# Definition of the Term “Fiduciary”; Conflict of Interest Rule-Retirement Investment Advice

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2015-08831

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** April 20, 2015
- **Citation:** 80 FR 21928

## Text

DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Parts 2509 and 2510
RIN 1210-AB32
Definition of the Term “Fiduciary”; Conflict of Interest Rule—Retirement Investment Advice

AGENCY:

Employee Benefits Security Administration, Department of Labor.

ACTION:

Notice of proposed rulemaking and withdrawal of previous proposed rule.

SUMMARY:

This document contains a proposed regulation defining who is a “fiduciary” of an employee benefit plan under the Employee Retirement Income Security Act of 1974 (ERISA) as a result of giving investment advice to a plan or its participants or beneficiaries. The proposal also applies to the definition of a “fiduciary” of a plan (including an individual retirement account (IRA)) under section 4975 of the Internal Revenue Code of 1986 (Code). If adopted, the proposal would treat persons who provide investment advice or recommendations to an employee benefit plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner as fiduciaries under ERISA and the Code in a wider array of advice relationships than the existing ERISA and Code regulations, which would be replaced. The proposed rule, and related exemptions, would increase consumer protection for plan sponsors, fiduciaries, participants, beneficiaries and IRA owners. This document also withdraws a prior proposed regulation published in 2010 (2010 Proposal) concerning this same subject matter. In connection with this proposal, elsewhere in this issue of the
Federal Register
, the Department is proposing new exemptions and amendments to existing exemptions from the prohibited transaction rules applicable to fiduciaries under ERISA and the Code that would allow certain broker-dealers, insurance agents and others that act as investment advice fiduciaries to continue to receive a variety of common forms of compensation that otherwise would be prohibited as conflicts of interest.

DATES:

As of April 20, 2015, the proposed rule published October 22, 2010 (75 FR 65263) is withdrawn. Submit written comments on the proposed regulation on or before July 6, 2015.

ADDRESSES:

To facilitate the receipt and processing of written comment letters on the proposed regulation, EBSA encourages interested persons to submit their comments electronically. You may submit comments, identified by RIN 1210-AB32, by any of the following methods:

Federal eRulemaking Portal: http://www.regulations.gov.
Follow instructions for submitting comments.

Email: e-ORI@dol.gov.
Include RIN 1210-AB32 in the subject line of the message.

Mail:
Office of Regulations and Interpretations, Employee Benefits Security Administration, Attn: Conflict of Interest Rule, Room N-5655, U.S. Department of Labor, 200 Constitution Avenue NW., Washington, DC 20210.

Hand Delivery/Courier:
Office of Regulations and Interpretations, Employee Benefits Security Administration, Attn: Conflict of Interest Rule, Room N-5655, U.S. Department of Labor, 200 Constitution Avenue NW., Washington, DC 20210.

Instructions:
All comments received must include the agency name and Regulatory Identifier Number (RIN) for this rulemaking (RIN 1210-AB32). Persons submitting comments electronically are encouraged not to submit paper copies. All comments received will be made available to the public, posted without change to
http://www.regulations.gov
and
http://www.dol.gov/ebsa,
and made available for public inspection at the Public Disclosure Room, N-1513, Employee Benefits Security Administration, U.S. Department of Labor, 200 Constitution Avenue NW., Washington, DC 20210, including any personal information provided.

FOR FURTHER INFORMATION CONTACT:

For Questions Regarding the Proposed Rule: Contact Luisa Grillo-Chope or Fred Wong, Office of Regulations and Interpretations, Employee Benefits Security Administration (EBSA), (202) 693-8825.

For Questions Regarding the Proposed Prohibited Transaction Exemptions: Contact Karen Lloyd, Office of Exemption Determinations, EBSA, 202-693-8824.

For Questions Regarding the Regulatory Impact Analysis: Contact G. Christopher Cosby, Office of Policy and Research, EBSA, 202-693-8425. (These are not toll-free numbers).

SUPPLEMENTARY INFORMATION:

I. Executive Summary

A. Purpose of the Regulatory Action

Under ERISA and the Code, a person is a fiduciary to a plan or IRA to the extent that he or she engages in specified plan activities, including rendering “investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan . . . ” ERISA safeguards plan participants by imposing trust law standards of care and undivided loyalty on plan fiduciaries, and by holding fiduciaries accountable when they breach those obligations. In addition, fiduciaries to plans and IRAs are not permitted to engage in “prohibited transactions,” which pose special dangers to the security of retirement, health, and other benefit plans because of fiduciaries' conflicts of interest with respect to the transactions. Under this regulatory structure, fiduciary status and responsibilities are central to protecting the public interest in the integrity of retirement and other important benefits, many of which are tax-favored.

In 1975, the Department issued regulations that significantly narrowed the breadth of the statutory definition of fiduciary investment advice by creating a five-part test that must, in each instance, be satisfied before a person can be treated as a fiduciary adviser. This regulatory definition applies to both ERISA and the Code. The Department created the test in a very different context, prior to the existence of participant-directed 401(k) plans, widespread investments in IRAs, and the now commonplace rollover of plan assets from fiduciary-protected plans to IRAs. Today, as a result of the five-part test, many investment professionals, consultants, and advisers
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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 proposes to 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.

1
By using the term “adviser,” the Department does not intend to limit its use to investment advisers registered under the Investment Advisers Act of 1940 or under state law. For example, as used herein, an adviser can be an individual or entity who can be, among other things, a representative of a registered investment adviser, a bank or similar financial institution, an insurance company, or a broker-dealer.

The Department has also sought to preserve beneficial business models for delivery of investment advice by separately proposing new exemptions from ERISA's prohibited transaction rules that would broadly permit firms to continue common fee and compensation practices, as long as they are willing to adhere to basic standards aimed at ensuring that their advice is in the best interest of their customers. Rather than create a highly prescriptive set of transaction-specific exemptions, the Department instead is proposing a set of exemptions that flexibly accommodate a wide range of current business practices, while minimizing the harmful impact of conflicts of interest on the quality of advice.

In particular, the Department is proposing a new exemption (the “Best Interest Contract Exemption”) that would provide conditional relief for common compensation, such as commissions and revenue sharing, that an adviser and the adviser's employing firm might receive in connection with investment advice to retail retirement investors.
2

In order to protect the interests of plans, participants and beneficiaries, and IRA owners, the exemption requires the firm and the adviser to contractually acknowledge fiduciary status, commit to adhere to basic standards of impartial conduct, adopt policies and procedures reasonably designed to minimize the harmful impact of conflicts of interest, and disclose basic information on their conflicts of interest and on the cost of their advice. Central to the exemption is the adviser and firm's agreement to meet fundamental obligations of fair dealing and fiduciary conduct—to give advice that is in the customer's best interest; avoid misleading statements; receive no more than reasonable compensation; and comply with applicable federal and state laws governing advice. This principles-based approach aligns the adviser's interests with those of the plan participant or IRA owner, while leaving the adviser and employing firm with the flexibility and discretion necessary to determine how best to satisfy these basic standards in light of the unique attributes of their business. The Department is similarly proposing to amend existing exemptions for a wide range of fiduciary advisers to ensure adherence to these basic standards of fiduciary conduct. In addition, the Department is proposing a new exemption for “principal transactions” in which advisers sell certain debt securities to plans and IRAs out of their own inventory, as well as an amendment to an existing exemption that would permit advisers to receive compensation for extending credit to plans or IRAs to avoid failed securities transactions. In addition to the Best Interest Contract Exemption, the Department is also seeking public comment on whether it should issue a separate streamlined exemption that would allow advisers to receive otherwise prohibited compensation in connection with plan, participant and beneficiary accounts, and IRA investments in certain high-quality low-fee investments, subject to fewer conditions. This is discussed in greater detail in the
Federal Register
notice related to the proposed Best Interest Contract Exemption.

2
For purposes of the exemption, retail investors include (1) the participants and beneficiaries of participant-directed plans, (2) IRA owners, and (3) the sponsors (including employees, officers, or directors thereof) of non participant-directed plans with fewer than 100 participants to the extent the sponsors (including employees, officers, or directors thereof) act as a fiduciary with respect to plan investment decisions.

This broad regulatory package aims to enable advisers and their firms to give advice that is in the best interest of their customers, without disrupting common compensation arrangements under conditions designed to ensure the adviser is acting in the best interest of the advice recipient. The proposed new exemptions and amendments to existing exemptions are published elsewhere in today's edition of the
Federal Register
.

B. Summary of the Major Provisions of the Proposed Rule

The proposed rule clarifies and rationalizes the definition of fiduciary investment advice subject to specific carve-outs for particular types of communications that are best understood as non-fiduciary in nature. Under the definition, a person renders investment advice by (1) providing investment or investment management recommendations or appraisals to an employee benefit plan, a plan fiduciary, participant or beneficiary, or an IRA owner or fiduciary, and (2) either (a) acknowledging the fiduciary nature of the advice, or (b) acting pursuant to an agreement, arrangement, or understanding with the advice recipient that the advice is individualized to, or specifically directed to, the recipient for consideration in making investment or management decisions regarding plan assets. When such advice is provided for a fee or other compensation, direct or indirect, the person giving the advice is a fiduciary.

Although the new general definition of investment advice avoids the weaknesses of the current regulation, standing alone it could sweep in some relationships that are not appropriately regarded as fiduciary in nature and that the Department does not believe Congress intended to cover as fiduciary relationships. Accordingly, the proposed regulation includes a number of specific carve-outs to the general definition. For example, the regulation draws an important distinction between fiduciary investment advice and non-fiduciary investment or retirement education. Similarly, under the “seller's carve-out,”
3

the proposal would not treat as fiduciary advice recommendations made to a plan in an arm's length transaction where there is generally no expectation of fiduciary investment advice, provided that the carve-out's specific conditions are met. In addition, the proposal includes specific carve-outs for advice rendered by employees of the plan sponsor, platform providers, and persons who offer or enter into swaps or security-based swaps with plans. All of the rule's carve-outs are subject to conditions designed to draw an appropriate line between fiduciary and non-fiduciary communications, consistent with the text and purpose of the statutory provisions.

3
Although referred to herein as the “seller's carve-out,” we note that the carve-out provided in paragraph (b)(1)(i) of the proposal is not limited to sales and would apply to incidental advice provided in connection with an arm's length sale, purchase, loan, or bilateral contract between a plan investor with financial expertise and the adviser.

Finally, in addition to the new proposal in this Notice, the Department is simultaneously proposing a new Best Interest Contract Exemption, revising other exemptions from the prohibited transaction rules of ERISA and the Code and is exploring through a request for comments the concept of an additional low-fee exemption.

C. Gains to Investors and Compliance Costs

When the Department promulgated the 1975 rule, 401(k) plans did not exist, IRAs had only just been authorized, and the majority of retirement plan assets were managed by professionals, rather than directed by individual investors. Today, individual retirement investors have much greater responsibility for directing their own investments, but they seldom have the training or specialized expertise necessary to prudently manage retirement assets on their own. As a result, they often depend on investment advice for guidance on how to manage their savings to achieve a secure retirement. In the current marketplace for retirement investment advice, however, advisers commonly have direct and substantial conflicts of interest, which encourage investment recommendations that generate higher fees for the advisers at the expense of their customers and often result in lower returns for customers even before fees.

A wide body of economic evidence supports a finding that the impact of these conflicts of interest on retirement investment outcomes is large and, from the perspective of advice recipients, negative. As detailed in the Department's Regulatory Impact Analysis (available at
www.dol.gov/ebsa/pdf/conflictsofinterestria.pdf
), the supporting evidence includes, among other things, statistical analyses of conflicted investment channels, experimental studies, government reports documenting abuse, and basic economic theory on the dangers posed by conflicts of interest and by the asymmetries of information and expertise that characterize interactions between ordinary retirement investors and conflicted advisers. This evidence takes into account existing protections under ERISA as well as other federal and state laws. A review of this data, which consistently points to substantial failures in the market for retirement advice, suggests that IRA holders receiving conflicted investment advice can expect their investments to underperform by an average of 100 basis points per year over the next 20 years. The underperformance associated with conflicts of interest—in the mutual funds segment alone—could cost IRA investors more than $210 billion over the next 10 years and nearly $500 billion over the next 20 years. Some studies suggest that the underperformance of broker-sold mutual funds may be even higher than 100 basis points, possibly due to loads that are taken off the top and/or poor timing of broker sold investments. If the true underperformance of broker-sold funds is 200 basis points, IRA mutual fund holders could suffer from underperformance amounting to $430 billion over 10 years and nearly $1 trillion across the next 20 years. While the estimates based on the mutual fund market are large, the total market impact could be much larger. Insurance products, Exchange Traded Funds (ETFs), individual stocks and bonds, and other products are all sold by agents and brokers with conflicts of interest.

The Department expects the proposal would deliver large gains for retirement investors. Because of data constraints, only some of these gains can be quantified with confidence. Focusing only on how load shares paid to brokers affect the size of loads paid by IRA investors holding load funds and the returns they achieve, the Department estimates the proposal would deliver to IRA investors gains of between $40 billion and $44 billion over 10 years and between $88 billion and $100 billion over 20 years. These estimates assume that the rule would eliminate (rather than just reduce) underperformance associated with the practice of incentivizing broker recommendations through variable front-end-load sharing; if the rule's effectiveness in this area is substantially below 100 percent, these estimates may overstate these particular gains to investors in the front-load mutual fund segment of the IRA market. The Department nonetheless believes that these gains alone would far exceed the proposal's compliance cost. For example, if only 75 percent of anticipated gains were realized, the quantified subset of such gains—specific to the front-load mutual fund segment of the IRA market—would amount to between $30 billion and $33 billion over 10 years. If only 50 percent were realized, this subset of expected gains would total between $20 billion and $22 billion over 10 years, or several times the proposal's estimated compliance cost of $2.4 billion to 5.7 billion over the same 10 years. These gain estimates also exclude additional potential gains to investors resulting from reducing or eliminating the effects of conflicts in financial products other than front-end-load mutual funds. The Department invites input that would make it possible to quantify the magnitude of the rule's effectiveness and of any additional, not-yet-quantified gains for investors.

These estimates account for only a fraction of potential conflicts, associated losses, and affected retirement assets. The total gains to IRA investors attributable to the rule may be much higher than these quantified gains alone for several reasons. The Department expects the proposal to yield large, additional gains for IRA investors, including potential reductions in excessive trading and associated transaction costs and timing errors (such as might be associated with return chasing), improvements in the performance of IRA investments other than front-load mutual funds, and improvements in the performance of defined contribution (DC) plan investments. As noted above, under current rules, adviser conflicts could cost IRA investors as much as $410 billion over 10 years and $1 trillion over 20 years, so the potential additional gains to IRA investors from this proposal could be very large.

The following accounting table summarizes the Department's conclusions:

Table 1—Partial Gains to Investors and Compliance Costs Accounting Table

Category

Primary
estimate

Low estimate
High estimate
Year dollar
Discount rate (9%)

Period
covered

Partial Gains to Investors

Annualized, Monetized ($millions/year)

$4,243
$5,170

$3,830
4,666

2015
2015

7
3

2017-2026
2017-2026

Notes:
The proposal is expected to deliver large gains for retirement investors. Because of limitations of the literature and other available evidence, only some of these gains can be quantified. The estimates in this table focus only on how load shares paid to brokers affect the size of loads IRA investors holding load funds pay and the returns they achieve. These estimates assume that the rule will eliminate (rather than just reduce) underperformance associated with the practice of incentivizing broker recommendations through variable front-end-load sharing. If, however, the rule's effectiveness in reducing underperformance is substantially below 100 percent, these estimates may overstate these particular gains to investors in the front-end-load mutual fund segment of the IRA market. However, these estimates account for only a fraction of potential conflicts, associated losses, and affected retirement assets. The total gains to IRA investors attributable to the rule may be higher than the quantified gains alone for several reasons. For example, the proposal is expected to yield additional gains for IRA investors, including potential reductions in excessive trading and associated transaction costs and timing errors (such as might be associated with return chasing), improvements in the performance of IRA investments other than front-load mutual funds, and improvements in the performance of DC plan investments.

The partial-gains-to-investors estimates include both economic efficiency benefits and transfers from the financial services industry to IRA holders.

The partial gains estimates are discounted to December 31, 2015.

Compliance Costs

Annualized, Monetized ($millions/year)

$348
328

$706
664

2015
2015

7
3

2016-2025
2016-2025

Notes:
The compliance costs of the current proposal including the cost of compliance reviews, comprehensive compliance and supervisory system changes, policies and procedures and training programs updates, insurance increases, disclosure preparation and distribution, and some costs of changes in other business practices. Compliance costs incurred by mutual funds or other asset providers have not been estimated.

Insurance Premium Transfers

Annualized Monetized ($millions/year)

$63
63

2015
2015

7
3

2016-2025
2016-2025

From/To
From: Service providers facing increased insurance premiums due to increased liability risk
To: Plans, participants, beneficiaries, and IRA investors through the payment of recoveries—funded from a portion of the increased insurance premiums

OMB Circular A-4 requires the presentation of a social welfare accounting table that summarizes a regulation's benefits, costs and transfers (monetized, where possible). A summary of this type would differ from and expand upon Table I in several ways:

• In the language of social welfare economics as reflected in Circular A-4, investor gains comprise two parts: Social welfare “benefits” attributable to improvements in economic efficiency and “transfers” of welfare to retirement investors from the financial services industry. Due to limitations of the literature and other available evidence, the investor gains estimates presented in Table I have not been broken down into benefits and transfer components, but making the distinction between these categories of impacts is key for a social welfare accounting statement.

• The estimates in Table I reflect only a subset of the gains to investors resulting from the rule, but may overstate this subset. As noted in Table I, the Department's estimates of partial gains to investors reflect an assumption that the rule will eliminate, rather than just reduce, underperformance associated with the practice of incentivizing broker recommendations through variable front-end-load sharing. If, however, the rule's effectiveness is substantially below 100 percent, these estimates would overstate these partial gains to investors in the front-load mutual fund segment of the IRA market. The estimates in Table I also exclude additional potential gains to investors resulting from reducing or eliminating the effects of conflicts in financial products other than front-end-load mutual funds in the IRA market, and all potential gains to investors in the plan market. The Department invites input that would make it possible to quantify the magnitude of the rule's effectiveness and of any additional, not-yet-quantified gains for investors.

• Generally, the gains to investors consist of multiple parts: Transfers to IRA investors from advisers and others in the supply chain, benefits to the overall economy from a shift in the allocation of investment dollars to projects that have higher returns, and resource savings associated with, for example, reductions in excessive turnover and wasteful and unsuccessful efforts to outperform the market. Some of these gains are partially quantified in Table I. Also, the estimates in Table I assume the gains to investors arise gradually as the fraction of wealth invested based on conflicted investment advice slowly declines over time based on historical patterns of asset turnover. However, the estimates do not account for potential transition costs associated with a shift of investments to higher-performing vehicles. These transition costs have not been quantified due to lack of granularity in the literature or availability of other evidence on both the portion of investor gains that consists of resource savings, as opposed to transfers, and the amount of transitional cost that would be incurred per unit of resource savings.

• Other categories of costs not yet quantified include compliance costs incurred by mutual funds or other asset providers. Enforcement costs or other costs borne by the government are also not quantified.

The Department requests detailed comment, data, and analysis on all of the issues outlined above for incorporation into the social welfare analysis at the finalization stage of the rulemaking process.

For a detailed discussion of the gains to investors and compliance costs of the

current proposal, please see Section J. Regulatory Impact Analysis, below.

II. Overview

A. Rulemaking Background

The market for retirement advice has changed dramatically since the Department first promulgated the 1975 regulation. Individuals, rather than large employers and professional money managers, have become increasingly responsible for managing retirement assets as IRAs and participant-directed plans, such as 401(k) plans, have supplanted defined benefit pensions. At the same time, the variety and complexity of financial products have increased, widening the information gap between advisers and their clients. Plan fiduciaries, plan participants and IRA investors must often rely on experts for advice, but are unable to assess the quality of the expert's advice or effectively guard against the adviser's conflicts of interest. This challenge is especially true of small retail investors who typically do not have financial expertise and can ill-afford lower returns to their retirement savings caused by conflicts. As baby boomers retire, they are increasingly moving money from ERISA-covered plans, where their employer has both the incentive and the fiduciary duty to facilitate sound investment choices, to IRAs where both good and bad investment choices are myriad and advice that is conflicted is commonplace. Such “rollovers” will total more than $2 trillion over the next 5 years. These trends were not apparent when the Department promulgated the 1975 rule. At that time, 401(k) plans did not yet exist and IRAs had only just been authorized. These changes in the marketplace, as well as the Department's experience with the rule since 1975, support the Department's efforts to reevaluate and revise the rule through a public process of notice and comment rulemaking.

On October 22, 2010, the Department published a proposed rule in the
Federal Register
(75 FR 65263) (2010 Proposal) proposing to amend 29 CFR 2510.3-21(c) (40 FR 50843, Oct. 31, 1975), which defines when a person renders investment advice to an employee benefit plan, and consequently acts as a fiduciary under ERISA section 3(21)(A)(ii) (29 U.S.C. 1002(21)(A)(ii)). In response to this proposal, the Department received over 300 comment letters. A public hearing on the 2010 Proposal was held in Washington, DC on March 1 and 2, 2011, at which 38 speakers testified. The transcript of the hearing was made available for additional public comment and the Department received over 60 additional comment letters. In addition, the Department has held many meetings with interested parties.

A number of commenters urged consideration of other means to attain the objectives of the 2010 Proposal and of additional analysis of the proposal's expected costs and benefits. In light of these comments and because of the significance of this rule, the Department decided to issue a new proposed regulation. On September 19, 2011 the Department announced that it would withdraw the 2010 Proposal and propose a new rule defining the term “fiduciary” for purposes of section 3(21)(A)(ii) of ERISA. This document fulfills that announcement in publishing both a new proposed regulation and withdrawing the 2010 Proposal. Consistent with the President's Executive Orders 12866 and 13563, extending the rulemaking process will give the public a full opportunity to evaluate and comment on the revised proposal and updated economic analysis. In addition, we are simultaneously publishing proposed new and amended exemptions from ERISA and the Code's prohibited transaction rules designed to allow certain broker-dealers, insurance agents and others that act as investment advice fiduciaries to nevertheless continue to receive common forms of compensation that would otherwise be prohibited, subject to appropriate safeguards. The existing class exemptions will otherwise remain in place, affording flexibility to fiduciaries who currently use the exemptions or who wish to use the exemptions in the future. The proposed new regulatory package takes into account robust public comment and input and represents a substantial change from the 2010 Proposal, balancing long overdue consumer protections with flexibility for the industry in order to minimize disruptions to current business models.

In crafting the current regulatory package, the Department has benefitted from the views and perspectives expressed in public comments to the 2010 Proposal. For example, the Department has responded to concerns about the impact of the prohibited transaction rules on the marketplace for retail advice by proposing a broad package of exemptions that are intended to ensure that advisers and their firms make recommendations that are in the best interest of plan participants and IRA owners, without disrupting common fee arrangements. In response to commenters, the Department has also determined not to include, as fiduciary in nature, appraisals or valuations of employer securities provided to ESOPs or to certain collective investment funds holding assets of plan investors. On a more technical point, the Department also followed recommendations that it not automatically assign fiduciary status to investment advisers under the Advisers Act, but instead follow an entirely functional approach to fiduciary status. In light of public comments, the new proposal also makes a number of other changes to the regulatory proposal. For example, the Department has addressed concerns that it could be misread to extend fiduciary status to persons that prepare newsletters, television commentaries, or conference speeches that contain recommendations made to the general public. Similarly, the rule makes clear that fiduciary status does not extend to internal company personnel who give advice on behalf of their plan sponsor as part of their duties, but receive no compensation beyond their salary for the provision of advice. The Department is appreciative of the comments it received to the 2010 Proposal, and more fully discusses a number of the comments that influenced change in the sections that follow. In addition, the Department is eager to receive comments on the new proposal in general, and requests public comment on a number of specific aspects of the package as indicated below.

The following discussion summarizes the 2010 Proposal, describes some of the concerns and issues raised by commenters, and explains the new proposed regulation, which is published with this notice.

B.
The Statute and Existing Regulation

ERISA (or the “Act”) is a comprehensive statute designed to protect the interests of plan participants and beneficiaries, the integrity of employee benefit plans, and the security of retirement, health, and other critical benefits. The broad public interest in ERISA-covered plans is reflected in the Act's imposition of stringent fiduciary responsibilities on parties engaging in important plan activities, as well as in the tax-favored status of plan assets and investments. One of the chief ways in which ERISA protects employee benefit plans is by requiring that plan fiduciaries comply with fundamental obligations rooted in the law of trusts. In particular, plan fiduciaries must manage plan assets prudently and with undivided loyalty to the plans and their participants and beneficiaries.
4

In addition, they must refrain from

engaging in “prohibited transactions,” which the Act does not permit because of the dangers to the interests of the plan and IRA posed by the transactions.
5

When fiduciaries violate ERISA's fiduciary duties or the prohibited transaction rules, they may be held personally liable for any losses to the investor resulting from the breach.
6

In addition, violations of the prohibited transaction rules are subject to excise taxes under the Code.

4
ERISA section 404(a).

5
ERISA section 406. The Act also prohibits certain transactions between a plan and a “party in interest.”

6
ERISA section 409;
see also
ERISA section 405.

The Code also protects individuals who save for retirement through tax-favored accounts that are not generally covered by ERISA, such as IRAs, through a more limited regulation of fiduciary conduct. Although ERISA's general fiduciary obligations of prudence and loyalty do not govern the fiduciaries of IRAs and other plans not covered by ERISA, these fiduciaries are subject to the prohibited transaction rules of the Code. In this context, however, the sole statutory sanction for engaging in the illegal transactions is the assessment of an excise tax enforced by the Internal Revenue Service (IRS). Thus, unlike participants in plans covered by Title I of ERISA, IRA owners do not have a statutory right to bring suit against fiduciaries under ERISA for violation of the prohibited transaction rules and fiduciaries are not personally liable to IRA owners for the losses caused by their misconduct.

Under this statutory framework, the determination of who is a “fiduciary” is of central importance. Many of ERISA's and the Code's protections, duties, and liabilities hinge on fiduciary status. In relevant part, section 3(21)(A) of ERISA provides that a person is a fiduciary with respect to a plan to the extent he or she (i) exercises any discretionary authority or discretionary control with respect to management of such plan or exercises any authority or control with respect to management or disposition of its assets; (ii) 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; or, (iii) has any discretionary authority or discretionary responsibility in the administration of such plan. Section 4975(e)(3) of the IRC identically defines “fiduciary” for purposes of the prohibited transaction rules set forth in Code section 4975.

The statutory definition contained in section 3(21)(A) deliberately casts a wide net in assigning fiduciary responsibility with respect to plan assets. Thus, “any authority or control” over plan assets is sufficient to confer fiduciary status, and any person who renders “investment advice for a fee or other compensation, direct or indirect” is an investment advice fiduciary, regardless of whether they have direct control over the plan's assets, and regardless of their status as an investment adviser and/or broker under the federal securities laws. The statutory definition and associated fiduciary responsibilities were enacted to ensure that plans can depend on persons who provide investment advice for a fee to make recommendations that are prudent, loyal, and untainted by conflicts of interest. In the absence of fiduciary status, persons who provide investment advice would neither be subject to ERISA's fundamental fiduciary standards, nor accountable under ERISA or the Code for imprudent, disloyal, or tainted advice, no matter how egregious the misconduct or how substantial the losses. Plans, individual participants and beneficiaries, and IRA owners often are not financial experts and consequently must rely on professional advice to make critical investment decisions. The statutory definition, prohibitions on conflicts of interest, and core fiduciary obligations of prudence and loyalty, all reflect Congress' recognition in 1974 of the fundamental importance of such advice to protect savers' retirement nest eggs. In the years since then, the significance of financial advice has become still greater with increased reliance on participant-directed plans and self-directed IRAs for the provision of retirement benefits.

In 1975, the Department issued a regulation, at 29 CFR 2510.3-21(c) defining the circumstances under which a person is treated as providing “investment advice” to an employee benefit plan within the meaning of section 3(21)(A)(ii) of ERISA (the “1975 regulation”), and the Department of the Treasury issued a virtually identical regulation under the Code.
7

The regulation narrowed the scope of the statutory definition of fiduciary investment advice by creating a five-part test that must be satisfied before a person can be treated as rendering investment advice for a fee. Under the regulation, for advice to constitute “investment advice,” an adviser who is not a fiduciary under another provision of the statute must—(1) render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property (2) on a regular basis (3) pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary that (4) the advice will serve as a primary basis for investment decisions with respect to plan assets, and that (5) the advice will be individualized based on the particular needs of the plan or IRA. The regulation provides that an adviser is a fiduciary with respect to any particular instance of advice only if he or she meets each and every element of the five-part test with respect to the particular advice recipient or plan at issue.

7
See 26 CFR 54.4975-9(c), which interprets Code section 4975(e)(3). 40 FR 50840 (Oct. 31, 1975). Under section 102 of Reorganization Plan No. 4 of 1978, the authority of the Secretary of the Treasury to interpret section 4975 of the Code has been transferred, with certain exceptions not here relevant, to the Secretary of Labor. References in this document to sections of ERISA should be read to refer also to the corresponding sections of the Code.

As the marketplace for financial services has developed in the years since 1975, the five-part test may now undermine, rather than promote, the statutes' text and purposes. The narrowness of the 1975 regulation allows advisers, brokers, consultants and valuation firms to play a central role in shaping plan and IRA investments, without ensuring the accountability that Congress intended for persons having such influence and responsibility. Even when plan sponsors, participants, beneficiaries, and IRA owners clearly rely on paid advisers for impartial guidance, the regulation allows many advisers to avoid fiduciary status and disregard ERISA's fiduciary obligations of care and prohibitions on disloyal and conflicted transactions. As a consequence, these advisers can steer customers to investments based on their own self-interest (
e.g.,
products that generate higher fees for the adviser even if there are identical lower-fee products available), give imprudent advice, and engage in transactions that would otherwise not be permitted by ERISA and the Code without fear of accountability under either ERISA or the Code.

Instead of ensuring that trusted advisers give prudent and unbiased advice in accordance with fiduciary norms, the current regulation erects a multi-part series of technical impediments to fiduciary responsibility. The Department is concerned that the specific elements of the five-part test—which are not found in the text of the Act or Code—now work to frustrate statutory goals and defeat advice recipients' legitimate expectations. In

light of the importance of the proper management of plan and IRA assets, it is critical that the regulation defining investment advice draws appropriate distinctions between the sorts of advice relationships that should be treated as fiduciary in nature and those that should not. In practice, the current regulation appears not to do so. Instead, the lines drawn by the five-part test frequently permit evasion of fiduciary status and responsibility in ways that undermine the statutory text and purposes.

One example of the five-part test's shortcomings is the requirement that advice be furnished on a “regular basis.” As a result of the requirement, if a small plan hires an investment professional or appraiser on a one-time basis for an investment recommendation or valuation opinion on a large, complex investment, the adviser has no fiduciary obligation to the plan under ERISA. Even if the plan is considering investing all or substantially all of the plan's assets, lacks the specialized expertise necessary to evaluate the complex transaction on its own, and the consultant fully understands the plan's dependence on his professional judgment, the consultant is not a fiduciary because he does not advise the plan on a “regular basis.” The plan could be investing hundreds of millions of dollars in plan assets, and it could be the most critical investment decision the plan ever makes, but the adviser would have no fiduciary responsibility under the 1975 regulation. While a consultant who regularly makes less significant investment recommendations to the plan would be a fiduciary if he satisfies the other four prongs of the regulatory test, the one-time consultant on an enormous transaction has no fiduciary responsibility.

In such cases, the “regular basis” requirement, which is not found in the text of ERISA or the Code, fails to draw a sensible line between fiduciary and non-fiduciary conduct, and undermines the law's protective purposes. A specific example is the one-time purchase of a group annuity to cover all of the benefits promised to substantially all of a plan's participants for the rest of their lives when a defined benefit plan terminates or a plan's expenditure of hundreds of millions of dollars on a single real estate transaction with the assistance of a financial adviser hired for purposes of that one transaction. Despite the clear importance of the decisions and the clear reliance on paid advisers, the advisers would not be plan fiduciaries. On a smaller scale that is still immensely important for the affected individual, the “regular basis” requirement also deprives individual participants and IRA owners of statutory protection when they seek specialized advice on a one-time basis, even if the advice concerns the investment of all or substantially all of the assets held in their account (
e.g.,
as in the case of an annuity purchase or a roll-over from a plan to an IRA or from one IRA to another).

Under the five-part test, fiduciary status can also be defeated by arguing that the parties did not have a
mutual
agreement, arrangement, or understanding that the advice would serve as a
primary basis
for investment decisions. Investment professionals in today's marketplace frequently market retirement investment services in ways that clearly suggest the provision of tailored or individualized advice, while at the same time disclaiming in fine print the requisite “mutual” understanding that the advice will be used as a primary basis for investment decisions.

Similarly, there appears to be a widespread belief among broker-dealers that they are not fiduciaries with respect to plans or IRAs because they do not hold themselves out as registered investment advisers, even though they often market their services as financial or retirement planners. The import of such disclaimers—and of the fine legal distinctions between brokers and registered investment advisers—is often completely lost on plan participants and IRA owners who receive investment advice. As shown in a study conducted by the RAND Institute for Civil Justice for the Securities and Exchange Commission (SEC), consumers often do not read the legal documents and do not understand the difference between brokers and registered investment advisers particularly when brokers adopt such titles as “financial adviser” and “financial manager.”
8

8
Angela A. Hung, Noreen Clancy, Jeff Dominitz, Eric Talley, Claude Berrebi, Farrukh Suvankulov,
Investor and Industry Perspectives on Investment Advisers and Broker-Dealers,
RAND Institute for Civil Justice, commissioned by the U.S. Securities and Exchange Commission, 2008, at
http://www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf

Even in the absence of boilerplate fine print disclaimers, however, it is far from evident how the “primary basis” element of the five-part test promotes the statutory text or purposes of ERISA and the Code. If, for example, a plan hires multiple specialized advisers for an especially complex transaction, it should be able to rely upon all of the consultants' advice, regardless of whether one could characterize any particular consultant's advice as primary, secondary, or tertiary. Presumably, paid consultants make recommendations—and retirement investors pay for them—with the hope or expectation that the recommendations could, in fact, be relied upon in making important decisions. When a plan, participant, beneficiary, or IRA owner directly or indirectly pays for advice upon which it can rely, there appears to be little statutory basis for drawing distinctions based on a subjective characterization of the advice as “primary,” “secondary,” or other.

In other respects, the current regulatory definition could also benefit from clarification. For example, a number of parties have argued that the regulation, as currently drafted, does not encompass advice as to the selection of money managers or mutual funds. Similarly, they have argued that the regulation does not cover advice given to the managers of pooled investment vehicles that hold plan assets contributed by many plans, as opposed to advice given to particular plans. Parties have even argued that advice was insufficiently “individualized” to fall within the scope of the regulation because the advice provider had failed to prudently consider the “particular needs of the plan,” notwithstanding the fact that both the advice provider and the plan agreed that individualized advice based on the plan's needs would be provided, and the adviser actually made specific investment recommendations to the plan. Although the Department disagrees with each of these interpretations of the current regulation, the arguments nevertheless suggest that clarifying regulatory text could be helpful.

Changes in the financial marketplace have enlarged the gap between the 1975 regulation's effect and the Congressional intent of the statutory definition. The greatest change is the predominance of individual account plans, many of which require participants to make investment decisions for their own accounts. In 1975, private-sector defined benefit pensions—mostly large, professionally managed funds—covered over 27 million active participants and held assets totaling almost $186 billion. This compared with just 11 million active participants in individual account defined contribution plans with assets of just $74 billion.
9

Moreover, the great majority of defined contribution plans at that time were professionally

managed, not participant-directed. In 1975, 401(k) plans did not yet exist and IRAs had just been authorized as part of ERISA's enactment the prior year. In contrast, by 2012 defined benefit plans covered just under 16 million active participants, while individual account-based defined contribution plans covered over 68 million active participants— including 63 million participants in 401(k)-type plans that are participant-directed.
10

9
U.S. Department of Labor,
Private Pension Plan Bulletin Historical Tables and Graphs, (
Dec. 2014), at
http://www.dol.gov/ebsa/pdf/historicaltables.pdf.

10
U.S. Department of Labor,
Private Pension Plan Bulletin Abstract of 2012 Form 5500 Annual Reports,
(Jan. 2015), at
http://www.dol.gov/ebsa/PDF/2012pensionplanbulletin.PDF.

With this transformation, plan participants, beneficiaries and IRA owners have become major consumers of investment advice that is paid for directly or indirectly. By 2012, 97 percent of 401(k) participants were responsible for directing the investment of all or part of their own account, up from 86 percent as recently as 1999.
11

Also, in 2013, more than 34 million households owned IRAs.
12

11
U.S. Department of Labor,
Private Pension Plan Bulletin Abstract of 1999 Form 5500 Annual Reports,
Number 12, Summer 2004 (Apr. 2008), at
http://www.dol.gov/ebsa/PDF/1999pensionplanbulletin.PDF.

12
Brien, Michael J., and Constantijn W.A. Panis. Analysis of Financial Asset Holdings of Households on the United States: 2013 Update. Advanced Analytic Consulting Group and Deloitte, Report Prepared for the U.S. Department of Labor, 2014.

Many of the consultants and advisers who provide investment-related advice and recommendations receive compensation from the financial institutions whose investment products they recommend. This gives the consultants and advisers a strong bias, conscious or unconscious, to favor investments that provide them greater compensation rather than those that may be most appropriate for the participants. Unless they are fiduciaries, however, these consultants and advisers are free under ERISA and the Code, not only to receive such conflicted compensation, but also to act on their conflicts of interest to the detriment of their customers. In addition, plans, participants, beneficiaries, and IRA owners now have a much greater variety of investments to choose from, creating a greater need for expert advice. Consolidation of the financial services industry and innovations in compensation arrangements have multiplied the opportunities for self-dealing and reduced the transparency of fees.

The absence of adequate fiduciary protections and safeguards is especially problematic in light of the growth of participant-directed plans and self-directed IRAs; the gap in expertise and information between advisers and the customers who depend upon them for guidance; and the advisers' significant conflicts of interest.

When Congress enacted ERISA in 1974, it made a judgment that plan advisers should be subject to ERISA's fiduciary regime and that plan participants, beneficiaries and IRA owners should be protected from conflicted transactions by the prohibited transaction rules. More fundamentally, however, the statutory language was designed to cover a much broader category of persons who provide fiduciary investment advice based on their functions and to limit their ability to engage in self-dealing and other conflicts of interest than is currently reflected in the five-part test. While many advisers are committed to providing high-quality advice and always put their customers' best interests first, the 1975 regulation makes it far too easy for advisers in today's marketplace not to do so and to avoid fiduciary responsibility even when they clearly purport to give individualized advice and to act in the client's best interest, rather than their own.

C. The 2010 Proposal

In 2010, the Department proposed a new regulation that would have replaced the five-part test with a new definition of what counted as fiduciary investment advice for a fee. At that time, the Department did not propose any new prohibited transaction exemptions and acknowledged uncertainty regarding whether existing exemptions would be available, but specifically invited comments on whether new or amended exemptions should be proposed. The proposal also provided carve-outs for conduct that would not result in fiduciary status. The general definition included the following types of advice: (1) Appraisals or fairness opinions concerning the value of securities or other property; (2) recommendations as to the advisability of investing in, purchasing, holding or selling securities or other property; and (3) recommendations as to the management of securities or other property. Reflecting the Department's longstanding interpretation of the 1975 regulations, the 2010 Proposal made clear that investment advice under the proposal includes advice provided to plan participants, beneficiaries and IRA owners as well as to plan fiduciaries.

Under the 2010 Proposal, a paid adviser would have been treated as a fiduciary if the adviser provided one of the above types of advice and either: (1) Represented that he or she was acting as an ERISA fiduciary; (2) was already an ERISA fiduciary to the plan by virtue of having control over the management or disposition of plan assets, or by having discretionary authority over the administration of the plan; (3) was already an investment adviser under the Investment Advisers Act of 1940 (Advisers Act); or (4) provided the advice pursuant to an agreement or understanding that the advice may be considered in connection with plan investment or asset management decisions and would be individualized to the needs of the plan, plan participant or beneficiary, or IRA owner. The 2010 Proposal also provided that, for purposes of the fiduciary definition, relevant fees included any direct or indirect fees received by the adviser or an affiliate from any source. Direct fees are payments made by the advice recipient to the adviser including transaction-based fees, such as brokerage, mutual fund or insurance sales commissions. Indirect fees are payments to the adviser from any source other than the advice recipient such as revenue sharing payments from a mutual fund.

The 2010 Proposal included specific carve-outs for the following actions that the Department believed should not result in fiduciary status. In particular, a person would not have become a fiduciary by—

1. Providing recommendations as a seller or purchaser with interests adverse to the plan, its participants, or IRA owners, if the advice recipient reasonably should have known that the adviser was not providing impartial investment advice and the adviser had not acknowledged fiduciary status.

2. Providing investment education information and materials in connection with an individual account plan.

3. Marketing or making available a menu of investment alternatives that a plan fiduciary could choose from, and providing general financial information to assist in selecting and monitoring those investments, if these activities include a written disclosure that the adviser was not providing impartial investment advice.

4. Preparing reports necessary to comply with ERISA, the Code, or regulations or forms issued thereunder, unless the report valued assets that lack a generally recognized market, or served as a basis for making plan distributions.

The 2010 Proposal applied to the definition of an “investment advice fiduciary” in section 4975(e)(3)(B) of the Code as well as to the parallel ERISA definition. These provisions apply to both certain ERISA covered plans, and certain non-ERISA plans such as individual retirement accounts.

In the preamble to the 2010 Proposal, the Department also noted that it had previously interpreted the 1975 regulation as providing that a recommendation to a plan participant on how to invest the proceeds of a contemplated plan distribution was not fiduciary investment advice. Advisory Opinion 2005-23A (Dec. 7, 2005). The Department specifically asked for comments as to whether the final rule should include such recommendations as fiduciary advice.

The 2010 Proposal prompted a large number of comments and a vigorous debate. As noted above, the Department made special efforts to encourage the regulated community's participation in this rulemaking. In addition to an extended comment period, the Department held a two-day public hearing. Additional time for comments was allowed following the hearing and publication of the hearing transcript on the Department's Web site and Department representatives held numerous meetings with interested parties. Many of the comments concerned the Department's conclusions regarding the likely economic impact of the proposal, if adopted. A number of commenters urged the Department to undertake additional analysis of expected costs and benefits particularly with regard to the 2010 Proposal's coverage of IRAs. After consideration of these comments and in light of the significance of this rulemaking to the retirement plan service provider industry, plan sponsors and participants, beneficiaries and IRA owners, the Department decided to take more time for review and to issue a new proposed regulation for comment.

D. The New Proposal

The new proposed rule makes many revisions to the 2010 Proposal, although it also retains aspects of that proposal's essential framework. The new proposal broadly updates the definition of fiduciary investment advice, and also provides a series of carve-outs from the fiduciary investment advice definition for communications that should not be viewed as fiduciary in nature. The definition generally covers the following categories of advice: (1) Investment recommendations, (2) investment management recommendations, (3) appraisals of investments, or (4) recommendations of persons to provide investment advice for a fee or to manage plan assets. Persons who provide such advice fall within the general definition of a fiduciary if they either (a) represent that they are acting as a fiduciary under ERISA or the Code or (b) provide the advice pursuant to an agreement, arrangement, or understanding that the advice is individualized or specifically directed to the recipient for consideration in making investment or investment management decisions regarding plan assets.

The new proposal includes several carve-outs for persons who do not represent that they are acting as ERISA fiduciaries, some of which were included in some form in the 2010 Proposal but many of which were not. Subject to specified conditions, these carve-outs cover—

(1) Statements or recommendations made to a “large plan investor with financial expertise” by a counterparty acting in an arm's length transaction;

(2) offers or recommendations to plan fiduciaries of ERISA plans to enter into a swap or security-based swap that is regulated under the Securities Exchange Act or the Commodity Exchange Act;

(3) statements or recommendations provided to a plan fiduciary of an ERISA plan by an employee of the plan sponsor if the employee receives no fee beyond his or her normal compensation;

(4) marketing or making available a platform of investment alternatives to be selected by a plan fiduciary for an ERISA participant-directed individual account plan;

(5) the identification of investment alternatives that meet objective criteria specified by a plan fiduciary of an ERISA plan or the provision of objective financial data to such fiduciary;

(6) the provision of an appraisal, fairness opinion or a statement of value to an ESOP regarding employer securities, to a collective investment vehicle holding plan assets, or to a plan for meeting reporting and disclosure requirements; and

(7) information and materials that constitute “investment education” or “retirement education.”

The new proposal applies the same definition of “investment advice” to the definition of “fiduciary” in section 4975(e)(3) of the Code and thus applies to investment advice rendered to IRAs. “Plan” is defined in the new proposal to mean any employee benefit plan described in section 3(3) of the Act and any plan described in section 4975(e)(1)(A) of the Code. For ease of reference in this proposal, the term “IRA” has been inclusively defined to mean any account described in Code section 4975(e)(1)(B) through (F), such as a true individual retirement account described under Code section 408(a) and a health savings account described in section 223(d) of the Code.
13

13
As discussed below in Section E. Coverage of IRAs and Other Non-ERISA Plans, in recognition of differences among the various types of non-ERISA plan arrangements described in Code section 4975(e)(1)(B) through (F), the Department solicits comments on whether it is appropriate for the regulation to cover the full range of these arrangements. These non-ERISA plan arrangements are tax favored vehicles under the Code like IRAs, but are not intended for retirement savings.

Many of the differences between the new proposal and the 2010 Proposal reflect the input of commenters on the 2010 Proposal as part of the public notice and comment process. For example, some commenters argued that the 2010 Proposal swept too broadly by making investment recommendations fiduciary in nature simply because the adviser was a plan fiduciary for purposes unconnected with the advice or an investment adviser under the Advisers Act. In their view, such status-based criteria were in tension with the Act's functional approach to fiduciary status and would have resulted in unwarranted and unintended compliance issues and costs. Other commenters objected to the lack of a requirement for these status-based categories that the advice be individualized to the needs of the advice recipient. The new proposal incorporates these suggestions: An adviser's status as an investment adviser under the Advisers Act or as an ERISA fiduciary for reasons unrelated to advice are no longer factors in the definition. In addition, unless the adviser represents that he or she is a fiduciary with respect to advice, the advice must be provided pursuant to an agreement, arrangement, or understanding that the advice is individualized or specifically directed to the recipient to be treated as fiduciary advice.

Furthermore, the carve-outs that treat certain conduct as non-fiduciary in nature have been modified, clarified, and expanded in response to comments. For example, the carve-out for certain valuations from the definition of fiduciary investment advice has been modified and expanded. Under the 2010 Proposal, appraisals and valuations for compliance with certain reporting and disclosure requirements were not treated as fiduciary advice. The new proposal additionally provides a carve-out from fiduciary treatment for appraisal and fairness opinions for ESOPs regarding employer securities. Although, the Department remains concerned about valuation advice concerning an ESOP's purchase of employer stock and about a plan's reliance on that advice, the Department has concluded that the concerns regarding valuations of closely held employer stock in ESOP transactions raise unique issues that are more

appropriately addressed in a separate regulatory initiative. Additionally, the carve-out for valuations conducted for reporting and disclosure purposes has been expanded to include reporting and disclosure obligations outside of ERISA and the Code, and is applicable to both ERISA plans and IRAs. Many other modifications to the other carve-outs from fiduciary status, as well as new carve-outs and prohibited transaction exemptions, are described below in Section IV—“The Provisions of the New Proposal.”

III. Coordination With Other Federal Agencies

Many comments to the 2010 rulemaking emphasized the need to harmonize the Department's efforts with rulemaking activities under the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. Law No. 111-203, 124 Stat. 1376 (2010), (Dodd-Frank Act), in particular, the Security and Exchange Commission's (SEC) standards of care for providing investment advice and the Commodity Futures Trading Commission's (CFTC) business conduct standards for swap dealers. While the 2010 Proposal discussed statutes over which the SEC and CFTC have jurisdiction, it did not specifically describe inter-agency coordination efforts. In addition, commenters questioned the adequacy of coordination with other agencies regarding IRA products and services. They argued that subjecting SEC-regulated investment advisers and broker-dealers to a special set of ERISA rules for plans and IRAs could lead to additional costs and complexities for individuals who may have several different types of accounts at the same financial institution some of which may be subject only to the SEC rules, and others of which may be subject to both SEC rules and new regulatory requirements under ERISA.

In the course of developing the new proposal and the related proposed prohibited transaction exemptions, the Department has consulted with staff of the SEC and other regulators on an ongoing basis regarding whether the proposals would subject investment advisers and broker-dealers who provide investment advice to requirements that create an undue compliance burden or conflict with their obligations under other federal laws. As part of this consultative process, SEC staff has provided technical assistance and information with respect to retail investors, the marketplace for investment advice and coordinating, to the extent possible, the agencies' separate regulatory provisions and responsibilities. As the Department moves forward with this project in accordance with the specific provisions of ERISA and the Code, it will continue to consult with staff of the SEC and other regulators on its proposals and their impact on retail investors and other regulatory regimes. One result of these discussions, particularly with staff of the CFTC and SEC, is the new provision at paragraph (b)(1)(ii) of the proposed regulations concerning counterparty transactions with swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants. Under the terms of that paragraph, such persons would not be treated as ERISA fiduciaries merely because, when acting as counterparties to swap or security-based swap transactions, they give information and perform actions required for compliance with the requirements of the business conduct standards of the Dodd-Frank Act and its implementing regulations.

In pursuing these consultations, the Department has aimed to coordinate and minimize conflicting or duplicative provisions between ERISA, the Code and federal securities laws, to the extent possible. However, the governing statutes do not permit the Department to make the obligations of fiduciary investment advisers under ERISA and the Code identical to the duties of advice providers under the securities laws. ERISA and the Code establish consumer protections for some investment advice that does not fall within the ambit of federal securities laws, and vice versa. Even if each of the relevant agencies were to adopt an identical definition of “fiduciary”, the legal consequences of the fiduciary designation would vary between agencies because of differences in the specific duties and remedies established by the different federal laws at issue. ERISA and the Code place special emphasis on the elimination or mitigation of conflicts of interest and adherence to substantive standards of conduct, as reflected in the prohibited transaction rules and ERISA's standards of fiduciary conduct. The specific duties imposed on fiduciaries by ERISA and the Code stem from legislative judgments on the best way to protect the public interest in tax-preferred benefit arrangements that are critical to workers' financial and physical health. The Department has taken great care to honor ERISA and the Code's specific text and purposes.

At the same time, the Department has worked hard to understand the impact of the proposed rule on firms subject to the securities laws and other federal laws, and to take the effects of those laws into account so as to appropriately calibrate the impact of the rule on those firms. The proposed regulation reflects these efforts. In the Department's view, it neither undermines, nor contradicts, the provisions or purposes of the securities laws, but instead works in harmony with them. The Department has coordinated—and will continue to coordinate—its efforts with other federal agencies to ensure that the various legal regimes are harmonized to the fullest extent possible.

The Department has also consulted with the Department of the Treasury and the IRS, particularly on the subject of IRAs. Although the Department has responsibility for issuing regulations and prohibited transaction exemptions under section 4975 of the Code, which applies to IRAs, the IRS maintains general responsibility for enforcing the tax laws. The IRS' responsibilities extend to the imposition of excise taxes on fiduciaries who participate in prohibited transactions.
14

As a result, the Department and the IRS share responsibility for combating self-dealing by fiduciary investment advisers to tax-qualified plans and IRAs. Paragraph (e) of the proposed regulation, in particular, recognizes this jurisdictional intersection.

14
Reorganization Plan No. 4 of 1978.

When the Department announced that it would issue a new proposal, it stated that it would consider proposing new and/or amended prohibited transaction exemptions to address the concerns of commenters about the broader scope of the fiduciary definition and its impact on the fee practices of brokers and other advisers. Commenters had expressed concern about whether longstanding exemptions granted by the Department allowing advisers, despite their fiduciary status under ERISA, to receive commissions in connection with mutual funds, securities and insurance products would remain applicable under the new rule. As explained more fully below, the Department is simultaneously publishing in the notice section of today's
Federal Register
proposed prohibited transaction class exemptions to address these concerns. The Department believes that existing exemptions and these new proposed exemptions would preserve the ability to engage in common fee arrangements, while protecting plan participants, beneficiaries and IRA owners from abusive practices that may result from conflicts of interest.

The terms of these new exemptions are discussed in more detail below and in the preambles to the proposed

exemptions. While the exemptions differ in terms and coverage, each imposes a “best interest” standard on fiduciary investment advisers. Thus, for example, the Best Interest Contract Exemption requires the investment advice fiduciary and associated financial institution to expressly agree to provide advice that is in the “best interest” of the advice recipient. As proposed, the best interest standard is intended to mirror the duties of prudence and loyalty, as applied in the context of fiduciary investment advice under sections 404(a)(1)(A) and (B) of ERISA. Thus, the “best interest” standard is rooted in the longstanding trust-law duties of prudence and loyalty adopted in section 404 of ERISA and in the cases interpreting those standards.

Accordingly, the Best Interest Contract Exemption provides:

Investment advice is in the “Best Interest” of the Retirement Investor when the Adviser and Financial Institution providing the advice act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person would exercise based on the investment objectives, risk tolerance, financial circumstances and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution, any Affiliate, Related Entity, or other party.

This “best interest” standard is not intended to add to or expand the ERISA section 404 standards of prudence and loyalty as they apply to the provision of investment advice to ERISA covered plans. Advisers to ERISA-covered plans are already required to adhere to the fundamental standards of prudence and loyalty, and can be held accountable for violations of the standards. Rather, the primary impact of the “best interest” standard is on the IRA market. Under the Code, advisers to IRAs are subject only to the prohibited transaction rules. Incorporating the best interest standard in the proposed Best Interest Contract Exemption effectively requires advisers to comply with these basic fiduciary standards as a condition of engaging in transactions that would otherwise be prohibited because of the conflicts of interest they create. Additionally, the exemption ensures that IRA owners and investors have a contract-based claim to hold their fiduciary advisers accountable if they violate these basic obligations of prudence and loyalty. As under current law, no private right of action under ERISA is available to IRA owners.

IV. The Provisions of the New Proposal

The new proposal would amend the definition of investment advice in 29 CFR 2510.3-21 (1975) of the regulation to replace the restrictive five-part test with a new definition that better comports with the statutory language in ERISA and the Code.
15

As explained below, the proposal accomplishes this by first describing the kinds of communications and relationships that would generally constitute fiduciary investment advice if the adviser receives a fee or other compensation. Rather than add additional elements that must be met in all instances, as under the current regulation, the proposal describes several specific types of advice or communications that would not be treated as investment advice. In the Department's view, this structure is faithful to the remedial purpose of the statute, but avoids burdening activities that do not implicate relationships of trust and expectations of impartiality.

15
For purposes of readability, this proposed rulemaking republishes 29 CFR 2510.3-21 in its entirety, as revised, rather than only the specific amendments to this section. See 29 CFR 2510.3-21(d)—Execution of securities transactions.

A. Categories of Advice or Recommendations

Paragraph (a)(1) of the proposal sets forth the following types of advice, which, when provided in exchange for a fee or other compensation, whether directly or indirectly, and given under circumstances described in paragraph (a)(2), would be “investment advice” unless one of the carve-outs in paragraph (b) applies. The listed types of advice are—

(i) A recommendation as to the advisability of acquiring, holding, disposing of or exchanging securities or other property, including a recommendation to take a distribution of benefits or a recommendation as to the investment of securities or other property to be rolled over or otherwise distributed from the plan or IRA;

(ii) A recommendation as to the management of securities or other property, including recommendations as to the management of securities or other property to be rolled over or otherwise distributed from the plan or IRA;

(iii) An appraisal, fairness opinion, or similar statement whether verbal or written concerning the value of securities or other property if provided in connection with a specific transaction or transactions involving the acquisition, disposition, or exchange, of such securities or other property by the plan or IRA; or

(iv) A recommendation of a person who is also going to receive a fee or other compensation to provide any of the types of advice described in paragraphs (i) through (iii) above.

Except for the prong of the definition concerning appraisals and valuations discussed below, the proposal is structured so that communications must constitute a “recommendation” to fall within the scope of fiduciary investment advice. In that regard, as stated earlier in Section III concerning coordination with other Federal Agencies, the Department has consulted with staff of other agencies with rulemaking authority over investment advisers and broker-dealers. FINRA Policy Statement 01-23 sets forth guidelines to assist brokers in evaluating whether a particular communication could be viewed as a recommendation, thereby triggering application of FINRA's Rule 2111 that requires that a firm or associated person have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer.
16

Although the regulatory context for the FINRA guidance is somewhat different, the Department believes that it provides useful standards and guideposts for distinguishing investment education from investment advice under ERISA. Accordingly, the Department specifically solicits comments on whether it should adopt some or all of the standards developed by FINRA in defining communications that rise to the level of a recommendation for purposes of distinguishing between investment education and investment advice under ERISA.

16
See also FINRA's Regulatory Notice 11-02, 12-25 and 12-55. Regulatory Notice 11-02 includes the following discussion:

For instance, a communication's content, context and presentation are important aspects of the inquiry. The determination of whether a “recommendation” has been made, moreover, is an objective rather than subjective inquiry. An important factor in this regard is whether—given its content, context and manner of presentation—a particular communication from a firm or associated person to a customer reasonably would be viewed as a suggestion that the customer take action or refrain from taking action regarding a security or investment strategy. In addition, the more individually tailored the communication is to a particular customer or customers about a specific security or investment strategy, the more likely the communication will be viewed as a recommendation. Furthermore, a series of actions that may not constitute recommendations when viewed individually may amount to a recommendation when considered in the aggregate. It also makes no difference whether the communication was initiated by a person or a computer software program. These guiding principles, together with numerous litigated decisions and the facts and circumstances of any particular case, inform the determination of whether the communication is a recommendation for purposes of FINRA's suitability rule.

Additionally, as paragraph (d) of the proposal makes clear, the regulation does not treat the mere execution of a securities transaction at the direction of

a plan or IRA owner as fiduciary activity. This paragraph remains unchanged from the 1975 regulation other than to update references to the proposal's structure. The definition's scope remains limited to advice relationships, as delineated in its text and does not impact merely administrative or ministerial activities necessary for a plan or IRA's functioning. It also does not apply to order taking where no advice is provided.

(1) Recommendations To Distribute Plan Assets

Paragraph (a)(1)(i) specifically includes recommendations concerning the investment of securities to be rolled over or otherwise distributed from the plan or IRA. Noting the Department's position in Advisory Opinion 2005-23A that it is not fiduciary advice to make a recommendation as to distribution options even if that is accompanied by a recommendation as to where the distribution would be invested, (Dec. 7, 2005), the 2010 Proposal did not include this type of advice, but the Department requested comments on whether it should be included in a final regulation. Some commenters stated that exclusion of this advice from the final rule would fail to protect participant accounts from conflicted advice in connection with one of the most significant financial decisions that participants make concerning retirement savings. Other commenters argued that including this advice would give rise to prohibited transactions that could disrupt the routine process that occurs when a worker leaves a job, contacts a financial services firm for help rolling over a 401(k) balance, and the firm explains the investments it offers and the benefits of a rollover.

The proposed regulation, if finalized, would supersede Advisory Opinion 2005-23A. Thus, recommendations to take distributions (and thereby withdraw assets from existing plan or IRA investments or roll over into a plan or IRA) or to entrust plan or IRA assets to particular money managers, advisers, or investments would fall within the scope of covered advice. However, as the proposal's text makes clear, one does not act as a fiduciary merely by providing participants with information about plan or IRA distribution options, including the consequences associated with the available types of benefit distributions. In this regard, the new proposal draws an important distinction between fiduciary investment advice and non-fiduciary investment information and educational materials. The Department believes that the proposal's treatment of such non-fiduciary educational and informational materials adequately covers the common types of distribution-related information that participants find useful, including information relating to annuitizations and other forms of lifetime income payment options, but welcomes input on other types of information that would help clarify the line between advice and education in this context.

(2) Recommendations as to the Management of Plan Investments

The preamble to the 2010 Proposal stated that the “management of securities or other property” would include advice and recommendations as to the exercise of rights appurtenant to shares of stock (
e.g.,
voting proxies). 75 FR 65266 (Oct. 22, 2010). The Department has long viewed the exercise of ownership rights as a fiduciary responsibility because of its material effect on plan investment goals. 29 CFR 2509.08-2 (2008). Consequently, individualized or specifically directed advice and recommendations on the exercise of proxy or other ownership rights are appropriately treated as fiduciary in nature. Accordingly, the proposed regulation's provision on advice regarding the management of securities or other property would continue to cover individualized advice or recommendations as to proxy voting and the management of retirement assets in paragraph (a)(1)(ii).

We received comments on the 2010 proposal seeking some clarification regarding its application to certain practices. In this regard, it is the Department's view that guidelines or other information on voting policies for proxies that are provided to a broad class of investors without regard to a client's individual interests or investment policy, and which are not directed or presented as a recommended policy for the plan or IRA to adopt, would not rise to the level of fiduciary investment advice under the proposal. Additionally, a recommendation addressed to all shareholders in a proxy statement would not result in fiduciary status on the part of the issuer of the statement or the person who distributes the proxy statement. These positions are clarified in the proposed regulation.

(3) Appraisals

The new proposal, like the current regulation which includes “advice as to the value of securities or other property,” continues to cover certain appraisals and valuation reports. However, it is considerably more focused than the 2010 Proposal. Responding to comments, the proposal in paragraph (a)(1)(iii) covers only appraisals, fairness opinions, or similar statements that relate to a particular transaction. The Department also expanded the 2010 Proposal's carve-out for general reports or statements of value provided to satisfy required reporting and disclosure rules under ERISA or the Code. The carve-out in the 2010 proposal covered general reports or statements of value that merely reflected the value of an investment of a plan or a participant or beneficiary, and provided for purposes of compliance with the reporting and disclosure requirements of ERISA, the Code, and the regulations, forms and schedules issued thereunder, unless the reports involved assets for which there was not a generally recognized market and served as a basis on which a plan could make distributions to plan participants and beneficiaries. The carve-out was broadened in this proposal to includes valuations provided solely for purposes of compliance with the reporting and disclosure provisions under the Act, the Code, and the regulations, forms and schedules issued thereunder, or any applicable reporting or disclosure requirement under a Federal or state law, or rule or regulation or self-regulatory organization (
e.g.,
FINRA) without regard to the type of asset involved. In this manner, the new proposal focuses on instances where the plan or IRA owner is looking to the appraiser for advice on the market value of an asset that the investor is considering to acquire, dispose, or exchange. In many cases the most important investment advice that an investor receives is advice as to how much it can or should pay for hard-to-value assets. In response to comments, the proposal also contains an entirely new carve-out at paragraph (b)(5)(ii) specifically addressing valuations or appraisals provided to an investment fund (
e.g.,
collective investment fund or pooled separate account) holding assets of various investors in addition to at least one plan or IRA. Also, as mentioned, the Department has decided not to extend fiduciary coverage to valuations or appraisals for ESOPs relating to employer securities at this time because the Department has concluded that its concerns in this space raise unique issues that are more appropriately addressed in a separate regulatory initiative. The proposal's carve-outs do not apply, however, if the provider of the valuation represents or acknowledges that it is acting as a fiduciary with respect to the advice.

Some representatives of the appraisal industry submitted comments on the 2010 Proposal arguing that ERISA's fiduciary duty to act solely in the interest of the plan and its participants and beneficiaries is inconsistent with the duty of appraisers to provide objective, independent value determinations. The Department disagrees. A biased or inaccurate appraisal does not help a plan, a participant or a beneficiary make prudent investment decisions. Like other forms of investment advice, an appraisal is a tool for plan fiduciaries, participants, beneficiaries, and IRA owners to use in deciding what price to pay for assets and whether to accept or decline proposed transactions. An appraiser complies with his or her obligations as an appraiser—and as a loyal fiduciary—by giving plan fiduciaries or participants an impartial and accurate assessment of the value of an asset in accordance with appraisers' professional standard of care. Nothing in ERISA or this regulation should be read as compelling an appraiser to slant valuation opinions to reflect what the plan wishes the asset were worth rather than what it is really worth. As stated in the preamble to the 2010 Proposal, the Department would expect a fiduciary appraiser's determination of value to be unbiased, fair and objective and to be made in good faith based on a prudent investigation under the prevailing circumstances then known to the appraiser. In the Department's view, these fiduciary standards are fully consistent with professional standards, such as the Uniform Standards of Professional Appraisal Practice (USPAP).
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A number of commenters also pointed to such professional standards as alternatives to fiduciary treatment under ERISA. While the Department believes that such professional standards are fully consistent with the fiduciary duties, the rights, remedies and sanctions under both ERISA and the Code importantly turn on fiduciary status, and advice on the value of an asset is often the most critical investment advice a plan receives. As a result, treating appraisals as fiduciary advice provides an additional layer of protection for consumers without conflicting with the duties of appraisers.

(4) Recommendations of a Person To Provide Investment Advice or Management Services

The proposal would treat recommendations on the selection of investment managers or advisers as fiduciary investment advice. In the Department's view, the current regulation already covers such advice. The proposal simply revises the regulation's text to remove any possible ambiguity. The Department believes that such advice should be treated as fiduciary in nature if provided under the circumstances in paragraph (a)(1)(iv) and for direct or indirect compensation. Covered advice would include recommendations of persons to perform asset management services or to make investment recommendations. Advice as to the identity of the person entrusted with investment authority over retirement assets is often critical to the proper management and investment of those assets. On the other hand, general advice as to the types of qualitative and quantitative criteria to consider in hiring an investment manager would not rise to the level of a recommendation of a person to manage plan investments nor would a trade journal's endorsement of an investment manager. Similarly, the proposed regulation would not cover recommendations of administrative service providers, property managers, or other service providers who do not provide investment services.

B. The Circumstances Under Which Advice Is Provided

As provided in paragraph (a)(2) of the proposal, unless a carve-out applies, a category of advice listed in the proposal would constitute “investment advice” if the person providing the advice, either directly or indirectly (
e.g.,
through or together with any affiliate)—

(i) Represents or acknowledges that it is acting as a fiduciary within the meaning of the Act or Code with respect to the advice described in paragraph (a)(1); or

(ii) Renders the advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is individualized to, or that such advice is specifically directed to, the advice recipient for consideration in making investment or management decisions with respect to securities or other property of the plan or IRA.

Under paragraph (a)(2)(i), advisers who claim fiduciary status under ERISA or the Code in providing advice would be taken at their word. They may not later argue that the advice was not fiduciary in nature. Nor may they rely upon the carve-outs described in paragraph (b) on the scope of the definition of fiduciary investment advice.

The 2010 Proposal provided that investment recommendations provided by an investment adviser under the Advisers Act would, in the absence of a carve-out, automatically be treated as investment advice. In response to comments, the new proposal drops this provision. Thus, the proposal avoids making such persons fiduciaries based solely on their or an affiliate's status as an investment adviser under the Advisers Act. Instead, their fiduciary status would be determined by reference to the same functional test that applies to all persons under the regulation.

Paragraph (a)(2)(ii) of the proposal avoids treating recommendations made to the general public, or to no one in particular, as investment advice and thus addresses concerns that the general circulation of newsletters, television talk show commentary, or remarks in speeches and presentations at financial industry educational conferences would result in the person being treated as a fiduciary. This paragraph requires an agreement, arrangement, or understanding that advice is directed to, a specific recipient for consideration in making investment decisions. The parties need not have a meeting of the minds on the extent to which the advice recipient will actually rely on the advice, but they must agree or understand that the advice is individualized or specifically directed to the particular advice recipient for consideration in making investment decisions. In this respect, paragraph (a)(2)(ii) differs significantly from its counterpart in the 2010 Proposal. In particular, and in response to comments, the proposal does not require that advice be individualized to the needs of the plan, participant or beneficiary or IRA owner if the advice is specifically directed to such recipient. Under the proposal, advisers could not specifically direct investment recommendations to individual persons, but then deny fiduciary responsibility on the basis that they did not, in fact, consider the advice recipient's individual needs or intend that the recipient base investment decisions on their recommendations. Nor could they continue the practice of advertising advice or counseling that is one-on-one or that a reasonable person would believe would be tailored to their individual needs and then disclaim that the recommendations are fiduciary investment advice in boilerplate language in the advertisement or in the paperwork provided to the client.

Like the 2010 Proposal, and unlike the 1975 regulation, the new proposal does not require that advice be provided on a regular basis. Investment advice that meets the requirements of the proposal, even if provided only once, can be critical to important investment decisions. If the adviser received a direct or indirect fee in connection with its advice, the advice recipients should reasonably expect adherence to fiduciary standards on the same terms as other retirement investors who get

recommendations from the adviser on a more routine basis.

C. Carve-Outs From the General Definition

The Department recognizes that in many circumstances, plan fiduciaries, participants, beneficiaries, and IRA owners may receive recommendations or appraisals that, notwithstanding the general definition set forth in paragraph (a) of the proposal, should not be treated as fiduciary investment advice. Accordingly, paragraph (b) contains a number of specific carve-outs from the scope of the general definition. The carve-out at paragraph (b)(5) of the proposal concerning financial reports and valuations was discussed above in connection with appraisals. The carve-out in paragraph (b)(5)(iii) covers communications to a plan, a plan fiduciary, a plan participant or beneficiary, an IRA or IRA owner solely for purposes of compliance with the reporting and disclosure provisions under the Act, the Code, and the regulations, forms and schedules issued thereunder, or any applicable reporting or disclosure requirement under a Federal or state law, rule or regulation or self-regulatory organization rule or regulation. The carve-out in paragraph (b)(6) covers education. The other carve-outs are limited to communications with plans and plan fiduciaries and do not cover communications to participants, beneficiaries or IRA owners. These more limited carve-outs are described more fully below. In each instance, the proposed carve-outs are for communications that the Department believes Congress did not intend to cover as fiduciary “investment advice” and that parties would not ordinarily view as communications characterized by a relationship of trust or impartiality. None of the carve-outs apply where the adviser represents or acknowledges that it is acting as a fiduciary under ERISA with respect to the advice.

(1) Seller's and Swap Carve-Outs

(a) The “Seller's Carve-Out”
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Although the preamble uses the shorthand expression “seller's carve-out,” we note that the carve-out provided in paragraph (b)(1)(i) of the proposal is not limited to sales but rather would apply to incidental advice provided in connection with an arm's length sale, purchase, loan, or bilateral contract between a plan investor with financial expertise and an adviser.

Paragraph (b)(1)(i) of the proposed regulation provides a carve-out from the general definition for incidental advice provided in connection with an arm's length sale, purchase, loan, or bilateral contract between an expert plan investor and the adviser. It also applies in connection with an offer to enter into such a transaction or when the person providing the advice is acting as a representative, such as an agent, for the plan's counterparty. This carve-out is subject to the following conditions.

First, the person must provide advice to an ERISA plan fiduciary who is independent of such person and who exercises authority or control respecting the management or disposition of the plan's assets, with respect to an arm's length sale, purchase, loan or bilateral contract between the plan and the counterparty, or with respect to a proposal to enter into such a sale, purchase, loan or bilateral contract.

Second, either of two alternative sets of conditions must be met. Under alternative one, prior to providing any recommendation with respect to the transaction, such person:

(1) Obtains a written representation from the plan fiduciary that he/she is a fiduciary who exercises authority or control with respect to the management or disposition of the employee benefit plan's assets (as described in section 3(21)(A)(i) of the Act), that the employee benefit plan has 100 or more participants covered under the plan, and that the fiduciary will not rely on the person to act in the best interests of the plan, to provide impartial investment advice, or to give advice in a fiduciary capacity;

(2) fairly informs the plan fiduciary of the existence and nature of the person's financial interests in the transaction;

(3) does not receive a fee or other compensation directly from the plan, or plan fiduciary, for the provision of investment advice in connection with the transaction (this does not preclude a person from receiving a fee or compensation for other services);

(4) knows or reasonably believes that the independent plan fiduciary has sufficient expertise to evaluate the transaction and to determine whether the transaction is prudent and in the best interest of the plan participants (such person may rely on written representations from the plan or the plan fiduciary to satisfy this condition).

The second alternative applies if the person knows or reasonably believes that the independent plan fiduciary has responsibility for managing at least $100 million in employee benefit plan assets (for purposes of this condition, when dealing with an individual employee benefit plan, a person may rely on the information on the most recent Form 5500 Annual Return/Report filed by the plan to determine the value of plan assets, and, in the case of an independent fiduciary acting as an asset manager for multiple employee benefit plans, a person may rely on representations from the independent plan fiduciary regarding the value of employee benefit plan assets under management). In that circumstance, the adviser need not obtain written representations from its counterparty to avail itself of the carve-out, but must fairly inform the independent plan fiduciary that the adviser is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity; and cannot receive a fee or other compensation directly from the plan, or plan fiduciary, for the provision of investment advice in connection with the transaction. In that circumstance, the adviser must also reasonably believe that the independent plan fiduciary has sufficient expertise to prudently evaluate the transaction.

The overall purpose of this carve-out is to avoid imposing ERISA fiduciary obligations on sales pitches that are part of arm's length transactions where neither side assumes that the counterparty to the plan is acting as an impartial trusted adviser, but the seller is making representations about the value and benefits of proposed deals. Under appropriate circumstances, reflected in the conditions to this carve-out, these counterparties to the plan do not suggest that they are an impartial fiduciary and plans do not expect a relationship of undivided loyalty or trust. Both sides of such transactions understand that they are acting at arm's length, and neither party expects that recommendations will necessarily be based on the buyer's best interests. In such a sales transaction, the buyer understands that it is buying an investment product, not advice about whether it is a good product, from a seller who has opposing financial interests. The seller's invitation to buy the product is understood as a sales pitch, not a recommendation. Also, a representative for the plan's counterparty, such as a broker, in such a transaction, would be able to use the carve-out if the conditions are met.

Although the 2010 Proposal also had a carve-out for sellers and other counterparties, the carve-out in the new proposal is significantly different. The changes are designed to ensure that the carve-out appropriately distinguishes incidental advice as part of an arm's length transactions with no expectation of trust or acting in the customer's best interest, from those instances of advice where customers may be expecting unbiased investment advice that is in their best interest. For example, the seller's carve-out is unavailable to an adviser if the plan directly pays a fee for investment advice. If a plan expressly

pays a fee for advice, the essence of the relationship is advisory, and the statute clearly contemplates fiduciary status. Thus, a service provider may not charge the plan a direct fee to act as an adviser, and then disclaim responsibility as a fiduciary adviser by asserting that he or she is merely an arm's length counterparty.

Commenters on the 2010 Proposal differed on whether the carve-out should apply to transactions involving plan participants, beneficiaries or IRA owners. After carefully considering the issue and the public comments, the Department does not believe such a carve-out can or should be crafted to cover recommendations to retail investors, including small plans, IRA owners and plan participants and beneficiaries. As a rule, investment recommendations to such retail customers do not fit the “arm's length” characteristics that the seller's carve-out is designed to preserve. Recommendations to retail investors and small plan providers are routinely presented as advice, consulting, or financial planning services. In the securities markets, brokers' suitability obligations generally require a significant degree of individualization. Research has shown that disclaimers are ineffective in alerting retail investors to the potential costs imposed by conflicts of interest, or the fact that advice is not necessarily in their best interest, and may even exacerbate these costs.
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Most retail investors and many small plan sponsors are not financial experts, are unaware of the magnitude and impact of conflicts of interest, and are unable effectively to assess the quality of the advice they receive. IRA owners are especially at risk because they lack the protection of having a menu of investment options chosen by a plan fiduciary who is charged to protect the interests of the IRA owner. Similarly, small plan sponsors are typically experts in the day-to-day business of running an operating company, not in managing financial investments for others. In this retail market, a seller's carve-out would run the risk of creating a loophole that would result in the rule failing to improve consumer protections by permitting the same type of boilerplate disclaimers that some advisers now use to avoid fiduciary status under the current “five-part test” regulation. Persons making investment recommendations should be required to put the interests of the investors they serve ahead of their own. The Department has addressed legitimate concerns about preserving existing fee practices and minimizing market disruptions through proposed prohibited transaction exemptions detailed below, rather than through a blanket carve-out from fiduciary status.

19
Loewenstein, George, Daylian Cain, Sunita Sah,
The Limits of Transparence: Pitfalls and Potential of Disclosing Conflicts of Interest,
American Economic Review: Papers and Proceedings 101, no. 3 (2011).

Moreover, excluding retail investors from the seller's carve-out is consistent with recent congressional action, the Pension Protection Act of 2006 (PPA). Specifically, the PPA created a new statutory exemption that allows fiduciaries giving investment advice to individuals (pension plan participants, beneficiaries and IRA owners) to receive compensation from investment vehicles that they recommend in certain circumstances. 29 U.S.C. 1108(b)(14); 26 U.S.C. 4975(d)(17). Recognizing the risks presented when advisers receive fees from the investments they recommend to individuals, Congress placed important constraints on such advice arrangements that are calculated to limit the potential for abuse and self-dealing, including requirements for fee-leveling or the use of independently certified computer models. The Department has issued regulations implementing this provision at 29 CFR 2550.408g-1 and 408g-2. Including retail investors in the seller's carve-out would undermine the protections for retail investors that Congress required under this PPA provision.

Although the seller's carve-out may not be available in the retail market, the proposal is intended to ensure that small plan fiduciaries, plan participants, beneficiaries and IRA owners would be able to obtain essential information regarding important decisions they make regarding their investments without the providers of that information crossing the line into fiduciary status. Under the platform provider carve-out under paragraph (b)(3), platform providers (
i.e.,
persons that provide access to securities or other property through a platform or similar mechanism) and persons that help plan fiduciaries select or monitor investment alternatives for their plans can perform those services without incurring fiduciary status. Similarly, under the investment education carve-out of paragraph (b)(6), general plan information, financial, investment and retirement information, and information and education regarding asset allocation models would all be available to a plan, plan fiduciary, participant, beneficiary or IRA owner and would not constitute the provision of investment advice, irrespective of who receives that information. The Department invites comments on whether the proposed seller's carve-out should be available for advice given directly to plan participants, beneficiaries, and IRA owners. Further, the Department invites comments on the scope of the seller's carve-out and whether the plan size limitation of 100 plan participants and 100 million dollar asset requirement in the proposal are appropriate conditions or whether other conditions would be more appropriate proxies for identifying persons with sufficient investment-related expertise to be included in a seller's carve-out.
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The Department is also interested in whether existing and proposed prohibited transaction exemptions eliminate or mitigate the need for any seller's carve-out.

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The proposed thresholds of 100 or more participants and assets of $100 million are consistent with thresholds used for similar purposes under existing rules and practices. For example, administrators of plans with 100 or more participants, unlike smaller plans, generally are required to report to the Department details on the identity, function, and compensation of their services providers; file a schedule of assets held for investments; and submit audit reports to the Department. Smaller plans are not subject to these same filing requirements that are imposed on large plans. The vast majority of plans with fewer than 100 participants have 10 or less participants. They are much more similar to individual retail investors than to large financially sophisticated institutional investors, who employ lawyers and have the time and expertise to scrutinize advice they receive for bias. Similarly, Congress established a $100 million asset threshold in enacting the PPA statutory cross-trading exemption under ERISA section 408(b)(19). In the transactions covered by 408(b)(19), an investment manager has discretion with respect to separate client accounts that are on opposite sides of the trade. The cross trade can create efficiencies for both clients, but it also gives rise to a prohibited transaction under ERISA § 406(b)(2) because the adviser or manager is “representing” both sides of the transaction and, therefore, has a conflict of interest. The exemption generally allows an investment manager to effect cash purchases and sales of securities for which market quotations are readily available between large sophisticated plans with at least $100 million in assets and another account under management by the investment manager, subject to certain conditions. In this context, the $100 million threshold serves as a proxy for identifying institutional fiduciaries that can be expected to have the expertise to protect their own interests in the conflicted transaction.

(b) Swap and Security-Based Swap Transactions

Paragraph (b)(1)(ii) of the proposal specifically addresses advice and other communications by counterparties in connection with certain swap or security-based swap transactions under the Commodity Exchange Act or the Securities Exchange Act. This broad class of financial transactions is defined and regulated under amendments to the Commodity Exchange Act and the Securities Exchange Act by the Dodd-Frank Act. Section 4s(h) of the Commodity Exchange Act (7 U.S.C. 6s(h)), and section 15F of the Securities

Exchange Act of 1934 (15 U.S.C. 78o-10(h) establishes similar business conduct standards for dealers and major participants in swaps or security-based swaps. Special rules apply for transactions involving “special entities,” a term that includes employee benefit plans under ERISA, but not IRAs and other non-ERISA plans.

In outline, paragraph (b)(1)(ii) of the proposal would allow swap dealers, security-based swap dealers, major swap participants and security-based major swap participants who make recommendations to plans to avoid becoming ERISA investment advice fiduciaries when acting as counterparties to a swap or security-based swap transaction. Under the swap carve out, if the person providing recommendations is a swap dealer or security-based swap dealer, it must not be acting as an adviser to the plan, within the meaning of the applicable business conduct standards regulations of the CFTC or the SEC. In addition, before providing any recommendations with respect to the transaction, the person providing recommendations must obtain a written representation from the independent plan fiduciary, that the fiduciary will not rely on recommendations provided by the person.

Under the Commodity Exchange Act, swap dealers or major swap participants that act as counterparties to ERISA plans, must have a reasonable basis to believe that the plans have independent representatives who are fiduciaries under ERISA. 7 U.S.C. 6s(h)(5). Similar requirements apply for security-based swap transactions. 15 U.S.C 78o-10(h)(4) and (5). The CFTC has issued a final rule to implement these requirements and the SEC has issued a proposed rule that would cover security-based swaps. 17 CFR 23.400 to 23.451 (2012).

Paragraph (b)(1)(ii) reflects the Department's coordination of its efforts with staff of the SEC and CFTC, and is intended to provide a clear road-map for swap counterparties to avoid ERISA fiduciary status in arm's length transactions with plans. The provision addresses commenters' concerns that the conduct required for compliance with the Dodd-Frank Act's business conduct standards could constitute fiduciary investment advice under ERISA even in connection with arm's length transactions with plans that are separately represented by independent fiduciaries who are not looking to their counterparties for disinterested advice. If that were the case, swaps and security-based swaps with plans would often constitute prohibited transactions under ERISA. Commenters also argued that their obligations under the business conduct standards could effectively preclude them from relying on the carve-out for counterparties in the 2010 Proposal. Although the Department does not agree that the carve-out in the 2010 Proposal would have been unavailable to plan's swap counterparty (see letter dated April 28, 2011, to CFTC Chairman Gary Gensler from EBSA's Assistant Secretary Phyllis Borzi), the separate proposed carve-out for swap and security-based swap transactions in the proposal should avoid any uncertainty.
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The Department will continue to coordinate its efforts with staff of the SEC and CFTC to ensure that any final regulation is consistent with the agencies' work in connection with the Dodd-Frank Act's business conduct standards.

21

http://www.dol.gov/ebsa/pdf/cftc20110428.pdf.

(2) Employees of the Plan Sponsor

The proposal at paragraph (b)(2) provides that employees of a plan sponsor of an ERISA plan would not be treated as investment advice fiduciaries with respect to advice they provide to the fiduciaries of the sponsor's plan as long as they receive no compensation for the advice beyond their normal compensation as employees of the plan sponsor. This carve-out from the scope of the fiduciary investment advice definition recognizes that internal employees, such as members of a company's human resources department, routinely develop reports and recommendations for investment committees and other named fiduciaries of the sponsors' plans, without acting as paid fiduciary advisers. The carve-out responds to and addresses the concerns of commenters who said that these personnel should not be treated as fiduciaries because their advice is largely incidental to their duties on behalf of the plan sponsor and they receive no compensation for these advice-related functions.

(3) Platform Providers/Selection and Monitoring Assistance

The carve-out at paragraph (b)(3) of the proposal is directed to service providers, such as recordkeepers and third party administrators, that offer a “platform” or selection of investment vehicles to participant-directed individual account plans under ERISA. Under the terms of the carve-out, the plan fiduciaries must choose the specific investment alternatives that will be made available to participants for investing their individual accounts. The carve-out merely makes clear that persons would not act as investment advice fiduciaries simply by marketing or making available such investment vehicles, without regard to the individualized needs of the plan or its participants and beneficiaries, as long as they disclose in writing that they are not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity.

Similarly, a separate provision at paragraph (b)(4) carves out certain common activities that platform providers may carry out to assist plan fiduciaries in selecting and monitoring the investment alternatives that they make available to plan participants. Under paragraph (b)(4), merely identifying offered investment alternatives meeting objective criteria specified by the plan fiduciary or providing objective financial data regarding available alternatives to the plan fiduciary would not cause a platform provider to be a fiduciary investment adviser. These two carve-outs are clarifying modifications to the corresponding provisions of the 2010 Proposal. They address certain common practices that have developed with the growth of participant-directed individual account plans and recognize circumstances where the platform provider and the plan fiduciary clearly understand that the provider has financial or other relationships with the offered investments and is not purporting to provide impartial investment advice. It also accommodates the fact that platform providers often provide general financial information that falls short of constituting actual investment advice or recommendations, such as information on the historic performance of asset classes and of the investments available through the provider. The carve-outs also reflect the Department's agreement with commenters that a platform provider who merely identifies investment alternatives using objective third-party criteria (
e.g.,
expense ratios, fund size, or asset type specified by the plan fiduciary) to assist in selecting and monitoring investment alternatives should not be considered to be rendering investment advice.

While recognizing the utility of the provisions in paragraphs (b)(3) and (b)(4) for the effective and efficient operation of plans by plan sponsors, plan fiduciaries and plan service providers, the Department reiterates its longstanding view, recently codified in 29 CFR 2550.404a-5(f) and 2550.404c-1(d)(2)(iv) (2010), that a fiduciary is always responsible for prudently selecting and monitoring providers of services to the plan or designated

investment alternatives offered under the plan.

Several commenters also asked the Department to clarify that the platform provider carve-out is available in the 403(b) plan marketplace. In the Department's view, a 403(b) plan that is subject to Title I of ERISA would be an individual account plan within the meaning of ERISA section 3(34) of the Act for purposes of the proposed regulation, so the platform provider carve-out would be available with respect to such plans.

Other commenters asked that the platform provider provision be generally extended to apply to IRAs. In the IRA context, however, there typically is no separate independent “plan fiduciary” who interacts with the platform provider to protect the interests of the account owners. As a result, it is much more difficult to conclude that the transaction is truly arm's length or to draw a bright line between fiduciary and non-fiduciary communications on investment options. Consequently, the proposed regulation declines to extend application of this carve-out to IRAs and other non-ERISA plans. As the Department continues its wor

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2015-08831. Public record. Not legal advice.