Department of Labor Proposes New Regulations on Fiduciary Advice

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By Brian M. Pinheiro, Esquire, Diane A. Thompson, Esquire, Mark F. Costley, Esquire, and Robert S. Kaplan, Esquire

Ballard Spahr LLP, Philadelphia, PA, Los Angeles, CA, and Washington, D.C.

The U.S. Department of Labor (DOL) has reissued long-awaited proposed regulations describing the circumstances in which a person who provides investment advice in connection with a retirement plan or individual retirement arrangement (IRA) acts as a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code. Once finalized, the proposed regulations (referred to as the "investment advice fiduciary rules") will significantly alter the landscape for how employee benefit plans, their fiduciaries and participants, and IRA holders receive investment advice. The DOL initially proposed a version of the controversial investment advice fiduciary rules in October 2010, but later withdrew the initial proposal due to concerns raised by the business community and lawmakers from both parties.

The new investment advice fiduciary rules broadly define a fiduciary to include any individual who provides investment advice for a fee for consideration in making a retirement investment decision to an ERISA-covered plan, a plan fiduciary, a plan participant or beneficiary, or an IRA holder. The proposed rules encompass:

  •  Recommendations as to: (i) the advisability of buying, selling or holding investments; and (ii) the management of investments, including the management of assets to be distributed from a plan or IRA;
  •  Recommendations as to the advisability of taking a distribution of assets from a plan, and the investment of those distributed assets;
  •  Appraisals and fairness opinions regarding investments in connection with specific transactions (other than appraisals and fairness opinions for a collective investment fund, a pooled separate account or employer securities held in an employee stock ownership plan (ESOP));
  •  Recommendations of a person who will receive a fee for any of the functions described above.

The proposed regulations acknowledge that a prohibited transaction exists under both ERISA and the Internal Revenue Code where an investment advice fiduciary receives compensation from a third party in connection with the investments that he or she sells to a retirement plan or IRA. This is due to the inherent conflict of interest between the investment advice fiduciary and the plan, plan participant, or IRA holder.

In conjunction with the proposed regulations, the DOL issued a proposed new series of prohibited transaction exemptions and amendments to existing prohibited transaction exemptions. A new exemption likely to receive the most attention is referred to as the "Best Interest Contract" exemption. It provides relief for compensation received by investment advice fiduciaries as a result of the purchase, sale, or holding by a plan or IRA of certain investments. Among other conditions, the exemption requires the investment advice fiduciary to adhere to basic standards of impartial conduct, which include:

  •  Giving advice that is in the client's best interest;
  •  Avoiding misleading statements; and
  •  Receiving no more than reasonable compensation.

The basic standards of impartial conduct set forth in the new proposed exemption reflect the conduct of many advisers in dealing with their clients, and standards that already apply under ERISA to advisers that work with employee benefit plans sponsored by employers. However, by making the standards a condition of the Best Interest Contract exemption, the DOL is extending the standards of impartial conduct to IRA advisers, many of whom have not historically been subject to formal regulation.

The Best Interest Contract exemption also requires that an investment advice fiduciary enter into a contract with the client that acknowledges the adviser's fiduciary status. The contract cannot include provisions limiting the liability of the investment advice fiduciary in the event of a violation of the contract's terms.  An investment advice fiduciary who breaches this contract could be subject to a private cause of action for breach of contract, which is especially important for IRA providers, as IRA owners do not currently have a cause of action against investment advisers for breach of fiduciary duties under ERISA. The proposed exemption permits the contract to require that individual disputes be resolved through arbitration, and prohibits any limitation on the right of a plan, participant, or IRA owner to bring or participate in a class action lawsuit to resolve disputes.

 The proposed regulations have a 75-day comment period, and it is expected that several hundred comments will be submitted. 

For more information, in the Tax Management Portfolios, see Horahan and Hennessy, 365 T.M., ERISA — Fiduciary Responsibility and Prohibited Transactions, Kennedy, 367 T.M., IRAs,  and in Tax Practice Series, see ¶5530, Fiduciary Duties and Prohibited Transactions, ¶5610, IRAs.

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