The conflict of interest final rule on fiduciary investment advice—AKA the Rule—drew its last gasp on March 18th, when the 5th Circuit District Court vacated the regulations first introduced by the Department of Labor (DOL) in 2009.
The 5th Circuit Court ruled that the DOL overreached its authority by placing rules on the investment industry, which includes insurance and annuity companies. The Court asserted that the states, not the DOL, were authorized by Congress to regulate insurance and annuity companies. Consequently, the 5th Circuit issued its mandate officially vacating the DOL’s fiduciary regulations, including the best interest contract exemption (BICE) and other related prohibited transaction exemptions.
The end of the Rule (finalized on June 21) has two immediate effects. First, the definition of “fiduciary” reverts to the original fiduciary standard for investment advisers provided with the creation of the Employee Retirement Income Security Act (ERISA) of 1974. Second, the exemptions created by the DOL regulations are rendered null and void.
The ERISA fiduciary standard is based on five criteria, all of which are required for an adviser to be deemed a fiduciary. Under the ERISA standard, an individual or entity is deemed a fiduciary if (i) it rendered advice or made recommendations as to the value of securities or other property, (ii) on a regular basis, (iii) pursuant to a mutual agreement between the person or entity and the plan, (iv) the advice served as the primary basis for investment decisions with respect to plan assets, and (v) the advice was individualized.
The original ERISA standard was considered less than airtight. As a result, regulatory agencies became increasingly concerned that advisers not deemed fiduciaries could operate with undisclosed conflicts of interest and steer customers to investments based on their own self-interest. Hence the DOL’s entry into the fray with the Rule.
The impact the 5th Circuit ruling will have on the fiduciary status of a plan vendor may depend on the relationship of the parties. For example, where plan sponsors have hired registered investment advisers (RIAs) to provide regular advice under a traditional direct fee for service advisory model, the RIAs will still be fiduciaries. In these cases, the advice given will still be considered “fiduciary” under the ERISA standard, and the RIA will generally acknowledge its fiduciary status in writing. Also, discretionary investment managers (e.g., 3(38) investment managers) remain fiduciaries, since managing plan assets on a discretionary basis is, and always has been, a fiduciary service.
Brokers may wish to avoid fiduciary status altogether. This will likely depend on which prohibited transaction exemptions become available to permit fiduciaries to receive commissions and other forms of compensation for their recommendations.
In response to the 5th Circuit’s ruling eliminating relied-upon exemptions, the DOL, under Field Assistance Bulletin 2018-02 (FAB), has taken the position that, until regulations, exemptions, or other administrative guidance are issued, it will not pursue prohibited transaction claims against fiduciaries, provided they are “working diligently and in good faith to comply with the impartial conduct standards for transactions that would have been exempted” under the previous exemptions.
The current regulatory climate leaves the ball squarely in the court of the Securities and Exchange Commission (SEC) with regard to issuance of any new conflict of interest regulations. The efforts of the SEC and DOL will need to be coordinated to ensure new regulations are workable. Financial institutions may also seek new exemptions that provide broad relief for advice fiduciaries. Consumer groups are sure to insist on consumer protection regulations at both the state and federal level.
There are some actions plan sponsors may want to consider in response to the 5th Circuit ruling. Likely, the most important among these is monitoring developments from regulators such as the SEC and legislative entities, including Congress and state legislatures, for any guidance, rules, or laws related to new fiduciary standards.
While the DOL Rule may be history, ERISA plan sponsors still have plenty of reasons to make sure their service providers are complying with their fiduciary duties under the previous (and once again current) regulations. The bottom line is that plan fiduciaries should take specific steps to make sure that they are getting advice from fiduciaries!