By Timothy Keehan
On April 6, the Department of Labor released its anxiously awaited final fiduciary rule, which greatly expands who is considered a “fiduciary” under the Employee Retirement Income Security Act and the Internal Revenue Code when investment advice is given to a retirement investor, such as an employee benefit plan or the owner of an individual retirement account.
In general, a “recommendation,” as defined under the rule, constitutes investment advice. If this advice is given for a fee or other compensation, then the person providing the advice becomes a “fiduciary” under ERISA or the Code. With a compliance date of April 10, 2017—and January 2018 for some provisions of the major exemption, the Best Interest Contract Exemption—bankers need to begin reviewing the rule’s effects on their wealth management and investment offerings and begin planning for compliance now.
DoL has said that the rule will ensure that retirement investors get advice in their best interest, while minimizing the compliance burden on the financial services industry. But the rule poses a significant and costly compliance challenge for banks, requiring them to reassess whether and how they will continue to market and sell their retirement products and services to employee benefit plans and to IRAs. The rule and its exemptions collectively total 1,023 pages of text, so it will take up to several months or longer before the issues have been identified and sorted.
Banks, in particular, will need to determine whether any of their activities constitutes “advice,” and if so, further determine how they will need to adjust or rework their practices to conform to the rule. This may involve a significant change to the way banks conduct their retirement business and how they are paid for their products and services. Moreover, it will likely fragment customer relationships, making it more difficult to provide holistic and strategic advice that takes into account the client’s entire financial picture.
Crux of the rule
The rule’s linchpin is what constitutes “advice,” since the giving of advice triggers fiduciary status. Under the rule, “advice” is a recommendation, plus direct or indirect compensation received as a result. A “recommendation” is a communication that can “reasonably be viewed as a suggestion . . . [to] engage in or refrain from a particular course of action” regarding a security or other investment property. DoL believes that the more individually tailored the communication to a specific person about specific investment property, the more likely it will be deemed a recommendation. This appears to be a sliding scale, though it’s not clear where the actual dividing line is between advice and non-advice.
The rule provides exemptions from coverage for platform providers, selection and monitoring assistance, general communications and investment education, although these need to be analyzed carefully and still leave many questions unanswered when held up to actual business practices. There are additional exemptions involving transactions with independent fiduciaries with financial expertise, swap- and security-based swap transactions and certain employees, such as those of a plan sponsor or affiliate. These likewise necessitate close examination to understand their parameters and conditions.
For those becoming fiduciaries, the Best Interest Contract Exemption, or BICE, is the primary exemption that will need to be relied upon in order to avoid the prohibited transaction provisions while maintaining many common compensation arrangements (for example, revenue-sharing or 12b-1 fees). Under the BICE, a person or entity generally must acknowledge fiduciary status, adhere to “impartial conduct standards” as defined under the BICE, implement policies and procedures designed to prevent violations of the impartial conduct standards, refrain from giving or using incentives for the adviser to act contrary to the customer’s best interest and fairly disclose fees, compensation and material conflicts of interest.
Those subject to the BICE must also notify DoL of their intent to rely on the BICE, and, in the case of IRAs and plans not covered by Title I of ERISA, become subject to a private right of action—including class action liability. But despite DoL’s numerous changes to facilitate compliance, the BICE remains a complex and puzzling exemption. Under it, fiduciaries still face potentially enormous compliance and operability challenges as well as significant litigation risk.
Targeted wins for the banking industry
In response from concerns specifically raised and pursued by ABA, DoL made several important changes from the proposal. First, in response to ABA’s deep concerns over DoL’s claimed authority to inspect and examine bank books and records, the department amended the proposal, which effectively prohibits it from coming into a national bank or federal savings association to inspect their books and records.
Second, responding to ABA’s assertion that bank networking arrangements under the Gramm-Leach-Bliley Act and Regulation R should not constitute investment advice, DoL added a new exemption to allow for traditional bank networking arrangements with third-party broker-dealers to continue without implicating the rule.
Finally, ABA requested that DoL make clear that a bank custodian providing statements of value of alternative investments and other hard-to-value assets held in a plan or IRA would not trigger ERISA fiduciary status. In response, the department withdrew altogether this requirement from the rule, stating that it would reserve rulemaking on this topic at a future time.
Effects on bank IRA programs
What’s still not clear under the rule is its impact on bank retail IRA programs. In the explanatory text to the rule, DoL concluded that bank CDs are “investment products” and therefore come within the ambit of the rule. However, the department did not address the relationship between the rule and the statutory exemptions (ERISA section 408(b)(4) and Code section 4975(d)(4), which allow banks to place plan and IRA assets in bank deposit products).
For instance, can a bank still rely on these statutory exemptions when placing a customer’s IRA assets in a bank deposit product and not trigger application of the rule? Or if the rule is triggered, can the bank still rely on these statutory exemptions to avoid implicating a prohibited transaction? Do the statutory exemptions cover the rollover portion of the transaction into the bank deposit product, or is the rollover considered a separate transaction subject to the rule? The rule is unclear and DoL will need to provide additional guidance in this area.
ABA will continue working with its members to analyze the rule and its impact on bank retirement products and services, and it will continue to highlight major issues as the financial services industry continues to work through the rule and solicit additional input and guidance from DoL.