June 28, 2022

Volume XII, Number 179


June 27, 2022

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It’s Official! DOL Finalizes Delay

The Fiduciary Rule transition period is extended until mid-2019, with financial institutions having flexibility in complying with the impartial conduct standards during this period.

The US Department of Labor (DOL) has finalized an 18-month extension of the transition period under the new Best Interest Contract (BIC) and the Principal Transactions (PrT) exemptions and the amended Prohibited Transaction Exemption 84-24 (the PTEs). This means that the full conditions (as originally finalized) of the PTEs—including the contract, warranty, and specific policies and procedures and disclosure conditions—will not become applicable until July 1, 2019, subject to the DOL’s ongoing review of the Fiduciary Rule and expected changes. In the meantime, exemptive relief under the BIC and PrT will be available so long as fiduciaries comply with the “impartial conduct standards” (ICS) that include prudence, loyalty, reasonable compensation, and disclosure.

Here are some highlights from the release:

  • Continued compliance flexibility during the transition period. Although the DOL emphasized that it expects that fiduciaries relying on the PTEs will “adopt prudent supervisory mechanisms to prevent violations of the” ICS, the DOL also reiterated that they have flexibility as to their approach to compliance during the transition period and cited its prior guidance in this regard, including the Conflict of Interest FAQs (Transition Period).

  • As discussed in our previous commentary on the Fiduciary Rule, we believe this guidance indicates that the DOL does not view the ICS as per se requiring financial institutions to adopt specific policies and procedures, including new compensation structures (such as by leveling compensation within product categories, or eliminating back-end awards and cliff-vesting in compensation grids). Rather, these requirements would become applicable if and when the full conditions of the BIC and PrT exemptions become applicable.

  • Nonetheless, the DOL indicated that firms can look to the not-yet-applicable conditions of the exemptions for guidance, and that although compliance with these conditions is not required during the transition period, reliance on them would constitute “good faith compliance” for purposes of the DOL’s temporary enforcement policy. The DOL further emphasized that it expects financial institutions will continue to “exercise care” in communications with retirement investors, including fairly disclosing and accurately describing recommended transactions and compensation practices.

  • Observation: As the ICS currently apply under the PTEs, financial institutions should continue to take meaningful steps to comply with them, including by identifying and addressing any potential conflicts in providing investment advice to retirement investors and ensuring effective disclosures.

  • However, in developing approaches to compliance, financial institutions may also want to consider the flexibility the DOL has provided, including in light of the ongoing re-examination of the Fiduciary Rule by both the DOL and the US Securities and Exchange Commission (SEC), as well as industry developments and evolution in response to the rule.

  • Temporary enforcement relief extended. The DOL also extended the temporary enforcement relief under Field Assistance Bulletin 2017-2 to July 1, 2019. This means that during the extended transition period, the DOL and the Internal Revenue Service (IRS) will not pursue claims or cite violations against investment advice fiduciaries who are working “diligently and in good faith to comply” with their fiduciary duties and to meet the conditions of the PTEs.

    According to the DOL, in reviewing the “compliance efforts of firms and advisers during the transition period, it will focus on the affirmative steps that firms have taken to comply with the Impartial Conduct Standards and to reduce the scope and severity of conflicts of interest that could lead to violations of those standards.” The DOL further noted that “it remains critically important that firms take action to ensure that investment recommendations are governed by the best interests of retirement investors, rather than the potentially competing financial incentives of the firm or adviser.”

    • Observation: As discussed above, financial institutions should continue to take meaningful steps to comply with the ICS during the transition period, while taking into account the flexibility as to the approach that the DOL has adopted for this period. As such relief is subject to the “diligence and good faith” condition, firms should consider approaches to demonstrate satisfaction of this requirement, which may include maintaining summaries or action plans for complying with the elements of the ICS, as discussed above.

      It is also important to note that the DOL and IRS temporary enforcement policy is not binding on potential litigants or other regulators, including the SEC, the Financial Industry Regulatory Authority (FINRA), bank regulators, or state securities or insurance regulators.

  • Streamlined Exemption Forthcoming. The DOL again indicated that it intends to formulate and propose a new streamlined class exemption in the “near future.”

    • Observation: Although there are no details available on the proposed streamlined exemption, in discussing why it did not adopt a delay that would be conditioned on the financial institution adopting a particular compliance approach or using a particular product structure (e.g., clean shares), the DOL stated that recent marketplace innovations “seem more relevant in the context of considering the development of additional and more streamlined exemption approaches.” Thus, we anticipate that the proposed streamlined exemption will incorporate new products or structures in some regard.

  • Coordination with Other Regulators. The DOL reiterated its desire to coordinate with other regulators, such as the SEC, FINRA, and the National Association of Insurance Commissioners in developing proposals or changes to the PTEs, pointing out that the chairman of the SEC is seeking public comments on the standards of conduct for SEC-regulated entities and has welcomed the DOL’s “invitation to engage as the SEC moves forward with its examination of the standards of conduct applicable to investment advisers and broker-dealers, and related matters.”

    • Observation: We encourage affected firms to submit comments to the SEC.

  • Solicitation of Additional Comments. The DOL also indicated that it remains available to support interested parties in their efforts to comply with the Fiduciary Rule and related PTEs, and to discuss “the compliance approaches they have adopted or plan to adopt.” Further, the DOL stated that it welcomes additional comment, input, and data from stakeholders in the community regarding the implementation of the ICS, grandfathering relief under the BIC, and product limitations under the PrT.

Copyright © 2022 by Morgan, Lewis & Bockius LLP. All Rights Reserved.National Law Review, Volume VII, Number 334

About this Author

Daniel Kleinman, Morgan Lewis, Labor and employment lawyer

Daniel R. Kleinman advises businesses on the fiduciary responsibilities provisions (Title I) of the Employee Retirement Income Security Act (ERISA). He also counsels these clients on 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 benefits plans. Additionally, Daniel handles issues related to the regulation of broker-dealers and investment advisers under US federal and state securities laws.

Michael Richman, Employment attorney, Morgan Lewis

Michael B. Richman counsels clients on the fiduciary responsibility rules under the Employee Retirement Income Security Act (ERISA), including the ERISA prohibited transaction rules. He advises plan sponsors on investment matters for defined benefit and defined contribution plans. He also counsels banks, investment adviser firms, and broker-dealer firms on ERISA compliance for ERISA plan separately-managed accounts, collective investment funds, private funds, and other arrangements. Additionally, he provides guidance to IRA custodians on permissible IRA investments and...

Lindsay Jackson, Morgan Lewis, Employment attorney

Lindsay B. Jackson counsels financial services clients on issues that arise under the Employee Retirement Income Security Act (ERISA) fiduciary responsibility and prohibited transaction rules. Clients turn to her for guidance on ERISA and IRC compliance when providing services to plans and IRAs. Lindsay also negotiates private fund investments and other service provider agreements on behalf of plans and plan asset entities. She advises clients involved in US Department of Labor and SEC examinations and investigations.

William Marx, Morgan Lewis Law Firm, Philadelphia, Labor and Employment Attorney

William J. Marx helps employee benefit plan sponsors and financial service providers with a range of matters related to employee benefits. His focus includes advising clients on qualified and nonqualified retirement plan issues, and the fiduciary and prohibited transaction rules under ERISA. William has several years of business experience in the retirement plan industry, including consulting plan sponsors on plan design, employee education, and investments among other business decisions.