How the Fiduciary Rule Affects Retirement Plan Sponsors

New rule will impact employer’s compliance obligations and costs

By David Tobenkin and Stephen Miller, CEBS Apr 8, 2016
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On April 8, the U.S. Department of Labor (DOL) published in the Federal Register its long-awaited—and highly controversial—final rule to address conflicts of interest in retirement advice by applying the so-called fiduciary standard to those who provide investment advice to sponsors and participants in 401(k)-type workplace retirement plans and individual retirement accounts (IRAs). The rule had been made public two days earlier.

The rule “affects how investment advice is provided to every 401(k) plan, every IRA, and every rollover or distribution to or from either,” according to a U.S. Chamber of Commerce issue brief.

While aimed at financial advisors who provide retirement plan services, the final rule will impact compliance obligations and costs for plan sponsors as well, regulatory experts say.

“Most retirement plan sponsors have a hazy understanding about what a fiduciary is and if their advisor is acting as one,” commented Robert Lawton, president of Lawton Retirement Plan Consultants in Milwaukee. “Plan sponsors working with advisors who haven’t been acting as fiduciaries will be approached by these advisors as they begin to define a new working relationship. They are likely to outline relationships that feature higher costs. There will also be additional paperwork to sign, which describes their fiduciary limitations.”

Advised Lawton, “Now may be a good time to re-evalute the relationship you have with your advisor, at the very least to gain clarity on his or her fiduciary relationship with your 401(k) plan.”

The DOL posted a fact sheet highlighting key aspects of the final rule, and a chart detailing the differences between the proposed and final rules.

Effective Dates

The DOL adopted a phased implementation approach to the final rule, with a transition period from an April 10, 2017 applicability date to Jan. 1, 2018, when additional conditions apply and all new systems and procedures must be in place.

“The good news is that major participant disclosures as well as the new documents, forms and contracts that need to be modified, updated and run by your legal team are tied to the Jan. 1, 2018, deadline,” said Erin Sweeney, of counsel at Miller & Chevalier in Washington, D.C. “The regulation itself is going to be applicable on April 10, 2017, which means the educational requirements and investment advice provisions are going to be effective a year from now.”

A ‘Best Interest’ Standard

The rule will require those providing investment advice to retirement plan sponsors and participants to follow the fiduciary standard of conduct under the Employee Retirement Income Security Act (ERISA). This will mean advisors may only offer advice that reflects loyalty to the “best interests” of plan participants and beneficiaries (i.e., without regard to commissions and fees), and must disclose any potential conflicts of interest. Failure to do so means that advisors—and the plan sponsors that hire them—could be sued by participants and face ERISA-violation penalties.

“The rule and exemptions ensure that advisors are held accountable to their clients if they provide advice that is not in their clients’ best interest,” according to a White House fact sheet.

Currently, many advisors associated with mutual fund, brokerage and insurance firms that administer 401(k) and similar workplace plans are held to a weaker “suitability” standard, meaning recommended investment products must fit a client’s general needs and risk tolerance but may result in greater rewards for the advisor than competing, lower-fee investments would.

Imposing the fiduciary standard on plan advisors and increasing their potential liability may reduce their willingness to provide financial advice to plan sponsors and participants, those opposing the change have warned. Others view the expansion of fiduciary requirements as a needed safeguard against conflicted advice.

Plan sponsors should take steps now to ensure that they're prepared to meet their new obligations.

Changing Relationships

“What HR people need to be aware of and stay on top of is that their relationship with their financial advisors will change,” said Marcia Wagner, managing director of Boston-based Wagner Law Group. “Their advisors will be fiduciaries to them. There will be more paperwork to execute, and there will be more need to know how and to whom the money flows—including who gets paid how. So the HR person will have to look at the fees and the new contracts, which they should be getting from their financial services vendors. If they are not getting new contracts and explanations of the relationships from vendors, there is probably a problem.”

HR needs to know how and to whom the money flows.

Among the key points that HR plan managers should keep in mind:

The employer and any board, management or staff committee involved in decision-making for the plan are already fiduciaries, obligating them to adhere to participants’ best interests when selecting and monitoring plan investments and service providers—and subjecting them to potential liability if they do not.

 Certain financial advisors, including broker-dealers, insurance agents and mutual-fund firm representatives, generally have not been subject to liability under the fiduciary standard.

Under the new rule, nearly all the types of advisors that a plan would rely on to provide investment advice to plan sponsors and plan participants will now be held to the fiduciary standard.

“The single most important action for plan sponsors to take is to ask their financial services advisors, ‘Are you a fiduciary to my plan?’ with documentation of the question and the response,” said Bill Heestand, AIF, president of Heestand Co., a Portland, Ore.-based financial services provider of retirement plans for small to medium businesses. “Many plan sponsors have not asked that question of their financial advisors, and under the new rule, the failure to ask could be deemed a fiduciary breach by the plan with all sorts of nasty implications.”

Because some financial firms have operations under the fiduciary standard and other operations that are not, “The only way to be sure if [those providing investment advice] are fiduciaries is to find out if they are a Securities and Exchange Commission-registered investment advisor” (RIA), said Chris Carosa, president of Carosa Stanton Asset Management in Mendon, N.Y., and chief contributing editor to “If a service provider also has non-RIA operations, plan sponsors will want to make sure that they are only buying from the RIA.”

Unless the plan sponsor is large enough to have an ERISA specialist in-house, experts recommend retaining an ERISA attorney or consultant to carefully vet any new contracts. The plan sponsor must then monitor the vendor to ensure that it complies with requirements under the fiduciary standard.

Focus on Fees

“The plan sponsor, which at many employers likely means the HR director, will have to make sure that the fees of whomever is providing financial advice are reasonable,” which may involve independent research into the nature, basis and level of investment fund costs, Wagner noted. “To do so, they can use the ERISA counsel, a registered financial planner or a benchmarking service.”

Many predict that the fiduciary standard will lead advisors to switch to a flat-dollar fee or percentage-of-assets fee for their services, rather than receiving payment from commissions or from mutual fund revenue-sharing arrangements (the behind-the-scenes transfer of revenue from selected investment funds to service providers, typically through so-called 12b-1 fees), given ERISA limitations on the latter forms of compensation for fiduciaries.

That could mean an end to offering participants no-cost investment advice that’s bundled together with other services, such as record-keeping, from firms that administer workplace retirement plans. Instead, plan sponsors or participants themselves would have to pay for investment advice separately, possibly from an independent investment advisor firm that adheres to the fiduciary standard.

Best Interest Contract Exemption

Like the proposed rule, the final rule provides for a best interest contract (BIC) exemption—also refered to as the BICE—to allow so-called “conflicted compensation” to be paid under certain conditions. The exemption involves disclosure requirements, including descriptions of material conflicts of interest, fees or charges paid by the retirement investor, and a statement of the types of compensation the firm expects to receive from third parties in connection with recommended investments.

According to a new set of DOL FAQs on conflicts of interest, the BIC exemption in the final rule allows those advising individual plan participants and sponsors of small plans: continue to use certain compensation arrangements that might otherwise be forbidden so long as they, among other things, commit to putting their client's best interest first, adopt anti-conflict policies and procedures (including avoiding certain incentive practices), and disclose any conflicts of interest that could affect their best judgment as a fiduciary rendering advice. Common forms of compensation, such as commissions, revenue sharing and 12b-1 fees, are permitted under this exemption, whether paid by the client or a third party such as a mutual fund, provided the conditions of the exemption are satisfied.

[The DOL issued further guidance on the BIC exemption​ in July 2016.]

The upshot is that while revenue-sharing fees are not banned outright, investment advisors will be bound by the fiduciary standard and must disclose these arrangements and the possible conflicts of interest they present. “The DOL is still casting a wide [regulatory] net, indicating they think these types of common arrangements may well fall within the prohibitions,” said Sweeney.

“Depending on which version of the BIC exemption applies, qualifying for that will require general disclosures regarding an adviser's compensation, transaction disclosures for each recommended investment, and disclosure of related conflicts of interest, as well as a warranty that the adviser's firm has adopted compliance policies to mitigate these conflicts,” explained Wagner.

The final rule includes a grandfathering provision that allows for additional compensation based on investments that were made prior to the applicability date of April 10, 2017.

Carve-Out for Education

The final rule follows the proposed rule in allowing advisers and plan sponsors to provide general education on retirement saving without triggering fiduciary duties and liabilities.

The final rule describes the types of information and activities that constitute nonfiduciary education, including plan information and general financial, investment and retirement information.

The rule “preserves the ability of financial firms to provide core elements of financial education. These include helping someone enroll, how much to save, and basic plan investment descriptions,” said Doug Fisher, senior vice president for thought leadership and policy development at Fidelity Investments.

As the DOL noted:

Education as defined in the rule will not constitute advice regardless of who provides the educational information (e.g. the plan sponsor or service provider), the frequency with which the information is shared, or the form in which the information and materials are provided (e.g. on an individual or group basis, in writing or orally, via a call center, or by way of video or computer software).

In response to comments on the 2015 proposal, in the plan context, the education provision allows specific investment alternatives to be included as examples in presenting hypothetical asset allocation models or in interactive investment materials intended to educate participants and beneficiaries as to what investment options are available under the plan so long as they are designated investment alternatives selected or monitored by an independent plan fiduciary and other conditions are met. [Emphasis added.]

If nonfiduciaries are presenting participants with asset allocation models that reference specific investment alternatives, “there has to be someone who is taking a look at that and making sure that these materials are presented as hypothetical examples and not treated as individual investment recommendations,” said Sweeney. “The lynchpin is that there has to be a plan fiduciary who is going to take ownership of the plan investments that are made available to participants and beneficiaries.”

Noted Fisher, “What’s important for HR executives is that they consider what level of investment assistance they want their employees to have—education or advice—and ensure that their employees continue to have access to the assistance they need.”

Rollover Recommendations

The rule will have a significant effect on rollovers from 401(k) and similar defined contribution plans to IRAs, as it will make the recommendation of a distribution or a rollover to an IRA a fiduciary act, noted Fred Reish and Bruce Ashton, partners in the Los Angeles office of Drinker Biddle and Reath.

“In the final rule, the DOL still indicated that a recommendation to roll money out of a 401(k) plan to an IRA is a fiduciary decision,” said Sweeney. “They stuck hard on that and drew a line in the sand.”

A potential impact could be that more departing employees will stay with a plan after leaving the employer. Don Trone, a fiduciary standards advocate and consultant at Mystic, Conn.-based 3ethos, said that the rule could cause financial services call centers to discontinue providing rollover advice for fear of triggering fiduciary obligations.

Noted Sweeney, “The DOL sort of paternalistically has reached the conclusion that participants are better off in employer 401(k) plans where there is a plan fiduciary deciding on the available investments, and where ultimately there could be a lawsuit brought if one of those investments are shown not be have been appropriate for the participants as a whole.” As a result, “more people will just simply, by inertia, keep their dollars in 401(k) plans, and that may not be right for everybody.”

If advisors are less willing to assist participants with rollover decisions, plan sponsors may want to examine if their plan offers adequate flexibility to allow employees to implement certain key rollover decisions on their own, said Nevin Adams, chief of communications at the American Retirement Association in Arlington, Va.

A Sale’s Pitch Exception

The final rule provides a narrowly tailored “seller’s exception” for sales pitches (as opposed to investment advice) where the service provider is not assumed to be acting as an impartial advisor. The exception applies only to transactions involving large plan fiduciaries with at least $50 million in employee benefit assets, with financial expertise sufficient to evaluate whether the transaction is in the best interest of the plan participants. The service provider needs to disclose to the plan fiduciary the existence and nature of its financial interests in the transaction, and inform the plan that it is not undertaking to provide impartial investment advice.

David Tobenkin is a Washington, D.C.-based freelance reporter specializing on employment and benefits issues. Stephen Miller, CEBS, is an online editor/manager for SHRM.

Related SHRM Articles:

Fiduciary Rule Affects Relationships with HSA Vendors, SHRM Online Benefits, August 2016

In Latest Salvo, Lawsuits Seek to Overturn Fiduciary Rule, SHRM Online Benefits, June 2016

DOL’s Fiduciary Rule Garners Support, Draws Concern, SHRM Online Benefits, April 2016

Fee Allocation in 401(k) Plans: Choose Your Model, SHRM Online Benefits, February 2016

401(k)s Shifting to Fixed-Dollar, Per-Head Fees, SHRM Online Benefits, October 2015

Lessons for 401(k) Plan Fiduciaries, HR Magazine, November 2012

Fiduciary Obligations: The Devil’s in the Details, SHRM Online Benefits, June 2011

Related News & Analysis:

The New Fiduciary Rule: How advisers' plan sponsor clients will feel the effect,, June 2016 

The DOL Fiduciary Rule: Six Immediate Concerns for Plan Sponsors, Ivins, Phillips & Barker, June 2016

Employer Action Required Following Issuance of Final Rule, Winstead PC, April 2016

Four Ways the Final Fiduciary Rule Affects Retirement Plans, International Foundation of Employee Benefit Plans, April 2016

A Plan Sponsor’s Overview of DOL’s Fiduciary/Conflict of Interest Rule, Xerox HR Services, April 2016

Recent Lawsuit Demonstrates Continuing Need for Plan Fiduciaries to Document Decision-Making Process, Bloomberg BNA, April 2016

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