# 82 FR 7336: Proposed Best Interest Contract Exemption for Insurance Intermediaries

> Federal · Regulations · In force

URL: https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2017-01316

## Section

- **Citation:** 82 FR 7336
- **Heading:** Proposed Best Interest Contract Exemption for Insurance Intermediaries
- **Jurisdiction:** Federal
- **Kind:** Regulations
- **Status:** In force
- **Text as of:** August 14, 2026
- **Source:** Compiled text
- **Location:** Federal Register / Vol. 82 / 82 FR 7336

## Text

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
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
. 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. 1 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
nt 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. 1 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.
1 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)
emption (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
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
xercise 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. 2 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
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.
2 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
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 3 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
uciary 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).
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 4 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
4 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
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
4 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
eir 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. 5 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. 6 When fiduciaries violate ERISA's fiduciary duties or the prohibited transaction rules, they may be held personally liable for the breach. 7 In addition, violations of the prohibited transaction rules are subject to excise taxes under the Code. 8
5 ERISA section 404(a).
6 ERISA section 406. ERISA also prohibits certain transactions between a plan and a “party in interest.”
7 ERISA section 409; see also ERISA section 405.
8 Code section 4975
r the prohibited transaction rules, they may be held personally liable for the breach. 7 In addition, violations of the prohibited transaction rules are subject to excise taxes under the Code. 8
5 ERISA section 404(a).
6 ERISA section 406. ERISA also prohibits certain transactions between a plan and a “party in interest.”
7 ERISA section 409; see also ERISA section 405.
8 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
her 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:
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
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 9 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. 10
9 29 CFR 2510.3-21(b)(1).
10 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
mined 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
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
eviously 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. 11 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. 12
11 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
g the plan or IRA. 12
11 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”).
12 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
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)
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), 13 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.
13 81 FR 21089 (April 8, 2016), as corrected at 81 FR 44784 (July 11, 2016)
ets between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs (Principal Transactions Exemption) (PTE 2016-02), 13 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.
13 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. 14 Taken together, the new exemptions and amendments to existing exemptions ensure that Retirement Investors are consistently protected by Impartial Conduct Standards, regardless of the particular exemption upon which the adviser relies.
14 The amended exemptions 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, 15 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. 16 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
-24, 15 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. 16 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.
15 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).
16 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
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
emption 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., 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;
• 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
sation, 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 17 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].” 18
17 See 81 FR at 21067.
18 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
Best Interest Contract Exemption].” 18
17 See 81 FR at 21067.
18 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.” 19
19 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
“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
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. 20 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. 21 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
Qs 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.
20 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.
21 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
onsibility 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 22
22 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
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
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
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
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
t 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
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
endent 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
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
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 23
23 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
re 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. 24 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. 25 Furthermore, when the Department promulgated the Best Interest Contract Exemption, it limited Financial Institution status to entities with well-established regulatory conditions and oversight. 26 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.
24 See Regulatory Impact Analysis for the Regulation, p. 8, available at www.dol.gov/ebsa.
25 See Best Interest Contract Exemption, 81 FR 21001, 21017 (April 8, 2016).
26 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
ry 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. 27
27 “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.” 28
28 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
iable annuity.” 28
28 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.' ” 29 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.” 30
29 SEC Office of Investor Education and Advocacy Investor Bulletin: Indexed Annuities, available at https://www.sec.gov/investor/alerts/secindexedannuities.pdf.
30 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. 31
31 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
ailable 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
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. 32 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,
32 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
le 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”? 33
33 See Final Amendment to PTE 84-24, 81 FR 211
rovide 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”? 33
33 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)
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. 34 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. 35 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.
34 See 81 FR 21067.
35 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
f 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
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
t 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. 36 In addition, under proposed Section III(b)(vii), the audited financial statements must be provided on the Financial Institution's Web site.
36 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
ons 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
sulting 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
suant 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
The Department requests comment on the approach taken in proposed subsection (3) of the definition
termediaries 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
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 b
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 $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
ers 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
ries 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. 37 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.
37 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
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 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
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 a
anding 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
oyees, 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 38
38 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
provisions described in 38
38 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
n 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
render 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. T

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Source: Frix Law Library, https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2017-01316. Check the current official text before relying on it. Not legal advice.