What the Fiduciary Rule Means for Investment Menu Advisement

The Retirement Security Rule, finalized in April by the Department of Labor, will require that investment menu designs and sales must follow the obligations of loyalty and prudence under the Employee Retirement Income Security Act. Previously, transactions of this kind were often considered one-time transactions and therefore not a fiduciary act.

In the final release, DOL wrote that “The Department has not changed its position from the proposal that presenting a list of investments as having been selected for and appropriate for the investor (i.e., the plan and its participants and beneficiaries) will not be carved out from ERISA fiduciary status.”

The department added that “When a firm or financial professional provides individualized recommendations to a plan on the construction of a prudent fund lineup, and otherwise meets the terms of the rule’s definition, the investor is entitled to rely on the recommendation as fiduciary advice intended to advance the plan’s best interest,” the DOL argued.

Jason Roberts, the CEO and founder of the Pension Resource Institute, says that this element of the final rule should be an “easy lift from a compliance perspective” and “less disruptive operationally” for retirement plan advisers and providers.

He explains that anyone dealing with an ERISA plan, including a non-fiduciary, must provide a written description of services and indicate if they are acting in a fiduciary capacity under current rules. He notes that providers may have to re-evaluate their offerings to be sure they meet ERISA fiduciary standards.

The DOL cited a study from Morningstar several times in its release that explains that this element of the rule will save plans sponsored by small businesses $55 billion in fees over the course of ten years, in part by reducing conflicts that can lead to higher fees for proprietary products.

Speaking of plans sponsored by smaller businesses, Morningstar wrote: “Some of these investment fees look outlandish compared with the investment universe, and we believe that the proposed rule and PTEs [prohibited transaction exemptions] would result in plan fiduciaries examining their investment lineups and the fees their plans pay.”

Because of the rule, providers “will need to ensure their recommendations are prudent and their fees are reasonable. Plans that currently have significantly above-average costs are unlikely to meet these standards, resulting in the firms providing them advice to recommend changes,” Morningstar added in their comment letter.

Morningstar recently stood by this argument as it relates to the final rule.

Brian Graff, the CEO of the American Retirement Association, which endorsed the rule, says that “the principal reason we support the rule is that it fills that regulatory gap.”

He explains that investment menu designs provided on a one-time basis were excluded because the previous five-part test required advice to be given on an ongoing basis. Graff adds that this element will help “ensure the fees are not higher than necessary due to conflicts of interest.”

Many in the retirement industry are anticipating relatively rapid growth in small, startup retirement plans in coming years in part due to federal tax incentives and state mandates. Cerulli Associates recently forecast that the retirement plan market would grow from 668,419 plans at the end of 2022 to nearly 1 million by the end of the decade.