DOL Proposes a New Fiduciary Investment Advice Exemption

On June 29, the U.S. Department of Labor (“DOL”) proposed a new exemption from the prohibited transaction provisions of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) in connection with the provision of investment advice (the “Proposed Exemption”). The Proposed Exemption is the DOL’s response to the vacatur of its prior fiduciary rule and reflects its desire to harmonize its approach with that of the Securities and Exchange Commission. In response to the vacatur, the DOL confirmed that its 1975 regulation defining investment advice by virtue of a five-part test remains in effect and directed that it be re-codified in the Code of Federal Regulations. [1]

Aligning with the SEC’s Regulation Best Interest, the Proposed Exemption is an extraordinary development in the form of a class exemption allowing financial institutions to give fiduciary investment advice to participants, plans and IRAs and to receive compensation resulting from that advice. Because of its breadth, the Proposed Exemption might be viewed as a “one stop shop” for providers of many types of fiduciary investment advice. Comments are due 30 days from publication in the Federal Register.

Because of our engagement with our clients, we at Groom Law Group have long recognized the need for fiduciary harmonization in a practical and workable framework. As part of our focus on this framework, we have engaged with the DOL in recent years providing input on this exemption. There are some major wins in the Proposed Exemption, which does not include a contract requirement, an arbitration ban, prescriptive conflict mitigation procedures or large disclosure system builds. Other positive developments include a best interest formulation mirroring that of recent SEC guidance, and broad relief for advice to a broad range of investors. However, as with any proposal, there are some surprises, particularly in the preamble, and plenty of room for constructive comments that could make the Proposed Exemption even more workable. We are already working with a number of clients to address these potential additional improvements.

The alert below provides important background on the Proposed Exemption, an overview of its coverage and conditions, and a discussion of its implications for existing business strategies.

In 2016, the DOL made available its final regulation on the definition of “fiduciary” under ERISA (the “2016 Fiduciary Rule”). The 2016 Fiduciary Rule greatly expanded those who would be considered a fiduciary to an ERISA plan or IRA by reason of providing investment advice, replacing a 1975 regulation providing that a non-discretionary investment advisor could become a fiduciary subject to ERISA’s fiduciary and prohibited transaction rules only if the adviser met each prong of a five-part test.

In the absence of an exemption, receipt by a fiduciary advisor of compensation paid by the plan, participant or beneficiary, or IRA, or its receipt of commissions, sales loads, 12b-1 fees, revenue sharing, or other payments from third parties that provide investment products would violate the prohibited transaction provisions of ERISA sections 406(a)(1)(D) and 406(b) because the amount of the fiduciary’s compensation (or the compensation paid to a party in which the fiduciary has an interest) would be affected by the investment advice it provides. DOL views prohibited compensation as the receipt of compensation by a fiduciary (or party in which the fiduciary has an interest) that varies based upon the investment advice given by the fiduciary and the receipt of compensation by fiduciaries from third parties in connection with the advice. To facilitate the continued provision of advice following the issuance of the 2016 Fiduciary Rule, the DOL finalized a Best Interest Contract Exemption, which purported to exempt prohibited transactions that may have arisen by reason of the payment of prohibited compensation in connection with the provision of investment advice. However, the conditions of the Best Interest Contract Exemption included substantial limitations, contract and disclosure requirements.

On March 15, 2018, the United States Court of Appeals for the Fifth Circuit issued an opinion concluding that the 2016 Fiduciary Rule should be vacated in total.[2]

As a result of the decision, the 2016 Fiduciary Rule was removed, and the DOL’s 1975 regulation was reinstated. Further, the Best Interest Contract Exemption was removed. However, many financial institutions developed investment advice programs in reliance on the broad exemptive relief provided by the Best Interest Contract Exemption. Groom Law Group pressed the DOL to recognize that under some circumstances, the pre-existing prohibited transaction exemptions available prior to the 2016 Fiduciary Rule would not provide relief to investment advice fiduciaries comparable to the relief that would have been provided under the Best Interest Contract Exemption.

As a result, the DOL issued Field Assistance Bulletin 2018-02 on May 7, 2018, which provides temporary non-enforcement of the prohibited transaction exemptions for investment advice fiduciaries who work “diligently and in good faith” to comply with certain conditions of the Best Interest Contract Exemption. Field Assistance Bulletin 2018-02 is transition relief that will continue only “until after regulations or exemptions or other administrative guidance has been issued” governing investment advice arrangements. The DOL indicated that Field Assistance Bulletin 2018-02 will continue to be available for now, but cautioned that it does not envision it to be a permanent compliance approach.

The Proposed Exemption would provide relief from the restrictions of ERISA sections 406(a)(1)(A),(D), and 406(b) and Internal Revenue Code of 1986, as amended (“Code”) sections 4975(c)(1)(A),(D), (E), and (F) for the receipt of prohibited compensation in connection with the provision of non-discretionary investment advice. The Proposed Exemption would be available to exempt prohibited transactions that arise by reason of the payment of otherwise prohibited compensation in connection the recommendation of any security or investment product, and fiduciary rollover recommendations, as well as recommendations of investment managers and investment advice providers. Moreover, the Proposed Exemption would apply to a Financial Institution’s recommendation of its proprietary investment products, or investment products that generate payments from third parties. Finally, the Proposed Exemption would cover, in addition to recommendations to engage in agency transactions and rollovers, recommendations to engage in riskless principal transactions and principal transactions involving certain types of covered securities, described below.

The Proposed Exemption would apply to investment advice given to “Retirement Investors,” defined as (i) a participant or beneficiary of a plan subject to Title I of ERISA, or a plan described in section 4975(e)(1)(A) of the Code but not subject to Title I of ERISA [3] (“Plan”) with authority to direct the investment of assets in his or her Plan account or to take a distribution,(ii) the beneficial owner of an IRA acting on behalf of the IRA, [4] or (iii) a fiduciary with respect to an Plan or IRA. Unlike the Best Interest Contract Exemption, the Proposed Exemption would apply when providing investment advice to the fiduciaries of Plans no matter the size of the Plan.

Investment advice fiduciaries – both individual “Investment Professionals” and the “Financial Institutions” that employ or otherwise contract with them – and their affiliates and related entities would be able to obtain relief under the Proposed Exemption.

• An “Investment Professional” is an employee, independent contractor, agent, or registered representative of a “Financial Institution” who acts as a fiduciary of a Plan or IRA when providing investment advice in connection with a transaction sought to be covered under the Proposed Exemption and satisfies applicable law and...