Roughly four and a half years after its first attempt, the U.S. Department of Labor today again proposed to redefine the term “fiduciary” as it applies in the investment advice context. The DOL withdrew the 2010 Proposed Rule following blistering criticism from the regulated community and Congress. Since the withdrawal, however, heated debate among stakeholders has continued. Earlier this year, President Obama publicly expressed his support for the 2015 Proposed Rule. Further complicating matters, SEC Chairman Mary Jo White recently committed the SEC to proposing a fiduciary standard for brokers who recommend financial products to clients—regardless of whether the clients are individuals, ERISA plans or individual retirement accounts. It is not immediately clear how the rules of the two agencies will ultimately co-exist.
Along with the fiduciary re-proposal, the DOL also issued two new “principles based” prohibited transaction class exemptions and proposed amendments to six existing prohibited transaction class exemptions, all with the stated aim of accommodating and adapting to a “broad range of evolving business practices.”
The remainder of this memorandum assumes the reader’s familiarity with the existing “5-part test” for determining ERISA fiduciary status in the investment advice context. For further background on the existing rule, please see our October 2010 memorandum, “DOL Proposes Significant Expansion of ERISA ‘Fiduciary’ Definition in the Investment Advice Context.” Below we briefly highlight the key features of the 2015 Proposed Rule. Given the debate engendered by the 2010 Proposed Rule before it was withdrawn and in the following years, we would expect the rulemaking process to be lengthy and highly scrutinized.
Much like the 2010 Proposed Rule, the 2015 Proposed Rule is focused more on regulating conduct between retail investors and their advisors than between institutional investors and their advisors. These distinctions appear to be drawn more sharply in the 2015 Proposed Rule, as we have briefly summarized under the heading “Carve-outs of Interest to Discretionary Asset Managers of Institutional ERISA Investors” below.
General Approach: Broad Definition of Fiduciary, Enumerated Carve-Outs
The 2015 Proposed Rule does away with the existing 5-part test and, most notably, the requirements that advice be provided on a regular basis and serve as a primary basis for a plan’s investment decisions. Instead, an advisor will be an ERISA fiduciary with respect to an employee benefit plan or IRA if the advisor renders “investment advice” for a fee or other compensation (direct or indirect) with respect to any securities or other property of the plan or IRA. For these purposes, a person renders investment advice with respect to securities or other property of a plan or IRA if (1) the person provides directly to a plan, plan fiduciary, plan participant, plan beneficiary, IRA or IRA owner any of the types of advice described in Column (A) below in exchange for a fee or other direct or indirect compensation AND (2) such person takes either of the actions described in Column (B) below.
|(A) Provision of the following advice in exchange for a fee or other direct or indirect compensation:||(B) Such person directly or indirectly (e.g., through or together with any affiliate) does either of the following:|
|(i) A recommendation as to the advisability of acquiring, holding, disposing of or exchanging securities or other property, including to take a distribution of benefits, or as to the investment of securities or other property to be rolled over or otherwise distributed from the plan or IRA(ii) A recommendation as to the management of securities or other property, including securities or other property to be rolled over or otherwise distributed from the plan or IRA;(iii) An appraisal, fairness opinion, or similar oral or written statement concerning the value of securities or other property provided in connection with a specific transaction(s) involving the acquisition, disposition, or exchange of such securities or other property by the plan or IRA; or
(iv) A recommendation of a person who will receive a fee or other compensation for providing any of the types of advice described in (i) through (iii).
|(i) Represents or acknowledges that it is acting as a fiduciary with respect to the advice described in Column (A)(i); OR(ii) Renders the advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is individualized or specifically directed to, the advice recipient for consideration in making investment or management decisions with respect to securities or other property of the plan or IRA.|
Thus, the 2015 Proposed Rule defines the term fiduciary much more broadly than the 5-part test and instead relies on a system of so-called “carve-outs” for exempting conduct that the DOL believes should not give rise to a fiduciary relationship.
Carve-outs of Interest to Discretionary Asset Managers of Institutional ERISA Investors
The 2015 Proposed Rule contains a number of carve-outs intended to address comments to the 2010 Proposed Rule which argued that the proposal would result in too many additional burdens in the institutional asset management space without any corresponding benefits. We briefly summarize these below.
- Transactions with plan fiduciaries with financial expertise. This carve-out permits “counterparties” to sophisticated plans to make recommendations to the fiduciaries of those plans without the counterparties themselves becoming fiduciaries. Although not explicit in the text of the rule itself, the intent of the carve-out is to allow, for example, an asset manager to recommend investment funds to institutional clients without the concern that a sales pitch itself would result in ERISA fiduciary status. There are two general ways to confirm if the plan fiduciary who receives the counterparty’s recommendation is sophisticated for this purpose: one path that depends on whether the fiduciary is responsible for managing at least $100 million in employee benefit plan assets, and another that depends on obtaining certain written representations from the fiduciary to the effect that the fiduciary is not relying on the counterparty to provide impartial investment advice.
- Swap and security-based swap transactions. In response to a common criticism of the 2010 Proposed Rule, the 2015 Proposed Rule contains a carve-out intended to clarify that a person who is a counterparty to an employee benefit plan in connection with a swap or security-based swap will not become a fiduciary to the plan merely by complying with the counterparty’s obligations under the Dodd-Frank business conduct standards.
- Valuation agents to “plan asset” funds. Finally, the 2015 Proposed Rule clarifies that persons providing appraisals, fairness opinions or statements of value to pooled investment vehicles that hold “plan assets” will not become ERISA fiduciaries under the proposed rule.
Other Notable Provisions
In addition to the carve-outs we address here, the 2015 Proposed Rule and related prohibited transaction exemptions contain a number of other carve-outs intended, among other things, to make the proposal workable in the context of retail brokerage and asset management, to preserve existing distinctions between investment advice and investment education, and to clarify that ESOP appraisers will not be treated as fiduciaries under the 2015 Proposed Rule (but should expect additional guidance from the DOL governing their conduct).
The full and original memorandum was published by Fried Frank on April 14, 2015 and is available here.