On June 29, 2020, the U.S. Department of Labor (DOL) proposed its new class exemption rule (the “Rule”) designed to replace the 2016 Best Interest Rule that was vacated by the U.S. Court of Appeals for the Fifth Circuit (“the Fifth Circuit”) in 2018.
Per the DOL, the Rule titled “Improving Investment Advice for Workers & Retirees,” is designed to meet best interest and impartiality standards while improving the availability of investment advice and products for retirees, and also granting broader exemptive relief to financial institutions and their professionals including investment advisers, broker-dealers, and insurance companies (“Financial Institutions”) and their employees, agents, and representatives (“Investment Professionals”).
The rule restores the five-part test to determine who is considered a fiduciary per the Fifth Circuit’s judgment, expresses the DOL’s view on whether the decision to roll over a retirement plan to an Individual Retirement Account (IRA) constitutes investment advice, and has been designed to align with the U.S. Securities and Exchange Commission’s (SEC) Reg BI and the best interest rules of various state regulators.
Under the Rule, Financial Institutions and Investment Professionals will now be allowed to receive compensation ordinarily prohibited under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (the Code) and Financial Institutions will be allowed to engage in principal transactions between retirement plans and their own inventories, among other considerations.
Background on the DOL’s Proposed Rule
In 1975, the DOL adopted a five-part test to determine who is considered to be an investment advice fiduciary under ERISA and the Code. The five-part test states that in order to be considered an investment advice fiduciary, the Investment Professional must:
- Render advice to the plan as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property,
- On a regular basis,
- Pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary or IRA owner, that
- The advice will serve as a primary basis for investment decisions with respect to plan or IRA assets, and that
- The advice will be individualized based on the particular needs of the plan or IRA.
Financial Institutions and Investment Professionals that receive compensation and meet the requirements of the test are considered investment advice fiduciaries under ERISA and the Code. Title I of ERISA imposes specific responsibilities and requirements for investment advice fiduciaries and prohibits them from engaging in certain transactions.
In 2016, the DOL, under the Obama Administration, sought to replace the five-part test with new investment advice fiduciary requirements and created new prohibited transaction exemptions including the Best Interest Class Exemption (BICE) and the Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs.
In 2018, the Fifth Circuit threw out the Obama Administration Best Interest rule holding that the DOL exceeded its authority in creating the revised rules, which thereby restored the original five-part test under ERISA as well as the requirements for participant investment education set forth under DOL’s Interpretive Bulletin 96-1.
The Proposed Rule
Under the Rule, Financial Institutions and Investment Professionals would be able to receive an exemption for the receipt of compensation that would normally be prohibited under ERISA and the Code so long as the Financial Institutions and Investment Professionals abide by Impartial Conduct Standards.
The types of prohibited compensation that would be exempted include 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs, and revenue sharing payments from investment providers or third parties.
Additionally, Financial Institutions would be able to engage in principal transactions with Plans and IRAs in which the Financial Institution purchases or sells certain investments from its own account.
In order to receive the exemption, Financial Institutions, and Investment Professionals would need to ensure that they abide by Impartial Conduct Standards, which require: the best interest standard; a reasonable compensation standard; and a requirement to make no materially misleading statements about recommended investment transactions and other relevant matters.
Additionally, Financial Institutions and Investment Professionals would need to disclose to retirement investors their status as investment advice fiduciaries under ERISA and the Code and provide an accurate written description of their services and material conflicts of interest.
Lastly, Financial Institutions would be required to establish, maintain, and enforce policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and to conduct annual reviews of those policies and procedures to ensure compliance with the Rule.
What Should I Consider When Reviewing the Proposed Rule?
Firms should begin by reviewing the DOL’s proposed rule to see how the exemption would apply to their business, especially if the Firm provides advisory services to retirement plans and plan participants.
Firms should then take steps to (1) evaluate their policies and procedures and determine what needs to be enhanced if the rule is enacted; (2) determine how to monitor the activities of its representatives to ensure that the purchase and sale of certain services and products are done in line with the Impartial Conduct Standards; (3) evaluate whether additional disclosures describing the services as investment advice fiduciaries and disclosing conflicts of interest need to be added to the Firm’s investment advisory agreements, brochures, and marketing collateral; and, (4) ensure that procedures have been implemented to review the policies and procedures at least annually to ensure compliance with the Rule.
Core Compliance can help your firm with reviewing the Rule and determining if additional policies and procedures, disclosures, and other facts and circumstances need to be evaluated in light of the Rule. Additionally, our consultants can assist you with reviewing and revising your Firm’s policies and procedures and disclosures to ensure compliance with the Rule should it be enacted.
Should you need assistance with evaluating the impact of the Rule, please contact us at (619) 278-0020 to schedule a consultation. Our compliance experts are standing by.