The DOL Seeks an Ideal Balance in a Brave New World of “Investment Advice” Under ERISA

The U.S. Department of Labor (the “DOL”) on April 14, 2015 issued the long-awaited re-proposal (the “2015 Proposed Regulations”) of the regulations defining “investment advice” in connection with the “fiduciary” rules under the Employee Retirement Income Security Act of 1974 (“ERISA”). Existing regulations (the “1975 Regulations”) on the definition of “investment advice” were promulgated in 1975, shortly after ERISA’s enactment and the DOL has come to be frustrated with what it perceives to be the narrowness of the 1975 Regulations. President Obama himself last February made the re-proposal the centerpiece of a speech to the AARP, further thrusting the DOL’s efforts into the national spotlight. This OnPoint provides a general overview of how the “investment advice” rules have developed over time, and of certain aspects of the 2015 Proposed Regulations. 

Previously, on October 22, 2010, the DOL had proposed to rework the existing “investment advice” regulations by dramatically expanding the scope of who might be considered an ERISA fiduciary. The 2010 proposal (the “2010 Proposed Regulations”) was met with a firestorm of controversy in the market and in political circles (including, in the words of the DOL, “a large number of comments and a vigorous debate”), and, on September 19, 2011, the DOL took the unusual step of issuing a statement that the 2010 Proposed Regulations would be withdrawn and re-proposed. Over three years later, we now have that re-proposal. Foreshadowing the DOL’s perspective on the 2015 Proposed Regulations, the re-proposal over the course of its development has been referred to as the “conflicted advice” regulations and as the “Conflict of Interest Rule.” 

Background 

As relevant here, under ERISA and the Internal Revenue Code of 1986 (the “Code”), a person is a fiduciary to an employee benefit plan or an individual retirement account (an “IRA” and, together with employee benefit plans, “plans”) to the extent that the person (i) exercises any discretionary authority or discretionary control with respect to management of such plan or exercises any authority or control with respect to management or disposition of its assets; (ii) renders investment advice for a fee or other compensation (direct or indirect) with respect to any moneys or other property of such plan, or has any authority or responsibility to do so; or (iii) has any discretionary authority or discretionary responsibility in the administration of such plan. ERISA generally safeguards plan participants by imposing standards of care (such as the duties of loyalty and prudence) on plan fiduciaries, and by holding fiduciaries accountable when they breach those obligations. In addition, fiduciaries to plans and IRAs are not permitted to engage in certain “prohibited transactions,” and prohibited transactions are subject to excise taxes under the Code or penalties under ERISA, as applicable. 

Regarding the “investment advice” provision of the “fiduciary” definition, the 1975 Regulations set forth a five-part test that must be satisfied before a person can be treated as rendering “investment advice” for a fee. Under the 1975 Regulations, advice does not constitute “investment advice” that would make a person a fiduciary unless the person is: (1) rendering advice as to the value of securities or other property, or making recommendations as to the advisability of investing in, purchasing or selling securities or other property (2) on a regular basis (3) pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary that (4) the advice will serve as a primary basis for investment decisions with respect to plan assets, and that (5) the advice will be individualized based on the particular needs of the plan. 

Initial Attempt in 2010 to Amend the 1975 Regulations 

With the 2010 Proposed Regulations, the DOL proposed to recast the 1975 Regulations in significant ways. The DOL has identified changes in the marketplace that have informed its efforts to amend the 1975 Regulations. According to the DOL, in the preamble to the 2015 Proposed Regulations: 

The market for retirement advice has changed dramatically since the Department first promulgated the 1975 regulation. Individuals, rather than large employers and professional money managers, have become increasingly responsible for managing retirement assets as IRAs and participant-directed plans, such as 401(k) plans, have supplanted defined benefit pensions. At the same time, the variety and complexity of financial products have increased, widening the information gap between advisers and their clients. Plan fiduciaries, plan participants and IRA investors must often rely on experts for advice, but are unable to assess the quality of the expert’s advice or effectively guard against the adviser’s conflicts of interest. This challenge is especially true of small retail investors who typically do not have financial expertise and can ill-afford lower returns to their retirement savings caused by conflicts. As baby boomers retire, they are increasingly moving money from ERISA-covered plans, where their employer has both the incentive and the fiduciary duty to facilitate sound investment choices, to IRAs where both good and bad investment choices are myriad and advice that is conflicted is commonplace. . . . These trends were not apparent when the Department promulgated the 1975 rule. 

The language used by the DOL in the 2015 preamble to criticize the 1975 Regulations is arguably provocative: 

Instead of ensuring that trusted advisers give prudent and unbiased advice in accordance with fiduciary norms, the current regulation erects a multi-part series of technical impediments to fiduciary responsibility. The Department is concerned that the specific elements of the five-part test – which are not found in the text of the Act or Code – now work to frustrate statutory goals and defeat advice recipients’ legitimate expectations. In light of the importance of the proper management of plan and IRA assets, it is critical that the regulation defining investment advice draws appropriate distinctions between the sorts of advice relationships that should be treated as fiduciary in nature and those that should not. In practice, the current regulation appears not to do so. Instead, the lines drawn by the five-part test frequently permit evasion of fiduciary status and responsibility in ways that undermine the statutory text and purposes. 

Under the 2010 Proposed Regulations, advice for a fee (direct or indirect) provided to plan fiduciaries and plan participants and beneficiaries (including IRA owners) generally would have been deemed to be “investment advice” (thereby making the provider a fiduciary) for these purposes if: 

(i) the advice was in the nature of 

(A) appraisals or fairness opinions concerning the value of securities or other property; 

(B) recommendations as to the advisability of investing in, purchasing, holding or selling securities or other property; or 

(C) recommendations as to the management of securities or other property; and 

(ii) the adviser 

(A) represented that the adviser was acting as an ERISA fiduciary; 

(B) was already an ERISA fiduciary to the plan by virtue of having control over the management or disposition of plan assets, or by having discretionary authority over the administration of the plan; 

(C) was already an investment adviser under the Investment Advisers Act of 1940; or

(D) provided the advice pursuant to an agreement or understanding that the advice may be considered in connection with plan investment or asset management decisions and would be individualized to the needs of the plan, plan participant or beneficiary (including an IRA owner). 

The 2010 Proposed Regulations included specific carve-outs pursuant to which a person would not become a fiduciary merely by (i) providing recommendations as a seller or purchaser with interests adverse to the plan or its participants (including IRA owners), if the advice recipient reasonably should have known that the adviser was not providing impartial investment advice and the adviser had not acknowledged fiduciary status, (ii) providing investment education information and materials in connection with an individual account plan, (iii) marketing or making available a menu of investment alternatives from which a plan fiduciary could choose, and providing general financial information to assist in selecting and monitoring those investments, if these activities include a written disclosure that the adviser was not providing impartial investment advice, or (iv) preparing reports necessary to comply with ERISA, the Code, or regulations or forms issued thereunder, unless the report in question valued assets that lack a generally recognized market or served as a basis for making plan distributions. 

The 2015 Proposed Regulations 

The 2015 Proposed Regulations differ in many respects from the 2010 Proposed Regulations, but retain certain aspects of the basic framework of the 2010 Proposed Regulations. The 2015 Proposed Regulations broadly update the definition of “investment advice,” and also provide a series of carve-outs for communications that would not be viewed as fiduciary in nature. The DOL stated that, in the course of developing the 2015 Proposed Regulations (and the related proposed new prohibited transaction exemption and proposed exemption amendments discussed below), it consulted with the staffs of the Securities and Exchange Commission and other regulators on an ongoing basis. 

Under the 2015 Proposed Regulations, advice for a fee (direct or indirect) to plan fiduciaries and plan participants and beneficiaries (including IRA owners) would generally be “investment advice” (thereby making the provider a fiduciary) for these purposes if: 

(i) the advice is in the nature of 

(A) a recommendation as to the advisability of acquiring, holding, disposing or exchanging securities or other property, including a recommendation to take a distribution of benefits or a recommendation as to the investment of rolled over assets (including IRA assets); 

(B) a recommendation as to the management of securities or other property, including assets rolled over or distributed from a plan or IRA; or 

(C) an appraisal, fairness opinion or similar statement concerning the value of securities or other property, if provided in connection with a specific transaction involving the acquisition, disposition or exchange of such securities or other property by the plan or IRA; and 

(ii) the person providing the advice 

(A) represents that the person is acting as a fiduciary under ERISA or the Code or 

(B) provides the advice pursuant to an agreement, arrangement or understanding that the advice is individualized or specifically directed to the recipient for consideration in making investment or investment management decisions regarding plan assets. 

The 2015 Proposed Regulations include several carve-outs for persons who do not affirmatively represent that they are acting as fiduciaries. Subject to certain specified conditions, these carve-outs cover: 

• statements or recommendations made to a large plan investor (generally, a plan that has 100 or more participants or whose fiduciary manages at least $100 million in plan assets) "with financial expertise” by a counterparty acting in an arm’s length transaction; 
• offers or recommendations to fiduciaries of ERISA plans to enter into a swap or security-based swap that is regulated under the Securities Exchange Act of 1934 or the Commodity Exchange Act; 
• statements or recommendations provided to a fiduciary of an ERISA plan by an employee of the plan sponsor if the employee receives no fee beyond the normally applicable compensation; 
• marketing or making available a platform of investment alternatives to be selected by a plan fiduciary for an ERISA participant-directed individual account plan; 
• the identification of investment alternatives that meet objective criteria specified by a plan fiduciary of an ERISA plan or the provision of objective financial data to such fiduciary; 
• the provision of an appraisal, fairness opinion or statement of value to an employee stock ownership plan regarding employer securities, to a collective investment vehicle holding plan assets or to a plan for meeting reporting and disclosure requirements; and 
• information and materials that constitute “investment education” or “retirement education.”*

Related Exemptions 

The expanded reach of the “fiduciary” rules under the 2015 Proposed Regulations could, without more, cause any number of compensation arrangements to raise additional issues under ERISA and the Code. To address this result, the DOL also proposed an exemption for the purpose of broadly permitting advisers treated as fiduciaries under the new proposed regulation to continue common fee and other compensation practices. The DOL indicated that the proposed exemption is intended “to preserve beneficial business models for delivery of investment advice.” The exemption would require those advisers to adhere to basic standards aimed at ensuring that their advice is in the best interest of their customers. 

In particular, the DOL has proposed a key new principles-based exemption that would provide conditional relief for common compensation, such as commissions and revenue sharing, that advisers might receive in connection with investment advice to “retail” retirement investors. For these purposes, “retail” investors include (i) participants and beneficiaries under participant-directed plans, (ii) IRA owners, and (iii) sponsors (including employees, officers and directors thereof) of non participant-directed plans with fewer than 100 participants, to the extent the sponsor acts as a fiduciary with respect to investment decisions.

In order to rely upon the exemption, the adviser would contractually need to acknowledge its fiduciary status, commit to adhere to basic standards of impartial conduct, adopt policies and procedures reasonably designed to minimize the harmful impact of conflicts of interest and disclose basic information on conflicts of interest and on the cost of advice. The applicable “best interest” standard generally would provide that investment advice is in the best interest of the investor when the adviser acts with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person would exercise based on the investment objectives, risk tolerance, financial circumstances and needs of the investor, without regard to the financial or other interests of the adviser, affiliates thereof or any other party. 

Certain other existing exemptions (in general, those providing relief from the “conflict-of-interest” prohibitions in ERISA and the Code) would also be amended to add a “best interest” component. According to the DOL, “This broad regulatory package aims to enable advisers and their firms to give advice that is in the best interest of their customers, without disrupting common compensation arrangements under conditions designed to ensure the adviser is acting in the best interest of the advice recipient.” 

A critical effect of the proposed regime would be to cause brokers and others advisers who are viewed as making recommendations to plans, plan fiduciaries and plan participants with respect to the investment and disposition of plan assets effectively to become subject to this “best interest” standard. The “best interest” standard would also be imposed on persons who make recommendations to IRAs and other plans that are not subject to ERISA, by (i) making such advisers fiduciaries for purposes of Section 4975 of the Code and thereby subjecting them to the Code's prohibited transaction rules, and (ii) then providing an exemption for their receipt of fees, where one of the conditions is the satisfaction of the “best interest” standard. 

It remains to be seen whether the DOL's revised approach will be perceived in the marketplace as having appropriately addressed concerns that led to the withdrawal of the 2010 Proposed Regulations, and whether any new concerns will emerge. It is proposed that final regulations would become effective 60 days after publication in the Federal Register, and the requirements of the final rule would generally become applicable eight months after publication of a final rule, subject to a number of potential exceptions. Comments are due on or before July 6, 2015. The DOL plans to hold an administrative hearing within 30 days after the close of the comment period. 

If you would like to discuss any aspect of the 2015 Proposed Regulations or would like any additional information, please contact one of the Dechert attorneys listed below or any Dechert attorney with whom you regularly work. 

*The Financial Industry Regulatory Authority ("FINRA") has set forth guidelines to assist brokers in evaluating whether a particular communication could be viewed as a recommendation, thereby triggering application of certain "suitability" rules. In the Preamble to the 2015 Proposed Regulations, the DOL specifically solicited comments on whether it should adopt standards developed by FINRA in defining communications that rise to the level of a recommendation, for purposes of distinguishing investment education from "investment advice" under ERISA.