April 24, 2017

April 24, 2017

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April 21, 2017

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DOL Fiduciary Rule—Slowed Down, but Not Out

The rule is delayed by 60 days, with core elements taking effect June 9 as the DOL conducts a study.

The Department of Labor (DOL) has issued in final form its eagerly awaited delay of changes to the fiduciary investment advice regulation, commonly referred to as the fiduciary rule, and related prohibited transaction exemptions (PTEs). The 60-day delay extends the original April 10, 2017 applicability date to June 9, and the DOL has further delayed the applicability of certain PTE conditions until January 1, 2018. 

Importantly, the new expansive definition of fiduciary investment advice and the PTEs’ best interest advice standard (as well as other impartial conduct standards)—core elements of the rule—are now scheduled to take effect in less than 60 days. The DOL also indicated in the release that it has little inclination to further delay these provisions while it examines the rule for potential harms as directed by President Donald Trump’s February 3 memorandum

Here are the key effects of the delay, subject to the possibility of further changes before the applicability dates occur.

What Happens on June 9, 2017?

  • The expanded definition of fiduciary investment advice goes into full effect. Among other things, this means that as of June 9,

    • investment-related recommendations (including recommendations with respect to specific securities, insurance products, and asset management) will generally result in fiduciary status;

    • recommendations regarding rollovers are fiduciary advice; and

    • Interpretive Bulletin 96-1, regarding investment education, is no longer applicable.

Observation: Although the DOL’s reexamination of the fiduciary rule is ongoing, this change would put the rule’s core element—its broadened definition of fiduciary investment advice—into effect on June 9. This means that, absent further delay, broker-dealers, investment advisers, banks, insurance companies, and other financial institutions will need to consider implementing fundamental changes to their business structures needed to comply with the rule. For example, where a firm intended to solve for the rule by discontinuing or limiting access to advised brokerage arrangements, such changes and any related customer notifications will need to be considered for June 9 implementation.

  • The exceptions to fiduciary status also become applicable on June 9, along with their conditions. Thus, where the intention is to rely on an exception, the goal would be to have any changes needed for compliance in place by then. For example:

    • Provide disclosures and obtain representations needed to fall within the independent fiduciary/sophisticated counterparty exception for transactions with fiduciaries that are financial services firms or manage at least $50 million in assets.

    • Provide disclosures needed to rely on the exceptions related to offering a platform of investments.

    • Ensure investment education materials include appropriate disclosures and disclaimers.

    • Determine whether interactive web-based tools and interfaces need to be taken down or revised.

    • The Best Interest Contract (BIC) Exemption and Principal Transaction (PrT) Exemption become available, but only the impartial conduct standards apply until January 1, 2018. This means that during the transition period, when providing investment recommendations subject to the BIC Exemption, firms and their representatives must

      • give advice that is in the retirement investor’s best interest,

      • earn no more than reasonable compensation (under the BIC Exemption) or seek best execution (under the PrT Exemption), and

      • not make materially misleading statements (which can include omissions) to the retirement investor.

Observation: Compliance with the impartial conduct standards will, in many cases, require firms to adopt or modify their policies and procedures in potentially significant ways—particularly where the BIC Exemption is relied on to permit variable, transaction-based compensation to the firm or its financial professionals. 

Firms should keep in mind the FAQs issued by the DOL concerning conflicts of interest, neutral factors, compensation of the representative, and oversight. While some of these were interpretations of the BIC Exemption’s warranties provision, which would not apply during the transition period, they may still be relevant to the extent they are helpful in demonstrating compliance with the impartial conduct standards.

  • Conditions of the BIC and PrT Exemptions previously scheduled to be effective April 10 are delayed until January 1, 2018. This includes the transition disclosure (including the acknowledgment of fiduciary status, statement of impartial conduct standards, and disclosure of material conflicts of interest and platform limitations); recordkeeping requirement; and the requirement to designate a person or persons responsible for addressing material conflicts of interest and monitoring advisers’ adherence to the impartial conduct standards.

Observation: Although the transition disclosures and other requirements have been delayed, firms may still wish to consider whether certain disclosures, recordkeeping, and other policies and procedures may be helpful in demonstrating compliance with the impartial conduct standards or may be protective in limiting liability under the rule (including limiting the scope and extent of fiduciary activities).

  • Grandfathering relief under the BIC Exemption is available beginning June 9. Following the latest change, it now would be available for investments held in a retirement account before the new applicability date of June 9 (and for certain investments acquired after that date in accordance with the terms of the grandfathering relief).

Observation: Firms will need to consider what operational changes need to be put in place as of June 9 for grandfathered accounts, including account flags and notifying clients of changes to service levels where required.

  • BIC Exemption relief is available for level-fee fiduciaries (including level-fee robo-advisors) during the transition period, subject to meeting the impartial conduct standards.

  • For PTE 84-24, only the amendment to add the impartial conduct standards becomes applicable on June 9, and all other amendments are delayed until January 1, 2018. This means that PTE 84-24 is generally available for transactions concerning any insurance or annuity products—including variable annuities, fixed-index annuities, and fixed annuities —until January 1, 2018, subject to satisfying the impartial conduct standards and current conditions of the exemption (including certain disclosure requirements).

Observation: Firms can cover the receipt of commissions on the sale of any annuity contract under either PTE 84-24 or the BIC Exemption until January 1, 2018. But compliance with the BIC Exemption may be easier during this time because PTE 84-24 currently requires specific disclosures and that certain other conditions be satisfied, whereas the only condition of the BIC Exemption that applies during this time is the impartial conduct standards.

  • All amendments to the other class exemptions (including, PTE 75-1, PTE 77-4, PTE 80-83, PTE 83-1, PTE 84-24, and PTE 86-128) go into effect. This means that

    • the impartial conduct standards become applicable for all of the amended class exemptions;

    • significant changes impacting the availability of PTE 86-128 (for affiliated brokerage transactions) will go into effect on June 9. In particular,

      • PTE 86-128 will no longer be available for nondiscretionary transactions with individual retirement accounts (IRAs), so firms will need to rely on the BIC Exemption for these transactions to the extent exemptive relief is necessary; 

      • the limitation of brokerage compensation to the defined term “commission”—which expressly excludes 12b–1 fees, revenue sharing payments, marketing fees, administrative fees, sub-TA fees and sub-accounting fees—becomes applicable; and 

      • firms must comply with the disclosure and consent requirements with respect to discretionary advice provided to IRAs beginning on June 9 (the amendments provide a negative consent process for this purpose).

Observation: Firms that intend to rely on PTE 86-128 for discretionary transactions will need to make sure that IRAs receive the disclosures that were previously required only for Employee Retirement Income Security Act (ERISA) plans as of June 9. Further, if a firm was relying on PTE 86-128 to cover compensation that will no longer be covered on June 9, the firm will need to consider whether another exemption is available (e.g., the BIC Exemption for nondiscretionary advice) or whether its compensation arrangements otherwise need to be restructured.

What Happens on January 1, 2018?

The full conditions of the BIC Exemption, PrT Exemption, and PTE 84-24 (as amended) become applicable. This means that

  • firms intending to rely on the BIC and PrT Exemptions (other than the grandfathering relief where applicable) will need to

    • acknowledge fiduciary status,

    • notify the DOL prior to receiving compensation in reliance on the exemption,

    • provide contracts (for IRAs) and disclosures for transactions with IRAs and ERISA plans, 

    • provide pre-transaction and website disclosures, and

    • comply with the recordkeeping requirements.

    • PTE 84-24 will no longer be available for transactions involving variable or fixed-index annuities and its amended disclosure requirements will apply, including the condition that the insurance commission be “expressed to the extent feasible as an absolute dollar figure.”

What Does This Mean for Financial Institutions?

In general, this means that, absent further delays or guidance by the DOL, financial institutions affected by the new rules will have to comply beginning June 9. Among other things, reliance on the exceptions for transactions with independent fiduciaries and investment education and platform providers may require action on the part of firms, including providing or updating disclosures. In addition, firms intending to rely on the new or amended PTEs will need to make sure they have appropriate systems in place to meet the impartial conduct standards. 

Although not required as a technical matter, firms will want to consider the extent to which policies, procedures, and recordkeeping may be needed to support compliance with the impartial conduct standards. Firms planning to move clients to execution-only arrangements, or to impose limitations on accounts for which they will be relying on the BIC Exemption grandfathering provisions, will want to consider doing so prior to June 9, taking into account any notice requirements under Financial Industry Regulatory Authority (FINRA) rules or other applicable laws.

In addition, absent further delays or guidance by the DOL, the full conditions of the new and amended PTEs will be applicable on January 1, 2018. This means that financial institutions have roughly eight months to build the systems necessary to comply with the extensive disclosure and other requirements under the BIC and PrT exemptions.

We note that the 45-day period for comment regarding the examination directed by the president's memorandum on the fiduciary rule and with respect to the specific areas described in the proposal to delay the rule closes on April 17, 2017. We encourage interested parties to submit comment letters regarding the rule and exemptions.

Copyright © 2017 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

TRENDING LEGAL ANALYSIS


About this Author

Partner

Daniel R. Kleinman is a partner in Morgan Lewis's Investment Management and Securities Industry Practice and a member of the ERISA Fiduciary Services Group. Mr. Kleinman's practice focuses on the fiduciary responsibilities provisions (Title I) of the Employee Retirement Income Security Act and the related tax, corporate and securities laws in connection with the structuring and marketing of investment products (including private equity and hedge funds) and financial services to employee benefit plans. He also handles issues with respect to the regulation of broker-dealers and investment...

202-739-5143
Of Counsel

Michael B. Richman is of counsel in Morgan Lewis's Employee Benefits and Executive Compensation Practice. In addition to employee benefits, Mr. Richman's practice includes the investment management and securities areas. His principal focus is on matters under the ERISA fiduciary responsibility rules. These have included fiduciary governance of ERISA plans, prohibited transaction issues in proposed transactions and transactions under government investigation, and preparing requests to the U.S. Department of Labor for prohibited transaction exemptions and advisory opinions. Mr. Richman has also worked on ERISA compliance for investment funds and investment managers and plan administrative matters.

202-739-5036
Lindsay B. Jackson, ERISA Attorney, Morgan Lewis, Law Firm
Associate

Lindsay B. Jackson is an associate in Morgan Lewis's Investment Management Practice and a member of the ERISA Fiduciary Services Group.  Ms. Jackson focuses her practice on matters under the ERISA fiduciary responsibility rules, and the related tax, corporate and securities laws in connection with employee benefit plan investments and other services provided to employee benefit plans. She also handles issues related to prohibited transactions and exemptions and the Department of Labor's fee disclosure requirements. Ms. Jackson has experience counseling clients on issues related to employee...

202-739-5120
Associate

Katrina L. Berishaj advises clients on the design, governance, operation, and compliance of qualified and nonqualified retirement plans, welfare benefit plans, and executive and equity compensation arrangements. In addition, Katrina counsels clients on the fiduciary and prohibited transaction rules of ERISA. She is admitted to practice in Maryland only, and her practice is supervised by DC Bar members.

202-739-5025