Proposed Best Interest Contract Exemption for Insurance Intermediaries

Federal RegisterJan 19, 2017

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DEPARTMENT OF LABOR

Employee Benefits Security Administration

29 CFR Part 2550

[Application No. D-11926]

ZRIN 1210-ZA26

Proposed Best Interest Contract Exemption for Insurance Intermediaries

AGENCY:

Employee Benefits Security Administration, U.S. Department of Labor.

ACTION:

Notification of Proposed Class exemption.

SUMMARY:

This document contains a notice of pendency before the Department of Labor of a proposed class exemption from certain prohibited transaction restrictions of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code of 1986, as amended (the Code). The provisions at issue generally prohibit fiduciaries with respect to employee benefit plans and individual retirement accounts (IRAs) from engaging in self-dealing and receiving compensation from third parties in connection with transactions involving the plans and IRAs. The exemption proposed in this document, if granted, would allow certain insurance intermediaries, and the insurance agents and insurance companies they contract with, to receive compensation in connection with fixed annuity transactions that may otherwise give rise to prohibited transactions as a result of the provision of investment advice to plan participants and beneficiaries, IRA owners and certain plan fiduciaries (including small plan sponsors). The proposed exemption includes protective conditions to safeguard the interests of the plans, participants and beneficiaries and IRA owners and is similar to the Department's Best Interest Contract Exemption (PTE 2016-01) granted on April 8, 2016, at 81 FR 21002, as corrected at 81 FR 44773 (July 11, 2016).

DATES:

Comments:

Written comments and requests for a public hearing on the proposed exemption must be submitted to the Department within 30 days from the date of publication of this

Federal Register

document.

Applicability:

The Department proposes to make this exemption available on April 10, 2017. Transition relief is proposed for the period from April 10, 2017, through August 15, 2018;

see

“Transition Relief,” below.

ADDRESSES:

All written comments and requests for a hearing concerning the proposed class exemption should be sent to the Office of Exemption Determinations by any of the following methods, identified by ZRIN 1210-ZA26:

Federal eRulemaking Portal:

http://www.regulations.gov

at Docket ID number: EBSA-2016-0026. Follow the instructions for submitting comments.

Email to: e-OED@dol.gov.

Fax to:

(202) 693-8474.

Mail:

Office of Exemption Determinations, Employee Benefits Security Administration, (Attention: D-11926), U.S. Department of Labor, 200 Constitution Avenue NW., Suite 400, Washington, DC 20210.

Hand Delivery/Courier:

Office of Exemption Determinations, Employee Benefits Security Administration, (Attention: D-11926), U.S. Department of Labor, 122 C St. NW., Suite 400, Washington, DC 20001.

Instructions:

All comments and requests for a hearing must be received by the end of the comment period. Requests for a hearing must state the issues to be addressed and include a general description of the evidence to be presented at the hearing. The comments and hearing requests will be available for public inspection in the Public Disclosure Room of the Employee Benefits Security Administration, U.S. Department of Labor, Room N-1513, 200 Constitution Avenue NW., Washington, DC 20210. Comments and hearing requests will also be available online at

www.regulations.gov,

at Docket ID number: EBSA-2016-0026 and

www.dol.gov/ebsa,

at no charge.

Warning:

All comments and hearing requests will be made available to the public. Do not include any personally identifiable information (such as Social Security number, name, address, or other contact information) or confidential business information that you do not want publicly disclosed. All comments and hearing requests may be posted on the Internet and can be retrieved by most Internet search engines.

FOR FURTHER INFORMATION CONTACT:

Brian Shiker or Erin Hesse, telephone (202) 693-8540, Office of Exemption Determinations, Employee Benefits Security Administration, U.S. Department of Labor (this is not a toll-free number).

SUPPLEMENTARY INFORMATION:

The Department is proposing this class exemption on its own motion pursuant to ERISA section 408(a) and Code section 4975(c)(2), and in accordance with procedures set forth in 29 CFR part 2570, subpart B (76 FR 66637, 66644, October 27, 2011). Effective December 31, 1978, section 102 of Reorganization Plan No. 4 of 1978, 5 U.S.C. App. 1 (1996), transferred the authority of the Secretary of the Treasury to issue exemptions of the type proposed by the Secretary of Labor.

Executive Summary

Purpose of Regulatory Action

The Department is proposing this exemption in connection with its regulation under ERISA section 3(21)(A)(ii) and Code section 4975(e)(3)(B) (Regulation), published in the

Federal Register

on April 8, 2016, and effective on April 10, 2017.

The Regulation defines 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. The Regulation also applies to the definition of a “fiduciary” of a plan (including an IRA) under the Code. The Regulation amended 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 1975 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.

See

Definition of the Term “Fiduciary”; Conflict of Interest Rule—Retirement Investment Advice, 81 FR 20946.

In conjunction with the Regulation, the Department granted Prohibited Transaction Exemption (PTE) 2016-01 (the Best Interest Contract Exemption), also on April 8, 2016, and corrected on July 11, 2016. The Best Interest Contract Exemption is designed to promote the provision of investment advice that is in the best interest of retail investors such as plan participants and beneficiaries, IRA owners, and certain plan fiduciaries, including small plan sponsors (Retirement Investors). ERISA and the Code generally prohibit fiduciaries from receiving payments from third parties and from acting on conflicts of interest, including using their authority to affect or increase their

own compensation, in connection with transactions involving a plan or IRA. Certain types of fees and compensation common in the retail market, such as brokerage or insurance commissions, 12b-1 fees and revenue sharing payments, may fall within these prohibitions when received by fiduciaries as a result of transactions involving advice to the plan, plan participants and beneficiaries, and IRA owners.

To facilitate continued provision of advice to Retirement Investors under conditions designed to safeguard the interests of these investors, the Best Interest Contract Exemption allows certain investment advice fiduciaries (Financial Institutions and Advisers) to receive various forms of compensation that, in the absence of an exemption, would not be permitted under ERISA and the Code. “Financial Institutions,” defined in the exemption to include banks, investment advisers registered under the Investment Advisers Act of 1940 or state law, broker-dealers, and insurance companies, and individual “Advisers” must adhere to basic standards of impartial conduct (Impartial Conduct Standards), namely, giving prudent advice that is in the customer's best interest, avoiding misleading statements, and receiving no more than reasonable compensation. Additionally, Financial Institutions must exercise supervisory authority over Advisers by adopting anti-conflict policies and procedures and insulating the Advisers from incentives to violate the exemption's Impartial Conduct Standards.

The class exemption proposed in this document would provide relief that is similar to the Best Interest Contract Exemption for certain insurance intermediaries that commit to act as Financial Institutions. Insurance intermediaries typically recruit, train and support independent insurance agents and market and distribute insurance products such as traditional fixed rate annuities and fixed indexed annuities. The intermediaries include organizations commonly referred to as independent marketing organizations (IMOs), field marketing organizations (FMOs) and brokerage general agencies (BGAs). The exemption would apply to recommendations of “Fixed Annuity Contracts,” which are generally defined as fixed rate annuities and fixed indexed annuities. If the conditions of the exemption are satisfied, insurance intermediaries that satisfy the definition of “Financial Institution,” as well as the insurance agents and insurance companies that they contract with, would be permitted to receive compensation and other consideration as a result of the provision of investment advice to Retirement Investors in connection with transactions involving these annuities.

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

Regulations at 29 CFR 2570.30 to 2570.52 describe the procedures for applying for an administrative exemption. Before granting an exemption, the Department must find 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. Interested parties are permitted to submit comments to the Department through February 21, 2017.

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)) (the 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 would provide relief from the indicated prohibited transaction provisions of both ERISA and the Code.

Summary of the Major Provisions

The proposed exemption would be available for insurance intermediaries satisfying the definition of “Financial Institution,” and insurance agents (Advisers) and insurance companies with whom they contract, as well as their affiliates and related entities (as defined in the proposal), when they make investment recommendations regarding Fixed Annuity Contracts to retail “Retirement Investors.” Retirement Investors are plan participants and beneficiaries, IRA

owners, and non-institutional (or “retail”) fiduciaries. As a condition of receiving compensation that would otherwise be prohibited under ERISA and the Code, the exemption would require the Financial Institutions to acknowledge their fiduciary status and the fiduciary status of the Advisers with whom they contract in writing. The Financial Institution and Advisers would have to adhere to enforceable standards of fiduciary conduct and fair dealing with respect to their advice. In the case of IRAs and non-ERISA plans, the exemption would require that the standards be set forth in an enforceable contract with the Retirement Investor. Under the exemption's terms, the Financial Institution would not be required to enter into a contract with ERISA plan investors, but it would be obligated to adhere to these same standards of fiduciary conduct, which the investors could effectively enforce pursuant to ERISA section 502(a)(2) and (3).

For purposes of the proposed exemption, “IRA” means any account or annuity described in Code section 4975(e)(1)(B) through (F).

The proposed exemption is designed to cover commissions and other forms of compensation received in connection with the recommendation of Fixed Annuity Contracts. Rather than prohibit such compensation structures, the exemption would permit individual Advisers

and related Financial Institutions to receive commissions and other common forms of compensation, provided that they implement appropriate safeguards against the harmful impact of conflicts of interest on investment advice. The proposed exemption strives to ensure that Advisers' recommendations reflect the best interest of their Retirement Investor customers, rather than the conflicting financial interests of the Advisers and the Financial Institutions with whom they contract. Protected Retirement Investors include plan participants and beneficiaries, IRA owners, and “retail” fiduciaries of plans or IRAs (generally persons who hold or manage less than $50 million in assets, and are not banks, insurance carriers, registered investment

advisers or broker dealers), including small plan sponsors.

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. For purposes of this proposal, an Adviser is an employee, independent contractor, or agent of an insurance intermediary that satisfies the definition of Financial Institution in the proposed exemption.

In order to protect the interests of plan participants and beneficiaries, IRA owners, and plan fiduciaries, the exemption would require the Financial Institution to acknowledge fiduciary status for itself and its Advisers. The Financial Institutions and Advisers would have to adhere to basic standards of impartial conduct. In particular, under the proposal's standards-based approach, the Adviser and Financial Institution must give prudent advice that is in the customer's best interest, avoid misleading statements, and receive no more than reasonable compensation. Additionally, Financial Institutions generally must adopt policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, and disclose basic information about their conflicts of interest, the recommended Fixed Annuity Contract and the cost of their advice. The exemption is calibrated to align the Adviser's interests with those of the plan or IRA customer, while leaving the Adviser and 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.

Background

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 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.

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.

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

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

ERISA section 404(a).

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

ERISA section 409;

see also

ERISA section 405.

Code section 4975.

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 beneficiaries, 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.

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,” which is defined as “a communication that, based on its content, context, and

presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.”

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.

29 CFR 2510.3-21(b)(1).

See

81 FR 20946 (April 8, 2016).

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:

(i) 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);

(ii) 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;

(iii) 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

(iv) 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.

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.

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.

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”).

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

Investment professionals often receive compensation for services to Retirement Investors in the retail market through a variety of arrangements that violate the prohibited transaction rules applicable to plan fiduciaries. These include commissions paid by the plan, participant or beneficiary, or IRA, or commissions and other payments from third parties that provide investment products. A fiduciary's receipt of such payments would generally violate the prohibited transaction provisions of ERISA section 406(b) and Code section 4975(c)(1)(E) and (F) because the amount of the fiduciary's compensation is affected by the use of its authority in providing investment advice, unless such payments meet the requirements of an exemption.

Prohibited Transaction Exemptions

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. For example, ERISA section 408(b)(14) and Code section 4975(d)(17) specifically exempt transactions involving the provision of fiduciary investment advice to a participant or beneficiary of an individual account plan or IRA owner if the advice, resulting transaction, and the Adviser's fees meet stringent conditions carefully designed to guard against 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 situations in which they have a conflict of interest, they must rely upon an exemption.

Pursuant to its exemptive authority, the Department has previously granted several conditional administrative class exemptions that are available to fiduciary advisers in defined circumstances. As a general proposition, these exemptions focused on specific advice arrangements and provided relief for narrow categories of compensation. However, the new Best Interest Contract Exemption (PTE 2016-01) is 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. Similarly, the Department has granted a new exemption for principal transactions, Exemption for Principal Transactions in Certain Assets between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs (Principal Transactions Exemption) (PTE 2016-02),

that permits investment advice fiduciaries to sell or purchase certain debt securities and other investments in principal transactions and riskless principal transactions with plans and IRAs.

81 FR 21089 (April 8, 2016), as corrected at 81 FR 44784 (July 11, 2016).

At the same time that the Department granted the new exemptions, it also amended existing exemptions to, among other things, 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.

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.

The amended exemptions are Prohibited Transaction Exemption (PTE) 75-1; PTE 77-4; PTE 80-83; PTE 83-1: PTE 84-24, and PTE 86-128.

See

81 FR 21208; 21139; 21147; and 21181 (April 8, 2016).

The amendments also revoked in whole or in part 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. Most notably for purposes of this proposal, PTE 84-24,

an exemption previously providing relief for transactions involving all annuity contracts, was amended to apply only to transactions involving “fixed rate annuity contracts,” as defined in the exemption.

As a result, the exemption no longer provides relief for variable annuities, indexed annuities and any other annuities that do not satisfy the definition of fixed rate annuity contracts.

Class Exemption for Certain Transactions Involving Insurance Agents and Brokers, Pension Consultants, Insurance Companies, Investment Companies and Investment Company Principal Underwriters, 49 FR 13208 (April 3, 1984), as amended, 71 FR 5887 (February 3, 2006), as amended 81 FR 21147 (April 8, 2016).

The definition of “fixed rate annuity contract” in PTE 84-24, as amended, is “a fixed annuity contract issued by an insurance company that is either an immediate annuity contract or a deferred annuity contract that (i) satisfies applicable state standard nonforfeiture laws at the time of issue, or (ii) in the case of a group fixed annuity, guarantees return of principal net of reasonable compensation and provides a guaranteed declared minimum interest rate in accordance with the rates specified in the standard nonforfeiture laws in that state that are applicable to individual annuities; in either case, the benefits of which do not vary, in part or in whole, based on the investment experience of a separate account or accounts maintained by the insurer or the investment experience of an index or investment model. A Fixed Rate Annuity Contract does not include a variable annuity or an indexed annuity or similar annuity.”

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 proposed exemption, if granted, 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 or this proposed exemption, if granted. 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.

The Best Interest Contract Exemption

In broadest outline, the Best Interest Contract Exemption permits Advisers and the Financial Institutions (as defined in the exemption) that employ or otherwise retain them to receive many common forms of compensation that ERISA and the Code would otherwise prohibit, provided that they give advice that is in their customers' best interest and the Financial Institution implements basic protections against the dangers posed by conflicts of interest. More specifically, under the Best Interest Contract Exemption, Financial Institutions generally must:

• Acknowledge fiduciary status with respect to investment advice to the Retirement Investor;

• Adhere to Impartial Conduct Standards requiring them to:

○ Give advice that is in the Retirement Investor's best interest (

i.e.,

○ Charge no more than reasonable compensation; 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

• Fairly disclose the fees, compensation, and material conflicts of interest, associated with their recommendations.

Advisers relying on the exemption must adhere to the Impartial Conduct Standards when making investment recommendations. In order for relief to be available under the exemption, there must be a “Financial Institution” that meets the definition set forth in the exemption and that satisfies the applicable conditions.

Section VIII(e) of the Best Interest Contract Exemption states that a “Financial Institution” can be a registered investment adviser (RIA), a bank or similar financial institution, a broker-dealer or an insurance company. The Department noted in the preamble to the exemption that these entities were identified by Congress as advice providers in the statutory exemption for investment advice under ERISA section 408(g) and Code section 4975(f)(8) and

that they are subject to well-established regulatory conditions and oversight.

However, in response to requests to broaden the definition to include marketing and distribution intermediaries, the Department added section VIII(e)(5), which states that a Financial Institution also includes “an entity that is described in the definition of Financial Institution in an individual exemption . . . that provides relief for the receipt of compensation in connection with investment advice provided by an investment advice fiduciary, under the same conditions as [the Best Interest Contract Exemption].”

See

81 FR at 21067.

See id.; id

at 21083.

Thus, although the definition of Financial Institution in the Best Interest Contract Exemption was limited to certain specified entities, the exemption provided a mechanism under which the definition can be expanded if an individual exemption is granted to another type of entity, under the same conditions. In that event, the individual exemption would provide relief to the applicants identified in the exemption, but the definition of Financial Institution in the Best Interest Contract Exemption would be expanded so that other entities that satisfy the definition in the individual exemption can rely on the Best Interest Contract Exemption. In the preamble to the Best Interest Contract Exemption, the Department stated that “[i]f parties wish to expand the definition of Financial Institution to include marketing intermediaries or other entities, they can submit an application to the Department for an individual exemption, with information regarding their role in the distribution of financial products, the regulatory oversight of such entities, and their ability to effectively supervise individual Advisers' compliance with the terms of this exemption.”

See id.

at 21067.

Pursuant to section VIII(e)(5) of the Best Interest Contract Exemption, the Department received 22 applications for individual exemptions from insurance intermediaries that contract with independent insurance agents to sell fixed annuities (applicants). The applicants describe themselves as “independent marketing organizations,” “insurance marketing organizations” and “field marketing organizations.”

Collectively, the Department refers to the applicants and similar entities as either “insurance intermediaries” or “IMOs.” The applicants sought individual exemptions under the same conditions as the Best Interest Contract Exemption, but with a new definition of “Financial Institution” incorporating insurance intermediaries.

Because of the large number of applications, the Department determined to propose, on its own motion, a class exemption for such intermediaries based on the facts and representations in the individual applications received by the Department. The applicants employ a wide variety of business models and approaches, however, and the proposal, while designed to provide class relief for insurance intermediaries, may not be available to all the applicants depending on their individual circumstances. As discussed below, there are a variety of compliance options available to the insurance industry under the Best Interest Contract Exemption. This proposed exemption would supplement these options by permitting the IMO or other intermediary to act as a covered “Financial Institution” with supervisory responsibilities under specified conditions, many of which parallel the conditions of the Best Interest Contract Exemption. To the extent insurance intermediaries wish to pursue additional exemptive relief, the Department will consider such additional requests.

Primarily, it is important to note that insurance intermediaries are not required to act as Financial Institutions under this exemption, if granted, in order to participate in the marketplace. They may provide valuable compliance assistance and other services to insurance companies or other insurance intermediaries that act as Financial Institutions under the Best Interest Contract Exemption or this exemption, if granted, and receive compensation for their services. In this regard, both the Best Interest Contract Exemption and this proposal, if granted, would specifically provide relief for compensation paid to “affiliates” and “related entities” of an Adviser and Financial Institution, which would typically include IMOs.

Therefore, an IMO that does not meet the definition of Financial Institution under this proposal can nevertheless continue to work with an insurance company or other intermediary, and receive compensation, if the insurance agent and the insurance company or other intermediary complies with the conditions applicable to Advisers and Financial Institutions, respectively, in the Best Interest Contract Exemption or this exemption, if granted.

As the Department noted in recent guidance, even if it decided not to grant this exemption, an insurer could bolster its oversight by contractually requiring an IMO to implement policies and procedures designed to ensure that all of the agents associated with the IMO adhere to the Impartial Conduct Standards. See

FAQs about Conflict of Interest Rules and Exemptions, Part I,

FAQs 22 and 23. Under this approach, the IMO could eliminate potentially troubling compensation incentives across all the insurance companies that work with the IMO. While the insurance company would remain responsible for compliance with the full Best Interest Contract Exemption, nothing in that exemption would preclude insurers from contracting with other parties, such as IMOs, for compliance work.

If an IMO is not an affiliate or related entity, or otherwise a party in interest or disqualified person with respect to the plan or IRA, the IMO's receipt of payments as a result of an Adviser's advice would not be a prohibited transaction requiring compliance with an exemption.

See FAQs about Conflict of Interest Rules and Exemptions, Part I,

FAQs 22 and 23,

https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-rules-and-exemptions-part-1.pdf.

Alternatively, even without this new exemption, an insurer could take direct responsibility for supervising agents, regardless of whether it chooses to market its products through a captive sales force, independent agents, or other channels, much as insurers currently have responsibility to oversee the activities of their agents—including independent agents—under state-law suitability rules. As FAQ 22 noted, the insurer's responsibility under the Best Interest Contract Exemption is to oversee the recommendation and sale of its products, not recommendations and transactions involving other insurers. See

FAQs about Conflict of Interest Rules and Exemptions, Part I,

FAQ 22. Under the Best Interest Contract Exemption, the insurer must adopt and implement prudent supervisory and review mechanisms to safeguard the agent's compliance with the Impartial Conduct Standards when recommending the insurer's products; avoid improper incentives to preferentially push the products, riders, and annuity features that are the most lucrative for the insurer at the customer's expense; ensure that the insurer and agent receive no more than reasonable compensation for their services in connection with the transaction; and adhere to the disclosure and other conditions set forth in its exemption. Thus, for example, an insurer could adopt policies and procedures that require agents (including independent agents) to engage in a process specified by the

insurer for making prudent recommendations; review the agent's final recommendation in light of the customer's investment objectives, risk tolerance, financial circumstances, and needs; ensure that its own compensation practices are in line with industry standards for reasonable compensation for the agent's services; and avoid creating any misaligned incentives that encourage the Adviser to choose between the insurer's various offerings based on the financial interests of the insurer or its affiliates, rather than the customer's interest. If the insurer believes that an independent agent may be improperly motivated by the size of the insurer's commissions as compared to its competitors, it may need to review the agent's recommendations particularly carefully and seek additional assurances from the agent as to the basis of its recommendations. However, nothing in the Best Interest Contract Exemption requires the insurer to pay precisely the same compensation to its agents as its competitors, as long as the compensation is reasonable in relation to the services rendered, and the insurer carefully oversees the recommendations for compliance with the Impartial Conduct Standards.

In general, as noted in the Department's FAQs Part I, the Financial Institution can comply with its obligations to pay no more than reasonable compensation by being attentive to market prices and benchmarks for the services; providing the investor proper disclosure of relevant costs, charges, and conflicts of interest, prudently evaluating the customer's need for the services; and avoiding fraudulent or abusive practices with respect to the service arrangement.

See FAQs about Conflict of Interest Rules and Exemptions, Part I,

FAQ 33,

https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-rules-and-exemptions-part-1.pdf

Applicants for Individual Exemptions

The following entities submitted applications for individual exemptions permitting them to act as Financial Institutions under the Best Interest Contract Exemption: Gradient Insurance Brokerage, Inc., C2P Advisory Group, LLC dba Clarity to Prosperity, Legacy Marketing Group, LLC, InForce Solutions, LLC, Futurity First Insurance Agency, Financial Independence Group, Brokers International Ltd, Insurance Advocates, Advisors Excel, AmeriLife Group, LLC, InsurMark, Annexus, Ideal Producers Group, ECA Marketing, Saybrus Partners, Inc., Alpine Brokerage Services, The Annuity Source, Inc., M&O Financial, Inc., Kestler Financial Group, Inc., First Income Advisors, Crump Life Insurance Services, Inc., and The IMPACT Partnership, LLC. The applicants provided background information on the distribution of fixed annuities, described their business models and discussed their anticipated approaches to compliance with the proposed exemption.

Distribution of Fixed Annuities

As described by various applicants, fixed annuities—and in particular, fixed indexed annuities—are commonly distributed by independent insurance agents. Independent insurance agents distribute the products of not one insurance company, but rather multiple insurance companies.

Typically, insurance intermediaries recruit, train and support independent insurance agents and market and distribute insurance products. Since the independent agents are not associated with any one particular insurance company, the intermediary steps in to develop sales processes, provide marketing material, and formulate supervisory procedures and methods for the independent agents to use. The insurance companies and the agents have come to rely on these insurance intermediaries to serve a wide variety of functions relating to the distribution of fixed annuities through the independent insurance agent channel. Insurance intermediaries commonly provide services that include: Agent recruitment and screening, licensing and contracting services, creation of product illustrations, case management, IT services, marketing services, new business processing, training and supervising agents and ensuring compliance with existing standards under state insurance law.

Further, insurance intermediaries can serve an important compliance function. Insurance intermediaries may serve to facilitate statutory and regulatory compliance as well as help to resolve compliance issues that may arise between state regulators, the insurance company and an agent. In performing this role, insurance intermediaries can perform compliance reviews, create policies and procedures and vet the practices of agents. Many insurance intermediaries contractually require that an agent comply with specific standards that are set by the insurance intermediary, as well as the federal and state laws and regulations that govern insurance.

Some insurance intermediaries currently work with the insurance companies to ensure that annuities sold by agents are “suitable” for their clients. This suitability standard generally requires agents and insurance companies to review detailed information about the client to determine if the fixed annuity purchase complies with the suitability standards under state insurance law (

see

2010 NAIC Suitability in Annuity Transactions Model Regulation, which applicants state has been adopted by most state insurance regulators). In order to assist the insurance company and the agent, the insurance intermediary will ensure that the agent has considered, at a minimum, the client's prospective age, annual income, financial situation and needs (including the source of the funds used to purchase the annuity), financial experience, financial objectives, intended use of the annuity, financial time horizon, existing assets (including investment and life insurance), liquidity needs, liquid net worth, risk tolerance and tax status.

The distribution services provided by the insurance intermediary generate multiple forms of compensation for the insurance intermediary. Most prominently, the sale of an annuity usually triggers the payment of a commission to the insurance intermediary. The commission can be based on many factors, including, but not limited to, the specific annuity product sold, the state in which it is sold, the premium amount and the age of the annuity owner. An insurance intermediary can also receive compensation for additional services, including, but not limited to, product development, marketing, administrative and compliance services and field support services. The specific compensation terms are generally spelled out in the contracts between the insurance intermediary and the insurance company and the insurance intermediary and the agent.

The compensation payments received by insurance intermediaries may trigger prohibited transaction concerns under both ERISA and the Code. After the applicability date of the Regulation, insurance agents who recommend fixed annuity products will generally be fiduciaries with respect to a Retirement Investor's account. The receipt of a commission or other compensation by a fiduciary, or an entity in which the fiduciary has an interest that would affect its judgment as a fiduciary, as a result of the provision of investment advice is a prohibited transaction for which an exemption is needed.

Under this fixed annuity distribution and compensation model, an insurance company could serve as a “Financial Institution” for purposes of the Best Interest Contract Exemption. However, the applicants express concern that insurance companies may not necessarily agree to satisfy the role of the Financial Institution under the Best Interest Contract Exemption with respect to independent insurance

agents, or may prefer to rely upon a captive sales force when relying upon that exemption. Additionally, some of the applicants stated that independent insurance agents do not want to lose the flexibility of their independent status.

The applicants represent that the independent insurance agent model benefits consumers because independent agents can offer a wider variety of products to satisfy consumers' goals. Thus, the applicants take the position that permitting insurance intermediaries to serve as Financial Institutions will facilitate independent insurance agents' continued sale of fixed annuities in the Retirement Investor marketplace under a single set of policies and procedures. The exemption proposed herein would apply to commissions and other compensation received by an insurance agent, insurance intermediary, insurance companies and any other affiliates and related entities, as a result of a plan's or IRA's purchase of Fixed Annuity Contracts.

Business Models

Many of the applicants stated that they had direct contractual relationships with the majority of the insurance companies for which they distribute fixed annuities. Frequently, these direct contractual relationships with the insurance companies assigned responsibility for the oversight of agents and sub-IMOs to the intermediaries. Some applicants indicated they are at the highest level of an insurance company's distribution hierarchy, or at the “top-tier” or “top-level.”

As top-level IMOs, most applicants represented that they oversee independent, insurance-only agents or sub-IMOs (which in turn oversee independent insurance-only agents), or both. This oversight is accomplished through the top-level IMO's use of its compliance structure and other business and administrative tools. The applicants use their compliance structure to directly oversee agents or to assist sub-IMOs in the distribution of fixed annuities and the oversight of their agents. One applicant, however, stated that it is a sub-IMO. As a sub-IMO, the applicant represents that it has contractual relationships with the insurance companies for which it distributes fixed annuities, but that it also has a contractual relationship with a top-level IMO. The top-level IMO provides the sub-IMO with distribution and other support services. Further, the top-level IMO assists the sub-IMO in accessing a wide variety of insurance products. The sub-IMO represents that contracting with a top-level IMO to provide this access and these services allows it to focus on the training and support of its agents.

Further, other applicants, in addition to describing themselves as top-level IMOs, also represented that they are affiliated with large insurance companies. One of these applicants wholly owns numerous sub-IMOs. Despite the differences in the ownership structure, the applicants represent that they, like the other top-level IMOs, assist in the distribution of fixed annuities, both their affiliates' and those sold by other insurance companies, and provide valuable business and administrative assistance to sub-IMOs and agents.

Finally, some applicants indicated that their services extend to assisting insurance companies in the design of insurance products.

Compliance Approach

The applicants represented to the Department that they have broad experience that will contribute to their ability to satisfy the conditions of the exemption. Some applicants pointed to their experience in providing oversight of independent agents for insurance law compliance. A number of the applicants indicated that they planned to rely on affiliated registered investment advisers and/or broker-dealer entities in developing systems to comply with the exemption.

The applicants generally indicated that they would maintain internal compliance departments and adopt supervisory structures to ensure compliance with the exemption. Several applicants pointed to technology that they would use to ensure compliance. Some applicants indicated that insurance agents would be required to use the intermediary's technology to ensure that clients receive the disclosures and a contract, where required. Agents would also be required to use the intermediary's Web site services and maintain records centrally.

Some of the applicants additionally described how their sales practices would ensure best interest recommendations. A number of the applicants plan to require centralized approval of agent recommendations; in some cases, the recommendations would be reviewed by salaried employees of the intermediary with additional credentials, such as Certified Financial Planners. One applicant indicated that internal review would include a comparison of the proposed product to other similar fixed indexed annuity products available in the marketplace in order to ensure it is appropriate for the purchaser, and that the analysis would include utilizing third party benchmarking services and industry comparisons. Another applicant indicated that it would ensure that an RIA representative would work with insurance-only agents where a recommendation would involve the liquidation of securities, to ensure that both state and federal securities laws are properly followed.

Some applicants additionally stated that their contracts with insurance agents would include certain specific requirements, including: Adherence to the intermediary's policies and procedures with respect to advertising, market conduct and point of sale processes, transparency and documentation; provision of advice in accordance with practices developed by the intermediary; and agreement that the agents will not accept any compensation, direct or indirect, from an insurance company, except as specifically approved by the intermediary. A number of the applicants indicated that they would perform background checks and rigorous selection processes before working with agents and would require ongoing training regarding compliance with the exemption.

A few of the applicants addressed product selection. These applicants indicated that agents making recommendations pursuant to the exemption would be limited to certain products and insurance companies. The applicants indicated there would be ongoing due diligence with respect to insurance companies and product offerings under the exemption.

After consideration of the applicants' representations and the information provided in the applications, the Department has decided to propose a class exemption for insurance intermediaries. The proposal is described below.

Description of the Proposed Exemption

General

Section I of the proposed exemption would provide relief for the receipt of compensation by insurance intermediary Financial Institutions and their “Advisers,” “Affiliates,” and “Related Entities,” as a result of the Adviser's or Financial Institution's provision of investment advice within the meaning of ERISA section 3(21)(A)(ii) or Code section 4975(e)(3)(B) to a “Retirement Investor” regarding the purchase of a Fixed Annuity Contract. The proposed exemption would broadly provide relief from the restrictions of ERISA section 406(b) and the sanctions imposed by

Code section 4975(a) and (b), by reason of Code section 4975(c)(1)(E) and (F).

Relief is also proposed from ERISA section 406(a)(1)(D) and Code section 4975(c)(1)(D), which prohibit transfer of plan assets to, or use of plan assets for the benefit of, a party in interest (including a fiduciary).

The definitions and conditions of the proposal vary in certain respects from those in the Best Interest Contract Exemption, as discussed below. The differences are intended to ensure that transactions involving fixed annuity contracts that are sold by independent insurance agents through insurance intermediaries occur only when they are in the best interest of Retirement Investors. Fixed indexed annuities, with their blend of limited financial market exposures and minimum guaranteed values, can play an important and beneficial role in retirement preparation, as the Department noted in its Regulatory Impact Analysis for the Regulation.

At the same time, however, these annuities, which are anticipated to be the primary type of fixed annuities sold under this exemption, often pose special risks and complexities for investors.

Furthermore, when the Department promulgated the Best Interest Contract Exemption, it limited Financial Institution status to entities with well-established regulatory conditions and oversight.

Insurance intermediaries are not subject to the same regulatory oversight, and often have not played the same supervisory role with respect to advisers, as the Financial Institutions covered by that exemption. As a result of such considerations, this proposal contains a restricted definition of Financial Institution and additional required policies and procedures and disclosures.

See

Regulatory Impact Analysis for the Regulation, p. 8, available at

www.dol.gov/ebsa.

See

Best Interest Contract Exemption, 81 FR 21001, 21017 (April 8, 2016).

See id.

at 21067.

These additional protections correspond to concerns, noted previously by the Department and expressed by other regulators, including the Securities and Exchange Commission (SEC) staff, the Financial Industry Regulatory Authority (FINRA), and the North American Securities Administrators Association, regarding fixed indexed annuities and the way they are marketed. Although indexed annuities are often sold as simple “no risk” products, they are neither simple nor risk free. Without proper care, Retirement Investors can all too easily be misled about the terms, guarantees, and risks associated with these products.

As FINRA noted in its Investor Alert, “Equity-Indexed Annuities: A Complex Choice”:

Sales of equity-indexed annuities (EIAs) . . . have grown considerably in recent years. Although one insurance company at one time included the word `simple' in the name of its product, EIAs are anything but easy to understand. One of the most confusing features of an EIA is the method used to calculate the gain in the index to which the annuity is linked. To make matters worse, there is not one, but several different indexing methods. Because of the variety and complexity of the methods used to credit interest, investors will find it difficult to compare one EIA to another.

“Equity-Indexed Annuities: A Complex Choice” available at

https://www.finra.org/investors/alerts/equity-indexed-annuities_a-complex-choice.

FINRA also explained that equity-indexed annuities “give you more risk (but more potential return) than a fixed annuity but less risk (and less potential return) than a variable annuity.”

Id.

Similarly, in its 2011 “Investor Bulletin: Indexed Annuities,” the SEC staff stated: “You can lose money buying an indexed annuity. If you need to cancel your annuity early, you may have to pay a significant surrender charge and tax penalties. A surrender charge may result in a loss of principal, so that an investor may receive less than his original purchase payments. Thus, even with a specified minimum value from the insurance company, it can take several years for an investment in an indexed annuity to `break even.' ”

As the SEC staff additionally observed, “[i]t is important to note that indexed annuity contracts commonly allow the insurance company to change the participation rate, cap, and/or margin/spread/asset or administrative fee on a periodic—such as annual—basis. Such changes could adversely affect your return.”

SEC Office of Investor Education and Advocacy Investor Bulletin: Indexed Annuities, available at

https://www.sec.gov/investor/alerts/secindexedannuities.pdf.

Id.

The North American Securities Administrators Association, the association of state securities regulators, issued the following statement on equity indexed annuities:

Equity indexed annuities are extremely complex investment products that have often been used as instruments of fraud and abuse. For years, they have taken an especially heavy toll on our nation's most vulnerable investors, our senior citizens for whom they are clearly unsuitable.

See

NASAA Statement on SEC Equity-Indexed Annuity Rule (December 17, 2008) available at

http://www.nasaa.org/5611/statement-on-sec-equity-indexed-annuity-rule/.

In the Department's view, the complexity and conflicted payment structures associated with fixed indexed annuities heighten the dangers posed by conflicts of interest when Advisers recommend these products to Retirement Investors. These are complex products requiring careful consideration of their terms and risks. Assessing the prudence of a particular indexed annuity requires an understanding of surrender terms and charges; interest rate caps; the particular market index or indexes to which the annuity is linked; the scope of any downside risk; associated administrative and other charges; the insurer's authority to revise terms and charges over the life of the investment; and the specific methodology used to compute the index-linked interest rate and any optional benefits that may be offered, such as living benefits and death benefits. In operation, the index-linked interest rate can be affected by participation rates; spread, margin or asset fees; interest rate caps; the particular method for determining the change in the relevant index over the annuity's period (annual, high water mark, or point-to-point); and the method for calculating interest earned during the annuity's term (

e.g.,

simple or compounded interest). Investors can all too easily overestimate the value of these contracts, misunderstand the linkage between the contract and index performance, underestimate the costs of the contract, and overestimate the scope of their protection from downside risk (or wrongly believe they have no risk of loss). As a result, Retirement Investors are acutely dependent on sound advice that is untainted by the conflicts of interest posed by Advisers' incentives to secure the annuity purchase, which can be quite substantial.

Accordingly, the Department has taken care to address these concerns, while preserving the beneficial and important role these products can play for retirement investors.

As noted above, when prudently recommended, fixed indexed annuities can promote investor interests because of their combination of limited financial market exposures and minimum guaranteed values. In addition, the Department seeks additional comments on insurers' ability to change the terms of a fixed indexed annuity contract during the life of the annuity, particularly during the period in which a surrender charge is in effect. To the extent that the insurer can change critical terms, such as the participation rate, indexing method,

cap, or relevant fees and charges, it can directly affect its own compensation. And to the extent it can make such changes during the surrender period, it can place the customer in a lose-lose situation: The customer must either accept an unfavorable change to the terms of the annuity or surrender the annuity and incur a charge against the amount of the annuity. The Department asks for comment on these issues and features, with the intent of providing additional guidance on them in the final exemption, if it is granted, or potentially limiting the exemption to annuity contracts that do not permit insurers to change critical terms during periods in which the customer is subject to a surrender charge or penalty. Specifically, the Department asks parties to provide information on how commonly fixed indexed annuity contracts are structured in this manner. In practice, how commonly do insurers make such changes to critical terms during surrender periods? What constraints are imposed on such conduct by state law or otherwise? Similarly, what constraints are placed on the size of surrender charges or the methodology for calculating the charges? How are these rights and practices disclosed to consumers? How commonly do insurers give consumers advance notice of the changes coupled with a right to withdraw assets without penalty before the changes take effect? To what extent can an Adviser prudently recommend a fixed indexed annuity if it is potentially subject to changes in key terms during the surrender period? To the extent insurers can unilaterally increase their compensation by changing key terms during the surrender period, do they need a separate exemption for the exercise of that authority? Finally, to what extent should the Department be concerned about similar issues with respect to fixed rate annuities?

See

Regulatory Impact Analysis for the Regulation, p. 8, available at

www.dol.gov/ebsa.

Definition of Fixed Annuity Contract

As stated above, the proposed exemption is limited to transactions involving Fixed Annuity Contracts. To ensure that the exemption would not be used more broadly than intended, the proposal includes a definition of Fixed Annuity Contract, which is “an annuity contract that satisfies applicable state standard nonforfeiture laws at the time of issue and the benefits of which do not vary, in whole or in part, on the basis of the investment experience of a separate account or accounts maintained by the insurer. This includes both fixed rate annuity contracts and fixed indexed annuity contracts.” The definition is intended to include fixed immediate annuities but exclude variable annuity contracts, which the Department understands are typically sold through securities distribution channels.

If this proposed exemption is granted, therefore, relief will be available for sales of fixed rate annuities sold by insurance intermediaries and independent insurance agents under several different exemptions. Relief for all annuity sales is available under the Best Interest Contract Exemption if, as discussed above, an insurance company acts as the Financial Institution under the terms of that exemption. Alternatively, relief for fixed rate annuity contracts is available under PTE 84-24. By also proposing relief for such transactions in this exemption, the Department is not indicating that these other exemptions are unavailable. The intent is to provide flexibility to parties depending on their individual circumstances.

The Department requests comment on the proposed definition of Fixed Annuity Contract. Does the definition adequately describe fixed annuities and carve out variable annuities? Are there other attributes of fixed annuity contracts that should be identified in the definition? Finally, should the definition address group annuity contracts, which may not be required to satisfy state nonforfeiture laws? Is relief necessary in this distribution channel for group annuity contracts? If so, should the definition provide that rather than satisfying the state nonforfeiture laws, the group annuity contract must “guarantee return of principal net of reasonable compensation, and provide a guaranteed declared minimum interest rate in accordance with the rates specified in the standard nonforfeiture laws in the state that are applicable to individual annuities”?

See

Final Amendment to PTE 84-24, 81 FR 21147, 21176 (April 8, 2016) (definition of “Fixed Rate Annuity Contract”).

Definition of Adviser

The proposed definition of Adviser in Section VIII(a) generally mirrors the definition in the Best Interest Contract Exemption, although a reference to banking law was not included in this proposed definition as the Department did not believe it was relevant. The definition states:

“Adviser” means an individual who:

(1) Is a fiduciary of the Plan or IRA by reason of the provision of investment advice described in ERISA section 3(21)(A)(ii) or Code section 4975(e)(3)(B), or both, and the applicable regulations, with respect to the assets of the Plan or IRA involved in the recommended transaction;

(2) Is an employee, independent contractor, or agent of a Financial Institution; and

(3) Satisfies the federal and state regulatory and licensing requirements of insurance laws with respect to the covered transaction, as applicable.

The Department requests comment on whether this definition accurately describes the relationship between independent insurance agents and insurance intermediaries who will serve as Financial Institutions under the exemption, and, if not, how the definition should be revised.

Definition of Financial Institution

The proposal includes a new definition of Financial Institution that would apply with respect to insurance intermediaries.

See

Section VIII(e). As the Department stated in the preamble to the Best Interest Contract Exemption, the definition of Financial Institution in that exemption included entities identified in the statutory exemption for investment advice under ERISA section 408(g) and Code section 4975(f)(8) and that are subject to well-established regulatory conditions and oversight.

In addition, in that preamble, the Department requested that intermediaries seeking to serve as Financial Institutions provide information as to their ability to effectively supervise Advisers' compliance with the terms of the exemption.

The applicants described their ability to oversee Advisers and proposed a variety of safeguards that they believed would be protective of Retirement Investors engaging in these transactions.

See

81 FR 21067.

See id.

The proposed definition of Financial Institution is based on the applicants' representations and suggestions and the Department's additional analysis of how best to safeguard Retirement Investors' interests in this distribution channel. The components of the definition are intended to describe insurance intermediaries that are likely to be able to comply with the exemption and provide meaningful oversight of Advisers working in the fixed annuity marketplace. The proposal seeks to identify insurance intermediaries with the financial stability and operational capacity to implement the anti-conflict policies and procedures required by the exemption. Additionally, insurance intermediaries described in the definition are sufficiently large and established to stand behind their contractual and other commitments to Retirement Investors, and to police conflicts of interest associated with a

wide range of insurance products offered by a wide range of insurance companies.

As an initial matter, the proposal defines a Financial Institution as an insurance intermediary that has a direct written contract regarding the distribution of Fixed Annuity Contracts with both the insurance company issuing the annuity contract and the Adviser or another intermediary (sub-intermediary) that has a direct written contract with the Adviser. Additional exemption conditions describe the terms of the required contract, see proposed Section II(d)(6) and (7). By requiring a contractual relationship between the insurance company and the intermediary, the proposal would ensure that the insurance intermediary and the insurance company have a direct relationship that will enable the insurance intermediary to satisfy its obligations under the exemption. By also requiring a contractual relationship between the intermediary and the Adviser or sub-intermediary, the proposal would further ensure that the intermediary will have the right to implement its oversight obligations as a Financial Institution pursuant to the requirements of the exemption, if granted. The Department requests comment on whether this condition should be adjusted to allow for multiple levels of intermediaries.

In addition to the baseline contractual relationship requirement, the proposal sets forth a series of conditions that would apply to the insurance intermediary. Subsection (1) of the proposed definition would require the insurance intermediary to satisfy the applicable licensing requirements of the insurance laws of each state in which it conducts business. Accordingly, the intermediary would be required to operate in accordance with the states' requirements in this respect.

Next, the proposal seeks to confirm that the insurance intermediary has sound business practices that have been reviewed by an independent entity. Subsection (2) of the proposed definition would require that the intermediary have financial statements that are audited annually by an independent certified public accountant. This condition would utilize the definition of Independent in Section VIII(f) of the proposed exemption.

In addition, under proposed Section III(b)(vii), the audited financial statements must be provided on the Financial Institution's Web site.

Under section VIII(f), “Independent” means a person that: (1) Is not the Adviser, the Financial Institution or any Affiliate relying on the exemption; (2) Does not have a relationship to or an interest in the Adviser, the Financial Institution or Affiliate that might affect the exercise of the person's best judgment in connection with transactions described in this exemption; and (3) Does not receive or is not projected to receive within the current federal income tax year, compensation or other consideration for his or her own account from the Adviser, Financial Institution or Affiliate in excess of 2% of the person's annual revenues based upon its prior income tax year.

This condition was suggested in several individual applications. Some applicants believed that periodic financial audits would provide reasonable assurance of the entity's financial health. The Department agrees. The Department anticipates that requiring an annual audit of the financial statements, coupled with the Financial Institution's web disclosures, will provide an opportunity for the Department and other interested persons to be alerted to any financial weaknesses or other items of concern with respect to the stability or solvency of the Financial Institution, or its ability to stand behind its commitments to Retirement Investors.

As an alternative to an audit of financial statements, one applicant suggested that the audit should relate to the intermediary's internal controls and procedures. The applicant noted that banks and trust companies are currently required to obtain these reports under SSAE 16 (formerly SAS 70), and that the applicant could work with its auditors to prepare a similar report, but suggested that such an approach would require additional transition relief as the accounting industry would have to agree on the appropriate data points for an internal controls audit for an insurance intermediary and the resulting topics of the SSAE 16-like report.

The Department requests comment on the utility of the proposed audited financial statements requirement as a protection of Retirement Investors, and the suggested alternative audit of internal controls and procedures. The Department also requests information on the cost of these alternatives to insurance intermediaries intending to rely on the exemption.

Insurance or Assets Set Aside for Potential Liability

Subsection (3) of the proposed definition would require the Financial Institution to maintain fiduciary liability insurance, or unencumbered cash, bonds, bank certificates of deposit, U.S. Treasury Obligations, or a combination of all of these, available to satisfy potential liability under ERISA or the Code as a result of the firm's failure to meet the terms of this exemption, or any contract entered into pursuant to Section II(a). The aggregate amount of these items must equal at least 1% of the average annual amount of premium sales of Fixed Annuity Contracts by the Financial Institution to Retirement Investors over the prior three fiscal years of the Financial Institution. To the extent this condition is satisfied by insurance, the proposal states that the insurance must apply solely to actions brought by the Department of Labor, the Department of Treasury, the Pension Benefit Guaranty Corporation, Retirement Investors or plan fiduciaries (or their representatives) relating to Fixed Annuity Contract transactions, including but not limited to, actions for failure to comply with the exemption or any contract entered into pursuant to Section II(a), and it may not contain an exclusion for Fixed Annuity Contracts sold pursuant to the exemption. Any such insurance also may not have a deductible that exceeds 5% of the policy limits and may not exclude coverage based on a self-insured retention or otherwise specify an amount that the Financial Institution must pay before a claim is covered by the fiduciary liability policy. To the extent this condition is satisfied by retaining assets, the assets must be unencumbered and not subject to security interests or other creditors.

This provision of the proposal seeks to ensure that the Financial Institution can stand behind its commitments to retirement investors and satisfy potential liabilities under the exemption. The Financial Institution's ability to back its commitments ensures that it can be held accountable when it violates its obligations and, thereby, promotes compliance. A number of the applicants specifically suggested that they would obtain insurance to cover potential liability under the exemption, although the approaches and suggested amounts varied. Additionally, as some applicants indicated uncertainty as to the current availability of insurance for liability under the exemption, the proposal would provide flexibility to the intermediaries to determine whether to acquire insurance or set aside assets to satisfy potential liability.

The Department has concluded that the condition should be included in this proposal based on the suggestion of applicants, as well as its understanding that insurance intermediaries often are not legally required to maintain, and do not maintain, significant amounts of capital. Particularly because these entities do not necessarily have the sort of history of regulatory oversight and supervisory experience that characterize Financial Institutions identified in the

Best Interest Contract Exemption, the Department believes that this additional condition is a necessary enhancement of the protections necessary to ensure that the intermediaries maintain full responsibility for compliance with the proposed exemption's conditions.

The Department requests comment on the approach taken in proposed subsection (3) of the definition. First, do commenters agree that the exemption should specify that insurance/assets should be based on a percentage of prior sales of Fixed Annuity Contracts? Is a three-year average an appropriate method for determining the amount of premium sales? Should a different and or minimum/maximum amount be specified, or should there be no specific level at all? For example, should the exemption instead require that a “reasonable” amount of insurance be obtained or assets set aside? As an additional protection for Retirement Investors, should individual Advisers be required to carry insurance themselves?

Moreover, should the final exemption retain the proposal's approach of allowing Financial Institutions flexibility to either obtain fiduciary liability insurance or set aside assets to satisfy potential liabilities? If the Department adopts this approach, should it specify how assets should be held (

i.e.,

in an escrow account) in order to ensure they are available in the event there is a judgment against the intermediary? Further, should the condition describe with more specificity which assets are acceptable, how they are to be valued, or how they are to be insulated from the claims of creditors other than Retirement Investors? As an alternative, should the final exemption require both fiduciary liability insurance coverage and a minimum level of assets set aside? If so, how should the requirement for a minimum level of assets be defined?

Premium Threshold

Finally, subsection (4) of the proposed definition would require the insurance intermediary to have had annual Fixed Annuity Contract sales averaging at least $1.5 billion in premiums over each of the three prior fiscal years to qualify as a Financial Institution. This proposed threshold is intended to identify insurance intermediaries that have the financial stability and operational capacity to implement the anti-conflict policies and procedures required by the exemption. The proposed condition aims to ensure that the insurance intermediary is in a position to meaningfully mitigate compensation conflicts across products and insurers, which is a critical safeguard of the exemption, as proposed. Although this proposed threshold would limit entities that could operate as the supervisory Financial Institution to larger intermediaries, it would not prevent smaller intermediaries from working with larger intermediaries, similarly to how some of them currently operate.

The proposed $1.5 billion threshold is based on a variety of factors. The intermediaries that approached the Department for individual exemptions and expressed their willingness and ability to function in a supervisory capacity to mitigate conflicts generally indicated sales of this amount or more in their applications, although not all applicants provided this information. Additionally, the Department believes that the $1.5 billion dollar threshold will cover those intermediaries that are most likely to make beneficial use of the exemption because economies of scale are likely to yield advantages in efficiently carrying out compliance responsibilities under this proposed exemption, especially if they step into the role that insurance companies would otherwise serve under the Best Interest Contract Exemption. The Department is also concerned that the conditions of the exemption will not serve their purpose in protecting Retirement Investors from conflicts of interest if the insurance intermediary does not have the requisite experience and resources to be able to effectively mitigate the potential adverse impact of these incentives.

To this point, the Department questions whether intermediaries with lower levels of annual sales will be able to effectively mitigate conflicts in an environment that is so heavily dependent on commission compensation, particularly without the history of regulatory oversight and supervisory experience that characterize other Financial Institutions, such as banks, insurance companies, and broker-dealers. One of the chief reasons for extending Financial Institution status to insurance intermediaries is their ability to mitigate the conflicts of interest posed by the variable compensation that independent agents may receive from different insurance companies paying different compensation. Sufficiently large intermediaries that sell many products from a wide variety of insurance companies are in a position to control the compensation that the agent stands to receive from the various insurers and products and, thereby, minimize or eliminate the independent agents' conflicts of interest in choosing between insurance companies and products. In addition, the anti-conflict purpose of the exemption's conditions would not be served with respect to an entity that is so small that the difference between the firm's conflicts and the individual advisers' conflicts is essentially non-existent.

The proposed requirement that the premium threshold be met using the preceding three-year average is intended, again, to identify intermediaries with an established history of significant sales. However, it is not intended as a barrier to new entities becoming Financial Institutions or for smaller intermediaries to operate under this exemption, albeit not as a Financial Institution. The Department notes that while a large intermediary would be responsible for acting as the Financial Institution under the exemption, smaller intermediaries will typically be eligible to obtain prohibited transaction relief under the proposed exemption's provisions that extend to “affiliates” and “related entities.” In this regard, the Department understands that the marketplace of intermediaries that distributes fixed annuities is hierarchical. Smaller intermediaries commonly work with larger intermediaries, and receive materials and support from the larger intermediaries in exchange for a fee or a portion of the sales commission. Therefore, smaller intermediaries could obtain relief from ERISA's prohibited transaction rules as long as there is an intermediary in their distribution hierarchy that acts as the Financial Institution and provides the requisite anti-conflict and supervisory role under the exemption, including execution of the best interest contract.

Accordingly, where several intermediaries (a top-level intermediary and one or more sub-intermediaries) receive commission compensation in connection with an annuity transaction, each intermediary would be eligible for prohibited transaction relief under this proposed exemption, although only one would act as the Financial Institution and need to satisfy the premium threshold.

If an intermediary is not an affiliate or related entity, or otherwise a party in interest or disqualified person with respect to the plan or IRA, the intermediary's receipt of payments as a result of an Adviser's advice would not be a prohibited transaction requiring compliance with an exemption.

Importantly, in determining whether an intermediary meets the $1.5 billion threshold, each intermediary that receives a commission for an annuity transaction could count the total premium amount involved towards the required premium threshold. This will facilitate the ability of smaller intermediaries to satisfy the premium

threshold under this exemption, and act as a Financial Institution, if desired. For example, assume an Annuity Adviser contracts with IMO A, which in turn is a part of IMO B's network. IMO B is a Financial Institution under this exemption. If Annuity Adviser sells an annuity to a Retirement Investor for $100,000, both IMO A and IMO B can count the $100,000 towards their own $1.5 billion threshold. If IMO A eventually reaches the $1.5 billion threshold (averaged over three years), it could act as a Financial Institution under this exemption, but would not be required to do so, as long as IMO B or another Financial Institution acts in the requisite role.

The Department notes that applicants suggested various other methods of defining which intermediaries should qualify as Financial Institutions. The most prevalent suggestion was to limit the exemption to “top tier” intermediaries with a significant number of direct relationships with insurance carriers. The “top tier” intermediary was generally described as the entity at the top of an insurance carrier's distribution hierarchy. Some applicants stated that the exemption should focus on the “top tier” intermediaries because such entities have a closer tie with the insurance company.

The Department's proposal is not limited to intermediaries with “top tier” status. As an initial matter, the Department understands that many insurance intermediaries have direct contracts with insurance carriers regardless of the intermediary's size and it may not be clear whether a particular contractual relationship is properly characterized as a “top tier” relationship. Additionally, even assuming that “top tier” could be defined objectively, the Department is not certain that status at the top of an insurance company's distribution hierarchy is necessary to indicate that an intermediary is an established entity capable of providing effective oversight of Advisers and mitigating compensation incentives. Accordingly, the Department has tentatively concluded that the premium threshold is a better indicator that an intermediary can serve these functions based on its involvement in a significant amount of sales over its three prior fiscal years.

The Department requests comment on a variety of aspects of the proposed premium threshold condition and possible alternatives. First, the Department seeks comment on alternative approaches to identifying intermediaries that are likely to be able to comply with the exemption and provide meaningful oversight of Advisers working in the fixed annuity marketplace. More specifically, the Department asks whether focusing on premium levels is an effective measure of compliance and conflict mitigation capability. The Department also seeks comment on the requirement that the premium condition be met by averaging premiums over the preceding three fiscal years. In particular, the Department asks the following questions:

—Is the $1.5 billion threshold likely to identify intermediaries with the history and capability of handling supervisory and regulatory compliance of this nature? If there is a threshold, should it be set at a different level?

—If a premium threshold is adopted, should it be indexed to grow with consumer price inflation or some other reference?

—If a premium threshold is included, is basing it on an average over the prior three years an effective way to account for fluctuations in annual sales to ensure intermediaries have certainty that they will continue to qualify as a Financial Institution? Are there alternative ways to address annual sales fluctuations to provide such certainty?

—In addition to entities that have satisfied the premium threshold, should the Financial Institution definition extend to entities with a “reasonable expectation” of meeting the threshold over the next three years, to ensure that newer or growing entities can more readily become Financial Institutions? Would a subjective threshold of this type provide adequate protections to Retirement Investors? How should the exemption apply to intermediaries that fail to meet the threshold, notwithstanding their previously “reasonable expectation” that they would meet the threshold?

—If the exemption did not include a premium threshold, would smaller intermediaries nevertheless be likely to rely on larger intermediaries for exemption compliance due to cost savings, efficiency, or other reasons?

—Are there a large number of smaller intermediaries selling fixed annuities that do not work with any other intermediaries that could satisfy the $1.5 billion or similar threshold?

—Should the premium threshold apply specifically to fixed annuity sales, or should it apply more broadly to all sales of insurance and annuity products? If it applies to insurance sales other than fixed annuities, how should premiums for those sales be measured?

—As an alternative or in addition to a premium threshold, should the exemption have a threshold based on the number of annuity contracts sold by the intermediary annually?

—Should a “top tier” requirement replace or be added to a premium threshold requirement? If so, how would the Department define “top tier” status, and should intermediaries be required to have a certain minimum number of contractual relationships with different insurance companies to satisfy such a requirement?

—Alternatively, or in addition to, either a premium threshold or a “top tier” requirement, should the exemption require that the intermediary also have agreements to sell fixed annuities with a specified minimum number of different insurance companies? If so, what would be an appropriate minimum number and why?

—Are there other conditions (

e.g.,

minimum number of employees, annual revenue threshold, capitalization requirement) that would satisfy the Department's intent to ensure the covered Financial Institutions are able and likely to comply with the exemption and engage in meaningful oversight of Advisers working in the fixed annuity marketplace?

Conditions

Sections II through V of the proposal contain the conditions proposed for relief under the exemption. The conditions are the same as the Best Interest Contract Exemption in many respects, but some of the conditions have been revised, augmented or deleted, as discussed in this section. The Department requests comments on these revisions.

Sections II(a), (b), (c)

Section II 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 IRA investments, and plans that are not covered by Title I of ERISA (non-ERISA plans), such as plans covering only partners or sole proprietors—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. Financial Institutions additionally must provide the disclosures set forth in Section II(e).

Unlike the Best Interest Contract Exemption, this proposal does not contain provisions addressing relief in the event of the failure to enter into a contract.

See

Best Interest Contract Exemption, section II(a)(1)(iii). This provision was included in the Best Interest Contract Exemption to address concerns voiced generally in the context of mutual fund transactions. Commenters raised concerns that it would be possible for a Retirement Investor to receive advice from an Adviser to enter into a transaction but fail to open an account with the particular Adviser or Financial Institution, yet nevertheless follow the advice in a way that generates additional compensation for the Financial Institution or an affiliate or related entity. The Department does not anticipate that such concerns are present in the context of the annuity transactions covered in this proposal and has therefore not included provisions in this proposal to parallel section II(a)(1)(iii) of the Best Interest Contract Exemption; however, the Department requests comment on this approach.

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) and the Financial Institution's agreement that it and its Advisers will adhere to the Impartial Conduct Standards as required by Section II(c). The Impartial Conduct Standards require Advisers and Financial Institutions to provide 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 their affiliates, related entities or other parties); charge no more than reasonable compensation; and make no misleading statements about investment transactions, compensation, and conflicts of interest. These provisions are unchanged from the Best Interest Contract Exemption.

In this regard, the Department cautions Financial Institutions and Advisers to avoid inaccurate or misleading statements regarding the risk characteristics of fixed indexed annuity contracts, particularly statements that inaccurately suggest these products have only upside potential and no risk of loss of principal.

See

Equity-Indexed Annuities: Member Responsibilities for Supervising Sales of Unregistered Equity-Indexed Annuities, available at

http://www.finra.org/industry/notices/05-50.

In particular, firms and Advisers violate the Impartial Conduct Standards if they fail to explain any limitations on the upside of the investments (

e.g.,

as imposed by caps, participation rates, and crediting practices), or if they falsely describe fixed indexed annuities as “no risk” products or state that there can be no loss of principal with Fixed Annuity Contracts, without acknowledging the potential impact of surrender charges or other provisions that could, in fact, result in the consumer's receiving less than he or she paid for the contract. As further discussed below, this proposal includes a new proposed Section II(d)(4) that would require that, as part of the policies and procedures requirement, the Financial Institution approve marketing materials used by Advisers, to increase oversight in this area.

Section II(d)—Policies and Procedures

Under Section II(d), the Financial Institution must warrant that it has adopted, and in fact must comply with, anti-conflict policies and procedures reasonably and prudently designed to ensure that Advisers adhere to the Impartial Conduct Standards. The policies and procedures requirements generally include all the elements in the Best Interest Contract Exemption, including the requirement that the Financial Institution designate a person or persons responsible for addressing material conflicts of interest and monitoring Advisers' adherence to the Impartial Conduct Standards.

See

Section II(d)(2).

Proposed Section II(d)(3)

Proposed Section II(d)(3) specifically addresses incentives to Advisers, and provides that the Financial Institution's policies and procedures must prohibit the use of quotas, appraisals, or performance or personnel actions, bonuses, contests, special awards, differential compensation, or other actions or incentives if they are intended or would reasonably be expected to cause Advisers to make recommendations that are not in the best interest of the Retirement Investor. The condition applies regardless of the source of the incentive. Independent insurance agents distribute the products of multiple insurance companies and accordingly, may be subject to more than one company's incentives. In some cases, the agents may also work for more than one intermediary. Under the terms of the exemption, however, the intermediary would be expected to ensure that these arrangements did not incentivize the agents to make recommendations that run counter to the best interest standard.

The insurance intermediaries indicated they are well positioned to mitigate the impact of the competing financial incentives offered by multiple insurance companies. Consistent with the intermediaries' representations, one of the key protections of this exemption is the requirement that the insurance intermediary Financial Institution manage the conflicts of interest that independent agents and other Advisers face in recommending the products of multiple insurance companies. Proposed Section II(d)(3) would tolerate differential compensation—regardless of source—only to the extent that it is not intended or reasonably expected to cause Advisers to make recommendations that are not in the best interest of the Retirement Investor. Financial Institutions can allow Advisers to receive differential compensation if it is justified by neutral factors tied to the differences in the services delivered to Retirement Investors.

See

Best Interest Contract Exemption, 81 FR at 21039-40 (preamble discussion of neutral factors analysis);

FAQs about Conflict of Interest Rules and Exemptions, Part I,

FAQ 9 (addressing compensation incentives).

See https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-rules-and-exemptions-part-1.pdf.

This is a broader requirement for the elimination or mitigation of conflicts of interest than would apply to an individual insurance company relying on section II(d)(3) of the Best Interest Contract Exemption. As discussed above (and in the Department's FAQ 22), the insurer's responsibility under the Best Interest Contract Exemption is to oversee the recommendation and sale of its products, not recommendations and transactions involving other insurers. Thus, under the Best Interest Contract Exemption, the insurance company has an obligation to ensure that it and its affiliates and related entities do not use or create inappropriate incentives, but it does not have an obligation to control the compensation incentives independently created by other insurance companies or parties. The different business model of IMOs and other intermediaries, however, enables them to broadly eliminate differential compensation that is not tied to neutral factors based upon differences in the services provided by the Adviser. This exemption requires them to eliminate such differentials and to avoid misaligned incentives with respect to all the independent agent's recommendations.

The Department views this as a critical safeguard of this proposed exemption. The proposed condition is intended to ensure that an Adviser's relationship with multiple insurance companies and even multiple insurance intermediaries does not generate compensation or incentive structures that undermine the Adviser's provision of advice that is in Retirement Investors' best interest.

Proposed Section II(d)(3) retains the principles based approach of the Best Interest Contract Exemption, and does not purport to detail any single approach for compliance with the condition. A number of applicants indicated that they expect their

relationships with Advisers to be exclusive with respect to the sale of Fixed Annuity Contracts to Retirement Investors. In that case, the Financial Institution would have a ready means of supervising the insurers and product that the Adviser recommended and controlling associated incentive structures. The proposal does not mandate exclusivity, however; a Financial Institution could alternatively require an Adviser to provide information to the Financial Institution regarding all the compensation and incentives provided by all the other insurance companies and intermediaries through which the Adviser sells Fixed Annuity Contracts. Whatever approach is adopted by a Financial Institution, the Financial Institution will ultimately be responsible for implementing the policies and procedures across all the Advisers' incentive arrangements.

New Proposed Policies and Procedures Requirements

A new proposed Section II(d)(4) would require Financial Institutions to approve in advance all written marketing materials used by Advisers after determining that such materials provide a balanced description of the risks and features of the annuity contracts to be recommended. The condition ensures that Advisers are not using marketing materials that do not fully and fairly disclose the risks and characteristics of an annuity.

New proposed Section II(d)(5) would impose additional requirements on the person or persons designated as responsible for addressing material conflicts of interest and monitoring Advisers' adherence to the Impartial Conduct Standards. The new section would require the person to approve, in writing, recommended annuity applications involving Retirement Investors prior to transmitting the applications to the insurance company. While a specific approval requirement is not in the Best Interest Contract Exemption, a number of applicants suggested they would have internal compliance departments review recommendations prior to the transmittal of an annuity contract to an insurance company. The condition would reinforce the duty of the Financial Institution to monitor and supervise the Advisers operating within the Financial Institution's distribution chain. This may be particularly important when there are sub-intermediaries, who may be more involved in day-to-day activities, between the Adviser and the Financial Institution.

The proposal also would establish certain specific requirements for the relationship between the insurance intermediary and the Adviser. Section II(d)(6) would specify certain aspects of the written contract between the Financial Institution and the Adviser or sub-intermediary. First, the Financial Institution must require in its written contract with the Adviser or sub-intermediary that Advisers may use written marketing materials only if they are approved by the Financial Institution. As discussed above, Section II(d)(4) of this proposal would require Financial Institutions to approve in advance all written marketing materials used by Advisers after determining that such materials provide a balanced description of the risks and features of the annuity contracts to be recommended.

Second, Advisers must be required to provide the transaction disclosure required by Section III(a) of the exemption and orally review the annuity-specific information required in Section III(a)(1) with the Retirement Investor, as discussed below. These marketing and disclosure conditions address the Department's objective that Advisers and Financial Institutions relying on the exemption should describe recommended annuity contracts fully and fairly, and that the Retirement Investor must be made aware of aspects of the annuity contract that could impact the amounts ultimately paid to the Retirement Investor.

New proposed Section II(d)(7) sets forth requirements that would govern the compensation of the Adviser and sub-intermediary. The applicants described two broad approaches to paying compensation, and Section II(d)(7) permits both. Under the first approach, all compensation to be paid to the Adviser or sub-intermediary with respect to the purchase of an annuity contract pursuant to the exemption must be paid to the Adviser or sub- intermediary exclusively by the insurance intermediary. Under this approach, the intermediary would contract with insurance companies to receive the entire commission itself, and then, in turn, would pay an Adviser and/or any sub-intermediary a portion of the commission.

Under the second approach, Advisers or sub-intermediaries could receive commissions from insurance companies for the sale of annuities to Retirement Investors provided that the commission structure was approved in advance by the insurance intermediary and all forms of compensation other than commissions, whether cash or non-monetary, are paid to the Adviser or sub-intermediary exclusively by the insurance intermediary. In this approach, insurance companies can continue the practice of paying commissions directly to agents, with an override payment going to the intermediary.

Under the proposal, the insurance intermediary may elect either compensation approach or some combination of the two. The proposal offers this flexibility because different applicants had different preferences for accomplishing the same general result, that the insurance intermediaries take responsibility for Adviser compensation and other incentives. Some applicants preferred to take in all compensation from insurance companies in order to facilitate compliance with the exemption and avoid the potential for errors. Other applicants preferred the second approach, expressing the view that it would not require the establishment of new internal accounting procedures and the engagement of additional personnel.

Several applicants indicated an interest in offering Advisers product-neutral incentives based solely on levels of sales activity. If this exemption is granted, entities relying on it would be subject to Section II(d)(3), under which Financial Institution must prohibit the use of quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause Advisers to make recommendations that are not in the best interest of the Retirement Investor. The extent to which such incentive programs satisfy the requirements of Section II(d) of the exemption (or the Best Interest Contract Exemption) would be based on all the factors surrounding the incentive programs. The Department has provided guidance on related issues in the context of compensation grids that escalate based on sales volume. See

FAQs about Conflict of Interest Rules and Exemptions, Part I,

FAQ9,

https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-rules-and-exemptions-part-1.pdf.

These principles would apply equally to Financial Institutions under this proposed exemption, if granted. In particular, the Department cautions against compensation and other incentives that are disproportionate and can undermine the best interest standard and create misaligned incentives for Advisers to make recommendations based on their own financial interest, rather than the customer's interest in sound advice.

A new proposed Section II(d)(8) would also require that Financial Institutions provide, and require Advisers to attend, annual training on compliance with the exemption, conducted by a person who has appropriate technical training and proficiency with ERISA and the Code. The training must, at a minimum, cover the policies and procedures, the Impartial Conduct Standards, material conflicts of interest, ERISA and Code compliance (including applicable fiduciary duties and the prohibited

transaction provisions), ethical conduct, and the consequences for not complying with the conditions of this exemption (including any loss of exemptive relief provided herein). The Department notes that a number of the applicants emphasized the importance of training. The Department agrees and emphasizes that Advisers must be trained on important areas that are key to understanding their duty to Retirement Investors under the exemption and that are not likely covered by state insurance laws.

Sections II(e), (f) and (g)

Section II(e) requires the Financial Institution to disclose information about its services and applicable fees and compensation. Section II(e) is generally unchanged from the Best Interest Contract Exemption, although some of the provisions were revised in minor ways to reflect the fact that this proposed exemption is limited to Fixed Annuity Contracts.

Like the Best Interest Contract Exemption, Section II(e)(7) of this proposal would require the Financial Institution to disclose whether or not the Adviser and Financial Institution will monitor the Retirement Investor's annuity contract and alert the Retirement Investor to any recommended change to the contract, and, if monitoring, the frequency with which the monitoring will occur and the reasons for which the Retirement Investor will be alerted. Financial Institutions and their Advisers should not disclaim responsibility for monitoring if they will receive ongoing compensation justified in whole or in part based on the provision of such monitoring services.

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 to the extent permitted by governing law. 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. These conditions are unchanged from the Best Interest Contract Exemption.

Section II(h) of the Best Interest Contract Exemption established streamlined conditions for “level fee fiduciaries” defined in section VIII(h) of that exemption. Under that definition, a Financial Institution and Adviser can be level fee fiduciaries if the only fee received by them and their affiliates is a “level fee” that is disclosed in advance to the Retirement Investor. A “level fee” is defined as a fee or compensation that is provided as a fixed percentage of the value of the assets or a set fee that does not vary with the particular investment recommended, rather than a commission or other transaction-based fee.

This proposal, however, does not include provisions for “level fee fiduciaries.” Although some of the applicants acknowledged they would level commissions across product categories, the mere leveling of commissions would not cause these Advisers and Financial Institutions to be “level fee fiduciaries” as defined in the Best Interest Contract Exemption because each purchase of a fixed annuity by a Retirement Investor would initiate the payment of a commission based on that particular transaction. The Department seeks comment on this aspect of the proposal. Are there business models in existence for the recommendation and sale of Fixed Annuity Contracts that would satisfy the level fee provisions of the Best Interest Contract Exemption, as described above?

Similarly, provisions applicable to “bank networking arrangements” are not included in this proposal, although they are in the Best Interest Contract Exemption.

See

Best Interest Contract Exemption, sections II(i) and VIII(c). Bank networking arrangements are defined to involve only banks or similar financial institutions, or savings associations and are therefore considered inapplicable to insurance intermediaries.

Section III

Section III proposes certain disclosure requirements, in addition to the disclosures in Section II(e) of the exemption. Section III(a)'s provisions on “transaction disclosure” generally require the disclosure of material conflicts of interest and basic information relating to those conflicts and the advisory relationship. In this respect, the proposal mirrors the Best Interest Contract Exemption.

In addition, the transaction disclosure in this proposal has an annuity-specific disclosure requirement that would apply to recommendations of all Fixed Annuity Contracts. A new proposed Section III(a)(1) would require the Financial Institution to provide a transaction disclosure in accordance with the most recent Annuity Disclosure Model Regulation published by the National Association of Insurance Commissioners (NAIC) or its successor.

Broadly, the 2015 Annuity Disclosure Model Regulation requires the disclosure of information regarding the contract, including, among other items: (i) Value reductions caused by withdrawals or surrenders; (ii) the guaranteed and non-guaranteed elements of the Fixed Annuity Contract and their limitations, including, for fixed indexed annuities, the elements used to determine the index-based interest, such as the participation rates, caps or spreads, and an explanation of how they operate; (iii) an explanation of the initial crediting rate, or for fixed annuities, an explanation of how the index-based interest is determined; (iv) available periodic income options; (v) how values in the annuity contract can be accessed; (vi) the death benefit, if available; (vii) a summary of the federal tax status; (viii) the impact of any riders; and (ix) a list of charges and fees and how they apply.

Annuity Disclosure Model Regulation, National Association of Insurance Commissioners (2015), available at

http://www.naic.org/store/free/MDL-245.pdf

Under the proposal, both the Adviser and the Retirement Investor must sign the disclosure after the Adviser orally reviews the information. The aim of this disclosure is to ensure that Retirement Investors are informed of the risks and features of annuity products prior to entering into the annuity contract. This disclosure would be required prior to the transmittal of the annuity application to the insurance company and would be required to be made in connection with any recommendations to make additional deposits into the contract. The Department understands that in some cases, insurance companies currently provide an advance disclosure document, commonly referred to as a “statement of understanding.” This condition of the exemption would be satisfied if the required information is provided in a “statement of understanding” in accordance with the applicable time frames specified in the condition. So long as the disclosure is delivered in a document that is distinct from the annuity contract, whether through a “statement of understanding” or otherwise the disclosure will satisfy the condition.

The Department requests comment on the proposed disclosure condition. Does the Annuity Disclosure Model Regulation require the information commenters believe is appropriate and necessary in transactions involving

Fixed Annuity Contracts sold pursuant to the exemption? Should the final exemption require disclosure of any additional information? In particular, with respect to fixed indexed annuity contracts, should the exemption require an illustration designed to convey the difference between the performance of the applicable index or indices and the amount credited to the customer's annuity, in light of the indexing features such as the participation rate; any spread, margin or asset fees; interest rate caps or floors; and the recognition of dividends. For example, should the exemption require that Financial Institutions provide a chart illustrating prior annual returns of an index for a certain number of years compared to the amounts that would have been credited annually under the terms of the indexed annuity contract? If commenters believe such a disclosure would be desirable, the Department requests comment on how it should be operationalized.

Section III(b) requires web-based disclosure that is intended to provide information about the Financial Institutions' arrangements with product manufacturers and other parties for Third Party Payments in connection with specific investments or classes of investments that are recommended to Retirement Investors, a description of the Financial Institution's business model and its compensation and incentive arrangements with Advisers and a copy of the Financial Institution's most recent audited financial statements as required pursuant to Section VIII(d)(2). Other than the disclosure of the audited financial statements, this provision is generally otherwise unchanged from the Best Interest Contract Exemption, except that certain provisions are revised in minor ways to account for the fact that the exemption will provide relief only for Fixed Annuity Contracts.

The Department requests comment on the proposed requirement to maintain a copy of the Financial Institution's most recent audited financial statements on the Web site.

Section IV

Section IV of the proposal relates to Financial Institutions that limit Advisers' investment recommendations, in whole or in part, based on whether the investments are Proprietary Products (as defined in Section VIII(j)) or to investments that generate Third Party Payments (as defined in Section VIII(n)). For purposes of this proposal, Section IV would apply to all Financial Institutions relying on the exemption because insurance intermediaries sell only investments that generate Third Party Payments (from the insurance company). Among other things, Section IV requires Financial Institutions to document the limitations they place on their Advisers' investment recommendations, the material conflicts of interest associated with proprietary or third party arrangements, and the services that will be provided both to Retirement Investors as well as third parties in exchange for payments. Such Financial Institutions must then reasonably conclude that the limitations will not cause the Financial Institution or its Advisers to receive compensation in excess of reasonable compensation, and, after consideration of their policies and procedures, reasonably determine that the limitations and associated conflicts of interest will not cause the Financial Institution or its Advisers to recommend imprudent investments. Financial Institutions must document the bases for their conclusions in these respects and retain the documentation pursuant to the recordkeeping requirements of the exemption, for examination upon request by the Department and other parties set forth in that section.

See

Section IV(b)(3).

Sections V, VI and VII

Section V of the proposed exemption would establish record retention and disclosure conditions that a Financial Institution must satisfy for the exemption to be available for compensation received in connection with recommended transactions. This provision is unchanged from the Best Interest Contract Exemption.

Sections VI and VII propose supplemental exemptions. Section VI would apply to certain prohibited transactions commonly associated with annuity purchases but which are not covered by Section I. Section I permits Advisers and Financial Institutions to receive compensation that would otherwise be prohibited by the self-dealing and conflicts of interest provisions of ERISA section 406(a)(1)(D) and 406(b), and Code section 4975(c)(1)(D)-(F). However, Section I does not extend to any other prohibited transaction sections of ERISA and the Code. ERISA section 406(a) and Code section 4975(c)(1)(A)-(D) contain additional prohibitions on certain specific transactions between plans and IRAs and “parties in interest” and “disqualified persons,” including service providers. These additional prohibited transactions include: (i) The purchase of a Fixed Annuity Contract by a plan/IRA from a party in interest/disqualified person, and (ii) the transfer of plan/IRA assets to a party in interest/disqualified person. These prohibited transactions are subject to excise tax and personal liability for the fiduciary.

Section VII proposes an exemption for pre-existing transactions involving Fixed Annuity Contracts. The exemption permits continued receipt of compensation based on transactions involving Fixed Annuity Contacts that occurred prior to the Applicability Date, as defined in Section VII(a), as well as the receipt of compensation for recommendations to continue to adhere to a systematic purchase program established before the Applicability Date. In this case, the Department anticipates that a systematic purchase program would involve a program in which a Retirement Investor would make regular, pre-scheduled contributions to an annuity contract; however, the Department requests comment on whether such relief is necessary or appropriate. The exemption also explicitly covers compensation received as a result of a recommendation to hold an annuity contract that was purchased prior to the Applicability Date but would not cover recommendations to exchange an annuity for another annuity. In addition, a few references to securities that are found in the Best Interest Contract Exemption were deleted from this exemption because it would not provide relief for securities transactions.

This preamble discussion focused on conditions in this proposal that differ from the Best Interest Contract Exemption. The preamble to the Best Interest Contract Exemption includes a lengthy and in-depth discussion of the remaining conditions, which is incorporated into this preamble by reference. Because of the significant length of that discussion, the Department did not repeat it in this document, but rather directs parties to the Best Interest Contract Exemption preamble for a more complete description of the scope, definitional terms, and conditions of the exemption.

81 FR 21002 (April 8, 2016).

Transition Relief

Section IX of the proposal provides for a transition period, from April 10, 2017, to August 15, 2018, under which fewer conditions would apply. During the transition period, the Financial Institution and its Advisers would be required to satisfy the conditions of Section IX(d) of the proposal. Prior to receiving compensation in reliance on the exemption, Financial Institutions would be required under Section IX(d)

to notify the Department of their intention to rely on the exemption and make a specific representation to the Department regarding their active engagement in creating systems and safeguards to satisfy the conditions applicable to the relief in Section I, following the transition period. The proposed required representation is: “[Name of Financial Institution] is presently taking steps to put in place the systems necessary to comply with Section I of the Best Interest Contract Exemption for Insurance Intermediaries, and fully intends to comply with all applicable conditions for such relief after the expiration of the transition period.” The Department proposed a transition period to give Financial Institutions under the proposed exemption time to comply with all the exemption's conditions, and the Department anticipates that parties relying on the transition period should be developing an approach to full compliance during the transition period.

During the transition period, the Adviser and Financial Institution must comply with the Impartial Conduct Standards. Additionally, the Financial Institution would be required to comply with applicable disclosure obligations under state insurance law with respect to the sale of the Fixed Annuity Contract, and certain additional disclosures would be required, including an acknowledgment of the Adviser's and Financial Institution's fiduciary status; a description of their material conflicts of interest; and a disclosure of whether they offer proprietary products or products that generate third party payments and the extent to which they limit investment recommendations on those bases. The Financial Institution would have to approve all written marketing materials used by Advisers, as described in Section II(d)(4). The Financial Institution would have to designate a person responsible for addressing material conflicts of interest and monitoring Advisers' adherence to the Impartial Conduct Standards, and such person would be required to approve, in writing, recommended annuity applications involving Retirement Investors prior to transmitting them to the insurance company. Finally, the Financial Institution would have to comply with the recordkeeping requirements of Section V(b) and (c).

It is proposed that, starting on August 16, 2018, parties intending to rely on the exemption must comply with all of the applicable conditions in Sections II-V.

No Relief Proposed From ERISA Section 406(a)(1)(C) or Code Section 4975(c)(1)(C) for the Provision of Services

This proposed exemption would not provide relief from a transaction prohibited by ERISA section 406(a)(1)(C), or from the taxes imposed by Code section 4975(a) and (b) by reason of Code section 4975(c)(1)(C), regarding the furnishing of goods, services or facilities between a plan and a party in interest. The provision of investment advice to a plan under a contract with a plan fiduciary is a service to the plan and compliance with this exemption will not relieve an Adviser or Financial Institution of the need to comply with ERISA section 408(b)(2), Code section 4975(d)(2), and applicable regulations thereunder.

Regulatory Impact Analysis

Executive Order 12866 and 13563 Statement

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 Executive Order 12866, OMB has tentatively determined that this proposed action is economically significant within the meaning of section 3(f)(1) of the Executive Order. Accordingly, OMB has reviewed the proposed prohibited transaction class exemption and the Department provides the following assessment of its impact.

Background of Proposed Exemption

As discussed earlier in this preamble, the prohibited transaction rules of ERISA and the Code prohibit employee benefit plan and individual retirement account (IRA) fiduciaries from receiving indirect or variable compensation as a result of their investment advice to the plans and IRAs. The exemption proposed in this document would allow certain insurance intermediaries, and the insurance agents and insurance companies with whom they contract, to receive compensation in connection with certain fixed annuity transactions that may otherwise give rise to prohibited transactions as a result of the provision of investment advice to plan participants and beneficiaries, IRA owners and certain plan fiduciaries. The proposed class exemption includes protective conditions, similar to those contained in the Department's Best Interest Contract Exemption (PTE 2016-01) granted on April 8, 2016,

that are designed to safeguard the interests of plans, participants and beneficiaries, and IRA investors and ensure that they receive investment advice that is in their best interest.

81 FR 21002 (April 8, 2016) as corrected at 81 FR 44773 (July 11, 2016).

The Best Interest Contract Exemption is available only to certain Financial Institutions that are subject to well-established regulatory conditions and oversight, namely banks, investment advisers registered under the Investment Advisers Act of 1940 or state law, broker-dealers, and insurance companies. However, the exemption provides a mechanism that would make it more broadly available to other entities that are described in the definition of Financial Institution in an individual prohibited transaction exemption providing relief under the same conditions as in the Best Interest Contract Exemption. Thus, if an individual exemption is granted, other entities that satisfy the applicable

conditions could rely on the Best Interest Contract Exemption.

In the preamble to the Best Interest Contract Exemption, the Department stated that “[i]f parties wish to expand the definition of Financial Institution to include marketing intermediaries or other entities, they can submit an application to the Department for an individual exemption, with information regarding their role in the distribution of financial products, the regulatory oversight of such entities, and their ability to effectively supervise individual [a]dvisers' compliance with the terms of this exemption.

See

81 FR at 21067.

In response to this provision, the Department received 22 individual exemption applications from insurance intermediaries that work with independent insurance agents to sell fixed annuity products (“applicants”). The applicants describe themselves as “independent marketing organizations,” “insurance marketing organizations” and “field marketing organizations” among other names. Collectively, the Department refers to the applicants and similar entities as “IMOs” in this analysis. The applicants sought individual exemptions under the same conditions as the Best Interest Contract Exemption, but with a new definition of “Financial Institution” incorporating insurance intermediaries.

Because of the large number and similar characteristics of the applicants, the Department decided that instead of utilizing the individual exemption process described in the Best Interest Contract Exemption, it would propose, on its own motion, a class exemption for IMOs based on the facts and representations provided in the individual exemption applications received by the Department. As discussed more fully below, the Department believes this is the most efficient way to provide relief to IMOs from the prohibited transaction rules of ERISA and the Code so long as they meet the protective conditions of the exemption that would safeguard the interests of affected plans, participants and beneficiaries, and IRA owners. Accordingly, the Department today is proposing a class exemption that would allow IMOs and associated independent insurance agents to continue to recommend fixed annuities in the Retirement Investor marketplace and receive commissions and other variable compensation.

Background Regarding Fixed-Indexed Annuities and IMOs

Fixed-Indexed Annuities (FIA) and Their Distribution Channel

The statistics presented here are for all FIAs, and not just FIAs sold to or held in IRAs.

As discussed in detail in in section 3.2 of the Regulatory Impact Analysis for the Regulation,

unlike fixed rate annuities where an insurer agrees to credit no less than a specified rate of interest during the time that the account value is growing, fixed-indexed annuities (FIAs) are annuity contracts whose return is based on the performance of a specified market index. Traditionally, common indexes used in FIAs are equity indexes such as the S&P 500 or Dow Jones Industrial Average. Although the S&P 500 is still the most often used index, various alternative indexes—including gold and a hybrid derived from one or more other indexes—have gained market share.

The RIA is available at

www.dol.gov/ebsa.

LIMRA U.S. Individual Annuity Yearbook—2015.

Insurers generally guarantee FIA contract holders at least a zero return. However, the actual return on a FIA is not determined until the end of the crediting period and is based on the performance of the index or other external reference.

Similar to variable annuities, the returns of fixed-indexed annuities can vary widely, which results in a risk to investors. Furthermore, insurers generally reserve rights to change participation rates, interest caps, and fees, which can limit the investor's exposure to the upside of the market and effectively transfer investment risks from insurers to investors.

In 2015, FIA sales totaled a record high $54.5 billion, which represents a 13% increase from sales of $48.2 billion in 2014.

This upward trend in FIA sales continued in 2016. In the first-half of 2016, FIA sales increased by 32% to $31.9 billion compared to the same period in 2015.

FIA sales are projected to exceed $64 billion by the end of 2016 according to LIMRA Secure Retirement Institute.

LIMRA U.S. Individual Annuity Sales—Fixed annuity breakout, 2015 Year-end Results

http://www.limra.com/uploadedFiles/limra.com/LIMRA_Root/Posts/PR/_Media/PDFs/2015-Top-20-Fixed-Breakout.pdf.

LifeHealthPro Editors, August 16, 2016, “Fixed indexed annuities break quarterly sales record” Available at

http://www.lifehealthpro.com/2016/08/16/fixed-indexed-annuities-break-quarterly-sales-reco?slreturn=1476799732.

LIMRA Individual Annuity Yearbook 2015.

Table 1 shows the shares of FIA sales by distribution channel for 2008-2015. In 2015, approximately 63% of FIAs, $34.1 billion, were sold through the independent agent distribution channel.

FIA sales through banks and broker-dealers (BDs) have been trending upward over time. In 2008, only 4% of FIAs were sold through banks and 2% were sold through independent BDs. By 2015, FIA sales by banks had steadily grown to 16% and sales by independent BDs had also grown to 12% of total FIA sales. In contrast, the share of FIA sales by independent agents has declined. For example, in 2008, 88% of FIAs were sold by independent agents; however by 2015 their share of FIA sales had decreased to 63%.

DOL's own calculations based on LIMRA U.S. Individual Annuity Yearbook 2014.

Table 1—Share of Fixed Indexed Annuity Sales by Distribution Channel (%) 2008-2015

2008

(%)

2009

(%)

2010

(%)

2011

(%)

2012

(%)

2013

(%)

2014

(%)

2015

(%)

Independent Agents

Banks

Independent BD

Career Agents

Full Service National BD

Total

100

Source:

LIMRA Individual Annuity Yearbook 2008-2015.

Role of IMOs in Distributing Insurance Products and Market Structure

As discussed earlier in this preamble, the main function of IMOs is to market, distribute and wholesale various insurance products.

This intermediary structure is appealing to both insurance carriers (insurers) and independent insurance producers (insurance agents) because it allows insurers to reduce their overhead costs while facilitating the sale of the products by independent insurance agents, as opposed to their captive insurance agent counterparts.

Joe Simonds, “Warning: Why FMOs will be extinct soon,” Lifehealthpro (Dec. 5, 2012); available at:

http://www.lifehealthpro.com/2012/12/05/warning-why-fmos-will-be-extinct-soon.

Ibid.

There is no centralized database containing information identifying all existing IMOs in the U.S., because IMOs are licensed as insurance agents or agencies in each state where they operate. Therefore, it is difficult to reliably estimate how many IMOs currently exist in the U.S. Some evidence indicates that the number of IMOs could be in the hundreds,

or, more specifically, as many as 350.

Regardless of the total number, one industry observer reported that the top 20 IMOs conduct the lion's share of the business.

Many large IMOs, such as Annexus, Legacy Marketing Group and Market Synergy Group act as intermediaries between insurers and multiple small IMOs, and therefore, are referred to as Super-IMOs, or IMO aggregators. One media report additionally identifies M&O Marketing, InsurMark and Advisors Excel as other large IMOs.

In 2015, Annexus alone reported approximately $4 billion in FIA sales representing approximately 7% of total FIA sales

and comprising a network of 17 IMOs. Legacy Marketing Group, Inc. contracted with approximately 200 IMOs, and actively conducts business with 50 to 60.

Market Synergy reported $15 billion in fixed-indexed sales collectively and consisted of 11 sub-IMOs.

This information suggests that the IMO market has a complex hierarchical structure.

Cyril Tuohy, June 10, 2016, Insurancenewsnet.com “Insurance Marketing Organizations Feel The DOL's Freezer Burn” Available at

http://insurancenewsnet.com/innarticle/wholesalers-mull-future.

Warren Hersch, August 12, 2016, LifeHealthPro.com “Unchartered waters: Why this IMO is seeking FI status under DOL rule.” Available at

http://www.lifehealthpro.com/2016/08/12/unchartered-waters-why-this-imo-is-seeking-fi-stat

Arthur Postal, August 10, 2016 LifeHealthPro.com “IMOs take on enhanced sales role under the new DOL rule” available at

http://www.lifehealthpro.com/2016/08/10/imos-take-on-enhanced-sales-role-under-the-new-dol?ref=related-embedded.

Cyril Tuohy, June 10, 2016, Insurancenewsnet.com “Insurance Marketing Organizations Feel The DOL's Freezer Burn” Available at

http://insurancenewsnet.com/innarticle/wholesalers-mull-future.

Cyril Tuohy, June 10, 2016, Insurancenewsnet.com “Insurance Marketing Organizations Feel The DOL's Freezer Burn” Available at

http://insurancenewsnet.com/innarticle/wholesalers-mull-future.

Greg Iacurci, June 23, 2016, Investment News, “Indexed annuity distributors weigh launching B-Ds due to DOL fiduciary rule” available at

http://www.investmentnews.com/article/20160623/FREE/160629957/indexed-annuity-distributors-weigh-launching-b-ds-due-to-dol.

Warren Hersch, September 16, 2016, “Not ready to become a DOL compliance FI? Go partner with one” Available at

http://www.lifehealthpro.com/2016/09/16/not-ready-to-become-a-dol-compliant-fi-go-partner?t=diversity-market.

See

Market Synergy Preliminary Injunction Memo filed June 17, 2016, in the United States District Court for the District of Kansas.

Common Characteristics of IMO Individual Exemption Applicants

In some cases, the information presented here is supported by sources beyond the applications, but in all cases the information is consistent with information provided in the applications.

As discussed earlier in this preamble, the Department has studied the characteristics of IMOs that applied for the individual exemptions. The applications indicate that most IMOs applicants have been in business for 25 to 40 years and operate in all 50 states. For example, one IMO applicant has over 600 offices across 50 states.

IMO applicants tend to be large: Almost all IMO applicants were identified as Super-IMOs or larger IMOs by industry trade press. Of those applicant IMOs that disclosed their sales information, all indicated sales of more than $1.5 billion in 2015, and two IMOs reported FIA sales of from $4-5 billion in 2015.

Other IMOs reported from $2-3 billion of annual fixed annuity sales. These data suggest that IMO applicants generate FIA sales equivalent to the FIA sales of some insurance companies. In 2015, FIA sales of the top 10 FIA issuers by sales ranged from $8.7 billion (Allianz Life of North America) to $1.8 billion (Security Benefit Life).

Individual Exemption Application of Advisors Excel.

Advisors Excel and Annexus reported $5 billion and $ 4 billion sales in FIAs respectfully according to the their individual exemption applications and Annexus reported $4 billion sales in the article by Greg Iacurci, June 23, 2016, Investment News, “Indexed Annuity Distributors Weigh Launching B-Ds Due to DOL Fiduciary Rule” available at

http://www.investmentnews.com/article/20160623/FREE/160629957/indexed-annuity-distributors-weigh-launching-b-ds-due-to-dol.

LIMRA Individual Annuity Yearbook 2015.

Most applicant IMOs partner with between 20 and 75 insurers. One IMO indicated that it conducts business with nine out of the top 10 insurers offering FIAs.

Many of the applicants state that they have direct contractual relationships with the majority of the insurers for whom they distribute fixed annuities. Frequently, these direct contractual relationships include recognition that the applicants are contractually responsible for the oversight of agents and sub-IMOs. This oversight is accomplished through applying the top-level IMO's use of its compliance structure and other business and administrative tools. The applicants use their compliance structure to directly oversee agents or they use those same tools to assist sub-IMOs in the distribution of fixed annuities and the oversight of their agents.

Individual Exemption Application submitted by Advisors Excel.

Sub-IMOs have contractual relationships with the insurers for whom they distribute fixed annuities, and they also have contractual relationships with top-level IMOs. Top-level IMOs generally provide their related sub-IMOs with distribution and other support services. Top-level IMOs often assist these sub-IMOs in accessing a wide variety of insurance products. Sub-IMOs contract with top-level IMOs to obtain this access, and these services allow some sub-IMOs to focus on the training and support of their agents.

Some applicants, in addition to describing themselves as top-level IMOs, also represented that they are affiliated with large insurers. One of these applicants, in turn, wholly owns numerous sub-IMOs. Despite the differences in the ownership structure, these applicants represent that they, like the other top-level IMOs, assist in the distribution of fixed annuities, both for their affiliates and for other insurers, and provide valuable business and administrative assistance to sub-IMOs and agents.

The number of smaller IMOs or sub-IMOs that larger IMOs conduct business with varies widely, but most applicant IMOs that disclosed this information in their applications state that they conduct business with between 7 and 35 sub-IMOs. Two IMO applicants indicate that they work with over 100 other IMOs.

However, not all affiliated sub-

IMOs generate sales on a regular basis.

Several IMO applicants indicate that they work with approximately 2,000 to 4,000 agents and others report that they have approximately 120,000 to 200,000 affiliated agents nationwide. However, according to some IMO applicants, only approximately 20% to 30% of the large number of contracted agents generates sales through them on a regular basis.

These independent agents can work with multiple IMOs. However, two IMOs indicated that they work with an exclusive group of affiliated agents or employee agents that are selected after undergoing a rigorous screening process.

The applications indicate that most IMOs currently not maintaining exclusive business relationships with independent agents would require independent agents to exclusively process FIA sales through them if the proposed exemption were granted.

Warren Hersch, September 7, 2016, LifeHealthPro, “Eye on the Future: Futurity First Readies Advisors for DOL Rule” Available at

http://www.lifehealthpro.com/2016/09/07/eye-on-the-future-futurity-first-readies-advisors.

Warren Hersch, September 16, 2016, “Not Ready to Become a DOL Compliance FI? Go partner with One” Available at

http://www.lifehealthpro.com/2016/09/16/not-ready-to-become-a-dol-compliant-fi-go-partner?t=diversity-market.

Warren Hersch, September 16, 2016, “Not Ready to become a DOL Compliance FI? Go Partner with One” Available at

http://www.lifehealthpro.com/2016/09/16/not-ready-to-become-a-dol-compliant-fi-go-partner?t=diversity-market.

Individual Exemption Applications of M&O Financial, Application of ECA Marketing and Warren Hersch, September 16, 2016, “Not Ready to Become a DOL Compliance FI? Go Partner with One” Available at

http://www.lifehealthpro.com/2016/09/16/not-ready-to-become-a-dol-compliant-fi-go-partner?t=diversity-market.

Individual Exemption Application of Saybrus Partners, Inc. and Warren Hersch, August 12, 2016, LifeHealthPro.com “Unchartered Waters: Why This IMO is Seeking FI Status under DOL Rule.” Available at

http://www.lifehealthpro.com/2016/08/12/unchartered-waters-why-this-imo-is-seeking-fi-stat.

Several IMO applicants are affiliated with BDs and/or registered investment advisers (RIAs). Moreover, some of the IMOs that currently are not affiliated with BDs or RIAs reported that they are developing a BD,

or have a subsidiary that is in the process of becoming a RIA.

One IMO stated that is has partnered with nearly 20 BDs and provided extensive training and mentoring to registered representatives regarding selling FIAs.

Two IMOs also stated that they have an affiliated IT firm or proprietary technology platform that will help them comply with the exemption.

Greg Iacurci, June 23, 2016, Investment News, “Indexed Annuity Distributors Weigh Launching B-Ds Due to DOL Fiduciary Rule” available at

http://www.investmentnews.com/article/20160623/FREE/160629957/indexed-annuity-distributors-weigh-launching-b-ds-due-to-dol.

Cyril Tuohy, August 9, 2016, insurancenewsnet.com “AmeriLife Files for FI Status Under DOL Fiduciary Rule” Available at

http://insurancenewsnet.com/innarticle/amerilife-files-fi-status-dol-fiduciary-rule.

Individual Exemption Application of InsurMark.

The applicants represented to the Department that they have experience in a variety of areas that will contribute to their ability to satisfy the conditions of the Best Interest Contract Exemption. Some applicants pointed to direct experience providing oversight of independent agents for insurance law compliance, while some indicated that they planned to rely on affiliated RIAs and/or BD entities in developing systems to comply with the exemption. The cost of developing a new compliance platform often represents a large share of total compliance costs. Thus, if an IMO does not have to develop a new system, it would save costs significantly for itself and the insurance industry as a whole would save significant costs if other IMOs were similarly positioned. In addition, IMOs with affiliated BDs and/or RIAs can draw from the supervisory experience of BDs and RIAs regarding properly training, monitoring, and not inappropriately incentivizing agents and even share personnel with them. They also can use disclosure forms similar to their affiliated BDs and/or RIAs.

The applicants generally indicated they would maintain internal compliance departments and adopt supervisory structures to ensure compliance with the exemption. Several applicants pointed to technology that would be used in ensuring compliance. Some applicants indicated that insurance agents would be required to use their technology to ensure clients receive disclosures and a contract, where required. Agents would also be required to use the IMO's Web site services and maintain records centrally.

Some applicants additionally described how their sales practices would ensure best interest recommendations. A number of the applicants specifically proposed to require centralized approval of agent recommendations; in some cases, the recommendations would be reviewed by salaried employees of the IMO with additional credentials, such as Certified Financial Planners. One applicant indicated that internal review would include a comparison of the proposed product to other similar fixed indexed annuity products available in the marketplace to ensure it is appropriate for the purchaser, and that the analysis would include utilizing third-party benchmarking services and industry comparisons. Another applicant indicated that it would ensure that a RIA representative would work with insurance-only agents when a recommendation would involve the liquidation of securities to ensure that both state and federal securities laws are properly followed.

Some applicants additionally stated that their contracts with insurance agents would include certain specific requirements, including: Adherence to the IMO's policies and procedures with respect to advertising, market conduct and point of sale processes, transparency and documentation; provision of advice in accordance with practices developed by the IMO; and agreement that the agents will not accept any direct or indirect compensation from an insurance company, except as specifically approved by the IMO. A number of the applicants indicated that they would perform background checks and rigorous selection processes before working with agents and would require agents to receive ongoing training regarding compliance with the exemption.

Based on information contained in the submitted applications, some qualified and willing IMOs might be able to perform compliance responsibilities more cost effectively than some insurance companies. Many IMO applicants indicate that they have affiliated BDs or RIAs, and these IMOs have several advantages in managing compliance costs: They can utilize compliance platforms already developed and implemented for BDs and/or RIAs with some necessary adjustments. This would allow large IMOs to save some large start-up fixed costs to develop a new system.

The applications also indicate that some IMOs already have many of the capacities and much of the infrastructure in place that would be necessary to carry out compliance responsibilities required by the exemption, and thus might incur only relatively small, incremental costs to comply with the exemption conditions.

The Department cautions that although its careful review of individual exemption applications reveals that many applicant IMOs share the common characteristics discussed above, the Department is uncertain regarding the extent to which these characteristics can be generalized to the overall IMO market. The Department welcomes comments regarding whether these

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