Reverting to old fiduciary guidance raises new questions for recommendations

The Obama-era regulation re-defining who is a “fiduciary” (the DOL fiduciary rule or the Rule) under the Employee Retirement Income Security Act of 1974 (ERISA) is officially dead.

On June 21, 2018, the Fifth Circuit Court of Appeals issued a mandate enforcing its March 2018 decision vacating the Rule and associated prohibited transaction exemptions.  Now the financial industry is strategizing for compliance with the “new old” rules.

The removal of the Rule means the resuscitation of the “old” ERISA definition of fiduciary, which is commonly referred to as the “five-part test” because five elements are required in order to be an ERISA fiduciary.

The Rule’s demise also means the removal of prohibited transaction exemptions issued with the Rule, including the Best Interest Contract Exemption (BIC Exemption). The DOL has, however, issued guidance indicating that fiduciaries may (but are not required to) continue to rely on the transitional BIC Exemption that was in effect immediately before the court’s decision – even after the mandate to vacate the Rule.

Rollover or distribution advice

The Rule and related guidance did several things that made advice regarding a rollover or distribution subject to ERISA fiduciary standards.  First, it expanded the ERISA regulation to cover individual retirement accounts (IRAs) and other “Section 4975” plans not subject to ERISA, placing advice to IRA owners on similar footing with advice to ERISA plans.

Second, it expressly superseded DOL Advisory Opinion 2005-23A (the Stapley Letter, discussed further below), which previously was interpreted to permit advisors to recommend a distribution from an ERISA plan without triggering ERISA fiduciary status for the recommending advisor or broker.

Third, the Rule’s revised fiduciary definition removed prior components of the five-part test, including one that required fiduciary advice to be provided on a regular basis, allowing one-time interactions to potentially trigger fiduciary status.

Reversion to the five-part test does not necessarily mean that no distribution or rollover recommendation is fiduciary advice.  Indeed, even assuming the Stapley letter is revived and all dicta associated with the fiduciary rule is of no further effect after the Fifth Circuit’s decision, many practitioners believe that the Stapley letter is unclear at best on many common scenarios.

The shifting regulatory landscape leaves many open questions for the regulated community on which additional guidance would be helpful.  This article highlights one: whether and how a person who is a fiduciary with respect to a distributing plan under the five-part test can advise plan participants regarding rollovers or other distributions from the plan.

This issue becomes more pressing post-Rule because more advisors may now acknowledge ERISA fiduciary status for some services to ERISA plans, whereas pre-Rule they may have disclaimed all ERISA obligations.

The Stapley letter

In 2005, the DOL addressed three questions in the Stapley Letter.  First: whether someone who advises a participant, for a fee, on how to invest his account in a plan is an ERISA fiduciary.  The answer was yes.

Second: whether the recommendation that a participant roll over his account to an IRA constitutes ERISA investment advice.  The DOL’s answer was a qualified no.

The significant caveat was that the DOL did not opine on, and expressed caution with respect to, when “someone who is already a plan fiduciary responds to participant questions concerning the advisability of taking a distribution or the investment of amounts withdrawn from the plan,” stating that such person must satisfy ERISA’s standards.

Moreover, the DOL suggested that if an existing fiduciary to the plan “exercises control” over plan assets to cause the distribution to be transferred to an IRA managed by the fiduciary, a prohibited transaction may occur.

Third: whether an advisor who is not otherwise a fiduciary to the transferring plan may recommend a rollover if the IRA will pay the advisor a fee.  DOL’s answer was a qualified yes, but hinged on prior cautions that the conclusion applies only to recommendations by an advisor who is not otherwise a fiduciary to the distributing plan.

Questions raised

Applying the Stapley letter in a post-DOL fiduciary rule environment, a third-party advisor who is not related to the plan is clearly permitted to recommend that a participant take a distribution and invest it in some manner, or take a rollover to an IRA – in either case that pays the advisor fees.

For example, a participant’s personal financial advisor who has no relationship with the distributing plan can advise the participant to take a rollover to an IRA that will pay them fees without implicating ERISA.  The Stapley letter does not, however, address the same situation if the recommending advisor is, or its affiliate is, a fiduciary of the distributing plan.

In addition to this confusion, many industry and legal commentators believe that the five-part test, as in effect post-DOL fiduciary rule, may be interpreted differently than the same guidance was interpreted prior to the Rule – and those different interpretations may depend on who you’re asking and for what purpose.

That is, prior to the Rule, many took an expansive interpretation of the Stapley letter and related guidance and disclaimed ERISA fiduciary status for all services provided to a plan or its participants.

Post-Rule, some providers are finding it impracticable or inadvisable to completely disclaim fiduciary status for all conduct (particularly due to changes and disclosures implemented while the Rule was in effect), but may nevertheless wish to take the position that the rollover advice, specifically, is excepted from ERISA fiduciary standards.

Courts or the DOL, on the other hand, may take the position that the Stapley letter requires that an advice fiduciary also be a fiduciary for the rollover recommendation if any guidance is provided on distributions.

Below are examples of questions that remain unclear:

1. If an advisor who already is a fiduciary to the distributing plan recommends a rollover or distribution, is that recommendation automatically subject to ERISA fiduciary standards?  

• Does it matter whether the advisor is a fiduciary with discretionary management authority, plan administrator authority or merely provides fiduciary advice that must be implemented by a third party?  For example, arguably, a fiduciary that has the power to cause a distribution that benefits itself should be more problematic than a fiduciary that simply recommends (but cannot cause or control) such a transaction.  Neither question is directly addressed by existing guidance.
• Instead, is it possible and practicable to “firewall” fiduciary status by accepting fiduciary responsibility for advice to the plan or plan sponsor on an “ongoing” basis, but specifically disclaiming fiduciary responsibility for distributions?
• Is it preferable in the absence of clear guidance to avoid fiduciary responsibility for rollover recommendations irrespective of whether the advisor provides any fiduciary services to the plan?

2. If a fiduciary to a plan does become a fiduciary for a recommended distribution from the plan, what are its options to ensure ERISA compliance?  A fiduciary may consider the following, for example:

• Reliance on the BIC Exemption, pursuant to transitional relief issued by DOL, for at least so long as such relief remains in effect;
• Attempting to level fees or otherwise avoid disparate fees for providing such recommendations;
• Requesting a new exemption; or
• Attempting to outsource distribution guidance to an independent third-party.

3. Is there a distinction between recommendations of voluntary distributions from a plan versus involuntary distributions (e.g., small cashouts or required minimum distributions)?  Does the analysis change if the advisor recommends, instead of a rollover, a direct distribution to a taxable account or investment that pays the fiduciary fees?

4. Is it possible for one entity to act as a fiduciary providing investment advice to the plan and/or participants, while a different but affiliated entity provides non-fiduciary information regarding rollovers or distributions?  Under what circumstances will conduct of affiliates be conflated?

While there are no clear answers to the above questions and each affected institution should consult with counsel regarding its particular facts and circumstances, these authors believe that the Stapley letter does not categorically prohibit an entity that is an “investment advice only” fiduciary to an ERISA plan from also encouraging a distribution or rollover, or its affiliate from doing so.

The Stapley letter suggests that if a fiduciary exercises “control” over such a distribution, it may constitute a prohibited transaction, but fiduciaries who advise only and require another’s action to implement do not have control over the transaction.

It also appears that there should be some ability to distinguish or firewall functions performed as a fiduciary versus those performed in a non-fiduciary or educational capacity (i.e., a person is only a fiduciary “to the extent” of its fiduciary functions).

These arguments, and others, which should be reviewed with qualified counsel, are of limited comfort in the current environment where there is additional scrutiny on fees and advisor conflicts of interest.  Even if it appears that the DOL has stepped back from enforcement in this area, there remains a risk of private litigation regarding conduct of those providing investment advice involving ERISA plans and, to a lesser extent, IRAs.

Finally, even if an advisor is able to avoid ERISA fiduciary status with respect to a rollover or distribution recommendation, such conduct may be subject to other regulation.  For example, FINRA Rule 2111 requires that such a transaction be suitable for the customer, and a FINRA Regulatory Notice requires that a rollover recommendation consider various factors depending on the individual’s needs and circumstances.

Further, the U.S. Security and Exchange Commission (SEC) proposed a Rule that creates a “best interest” standard for brokers when interacting with retail customers.

Allison W. Sizemore is a partner in the Employee Benefits and Executive Compensation Group of Reed Smith.  She regularly counsels clients regarding ERISA compliance matters, including extensive counseling of financial institutions regarding compliance with the DOL fiduciary rule.

Khalif I. Ford is Senior Counsel and Assistant Vice President for Lincoln Financial Group.  He provides counsel on legal and compliance considerations associated with retirement plans and products.