers and their financial institutions who wish to rely on the BIC Exemption must agree to be subject to the same fiduciary standards as apply under ERISA.

Financial institutions are required to adopt written anti-conflict policies and procedures to ensure that advisers adhere to the Impartial Conduct Standards described above.  The policies and procedures must prohibit use of quotas, bonuses, special awards and other incentives that would reasonably be expected to cause advisers to violate the Impartial Conduct Standards.  The exemption expressly permits differential compensation based on investment decisions by retirement investors (including, but not limited to, commissions). However, the financial institution’s incentives and incentive practices must be “reasonably and prudently designed to avoid a misalignment of the interests of advisers with the interests of the retirement investors they serve as fiduciaries.”  In addition, in formulating policies and procedures, the financial institution must (i) identify and document material conflicts of interest; (ii) adopt measures to prevent material conflicts of interest from causing impartial conduct standard violations; and (iii) designate a person or persons responsible for addressing related issues.

Disclosure Requirements

The final BIC Exemption adopts a “two-tier” approach to disclosures, requiring financial institutions to provide general information in an initial contract disclosure and periodic pre-transaction disclosures, and more specific information in website disclosures or upon request.

The initial contract disclosure must be provided to the retirement investor when the advisery relationship begins and before the execution of any recommended transaction. For IRA and non-ERISA plan investors, the contract disclosure may be incorporated into the Best Interest Contract.  The contract disclosure must identify, among other specified items, the services to be provided, how the retirement investor will pay for services, and material conflicts of interest. The contract disclosure must also inform the retirement investor of its right to obtain, free of charge, the financial institutions anti-conflict policies and procedures and a specific disclosure of costs, fees and compensation.  

The pre-transaction disclosure is a brief, periodic disclosure that supplements the initial contract disclosure for advisory relationships covering multiple transactions over extended periods of time. Updated pre-transaction disclosures must be provided before the execution of recommended transactions, but no more frequently than annually after the initial contract disclosure.

The website disclosure provides more detailed information regarding, among other items, the financial institution’s business model and associated material conflicts of interest, typical account or contract fees and service charges, the financial institution’s compensation and incentive arrangements with advisers, and the financial institution’s anti-conflict policies and procedures. The financial institution must update the disclosure website on at least a quarterly basis and make it freely accessible to the public.  

The DOL states that it reworked the 2015 proposal’s disclosure requirements using a “principles-based approach” to ease concerns about logistics, costs and confidentiality risks. For example, the proposed annual disclosure has been eliminated and pre-transaction disclosures need not disclose an asset’s total cost over one-, five- and ten-year periods. With respect to the website disclosure, the final exemption provides greater flexibility on how the information may be presented, allows the website to link to other public disclosures, and does not require website disclosures to be “machine readable.”  The final exemption also provides relief for good faith errors relating to all of the exemption’s disclosure requirements.

Agency Notification and Recordkeeping

The financial institution must provide advance notification of its reliance on the BIC Exemption to the DOL and must maintain certain data accessible to the DOL and the retirement investor for six years from the transaction date. The final BIC Exemption eliminates the detailed recordkeeping requirements of the 2015 proposal; firms are only required to retain records that show they complied with the exemption.

Proprietary Products and Third Party Payments

The final BIC Exemption imposes heightened Best Interest requirements on financial institutions that restrict advisers’ investment recommendations, in whole or in part, to Proprietary Products or to investments that generate Third Party Payments. For this purpose, “Proprietary Products” include any product managed, issued or sponsored by the financial institution or any of its affiliates. “Third Party Payments” include sales charges not paid directly by the Plan, participant or beneficiary account, or IRA; gross dealer concessions; revenue sharing payments; 12b-1 fees; distribution, solicitation or referral fees; volume-based fees; fees for seminars and educational programs; and any other compensation, consideration or financial benefit provided to the financial institution or its affiliates or related entities by a third party as a result of the transaction.

The Proprietary Product and Third Party Payments provisions reflect the DOL’s “deep and continuing concern regarding the financial institutions’ own conflicts of interest in limiting products available for investment recommendations.”  In broad terms, a financial institution that imposes Proprietary Product or Third Party Payment limitations must document, in conjunction with the anti-conflict policies and procedures, its reasonable determination that the material conflicts of interest created by its business model will not result in excess compensation or imprudent investment recommendations. Specific information regarding the use and nature of Proprietary Product and Third Party Payments limitations must also be disclosed, in significant detail, through the BIC Exemption’s disclosure regime.

The final exemption’s Proprietary Product and Third Party Payment provisions clarify some aspect of the 2015 proposed rule’s “limited range of investment” requirement, confirming that the exemption does not foreclose proprietary investment providers from receiving compensation under the exemption. It remains to be seen, however, how firms will adapt to the exemption’s requirements and insulate advisers from conflicts of interest when making recommendations from a restricted menu.

Level Fee Fiduciaries

The BIC Exemption provides streamlined exemption conditions for “Level Fee Fiduciaries,” which include financial institutions and advisers that receive only a set fee or fees and compensation based on a fixed percentage of the value of assets (rather than a commission or transaction-based fee) as a result of the adviser’s recommendation.  In these circumstances, the DOL recognizes that the retirement investor’s interest in receiving prudent investment recommendations will ordinarily be aligned with the adviser’s interest in increasing and protecting account investments.

Level Fee Fiduciaries are exempt from the contract requirement, anti-conflict policies and procedure requirements, transaction disclosures, and website disclosure requirements. However, Level Fee Fiduciaries must acknowledge their fiduciary status and abide by the exemption’s Impartial Conduct Standards. In addition, for any recommendation to roll over from an ERISA plan or IRA, the financial institution must document the specific reason why the recommendation is considered to be in the Best Interest of retirement investor.

Transitional Relief and Grandfathering Provision

Two provisions of the final BIC Exemption provide significant transitional relief.

First, the full requirements of the final BIC Exemption will not take full effect until January 1, 2018. During the transition period between April 10, 2017 (when the final rule’s definition of “investment advice” fiduciaries takes effect) and January 1, 2018, financial institutions will not be required to execute the Best Interest Contract or provide warranties or disclosures regarding anti-conflict policies and procedures.

Second, the BIC Exemption “grandfathers” certain pre-existing advisory relationships. The grandfather provision removes the need to comply with the BIC Exemption’s full requirements for compensation received as a result of investment advice on property purchased before April 10, 2017. Grandfather relief is subject to reasonable compensation and basic best interest requirements.

Other Prohibited Transaction Exemptions

The final fiduciary rule package creates or amends several other PTEs in connection with the expanded definition of investment advice fiduciary.

The new Principal Transaction Exemption will allow advisers to purchase and sell certain debt securities directly from their own inventory, or purchase investment property from the customer, subject to impartial conduct standards. As in the BIC Exemption, the final Principal Transaction Exemption provides transitional relief, requiring full compliance by January 1, 2018.

PTE 84-24, as amended, will be available for plan or IRA purchases of mutual fund shares and insurance or “fixed rate annuity contracts.”  The final PTE 84-24 differs significantly from the 2015 proposal because its will not be available for transactions in fixed indexed annuities. While PTE 84-24 will cover traditional fixed annuities, variable annuities and fixed indexed annuities must rely on the final BIC Exemption to obtain prohibited transaction relief.  

Several other existing PTEs were modified to make changes conforming to these new rules.

Moving Forward
While the final regulations and the final PTEs have generally been made more workable for financial service providers, much more work and analysis will be required during the transition period. Providers of call center services, investment education services or asset allocation models will need to review the specific conditions for those exceptions. Financial institutions that had relied on a commission or other transaction-based model will need to study what steps need to be taken to satisfy the requirements of the BIC Exemption. And some might consider shifts to a level-fee model rather than undertake the steps needed to rely on the BIC Exemption. The DOL has indicated that it intends to work with interested parties on compliance assistance activities and materials and invites stakeholders to identify areas or specific issues where they believe additional clarifying guidance is needed.

Questions to ask a Recordkeeper

This is Part I in a series on issues to consider when contemplating a change in plan vendors and what to expect during the conversion…
The decision to move a company’s retirement plan to a new recordkeeper involves careful analysis and is not something that should be approached lightly.

There are many reasons that a plan sponsor may consider changing vendors – poor customer service, inaccurate or late compliance reporting or Form 5500 filings, high fees, a desire for a more robust investment platform, etc.

However, before a plan “jumps ship” to a new provider, the plan sponsor needs to be sure that it has a basic understanding of the processes and procedures used at the new recordkeeper. If there are particular areas of concern with the current recordkeeper, the plan sponsor will want to be sure that the new recordkeeper has the systems and processes in place to provide a better plan experience. Otherwise, the transfer to the new vendor will result in the same frustrations as the plan was experiencing before the transfer, or will create new frustrations that weren’t there before. In addition to asking the potential new recordkeeper to explain how it will address the problems that the plan is experiencing with the current provider, the plan sponsor should ask to be shown a comprehensive overview of the new recordkeeper’s plan sponsor website so that it knows exactly what the screens will look like and what types of on-line reporting functions are available.

When evaluating a potential new recordkeeper, the plan administrator should ask for detailed responses to the following questions:

•    How will the payroll file be transmitted? Can the recordkeeper work directly
with the payroll provider? Is there a charge to have the payroll information transmitted directly from the payroll provider to the recordkeeper? If the plan sponsor will be uploading the payroll file, ask to be shown an on-line demonstration of exactly what the file looks like, how to populate the data needed in the file and the steps that are taken to upload the file to the recordkeeper. What happens if there are participants on the payroll file who aren’t in the recordkeeping system?
•    Does the recordkeeper gather census information on all employees; OR only eligible employees; OR only participating employees?
•    If the employer has more than one payroll location or pay code, can each location submit a separate payroll file or must all the payroll files be consolidated and submitted as one upload?
•    If needed, is the recordkeeper able to ACH from separate employer bank accounts for the contribution funding transfers?
•    Does the recordkeeping system track multiple location codes or pay codes and can plan reports be generated by location, in instances where the employer needs to separately account for multiple profit centers?
•    Will the recordkeeper prepare the annual Participant Fee and Qualified Default Investment Alternative (QDIA) notices? If so, will they mail those directly to participants or provide them to the employer to give to the participants? Will they be posted on the plan sponsor website? If so, how and when will the plan sponsor be notified that the notices are ready?
•    Will the Third Party Administrator (TPA) be able to add its fees to the Participant Fee Notice produced by the recordkeeping system or will a supplemental notice be required?
•    For plans that are subject to an annual audit, will an audit package be provided? How soon after plan year-end will it be available?
•    Does the plan sponsor want employees to be able to enroll in the plan or make deferral changes via the recordkeeper’s website? If so, how will those changes be communicated back to the employer or fed into the payroll system? If newly eligible employees can enroll on-line, is a feedback file sent to the plan sponsor? How often is the feedback file generated? Will it be
emailed to the plan sponsor or will the plan sponsor need to go on-line to the website and pull down the file?
•    What does the plan participant website look like? Ask to see a demonstration of the tools and functions available to employees on the plan’s website. What kinds of calculators and/or retirement planning tools are available to participants? Is the participant website intuitive and easy to navigate?
•    Will the recordkeeper provide an enrollment specialist to come to the employer’s location(s) during the meetings to introduce and explain the conversion? What if the employer has multiple locations and works multiple shifts?
•    What is the flow of distribution requests? Can the participant make the request on-line? Does the TPA review the request? Is it paperless? How long will it take before the employee gets his money?
•    Does the recordkeeping system track hardship available amounts for participants? Can that amount be seen by the plan sponsor and the TPA on the website?
•    Does the recordkeeping system track employees that need required minimum distributions? Will the system automatically calculate and process those distributions or does the plan sponsor initiate them?
•    What is the flow of loan requests? How does the plan sponsor know that a participant has requested or taken a loan? Does the plan sponsor get an amortization schedule? Is the process paperless?
•    Does the recordkeeping system track plan loans? If so, is the loan activity included on the trust report and added to the participant account information or is it a separate report that is not included in the plan balances? Are loans reported on the participant statements as a separate line item or is the loan balance incorporated into the other assets on the statement and not identified separately?
•    If the plan contains less common money types, like Prevailing Wage contributions, does the recordkeeping system and the Plan Manager at the recordkeeper have expertise in tracking and administering those accounts?
•    How is the forfeiture balance tracked and reported? Is the forfeiture account included in total plan assets, or is it tracked separately which requires it to be manually added to the other assets in the plan for 5500 reporting?
•    Will the recordkeeper track eligibility and send out participant enrollment materials? If so, exactly how does this process work?
•    For plans that use auto enrollment (and possibly auto escalation), exactly how does that process work? Will the recordkeeper track employees who don’t respond, and automatically feed the default contribution percentage into the payroll system? For plans with auto escalation, when will the increase take effect? Are these procedures consistent with the terms of the plan’s legal document?
•    What will the participant statements look like? If the plan has many different sources of money, how many sources can fit on the statement? Will any of the sources be consolidated?
•    If the plan utilizes an integrated contribution formula and/or self-directed brokerage accounts, will the participant statements contain required disclosures about those options?
•    If a participant calls the call center, exactly where is he calling? What are the qualifications of the individuals who will be answering participant questions?
•    Will the plan sponsor have a dedicated Plan Manager or team of Plan Specialists at the recordkeeper?
•    Does the recordkeeper track vesting? If so, make sure it is gathering correct and timely information from the payroll uploads to do this accurately. For example, if vesting service should be updated after a participant works 1,000 hours, and the employer is not submitting hours information for ALL employees, the vesting will not be correct.
•    If the plan imposes a waiting period before employees can request a distribution, who tracks that?
•    If the plan has outside investment accounts, can that information be imported into the recordkeeping system for annual trust reports?
•    Does the recordkeeper set up an ERISA expense account for plan fees? How will the plan sponsor and TPA know the available balance in that account?

Deciding to transfer the assets and recordkeeping files of the retirement plan to a new recordkeeper is a plan fiduciary function that requires due diligence by the Plan Administrator or Plan Committee. The plan’s financial advisor and TPA can offer assistance in evaluating various recordkeepers and helping the Administrator or Committee understand the services and fees of specific providers. Having a thorough understanding of how the recordkeeping system works and how data will flow between the plan sponsor, the TPA, the Financial Advisor and the recordkeeper BEFORE the commitment is made to switch vendors will go a long way toward ensuring that the new recordkeeper is the right fit for the plan. Hopefully, once the conversion is complete, the new recordkeeper will provide exceptional service to the plan for many years!

Can employers email plan documents to employees?

Keith R. McMurdy; APR 2, 2015; 1:19pm ET
It seems that everyone has a smartphone or a tablet, and I can’t think of anyone I know who does not have Internet access at home. Consequently, plan sponsors ask all the time if they can just email plan documents to employees to satisfy the notice requirements, or maybe just post new plan documents on the company intranet.

Well, the recent decision in Thomas v. CIGNA (E.D.N.Y.) serves as a reminder that the short answer to that question is no.
Factually, the case involves a claim for benefits. A plan participant had life insurance through her employer’s ERISA plan. She ultimately became disabled and stopped working or paying premiums.

When she passed away, her beneficiaries made a claim for life insurance benefits, which the insurer denied because, although the coverage allowed premium waivers for disability, the participant had not timely requested a premium waiver and thus was not covered when she died. Of course the beneficiaries sued, claiming that the premium waiver requirements had not been appropriately communicated to the participant due to inadequate summary plan description (SPD) distribution. 

Guess what? The court held that there was no evidence that the plan administrator had provided the participant with an SPD.
While the new SPD was available electronically, the company never sent notices out that the document was available. Plus, there was no evidence that new SPDs were furnished in any manner other than intranet posting.

There are actually rules that govern electronic disclosure of plan documents. If employees have work-related computer access, ERISA disclosures may be delivered electronically, or posted on the intranet, if the employees have the ability to effectively access documents furnished in electronic form at any location where the employee is reasonably expected to perform his duties, and are expected to have access to the employer’s electronic information as an integral part of those duties.

It is not enough that they have access somewhere at work or have access at a common location (like a break room).  Accessing the computer has to be an actual requirement for their job function.

Documents can still be sent to employees and beneficiaries without work-related access to a computer as long as additional requirements are met. The employer or plan administrator must first obtain a consent form signed by the employee or beneficiary that specifically states the following:
•    The names or types of documents to which the consent applies
•    A sentence stating that consent can be withdrawn at any time without charge
•    An email address where the employee will be able to receive future announcements and/or documents if sent by email
•    The procedures for updating the email address used for receipt of electronically furnished documents
•    The procedures for withdrawing consent
•    The right to request and obtain a printed version of an electronically furnished document and, if there is a charge for the printed document, how much it will cost.
•    The computer hardware or software needed to access and download the electronically delivered documents.
•    If the plan administrator changes the hardware or software requirements, it must provide a new notice and obtain a new consent.

Without this consent, electronically providing documents is not sufficient. Hard copies have to be provided.

But don’t forget this case. Even if documents are provided electronically, notifications must be sent either in electronic or paper form to each employee or beneficiary at the time a document is provided electronically explaining the significance of the document and that the participant’s right to request a paper copy.

You can’t just send an email and say “here it is.” Likewise, you can’t just post a document on the intranet and not alert everyone. And unless you have consents, you can’t say that you satisfied the delivery obligation to employees who don’t have regular access to a computer at work.

So if you want to distribute plan documents electronically you can. But you have to follow the rules. Don’t assume intranet posting is enough because it is not.

IRS Expands Auto-Feature Voluntary Correction Safe Harbors

By John Manganaro This email address is being protected from spambots. You need JavaScript enabled to view it. | April 03, 2015

New safe harbor correction methods related to automatic enrollment features in defined contribution plans are being implemented by the Internal Revenue Service.

The Internal Revenue Service (IRS) says a new revenue procedure, 2015-28, “modifies but does not supersede” an earlier revenue procedure, 2013-12, which in part defines methods for plan sponsors to voluntarily correct issues with plan “auto features” so as to avoid jeopardizing their plans’ tax-advantaged status.

In short, the 2015-28 revenue procedure modifies the safe harbor correction methods and examples in Appendices A and B of the 2013-12 revenue procedure to provide additional leeway and alternative correction methods for employee elective deferral failures. As explained by the IRS, these elective deferral failures usually occur when a plan sponsor misses elective deferrals for eligible employees who should be subject to automatic plan features—whether automatic enrollment or automatic deferral escalation—within a 401(k) plans or 403(b) plan.
The 2015-28 revenue procedure explains that “if a failure to implement an automatic contribution feature for an affected eligible employee, or the failure to implement an affirmative election of an eligible employee who is otherwise subject to an automatic contribution feature, does not extend beyond the end of the 9.5 month period after the end of the plan year of the failure,” no qualified non-elective contribution (QNEC), as defined in Section 1.401(k)-6 of the IRS’s income tax regulations, for the missed elective deferrals is required.

For this new safe harbor to apply, however, the following conditions must be satisfied:
•    Correct deferrals must begin no later than the earlier of: 1) the first payment of compensation made on or after the last day of the 9.5 month period after the end of the plan year in which the failure first occurred for the affected eligible employee, or 2) if the plan sponsor was notified of the failure by the affected eligible employee, the first payment of compensation made on or after the last day of the month after the month of notification.
•    Notice of the failure that satisfies specified requirements in new Section .05(8)(c) of Appendix A of the 2013-12 revenue procedure is given to the affected eligible employee no later than 45 days after the date on which correct deferrals begin.
•    Corrective contributions to make up for any missed matching contributions are made in accordance with timing requirements under IRS self-correction program (SCP) for significant operational failures (as described in Section 9.02 of the 2013-12 revenue procedure) and are adjusted for earnings, vis a vis Section 9.04 of 2013-12 revenue procedure.
The new revenue procedure also impacts the calculation of earnings for certain failures to implement automatic contribution features.
As explained by the IRS, “this revenue procedure provides an alternative safe harbor method for calculating earnings for employee elective deferral failures under Section 401(k) plans or Section 403(b) plans that have automatic contribution features and that are corrected in accordance with the procedures in Section 3.02(1) or 3.03 of this revenue procedure.”
If an affected eligible employee has not affirmatively designated an investment alternative, missed earnings may be calculated based on the plan’s default investment alternative, provided that, with respect to a correction made in accordance with the procedures in Section 3.02(1) of the new revenue procedure, any cumulative losses reflected in the earnings calculation will not result in a reduction in the required corrective contributions relating to any matching contributions.