# Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/fr%3A2016-07926

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** April 8, 2016
- **Citation:** 81 FR 21089

## Text

DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
[Application Number D-11713]
ZRIN 1210-ZA25
Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs

AGENCY:

Employee Benefits Security Administration (EBSA), U.S. Department of Labor.

ACTION:

Adoption of Class Exemption.

SUMMARY:

This document contains an exemption from certain prohibited transactions provisions of the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (the Code). The provisions at issue generally prohibit fiduciaries with respect to employee benefit plans and individual retirement accounts (IRAs) from purchasing and selling investments when the fiduciaries are acting on behalf of their own accounts (principal transactions). The exemption permits principal transactions and riskless principal transactions in certain investments between a plan, plan participant or beneficiary account, or an IRA, and a fiduciary that provides investment advice to the plan or IRA, under conditions to safeguard the interests of these investors. The exemption affects participants and beneficiaries of plans, IRA owners, and fiduciaries with respect to such plans and IRAs.

DATES:

Issuance date:
This exemption is issued June 7, 2016.

Applicability date:
This exemption is applicable to transactions occurring on or after April 10, 2017. See Section F of this preamble,
Applicability Date and Transition Rules
in this preamble, for further information.

FOR FURTHER INFORMATION CONTACT:

Brian Shiker, Office of Exemption Determinations, Employee Benefits Security Administration, U.S. Department of Labor (202) 693-8824 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Executive Summary

Purpose of Regulatory Action

The Department grants this exemption in connection with its publication today, elsewhere in this issue of the
Federal Register
, of a final regulation defining who is a “fiduciary” of an employee benefit plan under ERISA as a result of giving investment advice to a plan or its participants or beneficiaries (Regulation). The Regulation also applies to the definition of a “fiduciary” of a plan (including an IRA) under the Code. The Regulation amends a prior regulation, dating to 1975, specifying when a person is a “fiduciary” under ERISA and the Code by reason of the provision of investment advice for a fee or other compensation regarding assets of a plan or IRA. The Regulation takes into account the advent of 401(k) plans and IRAs, the dramatic increase in rollovers, and other developments that have transformed the retirement plan landscape and the associated investment market over the four decades since the existing regulation was issued. In light of the extensive changes in retirement investment practices and relationships, the Regulation updates existing rules to distinguish more appropriately between the sorts of advice relationships that should be treated as fiduciary in nature and those that should not.

This exemption allows investment advice fiduciaries to engage in purchases and sales of certain investments out of their inventory (
i.e.,
engage in principal transactions) with plans, participant or beneficiary accounts, and IRAs, under conditions designed to safeguard the interests of these investors. In the absence of an exemption, these transactions would be prohibited under ERISA and the Code. In this regard, ERISA and the Code generally prohibit fiduciaries with respect to plans and IRAs from purchasing or selling any property to plans, participant or beneficiary accounts, or IRAs. Fiduciaries also may not engage in self-dealing or, under ERISA, act in any transaction involving the plan on behalf of a party whose interests are adverse to the interests of the plan or the interests of its participants and beneficiaries. When a fiduciary purchases or sells an investment in a principal transaction or riskless principal transaction, it violates these prohibitions.

ERISA section 408(a) specifically authorizes the Secretary of Labor to grant administrative exemptions from ERISA's prohibited transaction provisions.
1

Regulations at 29 CFR 2570.30 to 2570.52 describe the procedures for applying for an administrative exemption. In granting this exemption, the Department has determined that the exemption is administratively feasible, in the interests of plans and their participants and beneficiaries and IRA owners, and protective of the rights of participants and beneficiaries of plans and IRA owners.

1
Code section 4975(c)(2) authorizes the Secretary of the Treasury to grant exemptions from the parallel prohibited transaction provisions of the Code. Reorganization Plan No. 4 of 1978 (5 U.S.C. app. at 214 (2000)) (Reorganization Plan) generally transferred the authority of the Secretary of the Treasury to grant administrative exemptions under Code section 4975 to the Secretary of Labor. To rationalize the administration and interpretation of dual provisions under ERISA and the Code, the Reorganization Plan divided the interpretive and rulemaking authority for these provisions between the Secretaries of Labor and of the Treasury, so that, in general, the agency with responsibility for a given provision of Title I of ERISA would also have responsibility for the corresponding provision in the Code. Among the sections transferred to the Department were the prohibited transaction provisions and the definition of a fiduciary in both Title I of ERISA and in the Code. ERISA's prohibited transaction rules, 29 U.S.C. 1106-1108, apply to ERISA-covered plans, and the Code's corresponding prohibited transaction rules, 26 U.S.C. 4975(c), apply both to ERISA-covered pension plans that are tax-qualified pension plans, as well as other tax-advantaged arrangements, such as IRAs, that are not subject to the fiduciary responsibility and prohibited transaction rules in ERISA. Specifically, section 102(a) of the Reorganization Plan provides the Department of Labor with “all authority” for ”regulations, rulings, opinions, and exemptions under section 4975 [of the Code]” subject to certain exceptions not relevant here. Reorganization Plan section 102. In President Carter's message to Congress regarding the Reorganization Plan, he made explicitly clear that as a result of the plan, “Labor will have statutory authority for fiduciary obligations. . . . Labor will be responsible for overseeing fiduciary conduct under these provisions.” Reorganization Plan, Message of the President. This exemption provides relief from the indicated prohibited transaction provisions of both ERISA and the Code.

Summary of the Major Provisions

The exemption allows an individual investment advice fiduciary (an Adviser)
2

and the firm that employs or otherwise contracts with the Adviser (a Financial Institution) to engage in principal transactions and riskless principal transactions involving certain investments, with plans, participant and beneficiary accounts, and IRAs. The exemption limits the type of investments that may be purchased or sold and contains conditions which the

Adviser and Financial Institution must satisfy in order to rely on the exemption. To safeguard the interests of plans, participants and beneficiaries, and IRA owners, the exemption requires Financial Institutions to give the appropriate fiduciary of the plan or IRA owner a written statement in which the Financial Institution acknowledges its fiduciary status and that of its Advisers. The Financial Institution and Adviser must adhere to enforceable standards of fiduciary conduct and fair dealing when providing investment advice regarding the transaction to Retirement Investors. In the case of IRAs and non-ERISA plans, the exemption requires that these standards be set forth in an enforceable contract with the Retirement Investor. Under the exemption's terms, Financial Institutions are not required to enter into a contract with ERISA plan investors, but they are obligated to acknowledge fiduciary status in writing, and adhere to these same standards of fiduciary conduct, which the investors can effectively enforce pursuant to section 502(a)(2) and (3) of ERISA. Under this standards-based approach, the Adviser and Financial Institution must give prudent advice that is in the customer's Best Interest, avoid misleading statements, and seek to obtain the best execution reasonably available under the circumstances with respect to the transaction. Additionally, Financial Institutions must adopt policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, and must disclose their conflicts of interest to Retirement Investors.

2
By using the term “Adviser,” the Department does not intend to limit the exemption to investment advisers registered under the Investment Advisers Act of 1940 or under state law. As explained herein, an Adviser must be an investment advice fiduciary of a plan or IRA who is an employee, independent contractor, agent, or registered representative of a registered investment adviser, bank, or registered broker-dealer.

The exemption is calibrated to align the Adviser's interests with those of the plan or IRA customer, while leaving the Adviser and the Financial Institution the flexibility and discretion necessary to determine how best to satisfy the exemption's standards in light of the unique attributes of their business. Financial Institutions relying on the exemption must obtain the Retirement Investor's consent to participate in principal transactions and riskless principal transactions, and the Financial Institutions are subject to recordkeeping requirements.

Executive Order 12866 and 13563 Statement

Under Executive Orders 12866 and 13563, the Department must determine whether a regulatory action is “significant” and therefore subject to the requirements of the Executive Order and subject to review by the Office of Management and Budget (OMB). Executive Orders 12866 and 13563 direct agencies to assess all costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing and streamlining rules, and of promoting flexibility. It also requires federal agencies to develop a plan under which the agencies will periodically review their existing significant regulations to make the agencies' regulatory programs more effective or less burdensome in achieving their regulatory objectives.

Under Executive Order 12866, “significant” regulatory actions are subject to the requirements of the Executive Order and review by the OMB. Section 3(f) of Executive Order 12866, defines a “significant regulatory action” as an action that is likely to result in a rule (1) having an annual effect on the economy of $100 million or more, or adversely and materially affecting a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or State, local or tribal governments or communities (also referred to as “economically significant” regulatory actions); (2) creating serious inconsistency or otherwise interfering with an action taken or planned by another agency; (3) materially altering the budgetary impacts of entitlement grants, user fees, or loan programs or the rights and obligations of recipients thereof; or (4) raising novel legal or policy issues arising out of legal mandates, the President's priorities, or the principles set forth in the Executive Order. Pursuant to the terms of the Executive Order, OMB has determined that this action is “significant” within the meaning of Section 3(f)(1) of the Executive Order. Accordingly, the Department has undertaken an assessment of the costs and benefits of the proposal, and OMB has reviewed this regulatory action. The Department's complete Regulatory Impact Analysis is available at
www.dol.gov/ebsa.

I. Background

The Department proposed this class exemption on its own motion, pursuant to ERISA section 408(a) and Code section 4975(c)(2), and in accordance with the procedures set forth in 29 CFR part 2570, subpart B (76 FR 66637 (October 27, 2011)).

A. Regulation Defining a Fiduciary

As explained more fully in the preamble to the Regulation, ERISA 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 its 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.
3

In addition, they must refrain from engaging in “prohibited transactions,” which ERISA does not permit because of the dangers posed by the fiduciaries' conflicts of interest with respect to the transactions.
4

When fiduciaries violate ERISA's fiduciary duties or the prohibited transaction rules, they may be held personally liable for the breach.
5

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

3
ERISA section 404(a).

4
ERISA section 406. ERISA also prohibits certain transactions between a plan and a party in interest.

5
ERISA section 409;
see also
ERISA section 405.

The Code also has rules regarding fiduciary conduct with respect to tax-favored accounts that are not generally covered by ERISA, such as IRAs. In particular, fiduciaries of these arrangements, including IRAs, are subject to the prohibited transaction rules and, when they violate the rules, to the imposition of an excise tax enforced by the Internal Revenue Service. Unlike participants in plans covered by Title I of ERISA, IRA owners do not have a statutory right to bring suit against fiduciaries for violations of the prohibited transaction rules.

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, ERISA section 3(21)(A) and Code section 4975(e)(3) provide that a person is a fiduciary with respect to a plan or IRA to the extent he or she (i) exercises any discretionary authority or discretionary control with respect to management of such plan or IRA, 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 IRA, or has any authority or responsibility to do so; or, (iii) has any discretionary authority or discretionary responsibility in the administration of such plan or IRA.

The statutory definition deliberately casts a wide net in assigning fiduciary responsibility with respect to plan and IRA assets. Thus, “any authority or control” over plan or IRA assets is sufficient to confer fiduciary status, and any persons who render “investment advice for a fee or other compensation, direct or indirect” are fiduciaries, regardless of whether they have direct control over the plan's or IRA's assets and regardless of their status as an investment adviser or broker under the federal securities laws. The statutory definition and associated responsibilities were enacted to ensure that plans, plan participants and IRA owners can depend on persons who provide investment advice for a fee to provide recommendations that are untainted by conflicts of interest. In the absence of fiduciary status, the providers of investment advice are neither subject to ERISA's fundamental fiduciary standards, nor accountable under ERISA or the Code for imprudent, disloyal, or biased advice.

In 1975, the Department issued a regulation, at 29 CFR 2510.3-21(c)(1975) 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).
6

The 1975 regulation narrowed the scope of the statutory definition of fiduciary investment advice by creating a five-part test for fiduciary advice. Under the 1975 regulation, for advice to constitute “investment advice,” an adviser 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. The 1975 regulation provided 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.

6
The Department of Treasury issued a virtually identical regulation, at 26 CFR 54.4975-9(c), which interprets Code section 4975(e)(3).

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 retail investors, who typically do not have financial expertise and can ill-afford lower returns to their retirement savings caused by conflicts. The IRA accounts of these investors often account for all or the lion's share of their assets, and can represent all of savings earned for a lifetime of work. Losses and reduced returns can be devastating to the investors who depend upon such savings for support in their old age. 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. These rollovers are expected to approach $2.4 trillion cumulatively from 2016 through 2020.
7

These trends were not apparent when the Department promulgated the 1975 regulation. At that time, 401(k) plans did not yet exist and IRAs had only just been authorized.

7
Cerulli Associates, “Retirement Markets 2015.”

As the marketplace for financial services has developed in the years since 1975, the five-part test has now come to undermine, rather than promote, the statutes' text and purposes. The narrowness of the 1975 regulation has allowed 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 relied on paid advisers for impartial guidance, the 1975 regulation has allowed many advisers to avoid fiduciary status and disregard basic fiduciary obligations of care and prohibitions on disloyal and conflicted transactions. As a consequence, these advisers have been able to 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 be prohibited by ERISA and the Code without fear of accountability under either ERISA or the Code.

In the Department's amendments to the 1975 regulation defining fiduciary advice within the meaning of ERISA section 3(21)(A)(ii) and Code section 4975(e)(3)(B) (the Regulation), which are also published in this issue of the
Federal Register
, the Department is replacing the existing regulation with one that more appropriately distinguishes between the sorts of advice relationships that should be treated as fiduciary in nature and those that should not, in light of the legal framework and financial marketplace in which IRAs and plans currently operate.
8

8
The Department initially proposed an amendment to its regulation defining a fiduciary within the meaning of ERISA section 3(21)(A)(ii) and Code section 4975(e)(3)(B) on October 22, 2010, at 75 FR 65263. It subsequently announced its intention to withdraw the proposal and propose a new rule, consistent with the President's Executive Orders 12866 and 13563, in order to give the public a full opportunity to evaluate and comment on the new proposal and updated economic analysis. The first proposed amendment to the rule was withdrawn on April 20, 2015,
see
80 FR 21927.

The Regulation describes the types of advice that constitute “investment advice” with respect to plan or IRA assets for purposes of the definition of a fiduciary at ERISA section 3(21)(A)(ii) and Code section 4975(e)(3)(B). The Regulation covers ERISA-covered plans, IRAs, and other plans not covered by Title I, such as Keogh plans, and health savings accounts described in Code section 223(d).

As amended, the Regulation provides that a person renders investment advice with respect to assets of a plan or IRA if, among other things, the person provides, directly to a plan, a plan fiduciary, plan participant or beneficiary, IRA or IRA owner, the following types of advice, for a fee or other compensation, whether direct or indirect:

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

recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred or distributed from the plan or IRA; and

(ii) A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, types of investment account arrangements (brokerage versus advisory), or recommendations with respect to rollovers, transfers or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer or distribution should be made.

In addition, in order to be treated as a fiduciary, such person, either directly or indirectly (
e.g.,
through or together with any Affiliate), must: Represent or acknowledge that it is acting as a fiduciary within the meaning of ERISA or the Code with respect to the advice described; represent or acknowledge that it is acting as a fiduciary within the meaning of ERISA or the Code; render the advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is based on the particular investment needs of the advice recipient; or direct the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

The Regulation also provides that as a threshold matter in order to be fiduciary advice, the communication must be a “recommendation” as defined therein. The Regulation, as a matter of clarification, provides that a variety of other communications do not constitute “recommendations,” including non-fiduciary investment education; general communications; and specified communications by platform providers. These communications which do not rise to the level of “recommendations” under the Regulation are discussed more fully in the preamble to the final Regulation.

The Regulation also specifies certain circumstances where the Department has determined that a person will not be treated as an investment advice fiduciary even though the person's activities technically may satisfy the definition of investment advice. For example, the Regulation contains a provision excluding recommendations to independent fiduciaries with financial expertise that are acting on behalf of plans or IRAs in arm's length transactions, if certain conditions are met. The independent fiduciary must be a bank, insurance carrier qualified to do business in more than one state, investment adviser registered under the Investment Advisers Act of 1940 or by a state, broker-dealer registered under the Securities Exchange Act of 1934 (Exchange Act), or any other independent fiduciary that holds, or has under management or control, assets of at least $50 million, and: (1) The person making the recommendation must know or reasonably believe that the independent fiduciary of the plan or IRA is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies (the person may rely on written representations from the plan or independent fiduciary to satisfy this condition); (2) the person must fairly inform the independent fiduciary that the person is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with the transaction and must fairly inform the independent fiduciary of the existence and nature of the person's financial interests in the transaction; (3) the person must know or reasonably believe that the independent fiduciary of the plan or IRA is a fiduciary under ERISA or the Code, or both, with respect to the transaction and is responsible for exercising independent judgment in evaluating the transaction (the person may rely on written representations from the plan or independent fiduciary to satisfy this condition); and (4) the person cannot receive a fee or other compensation directly from the plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner for the provision of investment advice (as opposed to other services) in connection with the transaction.

Similarly, the Regulation provides that the provision of any advice to an employee benefit plan (as described in ERISA section 3(3)) by a person who is a swap dealer, security-based swap dealer, major swap participant, major security-based swap participant, or a swap clearing firm in connection with a swap or security-based swap, as defined in section 1a of the Commodity Exchange Act (7 U.S.C. 1a) and section 3(a) of the Exchange Act (15 U.S.C. 78c(a)) is not investment advice if certain conditions are met. Finally, the Regulation describes certain communications by employees of a plan sponsor, plan, or plan fiduciary that would not cause the employee to be an investment advice fiduciary if certain conditions are met.

B. Prohibited Transactions

The Department anticipates that the Regulation will cover many investment professionals who did not previously consider themselves to be fiduciaries under ERISA or the Code. Under the Regulation, these entities will be subject to the prohibited transaction restrictions in ERISA and the Code that apply specifically to fiduciaries. ERISA section 406(b)(1) and Code section 4975(c)(1)(E) prohibit a fiduciary from dealing with the income or assets of a plan or IRA in his own interest or his own account. ERISA section 406(b)(2), which does not apply to IRAs, provides that a fiduciary shall not “in his individual or in any other capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries.” ERISA section 406(b)(3) and Code section 4975(c)(1)(F) prohibit a fiduciary from receiving any consideration for his own personal account from any party dealing with the plan or IRA in connection with a transaction involving assets of the plan or IRA.

Parallel regulations issued by the Departments of Labor and the Treasury explain that these provisions impose on fiduciaries of plans and IRAs a duty not to act on conflicts of interest that may affect the fiduciary's best judgment on behalf of the plan or IRA.
9

The prohibitions extend to a fiduciary causing a plan or IRA to pay an additional fee to such fiduciary, or to a person in which such fiduciary has an interest that may affect the exercise of the fiduciary's best judgment as a fiduciary. Likewise, a fiduciary is prohibited from receiving compensation from third parties in connection with a transaction involving the plan or IRA.
10

9
Subsequent to the issuance of these regulations, Reorganization Plan No. 4 of 1978, 5 U.S.C. App. (2010), divided rulemaking and interpretive authority between the Secretaries of Labor and the Treasury. The Secretary of Labor was given interpretive and rulemaking authority regarding the definition of fiduciary under both Title I of ERISA and the Internal Revenue Code.
Id.
section 102(a) (“all authority of the Secretary of the Treasury to issue [regulations, rulings opinions, and exemptions under section 4975 of the Code] is hereby transferred to the Secretary of Labor”).

10
29 CFR 2550.408b-2(e); 26 CFR 54.4975-6(a)(5).

The purchase or sale of an investment in a principal transaction or riskless principal transaction between a plan or IRA and a fiduciary, resulting from the fiduciary's provision of investment advice, implicates the prohibited

transaction rules set forth in ERISA section 406(b) and Code section 4975(c)(1)(E).
11

Nevertheless, the Department recognizes that certain investment advice fiduciaries view the ability to execute principal transactions or riskless principal transaction as integral to the economically efficient distribution of fixed income securities. Therefore, in connection with the Regulation, the Department reviewed the existing legal framework to determine whether additional exemptions were needed for investment advice fiduciaries to engage in these transactions. In this regard, as further discussed below, fiduciaries who engage in such transactions under certain circumstances can avoid the ERISA and Code restrictions. Moreover, there are existing statutory and administrative exemptions, also discussed below, that already provide prohibited transaction relief for fiduciaries engaging in principal transactions and riskless principal transactions with plans and IRAs. Nevertheless, the Department determined that additional relief in this area is necessary and therefore, after reviewing the comments on the proposal, determined to grant this exemption for investment advice fiduciaries to engage in certain principal transactions and riskless principal transactions with plans and IRAs.

11
The purchase or sale of an investment in a principal transaction or a riskless principal transaction between a plan or IRA and a fiduciary also is prohibited by ERISA section 406(a)(1)(A) and (D) and Code section 4975(c)(1)(A) and (D).

1. Blind Transactions

Certain principal transactions and riskless principal transactions between a plan or IRA and an investment advice fiduciary may not need exemptive relief because they are blind transactions executed on an exchange. The ERISA Conference Report states that a transaction will, generally, not be a prohibited transaction if the transaction is an ordinary “blind” purchase or sale of securities through an exchange where neither the buyer nor the seller (nor the agent of either) knows the identity of the other party involved.
12

12

See
H.R. Rep. 93-1280, 93rd Cong., 2d Sess. 307 (1974); s
ee also
ERISA Advisory Opinion 2004-05A (May 24, 2004).

2. Principal Transactions Permitted Under an Exemption

As the prohibited transaction provisions demonstrate, ERISA and the Code strongly disfavor conflicts of interest. In appropriate cases, however, the statutes provide exemptions from their broad prohibitions on conflicts of interest. In addition, the Secretary of Labor has discretionary authority to grant administrative exemptions under ERISA and the Code on an individual or class basis, but only if the Secretary first finds that the exemptions are (1) administratively feasible, (2) in the interests of plans and their participants and beneficiaries and IRA owners, and (3) protective of the rights of the participants and beneficiaries of such plans and IRA owners. Accordingly, fiduciary advisers may always give advice without need of an exemption if they avoid the sorts of conflicts of interest that result in prohibited transactions. However, when they choose to give advice in which they have a conflict of interest, they must rely upon an exemption.

a. Statutory Exemptions

ERISA section 408(b)(14) provides a statutory exemption for transactions entered into in connection with the provision of fiduciary investment advice to a participant or beneficiary of an individual account plan or an IRA owner. The exemption provides relief for, among other things, the acquisition, holding, or sale of a security or other property as an investment under the plan pursuant to the investment advice. As set forth in ERISA section 408(g), the exemption is available if the advice is provided under an “eligible investment advice arrangement” which either (1) “provides that any fees (including any commission or other compensation) received by the fiduciary adviser for investment advice or with respect to the sale, holding or acquisition of any security or other property for purposes of investment of plan assets do not vary depending on the basis of any investment option selected” or (2) “uses a computer model under an investment advice program meeting the requirements of [ERISA section 408(g)(3)].” The ERISA section 408(g) exemptions include special conditions calibrated to insulate the fiduciary adviser from conflicts of interest. Code section 4975(d)(17) provides the same relief from the taxes imposed by Code section 4975(a) and (b).

ERISA section 408(b)(16) provides relief for transactions involving the purchase or sale of securities between a plan and a party in interest, including an investment advice fiduciary, if the transactions are executed through an electronic communication network, alternative trading system, or similar execution system or trading venue. Among other conditions, subparagraph (B) of the statutory exemption requires that either: (i) “the transaction is effected pursuant to rules designed to match purchases and sales at the best price available through the execution system in accordance with applicable rules of the Securities and Exchange Commission or other relevant governmental authority,” or (ii) “neither the execution system nor the parties to the transaction take into account the identity of the parties in the execution of trades[.]” The transactions covered by ERISA section 408(b)(16) include principal transactions between a plan and an investment advice fiduciary. Code section 4975(d)(19) provides the same relief from the taxes imposed by Code section 4975(a) and (b).

b. Administrative Exemptions

An administrative exemption for certain principal transactions will continue to be available through PTE 75-1.
13

Specifically, PTE 75-1, Part IV, provides an exemption that is available to investment advice fiduciaries who are “market-makers.” Relief is available from ERISA section 406 for the purchase or sale of securities by a plan or IRA, from or to a market-maker with respect to such securities who is also an investment advice fiduciary with respect to the plan or IRA, or an affiliate of such fiduciary. However, PTE 75-1, Part IV, is amended today in a Notice, published elsewhere in this issue of the
Federal Register
, to require fiduciaries relying on the exemption to comply with the Impartial Conduct Standards that are also incorporated in this exemption.

13
40 FR 50845 (Oct. 31, 1975), as amended, 71 FR 5883 (Feb. 3, 2006).

Further, Part II(1) of PTE 75-1 provides relief from ERISA section 406(a) and Code section 4975(c)(1)(A) through (D) for the purchase or sale of a security in a principal transaction between a plan or IRA and a broker-dealer registered under the Exchange Act or a bank supervised by the United States or a state. However, the exemption permits plans and IRAs to engage in principal transactions with broker-dealers and banks only if the broker-dealers and banks do not have or exercise any discretionary authority or control (except as a directed trustee) with respect to the investment of plan or IRA assets involved in the transaction, and
do not render investment advice (within the meaning of 29 CFR 2510.3-21(c)) with respect to the investment of those assets.
PTE 75-1, Part II(1) will continue to be available to parties in interest that are not fiduciaries and that satisfy its conditions. In this regard, the Regulation provides that parties will not be investment advice fiduciaries if they engage in arm's length transactions with

certain independent fiduciaries of a plan or IRA with financial expertise, including banks, insurance carriers, registered investment advisers, broker-dealers and persons holding, or possessing under management or control, total assets of at least $50 million, and who are capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies, and certain other conditions are satisfied. These non-fiduciary counterparties can continue to rely on PTE 75-1, Part II, for relief regarding principal transactions.

In connection with the proposed Regulation, the Department recognized the need for additional relief. Accordingly, the Department proposed this exemption for principal transactions in certain debt securities between a plan, participant or beneficiary account, or IRA, and an investment advice fiduciary. The proposed exemption was intended to facilitate continued access by plan and IRA investors to certain types of investments commonly sold in principal transactions.

The Department also proposed the Best Interest Contract Exemption, which is adopted elsewhere in this issue of the
Federal Register
. The Best Interest Contract Exemption provides broad relief for investment advice fiduciaries and their Affiliates and related entities to receive compensation as a result of investment advice to retail Retirement Investors (plan participants and beneficiaries, IRA owners, and certain plan fiduciaries, including small plan sponsors) under conditions specifically designed to address the conflicts of interest associated with the wide variety of payments advisers receive in connection with retail transactions involving plans and IRAs.

At the same time that the Department has granted these new exemptions, it has also amended existing exemptions to ensure uniform application of the Impartial Conduct Standards, which are fundamental obligations of fair dealing and fiduciary conduct, and include obligations to act in the customer's Best Interest, avoid misleading statements, and receive no more than reasonable compensation.
14

Taken together, the new exemptions and amendments to existing exemptions ensure that Retirement Investors are consistently protected by Impartial Conduct Standards, regardless of the particular exemption upon which the adviser relies.

14
The amended exemptions, published elsewhere in this
Federal Register
, include Prohibited Transaction Exemption (PTE) 75-1; PTE 77-4; PTE 80-83; PTE 83-1: PTE 84-24; and PTE 86-128.

The amendments also revoke certain existing exemptions, which provided little or no protections to IRA and non-ERISA plan participants, in favor of a more uniform application of the Best Interest Contract Exemption in the market for retail investments. With limited exceptions, it is the Department's intent that investment advice fiduciaries in the retail investment market rely on statutory exemptions, the Best Interest Contract Exemption, or this exemption to the extent that they receive conflicted forms of compensation that would otherwise be prohibited. The new and amended exemptions reflect the Department's view that Retirement Investors should be protected by a more consistent application of fundamental fiduciary standards across a wide range of investment products and advice relationships, and that retail investors, in particular, should be protected by the stringent protections set forth in the Best Interest Contract Exemption and this exemption. When fiduciaries have conflicts of interest, they will uniformly be expected to adhere to fiduciary norms and to make recommendations that are in their customer's Best Interest.

These new and amended exemptions follow a lengthy public notice and comment process, which gave interested persons an extensive opportunity to comment on this proposed exemption, proposed Regulation and other related exemption proposals. The proposals initially provided for 75-day comment periods, ending on July 6, 2015, but the Department extended the comment periods to July 21, 2015. The Department then held four days of public hearings on the new regulatory package, including the proposed exemptions, in Washington, DC from August 10 to 13, 2015, at which over 75 speakers testified. The transcript of the hearing was made available on September 8, 2015, and the Department provided additional opportunity for interested persons to comment on the proposals or hearing transcript until September 24, 2015. A total of over 3000 comment letters were received on the new proposals. There were also over 300,000 submissions made as part of 30 separate petitions submitted on the proposal. These comments and petitions came from consumer groups, plan sponsors, financial services companies, academics, elected government officials, trade and industry associations, and others, both in support and in opposition to the rule.
15

The Department has reviewed all comments, and after careful consideration of the comments, has decided to grant this exemption.

15
As used throughout this preamble, the term “comment” refers to information provided through these various sources, including written comments, petitions and witnesses at the public hearing.

II. Exemption for Principal Transactions in Certain Assets

As finalized, this exemption for certain principal transactions and riskless principal transactions retains the core protections of the proposed exemption, but with revisions designed to facilitate implementation and compliance with the exemption's terms. In broadest outline, the exemption permits Advisers and the Financial Institutions that employ or otherwise retain them to enter into principal transactions and riskless principal transactions with plans and IRAs regarding certain investments, provided that they give advice regarding the transactions that is in their customers' Best Interest and the Financial Institution implements basic protections against the dangers posed by conflicts of interest. In particular, to rely on the exemption, Financial Institutions must:

• Acknowledge fiduciary status with respect to any investment advice regarding principal transactions or riskless principal transactions;

• Adhere to Impartial Conduct Standards requiring them to

○ Give advice that is in the Retirement Investor's Best Interest (
i.e.,
prudent advice that is based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to financial or other interests of the Adviser, Financial Institution or any Affiliates or other parties);

○ Seek to obtain the best execution reasonably available under the circumstances with respect to the transaction; and

○ Make no misleading statements about investment transactions, compensation, and conflicts of interest;

• Implement policies and procedures reasonably and prudently designed to prevent violations of the Impartial Conduct Standards;

• Refrain from giving or using incentives for Advisers to act contrary to the customer's Best Interest; and

• Make additional disclosures.

Advisers relying on the exemption must comply with the Impartial Conduct Standards when making investment recommendations regarding principal transactions and riskless principal transactions.

The exemption takes a principles-based approach that permits Financial Institutions and Advisers to enter into transactions that would otherwise be prohibited. The exemption holds Financial Institutions and their Advisers responsible for adhering to fundamental standards of fiduciary conduct and fair dealing, while leaving them the flexibility and discretion necessary to determine how best to satisfy these basic standards in light of the unique attributes of their particular businesses. The exemption's principles-based conditions, which are rooted in the law of trust and agency, have the breadth and flexibility necessary to apply to a large range of investment and compensation practices, while ensuring that Advisers put the interests of Retirement Investors first. When Advisers choose to give advice regarding principal transactions and riskless principal transactions to Retirement Investors, they must protect their customers from the dangers posed by conflicts of interest.

In order to ensure compliance with the exemption's broad protective standards and purposes, the exemption gives special attention to the enforceability of the exemption's terms by Retirement Investors. When Financial Institutions and Advisers breach their obligations under the exemption and cause losses to Retirement Investors, it is generally critical that the investors have a remedy to redress the injury. The existence of enforceable rights and remedies gives Financial Institutions and Advisers a powerful incentive to comply with the exemption's standards, implement policies and procedures that are more than window-dressing, and carefully police conflicts of interest to ensure that the conflicts of interest do not taint the advice.

Thus, in the case of IRAs and non-ERISA plans, the exemption requires the Financial Institution to commit to the Impartial Conduct Standards in an enforceable contract with Retirement Investor customers. The exemption does not similarly require the Financial Institution to execute a separate contract with ERISA investors (plan participants, beneficiaries, and fiduciaries), but the Financial Institution must acknowledge its fiduciary status and that of its Advisers, and ERISA investors can directly enforce their rights to proper fiduciary conduct under ERISA section 502(a)(2) and (3). In addition, the exemption safeguards Retirement Investors' enforcement rights by providing that Financial Institutions and Advisers may not rely on the exemption if they include contractual provisions disclaiming liability for compensatory remedies or waiving or qualifying Retirement Investors' right to pursue a class action or other representative action in court. However, the exemption does permit Financial Institutions to include provisions waiving the right to punitive damages or rescission as contract remedies to the extent permitted by other applicable laws. In the Department's view, the availability of make-whole relief for such claims is sufficient to protect Retirement Investors and incentivize compliance with the exemption's conditions.

While the final exemption retains the proposed exemption's core protections, the Department has revised the exemption to ease implementation in response to commenters' concerns about the exemption's workability. Thus, for example, the final exemption eliminates the contract requirement altogether in the ERISA context and simplifies the mechanics of contract-formation for IRAs and plans not covered by Title I of ERISA. For new customers, the final exemption provides that the required contract terms may simply be incorporated in the Financial Institution's account opening documents and similar commonly-used agreements. The exemption additionally permits reliance on a negative consent process for existing contract holders. The Department recognizes that Retirement Investors may talk to numerous Advisors in numerous settings over the course of their relationship with a Financial Institution. Accordingly, the exemption also simplifies execution of the contract by simply requiring the Financial Institution to execute the contract, rather than each of the individual Advisers from whom the Retirement Investor receives advice. For similar reasons, the exemption does not require execution of the contract at the start of Retirement Investors' conversations with Advisers, as long as it is entered into prior to or at the same time as the recommended transaction.

As a means of facilitating use of the exemption, the Department also reduced compliance burdens by eliminating some of the conditions that were not critical to the exemption's protective purposes, and expanding the scope of the exemption's coverage (
e.g.,
by covering interests in unit investment trusts (UITs) and certificates of deposit (CDs)). The Department eliminated the requirement of adherence to other state and federal laws relating to advice as unduly expansive and duplicative of other laws; dropped a two-quote requirement; and eliminated a mark-up and mark-down disclosure requirement. In addition, the Department streamlined the disclosure conditions by simplifying the obligations. The Department also provided a mechanism for correcting good faith violations of the disclosure conditions, so that Financial Institutions would not lose the benefit of the exemption as a result of such good faith errors and would have an incentive to promptly correct them.

While making these changes to facilitate the implementation of the exemption, the Department emphasizes that the exemption is limited because of the severity of the conflicts of interest associated with principal transactions. When acting as a principal in a transaction involving a plan, participant or beneficiary account, or IRA, a fiduciary can have difficulty reconciling its duty to avoid conflicts of interest with its concern for its own financial interests as the Retirement Investor's counterparty. Of primary concern are issues involving liquidity, pricing, transparency, and the fiduciary's possible incentive to “dump” unwanted assets. The scope of this exemption balances the Department's significant concerns regarding principal transactions with the need to preserve market choice for plans, participants and beneficiary accounts, and IRAs.

The comments on this exemption, the Best Interest Contract Exemption, the Regulation, and related exemptions have helped the Department improve this exemption, while preserving and enhancing its protections. As described above, the Department has revised the exemption to facilitate implementation and compliance with the exemption, without diluting its core protections, which are critical to reducing the harm caused by conflicts of interest in the marketplace for advice. The tax-preferred investments covered by the exemption are critical to the financial security and physical health of investors. After consideration of the comments, the Department remains convinced of the importance of the exemption's core protections.

ERISA and the Code are rightly skeptical of the dangers posed by conflicts of interest, and generally prohibit conflicted advice. Before granting exemptive relief, the Department has a statutory obligation to ensure that the exemption is in the interests of plan and IRA investors and protective of their rights. Adherence to the fundamental fiduciary norms and basic protective conditions of this exemption helps ensure that investment recommendations are not driven by Adviser conflicts, but by the Best Interest of the Retirement Investor. The

conditions of this exemption are carefully calibrated to permit principal transaction and riskless principal transactions in certain investments, while protecting Retirement Investors' interest in receiving sound advice on vitally important investments. Based upon these protective conditions, the Department finds that the exemption is administratively feasible, in the interests of plans and their participants and beneficiaries and IRA owners, and protective of the rights of participants and beneficiaries of plans and IRA owners.

The preamble sections that follow provide a much more detailed discussion of the exemption's terms, comments on the exemption, and the Department's responses to those comments. After a discussion of the exemption's scope and limitations, the preamble discusses the conditions of the exemptions.

A. Scope of Relief in the Exemption

The exemption provides relief for “Advisers” and “Financial Institutions” to enter into “principal transactions” and “riskless principal transactions” in “principal traded assets” with plans and IRAs. For purposes of the exemption, a principal transaction is a transaction in which an Adviser or Financial Institution is purchasing from or selling to the plan, participant or beneficiary account, or IRA on behalf of the account of the Financial Institution or the account of any person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the Financial Institution. The term principal transaction does not include a riskless principal transaction as defined in the exemption. A riskless principal transaction is defined as a transaction in which a Financial Institution, after having received an order from a Retirement Investor to buy or sell a principal traded asset, purchases or sells the asset for the Financial Institution's own account to offset the contemporaneous transaction with the Retirement Investor.

The exemption uses the term “Retirement Investor” to describe the types of persons who can be investment advice recipients under the exemption, and the term “Affiliate” to describe people and entities with a connection to the Adviser or Financial Institution. These terms are defined in Section VI of this exemption. The following sections discuss the scope and conditions of the exemption as well as key definitional terms.

1. Principal Traded Assets

The exemption provides relief for principal transactions and riskless principal transactions involving certain investments, referred to as “principal traded assets,” between a plan, participant or beneficiary account, or IRA, and an Adviser, Financial Institution or an entity in a control relationship with the Financial Institution, when the transaction is a result of an Adviser's or Financial Institution's provision of investment advice. Relief is provided from ERISA sections 406(a)(1)(A) and (D), and 406(b)(1) and (2), and the taxes imposed by Code section 4975(a) and (b), by reason of Code section 4975(c)(1)(A), (D) and (E). Relief has not been provided in this exemption from ERISA section 406(b)(3) and Code section 4975(c)(1)(F), which prohibit a fiduciary from receiving any consideration for its own personal account from any party dealing with the plan or IRA in connection with a transaction involving the assets of the plan or IRA.

The principal traded assets that are permitted to be
purchased
by plans, participant and beneficiary accounts, and IRAs, under the exemption include CDs, interests in UITs, and securities within the exemption's definition of “debt security.” Debt securities are generally defined as corporate debt securities offered pursuant to a registration statement under the Securities Act of 1933; treasury securities; agency securities; and asset-backed securities that are guaranteed by an agency or government sponsored enterprise (GSE).

In addition, the final exemption includes a feature under which the definition of principal traded asset can be expanded without amending the class exemption. Under the definition of principal traded asset, investments can be added to the class exemption in the future based on an individual exemption granted by the Department. Accordingly, a principal traded asset for purposes of the class exemption also includes an investment that is permitted to be purchased under an individual exemption granted by the Department after the issuance date of this exemption, that provides relief for investment advice fiduciaries to engage in the purchase of the investment in a principal transaction or riskless principal transaction with a plan or IRA under the same conditions as this exemption. To the extent parties wish to expand the definition of principal traded asset in the future, they can submit a request for an individual exemption to the Department setting forth the specific attributes of the principal traded asset, the sales and compensation practices, and how conflicts of interest will be mitigated with respect to principal transactions and riskless principal transactions in that principal traded asset. If the exemption is granted, the class exemption will expand to include that investment within the definition of principal traded asset.

The exemption's definition of principal traded assets is more expansive with respect to the
sale
of principal traded assets by plans and IRAs. The definition extends to “securities or other investment property,” which corresponds to the broad range of assets that can be recommended by fiduciary advisers under the Regulation. This permits trades that may be necessary, according to commenters, when a Retirement Investor seeks to sell an investment and cannot obtain a reasonable price from a third party. In addition, in response to commenters, the Department expanded the scope of the Best Interest Contract Exemption to cover riskless principal transactions involving all investment products.

As proposed, the exemption limited the types of assets that could be traded (both bought and sold) on a principal basis to corporate debt securities offered pursuant to a registration statement under the Securities Act of 1933, treasury securities, and agency securities. The Department received many comments regarding this limitation and the general intent of the exemption. Supporting comments emphasized that the exemption's limited scope and conditions were appropriate for the mitigation of conflicts of interest and the protection of plans and IRAs. One commenter particularly supported the exemption's approach of granting relief only to those securities least likely to be subject to principal trading abuses. The commenter supported, in particular, the exclusion of municipal securities.

Others urged the Department to broaden the scope of the exemption. Many of these commenters argued that principal transactions are necessary for the maintenance of inventory, liquidity, access to investments, and best execution. They contended that the failure to provide broader relief would drive up the cost to investors, and hinder normal transactions that are generally classified as facilitation trades or riskless principal transactions. Commenters took the position that the Department should not substitute its judgment for the judgment of investors and advisers. In particular, commenters

urged the Department to: (a) Provide relief for riskless principal transactions, (b) add specific additional securities to the scope of the exemption, and (c) provide broad principal transaction relief for all securities and other property.

a. Riskless Principal Transactions

A number of comments noted that the proposal did not specifically address riskless principal transactions. In a riskless principal transaction, according to a commenter, a Financial Institution, after receiving an order to purchase or sell a security from a customer, purchases or sells the investment for its own account to offset the contemporaneous transaction with the customer. Commenters argued that riskless principal transactions are the functional equivalent of agency transactions. A commenter asserted that for this reason, riskless principal transactions would not involve the incentive to dump unwanted investments on Retirement Investors, which was one of the Department's concerns. Another commenter indicated that without wider availability of riskless principal transactions, many investments would not be available at all to plans and IRAs because it is typical for broker-dealers to engage in transactions with third parties on a riskless principal basis rather than a pure agency basis. One commenter stated that this is because counterparties may not want to assume settlement risk with an investor.

After consideration of these comments, the Department concurs with commenters that broader relief in this area is appropriate. The Department intended that the proposal cover riskless principal transactions within the general meaning of principal transactions, but the transactions would have been limited to the debt securities covered under the proposed exemption. The Department agrees with commenters that, to the extent a Financial Institution engages in a transaction based on an existing customer order, the riskless principal transaction can be viewed as functionally similar to an agency transaction, and the Department accepts the position of commenters that some investments may not be functionally available without this relief. For this reason, the Department expanded the scope of the companion Best Interest Contract Exemption to permit riskless principal transactions in all investments, and provide relief for compensation received in connection with such transactions, subject to the conditions of that exemption.

The Department also clarified that this exemption is available for riskless principal transactions involving principal traded assets. The definition of a principal transaction now explicitly excludes riskless principal transactions, and the exemption's scope specifically encompasses both principal transactions and separately-defined riskless principal transactions. In this manner, the exemption now clearly draws a distinction between principal transactions and riskless principal transactions and provides relief for both with respect to principal traded assets.

This approach results in some overlap between coverage of riskless principal transactions in the Best Interest Contract Exemption and this exemption. With respect to a recommended purchase of an investment that occurs in a riskless principal transaction, this exemption is available for principal traded assets. The Best Interest Contract Exemption, however, provides broader relief for all recommended purchases. In addition,
sales
from a plan or IRA in riskless principal transactions can occur under either exemption.

This approach is intended to provide flexibility to Financial Institutions relying on the exemptions. The Department believes that some Financial Institutions have business models that involve only riskless principal transactions. These Financial Institutions may not, as a general matter, hold investments in inventory to sell in principal transactions, but they may execute certain transactions as riskless principal transactions. Financial Institutions that do not engage in principal transactions, as defined in the exemptions, do not have to rely on this exemption at all, and can organize their practices to comply with the Best Interest Contract Exemption alone.

On the other hand, Financial Institutions that engage in both principal transactions and riskless principal transactions may want to organize their practices to comply with this exemption. They may not be certain at the outset whether a particular purchase by a plan or IRA will be executed as a principal transaction or a riskless principal transaction. Those Financial Institutions can rely on this exemption for principal traded assets that may be sold to plans and IRAs without concern for whether the transaction is, in fact a riskless principal transaction or principal transaction.

b. Adding to the Definition of Principal Traded Assets

Some commenters requested that this exemption extend to principal transactions in specific additional types of securities or investments, including municipal securities, currency, agency debt securities, CDs (including brokered CDs), asset backed securities, unit investment trusts (UITs), equities (including new issue and initial public offerings), new issue of debt securities, preferred securities, foreign corporate securities, foreign sovereign debt, debt of a charitable organization, derivatives, bank note offerings and wrap or other contracts that are not insurance products.

In response, the Department added to this final exemption CDs, UITs, and asset backed securities guaranteed by an agency or GSE. Both CDs and UITs were included as investments permitted to be sold under the proposed Best Interest Contract Exemption, and commenters informed us that these investments are typically sold in principal transactions. Without relief for CDs and UITs in this exemption, commenters asserted that Retirement Investors might lose access to such investments. Commenters indicated that these investments were common investments in ERISA plans, IRAs and non-ERISA plans. The Department therefore included them in this final exemption. As with the exemptive relief originally proposed regarding principal transactions in debt securities, the Department believes that the conflicts of interest created by principal transactions in CDs and UITs are effectively addressed by the conditions of this exemption so as to protect the interests of Retirement Investors while maintaining Retirement Investors' access to these investments.

Agency and GSE guaranteed asset backed securities were always intended to be included in the definition of debt security. The proposal provided that agency debt securities were defined by reference to the Financial Industry Regulatory Authority (FINRA) rule 6710(l).
16

Commenters informed us that the Department's definition omitted agency and GSE mortgage backed securities. Based on the Department's original intent to provide relief for these investments, and the view that the conditions are protective in these contexts, the Department included them in the final exemption.

16
FINRA is registered with the Securities and Exchange Commission (SEC) as a national securities association and is a self-regulatory organization, as those terms are defined in the Exchange Act, which operates under SEC oversight.

Reflecting this expansion of relief to CDs, UITs and agency and GSE guaranteed asset backed securities, the final exemption uses the term “principal traded asset,” rather than “debt security” to describe the

investments that can be purchased or sold.

As explained in greater detail below, the Department did not expand the purchase provisions of the exemption, as some commenters suggested, to include other investments such as municipal securities, currency, asset backed securities, equities (including new issue and initial public offerings), new issue of debt securities, preferred securities, foreign corporate securities, foreign sovereign debt, debt of a charitable organization, derivatives, bank note offerings and wrap or other contracts that are not insurance products. The Department determined that the conditions of this exemption may not be appropriately tailored to these types of investments. The Department invites interested parties to request an individual exemption for other investments that they would like to see included in this class exemption. This will provide the Department with the opportunity to gain additional information about those investments, their sales practices and associated conflicts of interest.

c. Principal Transaction Relief for All Securities and Other Property

Other commenters sought to more generally expand the scope of the exemption. Some commenters felt that unrestricted relief should be provided with respect to all principal transactions with few, if any, conditions. Some of these commenters took issue with the Department's decision to place any limitations at all on investments that can be purchased or sold in a principal transaction. The commenters expressed the view that the Department was substituting its judgment for those of individual investors and their advisers.

In support of their approach, a few commenters urged the Department to more closely hew to the approach taken under the securities laws, citing Temporary Rule 206(3)-3T issued by the Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940.
17

According to the commenters, Temporary Rule 206(3)-3T applies to institutions that are dually registered as investment advisers and broker-dealers and to transactions in non-discretionary accounts at such institutions, and it permits principal transactions involving all securities unless the investment adviser or Affiliate is the issuer of, or, at the time of the sale, an underwriter of, a security that is not an investment grade debt security. The rule generally requires written prospective consent by the customer to principal transactions; oral or written pre-transaction disclosure and customer consent; written confirmation to the customer; and written annual disclosure to the customer of transactions entered into in reliance on the rule.

17
17 CFR 275.206(3)-3T.

Commenters also focused on principal transactions involving sales by plans and IRAs. Commenters indicated that broader relief was necessary to provide liquidity for Retirement Investors. They said that Financial Institutions serve an essential function in purchasing securities from their clients who need such liquidity.

The Department did not accept the commenters' call for relief for all principal transactions. The Department's approach in the proposal of this exemption was intentionally narrow, based on the potentially acute conflicts of interest associated with principal transactions that are recommended by fiduciaries. The Department believes that broad relief for all principal transactions, without tailored conditions, is inconsistent with longstanding principles that fiduciaries must act with loyalty to Retirement Investors. Because the fiduciary is on both sides of a principal transaction, the fiduciary duty of loyalty is sorely tested. In addition, the securities typically traded in principal transactions often lack objective market prices and Retirement Investors may have difficulty evaluating the fairness of a particular transaction. Principal traded investments also can be associated with low liquidity, low transparency and the possible incentive to dump unwanted investments.

Therefore, although the Department's approach harmonizes in many ways, as discussed below, with the disclosures required by the SEC's Temporary Rule 206(3)-3T, the Department did not adopt an exemption that is as broad in scope. The Department also notes in this respect that the SEC has not yet finalized its approach to rule 206(3)-3T, and the SEC has indicated the delay is related to the SEC's consideration of regulatory standards of care for broker-dealers and investment advisers under section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). In the most recent release proposing to extend the Temporary Rule, the SEC stated:

As part of our broader consideration of the regulatory requirements applicable to broker-dealers and investment advisers, we intend to carefully consider principal trading by advisers, including whether rule 206(3)-3T should be substantively modified, supplanted, or permitted to sunset.
18

18
See SEC's Release No. IA-3893, August 12, 2014.

Given the SEC's ongoing consideration of these issues, the Department does not believe there is a significant advantage to mirroring the scope of the Temporary Rule.

Although the Department retained the limited definition of principal traded asset, as discussed above, for recommendations that a plan or IRA
purchase
an investment, the Department did provide broader relief for recommended
sales
from a plan or IRA to a Financial Institution. The Department is persuaded by commenters that a broader exemption is necessary to provide liquidity to plans and IRAs.

The Department also notes that the final Regulation provides additional ways in which parties can engage in principal transactions and riskless principal transactions and avoid prohibited transactions. The Regulation provides that a person is not a fiduciary when the person engages in an arm's length transaction with an independent plan fiduciary with financial expertise, as defined in the Regulation. Financial professionals that engage in such transactions are not considered fiduciaries, and may rely on other exemptions such as PTE 75-1, Part II, or ERISA section 408(b)(17) and Code section 4975(d)(20), for a broader range of principal transactions and riskless principal transactions. Therefore, the concerns of commenters such as the Stable Value Investment Association, about principal transactions involving a stable value fund managed by a professional investment manager, should be addressed in that fashion.

Finally, this exemption does not affect the ability of a self-directed investor to obtain the services of a financial professional to effect or execute a transaction involving any type of investment, in the absence of investment advice. In that sense, the Department is not limiting investment opportunities for individual investors or substituting the Department's judgment for theirs. Instead, the exemption is aimed squarely at conflicted investment advice by fiduciaries and is intended to minimize the harms of such conflicts of interest.

In this regard, one commenter requested a clarification as to whether an exemption is necessary for the provision of principal transaction services where the services do not involve the provision of individual recommendations to a plan or IRA. In

response, the Department notes that relief from ERISA section 406(b) would only be necessary to the extent the service provider was acting as a fiduciary. To the extent the service provider does not make recommendations, it does not act as a fiduciary investment adviser. If the service provider is not a fiduciary, ERISA section 406(b) relief is not necessary, and the other exemptions referenced above, apply.

2. Exclusions

The exclusions set forth in Section I(c) of the proposal remain a part of the final exemption. First, under Section I(c)(1), Advisers who have or exercise discretionary authority or discretionary control with respect to management of the assets of a plan, participant or beneficiary account, or IRA or who exercise any discretionary authority or control respecting management or the disposition of the assets, or have any discretionary authority or discretionary responsibility in the administration of the plan, participant or beneficiary account, or IRA, may not take advantage of relief under the exemption to engage in principal transactions and riskless principal transactions with such investors.

A comment related to this provision asked that the limitation on investment managers be modified so that Financial Institutions that sponsor separately managed accounts that use independent, individual investment managers should be permitted to engage in principal transactions on behalf of their managed plans and IRAs with the sponsor. The Department did not adopt this suggestion. Instead, the Department notes that the Regulation was revised to provide that a person does not act as a fiduciary when engaged in an arm's length transaction with a plan fiduciary with financial expertise under the circumstances set forth in the Regulation. In such circumstances, the financial professionals may, therefore, rely on existing exemptions for non-fiduciary principal transactions and riskless principal transactions.

Second, under Section I(c)(2), the exemption is not available for a principal transaction involving a plan covered by Title I of ERISA if the Adviser or Financial Institution, or any Affiliate is the employer of employees covered by the plan. In accordance with this condition, the exemption is not available for a principal transaction entered into as part of a rollover from such a plan to an IRA, where the principal transaction is being executed by the plan, not the IRA. This restriction on employers does not apply in the case of an IRA or other similar plan that is not covered by Title I of ERISA. Accordingly, an Adviser or Financial Institution may provide advice to the beneficial owner of an IRA who is employed by the Adviser, its Financial Institution or an Affiliate, and receive compensation as a result, provided the IRA is not covered by Title I of ERISA.

No comments were received specific to the principal transactions exemption on proposed Section I(c)(2). Comments were received, however, on the same language, proposed in Section I(c)(1), of the Best Interest Contract Exemption. Specifically, industry commenters requested elimination of this exclusion in the Best Interest Contract Exemption. In particular, they said that Financial Institutions in the business of providing investment advice should not be compelled to hire a competitor to provide services to the Financial Institution's own plan. They warned that the exclusion could effectively prevent these Financial Institutions from providing any investment advice to their employees. Some commenters additionally stated that for compliance reasons, employees of a Financial Institution are often required to maintain their financial assets with that Financial Institution. As a result, they argued employees of Financial Institutions could be denied access to investment advice on their retirement savings.

As with the Best Interest Contract Exemption, the Department has not scaled back the exclusion. As noted above, the Department did not receive comments requesting that Financial Institutions be able to engage in principal transactions with their in-house plans. More generally, however, the Department continues to be concerned that the danger of abuse is compounded when the advice recipient receives recommendations from the employer, upon whom he or she depends for a job, to make investments in which the employer has a financial interest. To protect employees from abuse, employers generally should not be in a position to use their employees' retirement benefits as potential revenue or profit sources, without stringent safeguards. See,
e.g.,
ERISA section 403(c)(1) (generally providing that “the assets of a plan shall never inure to the benefit of any employer”). Additionally, the exclusion of employers in Section I(c) does not apply in the case of an IRA or other similar plan that is not covered by Title I of ERISA. The decision to open an IRA account or obtain IRA services from the employer is much more likely to be entirely voluntary on the employees' part than would be true of their interactions with the retirement plan sponsored and designed by their employer for its employee benefit program. Accordingly, an Adviser or Financial Institution may provide advice to the beneficial owner of an IRA who is employed by the Adviser, its Financial Institution or an Affiliate regarding a principal transaction or riskless principal transaction, and engage in a principal transaction or riskless principal transaction as a result, provided the IRA is not covered by Title I of ERISA, and the conditions of this exemption are satisfied.

Section I(c)(2) further provides that the exemption is unavailable if the Adviser or Financial Institution is a named fiduciary or plan administrator, as defined in ERISA section 3(16)(A) with respect to an ERISA plan, or an Affiliate thereof, that was selected to provide advice to the plan by a fiduciary who is not independent of them. This provision is intended to disallow the selection of Advisers and Financial Institutions by named fiduciaries or plan administrators that have a significant financial stake in the selection and was adopted in the final exemption unchanged from the proposal.
19

19
The definition of “independent” was adjusted in response to comments, as discussed below, to permit circumstances in which the person selecting the Adviser and Financial Institution could receive no more than 2% of its compensation from the Financial Institution.

B. Conditions of the Exemption

Section I, discussed above, establishes the scope of relief provided by this Principal Transactions Exemption. Sections II-V set forth the conditions of the exemption. All applicable conditions must be satisfied in order to avoid application of the specified prohibited transaction provisions of ERISA and the Code. The Department finds that, subject to these conditions, the exemption is administratively feasible, in the interests of plans and of their participants and beneficiaries, and IRA owners and protective of the rights of the participants and beneficiaries of such plans and IRA owners. Under ERISA section 408(a), and Code section 4975(c)(2), the Secretary may not grant an exemption without making such findings. The conditions of the exemption, comments on those conditions, and the Department's responses, are described below.

1. Enforceable Right to Best Interest Advice (Section II)

Section II of the exemption sets forth the requirements that establish the Retirement Investor's enforceable right

to adherence to the Impartial Conduct Standards and related conditions. For advice to certain Retirement Investors—specifically, advice regarding transactions with IRAs, and plans that are not covered by Title I of ERISA (non-ERISA plans), such as Keogh plans—Section II(a) requires the Financial Institution and Retirement Investor to enter into a written contract that includes the provisions described in Section II(b)-(d) of the exemption and that also does not include any of the ineligible provisions described in Section II(f) of the exemption, and provide the disclosures set forth in Section II(e). As discussed further below, pursuant to Section II(g) of the exemption, advice to Retirement Investors regarding ERISA plans does not have to be subject to a written contract but Advisers and Financial Institutions must comply with the substantive standards established in Section II(b)-(e) to avoid liability for a non-exempt prohibited transaction.

The contract with Retirement Investors regarding IRAs and non-ERISA plans must include the Financial Institution's acknowledgment of its fiduciary status and that of its Advisers, as required by Section II(b); the Financial Institution's agreement that it and its Advisers will adhere to the Impartial Conduct Standards, including a Best Interest standard, as required by Section II(c); the Financial Institution's warranty that it has adopted and will comply with certain policies and procedures, including anti-conflict policies and procedures reasonably and prudently designed to ensure that Advisers adhere to the Impartial Conduct Standards, as required by Section II(d). The Financial Institution's disclosure of information about Material Conflicts of Interest associated with principal transactions and riskless principal transactions, as required by Section II(e), may be provided in the contract or in a separate single written disclosure. Section II(f) generally provides that the exemption is unavailable if the contract includes exculpatory provisions or provisions waiving the rights and remedies of the plan, IRA or Retirement Investor, including their right to participate in a class action in court. The contract may, however, provide for binding arbitration of individual claims, and may waive contractual rights to punitive damages or rescission.

The contract between the IRA or non-ERISA plan, and the Financial Institution, forms the basis of the IRA's or non-ERISA plan's enforcement rights. The Department intends that all the contractual obligations imposed on the Financial Institution (the Impartial Conduct Standards and warranties) will be actionable by the IRAs and non-ERISA plans. Because these standards are contractually imposed, an IRA or non-ERISA plan has a contract claim if, for example, its Adviser recommends an investment product that is not in the Best Interest of the IRA or other non-ERISA plan.

In the Department's view, these contractual rights serve a critical function for IRA owners and participants and beneficiaries of non-ERISA plans. Unlike participants and beneficiaries in plans covered by Title I of ERISA, IRA owners and participants and beneficiaries in non-ERISA plans do not have an independent statutory right to bring suit against fiduciaries for violation of the prohibited transaction rules. Nor can the Secretary of Labor bring suit to enforce the prohibited transactions rules on their behalf.
20

Thus, for investors in IRAs and non-ERISA plans, the contractual requirement creates a mechanism for investors to enforce their rights and ensures that they will have a remedy for misconduct. In this way, the exemption creates a powerful incentive for Financial Institutions and Advisers alike to oversee and adhere to basic fiduciary standards when engaging in principal transactions and riskless principal transactions, without requiring the imposition of unduly rigid and prescriptive rules and conditions.

20
An excise tax does apply in the case of a violation of the prohibited transaction provisions of the Code, generally equal to 15% of the amount involved. The excise tax is generally self-enforced; requiring parties not only to realize that they've engaged in a prohibited transaction but also to report it and pay the tax. Parties who have participated in a prohibited transaction for which an exemption is not available must pay the excise tax and file Form 5330 with the Internal Revenue Service.

Under Section II(g), however, the written contract requirement does not apply to advice to Retirement Investors regarding transactions with plans that are covered by Title I of ERISA (ERISA plans) in light of the existing statutory framework which provides a pre-existing enforcement mechanism for these investors and the Department. Instead, Advisers and Financial Institutions must satisfy the provisions in Section II(b)-(e) as conditions of the exemption when transacting with such Retirement Investors. Under the terms of the exemptions, the Financial Institution must provide a written acknowledgment of its and its Advisers' fiduciary status prior to or at the same time as the execution of the transaction, although it does not have to be part of a contract, as required by Section II(b); the Financial Institution and its Advisers must comply with the Impartial Conduct Standards, as required by Section II(c); the Financial Institutions must establish and comply with certain policies and procedures, as required by Section II(d); and they must provide the disclosures required by Section II(e).

If these conditions are not satisfied with respect to an ERISA plan engaging in a principal transaction or a riskless principal transaction, the Adviser and Financial Institution would be unable to rely on the exemption for relief from ERISA's prohibited transactions restrictions. An Adviser's failure to comply with the exemption would result in a non-exempt prohibited transaction under ERISA section 406 and would likely constitute a fiduciary breach under ERISA section 404. As a result, a plan, plan participant or beneficiary would be able to sue under ERISA section 502(a)(2) or (3) to recover any loss in value to the plan (including the loss in value to an individual account), or to obtain disgorgement of any wrongful profits or unjust enrichment. In addition, the Secretary of Labor can enforce ERISA's prohibited transaction and fiduciary duty provisions with respect to these ERISA plans, and an excise tax under the Code, as described above, applies.

In this regard, under Section II(g)(5) of the exemption, the Financial Institution and Adviser may not rely on the exemption if, in any contract, instrument, or communication they disclaim any responsibility or liability for any responsibility, obligation, or duty under Title I of ERISA to the extent the disclaimer would be prohibited by ERISA section 410, waive or qualify the right of the Retirement Investor to bring or participate in a class action or other representative action in court in a dispute with the Adviser or Financial Institution, or require arbitration or mediation of individual claims in locations that are distant or that otherwise unreasonably limit the ability of the Retirement Investors to assert the claims safeguarded by this exemption. The exemption's enforceability, and the potential for liability, is critical to ensuring adherence to the exemption's stringent standards and protections, notwithstanding the competing pull of the conflicts of interest associated with principal transactions and riskless principal transactions.

The Department expects claims of Retirement Investors regarding investments in ERISA plans to be brought under ERISA's enforcement provisions, discussed above. In general, ERISA section 410 invalidates

instruments purporting to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under ERISA. Accordingly, provisions purporting to waive fiduciary obligations under ERISA serve only to mislead Retirement Investors about the scope of their rights. Additionally, the legislative intent of ERISA was, in part, to provide for “ready access to federal courts.” Accordingly, any recommended transaction covered by a contract or other instrument that waives or qualifies the right of the Retirement Investor to bring or participate in a class action or other representative action in court, will not be eligible for relief under this exemption.

A number of comments were received on the contract requirement as it was proposed. The comments, and the Department's responses, are discussed below. The Department notes that some of the commenters simply cross-referenced their comments, in the entirety, with respect to the same provisions in the proposed Best Interest Contract Exemption. Additionally, some commenters focused their comments solely on the Best Interest Contract Exemption. The Department determined it was important that the contract provisions in the Best Interest Contract Exemption be compatible with the contract provisions in this exemption, so that the two exemptions can easily be used together. For this reason, the Department considered all comments made on either exemption on a consolidated basis, and made corresponding changes in the two exemptions. For ease of use, the Department has included in this preamble the same general discussion of comments as in the Best Interest Contract Exemption, despite the fact that some comments discussed below were not made directly with respect to this exemption.

In this regard, one commenter inquired as to whether the contract required in this exemption could be combined with the contract required by the Best Interest Contract Exemption, or whether two contracts would be needed. It was the Department's intent in crafting this exemption that it could be used in connection with the Best Interest Contract Exemption, and it is the Department's view that there need only be one contract. If parties wish to give themselves flexibility to engage in principal transactions and riskless principal transactions with Retirement Investors, they can include the contract provisions that are specific to principal transactions and riskless principal transactions and obtain the Retirement Investor's consent to participate in such transactions.

a. Contract Requirement Applicable to IRAs and Non-ERISA Plans

A number of commenters took the position that the consumer protections afforded by the contract requirement are an essential feature of the exemption, particularly in the IRA market. Commenters indicated that enforceability is critical in the IRA market because of IRA owners' lack of a statutory right to enforce prohibited transactions provisions. Commenters said that, in order to achieve the goal of providing meaningful new protections to Retirement Investors, the exemption must provide a mechanism by which Advisers and Financial Institutions can be held legally accountable for the retirement recommendations they make.

Many other commenters, however, raised significant objections to the contract requirement. Commenters pointed to certain conditions of the exemption that they found ambiguous or subjective and indicated that these conditions could form the basis of class action lawsuits by disappointed investors. Some commenters said the contract requirement and associated litigation exposure will cause investment advice providers to cease serving Retirement Investors or provide only fee-based accounts that do not vary on the basis of the advice provided, resulting in the loss of services to retirement investors with smaller account balances. These commenters stated that investment advice fiduciaries would not risk the anticipated legal liability for Retirement Investors, or at least with respect to small accounts. Commenters also indicated that the SEC's Temporary Rule 206(3)-3T already addresses the issues regarding principal transactions that the Department is attempting to address.

In the final exemption, the Department retained the contract requirement with respect to IRAs and non-ERISA plans. The contractual commitment provides an administrable means of ensuring fiduciary conduct, eliminating ambiguity about the fiduciary nature of the relationship, and enforcing the exemption's conditions, thereby assuring compliance. The existence of enforceable rights and remedies gives Financial Institutions and Advisers a powerful incentive to comply with the exemption's standards, implement effective anti-conflict policies and procedures, and carefully police conflicts of interest. The enforceable contract gives clarity to the fiduciary nature of the undertaking, and ensures that Advisers and Financial Institutions do not subordinate the interests of the Retirement Investor to their own competing financial interests. The contract effectively aligns the interests of Retirement Investor, Advisers, and the Financial Institution, and gives the Retirement Investor the means to redress injury when violations occur.

Without a contract, the possible imposition of an excise tax provides an additional, but inadequate incentive to ensure compliance with the exemption's standards-based approach. This is particularly true because imposition of the excise tax critically depends on fiduciaries' self-reporting of violations, rather than independent investigations and litigation by the IRS. In contrast, contract enforcement does not rely on conflicted fiduciaries' assessment of their own adherence to fiduciary norms or require the creation and expansion of a government enforcement apparatus. The contract provides an administrable way of ensuring adherence to fiduciary standards, broadly applicable to an enormous range of investments and advice relationships.

The enforceability of the exemption's provisions enables the Department to grant exemptive relief based upon broad protective standards rather than rely exclusively upon highly proscriptive conditions. In the context of this exemption, the risk of litigation and enforcement serves many of the same functions that it has for hundreds of years under the law of trust and agency. It gives fiduciaries a powerful incentive to adhere to broad, flexible, and protective standards applicable to principal transactions and riskless principal transactions by imposing liability and providing a remedy when fiduciaries fail to comply with those standards.

In addition, a number of features of this final exemption, discussed more fully below, should temper commenters' concerns about the risk of excessive litigation. In particular, the exemption permits Advisers and Financial Institutions to require mandatory arbitration of individual claims, so that claims that do not involve systemic abuse or entire classes of participants can be resolved outside of court. Similarly, the exemption permits waivers of the right to obtain punitive damages or rescission based on violation of the contract. In the Department's view, make-whole compensatory relief is sufficient to incentivize compliance and redress injury caused by fiduciary misconduct. The Department has also clarified a number of the exemption's conditions and simplified the disclosure and

compliance obligations to facilitate adherence to the exemption's terms.

The core principles of the exemption are well-established under trust law, ERISA and the Code, and have a long history of interpretations in court. Moreover, the Impartial Conduct Standards are measured based on the circumstances existing at the time of the recommendation, not based on the ultimate performance of the investment with the benefit of hindsight. It is well settled as a legal matter that fiduciary advisers are not guarantors of the success of investments under ERISA or the Code, and this exemption does nothing to change that fact. Finally, the Department added provisions enabling Advisers and Financial Institutions to correct good faith errors in disclosure, without facing loss of the exemption.

The Department did not rely solely on the approach in the SEC's Temporary Rule 206(3)-3T, or another primarily disclosure-based approach, as suggested by some commenters. In the Department's view, disclosure of conflicts is a necessary, but not sufficient, basis for relief in the context of fiduciary self-dealing involving tax-favored accounts.

One commenter asked the Department to address the interaction of the contract cause of action and state securities laws. In this connection, the Department confirms that it is not the Department's intent to preempt or supersede state securities law and enforcement, and the state securities laws remain subject to the ERISA section 514(b)(2)(A) savings clause.

b. No Contract Requirement Applicable to ERISA Plans

Under Section II(g) of the exemption, there is no contract requirement for transactions involving ERISA plans, but Financial Institutions and their Advisers must satisfy the conditions of Section II(b)-(e), including the conditions requiring written fiduciary acknowledgment, adherence to Impartial Conduct Standards, policies and procedures, and disclosures.

The Department eliminated the proposed contract requirement with respect to ERISA plans in this final exemption in response to public comment on this issue. A number of commenters indicated that the contract requirement was unnecessary for ERISA plans due to the statutory framework that already provides enforcement rights to such plans, their participants and beneficiaries, and the Secretary of Labor. Some commenters additionally questioned the extent to which the contract provided additional rights or remedies, and whether state-law contract claims would be pre-empted under ERISA's pre-emption provisions.

In the Department's view, the requirement that a Financial Institution provide written acknowledgement of fiduciary status for itself and its Advisers provides protections in the ERISA plan context that are comparable to the contract requirement for IRAs and non-ERISA plans. As a result of the written acknowledgment of fiduciary status, the fiduciary nature of the relationship will be clear to the parties both at the time of the investment transaction, and in the event of subsequent disputes over the conduct of the Advisers or Financial Institutions. There will be far less cause for the parties to litigate disputes over fiduciary status, as opposed to the substance of the fiduciaries' recommendations and conduct.

2. Contract Operational Issues—Section II(a)

Section II(a) specifies the mechanics of entering into the contract and provides that the contract must be enforceable against the Financial Institution. In addition, the section indicates that the contract may be a master contract covering multiple recommendations, and that it may cover advice that was rendered prior to the execution of the contract as long as the contract is entered into prior to or at the same time as the execution of the recommended transaction.

Section II(a)(1) further describes the methods for obtaining customer assent to the contract. For “new contracts,” the Retirement Investor's assent must be demonstrated through a written or electronic signature. The exemption provides flexibility by permitting the contract terms to be set forth in a standalone document or in an investment advisory agreement, investment program agreement, account opening agreement, insurance or annuity contract or application, or similar document, or amendment thereto.

For Retirement Investors with “existing contracts,” the exemption permits assent to be evidenced either by affirmative consent, as described above, or by a negative consent procedure. Under the negative consent procedure, the Financial Institution delivers a proposed contract amendment along with the disclosure required in Section II(e) to the Retirement Investor prior to January 1, 2018, and if the Retirement Investor does not terminate the amended contract within 30 days, the amended contract is effective. If the Retirement Investor does terminate the contract within that 30-day period, this exemption will provide relief for 14 days after the date on which the termination is received by the Financial Institution.
21

An existing contract is defined in the exemption as “an investment advisory agreement, investment program agreement, account opening agreement, insurance contract, annuity contract, or similar agreement or contract that was executed before January 1, 2018 and remains in effect.” If the Financial Institution elects to use the negative consent procedure, it may deliver the proposed amendment by mail or electronically, but it may not impose any new contractual obligations, restrictions, or liabilities on the Retirement Investor by negative consent.

21
Alternatively, for purposes of this exemption, Advisers and Financial Institutions can provide the contractual terms required by the exemption and permit the Retirement Investor to specifically decline to authorize principal transactions and riskless principal transactions within 30 days but continue the existing contract. Of course, to the extent prohibited transaction relief is needed for transactions under the existing contract, the Adviser and Financial Institution would need to comply with another exemption.

Finally, Section II(a)(2) of the exemption requires the Financial Institution to maintain an electronic copy of the Retirement Investor's contract on its Web site that is accessible by the Retirement Investor. This condition ensures that the Retirement Investor has ready access to the terms of the contract, and reinforces the exemption's goals of clearly establishing the fiduciary status of the Adviser and Financial Institution and ensuring their adherence to the exemption's conditions.

Comments on specific contract operational issues are discussed below.

a. Contract Timing

As proposed, Section II(a) required that, “[p]rior to recommending that the plan, participant or beneficiary account, or IRA purchase, sell or hold the Asset, the Adviser and Financial Institution enter into a written contract with the Retirement Investor that incorporates the terms required by Section II(b)-(e).” A large number of commenters responded to various aspects of this proposed requirement.

Many commenters objected to the timing of the contract requirement. They said that requiring execution of a contract “prior to” any recommendations would be contrary to existing industry practices. The commenters indicated that preliminary discussions may evolve into recommendations before a Retirement Investor has decided to work with a particular Adviser and Financial Institution. Requiring a contract upfront

could chill such preliminary discussions, unduly complicate the relationship between the Adviser and the Retirement Investor, and interfere with an investor's ability to shop around. Many commenters suggested that it would be better to time the requirement so that the contract would have to be entered into prior to the execution of the actual principal transaction, or even later, rather than before any advice was rendered. While some other commenters supported the proposed timing, noting the benefit of allowing Retirement Investors the chance to carefully review the contract prior to engaging in transactions, several commenters that strongly supported the contract requirement agreed that the timing could be adjusted without loss of protection to the Retirement Investor.

In the Department's view, the precise timing of the contract is not critical to the exemption, provided that the parties enter into a contract covering the advice. The Department did not intend to chill developing advice relationships or limit investors' ability to shop around. Therefore, the Department adjusted the exemption on this point by deleting the proposed requirement that the contract be entered into prior to the advice recommendation. Instead, the exemption generally provides that the advice must be subject to an enforceable written contract entered into prior to or at the same time as the execution of the recommended transaction. However, in order for the exemption to be available to recommendations made prior to the contract's formation, the contract's terms must cover the prior recommendations.

A few commenters suggested that the Department require the contract to be a separate document, not combined with any other document. However, other commenters requested that the Department allow Financial Institutions to incorporate the contract terms into other account documents. While the Department believes the contract is critical to IRA and non-ERISA plan investors, the Department recognizes the need for flexibility in its implementation. Therefore, the exemption contemplates that the contract may be incorporated into other documents to the extent desired by the Financial Institution. Additionally, as requested by commenters, the Department confirms that the contract requirement may be satisfied through a master contract covering multiple recommendations and does not require execution prior to each additional recommendation.

b. Contract Parties

A number of commenters questioned the necessity of the proposed requirement that Advisers be parties to the contract. These commenters indicated that the proposed requirement posed significant logistical challenges. For example, commenters stated that Advisers often work in teams and it would be difficult to obtain signatures from all such Advisers. Similarly, if call center representatives made recommendations that include principal transactions and riskless principal transactions, it could be hard to cover them under a contract. Over the course of a Retirement Investor's relationship with a Financial Institution, he or she could receive advice from a number of persons. Requiring that each such person execute a contract could prove difficult and unwieldy.

Based upon these objections, the Department deleted the requirement that individual Advisers be parties to the contract. The Financial Institution must be a party to the contract and take responsibility for satisfying the exemption's conditions, including the obligation to have policies and procedures reasonably and prudently designed to ensure that individual Advisers adhere to the Impartial Conduct Standards, and the obligation to insulate the Adviser from incentives to violate the Best Interest standard. Such Advisers include call center representatives who provide investment advice within the meaning of the Regulation.

Some commenters suggested that the Department provide additional flexibility and allow the individual Adviser to be obligated under the contract instead of the Financial Institution. The Department has not adopted that suggestion. To ensure operation of the exemption as intended, the Financial Institution should be a party to the contract. The supervisory responsibility and liability of the Financial Institution is important to the exemption's protections. In particular, the exemption contemplates that the Financial Institution will adopt and monitor stringent anti-conflict policies and procedures; avoid financial incentives that undermine the Impartial Conduct standards; and take appropriate measures to ensure that it and its representatives adhere to the exemption's conditions. The contract provides both a mechanism for imposing these obligations on the Financial Institution and creates a powerful incentive for the Financial Institution to take the obligations seriously in the management and supervision of investment recommendations.

c. Contract Signatures

Section II(a) of the exemption provides that the contract must be enforceable against the Financial Institution. As long as that is the case, the Financial Institution is not required to sign the contract. Section II(a) of the exemption further describes the methods through which customer assent may be achieved, and reflects commenters' requests for greater specificity on this point.

With respect to new contracts, a few commenters asked the Department to confirm that electronic execution by the Retirement Investor is sufficient. Another commenter asked about telephone assent. In the final exemption, the Department specifically permits electronic execution as a form of customer assent. The Department has not permitted telephone assent, however, because of the potential issues of proof regarding the existence and terms of a contract executed in that manner. It is the Department's goal that Retirement Investors obtain clear evidence of the contract terms and their applicability to the Retirement Investor's own account or contract. The exemption will best serve its purpose if the contractual commitments are clear to all the parties, and if ancillary disputes about the fiduciary nature of the advice relationship are avoided. For this same reason, the exemption requires that a copy of the applicable contract be maintained on a Web site accessible to the Retirement Investor.

Commenters also asked for the ability to use a negative consent procedure with respect to existing customers to avoid the expense and difficulty associated with obtaining a large number of client signatures. The Department adjusted the exemption on this point to permit amendment of existing contracts by negative consent, as discussed above. As this approach will still result in the Retirement Investor receiving clear evidence of the contract terms and their applicability to the Retirement Investor's own account or contract, the Department concurred with commenters on its use.

Treating the Retirement Investor's silence as consent after 30 days provides the Retirement Investor a reasonable opportunity to review the new terms and to reject them. The Financial Institution may not use the negative consent procedure, however, to impose new obligations, restrictions or liabilities on the Retirement Investor in connection with this exemption. Any attempt by the Financial Institution to

impose additional obligations, restrictions or liabilities on the Retirement Investor must receive affirmative consent from the Retirement Investor, and cannot violate Section II(f).

A number of commenters also asked that the exemption authorize Financial Institutions to satisfy the contract requirement for all Retirement Investors—including new customers after the January 1, 2018—through unilateral contracts or implied or negative consent. Some commenters suggested that the Department should not require a contract at all, but only a “customer bill of rights” or similar disclosure, without any additional signature requirement. Some commenters suggested that the requirement of obtaining signatures could delay execution of time sensitive investment strategies.

Although the final exemption accommodates a wide variety of concerns regarding contract operational issues, the Department did not adopt the alternative approaches suggested by some commenters, such as merely requiring delivery of a customer bill of rights, broader reliance on a unilateral contract approach, or increased reliance on negative consent. The Department intends that Retirement Investors that are new customers of the Financial Institution should enter into an enforceable contract under Section II(a)(1)(i). Consistent with the Department's goal that Retirement Investors obtain clear evidence of the contract terms and their applicability to the Retirement Investor's own account or contract, the exemption limits the negative consent option to existing customers as a form of transitional relief, so that Financial Institutions can avoid the burdens associated with obtaining signatures from a large number of already-existing customers.

Apart from this transitional relief, the Department does not believe it is appropriate to dispense with the clarity, enforceability and legal protections associated with an affirmative contract. Contracts are commonplace in a wide range of commercial transactions occurring in person, on the web, and elsewhere. The Department has facilitated the process by providing that Financial Institutions can incorporate the contract terms into commonplace account opening or similar documents that they already use; by permitting electronic signatures; and by revising the timing rules, so that the contract's execution can follow the provision of advice, as long as it precedes or occurs at the same time as the execution of the recommended transaction.

3. Fiduciary Acknowledgment—Section II(b)

Section II(b) of the exemption requires the Financial Institution to affirmatively state in writing that the Financial Institution and the Adviser(s) act as fiduciaries under ERISA or the Code, or both, with respect to any investment advice regarding principal transactions and riskless principal transactions provided by the Financial Institution or the Adviser subject to the contract or, in the case of an ERISA plan, with respect to any investment advice regarding the principal transactions and riskless principal transactions between the Financial Institution and the Plan or participant or beneficiary account.

With respect to IRAs and non-ERISA plans, if this acknowledgment of fiduciary status does not appear in a contract with a Retirement Investor, the exemption is not satisfied with respect to transactions involving that Retirement Investor. With respect to ERISA plans, this acknowledgment must be provided to the Retirement Investor prior to or at the same time as the execution of the recommended transaction, but not as part of a contract. This fiduciary acknowledgment is critical to ensuring clarity and certainty with respect to fiduciary status of both the Adviser and Financial Institution under ERISA and the Code with respect to that advice.

The fiduciary acknowledgment provision received significant support from some commenters. Commenters described it as a necessary protection and noted that it would clarify the obligations of the Adviser. One commenter said that facilitating proof of fiduciary status should enhance investors' ability to obtain a remedy for Adviser misconduct in arbitration by eliminating ancillary litigation over fiduciary status. Rather than litigate over fiduciary status, the fiduciary acknowledgment would help ensure that the proceedings focused on the Advisers' compliance with fundamental fiduciary norms.

Some commenters opposed the fiduciary acknowledgment requirement in the proposal, as applicable to Financial Institutions, on the basis that it could force Financial Institutions to take on fiduciary responsibilities, even if they would not otherwise be functional fiduciaries under ERISA or the Code. The commenters pointed out that under the proposed Regulation, the acknowledgment of fiduciary status would have been a factor in imposing fiduciary status on a party. Therefore, Financial Institutions could become fiduciaries by virtue of the fiduciary acknowledgment. To address these concerns, a few commenters suggested language under which a Financial Institution would only be considered a fiduciary to the extent that it is “an affiliate of the Adviser within the meaning of 29 CFR 2510.3-21(f)(7) that, with the Adviser, functions as a fiduciary.”

The Department has not adjusted the exemption as these commenters requested. The exemption requires as a condition of relief that a sponsoring Financial Institution accept fiduciary responsibility for the recommendations of its Adviser(s). The Financial Institution's role in supervising individual Advisers and overseeing their adherence to the Impartial Conduct Standards is a key safeguard of the exemption. The exemption's success critically depends on the Financial Institution's careful implementation of anti-conflict policies and procedures, avoidance of Adviser incentives to violate the Impartial Conduct Standards and broad oversight of Advisers. Accordingly, Financial Institutions that wish to engage in principal transactions and riskless principal transactions that would otherwise be prohibited under ERISA and the Code must agree to take on these responsibilities as a condition of relief under the exemption. To the extent Financial Institutions do not wish to take on this role with their associated responsibilities and liabilities, they may structure their operations to avoid prohibited transactions and the resultant need of the exemption.

Other commenters expressed the view that the fiduciary acknowledgement would potentially require broker-dealers to satisfy the requirements of the Investment Advisers Act of 1940. As described by commenters, the Act does not require broker-dealers to register as investment advisers if they provide advice that is solely incidental to their brokerage services. Commenters expressed concern that acknowledging fiduciary status and providing advice in satisfaction of the Impartial Conduct Standards could call into question whether the advice provided was solely incidental.

The Department does not, however, require the Adviser or Financial Institution to acknowledge fiduciary status under the securities laws, but rather under ERISA or the Code or both. Neither does the Department require Advisers to agree to provide investment advice on an ongoing, rather than transactional, basis. An Adviser's status as an ERISA fiduciary is not dispositive of its obligations under

[Text truncated at 120,000 characters. The full text is on the page linked above.]

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2016-07926. Public record. Not legal advice.