The US Department of Labor’s (the “DOL’s”) controversial final fiduciary rule and related prohibited transaction exemptions will apply beginning June 9, 2017, although some provisions of the prohibited transaction exemptions will be further delayed until January 1, 2018. During the transition period between June 9, 2017 and December 31, 2017, the DOL will not pursue claims against fiduciaries who are working diligently and in good faith to comply with the final fiduciary rule and related exemptions, or treat those fiduciaries as being in violation of the final fiduciary rule and related exemptions.
Background on DOL’s Final Fiduciary Rule
The DOL’s final fiduciary rule substantially broadens the group of financial advisers and other parties that will be deemed to be fiduciaries with respect to plans subject to the U.S. Employee Retirement Income Security Act of 1974 (“ERISA”) and individual retirement arrangements (“IRAs”) and certain other arrangements subject to the U.S. Internal Revenue Code (the “Code”). Under this broadened final fiduciary rule, financial advisers and other parties may be considered fiduciaries as a result of marketing activities, sales pitches, and other common communications in the ordinary course of business, unless such activities are specifically excluded or covered under a related exemption. For example, the DOL has provided exclusions or related exemptions for sophisticated counterparties, “best interest contracts” (or “BIC”), and principal transactions. For more information on the DOL’s final fiduciary rule and its exclusions and related exemptions, see DOL’s Final Fiduciary Rule is Expected to Have Significant Impact on Private Funds.
The DOL issued the final fiduciary rule on April 6, 2016, and the rule became effective on June 7, 2016. The rule was scheduled to apply on April 10, 2017 but was delayed until June 9, 2017. In recent months, there have been some executive and legislative efforts that called into question whether the rule would apply on June 9th or would instead be further delayed, replaced or repealed.
On May 22nd, Secretary of Labor Alexander Acosta wrote an op-ed in the Wall Street Journal announcing that the DOL would not further delay the initial applicability of the final fiduciary rule. Also on May 22nd, the DOL issued a temporary enforcement policy that will apply during the transition period from June 9 through December 31, 2017. See Field Assistance Bulletin No. 2017-02 (“FAB 2017-02”). Under the temporary enforcement policy, the DOL will not focus on citing violations or imposing penalties, but instead will place an emphasis on assisting those who are working in good faith to understand and comply with the final fiduciary rule and related exemptions. During this transition period, the DOL will not pursue claims against fiduciaries who are working diligently and in good faith to comply with the final fiduciary duty rule and exemptions, or treat those fiduciaries as being in violation of the final fiduciary rule and exemptions. The Treasury Department and Internal Revenue Service (“IRS”) have confirmed that the relief from Code 4975 excise taxes and related reporting obligations will apply during this transition period.
In FAB 2017-02, the DOL also announced that it would continue analyzing the new rule and may request additional comments or consider a further delay of the January 1, 2018 full application date.
The DOL has also recently issued a third set of FAQs under the final fiduciary rule, which provide additional information on the transition period from June 9, 2017 to January 1, 2018.
Beginning June 9, 2017, “recommendations” to a plan, plan fiduciary, plan participant or beneficiary, IRA or IRA owner for a fee or other direct or indirect compensation must comply with the “impartial conduct standards,” while other more onerous requirements under the BIC exemption and amendments to other exemptions are delayed until January 1, 2018.
General Next Steps
The June 9, 2017 initial applicability date for the final fiduciary rule is nearly here. Next steps should include the following, to the extent that they have not already been taken:
- Become Educated About the New Rule. Become knowledgeable about the final fiduciary rule and the requirements that may apply to your company, institution, or fund, advisers or managers and their products and services, and educate and train appropriate personnel.
- Assess and Determine Strategy. Review existing products, services, and practices, as well as investor and client bases, to determine what is impacted by the final fiduciary rule. Decide whether to change any such products, services, or practices, or stop serving certain types of investors or clients, to avoid the application of the final fiduciary rule, fit within an exception, or comply with a related exemption. Consider whether “grandfathered” relief (discussed further below) may be available.
- Compliance Policies. Develop policies, procedures and checklists for compliance.
- Revise Documents. Revise subscription agreements, fund documents, and other written materials to reflect the final fiduciary rule and the chosen strategy.
Next Steps for Investment Fund Managers
- Evaluate Existing Marketing Practices. Determine whether existing marketing and other practices would be considered “investment advice” under the final fiduciary rule. If so, consider whether the exception for sophisticated counterparties or exemption for “grandfathered” investments would apply, or whether any other exceptions or exemptions may be available.
- Sophisticated Counterparties Exception. As noted in our prior client alert linked above, the exception for “sophisticated counterparties” applies generally to transactions with independent fiduciaries with financial expertise. Determine whether this exception may be used for communications with investors and clients covered by ERISA, and whether to revise applicable documents to confirm that the investor or client fits within that exception and to require that the investor or client make corresponding representations and warranties.
- Note that the exception for sophisticated counterparties may not be used for communications to IRA owners or small plans that are not separately advised by an independent fiduciary.
- Grandfathered Exemption. If existing investments by IRAs, small plans, and/or other ERISA plan clients or investors do not fall within the exception for sophisticated counterparties, consider whether to rely on “grandfathered” relief under the BIC exemption and take steps to comply with the requirements for such “grandfathered” relief.
- The BIC exemption provides “grandfathered” relief for investments acquired before June 9, 2017 or acquired pursuant to a recommendation to continue a systemic purchase program established before June 9, 2017, but not to additional subscriptions or investments made after that date. The “grandfathered” relief is only available if the compensation received in connection with the transaction is “reasonable” under ERISA Section 408(b)(2) and Code Section 4975(d)(2), is received pursuant to an arrangement entered into before June 9, 2017 that has not expired or come up for renewal after that date, and is not received in connection with the investment of additional amounts in the previously acquired investment vehicle. Any new advice regarding the grandfathered investments must also meet the best interests standard of the final fiduciary rule.
- Consider Changes to Marketing Practices. Consider whether to stop marketing to IRAs, small plans, and/or other ERISA plans that do not fall within the exception for sophisticated counterparties, or whether to modify such practices so that they would not be considered “investment advice” under the final fiduciary rule.
- If a decision is made to stop accepting new or additional subscriptions from IRAs, small plans, and/or other ERISA plan clients or investors that do not fall within the exception for sophisticated counterparties, revise offering documents to ban these types of investors, and revise subscription agreements to include representations that ERISA plan investors fit within the exception for sophisticated counterparties. Review and revise all relevant fund documents and follow the investment ban.
- If a decision is made to continue to accept new or additional subscriptions from IRAs, small plans, and/or other ERISA plan clients or investors that do not fall within the exception for sophisticated counterparties, revise all marketing and other communications to fit within one of the exceptions to the final fiduciary rule or related exemptions or to comply with the “impartial conduct standards” by June 9, 2017.
Next Steps for Private Funds
- Private funds that may otherwise generally avoid the application of ERISA (such as by limiting investment by benefit plan investors to less than 25% of any class of equity) may still fall within the scope of the ERISA fiduciary rule if they provide “recommendations” to ERISA plan or IRA clients to invest in their funds or products. Such funds should review their practices to determine whether they may need to be revised to avoid making “recommendations” that would be subject to the final fiduciary rule, fit within another exception or exemption from the final fiduciary rule, or comply with the final fiduciary rule.
- Contact us to determine whether your specific hedge fund, private equity fund or investment adviser engages in any marketing or other practices that could be considered providing “recommendations” under the final fiduciary rule. If a fund does not provide “recommendations” within the meaning of the final fiduciary rule, revise subscription agreements and other documents to include representations that the investor understands and agrees that the fund has not made any recommendation or provided any investment advice in connection with whether to invest in the fund and is not acting as a fiduciary.
- “Recommendations” are only covered by the final fiduciary rule if made to a plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner. The definition of “plan” in the final fiduciary rule generally applies only to plans covered under Title I of ERISA or Code Section 4975 (e.g., IRAs). Plans such as state and local governmental plans, and some Code Section 403(b) plans (such as “safe harbor” 403(b) plans), are not covered under Title I of ERISA, so most recommendations made to such plans would not be covered by the final fiduciary rule. However, recommendations about whether to roll amounts from such plans to an ERISA plan or IRA would be covered.
- Many of the “next steps” noted above for investment fund managers will also apply to private funds. To the extent that a private fund intends to rely on the sophisticated counterparties exception and ban other investments, it should consider seeking representations from investors that they satisfy the applicable requirements for that exception.
Next Steps for Registered Investment Advisers and Other Financial Institutions
Registered investment advisers and other financial institutions may want to consider whether they will take advantage of certain other exemptions under the final fiduciary rule. While the “impartial conduct standards” will apply beginning June 9th, more specific requirements of the exemptions will apply beginning January 1, 2018.
- Exemptions that may be available to registered investment advisers and other financial institutions include the BIC exemption, the streamlined requirements for advisers who only accept “level fee” arrangements (sometimes referred to as the “BIC Lite” exemption), and the exemption for firms that limit recommendations to proprietary products. Review current practices to determine whether any of these exemptions may be available. For more information on these exemptions, see DOL’s Final Fiduciary Rule is Expected to Have Significant Impact on Private Funds.
Next Steps for Plan Sponsors
- Review practices of providing education, plan information, and/or general financial, investment, or retirement information to plan participants, and ensure that such practices and any written materials fit within the final fiduciary rule’s exceptions for providing such education or information such that it is not considered “investment advice.”
- Review practices and communications provided to participants regarding rollovers. Recommendations regarding rollovers constitute fiduciary investment advice under the final fiduciary rule, and will need to comply with the “impartial conduct standards” by June 9, 2017.
- Review notices from plan trustees and other service providers regarding the scope of plan level or participant level investment advice provided with respect to the plan. Some of the notices include the “sophisticated counterparty” and other representations that may be requested on behalf of your plan or your plan’s advisors.
We are happy to answer any questions or otherwise assist you with understanding your compliance obligations, reviewing and revising fund and related documents or responding to requests from trustees or other service providers regarding compliance with the final fiduciary rule.
Our client alerts are for general informational purposes and should not be regarded as legal advice.
Global asset management quarterly: A global briefing on developments and market trends
Welcome to the thirteenth edition of Global asset management quarterly.