The proposed rule was unveiled today by the Department of Labor (DoL), which noted that its adoption “would protect beneficiaries of pension plans and individual retirement accounts by more broadly defining the circumstances under which a person is considered to be a ‘fiduciary’ by reason of giving investment advice to an employee benefit plan or a plan’s participants.”
The proposed rule is designed to “take account of significant changes” in both the financial industry and what was described as “the expectations of plan officials and participants who receive investment advice,” as well as to protect participants from “conflicts of interest and self-dealing.”
In explaining the proposal, the Labor Department noted that while Section 3(21)(A) of ERISA provided a “simple two-part test for determining fiduciary status,” a subsequent (1975) regulation served to “significantly narrow” the “plain language” of the legislation; effectively replacing the two-part test that would impose fiduciary status when a person renders investment advice with respect to any moneys or other property of a plan, or has any authority or responsibility to do so and receives payment (direct or indirect) for that advice, with a 5-part test that included conditions that: the advice regarding plan investments be rendered “on a regular basis,” that the advice would serve as a primary basis for investment decisions with respect to plan assets, that the recommendations are individualized for the plan, that the party making the recommendations receives a fee for such advice, and that it be pursuant to a mutual understanding of the parties. Moreover, the Labor Department noted that it further limited the definition of “investment advice” in a 1976 advisory opinion, when it concluded that the valuation of closely-held employer securities in an employee stock ownership plan (ESOP) relied on in purchasing those securities would not constitute investment advice.
Well, that was then—and this is now, and the Labor Department noted that the financial marketplace and the types and complexity of services have expanded dramatically. The proposal notes that although professionals such as consultants, advisers, and appraisers “…significantly influence the decisions of plan fiduciaries, and have a considerable impact on plan investments,” if they are not deemed fiduciaries under ERISA “…they may operate with conflicts of interest that they need not disclose to the plan fiduciaries who expect impartiality and often must rely on their expertise, and have limited liability under ERISA for the advice they provide.”
In essence, the Labor Department now says that ERISA does not compel it to apply its own five-part test, and that new facts and circumstances mean it is now time to update the investment advice definition. Specifically cited is that the proposal no longer requires that the advice be provided on a “regular” basis, not does it require that there be a mutual understanding that the advice will serve as a primary basis for plan investment decisions.
As for what constitutes advice, the proposal now includes the provision of appraisals and fairness opinions as a type of advice, noting that the incorrect valuation of employer securities was a “common problem” identified in the DoL’s recent national enforcement project, including cases where plan fiduciaries have “reasonably relied on faulty valuations prepared by professional appraisers.” The proposal also makes specific reference to advice and recommendations as to the management of securities and other property, including such things as voting proxies or recommendations regarding the selection of persons to manage plan investments.
Finally, in what was described as reflecting “the Department’s longstanding interpretation of the current regulation,” the proposal makes clear that fiduciary status “may result from the provision of advice or recommendations not only to a plan fiduciary, but also to a plan participant or beneficiary.”
At that point, the proposal notes that while the DoL has previously taken the position that a recommendation to a plan participant to take a permissible plan distribution would not constitute investment advice, even when combined with a recommendation as to how the distribution should be invested, “[c]oncerns have been expressed that, as a result of this position, plan participants may not be adequately protected from advisers who provide distribution recommendations that subordinate participants’ interests to the advisers’ own interests.” As a result, the Labor Department is now seeking comment “on whether and to what extent the final regulation should define the provision of investment advice to encompass recommendations related to taking a plan distribution.” The proposal notes that the agency is specifically interested in:
- information on other laws that apply to the provision of these types of recommendations,
- whether and how those laws safeguard the interests of plan participants,
- the costs and benefits associated with extending the regulation to these types of recommendations.
The proposal says that the definition of advice does not include “the preparation of a general report or statement that merely reflects the value of an investment of a plan or a participant or beneficiary, provided for purposes of compliance with the reporting and disclosure requirements,…unless such report involves assets for which there is not a generally recognized market and serves as a basis on which a plan may make distributions to plan participants and beneficiaries.”
The proposal says that the DoL believes that explicitly claiming ERISA fiduciary status, orally or in writing, is sufficient to result in fiduciary status, if provided for a fee (in that it “enhances the adviser’s influence, and gives the advice recipient a reasonable expectation that the advice will be impartial and prudent”).
Consistent with existing regulations, the proposal acknowledges that the provision of investment education materials (plan information, general financial and investment information, asset allocation models, and interactive materials) would not be deemed advice.
The proposal notes that the “marketing or making available” investments or an investment menu (e.g., through a platform or similar mechanism) “without regard to the individualized needs of the plan, its participants, or beneficiaries…will not, by itself, be treated as the rendering of investment advice within the meaning of section 3(21)(A)(ii) of ERISA”—if the person making those investments available “discloses in writing to the plan fiduciary that the person is not undertaking to provide impartial investment advice.” Additionally, the provision of information and data to assist a plan fiduciary’s selection or monitoring of investments isn’t deemed to be rendering advice “if the person providing such information or data discloses in writing to the plan fiduciary that the person is not undertaking to provide impartial investment advice.”
The proposal does set aside some limitations, exempting from the fiduciary umbrella persons that can demonstrate that the advice recipient “knows or, under the circumstances, reasonably should know, that the person is providing the advice or making the recommendation in its capacity as a purchaser or seller of a security or other property, or as an agent of, or appraiser for, such a purchaser or seller, whose interests are adverse to the interests of the plan or its participants or beneficiaries, and that the person is not undertaking to provide impartial investment advice.”
Finally, noting that a necessary element of fiduciary status is that the advice be rendered for a fee or other compensation, the proposal states that that includes, but is not limited to, “brokerage, mutual fund sales, and insurance sales commissions,” and that it includes fees and commissions based on multiple transactions involving different parties.
The proposal is set to take effect 180 days after publication in the Federal Register tomorrow, but the Labor Department is first seeking comments on the proposal. The comment period for the proposed regulations will end 90 days after publication of the proposed rule in the Federal Register. That means that the comment period will end January 20, 2011. Comments can be submitted electronically by e-mail to e-ORI@dol.gov (enter into subject line: Definition of Fiduciary Proposed Rule) or by using the Federal eRulemaking portal at http://www.regulations.gov.
The DoL notes that persons submitting comments electronically are encouraged not to submit paper copies. More information on paper submissions is available (along with the proposal itself) at http://www.ofr.gov/OFRUpload/OFRData/2010-26236_PI.pdf