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Analysis: Impact of the DOL’s Fiduciary Proposal on Participant Investment Advice

This article explains the basis for our conclusions about the impact on the investment recommendations to participants of the Department of Labor’s (DOL) proposal to amend the fiduciary investment advice regulation and to establish a new “Best Interest Contract” Exemption (BICE).  BICE is a prohibited transaction (PT) exemption that would permit financial institutions to receive variable and indirect compensation based on advisor recommendations. 

The DOL proposal would significantly impact broker-dealers, where their affiliated advisors assist participants with investment decisions.  When we refer to “affiliated advisors,” we mean both a broker-dealer’s registered representatives and investment advisor representatives where the firm is dual-registered.

As a word of caution, the DOL’s proposal is just that . . . a proposal. It appears that the DOL may be willing to make significant changes to some of the provisions (and particularly to the BICE conditions).

Conclusion No. 1:  The proposal expands the definition of fiduciary investment advice by providing that a “recommendation” to a participant would trigger fiduciary status.  A “recommendation” is a communication that would reasonably be viewed as a “suggestion” that a participant engage in or refrain from a particular course of action.  Under this standard, many common sales and investment education practices would constitute fiduciary advice.

This standard will likely make it challenging for advisors to avoid fiduciary status when assisting participants, as most communications could be viewed as suggestions.  Also, the proposal does not recognize any “carve-out” for sales transactions with participants.  An advisor who “recommends” an investment to participants could not avoid fiduciary status by disclosing that he or she is not offering individualized advice, but rather, is just selling a product.

Broker-dealers should recognize that this is a change from the current DOL regulation defining fiduciary investment advice, which requires a mutual understanding that individualized advice is being offered.  Another difference is that, unlike the current DOL rule, the proposal does not include a “regular basis” requirement – under the proposal, even one conversation could trigger fiduciary status. (However, fiduciary status still requires at least some compensation for the advice, but any payment from any source, direct or indirect, would likely satisfy that requirement.)

The proposal recognizes a carve-out for investment education (discussed below), but it is narrow and does not cover some communications previously regarded as merely educational.

Conclusion No. 2:  Advisors could provide generalized investment education to participants without triggering fiduciary status and prohibited transaction (PT) concerns, if they avoid “recommendations.”  But this will be challenging – under the proposal, referencing available investment options would likely be a fiduciary act.

The proposal recognizes a carve-out from the fiduciary definition for certain types of general information and educational materials.  However, broker-dealers should be aware that the investment education carve-out is narrowly crafted, and should take steps to ensure that any investment information or materials provided to participants by their advisors do not cross the line into advice (if fiduciary advice is not intended).

In Interpretive Bulletin 96-1, the DOL identified four categories of information and materials that do not constitute advice, but instead are non-fiduciary investment education:  (1) plan information, (2) general financial and investment information, (3) asset allocation models and (4) interactive investment materials.  The investment education carve-out in the proposal includes these same categories, but it requires that materials cannot include or identify any of the investment alternatives available to participants.  Educational materials also could not contain investment recommendations, even “in combination with other materials.” 

In reviewing information and materials that are intended to meet the education carve-out, broker-dealers need to ensure they are “investment-neutral.”  For example, information about asset allocation models may not refer to specific investments, and other materials concurrently furnished by the advisor should not refer to investments available within the asset classes described in the models.   

Conclusion No. 3:  Broker-dealers receive 12b-1 fees and other variable/indirect compensation from investment products they sell.  Advisors who recommend investments to participants influence this compensation.  This would constitute a “fiduciary self-dealing” PT under the proposal, and exemptive relief is needed.

Where providing fiduciary advice to participants, an advisor cannot (1) recommend investments that would cause the advisor to receive additional compensation without violating Section 406(b)(1) of ERISA, which prohibits a fiduciary from dealing with plan assets for his own interest or account; or (2) receive compensation from the recommended investments, which would also be a PT under Section 406(b)(3).  The same rules extend to compensation paid to affiliates or other parties in which the advisor has an interest that could reasonably affect the advisor’s judgment.

Therefore, where an affiliated advisor recommends investments to a participant, ERISA prohibits the broker-dealer from receiving variable/indirect compensation on the basis of the recommendations, unless an exemption for the resulting PT is satisfied.  In the context of participant advice, there are a few options available (discussed below).

We should also point out that PTs can be avoided in the first place by utilizing a flat-fee arrangement and offsetting the flat fee dollar-for-dollar by any indirect compensation received, such that the broker-dealer’s total compensation is not being influenced by the recommendations.  This model is permitted under Advisory Opinion 97-15A, the “Frost Bank” opinion.  

Conclusion No. 4:  BICE would provide an exemption permitting broker-dealers to receive variable and indirect compensation based on their advisors’ non-discretionary recommendations.  However, BICE imposes disclosure and other requirements that may be practically impossible, or prohibitively expensive, to comply with.

BICE would permit a broker-dealer’s receipt of “otherwise prohibited compensation,” but the exemption would impose conditions that the broker-dealer may not be willing or able to satisfy.  Some of the key requirements of BICE include:

  • A three-way written contract between the participant, advisor and broker-dealer, entered into before any recommendations are given, requiring the advisor to act in the participant’s best interests (and without regard to the interests of the advisor or broker-dealer).  The contract would have to include various representations, disclosures about fees and proprietary funds, and warranties about a number of issues, including that the broker-dealer has implemented policies and procedures to mitigate conflicts of interest and ensure that advisors are observing impartial conduct standards. 

  • The proposal says that the warranties about conflicts of interest do not prevent the broker-dealer, advisor or affiliates from receiving variable compensation so long as the compensation does not encourage advice that runs counter to the investor’s “best interest.”  It adds that differential compensation based on “neutral factors,” such as the difference in time and the analysis needed to give prudent advice, would be permissible.  Avoiding a “best interest” violation and coming up with “neutral factors” will clearly be challenging.  

  • Notice of a publicly available website detailing all direct and indirect compensation payable to the advisor, broker-dealer, etc. with respect to assets that could be purchased by plans and IRAs, over the previous year.  In the context of IRAs, this could include an enormous amount of information.

  • Additional disclosures about estimated future costs (for each sale, utilizing estimates of future investment performance), and annual disclosures regarding investment transactions and compensation.

  • Disclosures to the DOL as to reliance on BICE, and significant recordkeeping requirements to demonstrate compliance.

This is a broad summary and not an exhaustive list.  However, it illustrates the level of practical challenges and costs that BICE would create, particularly regarding the numerous and detailed participant (and public) disclosures required.  Even the written contract itself may be problematic, because many participants may not wish to sign a contract before deciding whether they want to work with the advisor.  Due to this concern, the DOL may relax the contract timing requirement in the final regulation. 

Broker-dealers that receive variable/indirect compensation on the basis of participant advice provided by affiliated advisors will need to evaluate the risks and costs associated with BICE versus other available exemptions.  Also, BICE does not cover discretionary account management, so broker-dealers whose advisors provide such services will need to look elsewhere for relief.  Finally, see our Insurance Products Alert regarding the application of PTE 84-24 to sales of insurance products to participants.

Because of the cost and complexity of complying with the proposed exemptions, at least some broker-dealers (who do not have proprietary products managed by affiliates) are considering moving to a level fee model.

Conclusion No. 5:  Broker-dealers and advisors could instead rely on the Pension Protection Act (PPA) exemptions for non-discretionary participant advice, but this provides limited relief and compliance is challenging.

As an alternative to BICE, broker-dealers could rely on the exemption for participant advice under Section 408(b)(14) of ERISA that was added by the Pension Protection Act of 2006 (PPA).  However, the PPA exemption also creates administrative challenges and additional costs.

The PPA exemption provides relief for (1) “flat-fee” models, where the broker-dealer receives variable compensation but the advisor’s remains flat; and (2) computer-based advice models which are certified by an independent investment expert.  Under both models, an annual compliance audit, certain participant disclosures and recordkeeping requirements are imposed, along with certain other conditions.  Also, no relief for discretionary investment management is available.  In short, both models are restrictive and will generate additional costs and administrative burdens.  As a result, the PPA exemption is not widely relied upon currently.  Following the proposal, broker-dealers may wish to re-examine it as a possibility, as it may provide a more practicable solution than BICE in some cases. 

Conclusion No. 6:  For participant non-discretionary investment advice and discretionary management, advisors could use a third-party computer-based asset allocation service – permitted in the DOL’s “SunAmerica” advisory opinion – since the advisor wouldn’t be influencing the broker-dealer’s compensation through its own recommendations.

Broker-dealers may choose to consider other approaches to avoid self-dealing PTs in the first place.  In addition to “flat-fee-only” and “fee-offset” models, the SunAmerica Advisory Opinion provides that asset allocation services offered to participants (involving advice and even discretionary management) that are the product of a computer model developed and overseen by an independent financial expert, and subject to certain additional conditions, would allow a service provider (the broker-dealer, in this case) to avoid PTs when receiving variable/indirect compensation from its platform of investment offerings.  Because the advisor is not using its fiduciary discretion in a way that could influence the provider’s compensation, no self-dealing occurs.  While this model is restrictive and does create expenses and compliance challenges, it may be an appropriate solution for some broker-dealers, particularly since (unlike BICE and the PPA exemption) it offers relief with respect to discretionary account management.  The restrictions are significant though, and may be unacceptable to many advisors because their advice would have to be limited to a third party’s computer model “recommendations.”

Closing Thoughts

The proposal will have a significant impact on broker-dealers.  It will be difficult for advisors to avoid fiduciary status when assisting participants with investment decisions.  Where broker-dealers receive variable/indirect compensation on the basis of advisor recommendations, all of the available PT exemptions are highly nuanced and challenging to satisfy.  Otherwise, broker-dealers will need to re-examine their advisors’ practices carefully to ensure that they are providing only investment education, or develop other strategies to avoid PTs.

© 2022 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume V, Number 203

About this Author

Fred Reis Faegre Drinker Biddle Law Firm, Los Angeles, Labor and Employment Law Attorney

Fred Reish represents clients in fiduciary issues, prohibited transactions, tax-qualification and Department of Labor, Securities and Exchange Commission and FINRA examinations of retirement plans and IRA issues.

Fred works with both private and public sector entities and their plans and fiduciaries and represents plans, employers and fiduciaries before federal agencies such as the DOL and IRS. He consults with banks, trust companies, insurance companies and mutual fund management companies on 401(k) recordkeeping services, investment products and...

(310) 203-4047
Bruce Ashton, Drinker Biddle Law Firm Los Angeles, Employment Benefits Attorney

Bruce L. Ashton has more than 35 years of experience handling employee benefits matters. His practice concentrates on representing plan service providers (including RIAs, independent record-keepers, third-party administrators, broker-dealers and insurance companies) in fulfilling their obligations under ERISA. His experience includes representing public and private sector plans and their sponsors, negotiating the resolution of plan qualification issues under IRS remedial correction programs, advising and defending fiduciaries on their obligations and...

Bradford Campbell Labor & Employment Attorney Faegre Drinker Biddle & Reath Washington, D.C.

Bradford Campbell is a nationally recognized figure in employer-sponsored retirement plans who leverages his prior experience as the U.S. Assistant Secretary of Labor for Employee Benefits to advise clients across a broad range of issues related to the Employee Retirement Income Security Act (ERISA). As ERISA’s former “top cop” and primary regulator, Brad has detailed and wide-ranging knowledge of the structure and operation of ERISA plans, insight that he applies to client engagements.

Brad advises financial service providers and plan sponsors, particularly in relation to ERISA...

Joan M. Neri, Counsel, Drinker Biddle, Employee Benefits, Executive Compensation

Her practice focuses on all aspects of employee benefits counseling.  Joan represents plan service providers (including registered investment advisers, third party administrators, and recordkeepers) in fulfilling their obligations under ERISA.  Joan also represents plan sponsor clients on the design of qualified retirement plans (including ESOPs), nonqualified executive compensation plans and welfare benefit plans, day-to-day plan administrative issues and transactional planning involving benefit plan acquisitions, plan mergers and plan terminations.  Joan has represented major publicly-...

Joshua Waldbeser, Employment lawyer, Drinker Biddle

Joshua J. Waldbeser counsels plan sponsors and committees with respect to their fiduciary responsibilities under ERISA, as well as design and operational considerations for 401(k) plans, ESOPs and other defined contribution plans, cash balance and traditional defined benefit plans, and deferred compensation arrangements of all types. Josh also works extensively with insurance companies, investment advisors and funds, banks and trust companies, broker-dealers, record keepers, TPAs and other service providers with respect to ERISA, tax, securities and...