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After years of effort and opposition from the financial service industry, the Department of Labor (DOL) has issued its final regulation clarifying the definition of who is a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA).

The newly issued regulation governs the behavior of persons giving investment advice to retirement plan and individual retirement accounts (IRAs). The regulations coupled with a series of proposed prohibited transaction exemptions (PTEs) will alter how retirement plans, their fiduciaries and IRA holders are advised with respect to their plan or IRAs.

ERISA fiduciary rules have typically covered retirement plans, but until now they did not cover IRAs. The new rule expands coverage to include IRAs.

ERISA has historically defined a fiduciary as a person who (among other things) renders “investment advice” for a fee. The new regulations expand dramatically what constitutes investment advice. Under the regulations, investment advice will include:

  • Recommendations as to the advisability of acquiring, holding or disposing or exchanging securities or other property

  • Recommendations with respect to rollovers, transfers or distributions from a plan or IRA including whether to take a distribution, in what amount or form and its destination

  • Recommendations as to how the investment or management of securities or other property should be handled after being rolled over or otherwise distributed from a plan or IRA

  • Recommendations as to investment policies, portfolio compensation or the selection of other persons to provide advice or investment management

  • Recommendations of any person who is also going to receive a fee or other compensation to do any of the things described above

By treating advisors as ERISA fiduciaries, the DOL is heightening the duty of care the advisor owes to a client. Among other things, as a fiduciary, an advisor has a duty to avoid providing advice where he or she may be conflicted. The classic situation is where an advisor may recommend an investment product or a course of action such as taking a distribution from a plan, and such recommendation would increase the advisor’s compensation.

ERISA does permit fiduciaries to receive reasonable compensation for service provided,but the burden will be on the fiduciary/advisor to justify the compensation.

The DOL has excluded certain activities from the coverage of the rule:

  • Stock appraisals for Employee Stock Ownership Plans (ESOPs) (but may be subject to regulations in the future)

  • Mere order taking

  • Sales pitches to plan fiduciaries with financial expertise;this will typically be large plans with sophisticated personnel

  • Retirement education of participants

The DOL is cognizant that individuals and plans need assistance. In order to facilitate such advice, the DOL has also issued proposed PTEs or amendments to existing PTEs, which describe a course of action advisors and their clients can follow permitting advisors to continue to provide recommendations without running afoul of the rules.

Simplistically, advisors and clients would enter into a “Best Interest Contract” or BIC wherein the advisor would agree to provide investment advice in an impartial manner. This would include only giving advice in the best interest of the client and receiving only reasonable compensation.

Because the new fiduciary rules and the attendant PTEs are complex and will dramatically change how advisors will need to operate the rule, they will be phased in between April 2017 and January 2018.

Many advisors have been acting as if they were fiduciaries with respect to plans and IRAs for some time. This new regulation will probably not affect their behavior, but will cause revisions to the paperwork and reporting they and their firms will be required to do.

For those advisors who may not have been so diligent or client-focused, the new regulation will require major behavioral changes as well.
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