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November 17, 2016 Practice Point

Recent Developments Affecting Qualified and Nonqualified Deferred Compensation, Part II: The New Department of Labor Fiduciary Rule

By David Pratt, Professor of Law, Albany Law School, Albany, NY


As of June 30, 2016, total U.S. retirement plan assets were $24.5 trillion, more than twice the $11.6 trillion reported for 2000.1 That is a very large amount of money—significantly larger than the GDP of the United States or China, the world’s two largest economies; more than 30 times the market value of the world’s most valuable company, Alphabet, the parent of Google; and more than 300 times the net worth of the world’s richest individual, Bill Gates.

The largest single component of retirement plan assets is the $7.5 trillion held in individual retirement accounts (IRAs), considerably more than the $4.9 trillion held in 401(k) plans. Between IRAs, 401(k) plans, and plans sponsored by small employers, an enormous pool of retirement funds is invested by what the U.S. Department of Labor (DOL) calls “retail investors.” The growth of IRAs is almost entirely attributable to tax-free rollovers from 401(k)s and other employer plans, and the vast majority of 401(k) plans allow participants to direct how their accounts are invested. Accordingly, the Obama administration, the Government Accountability Office and pension experts (among others) have expressed concern in recent years regarding the integrity of the IRA rollover process and the quality of the investment advice retail investors receive in connection with retirement asset rollover and investment decisions.

In addition to these tax-favored retirement savings, many employers make additional “nonqualified” deferred compensation available to their high-level employees. A 2015 report by the Center for Effective Government and the Institute of Policy Studies found that the 100 largest U.S. CEO retirement packages were worth $4.9 billion, equal to the entire retirement savings of 41% of American families.2

ERISA and Fiduciaries

The Employee Retirement Income Security Act (ERISA) was enacted on September 2, 1974.3 Title I (the “labor” title) describes the rights of employee benefit plan participants and beneficiaries and the obligations of fiduciaries. The DOL has enforcement authority under Title I. A person is a fiduciary with respect to a plan to the extent that, inter alia, the person “renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so.”4 Most employer-sponsored plans are subject to Title I; IRAs, unless employer-sponsored, are not.

Both ERISA and the Internal Revenue Code (Code) prohibit fiduciaries and certain other parties from engaging in prohibited transactions with respect to a retirement plan. The ERISA prohibited transaction rules do not apply to IRAs, bur the Code rules do.5 The Code includes an essentially identical definition of “fiduciary” for that purpose.6 The Code does not impose the same standards of conduct on fiduciaries that ERISA does,7 and, unlike ERISA, it does not establish a private right of action for participants, beneficiaries and IRA owners against fiduciaries. Instead, the Code’s prohibited transaction rules are enforced through excise taxes imposed by the Treasury Department.8

Originally, the IRS and DOL both had jurisdiction over prohibited transactions. Reorganization Plan No.4 of 1978 transferred to the Secretary of Labor authority to issue certain regulations under section 4975, including regulations relating to the section’s definition of “fiduciary”.9

The DOL Fiduciary Rule

Approximately one year after ERISA was enacted, the DOL issued a regulation defining “investment advice”. The IRS issued an essentially identical regulation under section 4975. In October 2010, the DOL published a proposed rule to amend the 1975 regulation.10 The proposed rule was highly controversial, and the DOL announced in September 2011 that it was withdrawing the proposed regulation and would re-propose it. On April 20, 2015, the DOL published its revised proposed fiduciary rule and several proposed new or amended prohibited transaction exemptions (PTEs) for financial professionals and others falling within the new fiduciary definition.11

The DOL received more than 3,000 comments on its proposal, many of them expressing concerns with the proposed changes.

The DOL’s explanation for the new rule appears in the preface to the final rule published in April 2016.

The Department created the five-part test in a very different context and investment advice marketplace. The 1975 regulation was adopted prior to the existence of participant-directed 401(k) plans, the widespread use of IRAs, and the now commonplace rollover of plan assets from ERISA-protected plans to IRAs. Today, as a result of the five-part test, many investment professionals, consultants, and advisers have no obligation to adhere to ERISA’s fiduciary standards or to the prohibited transaction rules, despite the critical role they play in guiding plan and IRA investments. Under ERISA and the Code, if these advisers are not fiduciaries, they may operate with conflicts of interest that they need not disclose and have limited liability under federal pension law for any harms resulting from the advice they provide. Non-fiduciaries may give imprudent and disloyal advice; steer plans and IRA owners to investments based on their own, rather than their customers’ financial interests; and act on conflicts of interest in ways that would be prohibited if the same persons were fiduciaries. In light of the breadth and intent of ERISA and the Code’s statutory definition, the growth of participant-directed investment arrangements and IRAs, and the need for plans and IRA owners to seek out and rely on sophisticated financial advisers to make critical investment decisions in an increasingly complex financial marketplace, the Department believes it is appropriate to revisit its 1975 regulatory definition as well as the Code’s virtually identical regulation. With this regulatory action, the Department will replace the 1975 regulations with a definition of fiduciary investment advice that better reflects the broad scope of the statutory text and its purposes and better protects plans, participants, beneficiaries, and IRA owners from conflicts of interest, imprudence, and disloyalty.12

The New DOL Fiduciary Regulation

The new rule significantly expands the definition of who is a fiduciary by virtue of giving investment advice. For purposes of ERISA section 3(21)(A)(ii) and Code section 4975(e)(3)(B), a person will generally be deemed to be “rendering investment advice with respect to moneys or other property of a plan or IRA”, and thus a fiduciary, if the following provisions apply:

(1) The person provides, for a fee or other compensation, direct or indirect:

(i) A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, or

(ii) A recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from a retirement plan or IRA; or

(iii) A recommendation as to the management of securities or other investment property, including recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made; and

(2) With respect to the investment advice described in (1), the recommendation is made either directly or indirectly (e.g., through or together with any affiliate) by a person who:

(i) Represents or acknowledges that it is acting as a fiduciary within the meaning of the Act or the Code; or

(ii) Renders the advice pursuant to a written or verbal agreement, arrangement, or understanding that the advice is based on the particular investment needs of the advice recipient; or

(iii) Directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.13

The advice may be provided to a retirement plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner.

A “recommendation” means a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.14 The determination of whether a “recommendation” has been made is an objective rather than subjective inquiry. The more individually tailored the communication is, the more likely that the communication will be viewed as a recommendation. The regulation identifies various activities that are not recommendations15 and provides exceptions for certain transactions.16

A new prohibited transaction exemption, the Best Interest Contract Exemption (BICE),17 is designed to promote the provision of investment advice that is in the best interest of retail investors: plan participants and beneficiaries, IRA owners, and certain plan fiduciaries, including small plan sponsors.

As a condition of receiving compensation that would otherwise be prohibited under ERISA and the Code, the exemption requires Financial Institutions to acknowledge their fiduciary status and the fiduciary status of their Advisers in writing. The Financial Institution and Advisers must adhere to enforceable standards of conduct and fair dealing with respect to their advice. In the case of IRAs and non-ERISA plans, the exemption requires that the standards be set forth in an enforceable contract with the Retirement Investor. Under the exemption’s terms, Financial Institutions are not required to enter into a contract with ERISA plan investors, but they are obligated to adhere to these same standards of fiduciary conduct, which the investors can effectively enforce pursuant to ERISA sections 502(a)(2) and (3). Likewise, “Level Fee” Fiduciaries that, with their Affiliates, receive only a Level Fee in connection with advisory or investment management services, do not have to enter into a contract with Retirement Investors, but they must provide a written statement of fiduciary status, adhere to standards of fiduciary conduct, and prepare a written documentation of the reasons for the recommendation.  . . . The exemption strives to ensure that Advisers’ recommendations reflect the best interest of their Retirement Investor customers, rather than the conflicting financial interests of the Advisers and their Financial Institutions.18

Under this standards-based approach, the Adviser and Financial Institution must give prudent advice that is in the customer’s best interest, avoid misleading statements, and receive no more than reasonable compensation. Additionally, Financial Institutions generally must adopt policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, and disclose basic information about their conflicts of interest and the cost of their advice. Level Fee Fiduciaries are subject to more streamlined conditions, including a written statement of fiduciary status, compliance with the standards of impartial conduct, and, as applicable, documentation of the specific reason or reasons for the recommendation of the Level Fee arrangement.19

The Department also granted a new Principal Transactions Exemption, published in the same issue of the Federal Register, that permits investment advice fiduciaries to sell or purchase certain debt securities and other investments in transactions with plans and IRAs.20 The DOL also amended other existing exemptions to ensure uniform application of the Impartial Conduct Standards.21

Prior to the issuance of the new rule, the sale of insurance and annuity products fell with the relatively liberal rules of PTE 84-24. Advisers and Financial Institutions are permitted to receive compensation in connection with the sale of insurance and annuity contracts. In the same issue of the Federal Register, however, the Department limited the relief available under PTE 84-24 to “fixed rate annuity contracts”. Fixed rate annuity contracts do not include variable annuities or indexed annuities or similar annuities. As a result of this change, the new rule is particularly unpopular with providers in the insurance industry, notably those who sell indexed annuities to retirement plans and IRAs.  On the other hand, critics of the ability of advisers to put their own interest above the interest of the consumers they advise have lauded the rule as providing particularly important consumer protections.22

Lawsuits Challenging the Fiduciary Rule

During the first two weeks of June 2016, five separate federal lawsuits were filed challenging the final rule on various grounds.23 A sixth case was filed in September, 2016.24 Three cases were filed in the Northern District of Texas,25 one in the District of Columbia,26 one in Kansas, and the sixth in Minnesota.27 The three Texas cases have been consolidated, and a June 24, 2016 joint motion states that the parties have agreed to proceed “on cross-motions for summary judgment without discovery or any other evidentiary proceedings.”28 A summary judgment hearing in the D.C. case took place on August 25, 2016.29 The Kansas court heard arguments on September 21, 2016.30 The Texas court has scheduled a summary judgment hearing for November 17, 2016.31

Most observers believe that the lawsuits are unlikely to succeed on their merits. They may, however, delay the proposed implementation of the rule, different parts of which are scheduled to take effect in 2017 and 2018. In addition, there is significant opposition to the rule in Congress. On June 8, 2016, President Obama vetoed a resolution, approved by the House in April and the Senate in May, to kill the DOL fiduciary rule.32 If the Republicans win the Presidency and retain control of the House and Senate in the November elections, the rule will almost certainly be killed, one way or another. Even if Secretary Clinton wins the Presidency, her administration might not support the rule as strongly as President Obama and Secretary Perez have done.


It is too early to predict the effect of the new fiduciary rule, if it survives. Supporters contend that it will improve the quality of advice received by retirement investors, thus increasing retirement security. Detractors claim that it will make advice unaffordable or unattainable for many, and that its benefits are outweighed by its costs.

1 Investment Company Institute, Retirement Assets Total $24.5 Trillion in Second Quarter 2016.

3 Pub. L. 93-406, codified, as amended, in scattered sections of Titles 26 and 29 of the U.S. Code.

4 ERISA § 3(21)(A).

7 See ERISA §§ 404 et seq.

9 Reorganization Plan, 5 U.S.C. App. 1, 92 Stat. 3790.

12 81 Fed. Reg. 20946, April 8, 2016.

13 29 C.F.R. § 2510.3-21(a) (emphasis added).

14 29 C.F.R. § 2510.3-21(b)(1) (emphasis added).

17 PTE 2016-01, 81 Fed. Reg. 21002, corrected by 81 Fed. Reg. 44773.

18 81 Fed. Reg. at 21003.

19 Id.

21 “Taken together, the new exemptions and amendments to existing exemptions ensure that Retirement Investors are consistently protected by Impartial Conduct Standards, regardless of the particular exemption upon which the adviser relies.” 81 Fed. Reg. at 21007.

22 See, e.g., Consumer Federation of America, 6 Ways the DOL Fiduciary Rule Improves Protections for Retirement Savers (Apr. 6, 2016).

23 See David Pratt, Focus On… Lawsuits Challenging The Department of Labor’s Fiduciary Rule, Journal of Pension Benefits (forthcoming 2016). The Texas lawsuit, for example, claims that the rule “oversteps the DOL’s authority [and] creates unwarranted burdens and liabilities” (among other issues raised in the complaint). See Greg Iacurci, Nine groups file lawsuit to strike down ‘capricious’ DOL fiduciary rule, Investment News (Jun 2, 2016).

24 Thrivent Financial for Lutherans v. Perez, Case No. 0:16-cv-03289-SRN-HB, D. Minn., filed Sept. 29, 2016.

25 The lead plaintiffs are the U.S. Chamber of Commerce, the American Council of Life Insurers and the Indexed Annuity Leadership Council.

26 The plaintiff is the National Association for Fixed Annuities.

27 The plaintiff is Market Synergy Group, Inc., an insurance agency based in Topeka.

28 Mark Schoeff Jr., Litigation schedule set for suits against DOL fiduciary rule, Investment News (Jun 27, 2016).

29 John Hilton, Tough Questioning in DOL Rule Injunction Hearing, Adviser News (Aug. 25, 2016).

30 John Hilton, Kansas Judge ‘Sympathetic’ to Market Synergy DOL Case, Insurance (Sept. 22, 2016).

31 Mark Schoeff Jr., Dallas court schedules hearing for lawsuits against DOL fiduciary rule, Investment News (July 8, 2016).

32 Mark Schoeff Jr., Obama vetoes resolution against DOL fiduciary rule, Investment News (June 8, 2016).