Is your investment adviser a fiduciary?

The contentious history of the conflict of interest final rule on fiduciary investment advice, referred to as the Rule, began in 2009. It ended—at least for the time being—in April 2016, when the Department of Labor (DOL) filed the “final” version of the Rule with the Office of the Federal Register.

Debate and resulting extensions brought the deadline for final implementation to January 2018. As of this writing, however, according to a DOL announcement in November 2017, key provisions—those covering exemptions for best-interest contracts and principal transactions, and some amendments to prohibited transaction exemptions—won’t go into effect until July 1, 2019.

Congress’ goal of protecting Americans’ retirement savings dates back to the creation of the Employee Retirement Income Security Act (ERISA) of 1974. The DOL has been working to protect Americans’ retirement savings through fiduciary standards ever since.

The reason for the “current” changes is the perception that the original ERISA definition of what it means to be a fiduciary has not kept pace with the changing retirement investment environment. Since ERISA’s creation, the retirement industry has shifted dramatically from employer-sponsored and directed defined benefit plans to participant-directed defined contribution plans, and there has been tremendous growth in individual retirement accounts.

The ERISA fiduciary standard is based on five criteria, all of which are required for an adviser to be deemed a fiduciary. This original rule was less than airtight. As a result, regulatory agencies became increasingly concerned that advisers not deemed fiduciaries could operate with undisclosed conflicts of interest with limited liability under federal law for any harms resulting from the advice they provided.

Specifically, these advisers could steer customers to investments based on their own self-interest; that is, toward higher adviser fee-generating products even when identical lower-fee products were available. It was perceived that, by allowing advisers, brokers and consultants to shape plans and IRA investments without ensuring their accountability as Congress intended, the original ERISA rule was “undermining, rather than promoting, the statute’s text and purposes.”

In 2009, the DOL initiated action with the goal of reducing conflicts of interest in investment advice. Separate proposals were published in 2010 and 2015 for public comment. The DOL held hearings and heard from hundreds of individuals and organizations; special interest groups for and against the changes also rang in.

In 2016, after years of debate and under increasing pressure from the White House to take action, the DOL enacted the Rule, which broadens the scope of who is deemed a fiduciary. Under the new Rule, a “fiduciary” is defined as a person who provides recommendations or advice for a fee to a plan, a plan fiduciary, a plan participant, or an IRA owner for a fee regarding: (i) the advisability of acquiring, holding, disposing, or exchanging plan or IRA assets; (ii) the investment of assets after those assets are rolled over, transferred, or distributed from a plan or IRA; and (iii) the management of those assets. In other words, the new Rule treats persons who provide investment advice or recommendations for a fee or other compensation with respect to assets of a plan or IRA as fiduciaries in a wider array of relationships than those included under the ERISA standard.

There are exceptions. For example, while the Rule doesn’t ban commissions or revenue sharing outright, it requires advisers who accept them to have clients sign a best interest contract exemption (BICE). A BICE pledges that the adviser will act in the client’s best interests and only earn “reasonable” compensation. But even BICE is not a complete safety net. Investors with a BICE in place will still be able to sue their advisers in court if they believe their interests haven’t been placed first.

As written, the Rule impacts any entity offering investment advice. Many advisers will need to change the way they are compensated. Additionally, the Rule may reduce the popularity of certain commission-based retirement investment vehicles.

The DOL has put in place interim regulations and agreed to delay full implementation of the Rule. No one can be certain of what the final, final Rule will look like. What does seem inevitable is that no matter how the Rule may be revised, the scope of advisers who are considered fiduciaries and the responsibilities of those fiduciaries will be broader than under ERISA.

So just what does this mean for plan sponsors? Always select an investment adviser that qualifies as a fiduciary under the most current Rule. In other words, act as if the interim regulations are fully implemented. Watch for updates to the regulations, and make sure your advisers are doing likewise. Finally, if you are ever in a situation where you are wondering if a proposed course of action will run afoul of the Rule, play it safe and get some advice from a lawyer who specializes in this area of the law.

The following sources were used in this article: