In helping dozens of broker-dealers and registered investment advisers prepare for the pending Labor Department fiduciary rule, we have seen a lot of confusion among advisers. Many have struggled to identify the particular account types that will be impacted, while others believe they will not be affected at all.
The bottom line is that all advisers, even those who only charge fees, will be subject to the new standards when advising retirement plans and individual plan participants covered by the Employee Retirement Income Security Act of 1974 and IRA holders.
WHAT'S CHANGING?
One of the primary impacts of the proposed rule is that many advisers who are not currently considered a fiduciary will be under the DOL/ERISA standard. There are several significant considerations if you become subject to the standard. The most obvious is that you will now be held to an ERISA fiduciary standard of care, meaning you have to, at a minimum, act “solely” in your clients' interests (versus the “best interest” standard under the Investment Advisers Act of 1940). Under the 1940 Act, you are required to disclose material conflicts, and the client can elect to do business with you or not. Under the DOL standard, those conflicts are considered “prohibited transactions.”
Among other things, the prohibited transactions under ERISA and the tax code prohibit you from providing advice that affects your compensation or that of any of your affiliates (e.g., your B-D, RIA, parent company). The penalties for breaching a fiduciary duty or engaging in a prohibited transaction are significant, including excise taxes, disgorgement and even personal liability to restore “losses” caused by your failure to act prudently or loyally. While it is true that IRA clients cannot sue for a breach of fiduciary duty under ERISA, the DOL rule provides for a private right of action for IRA clients under the best interest contract.
Lastly, when dealing with an ERISA-covered plan, fiduciaries are subject to “co-fiduciary liability” under ERISA Sec. 405, and can be held liable for failing to detect or prevent the breach of another fiduciary (e.g., the employer/plan sponsor).
RECOMMENDATIONS
Under the new rule, you will now be a fiduciary to the extent you recommend any of the following to an ERISA plan sponsor, participant or an IRA holder:
• Buying, selling, holding or exchanging securities or other property.
• Distributing benefits from a plan or IRA (e.g., IRA rollover).
• Reinvesting the proceeds of a distribution (e.g., inside the IRA).
• Investing with a third-party adviser or manager.
Although the new rule will apply a fiduciary standard to a far broader array of activities, to be considered a fiduciary, your recommendations must also be individualized or specifically directed to the plan, participant or IRA client for consideration in making investment decisions.
There will no longer be a requirement that the advice be provided on a “regular basis,” such that even one-time advice will be considered fiduciary.
So ultimately we must ask, what is considered a recommendation? Interestingly, the DOL points to the
Financial Industry Regulatory Authority Inc. definition of that term in the context of its suitability rule, Finra Regulatory Notice 11-02,
“The determination of whether a 'recommendation' has been made … is an objective rather than subjective inquiry. An important factor in this regard is whether … [your] communication … would be viewed as a suggestion [to] take action or refrain from taking action regarding a security or investment strategy … a series of actions that may not constitute recommendations when viewed individually may amount to a recommendation when considered in the aggregate.”
Suffice it to say, if you are the only financial adviser meeting with a particular plan or individual, you will be hard pressed to avoid making a recommendation. Essentially, any guidance you provide could be interpreted as a recommendation.
2 QUESTIONS
Consider these two foundational questions when working with retirement accounts: 1) Have I collected sufficient information from my client, or prospect, for that matter, to deliver prudent fiduciary advice? and 2) Will my compensation (or that of any of my affiliates) increase if the client or prospect follows my advice?
The fiduciary risk associated with each of these scenarios will be discussed in future blog posts with InvestmentNews. While technical, there are a number of workable solutions that will allow you to remain competitive, provided you understand the rules and how to comply.
Jason C. Roberts is the CEO of Pension Resource Institute, an ERISA compliance consulting firm, and a partner with Retirement Law Group.
