Federal Register, Volume 81 Issue 68 (Friday, April 8, 2016)
[Federal Register Volume 81, Number 68 (Friday, April 8, 2016)]
[Rules and Regulations]
[Pages 21002-21089]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-07925]
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
29 CFR Part 2550
[Application No. D-11712]
ZRIN 1210-ZA25
Best Interest Contract Exemption
AGENCY: Employee Benefits Security Administration (EBSA), U.S.
Department of Labor.
ACTION: Adoption of Class Exemption.
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SUMMARY: This document contains an exemption from certain prohibited
transactions provisions of the Employee Retirement Income Security Act
of 1974 (ERISA) and the Internal Revenue Code (the Code). The
provisions at issue generally prohibit fiduciaries with respect to
employee benefit plans and individual retirement accounts (IRAs) from
engaging in self-dealing and receiving compensation from third parties
in connection with transactions involving the plans and IRAs. The
exemption allows entities such as registered investment advisers,
broker-dealers and insurance companies, and their agents and
representatives, that are ERISA or Code fiduciaries by reason of the
provision of investment advice, to receive compensation that may
otherwise give rise to prohibited transactions as a result of their
advice to plan participants and beneficiaries, IRA owners and certain
plan fiduciaries (including small plan sponsors). The exemption is
subject to protective conditions to safeguard the interests of the
plans, participants and beneficiaries and IRA owners. The exemption
affects participants and beneficiaries of plans, IRA owners and
fiduciaries with respect to such plans and IRAs.
DATES: Issuance date: This exemption is issued June 7, 2016.
Applicability date: This exemption is applicable to transactions
occurring on or after April 10, 2017. See Section K of this preamble,
Applicability Date and Transition Rules, for further information.
FOR FURTHER INFORMATION CONTACT: Brian Shiker or Susan Wilker, Office
of Exemption Determinations, Employee Benefits Security Administration,
U.S. Department of Labor, (202) 693-8824 (this is not a toll-free
number).
SUPPLEMENTARY INFORMATION:
Executive Summary
Purpose of This Regulatory Action
The Department grants this exemption in connection with its
publication, elsewhere in this issue of the Federal Register, of a
final regulation defining who is a ``fiduciary'' of an employee benefit
plan under ERISA as a result of giving investment advice to a plan or
its participants or beneficiaries (Regulation). The Regulation also
applies to the definition of a ``fiduciary'' of a plan (including an
IRA) under the Code. The Regulation amends a prior regulation, dating
to 1975, specifying when a person is a ``fiduciary'' under ERISA and
the Code by reason of the provision of investment advice for a fee or
other compensation regarding assets of a plan or IRA. The Regulation
takes into account the advent of 401(k) plans and IRAs, the dramatic
increase in rollovers, and other developments that have transformed the
retirement plan landscape and the associated investment market over the
four decades since the existing regulation was issued. In light of the
extensive changes in retirement investment practices and relationships,
the Regulation updates existing rules to distinguish more appropriately
between the sorts of advice relationships that should be treated as
fiduciary in nature and those that should not.
This 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. ERISA and the
Code generally prohibit fiduciaries from receiving payments from third
parties and from acting on conflicts of interest, including using their
authority to affect or increase their own compensation, in connection
with transactions involving a plan or IRA. Certain types of fees and
compensation common in the retail market, such as brokerage or
insurance commissions, 12b-1 fees and revenue sharing payments, may
fall within these prohibitions when received by fiduciaries as a result
of transactions involving advice to the plan, plan participants and
beneficiaries, and IRA owners. To facilitate continued provision of
advice to such retail investors under conditions designed to safeguard
the interests of these investors, the exemption allows investment
advice fiduciaries, including investment advisers registered under the
Investment Advisers Act of 1940 or state law, broker-dealers, and
insurance companies, and their agents and representatives, to receive
these various forms of compensation that, in the absence of an
exemption, would not be permitted under ERISA and the Code.
Rather than create a set of highly prescriptive transaction-
specific exemptions, which has been the Department's usual approach,
the exemption flexibly accommodates a wide range of compensation
practices, while minimizing the harmful impact of conflicts of interest
on the quality of advice. As a condition of receiving compensation that
would otherwise be prohibited, individual Advisers and the Financial
Institutions that employ or otherwise retain them must adhere to
conditions designed to mitigate the harmful impact of conflicts of
interest. By taking a standards-based approach, the exemption permits
firms to continue to rely on many common compensation
[[Page 21003]]
and fee practices, as long as they adhere to basic fiduciary standards
aimed at ensuring that their advice is in the best interest of their
customers and take certain steps to minimize the impact of conflicts of
interest.
ERISA section 408(a) specifically authorizes the Secretary of Labor
to grant administrative exemptions from ERISA's prohibited transaction
provisions.\1\ Regulations at 29 CFR 2570.30 to 2570.52 describe the
procedures for applying for an administrative exemption. In granting
this exemption, the Department has determined that the exemption is
administratively feasible, in the interests of plans and their
participants and beneficiaries and IRA owners, and protective of the
rights of participants and beneficiaries of plans and IRA owners.
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\1\ Code section 4975(c)(2) authorizes the Secretary of the
Treasury to grant exemptions from the parallel prohibited
transaction provisions of the Code. Reorganization Plan No. 4 of
1978 (5 U.S.C. app. at 214 (2000)) (the Reorganization Plan)
generally transferred the authority of the Secretary of the Treasury
to grant administrative exemptions under Code section 4975 to the
Secretary of Labor. To rationalize the administration and
interpretation of dual provisions under ERISA and the Code, the
Reorganization Plan divided the interpretive and rulemaking
authority for these provisions between the Secretaries of Labor and
of the Treasury, so that, in general, the agency with responsibility
for a given provision of Title I of ERISA would also have
responsibility for the corresponding provision in the Code. Among
the sections transferred to the Department were the prohibited
transaction provisions and the definition of a fiduciary in both
Title I of ERISA and in the Code. ERISA's prohibited transaction
rules, 29 U.S.C. 1106-1108, apply to ERISA-covered plans, and the
Code's corresponding prohibited transaction rules, 26 U.S.C.
4975(c), apply both to ERISA-covered pension plans that are tax-
qualified pension plans, as well as other tax-advantaged
arrangements, such as IRAs, that are not subject to the fiduciary
responsibility and prohibited transaction rules in ERISA.
Specifically, section 102(a) of the Reorganization Plan provides the
Department of Labor with ``all authority'' for ``regulations,
rulings, opinions, and exemptions under section 4975 [of the Code]''
subject to certain exceptions not relevant here. Reorganization Plan
section 102. In President Carter's message to Congress regarding the
Reorganization Plan, he made explicitly clear that as a result of
the plan, ``Labor will have statutory authority for fiduciary
obligations. . . . Labor will be responsible for overseeing
fiduciary conduct under these provisions.'' Reorganization Plan,
Message of the President. This exemption provides relief from the
indicated prohibited transaction provisions of both ERISA and the
Code.
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Summary of Major Provisions
This Best Interest Contract Exemption is broadly available for
Advisers and Financial Institutions that make investment
recommendations to retail ``Retirement Investors,'' including plan
participants and beneficiaries, IRA owners, and non-institutional (or
``retail'') fiduciaries. As a condition of receiving compensation that
would otherwise be prohibited under ERISA and the Code, the exemption
requires Financial Institutions to acknowledge their fiduciary status
and the fiduciary status of their Advisers in writing. The Financial
Institution and Advisers must adhere to enforceable standards of
fiduciary conduct and fair dealing with respect to their advice. In the
case of IRAs and non-ERISA plans, the exemption requires that the
standards be set forth in an enforceable contract with the Retirement
Investor. Under the exemption's terms, Financial Institutions are not
required to enter into a contract with ERISA plan investors, but they
are obligated to adhere to these same standards of fiduciary conduct,
which the investors can effectively enforce pursuant to ERISA sections
502(a)(2) and (3). Likewise, ``Level Fee'' Fiduciaries that, with their
Affiliates, receive only a Level Fee in connection with advisory or
investment management services, do not have to enter into a contract
with Retirement Investors, but they must provide a written statement of
fiduciary status, adhere to standards of fiduciary conduct, and prepare
a written documentation of the reasons for the recommendation.
The exemption is designed to cover a wide variety of current
compensation practices, which would otherwise be prohibited as a result
of the Department's Regulation extending fiduciary status to many
investment professionals who formerly were not treated as fiduciaries.
Rather than flatly prohibit compensation structures that could be
beneficial in the right circumstances--such as commission accounts for
investors that make infrequent trades--the exemption permits individual
Advisers \2\ 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 exemption strives to ensure that
Advisers' recommendations reflect the best interest of their Retirement
Investor customers, rather than the conflicting financial interests of
the Advisers and their Financial Institutions. Protected Retirement
Investors include plan participants and beneficiaries, IRA owners, and
``retail'' fiduciaries of plans or IRAs (generally persons who hold or
manage less than $50 million in assets, and are not banks, insurance
carriers, registered investment advisers or broker dealers), including
small plan sponsors.
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\2\ By using the term ``Adviser,'' the Department does not
intend to limit the exemption to investment advisers registered
under the Investment Advisers Act of 1940 or under state law. As
explained herein, an Adviser is an individual who can be a
representative of a registered investment adviser, a bank or similar
financial institution, an insurance company, or a broker-dealer.
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In order to protect the interests of the plan participants and
beneficiaries, IRA owners, and plan fiduciaries, the exemption requires
the Financial Institution to acknowledge fiduciary status for itself
and its Advisers. The Financial Institutions and Advisers must adhere
to basic standards of impartial conduct. In particular, under this
standards-based approach, the Adviser and Financial Institution must
give prudent advice that is in the customer's best interest, avoid
misleading statements, and receive no more than reasonable
compensation. Additionally, Financial Institutions generally must adopt
policies and procedures reasonably designed to mitigate any harmful
impact of conflicts of interest, and disclose basic information about
their conflicts of interest and the cost of their advice. Level Fee
Fiduciaries are subject to more streamlined conditions, including a
written statement of fiduciary status, compliance with the standards of
impartial conduct, and, as applicable, documentation of the specific
reason or reasons for the recommendation of the Level Fee arrangement.
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.
Executive Order 12866 and 13563 Statement
Under Executive Orders 12866 and 13563, the Department must
determine whether a regulatory action is ``significant'' and therefore
subject to the requirements of the Executive Order and subject to
review by the Office of Management and Budget (OMB). Executive Orders
12866 and 13563 direct agencies to assess all costs and benefits of
available regulatory alternatives and, if regulation is necessary, to
select regulatory approaches that maximize net benefits (including
potential economic, environmental, public health and safety effects,
distributive impacts, and equity). Executive Order 13563 emphasizes the
importance of quantifying both costs and benefits, of reducing costs,
of harmonizing and streamlining rules, and of promoting flexibility. It
also requires federal
[[Page 21004]]
agencies to develop a plan under which the agencies will periodically
review their existing significant regulations to make the agencies'
regulatory programs more effective or less burdensome in achieving
their regulatory objectives.
Under Executive Order 12866, ``significant'' regulatory actions are
subject to the requirements of the Executive Order and review by the
OMB. Section 3(f) of Executive Order 12866, defines a ``significant
regulatory action'' as an action that is likely to result in a rule (1)
having an annual effect on the economy of $100 million or more, or
adversely and materially affecting a sector of the economy,
productivity, competition, jobs, the environment, public health or
safety, or State, local or tribal governments or communities (also
referred to as ``economically significant'' regulatory actions); (2)
creating serious inconsistency or otherwise interfering with an action
taken or planned by another agency; (3) materially altering the
budgetary impacts of entitlement grants, user fees, or loan programs or
the rights and obligations of recipients thereof; or (4) raising novel
legal or policy issues arising out of legal mandates, the President's
priorities, or the principles set forth in the Executive Order.
Pursuant to the terms of the Executive Order, OMB has determined that
this action is ``significant'' within the meaning of Section 3(f)(1) of
the Executive Order. Accordingly, the Department has undertaken an
assessment of the costs and benefits of the proposal, and OMB has
reviewed this regulatory action. The Department's complete Regulatory
Impact Analysis is available at www.dol.gov/ebsa.
I. Background
The Department proposed this class exemption on its own motion,
pursuant to ERISA section 408(a) and Code section 4975(c)(2), and in
accordance with the procedures set forth in 29 CFR art 2570, subpart B
(76 FR 66637 (October 27, 2011)).
A. Regulation Defining a Fiduciary
As explained more fully in the preamble to the Regulation, ERISA is
a comprehensive statute designed to protect the interests of plan
participants and beneficiaries, the integrity of employee benefit
plans, and the security of retirement, health, and other critical
benefits. The broad public interest in ERISA-covered plans is reflected
in its imposition of fiduciary responsibilities on parties engaging in
important plan activities, as well as in the tax-favored status of plan
assets and investments. One of the chief ways in which ERISA protects
employee benefit plans is by requiring that plan fiduciaries comply
with fundamental obligations rooted in the law of trusts. In
particular, plan fiduciaries must manage plan assets prudently and with
undivided loyalty to the plans and their participants and
beneficiaries.\3\ In addition, they must refrain from engaging in
``prohibited transactions,'' which ERISA does not permit because of the
dangers posed by the fiduciaries' conflicts of interest with respect to
the transactions.\4\ When fiduciaries violate ERISA's fiduciary duties
or the prohibited transaction rules, they may be held personally liable
for the breach.\5\ In addition, violations of the prohibited
transaction rules are subject to excise taxes under the Code.
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\3\ ERISA section 404(a).
\4\ ERISA section 406. ERISA also prohibits certain transactions
between a plan and a ``party in interest.''
\5\ ERISA section 409; see also ERISA section 405.
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The Code also has rules regarding fiduciary conduct with respect to
tax-favored accounts that are not generally covered by ERISA, such as
IRAs. In particular, fiduciaries of these arrangements, including IRAs,
are subject to the prohibited transaction rules and, when they violate
the rules, to the imposition of an excise tax enforced by the Internal
Revenue Service. Unlike participants in plans covered by Title I of
ERISA, IRA owners do not have a statutory right to bring suit against
fiduciaries for violations of the prohibited transaction rules.
Under this statutory framework, the determination of who is a
``fiduciary'' is of central importance. Many of ERISA's and the Code's
protections, duties, and liabilities hinge on fiduciary status. In
relevant part, ERISA section 3(21)(A) and Code section 4975(e)(3)
provide that a person is a fiduciary with respect to a plan or IRA to
the extent he or she (i) exercises any discretionary authority or
discretionary control with respect to management of such plan or IRA,
or exercises any authority or control with respect to management or
disposition of its assets; (ii) renders investment advice for a fee or
other compensation, direct or indirect, with respect to any moneys or
other property of such plan or IRA, or has any authority or
responsibility to do so; or, (iii) has any discretionary authority or
discretionary responsibility in the administration of such plan or IRA.
The statutory definition deliberately casts a wide net in assigning
fiduciary responsibility with respect to plan and IRA assets. Thus,
``any authority or control'' over plan or IRA assets is sufficient to
confer fiduciary status, and any persons who render ``investment advice
for a fee or other compensation, direct or indirect'' are fiduciaries,
regardless of whether they have direct control over the plan's or IRA's
assets and regardless of their status as an investment adviser or
broker under the federal securities laws. The statutory definition and
associated responsibilities were enacted to ensure that plans, plan
participants, and IRA owners can depend on persons who provide
investment advice for a fee to provide recommendations that are
untainted by conflicts of interest. In the absence of fiduciary status,
the providers of investment advice are neither subject to ERISA's
fundamental fiduciary standards, nor accountable under ERISA or the
Code for imprudent, disloyal, or biased advice.
In 1975, the Department issued a regulation, at 29 CFR 2510.3-
21(c)(1975), defining the circumstances under which a person is treated
as providing ``investment advice'' to an employee benefit plan within
the meaning of ERISA section 3(21)(A)(ii) (the ``1975 regulation'').\6\
The 1975 regulation narrowed the scope of the statutory definition of
fiduciary investment advice by creating a five-part test for fiduciary
advice. Under the 1975 regulation, for advice to constitute
``investment advice,'' an adviser must (1) render advice as to the
value of securities or other property, or make recommendations as to
the advisability of investing in, purchasing or selling securities or
other property (2) on a regular basis (3) pursuant to a mutual
agreement, arrangement or understanding, with the plan or a plan
fiduciary that (4) the advice will serve as a primary basis for
investment decisions with respect to plan assets, and that (5) the
advice will be individualized based on the particular needs of the
plan. The 1975 regulation provided that an adviser is a fiduciary with
respect to any particular instance of advice only if he or she meets
each and every element of the five-part test with respect to the
particular advice recipient or plan at issue.
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\6\ The Department of Treasury issued a virtually identical
regulation, at 26 CFR 54.4975-9(c), which interprets Code section
4975(e)(3).
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The market for retirement advice has changed dramatically since the
Department first promulgated the 1975 regulation. Individuals, rather
than large employers and professional money managers, have become
increasingly responsible for managing retirement assets as IRAs and
participant-directed plans, such as 401(k) plans, have supplanted
defined benefit pensions. At
[[Page 21005]]
the same time, the variety and complexity of financial products have
increased, widening the information gap between advisers and their
clients. Plan fiduciaries, plan participants and IRA investors must
often rely on experts for advice, but are unable to assess the quality
of the expert's advice or effectively guard against the adviser's
conflicts of interest. This challenge is especially true of retail
investors with smaller account balances who typically do not have
financial expertise, and can ill-afford lower returns to their
retirement savings caused by conflicts. The IRA accounts of these
investors often account for all or the lion's share of their assets and
can represent all of savings earned for a lifetime of work. Losses and
reduced returns can be devastating to the investors who depend upon
such savings for support in their old age. As baby boomers retire, they
are increasingly moving money from ERISA-covered plans, where their
employer has both the incentive and the fiduciary duty to facilitate
sound investment choices, to IRAs where both good and bad investment
choices are myriad and advice that is conflicted is commonplace. These
rollovers are expected to approach $2.4 trillion cumulatively from 2016
through 2020.\7\ These trends were not apparent when the Department
promulgated the 1975 regulation. At that time, 401(k) plans did not yet
exist and IRAs had only just been authorized.
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\7\ Cerulli Associates, ``Retirement Markets 2015.''
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As the marketplace for financial services has developed in the
years since 1975, the five-part test has now come to undermine, rather
than promote, the statutes' text and purposes. The narrowness of the
1975 regulation has allowed advisers, brokers, consultants and
valuation firms to play a central role in shaping plan and IRA
investments, without ensuring the accountability that Congress intended
for persons having such influence and responsibility. Even when plan
sponsors, participants, beneficiaries, and IRA owners clearly relied on
paid advisers for impartial guidance, the 1975 regulation has allowed
many advisers to avoid fiduciary status and disregard basic fiduciary
obligations of care and prohibitions on disloyal and conflicted
transactions. As a consequence, these advisers have been able to steer
customers to investments based on their own self-interest (e.g.,
products that generate higher fees for the adviser even if there are
identical lower-fee products available), give imprudent advice, and
engage in transactions that would otherwise be prohibited by ERISA and
the Code without fear of accountability under either ERISA or the Code.
In the Department's amendments to the 1975 regulation defining
fiduciary advice within the meaning of ERISA section 3(21)(A)(ii) and
Code section 4975(e)(3)(B), (the ``Regulation'') which are also
published in this issue of the Federal Register, the Department is
replacing the existing regulation with one that more appropriately
distinguishes between the sorts of advice relationships that should be
treated as fiduciary in nature and those that should not, in light of
the legal framework and financial marketplace in which IRAs and plans
currently operate.\8\ The Regulation describes the types of advice that
constitute ``investment advice'' with respect to plan or IRA assets for
purposes of the definition of a fiduciary at ERISA section 3(21)(A)(ii)
and Code section 4975(e)(3)(B). The Regulation covers ERISA-covered
plans, IRAs, and other plans not covered by Title I, such as Keogh
plans, and health savings accounts described in Code section 223(d).
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\8\ The Department initially proposed an amendment to its
regulation defining a fiduciary within the meaning of ERISA section
3(21)(A)(ii) and Code section 4975(e)(3)(B) on October 22, 2010, at
75 FR 65263. It subsequently announced its intention to withdraw the
proposal and propose a new rule, consistent with the President's
Executive Orders 12866 and 13563, in order to give the public a full
opportunity to evaluate and comment on the new proposal and updated
economic analysis. The first proposed amendment to the rule was
withdrawn on April 20, 2015, see 80 FR 21927.
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As amended, the Regulation provides that a person renders
investment advice with respect to assets of a plan or IRA if, among
other things, the person provides, directly to a plan, a plan
fiduciary, plan participant or beneficiary, IRA or IRA owner, the
following types of advice, for a fee or other compensation, whether
direct or indirect:
(i) A recommendation as to the advisability of acquiring, holding,
disposing of, or exchanging, securities or other investment property,
or a recommendation as to how securities or other investment property
should be invested after the securities or other investment property
are rolled over, transferred or distributed from the plan or IRA; and
(ii) A recommendation as to the management of securities or other
investment property, including, among other things, recommendations on
investment policies or strategies, portfolio composition, selection of
other persons to provide investment advice or investment management
services, types of investment account arrangements (brokerage versus
advisory), or recommendations with respect to rollovers, transfers or
distributions from a plan or IRA, including whether, in what amount, in
what form, and to what destination such a rollover, transfer or
distribution should be made.
In addition, in order to be treated as a fiduciary, such person,
either directly or indirectly (e.g., through or together with any
affiliate), must: Represent or acknowledge that it is acting as a
fiduciary within the meaning of ERISA or the Code with respect to the
advice described; represent or acknowledge that it is acting as a
fiduciary within the meaning of ERISA or the Code; render the advice
pursuant to a written or verbal agreement, arrangement or understanding
that the advice is based on the particular investment needs of the
advice recipient; or direct the advice to a specific advice recipient
or recipients regarding the advisability of a particular investment or
management decision with respect to securities or other investment
property of the plan or IRA.
The Regulation also provides that as a threshold matter in order to
be fiduciary advice, the communication must be a ``recommendation'' as
defined therein. The Regulation, as a matter of clarification, provides
that a variety of other communications do not constitute
``recommendations,'' including non-fiduciary investment education;
general communications; and specified communications by platform
providers. These communications which do not rise to the level of
``recommendations'' under the Regulation are discussed more fully in
the preamble to the final Regulation.
The Regulation also specifies certain circumstances where the
Department has determined that a person will not be treated as an
investment advice fiduciary even though the person's activities
technically may satisfy the definition of investment advice. For
example, the Regulation contains a provision excluding recommendations
to independent fiduciaries with financial expertise that are acting on
behalf of plans or IRAs in arm's length transactions, if certain
conditions are met. The independent fiduciary must be a bank, insurance
carrier qualified to do business in more than one state, investment
adviser registered under the Investment Advisers Act of 1940 or by a
state, broker-dealer registered under the Securities Exchange Act of
1934 (Exchange Act), or any other independent fiduciary that holds, or
has under management or control, assets of at least $50 million, and:
(1) The person
[[Page 21006]]
making the recommendation must know or reasonably believe that the
independent fiduciary of the plan or IRA is capable of evaluating
investment risks independently, both in general and with regard to
particular transactions and investment strategies (the person may rely
on written representations from the plan or independent fiduciary to
satisfy this condition); (2) the person must fairly inform the
independent fiduciary that the person is not undertaking to provide
impartial investment advice, or to give advice in a fiduciary capacity,
in connection with the transaction and must fairly inform the
independent fiduciary of the existence and nature of the person's
financial interests in the transaction; (3) the person must know or
reasonably believe that the independent fiduciary of the plan or IRA is
a fiduciary under ERISA or the Code, or both, with respect to the
transaction and is responsible for exercising independent judgment in
evaluating the transaction (the person may rely on written
representations from the plan or independent fiduciary to satisfy this
condition); and (4) the person cannot receive a fee or other
compensation directly from the plan, plan fiduciary, plan participant
or beneficiary, IRA, or IRA owner for the provision of investment
advice (as opposed to other services) in connection with the
transaction.
Similarly, the Regulation provides that the provision of any advice
to an employee benefit plan (as described in ERISA section 3(3)) by a
person who is a swap dealer, security-based swap dealer, major swap
participant, major security-based swap participant, or a swap clearing
firm in connection with a swap or security-based swap, as defined in
section 1a of the Commodity Exchange Act (7 U.S.C. 1a) and section 3(a)
of the Exchange Act (15 U.S.C. 78c(a)) is not investment advice if
certain conditions are met. Finally, the Regulation describes certain
communications by employees of a plan sponsor, plan, or plan fiduciary
that would not cause the employee to be an investment advice fiduciary
if certain conditions are met.
B. Prohibited Transactions
The Department anticipates that the Regulation will cover many
investment professionals who did not previously consider themselves to
be fiduciaries under ERISA or the Code. Under the Regulation, these
entities will be subject to the prohibited transaction restrictions in
ERISA and the Code that apply specifically to fiduciaries. ERISA
section 406(b)(1) and Code section 4975(c)(1)(E) prohibit a fiduciary
from dealing with the income or assets of a plan or IRA in his own
interest or his own account. ERISA section 406(b)(2), which does not
apply to IRAs, provides that a fiduciary shall not ``in his individual
or in any other capacity act in any transaction involving the plan on
behalf of a party (or represent a party) whose interests are adverse to
the interests of the plan or the interests of its participants or
beneficiaries.'' ERISA section 406(b)(3) and Code section 4975(c)(1)(F)
prohibit a fiduciary from receiving any consideration for his own
personal account from any party dealing with the plan or IRA in
connection with a transaction involving assets of the plan or IRA.
Parallel regulations issued by the Departments of Labor and the
Treasury explain that these provisions impose on fiduciaries of plans
and IRAs a duty not to act on conflicts of interest that may affect the
fiduciary's best judgment on behalf of the plan or IRA.\9\ The
prohibitions extend to a fiduciary causing a plan or IRA to pay an
additional fee to such fiduciary, or to a person in which such
fiduciary has an interest that may affect the exercise of the
fiduciary's best judgment as a fiduciary. Likewise, a fiduciary is
prohibited from receiving compensation from third parties in connection
with a transaction involving the plan or IRA.\10\
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\9\ Subsequent to the issuance of these regulations,
Reorganization Plan No. 4 of 1978, 5 U.S.C. App. (2010), divided
rulemaking and interpretive authority between the Secretaries of
Labor and the Treasury. The Secretary of Labor was given
interpretive and rulemaking authority regarding the definition of
fiduciary under both Title I of ERISA and the Internal Revenue Code.
Id. section 102(a) (``all authority of the Secretary of the Treasury
to issue [regulations, rulings opinions, and exemptions under
section 4975 of the Code] is hereby transferred to the Secretary of
Labor'').
\10\ 29 CFR 2550.408b-2(e); 26 CFR 54.4975-6(a)(5).
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Investment professionals typically receive compensation for
services to retirement investors in the retail market through a variety
of arrangements, which would typically violate the prohibited
transaction rules applicable to plan fiduciaries. These include
commissions paid by the plan, participant or beneficiary, or IRA, or
commissions, sales loads, 12b-1 fees, revenue sharing 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.
C. Prohibited Transaction Exemptions
As the prohibited transaction provisions demonstrate, ERISA and the
Code strongly disfavor conflicts of interest. In appropriate cases,
however, the statutes provide exemptions from their broad prohibitions
on conflicts of interest. For example, ERISA section 408(b)(14) and
Code section 4975(d)(17) specifically exempt transactions involving the
provision of fiduciary investment advice to a participant or
beneficiary of an individual account plan or IRA owner if the advice,
resulting transaction, and the adviser's fees meet stringent conditions
carefully designed to guard against conflicts of interest.
In addition, the Secretary of Labor has discretionary authority to
grant administrative exemptions under ERISA and the Code on an
individual or class basis, but only if the Secretary first finds that
the exemptions are (1) administratively feasible, (2) in the interests
of plans and their participants and beneficiaries and IRA owners, and
(3) protective of the rights of the participants and beneficiaries of
such plans and IRA owners. Accordingly, fiduciary advisers may always
give advice without need of an exemption if they avoid the sorts of
conflicts of interest that result in prohibited transactions. However,
when they choose to give advice in which they have a conflict of
interest, they must rely upon an exemption.
Pursuant to its exemption 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. In contrast
to these earlier exemptions, this new Best Interest Contract Exemption
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), also published in this issue
of the Federal Register, that permits investment advice fiduciaries to
sell or purchase certain debt securities and other investments in
[[Page 21007]]
principal transactions and riskless principal transactions with plans
and IRAs.
At the same time that the Department has granted these new
exemptions, it has also amended existing exemptions to ensure uniform
application of the Impartial Conduct Standards, which are fundamental
obligations of fair dealing and fiduciary conduct, and include
obligations to act in the customer's best interest, avoid misleading
statements, and receive no more than reasonable compensation.\11\ 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.
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\11\ The amended exemptions, published elsewhere in this issue
of the Federal Register, include Prohibited Transaction Exemption
(PTE) 75-1; PTE 77-4; PTE 80-83; PTE 83-1: PTE 84-24; and PTE 86-
128.
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The amendments also revoke certain existing exemptions, which
provided little or no protections to IRA and non-ERISA plan
participants, in favor of a more uniform application of the Best
Interest Contract Exemption in the market for retail investments. With
limited exceptions, it is the Department's intent that investment
advice fiduciaries in the retail investment market rely on statutory
exemptions or the Best Interest Contract Exemption to the extent that
they receive conflicted forms of compensation that would otherwise be
prohibited. The new and amended exemptions reflect the Department's
view that Retirement Investors should be protected by a more consistent
application of fundamental fiduciary standards across a wide range of
investment products and advice relationships, and that retail
investors, in particular, should be protected by the stringent
protections set forth in the Best Interest Contract Exemption. When
fiduciaries have conflicts of interest, they will uniformly be expected
to adhere to fiduciary norms and to make recommendations that are in
their customer's best interest.
These new and amended exemptions follow a lengthy public notice and
comment process, which gave interested persons an extensive opportunity
to comment on the proposed Regulation and exemption proposals. The
proposals initially provided for 75-day comment periods, ending on July
6, 2015, but the Department extended the comment periods to July 21,
2015. The Department then held four days of public hearings on the new
regulatory package, including the proposed exemptions, in Washington,
DC from August 10 to 13, 2015, at which over 75 speakers testified. The
transcript of the hearing was made available on September 8, 2015, and
the Department provided additional opportunity for interested persons
to comment on the proposals or hearing transcript until September 24,
2015. A total of over 3000 comment letters were received on the new
proposals. There were also over 300,000 submissions made as part of 30
separate petitions submitted on the proposal. These comments and
petitions came from consumer groups, plan sponsors, financial services
companies, academics, elected government officials, trade and industry
associations, and others, both in support and in opposition to the
rule.\12\ The Department has reviewed all comments, and after careful
consideration of the comments, has decided to grant this Best Interest
Contract Exemption.
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\12\ As used throughout this preamble, the term ``comment''
refers to information provided through these various sources,
including written comments, petitions and witnesses at the public
hearing.
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II. Best Interest Contract Exemption
As finalized, the Best Interest Contract Exemption retains the core
protections of the proposed exemption, but with revisions designed to
facilitate implementation and compliance with the exemption's terms. In
broadest outline, the exemption permits Advisers and the Financial
Institutions that employ or otherwise retain them to 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. In
particular, to rely on the 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:
[cir] 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);
[cir] Charge no more than reasonable compensation; and
[cir] 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.
The exemption takes a principles-based approach that permits
Financial Institutions and Advisers to receive many forms of
compensation that would otherwise be prohibited, including, inter alia,
commissions, trailing commissions, sales loads, 12b-1 fees, and
revenue-sharing payments from investment providers or other third
parties to Advisers and Financial Institutions. The exemption is
available for advice to retail ``Retirement Investors,'' including IRA
owners, plan participants and beneficiaries, and ``retail fiduciaries''
(including such fiduciaries of small participant-directed plans). All
Financial Institutions relying on the exemption must notify the
Department in advance of doing so, and retain records that can be made
available to the Department and Retirement Investors for evaluating
compliance with the exemption.
The exemption neither bans all conflicted compensation, nor permits
Financial Institutions and Advisers to act on their conflicts of
interest to the detriment of the Retirement Investors they serve as
fiduciaries. Instead, it holds Financial Institutions and their
Advisers responsible for adhering to fundamental standards of fiduciary
conduct and fair dealing, while leaving them the flexibility and
discretion necessary to determine how best to satisfy these basic
standards in light of the unique attributes of their particular
businesses. The exemption's principles-based conditions, which are
rooted in the law of trust and agency, have the breadth and flexibility
necessary to apply to a large range of investment and compensation
practices, while ensuring that Advisers put the interests of Retirement
Investors first. When Advisers choose to give advice to retail
Retirement Investors pursuant to conflicted compensation structures,
they must protect their customers from the dangers posed by conflicts
of interest.
[[Page 21008]]
In order to ensure compliance with its broad protective standards
and purposes, the exemption gives special attention to the
enforceability of its terms by Retirement Investors. When Financial
Institutions and Advisers breach their obligations under the exemption
and cause losses to Retirement Investors, it is generally critical that
the investors have a remedy to redress the injury. The existence of
enforceable rights and remedies gives Financial Institutions and
Advisers a powerful incentive to comply with the exemption's standards,
implement policies and procedures that are more than window-dressing,
and carefully police conflicts of interest to ensure that the conflicts
of interest do not taint the advice.
Thus, in the case of IRAs and non-ERISA plans, the exemption
generally requires the Financial Institution to commit to the Impartial
Conduct Standards in an enforceable contract with Retirement Investor
customers. The exemption does not similarly require the Financial
Institution to execute a separate contract with ERISA investors (which
includes plan participants, beneficiaries, and fiduciaries), but the
Financial Institution must acknowledge its fiduciary status and that of
its advisers, and ERISA investors can directly enforce their rights to
proper fiduciary conduct under ERISA section 502(a)(2) and (3). In
addition, the exemption safeguards Retirement Investors' enforcement
rights by providing that Financial Institutions and Advisers may not
rely on the exemption if they include contractual provisions
disclaiming liability for compensatory remedies or waiving or
qualifying Retirement Investors' right to pursue a class action or
other representative action in court. However, the exemption does
permit Financial Institutions to include provisions waiving the right
to punitive damages or rescission as contract remedies to the extent
permitted by other applicable laws. In the Department's view, the
availability of make-whole relief for such claims is sufficient to
protect Retirement Investors and incentivize compliance with the
exemption's conditions.
While the final exemption retains the proposed exemption's core
protections, the Department has revised the exemption to ease
implementation in response to commenters' concerns about its
workability. Thus, for example, the final exemption eliminates the
contract requirement altogether in the ERISA context, simplifies the
mechanics of contract-formation for IRAs and plans not covered by Title
I of ERISA, and provides streamlined conditions for ``Level Fee
Fiduciaries'' that give ongoing advice on a relatively un-conflicted
basis. For new customers, the final exemption provides that the
required contract terms may simply be incorporated in the Financial
Institution's account opening documents and similar commonly-used
agreements. The exemption additionally permits reliance on a negative
consent process for existing contract holders; and provides a mechanism
for Financial Institutions and Advisers to rely on the exemption in the
event that the Retirement Investor does not open an account with the
Adviser but nevertheless acts on the advice through other channels. The
Department recognizes that Retirement Investors may talk to numerous
Advisers in numerous settings over the course of their relationship
with a Financial Institution. Accordingly, the exemption also
simplifies execution of the contract by simply requiring the Financial
Institution to execute the contract, rather than each of the individual
Advisers from whom the Retirement Investor receives advice. For similar
reasons, the exemption does not require execution of the contract at
the start of Retirement Investors' conversations with Advisers, as long
as it is entered into prior to or at the same time as the recommended
investment transaction.
Other changes similarly facilitate reliance on the exemption by
clarifying key terms, reducing compliance burden, increasing the
exemption's availability with respect to the types of advice recipients
and the types of investments that may be recommended, and streamlining
and simplifying disclosure requirements. For example, in response to
commenter's concerns, the final exemption clarifies that, subject to
its conditions, the exemption provides relief for all of the categories
of fiduciary recommendations covered by the Regulation, including
advice on rollovers, distributions, and services, as well as investment
recommendations concerning any asset, rather than a limited list of
specified assets. Similarly, the exemption is broadly available to
small plan fiduciaries, regardless of the type of plan, as well as to
IRA owners, plan participants, and other Retirement Investors.
Additionally, in response to concerns about the application of the Best
Interest standard to Financial Institutions that limit investment
recommendations to Proprietary Products and/or investments that
generate Third Party Payments, the exemption includes a specific test
for satisfying the Best Interest standard in these circumstances. Also
in response to comments, the exemption makes clear that it does not ban
commissions or mandate rigid fee-leveling (e.g., by requiring identical
fees for recommendations to invest in insurance products as to invest
in mutual funds).
The Department also streamlined compliance for ``Level Fee
Fiduciaries''--fiduciaries that, together with their Affiliates,
receive only a Level Fee in connection with advisory or investment
management services with respect to plan or IRA assets (e.g.,
investment advice fiduciaries that provide ongoing advice for a fee
based on a fixed percentage of assets under management).
As a means of facilitating use of this exemption, the Department
also reduced the compliance burden by eliminating some of the proposed
conditions that were not critical to its protective purposes, and by
expanding the scope of its coverage (e.g., by covering all investment
products and advice to retail fiduciaries of participant-directed
plans). The Department eliminated the proposed requirement of adherence
to other state and federal laws relating to advice as unduly expansive
and duplicative of other laws; dropped a proposed data collection
requirement that would have required collection and retention of
specified data relating to the Financial Institution's inflows,
outflows, holdings, and returns for retirement investments; and
eliminated some of the more detailed proposed disclosure requirements,
including the requirement for projections of the total cost of an
investment at the point of sale over 1-, 5- and 10-year periods, as
well as the annual disclosure requirement. In addition, the Department
streamlined the disclosure conditions by simplifying them and requiring
the most detailed customer-specific information to be disclosed only
upon request of the customer. The Department also provided a mechanism
for correcting good faith violations of the disclosure conditions, so
that Financial Institutions would not lose the benefit of the exemption
as a result of such good faith errors and would have an incentive to
promptly correct them.
In making these adjustments to the exemption, the Department was
mindful of public comments that expressed concern about the 2015
proposal's potential negative effects on small investors' access to
affordable investment advice. In particular, the Department considered
comments on the costs and benefits of the proposed Regulation and
exemptions. As detailed in the Regulatory Impact Analysis
[[Page 21009]]
accompanying this final rulemaking,\13\ a number of comments on the
Department's 2015 proposal, including those from consumer advocates,
some independent researchers, and some independent financial advisers,
largely endorsed its accompanying impact analysis, affirming that
adviser conflicts cause avoidable harm and that the proposal would
deliver gains for retirement investors that more than justify
compliance costs, with minimal or no attendant unintended adverse
consequences. In contrast, many other comments, including those from
most of the financial industry (generally excepting only comments from
independent financial advisers), strongly criticized the Department's
analysis and conclusions. These comments variously argued that the
Department's evidence was weak, that its estimates of conflicts'
negative effects and the proposal's benefits were overstated, that its
compliance cost estimates were understated, and that it failed to
anticipate predictable adverse consequences including increases in the
cost of advice and reductions in its availability to small investors,
which the commenters said would depress savings and exacerbate rather
than reduce investment mistakes. Some of these comments took the form
of or were accompanied by research reports that variously offered
direct, sometimes technical critiques of the Department's analysis, or
presented new data and analysis that challenged the Department's
conclusions. The Department took these comments into account in
developing the final exemption. Many of these comments were grounded in
practical operational concerns which the Department believes it has
alleviated through revisions to the final exemption. At the same time,
however, many suffered from analytic weaknesses that undermined the
credibility of some of their conclusions.
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\13\ See Regulatory Impact Analysis.
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Many comments anticipating sharp increases in the cost of advice
neglected many of the costs currently attributable to conflicted advice
including, for example, indirect fees. Many exaggerated the negative
impacts (and neglected the positive impacts) of recent overseas reforms
and/or the similarity of such reforms to the 2015 proposal. Many
implicitly and without support assumed rigidity in existing business
models, service levels, compensation structures and/or pricing levels,
neglecting the demonstrated existence of low-cost solutions and
potential for investor-friendly market adjustments. Many that predicted
that only wealthier investors would be served appeared to neglect that
once the fixed costs of serving these investors was defrayed only the
relatively small marginal cost of serving smaller investors would
remain for firms and investors to bear.
Many comments arguing that costlier advice will compromise savings
exaggerated their case by presenting mere correlation (wealth and
advisory services are found together) as evidence that advice causes
large increases in saving. Some wrongly implied that earlier Department
estimates of the potential for fiduciary advice to reduce retirement
investment errors--when accompanied by very strong anti-conflict
consumer protections--constituted an acknowledgement that conflicted
advice yields large net benefits.
The negative comments that offered their own original analysis, and
whose conclusions contradicted the Department's, also are generally
unpersuasive on balance in the context of this present analysis. For
example, these comments variously neglected important factors such as
indirect fees, made comparisons without adjusting for risk, relied on
data that is likely to be unrepresentative, failed to distinguish
conflicted from independent advice, and/or presented as evidence median
results when the problems targeted by the 2015 proposal and the
proposal's expected benefits are likely to be concentrated on one side
of the distribution's median.
In light of these weaknesses in the aforementioned negative
comments, the Department found their arguments largely unpersuasive.
Moreover, responsive changes to the 2015 proposal reflected in this
final rulemaking further minimize any risk of an unintended negative
impact on small investors' access to affordable advice. The Department
therefore stands by its conclusions that adviser conflicts are
inflicting large, avoidable losses on retirement investors, that
appropriate, strong reforms are necessary, and this final rulemaking
will deliver large net gains to retirement investors. The Department
does not anticipate the substantial, long-term unintended consequences
predicted in these negative comments.
To ease the transition for Financial Institutions and Advisers that
are now more clearly recognized as fiduciaries under the Regulation,
the Department has also expanded the ``grandfathered'' relief for
compensation associated with investments made prior to the Regulation's
Applicability Date. The final exemption also provides a transition
period in Section IX under which prohibited transaction relief is
available for Financial Institutions and Advisers during the period
between the Applicability Date and January 1, 2018, subject to more
limited conditions.
The comments on the Best Interest Contract Exemption, the
Regulation, and related exemptions have helped the Department improve
this exemption, while preserving and enhancing its protections. As
described above, the Department has revised the exemption to facilitate
implementation and compliance with the exemption, without diluting its
core protections, which are critical to reducing the harm caused by
conflicts of interest in the marketplace for advice. The tax-preferred
investments covered by the exemption are critical to the financial
security and physical health of investors. After consideration of the
comments, the Department remains convinced of the importance of the
exemption's core protections.
ERISA and the Code are rightly skeptical of the dangers posed by
conflicts of interest, and generally prohibit conflicted advice. Before
granting exemptive relief, the Department has a statutory obligation to
ensure that the exemption is in the interests of plan and IRA investors
and protective of their rights. Adherence to the fundamental fiduciary
norms and basic protective conditions of this exemption helps ensure
that investment recommendations are not driven by Adviser conflicts,
but by the Best Interest of the Retirement Investor. Advisers can
always give conflict-free advice. But if they choose to rely upon
conflicted payment structures, they should be prepared to make an
enforceable commitment to safeguard Retirement Investors from biased
advice that is not in the investor's Best Interest. The conditions of
this exemption are carefully calibrated to permit a wide variety of
compensation structures, while protecting Retirement Investors'
interest in receiving sound advice on vitally important investments.
Based upon these protective conditions, the Department finds that the
exemption is administratively feasible, in the interests of plans and
their participants and beneficiaries and IRA owners, and protective of
the rights of participants and beneficiaries of plans and IRA owners.
The preamble sections that follow provide a much more detailed
discussion of the exemption's terms, comments on the exemption, and the
Department's responses to those comments. After a discussion of the
exemption's scope and limitations, the preamble discusses the
conditions of the
[[Page 21010]]
exemption, certain exclusions from relief, and the terms of subsidiary
exemptions provided in this document, including an exemption providing
grandfathered relief for certain pre-existing investments.
A. Scope of Relief in the Best Interest Contract Exemption
The exemption provides relief for the receipt of compensation by
``Advisers'' and ``Financial Institutions,'' and their ``Affiliates''
and ``Related Entities,'' as a result of their 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.'' \14\ These definitional
terms are discussed below. The exemption broadly provides relief from
the restrictions of ERISA section 406(b) and the sanctions imposed by
Code section 4975(a) and (b), by reason of Code section 4975(c)(1)(E)
and (F). These provisions prohibit conflict of interest transactions
and receipt of third-party payments by investment advice
fiduciaries.\15\ In general, the exemption is intended to provide
relief for a wide variety of prohibited transactions related to the
provision of fiduciary advice in the market for retail investments. The
exemption permits many common compensation practices that result in
prohibited transactions to continue notwithstanding the expanded
definition of fiduciary advice, so long as the exemption's protective
conditions are satisfied.
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\14\ While the Department uses the term ``Retirement Investor''
throughout this document, the exemption is not limited only to
investment advice fiduciaries of employee pension benefit plans and
IRAs. Relief would be available for investment advice fiduciaries of
employee welfare benefit plans as well.
\15\ Relief is also provided 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).
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In response to commenters' concerns, the exemption expressly
provides relief for all categories of fiduciary recommendations set
forth in the Regulation. In addition to covering asset recommendations,
for example, an Adviser and Financial Institution can provide
investment advice regarding the rollover or distribution of assets of a
plan or IRA; the hiring of a person to advise on or manage the assets;
and the advisability of acquiring, holding, disposing, or exchanging
certain common investments by Retirement Investors. These activities
fall within the provisions of the Regulation identifying, as fiduciary
conduct: (i) Recommendations 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 property is
rolled over, transferred distributed from the plan or IRA, and (ii)
recommendations 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,
selection of investment account arrangements (e.g., brokerage versus
advisory); or recommendations with respect to rollovers, distributions,
or transfers 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.
The exemption has also been revised to extend to recommendations
concerning any investment product, rather than restricted to a specific
list of defined ``Assets,'' and to cover riskless principal
transactions.
The exemption does not, however, provide relief for all
transactions involving advice in the retail market. In particular, the
exemption excludes advice rendered in connection with principal
transactions that are not riskless principal transactions, advice from
fiduciaries with discretionary authority over the recommended
transaction, so-called robo-advice (unless provided by Level Fee
Fiduciaries in accordance with Section II(h)), and specified advice
concerning in-house plans. These exclusions, set forth in Section I(c),
involve special circumstances that warrant a different approach than
the one set forth in this exemption, and are discussed further below.
Commenters on the scope of the exemption, as proposed, primarily
focused on six categories of issues: (1) The treatment of rollovers,
distributions and services; (2) the definition of Retirement Investor;
(3) the limits on the Asset recommendations covered by the exemption;
(4) riskless principal transactions, (5) indexed annuities and variable
annuities, and (6) the types of compensation that the Adviser or
Financial Institution may receive. These issues are discussed below.
1. Relief for Rollovers, Distributions and Services
a. General
As proposed, the exemption would have applied to ``compensation for
services provided in connection with a purchase, sale or holding of an
Asset by a plan, participant or beneficiary account, or IRA.'' A number
of commenters requested clarification or revision of this language.
These commenters questioned whether the exemption would cover
recommendations regarding rollovers, distributions, or services such as
managed accounts and advice programs. Although the Department had
intended to cover these recommendations as part of its original
proposal, commenters expressed concern that in some circumstances, the
recommendations might not be considered sufficiently connected to the
purchase, sale or holding of an Asset to meet the exemption's terms.
In this regard, some commenters stated that, while the proposed
Regulation made clear that providing advice to take a distribution or
to roll over assets from a plan or IRA, for a fee, was clearly
fiduciary advice, it did not appear that relief for any resulting
prohibited transactions was contemplated in the proposed exemption.
More specifically, a few commenters argued that there are several steps
to a rollover recommendation and that relief may be necessary at each
step. For example, one commenter suggested that a rollover
recommendation is best evaluated as including four separate
recommendations: ``(i) A recommendation to take a distribution `from'
the plan; (ii) a recommendation to hire the Adviser; (iii) the
recommendation to rollover to an IRA; and (iv) the recommendation
regarding how to invest the assets of the IRA once rolled over.'' Other
commenters indicated that in their view recommendations of individuals
to provide investment advisory or investment management services, also
fiduciary conduct, was not clearly covered by the proposed exemption.
In response, the Department has revised the final exemption's
description of covered transactions to more clearly coincide with the
fiduciary conduct described in the Regulation. Although the Department
also intended to cover these recommendations in its original proposal,
it agrees that the exemption should more clearly state its broad
applicability. The final exemption therefore broadly permits
``Advisers, Financial Institutions, and their Affiliates and Related
Entities to receive compensation as a result of their 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.''
[[Page 21011]]
In addition to questions about whether these types of
recommendations were covered, commenters also asked how the conditions
of the proposed exemption would apply to recommendations regarding
rollovers, distributions and services. Commenters expressed the view
that the proposed disclosure requirements were too focused on the costs
associated with investments and therefore did not appear tailored to
recommendations to rollover plan assets, take a distribution, or hire a
provider of investment advisory or management services. Other
commenters asked whether there were ongoing monitoring obligations,
even when a recommendation involved only a discrete interaction between
the Adviser and Retirement Investor. Many commenters indicated that due
to the general burden of compliance with the exemption, Advisers and
Financial Institutions might be unwilling to provide advice to
Retirement Investors who were eligible to take a distribution from
their employer's plan, and that left on their own, these investors
might decide to take the money out of retirement savings.
In connection with these concerns, a few commenters requested
separate exemptions for rollover and distribution recommendations, and
services recommendations. One commenter asked the Department to create
an exemption for rollovers subject only to the condition that the
Adviser act in the Retirement Investor's Best Interest. Another
commenter suggested an exemption based on disclosure, signed by the
participant, of the options associated with a rollover. Others
requested a safe harbor for rollovers based on the Financial Industry
Regulatory Authority's (FINRA's) Regulatory Notice 13-45 (``Rollovers
to Individual Retirement Accounts'').\16\ Commenters also requested
separate exemptions for advice programs, managed accounts and Advisers
who would receive level fees after being hired.
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\16\ FINRA is registered with the Securities and Exchange
Commission (SEC) as a national securities association and is a self-
regulatory organization, as those terms are defined in the Exchange
Act, which operates under SEC oversight.
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Citing the critical importance of the decision to rollover plan
assets or take a distribution, other commenters asserted that the
protections of the exemption would be especially important in the
rollover and distribution context, and could even be strengthened.
Advisers and Financial Institutions frequently stand to earn
compensation as a result of a rollover that they would not be able to
earn if the money remains invested in an ERISA plan. In addition,
rollovers from an ERISA plan to an IRA can involve the entirety of
workers' savings over a lifetime of work. Because large and
consequential sums are often involved, bad advice on rollovers or
distributions can have catastrophic consequences with respect to such
workers' financial security in retirement.
The Department has considered these comments and questions. Rather
than adopt separate exemptions, as requested by some commenters, the
approach taken in the final exemption is to retain the proposed
exemption's core protections, while revising the exemption to reduce
burden and facilitate compliance in a wide variety of contexts.
Accordingly, as described in more detail below, the Department revised
the disclosure and data retention requirements in this final exemption.
The exemption does not require a pre-transaction disclosure that
includes projections of the total costs of the investment over time,
and no longer includes the proposed annual disclosure or data
collection requirements. Rather than require up-front highly-customized
disclosure, the exemption requires a more general statement of the Best
Interest standard of care and the Advisers' and Financial Institutions'
Material Conflicts of Interest, and related disclosures, with the
provision of more specific, customized disclosure, only upon the
Retirement Investor's request. The exemption also expressly clarifies
that the parties involved in the transaction are generally free not to
enter into an arrangement involving ongoing monitoring, so that a
discrete rollover or distribution recommendation, or services
recommendation, without further involvement by an Adviser or Financial
Institution, does not necessarily create an ongoing monitoring
obligation. As a result of these changes, Advisers and Financial
Institutions can satisfy the disclosure conditions of the exemption
with respect to transactions involving rollovers, distributions and
services.\17\
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\17\ The Department notes that the exemption's relief applies to
investment advice, but not to discretionary asset management.
Accordingly, the exemption would provide relief for a recommendation
on how plan or IRA assets should be managed, but would not extend
relief to an investment manager's exercise of investment discretion
over the assets. This is particularly relevant to ``Level Fee
Fiduciaries'' as discussed in the next section.
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b. Level Fee Fiduciaries
The final exemption provides streamlined conditions for ``Level Fee
Fiduciaries.'' A Financial Institution and Adviser are Level Fee
Fiduciaries if the only fee or compensation received by the Financial
Institution, Adviser and any Affiliate in connection with the advisory
or investment management services is a ``Level Fee'' that is disclosed
in advance to the Retirement Investor. A Level Fee is defined in the
exemption as a fee or compensation that is provided on the basis of a
fixed percentage of the value of the assets or a set fee that does not
vary with the particular investment recommended, rather than a
commission or other transaction-based fee.
In this regard, the Department believes that, by itself, the
ongoing receipt of a Level Fee such as a fixed percentage of the value
of a customer's assets under management, where such values are
determined by readily available independent sources or independent
valuations, typically would not raise prohibited transaction concerns
for the Adviser or Financial Institution. Under these circumstances,
the compensation amount depends solely on the value of the investments
in a client account, and ordinarily the interests of the Adviser in
making prudent investment recommendations, which could have an effect
on compensation received, are aligned with the Retirement Investor's
interests in increasing and protecting account investments. However,
there is a clear and substantial conflict of interest when an Adviser
recommends that a participant roll money out of a plan into a fee-based
account that will generate ongoing fees for the Adviser that he would
not otherwise receive, even if the fees going-forward do not vary with
the assets recommended or invested. Similarly, the prohibited
transaction rules could be implicated by a recommendation to switch
from a low activity commission-based account to an account that charges
a fixed percentage of assets under management on an ongoing basis.
Because the prohibited transaction in these examples is relatively
discrete and the provision of advice thereafter generally does not
involve prohibited transactions, the final exemption includes
streamlined conditions to cover the discrete advice that requires the
exemption.\18\ This streamlined
[[Page 21012]]
exemption is broadly available for Advisers and Financial Institutions
that give advice on a Level Fee basis, and focuses on the discrete
recommendation that requires an exemption. Although ``robo-advice
providers'' \19\ are generally carved out of the Best Interest Contract
Exemption, this streamlined exemption is available to them too to the
extent they satisfy the definition of Level Fee Fiduciary and comply
with the exemption's conditions.
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\18\ In general, after the rollover, the ongoing receipt of
compensation based on a fixed percentage of the value of assets
under management does not require a prohibited transaction
exemption. However, certain practices involve violations that would
not be eligible for the relief granted in this Best Interest
Contract Exemption. For instance, if an Adviser compensated in this
manner engaged in ``reverse churning,'' or recommended holding an
asset solely to generate more fees for the Adviser, the Adviser's
behavior would constitute a violation of ERISA section 406(b)(1)
that is not covered by the Best Interest Contract Exemption or its
Level Fee provisions. In its ``Report on Conflicts of Interest''
(Oct. 2013), p. 29, FINRA suggests a number of circumstances in
which Advisers may recommend inappropriate commission- or fee-based
accounts as means of promoting the Adviser's compensation at the
expense of the customer (e.g., recommending a fee-based account to
an investor with low trading activity and no need for ongoing
monitoring or advice; or first recommending a mutual fund with a
front-end sales load, and shortly later, recommending that the
customer move the shares into an advisory account subject to asset-
based fees). Such abusive conduct, which is designed to enhance the
Adviser's compensation at the Retirement Investor's expense, would
violate the prohibition on self-dealing in ERISA section 406(b)(1)
and Code section 4795(c)(1)(E), and fall short of meeting the
Impartial Conduct Standards required for reliance on the Best
Interest Contract Exemption and other exemptions.
\19\ Robo-advice providers furnish investment advice to a
Retirement Investor generated solely by an interactive Web site in
which computer software-based models or applications make investment
recommendations based on personal information each investor supplies
through the Web site without any personal interaction or advice from
an individual Adviser.
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Section II(h) establishes the conditions of the exemption for Level
Fee Fiduciaries. It requires that the Financial Institution give the
Retirement Investor the written fiduciary statement described in
Section II(b) and that both the Financial Institution and any Adviser
comply with the Impartial Conduct Standards described in Section II(c).
Additionally, when recommending a rollover from an ERISA plan to an
IRA, a rollover from another IRA, or a switch from a commission-based
account to a fee-based account, the Level Fee Fiduciary must document
the reasons why the level fee arrangement was considered to be in the
Best Interest of the Retirement Investor.
When Level Fee Fiduciaries recommend rollovers from an ERISA plan,
they must document their consideration of the Retirement Investor's
alternatives to a rollover, including leaving the money in his or her
current employer's plan, if permitted. Specifically, the documentation
must take into account the fees and expenses associated with both the
plan and the IRA; whether the employer pays for some or all of the
plan's administrative expenses; and the different levels of services
and different investments available under each option. In this regard,
Advisers and Financial Institutions should consider the Retirement
Investor's individual needs and circumstances, as described in FINRA
Regulatory Notice 13-45. If a Level Fee arrangement is recommended as
part of a rollover from another IRA, or a switch from a commission-
based account, the Level Fee Fiduciary's documentation must include the
reasons that the arrangement is considered in the Retirement Investor's
Best Interest, including, specifically, the services that will be
provided for the fee. The exemption does not specify any particular
format or method for generating or retaining the documentation, which
could be paper or electronic, but rather gives the Level Fee Fiduciary
flexibility to determine what works best for its business model, so
long as it meets the exemption's conditions.
It is important to note that the definition of Level Fee explicitly
excludes receipt by the Adviser, Financial Institution or any Affiliate
of commissions or other transaction-based payments. Accordingly, if
either the Financial Institution or the Adviser or their Affiliates,
receive any other remunerations (e.g., commissions, 12b-1 fees or
revenue sharing), beyond the Level Fee in connection with investment
management or advisory services with respect to, the plan or IRA, the
Financial Institution and Adviser will not be able to rely on these
streamlined conditions in Section II(h). They will, however, be able to
rely on the general conditions described in Sections II-V.\20\
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\20\ Robo-advice providers, however, are carved out of the rest
of the Best Interest Contract Exemption and could not rely upon
Sections II-V.
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As noted above, a number of commenters requested separate
exemptions for fiduciaries that would only receive level fees after
being retained. Some of these commenters indicated that more
streamlined conditions would promote the receipt of rollover advice by
plan participants. The commenters suggested a variety of conditions,
including a contract, a best interest standard, and disclosure of
compensation.
The provisions for Level Fee Fiduciaries in this exemption respond
to those commenters by streamlining the conditions applicable to
fiduciaries that provide advice on a Level Fee basis. Thus, for
example, the exemption does not require Level Fee Fiduciaries to make
the warranties required of other Advisers whose Financial Institutions
will continue to receive compensation that varies with their investment
recommendations. Similarly, because the most common scenario in which
Level Fee Fiduciaries need an exemption is when they make a
recommendation to rollover assets from an ERISA plan to an IRA, the
final exemption does not require Level Fee Fiduciaries to enter into a
contract. Instead, such Retirement Investors would be able to rely on
their statutory rights under ERISA in the event the applicable
standards are not met.
The Department did not adopt other streamlined or separate
exemptions as requested by other commenters. In general, these separate
exemptions suggested by commenters were not premised on the receipt of
truly level fees, but would have permitted some variable compensation
to occur based on the Retirement Investor's investment decisions after
the fiduciary was retained. The Department determined that these
transactions should occur in accordance with the general conditions of
this exemption which provide additional safeguards for Retirement
Investors in the context of such variable payments.
2. Relief Limited to Advice to ``Retirement Investors''
This exemption is designed to promote the provision of investment
advice to retail investors that is in their Best Interest and untainted
by conflicts of interest. The exemption permits receipt by Advisers and
Financial Institutions, and their Affiliates and Related Entities, of
compensation commonly received in the retail market, such as
commissions, 12b-1 fees, and revenue sharing payments, subject to
conditions specifically designed to protect the interests of retail
investors. For consistency with these objectives, the exemption applies
to the receipt of such compensation by Advisers, Financial
Institutions, and their Affiliates and Related Entities, only when
advice is provided to ``Retirement Investors,'' defined as participants
and beneficiaries of a plan subject to Title I of ERISA or described in
Code section 4975(e)(1)(A); IRA owners; and ``Retail Fiduciaries'' of
plans or IRAs to the extent they act as fiduciaries with authority to
make investment decisions for the plan. Unlike the proposed exemption,
Retail Fiduciaries can include the fiduciaries of both participant-
directed and non-participant directed plans. The Department also
confirms that Retirement Investors can include plan participants and
beneficiaries who invest through a self-directed brokerage window.
[[Page 21013]]
The definition of Retail Fiduciary dovetails with provisions in the
Regulation that permit persons to avoid fiduciary status when they
provide advice to independent fiduciaries with financial expertise
(described in paragraph (c)(1)(i) of the Regulation) under certain
conditions.\21\ As defined in the Regulation, such independent
fiduciaries are financial institutions (including banks, insurance
carriers, registered investment advisers and broker dealers) or persons
that otherwise hold or have under management or control, total assets
of $50 million or more. Retail Fiduciaries, by contrast, are
fiduciaries that do not meet these characteristics.\22\
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\21\ 29 CFR 2510.3-21(c)(1)(i). In addition, the Regulation
provides that persons do not act as fiduciaries simply by marketing
or making available platforms of investment vehicles to participant-
directed plans, without regard to the individualized needs of the
plan or its participants and beneficiaries. See 29 CFR 2510.3-
21(b)(2)(i).
\22\ The $50 million threshold established in the Regulation is
based, in part, on the definition of ``institutional account'' in
FINRA Rule 4512(c)(3) to which the suitability rules of FINRA rule
2111 apply, and responds to the requests of commenters that the test
for sophistication be based on market concepts that are well
understood by brokers and advisors. Specifically, FINRA rule 2111(b)
on suitability and FINRA's ``books and records'' Rule 4512(c) both
use a definition of ``institutional account,'' which means the
account of a bank, savings and loan association, insurance company,
registered investment company, registered investment adviser or any
other person (whether a natural person, corporation, partnership,
trust or otherwise) with total assets of at least $50 million. Id.
at Q&A 8.1. In addition, the FINRA rule, but not this exemption,
requires: (1) That the broker have ``a reasonable basis to believe
the institutional customer is capable of evaluating investment risks
independently, both in general and with regard to particular
transactions and investment strategies involving a security or
securities'' and (2) that ``the institutional customer affirmatively
indicates that it is exercising independent judgment.''
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The exemption's definition of ``Retail Fiduciary'' is intended to
work with the definition of independent fiduciary in the Regulation, so
that if a person providing advice in the retail market cannot avoid
fiduciary status under the Regulation because the advice recipient
fails to meet the conditions for advice to independent fiduciaries
under paragraph (c)(1)(i) of the rule, the person can rely on this
exemption for advice to a Retirement Investor, if the conditions are
satisfied.
As initially proposed, the definition of Retirement Investor was
much more limited. It included only plan sponsors (and employees,
officers and directors thereof) of non-participant directed plans with
fewer than 100 participants. The proposal did not extend to small
participant-directed plans, although the Department specifically sought
comment on whether the exemption should be expanded in that respect.
The definition of ``Retail Fiduciary'' in the final exemption
effectively eliminates this limitation by covering the fiduciaries of
such plans (including plan sponsors, employees, officers, and
directors), unless they are institutional fiduciaries or fiduciaries
that hold, manage, or control $50 million or more in assets.
The final exemption, like the proposal, is limited to retail
investors, subject to the definitional changes described above. Persons
making recommendations to independent institutional fiduciaries and
large money managers in arm's length transactions have a ready means to
avoid fiduciary status, and correspondingly less need for the
exemption. Moreover, investment advice fiduciaries with respect to
large ERISA plans have long acknowledged fiduciary status and operated
within the constraints of prohibited transaction rules. As a result,
extending this Best Interest Contract Exemption to such fiduciaries,
and facilitating their receipt of otherwise prohibited compensation,
could result in the promotion, rather than reduction, of conflicted
investment advice.
Comments on the definition of Retirement Investor, and the
Department's responses, are discussed in the next sections of this
preamble.
a. Participant-Directed Plans
Commenters generally indicated that the exemption should extend to
participant-directed plans. Many commenters expressed concern that
excluding such plans as Retirement Investors would leave them without
sufficient access to much needed investment advice, particularly on
choosing the menu of investment options available to participants and
beneficiaries, and might even discourage employers from adopting ERISA-
covered plans. The U.S. Small Business Administration Office of
Advocacy (SBA Office of Advocacy) commented that, according to the
reports from small business owners, most small plans are participant-
directed, and suggested that the exclusion of participant-directed
plans would result in small business advisers to small plans being
prevented from taking advantage of the exemption all together.
Commenters noted that advisers to these plan fiduciaries could not
avoid fiduciary status under the proposed Regulation's provision on
counterparty transactions (the Seller's Exception), and the ``carve-
out'' for platform providers in the Regulation did not permit
individualized advice. While one commenter acknowledged that
fiduciaries of participant-directed plans could receive investment
advice under compensation arrangements that do not raise prohibited
transactions issues, the commenter nevertheless supported extending the
exemption to participant-directed plans to facilitate access to advice
under a variety of compensation arrangements.
The Department also received comments on the aspect of the proposal
that limited Retirement Investors to plan sponsors (and employees,
officers and directors thereof) of plans. A few commenters asserted
that all types of plan fiduciaries should be able to receive advice
under the exemption. One commenter specifically identified ``trustees,
fiduciary committees and other fiduciaries.''
The Department's expanded definition of Retail Fiduciaries in the
final exemption applies generally to all fiduciaries who are not
institutional fiduciaries or large money managers, regardless of
whether they are fiduciaries of participant-directed plans or other
plans. In addition, the exemption extends coverage to advice to all
plan fiduciaries, not just plan sponsors and their employees, officers
and directors. As noted above, the Department intends to cover all
advisers, regardless of plan-type, who cannot avail themselves of the
Regulation's exception for fiduciaries with financial expertise (i.e.
independent institutional fiduciaries and fiduciaries holding,
managing, or controlling $50 million or more in assets). These changes
respond to the comments described above, including the comment from the
SBA Office of Advocacy.
However, while the Department has expanded the exemption to cover
Retail Fiduciaries with respect to participant-directed plans, it
believes the commenters' concerns about a significant loss of advice
and services to participant-directed plans were overstated. Investment
advice providers who became fiduciaries under the Regulation would have
been able to provide investment advice to all plans, as long as they
did so under an arrangement that does not raise prohibited transactions
issues, including by offsetting Third Party Payments against level
fees.\23\ In addition, under the Regulation, all plans can receive non-
fiduciary education and services. Moreover, the exemption as proposed
(and, of course, as finalized) covered advice to participants and
[[Page 21014]]
beneficiaries of participant-directed plans.
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\23\ See Advisory Opinion 97-15A (May 22, 1997).
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Nevertheless, the conditions of this final exemption have been
carefully crafted to protect retail investors, including small,
participant-directed plans. After considering the comments, the
Department agrees that small plans would benefit from the protections
of the exemption, and that expanding the scope of this exemption to all
Retail Fiduciaries, including such fiduciaries of participant-directed
plans, would better promote the provision of best interest advice to
all retail Retirement Investors.
b. Plan Size
The Department also received comments regarding the proposed 100-
participant threshold for plans to qualify as Retirement Investors.
Some commenters requested that the Retirement Investor definition
include fiduciaries of plans with more than 100 participants. These
commenters saw no reason to distinguish between small and large plans,
since ERISA applies equally to both. One commenter requested that the
Department use an asset-based test rather than a test based on number
of participants, as a method of determining which plans should be
Retirement Investors under the exemption. The commenter expressed the
view that plan size might not be a proxy for sophistication, as many
large employers have multiple plans, some of which may have fewer than
100 participants. Other commenters asserted that it could be difficult
for Advisers and Financial Institutions to keep track of the number of
plan participants to determine whether a particular plan satisfied the
Retirement Investor definition.
Other commenters supported the limitation to smaller plans, writing
that larger plans have other means of access to high-quality advice,
including the provision in the proposed Regulation for counterparties
in arm's length transactions with an independent fiduciary with
financial expertise, and so did not need the protections and
constraints of the exemption.
One commenter suggested that the exemption be available for advice
to IRAs only, because the exemption would reduce the existing
protections for ERISA plans of all sizes. According to the commenter,
investment advice fiduciaries to ERISA plans should rely instead on the
statutory exemption in ERISA section 408(b)(14) for ``eligible
investment advice arrangements'' as described in ERISA section 408(g).
In the commenter's view, this exemption would undermine the protections
of that exemption and the regulations thereunder. In the Department's
judgment, however, the exemption's conditions strike an appropriate
balance for small plan investors by facilitating the continued
provision of advice in reliance on common fee structures, while
mitigating the impact of the conflicts of interest on the quality of
the advice.
The final exemption retains the limitation for advice to retail
Retirement Investors. In determining whether a plan fiduciary is a
Retirement Investor, however, the Department has revised the exemption
to focus on characteristics of the advice recipient rather than plan
size for determining whether a plan fiduciary is a Retirement Investor.
As discussed above, the definition of Retail Fiduciary, therefore,
generally focuses on the fiduciary's status as a financial institution
or the amount of its assets under management.
This approach in effect still limits the exemption to smaller
plans, as fiduciaries that hold, manage, or control $50 million or more
in assets will generally be excluded as Retirement Investors. In many
cases, persons making recommendations to large plans can avoid
fiduciary status by availing themselves of the Rule's exception for
transactions with sophisticated investor counterparties. But when they
instead act as investment advice fiduciaries, the Department believes
they are appropriately excluded from the scope of this exemption, which
was designed for retail Retirement Investors. As discussed above,
including larger plans within the definition of Retirement Investor
could have the undesirable consequence of reducing protections provided
under existing law to these investors, without offsetting benefits. In
particular, it could have the undesirable effect of increasing the
number and impact of conflicts of interest, rather than reducing or
mitigating them. Accordingly the final exemption was not expanded to
include larger plans as Retirement Investors.
c. SEPs, SIMPLEs, and Keogh Plans
Several commenters asked for clarification of the types of plans
that could be represented by fiduciaries that are Retirement Investors.
A few commenters requested that the exemption extend to Simplified
Employee Pensions (SEPs) and Savings Incentive Match Plans for
Employees (SIMPLEs). In the final exemption, the definition of Retail
Fiduciary includes a fiduciary with respect to both ERISA plans and
plans described in Code section 4975(e)(1)(A). This definition includes
SEPs and SIMPLEs.\24\
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\24\ In addition to covering advice to these fiduciaries of SEPs
and SIMPLEs, the exemption also covers advice to the participants
and beneficiaries of such plans. ERISA plan participants and
beneficiaries are uniformly treated as covered Retirement Investors
under the terms of the exemption.
---------------------------------------------------------------------------
Other commenters observed that Keogh plans were excluded from the
proposed definition of Retirement Investor. While these plans are not
subject to Title I of ERISA, they are defined in Code section
4975(e)(1)(A) and are covered under the prohibited transaction
provisions of Code section 4975. The definition of Retail Fiduciary
covers a fiduciary with respect to a plan described in Code section
4975(e)(1)(A). In addition, the Department has revised the definition
of Retirement Investor to include participants and beneficiaries of
plans described in Code section 4975(e)(1)(A). Conflicts of interest
pose similar dangers to all retail investors, and the Department,
accordingly, believes that all retail investors would benefit from the
protections set forth in this Best Interest Contract Exemption.
3. No Limited Definition of ``Asset''
The final exemption does not limit the types of investments that
can be recommended by Advisers and Financial Institutions. The
exemption is significantly broader in this respect than the proposal,
which would have limited the investments that could be recommended as
covered ``Assets.'' Although the definition in the proposed exemption
was quite expansive, it did not cover all ``securities or other
investment property'' that could be the subject of an investment
recommendation under the Regulation.
As proposed, the definition of Asset included the following
investment products:
Bank deposits, certificates of deposit (CDs), shares or
interests in registered investment companies, bank collective funds,
insurance company separate accounts, exchange-traded REITs,
exchange-traded funds, corporate bonds offered pursuant to a
registration statement under the Securities Act of 1933, agency debt
securities as defined in FINRA Rule 6710(l) or its successor, U.S.
Treasury securities as defined in FINRA Rule 6710(p) or its
successor, insurance and annuity contracts, guaranteed investment
contracts, and equity securities within the meaning of 17 CFR
230.405 that are exchange-traded securities within the meaning of 17
CFR 242.600. Excluded from this definition is any equity security
that is a security future or a put, call, straddle, or other option
or privilege of buying an equity security from or selling an equity
security to another without being bound to do so.
[[Page 21015]]
The Department viewed the limited definition of Asset in the
proposal as part of the protective framework of the exemption. The
intent in proposing a limited definition of Asset was to permit
investment advice on of the types of investments that Retirement
Investors typically rely on to build a basic diversified portfolio,
under a uniform set of protective conditions, while avoiding potential
issues with less common investments that may possess unusual
complexity, illiquidity, risk, lack of transparency, high fees or
commissions, or illusory tax ``efficiencies.'' In the context of some
of these investments, Retirement Investors may be less able to police
the conduct of their Adviser or assess whether they are getting a good
or bad deal. Accordingly, the Asset limitation was intended to work
with the other safeguards in the exemption to ensure investment advice
is provided in Retirement Investors' Best Interest.
Commenters representing the industry strenuously objected to the
limited definition of ``Asset.'' Commenters took the position that the
limited definition would be inconsistent with the Department's
historical approach of declining to create a ``legal list'' of
investments for plan fiduciaries. Some commenters argued that Congress
imposed only very narrow limits on the types of investments IRAs may
make, and therefore the Department should not impose other limitations
in an exemption.
Many commenters viewed the proposed limited definition of Asset as
the Department substituting its judgment for that of the Adviser and
stating which investments are permissible or ``worthy.'' Some
commenters believed that the Best Interest standard alone should guide
the recommendations of specific investments. Some asserted that the
limitations could even undermine Advisers' obligation to act in the
best interest of Retirement Investors.
In the event that the Department determined to proceed with the
limited definition of Asset, commenters argued that it should be
expanded to include specific additional investments. Some examples of
such additional investments include: Non-traded business development
companies, cleared swaps and cleared security-based swaps, commodities,
direct participation programs, energy and equipment leasing programs,
exchange traded options, federal agency and government sponsored
enterprise guaranteed mortgage-backed securities, foreign bonds,
foreign currency, foreign equities, futures (including exchange-traded
futures), hedge funds, limited partnerships, market linked CDs,
municipal bonds, non-traded REITs, over-the-counter equities, precious
metals, private equity, real estate, stable value wrap contracts,
structured notes, structured products, and non-U.S. funds that are
registered or listed on an exchange in their home jurisdiction.
Some commenters also asked how the exemption would be updated to
accommodate new investments over time. One commenter suggested that, as
an alternative to the definition of Asset, the exemption should
establish a series of principles governing the types of investments
that could be recommended. The principles suggested by the commenter
included transparent pricing, sufficient liquidity, lack of excessive
complexity and leverage, a sufficient track record to demonstrate its
utility, and not providing a redundant or illusory tax benefit inside a
retirement account.
Other commenters argued for an expansion of the types of
investments that could be recommended to sophisticated investors.
Commenters indicated that the definition of Asset could be expanded or
eliminated entirely for these Retirement Investors, on the basis that
alternative investments could be appropriate for them. These commenters
suggested the Department could rely on the securities laws,
specifically the accredited investor rules, to make sure that investors
could bear the potential losses of their investments.
However, the Department also received comments supporting the
proposed definition of Asset as an appropriate safeguard of the
exemption. These commenters expressed the view that the list was
sufficiently broad to allow an Adviser to meet a Retirement Investor's
needs, while limiting the risks of other types of investments.
Retirement Investors would still have access to these excluded
investments under either pooled investment vehicles such as mutual
funds, or pursuant to compensation models that do not involve
conflicted advice. Some commenters expressed support for exclusion of
specific investment products, such as non-traded Real Estate Investment
Trusts (REITs), private placements, and other complex products,
indicating these investments may be associated with extremely high
fees. A commenter asserted that there have been significant problems
with recommendations of non-traded REITs and private placements in
recent years. Another commenter urged that the exemption not provide
relief for the recommendation of variable annuity contracts, although
they were in the proposed definition of Asset.
Likewise, some commenters opposed any different treatment of
sophisticated investors. The commenters said that net worth of an
individual is not a reliable measure of financial knowledge, and the
thresholds under securities law may be too low to identify those who
can risk substantial portions of their retirement savings.
After careful consideration of these comments, the Department
eliminated the definition of Asset in the final exemption. In this
regard, the Department ultimately determined that the other safeguards
adopted in the final exemption--in particular, the requirement that
Advisers and Financial Institutions provide investment advice in
accordance with the Impartial Conduct Standards, the requirement that
Financial Institutions adopt anti-conflict policies and procedures and
the requirement that Financial Institutions disclose their Material
Conflicts of Interest--were sufficiently protective to allow the
exemption to apply more broadly to all securities and other investment
property. If adhered to, these conditions should be protective with
respect to all investments. It is not the Department's intent to
foreclose fiduciaries, adhering to the exemption's standards, from
recommending such investments if they prudently determine that they are
the right investments for the particular customer and circumstances.
For these same reasons, the Department has decided not to limit the
exemption to investments meeting certain principles, as suggested by a
commenter.
However, the fact that the exemption was broadened does not mean
the Department is no longer concerned about some of the attributes of
the investments that were not initially included in the proposed
definition of Asset, such as unusual complexity, illiquidity, risk,
lack of transparency, high fees or commissions, or tax benefits that
are generally unnecessary in these tax preferred accounts. This
broadening of the exemption for products with these attributes must be
accompanied by particular care and vigilance on the part of Financial
Institutions responsible for overseeing Advisers' recommendations of
such products. Moreover, the Department intends to pay special
attention to recommendations involving such products after the
Applicability Date to ensure adherence to the Impartial Conduct
Standards and verify that the exemption is sufficiently protective.
The Department expects that Advisers and Financial Institutions
providing
[[Page 21016]]
advice will exercise special care when assets are hard to value,
illiquid, complex, or particularly risky. Financial Institutions
responsible for overseeing recommendations of these investments must
give special attention to the policies and procedures surrounding such
investments and their oversight of Advisers' recommendations, if they
are to properly discharge their fiduciary responsibilities. Financial
Institutions should identify such investments and ensure that their
policies and procedures are reasonably and prudently designed to ensure
Advisers' compliance with the Impartial Conduct Standards when
recommending them. In particular, Financial Institutions must ensure
that Advisers are provided with information and training to fully
understand all investment products being sold, and must similarly
ensure that customers are fully advised of the risks. Additionally,
when recommending such products, the Financial Institution and Adviser
should take special care to prudently document the bases for their
recommendation and for their conclusions that their recommendations
satisfy the Impartial Conduct Standards.
Further, when determining the extent of the monitoring to be
provided, as disclosed in the contract pursuant to Section II(e) of the
exemption, such Financial Institutions should carefully consider
whether certain investments can be prudently recommended to the
individual Retirement Investor, in the first place, without a mechanism
in place for the ongoing monitoring of the investment. This is
particularly a concern with respect to investments that possess unusual
complexity and risk, and that are likely to require further guidance to
protect the investor's interests. Without an accompanying agreement to
monitor certain recommended investments, or at least a recommendation
that the Retirement Investor arrange for ongoing monitoring, the
Adviser may be unable to satisfy the exemption's Best Interest
obligation with respect to such investments. Similarly, the added cost
of monitoring such investments should be considered by the Adviser and
Financial Institution in determining whether the recommended
investments are in the Retirement Investors' Best Interest.
4. Riskless Principal Transactions
The final exemption extends to compensation received in
transactions that are ``riskless principal transactions.'' A riskless
principal transaction is defined in Section VIII(p) as ``a transaction
in which a Financial Institution, after having received an order from a
Retirement Investor to buy or sell an investment product, purchases or
sells the same investment product for the Financial Institution's own
account to offset the contemporaneous transaction with the Retirement
Investor.''
Apart from riskless principal transactions, Section I(c)(2) of the
final exemption, which sets forth the exclusions from relief, states
that the exemption does not apply to compensation that is received as a
result of a principal transaction. A ``principal transaction'' is
defined in Section VIII(k) as ``a purchase or sale of an investment
product if an Adviser or Financial Institution is purchasing from or
selling to a Plan, participant or beneficiary account, or IRA on behalf
of the Financial Institution's own account or the account of a person
directly or indirectly, through one or more intermediaries,
controlling, controlled by, or under common control with the Financial
Institution.'' The definition further states that a principal
transaction does not include a riskless principal transaction as
defined in Section VIII(p). Thus, the exemption draws a distinction
between principal transactions and riskless principal transactions.
In the Department's view, principal transactions pose especially
acute conflicts of interest because the investment advice fiduciary and
Retirement Investor are on opposite sides of the transaction. As a
result of the special risks posed by such transactions, the Department
has proposed a separate exemption for investment advice fiduciaries to
engage in principal transactions involving specified investments, but
subject to additional protective conditions. That exemption is also
adopted today, as published elsewhere in this issue of the Federal
Register.
Commenters on the proposed Best Interest Contract Exemption and the
proposed Principal Transactions Exemption asked about the treatment of
riskless principal transactions. Some commenters asked the Department
to expand the scope of the Best Interest Contract Exemption to include
all riskless principal transactions. Commenters argued that riskless
principal transactions are the functional equivalent of agency
transactions. A commenter asserted that for this reason, riskless
principal transactions would not involve the incentive to ``dump''
unwanted investments on Retirement Investors, which was one of the
Department's concerns. The commenters indicated that many investment
transactions occur on a ``riskless principal'' basis rather than a pure
agency basis. One commenter stated that this is because counterparties
may not want to assume settlement risk with an investor.
The commenters indicated that the proposed restriction in the Best
Interest Contract Exemption applicable to all principal transactions,
in conjunction with the limited scope of the Principal Transactions
Exemption, as proposed, would cause valuable investments to be
unavailable to plans and IRAs as a practical matter. Commenters also
asked the Department to confirm that riskless principal transactions
were covered within the scope of the Principal Transactions Exemption.
In response to comments, the Department has determined to provide
broader relief with respect to recommended riskless principal
transactions. The scope of the Best Interest Contract Exemption is
expanded to extend to riskless principal transactions involving all
investments. The Department accepts commenters' representations that
the lack of broader relief for riskless principal transactions would
result in unnecessarily limited investment choices for Retirement
Investors. In addition, the Department also confirmed in the Principal
Transactions Exemption that riskless principal transactions are
included in the scope of that exemption as well for the specific
investments covered therein.
This approach results in some overlap between coverage of riskless
principal transactions in this Best Interest Contract Exemption and the
Principal Transactions Exemption. With respect to a recommended
purchase of an investment that occurs in a riskless principal
transaction, the Principal Transactions Exemption is available for the
specified investments that are covered in that exemption. The Best
Interest Contract Exemption, however, provides broader relief for all
recommended purchases. In addition, sales from a plan or IRA in
riskless principal transactions can occur under either exemption.
This approach is intended to provide flexibility to Financial
Institutions relying on the exemptions. The Department believes that
some Financial Institutions have business models that involve only
riskless principal transactions. These Financial Institutions may not,
as a general matter, hold investments in inventory to sell in principal
transactions, but they may execute certain transactions as riskless
principal transactions. Financial Institutions that do not engage in
principal transactions, as defined in the
[[Page 21017]]
exemptions, do not have to rely on the Principal Transactions Exemption
at all, and can organize their practices to comply with this Best
Interest Contract Exemption alone.
On the other hand, Financial Institutions that engage in principal
transactions may want to organize their practices to comply with the
Principal Transactions Exemption. They may not be certain at the outset
whether a particular purchase by a plan or IRA will be executed as a
principal transaction or a riskless principal transaction. Those
Financial Institutions can rely on the Principal Transactions Exemption
for the specified assets that may be sold to plans and IRAs without
concern whether the transaction is, in fact a riskless principal
transaction or a principal transaction.
A discussion of comments on the treatment of specific investments
as Principal Transactions is included in a later section of this
preamble, explaining the definitions used in this exemption.
5. Indexed and Variable Annuities
The Department received many comments on the proposed exemption's
approach to annuity contracts. The final exemption was not revised from
the proposal with respect to the coverage of insurance and annuity
products, although a number of changes were made to the exemption to
make it more readily usable with respect to these products, as
discussed below. Advisers and Financial Institutions are permitted to
receive compensation in connection with the sale of all insurance and
annuity contracts under the exemption.
However, in a companion Notice published elsewhere in this issue of
the Federal Register, the Department limited relief available in
another exemption, PTE 84-24,\25\ to ``fixed rate annuity contracts,''
defined in the exemption as fixed annuity contracts issued by an
insurance company that are either immediate annuity contracts or
deferred annuity contracts that (i) satisfy applicable state standard
nonforfeiture laws at the time of issue, or (ii) in the case of a group
fixed annuity, 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 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. Fixed rate annuity contracts do not include variable annuities
or indexed annuities or similar annuities. As a result, investment
advice fiduciaries will generally rely on this Best Interest Contract
Exemption for compensation received for the recommendation of variable
annuities, indexed annuities, similar annuities, and any other
annuities that do not satisfy the definition of fixed rate annuity
contracts.
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\25\ 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 elsewhere in this issue of the
Federal Register.
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In response to the proposal, some commenters, expressing concern
about the risks associated with variable annuities, commended the
Department for proposing that they should be recommended under the
conditions of this exemption rather than PTE 84-24. One commenter cited
the provision of FINRA's Investor Alert, ``Variable Annuities: Beyond
the Hard Sell,'' which says:
Investing in a variable annuity within a tax-deferred account,
such as an individual retirement account (IRA) may not be a good
idea. Since IRAs are already tax-advantaged, a variable annuity will
provide no additional tax savings. It will, however, increase the
expense of the IRA, while generating fees and commissions for the
broker or salesperson.\26\
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\26\ ``Variable Annuities: Beyond the Hard Sell,'' available at
http://www.finra.org/sites/default/files/InvestorDocument/p125846.pdf. FINRA also has special suitability rules for certain
investment products, including variable annuities. See FINRA Rule
2330 (imposing heightened suitability, disclosure, supervision and
training obligations regarding variable annuities); see also FINRA
rule 2360 (options) and FINRA rule 2370 (securities futures).
Other commenters wrote that fixed annuities, particularly indexed
annuities, should also be subject to the requirements of this Best
Interest Contract Exemption rather than PTE 84-24. One commenter
indicated that indexed and variable annuities raise similar issues with
respect to conflicted compensation, and that different treatment of the
two would create incentives to sell more indexed annuities subject to
the less restrictive regulation.
Other commenters urged that Advisers and Financial Institutions
should be able to rely on PTE 84-24 for all insurance products, rather
than bifurcating relief between two exemptions. Commenters emphasized
the benefit, for compliance purposes, of one exemption for all
insurance products. These commenters highlighted the importance of
lifetime income options, and the ways the Department, the Treasury
Department and the IRS have worked to make annuities more accessible to
Retirement Investors. They expressed concern that the approach to
annuity contracts in the proposals could undermine those efforts.
In this regard, many commenters expressed concern that the
disclosure requirements proposed in this exemption were inapplicable to
insurance products and that they would not be able to satisfy the Best
Interest and other Impartial Conduct Standards, or provide a
sufficiently broad range of Assets to satisfy the conditions of Section
IV of this exemption, as proposed. Several raised questions about how
the proposed definition of ``Financial Institution'' would apply to
insurance companies. According to these commenters, the conditions
proposed for this exemption would be so difficult and costly that
broker-dealers would stop selling variable annuities to certain IRA
customers and retirement plans rather than comply.
Both the Securities and Exchange Commission (SEC) staff and FINRA
have issued guidance on indexed annuities. In its 2010 Investor Alert,
``Equity-Indexed Annuities: A Complex Choice,'' FINRA explained the
need for an Alert, as follows:
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\
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\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\
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\28\ Id.
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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
[[Page 21018]]
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\
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\29\ SEC Office of Investor Education and Advocacy Investor
Bulletin: Indexed Annuities, available at https://www.sec.gov/investor/alerts/secindexedannuities.pdf.
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Given the risks and complexities of these investments, the
Department has determined that indexed annuities are appropriately
subject to the same protective conditions of the Best Interest Contract
Exemption that apply to variable annuities. These are complex products
requiring careful consideration of their terms and risks. Assessing the
prudence of a particular indexed annuity requires an understanding,
inter alia, 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; 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 value and the 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. Both
categories of annuities, variable and indexed annuities, are
susceptible to abuse, and Retirement Investors would equally benefit in
both cases from the protections of this exemption, including the
conditions that clearly establish the enforceable standards of
fiduciary conduct and fair dealing as applicable to Advisers and
Financial Institutions.
In response to comments, however, the final exemption has been
revised so that the conditions identified by commenters are less
burdensome and more readily complied with by all Financial
Institutions, including insurance companies and distributors of
insurance products. In particular, the Department has revised the pre-
transaction disclosure so that it does not require a projection of the
total cost of the recommended investment, which commenters indicated
would be difficult to provide in the insurance context. The Department
also did not adopt the proposed data collection requirement, which also
posed problems for insurance products, according to commenters.
Further, the Department adjusted the language of the exemption in
other places and addressed interpretive issues in the preamble to
address the particular questions and concerns raised by the insurance
industry. For example, the Department revised the ``reasonable
compensation'' standard throughout the exemption to address comments
from the insurance industry regarding the application of the standard
to insurance transactions. Additionally, guidance is provided further
in this preamble regarding the treatment of insurers as Financial
Institutions, within the meaning of the exemption. Finally, the
Department provided specific guidance in Section IV of the exemption on
satisfaction of the Best Interest standard by Proprietary Product
providers.
The Department notes that many insurance industry commenters
stressed a desire for one exemption covering all insurance and annuity
products. The Department agrees that efficient compliance with
fiduciary norms could be promoted by a common set of requirements, but
concludes, for the reasons set forth above, that this exemption is best
suited to address the conflicts of interest associated with variable
annuities, indexed annuities, and similar investments, rather than the
less stringent PTE 84-24. Accordingly, the Department has limited the
availability of PTE 84-24 to ``fixed rate annuity contracts,'' while
requiring Advisers recommending variable and indexed annuities to rely
on this Best Interest Contract Exemption, which is broadly available
for any kind of annuity or asset, subject to its specific conditions.
In this manner, the final exemption creates a level playing field for
variable annuities, indexed annuities, and mutual funds under a common
set of requirements, and avoids creating a regulatory incentive to
preferentially recommend indexed annuities.
The Department did, however, leave PTE 84-24 available for
recommendations involving ``fixed rate annuity contracts.'' The
Department concluded that this approach in the final exemption and
final amendment to PTE 84-24 draws the correct lines, applying
protective conditions to particularly complex annuities while leaving
in place a somewhat more streamlined exemption that would remain
applicable to the recommendation of relatively simpler annuity
products, which promote lifetime income. To illustrate the features of
these products, the Department prepared a chart comparing fixed rate
annuities, fixed indexed annuities and variable annuities, which is
included as Appendix I.
A few commenters expressed concern that the requirements of this
exemption, as proposed, would interfere with state insurance regulatory
programs, which would lead to litigation. Commenters asserted that the
Department's proposal ignored the role of state insurance regulators in
providing consumer protections. The Department does not agree with
these comments. In addition to meeting with and consulting with state
insurance regulators and the NAIC as part of this project, the
Department has also reviewed NAIC model laws and regulations and state
reactions to those models in order to ensure that the requirements of
this exemption work cohesively with the requirements currently in
place. For example, in 2010 the NAIC adopted the Suitability in Annuity
Transactions Model Regulation to establish suitability standards in
annuity transactions. According to the NAIC, this regulation was
adopted specifically to establish a framework under which insurance
companies, not just the agent or broker, are ``responsible for ensuring
that the annuity transactions are suitable.'' \30\ Much like the
policies and procedures requirement of this exemption, the NAIC
requires insurance companies to develop a system of supervision
designed to achieve compliance with the suitability obligations.\31\
This is not to say that the
[[Page 21019]]
requirements of this exemption are identical to those included in
NAIC's model regulation. However, the Department has crafted the
exemption so that it will work with, and complement, state insurance
regulations. In addition, the Department confirms that it is not its
intent to preempt or supersede state insurance law and enforcement, and
that state insurance laws remain subject to the ERISA section
514(b)(2)(A) savings clause.\32\
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\30\ NAIC, Suitability in Annuity Transactions Model Regulation,
Executive Summary--http://www.naic.org/documents/committees_a_suitability_reg_guidance.pdf.
\31\ NAIC Model Regulations, section 6(F)(1) (``An insurer shall
establish a supervision system that is reasonably designed to
achieve the insurer's and its insurance producers' compliance with
this regulations including, but not limited to the following: . . .
(d) The insurer shall maintain procedures for review of each
recommendation prior to issuance of an annuity that designed to
ensure that there is a reasonable basis to determine that a
recommendation is suitable. . . .'') (2010); NAIC, Suitability in
Annuity Transactions Model Regulation, Executive Summary,--http://www.naic.org/documents/committees_a_suitability_reg_guidance.pdf.
Most states--35 states and the District of Columbia--have adopted
some form of the NAIC's model regulations regarding suitability.
\32\ A few commenters raised questions about the role of the
McCarran-Ferguson Act and the Department's authority to regulate
insurance products. The McCarran-Ferguson Act states that federal
laws do not preempt state laws to the extent they relate to or are
enacted for the purpose of regulating the business of insurance; it
does not, however, prohibit federal regulation of insurance. See
John Hancock Mut. Life Ins. Co. v. Harris Trust & Sav. Bank, 510
U.S. 86, 97-101 (1993) (holding that ``ERISA leaves room for
complementary or dual federal or state regulation, and calls for
federal supremacy when the two regimes cannot be harmonized or
accommodated''). The Department has designed the exemption to work
with and complement state insurance laws, not to invalidate, impair,
or preempt state insurance laws. See BancOklahoma Mortg. Corp. v.
Capital Title Co., Inc., 194 F.3d 1089 (10th Cir. 1999) (stating
that McCarran-Ferguson Act bars the application of a federal statute
only if (1) the federal statute does not specifically relate to the
business of insurance; (2) a state statute has been enacted for the
purpose of regulating the business of insurance; and (3) the federal
statute would invalidate, impair, or supersede the state statute);
Prescott Architects, Inc. v. Lexington Ins. Co., 638 F. Supp. 2d
1317 (N.D. Fla. 2009); see also U.S. v. Rhode Island Insurers'
Insolvency Fund, 80 F.3d 616 (1st Cir. 1996). Specifically, the
Supreme Court has made it clear that ``the McCarran-Ferguson Act
does not surrender regulation exclusively to the States so as to
preclude the applicable of ERISA to an insurer's actions.'' John
Hancock, 510 U.S. at 98.
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6. Types of Compensation Covered by the Exemption
a. General
Further addressing the scope of the exemption, a number of
commenters requested clear confirmation of the types of payments the
exemption would permit. As the commenters requested, the Department
confirms that this exemption provides relief for commissions paid
directly by the plan or IRA, as well as commissions, trailing
commissions, sales loads, 12b-1 fees, revenue sharing payments, and
other payments by investment product manufacturers or other third
parties to Advisers and Financial Institutions. The exemption also
covers other compensation received by the Adviser, Financial
Institution or their Affiliates and Related Entities as a result of an
investment by a plan, participant or beneficiary account, or IRA, such
as investment management fees and administrative services fees from an
investment vehicle in which the plan, participant or beneficiary
account, or IRA invests, and account type fees earned as a result of
the Adviser's or Financial Institution's recommendations.
A few comments suggested that the Department should grant a more
limited exemption with respect to certain fees, including 12b-1 fees
and account maintenance fees. One commenter asserted that account
maintenance fees tend to exceed reasonable compensation and should be
further constrained by a condition requiring the terms of the
transaction to be arm's length. The Department has not adopted this
requirement, but rather has sought to draft conditions, including the
reasonable compensation conditions, which should be broadly protective,
without regard to the particular type of payment or business model.
b. Referral Fees Pursuant to Bank Networking Arrangements
The exemption also provides relief for referral fees received by
banks and bank employees, pursuant to ``Bank Networking Arrangements.''
A Bank Networking Arrangement is defined in Section VIII(c) of the
exemption as an arrangement for the referral of retail non-deposit
investment products that satisfies applicable federal banking,
securities and insurance regulations, under which bank employees refer
bank customers to an unaffiliated investment adviser registered under
the Investment Advisers Act of 1940 or under the laws of the state in
which the adviser maintains its principal office and place of business,
insurance company qualified to do business under the laws of a state,
or broker or dealer registered under the Exchange Act, as amended. The
exemption provides relief for the receipt of compensation by an Adviser
who is a bank employee, and a Financial Institution that is a bank or
similar financial institution supervised by the United States or state,
or a savings association (as defined in section 3(b)(1) of the Federal
Deposit Insurance Act (12 U.S.C. 1813(b)(1)) (a bank), pursuant to a
Bank Networking Arrangement in connection with their provision of
investment advice to a Retirement Investor, provided the investment
advice adheres to the Impartial Conduct Standards set forth in Section
II(c).
The exemption's provisions regarding such payments were developed
in response to a comment from the American Bankers Association (ABA)
regarding such arrangements. The ABA stated that bank employees are
permitted to receive a fee for referring bank customers to the bank's
brokerage unit or unaffiliated third party under the Gramm-Leach-Bliley
Act (GLBA), and indicated that such referrals could result in
prohibited transactions if the employees are deemed fiduciaries. The
ABA requested that the Department clarify in the final Regulation that
referrals permitted under applicable federal banking and securities
regulations do not result in fiduciary status in order to avoid
potential prohibited transaction liability for an activity that is
expressly permitted under federal banking laws.
The Department has considered the ABA's comment and has reviewed
related banking, insurance and securities regulations regarding bank
referral of retail nondeposit investment products.\33\ It is the
Department's understanding that bank employees may receive a fee that
is generally limited to a nominal one-time cash fee of a fixed dollar
amount for referring bank customers to retail non-deposit investment
products, which include not only securities products but also insurance
and investment advice services. Under the exception from federal
securities laws registration created by GLBA, bank employees must
perform only clerical or ministerial functions in connection with
brokerage transactions including scheduling appointments with the
associated persons of a broker or dealer, except that bank employees
may forward customer funds or securities and may describe in general
terms the types of investment vehicles available from the bank and
broker-dealer under the arrangement.\34\ Bank employees referring a
customer to a broker-dealer under the exception may not provide
investment advice concerning securities or make specific securities
recommendations to the customer under OCC guidance.\35\
[[Page 21020]]
Similar compensation restrictions exist with respect to bank employees'
referrals regarding insurance products \36\ and investment
advisers.\37\
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\33\ See Interagency Statement on Retail Sales of Nondeposit
Investment Products (Feb. 1994); 15 U.S.C. 78c(a)(4)(B) (Securities
Exchange Act of 1934 exception from the term ``broker'' for certain
bank activities); Regulation R, Securities Exchange Act Release No.
34-56501 (September 24, 2007), 72 FR 56514 (Oct. 3, 2007),
www.sec.gov/rules/final/2007/34-56501.pdf and Securities Exchange
Act Release No. 34-56502 (Sept. 24, 2007) 72 FR 56562 (Oct. 3,
2007), www.sec.gov/rule/final/2007/34-56502.pdf; 12 CFR parts 14,
208, 343 and 536 (Consumer Protection in Sales of Insurance); OCC
Comptroller's Handbook, Retail Nondeposit Investment Products
(January 2015); Federal Deposit Insurance Corporation ``Uninsured
Investment Products: A Pocket Guide for Financial Institutions,''
available at: https://www.fdic.gov/regulations/resources/financial/.
\34\ 15 U.S.C. 78c(a)(4)(B)(i)(I)-(V).
\35\ See Federal Reserve Board and Securities Exchange
Commission Release, Definitions of Terms and Exemptions Relating to
the ``Broker'' Exceptions for Banks, 72 FR 56514 (Oct. 3, 2007); see
also OCC Comptroller's Handbook, Retail Nondeposit Investment
Products (January 2015).
\36\ See 12 CFR parts 14, 208, 343 and 536 (Consumer Protection
in Sales of Insurance).
\37\ See OCC Comptroller's Handbook, Retail Nondeposit
Investment Products (``While the provision of financial planning
services and investment advice to bank customers is not a sale of an
RNDIP, the OCC treats these services as if they were the sale of
RNDIPs if provided to bank customers outside of a bank's trust
department. Therefore, if a bank chooses to provide financial
planning or investment advice through an RIA or other provider, in
order to provide a high level of customer protection, the bank
should meet all of the risk management standards contained in the
Interagency Statement [on Retail Sales of Nondeposit Investment
Products] and third-party relationship guidance contained in OCC
Bulletin 2013-29, `Third-Party Relationships: Risk Management
Guidance.' '') (citing OCC Interpretive Letter #850, January 27,
1999).
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Because of the limitations on the activities of bank employees in
making referrals, the Department believes in most cases such referrals
will not constitute fiduciary investment advice because they will not
constitute a ``recommendation'' within the meaning of the Regulation or
because they will not involve a covered recommendation to hire a non-
affiliated third party. However, to the extent banks do not choose to
structure their operations to avoid providing fiduciary investment
advice, the Department concurs with commenters that relief for bank
referral compensation is appropriate as long as the arrangement
satisfies applicable banking, securities and insurance regulations and
the advice is provided in accordance with the Impartial Conduct
Standards. In general, the Department is of the view that the existing
regulatory structure governing referrals of retail nondeposit
investment products provides significant protections to Retirement
Investors.
However, should banks choose to provide investment advice within
the meaning of the Regulation, the exemption requires that the advice
satisfy the core fiduciary standards required under this exemption for
conflicted investment advice--they must give prudent advice that is in
the customer's best interest, avoid misleading statements, and receive
no more than reasonable compensation.\38\
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\38\ National banks are currently expected to implement an
effective initial due diligence process when selecting a third party
for the bank's networking sales programs, as well as adopt an
effective ongoing due diligence process to monitor the third party's
activities, which may include requiring the third party to provide
various reports and provide access to the third party's sales
program records. See OCC Comptroller's Handbook, Retail Nondeposit
Investment Products; OCC Bulletin 2013-29. In addition, a bank's
management is responsible for overseeing its vendors regardless of
whether they are operating on or off-site. Typical oversight would
include reviewing: (1) The types and volume of products being sold;
(2) the number of opened and closed accounts; (3) new products being
offered; (4) discontinued products; and (5) customer complaints and
their resolution. See Federal Deposit Insurance Corporation.
``Uninsured Investment Products: A Pocket Guide for Financial
Institutions,'' available at: https://www.fdic.gov/regulations/resources/financial/.
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B. Conditions of the Exemption
Section I, discussed above, establishes the scope of relief
provided by this Best Interest Contract Exemption. Sections II-V of the
exemption set forth the conditions applicable to the exemption
described in Section I. All applicable conditions must be satisfied in
order to avoid application of the specified prohibited transaction
provisions of ERISA and the Code. The Department finds that, subject to
these conditions, the exemption is administratively feasible, in the
interests of plans and of their participants and beneficiaries, and IRA
owners and protective of the rights of the participants and
beneficiaries of such plans and IRA owners. Under ERISA section 408(a),
and Code section 4975(c)(2), the Secretary may not grant an exemption
without making such findings. The conditions of the exemption, comments
on those conditions, and the Department's responses, are described
below.
1. Enforceable Right to Best Interest Advice (Section II)
Section II of the exemption sets forth the requirements that
establish the Retirement Investor's enforceable right to adherence to
the Impartial Conduct Standards and related conditions. For advice to
certain Retirement Investors--specifically, advice regarding
investments in IRAs, and plans that are not covered by Title I of ERISA
(``non-ERISA plans''), such as Keogh plans--Section II(a) requires the
Financial Institution and Retirement Investor to enter into a written
contract that includes the provisions described in Section II(b)-(d) of
the exemption and that also does not include any of the ineligible
provisions described in Section II(f) of the exemption. Financial
Institutions additionally must provide the disclosures set forth in
Section II(e). As discussed further below, pursuant to Section II(g) of
the exemption, advice to Retirement Investors regarding ERISA plans
does not have to be subject to a written contract, but Advisers and
Financial Institutions must comply with the substantive standards
established in Section II(b)-(e) to avoid liability for a non-exempt
prohibited transaction. Likewise, in Section II(h), Level Fee
Fiduciaries do not have to provide a contract but must provide the
written fiduciary acknowledgment, satisfy the Impartial Conducts and
document the specific reasons for a recommendation of the level fee
arrangement.
The contract with Retirement Investors regarding IRAs and non-ERISA
plans must include the Financial Institution's acknowledgment of its
fiduciary status and that of its Advisers, as required by Section
II(b); the Financial Institution's agreement that it and its Advisers
will adhere to the Impartial Conduct Standards, including a Best
Interest standard, as required by Section II(c); the Financial
Institution's warranty that it has adopted and will comply with anti-
conflict policies and procedures reasonably and prudently designed to
ensure that Advisers adhere to the Impartial Conduct standards, as
required by Section II(d); and the Financial Institution's disclosure
of information about its services and applicable fees and compensation,
as required by Section II(e). Section II(f) generally provides that the
exemption is unavailable if the contract includes exculpatory
provisions or provisions waiving the rights and remedies of the plan,
IRA or Retirement Investor, including their right to participate in a
class action in court. The contract may, however, provide for binding
arbitration of individual claims, and may waive contractual rights to
punitive damages or rescission.
Of course, Advisers and Financial Institutions are not required to
enter into the contract contemplated by this exemption in order to
provide investment advice to these Retirement Investors. Advisers and
Financial Institutions may always provide advice and receive
compensation without the contract requirement if they work with IRAs
and non-ERISA plans under circumstances that do not give rise to a
prohibited transaction. The contract is required so that Advisers and
Financial Institutions can receive the types of compensation as a
result of their advice, such as commissions, that are otherwise
prohibited by ERISA and the Code due to the significant conflicts of
interest they create. To appropriately offset these conflicts, the
Department has determined that the enforceable right to adherence to
the Impartial Conduct Standards is a critical safeguard with respect to
investments in IRAs and non-ERISA plans.
The contract between the IRA or non-ERISA plan, and the Financial
Institution, forms the basis of the IRA's or non-ERISA plan's
enforcement rights. The Department intends that all the contractual
obligations imposed on the
[[Page 21021]]
Financial Institution (the Impartial Conduct Standards and warranties)
will be actionable by the IRAs and non-ERISA plans. Because these
standards are contractually imposed, an IRA or non-ERISA plan has a
contract claim if, for example, its Adviser recommends an investment
product that is not in the Best Interest of the IRA or other non-ERISA
plan.
In the Department's view, these contractual rights serve a critical
function for IRA owners and participants and beneficiaries of non-ERISA
plans. Unlike participants and beneficiaries in plans covered by Title
I of ERISA, IRA owners and participants and beneficiaries in non-ERISA
plans do not have an independent statutory right to bring suit against
fiduciaries for violation of the prohibited transaction rules. Nor can
the Secretary of Labor bring suit to enforce the prohibited
transactions rules on their behalf.\39\ Thus, for investors in IRAs and
plans not covered by Title I of ERISA, the contractual requirement
creates a mechanism for investors to enforce their rights and ensures
that they will have a remedy for misconduct. In this way, the exemption
creates a powerful incentive for Financial Institutions and Advisers
alike to oversee and adhere to basic fiduciary standards, without
requiring the imposition of unduly rigid and prescriptive rules and
conditions.
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\39\ An excise tax does apply in the case of a violation of the
prohibited transaction provisions of the Code, generally equal to
15% of the amount involved. The excise tax is generally self-
enforced; requiring parties not only to realize that they've engaged
in a prohibited transaction but also to report it and pay the tax.
Parties who have participated in a prohibited transaction for which
an exemption is not available must pay the excise tax and file Form
5330 with the Internal Revenue Service.
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Under Section II(g), however, the written contract requirement does
not apply to advice to Retirement Investors regarding investments in
plans that are covered by Title I of ERISA (``ERISA plans'') in light
of the existing statutory framework which provides a pre-existing
enforcement mechanism for these investors and the Department. Instead,
Advisers and Financial Institutions must simply satisfy the provisions
in Section II(b)-(e) as conditions of the exemption when transacting
with such Retirement Investors. Under the terms of the exemption, the
Financial Institution must provide an acknowledgment of its and its
Advisers fiduciary status, although it does not have to be part of a
contract, as required by Section II(b); the Financial Institution and
its Advisers must comply with the Impartial Conduct Standards, as
required by Section II(c); the Financial Institutions must establish
and comply with anti-conflict policies and procedures, as required by
Section II(d); and they must provide the disclosures required by
Section II(e).
If these conditions are not satisfied with respect to an ERISA plan
in a transaction in which an Adviser or Financial Institution received
prohibited compensation, the Adviser and Financial Institution would be
unable to rely on the exemption for relief from ERISA's prohibited
transactions restrictions. An Adviser's failure to comply with the
exemption would result in a non-exempt prohibited transaction under
ERISA section 406 and would likely constitute a fiduciary breach under
ERISA section 404. As a result, a plan, plan participant or beneficiary
would be able to sue under ERISA section 502(a)(2) or (3) to recover
any loss in value to the plan (including the loss in value to an
individual account), or to obtain disgorgement of any wrongful profits
or unjust enrichment. In addition, the Secretary of Labor can enforce
ERISA's prohibited transaction and fiduciary duty provisions with
respect to these ERISA plans, and an excise tax under the Code, as
described above, applies.
In this regard, under Section II(g)(5) of the exemption, the
Financial Institution and Adviser may not rely on the exemption if, in
any contract, instrument, or communication they purport to disclaim any
responsibility or liability for any responsibility, obligation, or duty
under Title I of ERISA to the extent the disclaimer would be prohibited
by ERISA section 410, waive or qualify the right of the Retirement
Investor to bring or participate in a class action or other
representative action in court in a dispute with the Adviser or
Financial Institution, or require arbitration or mediation of
individual claims in locations that are distant or that otherwise
unreasonably limit the ability of the Retirement Investors to assert
the claims safeguarded by this exemption. The exemption's
enforceability, and the potential for liability, are critical to
ensuring adherence to the exemption's stringent standards and
protections, notwithstanding the competing pull of the conflicts of
interest associated with the covered compensation structures.
The Department expects claims of Retirement Investors regarding
investments in ERISA plans to be brought under ERISA's enforcement
provisions, discussed above. In general, Section 410 of ERISA
invalidates instruments purporting to relieve a fiduciary from
responsibility or liability for any responsibility, obligation, or duty
under ERISA. Accordingly, provisions purporting to waive fiduciary
obligations under ERISA serve only to mislead Retirement Investors
about the scope of their rights. Additionally, the legislative intent
of ERISA was, in part, to provide for ``ready access to federal
courts.'' Accordingly, any recommended transaction covered by a
contract or other instrument that waives or qualifies the right of the
Retirement Investor to bring or participate in a class action or other
representative action in court will not be eligible for relief under
this exemption.
A number of comments were received on the contract requirement as
it was proposed. The comments, and the Department's responses, are
discussed below.
a. Contract Requirement Applicable to IRAs and Non-ERISA Plans
A number of commenters took the position that the consumer
protections afforded by the contract requirement are an essential
feature of the exemption, particularly in the IRA market. Commenters
indicated that enforceability is critical in the IRA market because of
IRA owners' lack of a statutory right to enforce prohibited
transactions provisions. Commenters said that, in order to achieve the
goal of providing meaningful new protections to Retirement Investors,
the exemption must provide a mechanism by which Advisers and Financial
Institutions can be held legally accountable for the retirement
recommendations they make. More than one commenter specifically stated
that due to the broad relief provided in the exemption, the contract
requirement is necessary for the Department to make the required
findings under ERISA section 408(a) and Code section 4975(c)(2) that
the exemption is in the interests of and protective of Retirement
Investors.
Many other commenters, however, raised significant objections to
the contract requirement. Commenters pointed to certain conditions of
the exemption that they found ambiguous or subjective and indicated
that these conditions could form the basis of class action lawsuits by
disappointed investors. Some commenters said the contract requirement
and associated litigation exposure would cause investment advice
providers to stop serving Retirement Investors or provide only fee-
based accounts that do not vary on the basis of the advice provided,
resulting in the loss of services to Retirement Investors with smaller
account balances. These commenters stated that investment advice
fiduciaries
[[Page 21022]]
would not risk the anticipated legal liability for Retirement
Investors, particularly with respect to small accounts.
In the final exemption, the Department retained the contract
requirement with respect to IRAs and non-ERISA plans. The contractual
commitment provides an administrable means of ensuring fiduciary
conduct, eliminating ambiguity about the fiduciary nature of the
relationship, and enforcing the exemption's conditions, thereby
assuring compliance. The existence of enforceable rights and remedies
gives Financial Institutions and Advisers a powerful incentive to
comply with the exemption's standards, implement effective anti-
conflict policies and procedures, and carefully police conflicts of
interest. The enforceable contract gives clarity to the fiduciary
nature of the undertaking, and ensures that Advisers and Financial
Institutions do not subordinate the interests of the Retirement
Investor to their own competing financial interests. The contract
effectively aligns the interests of Retirement Investor, Advisers, and
the Financial Institution, and gives the Retirement Investor the means
to redress injury when violations occur.
Without a contract, the possible imposition of an excise tax
provides an additional, but inadequate, incentive to ensure compliance
with the exemption's standards-based approach. This is particularly
true because imposition of the excise tax critically depends on
fiduciaries' self-reporting of violations, rather than independent
investigations and litigation by the IRS. In contrast, contract
enforcement does not rely on conflicted fiduciaries' assessment of
their own adherence to fiduciary norms or require the creation and
expansion of a government enforcement apparatus. The contract provides
an administrable way of ensuring adherence to fiduciary standards,
broadly applicable to an enormous range of investments and advice
relationships.
The enforceability of the exemption's provisions enables the
Department to grant exemptive relief based upon broad protective
standards, applicable to a wide range of investments and compensation
structures, rather than rely exclusively upon highly prescriptive
conditions applicable only to tightly-specified investments and
compensation structures. In the context of this exemption, the risk of
litigation and enforcement serves many of the same functions that it
has for hundreds of years under the law of trust and agency. It gives
fiduciaries a powerful incentive to adhere to broad, flexible, and
protective standards applicable to an enormous range of transactions by
imposing liability and providing a remedy when fiduciaries fail to
comply with those standards.
In addition, a number of features of this final exemption,
discussed more fully below, should temper concerns about the risk of
excessive litigation. In particular, the exemption permits Advisers and
Financial Institutions to require mandatory arbitration of individual
claims, so that claims that do not involve systemic abuse or entire
classes of participants can be resolved outside of court. Similarly,
the exemption permits waivers of the right to obtain punitive damages
or rescission based on violation of the contract. In the Department's
view, make-whole compensatory relief is sufficient to incentivize
compliance and redress injury caused by fiduciary misconduct.
The Department has also clarified a number of the exemption's
conditions and simplified the disclosure and compliance obligations to
facilitate adherence to the exemption's terms. The core principles of
the exemption are well-established under trust law, ERISA and the Code,
and have a long history of interpretations in court. Moreover, the
Impartial Conduct standards are measured based on the circumstances
existing at the time of the recommendation, not based on the ultimate
performance of the investment with the benefit of hindsight. It is well
settled as a legal matter that fiduciary advisers are not guarantors of
the success of investments under ERISA or the Code, and this exemption
does nothing to change that fact. Finally, the Department added several
provisions enabling Advisers and Financial Institutions to correct good
faith errors in disclosure, without facing loss of the exemption. These
factors should ease commenters' concerns about loss of services to
Retirement Investors with smaller account balances.\40\
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\40\ See Regulatory Impact Analysis.
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One commenter asked the Department to address the interaction of
the contract cause of action and state securities laws. In this
connection, the Department confirms that it is not its intent to
preempt or supersede state securities law and enforcement, and that
state securities laws remain subject to the ERISA section 514(b)(2)(A)
savings clause.
b. No Contract Requirement Applicable to ERISA Plans
Under Section II(g) of the exemption, there is no contract
requirement for transactions involving ERISA plans, but Financial
Institutions and their Advisers must satisfy the conditions of Section
II(b)-(e), including the conditions requiring written fiduciary
acknowledgment, adherence to Impartial Conduct Standards, anti-conflict
policies and procedures, and disclosures. Likewise, in Section II(h),
Level Fee Fiduciaries do not have to enter into a contract but must
provide the written fiduciary acknowledgment, adhere to the Impartial
Conduct Standards and document the specific reason or reasons for a
recommendation to enter into the level fee arrangement.
The Department eliminated the proposed contract requirement with
respect to ERISA plans in this final exemption in response to public
comment on this issue. A number of commenters indicated that the
contract requirement was unnecessary for ERISA plans due to the
statutory framework that already provides enforcement rights to such
plans, their participants and beneficiaries, and the Secretary of
Labor. Some commenters additionally questioned the extent to which the
contract provided additional rights or remedies, and whether state-law
contract claims would be pre-empted under ERISA's pre-emption
provisions.
In the Department's view, the requirement that a Financial
Institution provide written acknowledgement of fiduciary status for
itself and its Advisers provides protections in the ERISA plan context
that are comparable to the contract requirement for IRAs and non-ERISA
plans. As a result of the written acknowledgment of fiduciary status,
the fiduciary nature of the relationship will be clear to the parties
both at the time of the investment transaction, and in the event of
subsequent disputes over the conduct of the Advisers or Financial
Institutions. There will be far less cause for the parties to litigate
disputes over fiduciary status, as opposed to the substance of the
fiduciaries' recommendations and conduct.
2. Contract Operational Issues--Section II(a)
Section II(a) specifies the mechanics of entering into the contract
and provides that the contract must be enforceable against the
Financial Institution. In addition, the section provides that the
contract may be a master contract covering multiple recommendations,
and that it may cover advice rendered prior to execution of the
contract as long as the contract is entered into prior to or at the
same time as the execution of the recommended transaction.
[[Page 21023]]
Section II(a)(1) further describes the methods for obtaining
customer assent to the contract. For ``new contracts,'' the Retirement
Investor's assent must be demonstrated through a written or electronic
signature. The exemption provides flexibility by permitting the
contract terms to be set forth in a standalone document or in an
investment advisory agreement, investment program agreement, account
opening agreement, insurance or annuity contract or application, or
similar document, or amendment thereto.
For Retirement Investors with ``existing contracts,'' the exemption
permits assent to be evidenced either by affirmative consent, as
described above, or by a negative consent procedure. Under the negative
consent procedure, the Financial Institution delivers a proposed
contract amendment along with the disclosure required in Section II(e)
to the Retirement Investor prior to January 1, 2018, and if the
Retirement Investor does not terminate the amended contract within 30
days, the amended contract is effective. If the Retirement Investor
does terminate the contract within that 30-day period, this exemption
will provide relief for 14 days after the date on which the termination
is received by the Financial Institution. In that event, the Retirement
Investor's account generally should be able to fall within the
provisions of Section VII for pre-existing transactions. An existing
contract is defined in the exemption as ``an investment advisory
agreement, investment program agreement, account opening agreement,
insurance contract, annuity contract, or similar agreement or contract
that was executed before the Applicability Date and remains in
effect.'' If the Financial Institution elects to use the negative
consent procedure, it may deliver the proposed amendment by mail or
electronically, but it may not impose any new contractual obligations,
restrictions, or liabilities on the Retirement Investor by negative
consent.
The final exemption additionally provides a method of complying
with the exemption in the event that the Retirement Investor does not
open an account with the Adviser but nevertheless acts on the advice
through other channels. In some circumstances, Retirement Investors
could receive fee-generating advice, fail to open an account with the
particular Adviser or Financial Institution, and nevertheless follow
the advice in a way that generates additional compensation for the
Financial Institution or an Affiliate or Related Entity. Commenters
expressed concern that this could result in a prohibited transaction
for which there was no relief because the Financial Institution would
have been unable to execute the required contract with the Retirement
Investor. Generally, commenters raised the issue in the context of
mutual funds. For example, an Adviser affiliated with the mutual fund
could recommend investment in that fund, which the Retirement Investor
followed by executing the transaction through a separate institution
unaffiliated with the mutual fund.
To address this concern, Section II(a)(1)(iii) provides conditions
under which the exemption will continue to be available notwithstanding
the Financial Institution's failure to affirmatively enter into a
contract with a Retirement Investor who does not have an existing
contract. These conditions are designed to ensure that the Financial
Institution does not use Section II(a)(1)(iii) to evade the contract
requirement. First, the individual Adviser making the recommendation
may not receive compensation, directly or indirectly, as a result of
the recommendation or the Retirement Investor's investment transaction.
This means that the individual Adviser may not receive transaction-
specific compensation, such as a commission or 12b-1 fee, that is tied
to the particular Retirement Investor's investment. Second, the
Financial Institution's policies and procedures must prohibit the
Financial Institution and its Affiliates and Related Entities from
providing compensation to the Adviser, in this circumstance, in lieu of
compensation that is reasonably attributable to the Retirement
Investor's investment transaction, including, but not limited to
bonuses or prizes or other incentives, and the Financial Institution
has to reasonably monitor such policies and procedures. Thus, the
Financial Institution may not compensate Advisers, directly or
indirectly, for providing advice as part of a scheme to avoid the
contract requirement with respect to Retirement Investors. Third, the
Adviser and Financial Institution must comply with the Impartial
Conduct Standards set forth in Section II(c), the policies and
procedures requirements of Section II(d) (except for the requirement of
a warranty with respect to those policies procedures), the web
disclosure requirements of Section III(b) and, as applicable, the
conditions of Section IV(b)(3)-(6) (Conditions for Advisers and
Financial Institution that restrict recommendations, in whole or part,
to Proprietary Products or to investments that generate Third Party
Payments) with respect to the recommendation. Finally, the Financial
Institution's failure to enter into the contract must not be part of an
effort, attempt, agreement, arrangement or understanding designed by
the Adviser or the Financial Institution to avoid compliance with the
exemption or enforcement of its conditions, including the contractual
conditions set forth in subsections (i) and (ii). This provision of the
exemption is intended for the narrow circumstances in which an Adviser
and Financial Institution provide advice that comports with the
conditions of the exemption but, due to circumstances generally outside
of their control, the Financial Institution did not have the
opportunity to enter into a contract with the Retirement Investor.
Finally, Section II(a)(2) of the exemption requires the Financial
Institution to provide an electronic copy of the Retirement Investor's
contract on its Web site that is accessible by the Retirement Investor.
The condition ensures that the Retirement Investor has ready access to
the terms of the contract, and reinforces the exemption's goals of
clearly establishing the fiduciary status of the Adviser and Financial
Institution and ensuring their adherence to the exemption's conditions.
Comments on specific contract operational issues are discussed
below.
a. Contract Timing
As proposed, Section II(a) required that, ``[p]rior to recommending
that the plan, participant or beneficiary account, or IRA purchase,
sell or hold the Asset, the Adviser and Financial Institution enter
into a written contract with the Retirement Investor that incorporates
the terms required by Section II(b)-(e).'' A large number of commenters
responded to various aspects of this proposed requirement.
Many commenters objected to the timing of the contract requirement.
They said that requiring execution of a contract ``prior to'' any
recommendations would be contrary to existing industry practices. The
commenters indicated that preliminary discussions may evolve into
recommendations before a Retirement Investor has decided to work with a
particular Adviser and Financial Institution. Requiring a contract
upfront could chill such preliminary discussions, unduly complicate the
relationship between the Adviser and the Retirement Investor, and
interfere with an investor's ability to shop around. Many commenters
suggested that it would be better to time the requirement so that the
contract would
[[Page 21024]]
have to be entered into prior to the execution of the actual investment
transaction, or even later, rather than before any advice was rendered.
While some other commenters supported the proposed timing, noting the
benefit of allowing Retirement Investors the chance to carefully review
the contract prior to engaging in transactions, several commenters that
strongly supported the contract requirement agreed that the timing
could be adjusted without loss of protection to the Retirement
Investor.
In the Department's view, the precise timing of the contract is not
critical to the exemption, provided that the parties enter into a
contract covering the advice (subject to the narrow exception above).
The Department did not intend to chill developing advice relationships
or limit investors' ability to shop around. Therefore, the Department
adjusted the exemption on this point by deleting the proposed
requirement that the contract be entered into prior to the advice
recommendation. Instead, the exemption generally provides that the
advice must be subject to an enforceable written contract entered into
prior to or at the same time as the execution of the recommended
transaction. However, in order for the exemption to be available to
recommendations made prior to the contract's formation, the contract's
terms must cover the prior recommendations.
A few commenters suggested that the Department require the contract
to be a separate document, not combined with any other document.
However, other commenters requested that the Department allow Financial
Institutions to incorporate the contract terms into other account
documents. While the Department believes the contract is critical to
IRA and non-ERISA plan investors, the Department recognizes the need
for flexibility in its implementation. Therefore, the exemption
contemplates that the contract may be incorporated into other documents
to the extent desired by the Financial Institution. Additionally, as
requested by commenters, the Department confirms that the contract
requirement may be satisfied through a master contract covering
multiple recommendations and does not require execution prior to each
additional recommendation.
b. Contract Parties
A number of commenters also questioned the necessity of the
proposed requirement that Advisers be parties to the contract. These
commenters indicated that the proposed requirement posed significant
logistical challenges. For example, commenters stated that Advisers
often work in teams and it would be difficult to obtain signatures from
all such Advisers. Similarly, if call center representatives made
recommendations, it could be hard to cover them under a contract. Over
the course of a Retirement Investor's relationship with a Financial
Institution, he or she could receive advice from a number of persons
concerning a wide variety of transactions. Requiring that each such
person execute a contract could prove difficult and unwieldy.
Based upon these objections, the Department has deleted the
requirement that individual Advisers be parties to the contract. The
Financial Institution must be a party to the contract and assume
responsibility for advice provided by any of its Advisers. Such
Advisers include call center representatives who provide investment
advice within the meaning of the Regulation.
Several commenters asked about the circumstance in which two
entities could satisfy the definition of Financial Institution with
respect to the same Adviser and same transaction. This largely came up
in the context of an insurance product that is offered by an insurance
company but sold by a representative of a broker-dealer. Commenters
asked whether multiple Financial Institutions would be required to be
parties to the contract.
In response, the Department notes that there must always be a
Financial Institution, as defined in the exemption, that is a party to
the contract. That Financial Institution must take responsibility for
satisfying the exemption's conditions, including the obligation to have
policies and procedures reasonably and prudently designed to ensure
that individual Advisers adhere to the Impartial Conduct Standards, and
the obligation to insulate the Adviser from incentives to violate the
Best Interest Standard.\41\ If these conditions are not satisfied, the
Adviser and Financial Institution are liable for a non-exempt
prohibited transaction.
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\41\ See Section II(c)(1), setting forth the Best Interest
standard, which specifically indicates that the interests of
Affiliates, Related Entities and other parties may not be considered
by the Adviser in making a recommendation.
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Some commenters suggested that the Department provide additional
flexibility and allow the individual Adviser to be obligated under the
contract instead of the Financial Institution. The Department has not
adopted that suggestion. To ensure operation of the exemption as
intended, the Financial Institution should be a party to the contract.
The supervisory responsibility and liability of the Financial
Institution is important to the exemption's protections. In particular,
the exemption contemplates that the Financial Institution will adopt
and monitor stringent anti-conflict policies and procedures; avoid
financial incentives that undermine Advisers' compliance with the
Impartial Conduct standards; and take appropriate measures to ensure
that it and its representatives adhere to the exemption's conditions.
The contract provides both a mechanism for imposing these obligations
on the Financial Institution and creates a powerful incentive for the
Financial Institution to take the obligations seriously in the
management and supervision of investment recommendations.
c. Contract Signatures
Section II(a) of the exemption provides that the contract must be
enforceable against the Financial Institution. As long as that is the
case, the Financial Institution is not required to sign the contract.
Section II(a) of the exemption further describes the methods through
which customer assent may be achieved, and reflects commenters'
requests for greater specificity on this point.
With respect to new contracts, a few commenters asked the
Department to confirm that electronic execution by the Retirement
Investor is sufficient. Another commenter asked about telephone assent.
In the final exemption, the Department specifically permits electronic
execution as a form of customer assent. The Department has not
permitted telephone assent, however, because of the potential issues of
proof regarding the existence and terms of a contract executed in that
manner. It is the Department's goal that Retirement Investors obtain
clear evidence of the contract terms and their applicability to the
Retirement Investor's own account or contract. The exemption will best
serve its purpose if the contractual commitments are clear to all the
parties, and if ancillary disputes about the fiduciary nature of the
advice relationship are avoided. For this same reason, the exemption
requires that a copy of the applicable contract be maintained on a Web
site accessible to the investor.
Commenters also asked for the ability to use a negative consent
procedure with respect to existing customers to avoid the expense and
difficulty associated with obtaining a large number of client
signatures. The Department adjusted the exemption on
[[Page 21025]]
this point to permit amendment of existing contracts by negative
consent. The negative consent procedure involves delivery of an amended
contract to the Retirement Investor with clear notice that the
Retirement Investor's failure to terminate the relationship within 30
days constitutes assent. As this approach will still result in the
Retirement Investor receiving clear evidence of the contract terms and
their applicability to the Retirement Investor's own account or
contract, the Department concurred with commenters on its use.
Treating the Retirement Investor's silence as consent after 30 days
provides the Retirement Investor a reasonable opportunity to review the
new terms and to reject them. The Financial Institution may not use the
negative consent procedure, however, to impose new obligations,
restrictions or liabilities on the Retirement Investor in connection
with the Best Interest Contract. Any attempt by the Financial
Institution to impose additional obligations, restrictions, or
liabilities on the Retirement Investor must receive affirmative consent
from the Retirement Investor, and cannot violate Section II(f).
A number of commenters also asked that the exemption authorize
Financial Institutions to satisfy the contract requirement for all
Retirement Investors--including new customers after the Applicability
Date--through unilateral contracts or implied or negative consent. Some
commenters suggested that the Department should not require a contract
at all, but only a ``customer bill of rights'' or similar disclosure,
without any additional signature requirement. Some commenters suggested
that the requirement of obtaining signatures could delay execution of
time sensitive investment strategies.
Although the final exemption accommodates a wide variety of
concerns regarding contract operational issues, the Department did not
adopt the alternative approaches suggested by some commenters, such as
merely requiring delivery of a customer bill of rights, broader
reliance on a unilateral contract approach, or increased reliance on
negative consent. The Department intends that Retirement Investors that
are new customers of the Financial Institution should enter into an
enforceable contract under Section II(a)(1)(i). Consistent with the
Department's goal that Retirement Investors obtain clear evidence of
the contract terms and their applicability to the Retirement Investor's
own account or contract, the exemption limits the negative consent
option to existing customers as a form of transitional relief, so that
Financial Institutions can avoid the burdens associated with obtaining
signatures from a large number of already-existing customers.
Apart from this transitional relief, the Department does not
believe it is appropriate to dispense with the clarity, enforceability
and legal protections associated with an affirmative contract.
Contracts are commonplace in a wide range of commercial transactions
occurring in person, on the web, and elsewhere. The Department has
facilitated the process by providing that Financial Institutions can
incorporate the contract terms into commonplace account opening or
similar documents that they already use; by permitting electronic
signatures; and by revising the timing rules, so that the contract's
execution can follow the provision of advice, as long as it precedes or
occurs at the same time as the execution of the recommended
transaction.
3. Fiduciary Acknowledgment--Section II(b)
Section II(b) of the exemption requires the Financial Institution
to affirmatively state in writing that it and its Adviser(s) act as
fiduciaries under ERISA or the Code, or both, with respect to the
investment advice subject to the contract or, in the case of an ERISA
plan, with respect to any investment advice regarding the plan or
beneficiary or participant account.
With respect to IRAs and non-ERISA plans, if this acknowledgment of
fiduciary status does not appear in a contract with a Retirement
Investor, the exemption is not satisfied with respect to transactions
involving that Retirement Investor. With respect to ERISA plans, this
acknowledgment must be provided to the Retirement Investor prior to or
at the same time as the execution of the recommended transaction, but
not as part of a contract. This fiduciary acknowledgment is critical to
ensuring clarity and certainty with respect to the fiduciary status of
both the Adviser and Financial Institution under ERISA and the Code
with respect to that advice.
The fiduciary acknowledgment provision received significant support
from some commenters. Commenters described it as a necessary protection
and noted that it would clarify the obligations of the Adviser. One
commenter said that facilitating proof of fiduciary status should
enhance investors' ability to obtain a remedy for Adviser misconduct in
arbitration by eliminating ancillary litigation over fiduciary status.
Rather than litigate over fiduciary status, the fiduciary
acknowledgment would help ensure that such proceedings focused on the
Advisers' compliance with fundamental fiduciary norms.
Some commenters opposed the fiduciary acknowledgment requirement in
the proposal, as applicable to Financial Institution, on the basis that
it could force Financial Institutions to take on fiduciary
responsibilities, even if they would not otherwise be functional
fiduciaries under ERISA or the Code. The commenters pointed out that,
under the proposed Regulation, the acknowledgment of fiduciary status
would have been a factor in imposing fiduciary status on a party.
Therefore, Financial Institutions could become fiduciaries by virtue of
the fiduciary acknowledgment. To address these concerns, a few
commenters suggested language under which a Financial Institution would
only be considered a fiduciary to the extent that it is ``an affiliate
of the Adviser within the meaning of 29 CFR 2510.3-21(f)(7) that, with
the Adviser, functions as a fiduciary.''
The Department has not adjusted the exemption as these commenters
requested. The exemption requires as a condition of relief that a
sponsoring Financial Institution accept fiduciary responsibility for
the recommendations of its Adviser(s). The Financial Institution's role
in supervising individual Advisers and overseeing their adherence to
the Impartial Conduct Standards is a key safeguard of the exemption.
The exemption's success critically depends on the Financial
Institution's careful implementation of anti-conflict policies and
procedures, avoidance of Adviser incentives to violate the Impartial
Conduct Standards, and broad oversight of Advisers. Accordingly,
Financial Institutions that wish to receive compensation streams that
would otherwise be prohibited under ERISA and the Code must agree to
take on these responsibilities as a condition of relief under the
exemption. To the extent Financial Institutions do not wish to take on
this role with its associated responsibilities and liabilities, they
may structure their operations to avoid prohibited transactions and the
resultant need of the exemption.
A commenter requested clarification of the circumstances in which a
credit union shares employees with a broker-dealer. The commenter
requested confirmation that the credit union would not have to comply
with the exemption merely because it shared employees. Consistent with
the approach set forth above, the
[[Page 21026]]
Department responds that the credit union would not have to act as the
Financial Institution under the exemption but the broker-dealer would.
Other commenters expressed the view that the fiduciary
acknowledgement would potentially require broker-dealers to satisfy the
requirements of the Investment Advisers Act of 1940. As described by
commenters, the Act does not require broker-dealers to register as
investment advisers if they provide advice that is solely incidental to
their brokerage services. Commenters expressed concern that
acknowledging fiduciary status and providing advice in satisfaction of
the Impartial Conduct Standards could call into question whether the
advice provided was solely incidental.
The Department does not, however, require the Adviser or Financial
Institution to acknowledge fiduciary status under the securities laws,
but rather under ERISA or the Code or both. Neither does the Department
require Advisers to agree to provide advice on an ongoing, rather than
transactional, basis. An Adviser's status as an ERISA fiduciary is not
dispositive of its obligations under the securities laws, and
compliance with the exemption does not trigger an automatic loss of the
broker-dealer exception under the separate requirements of those laws.
A broker-dealer who provides investment advice under the Regulation is
an ERISA fiduciary; acknowledgment of ERISA fiduciary status would not,
by itself, cause the Adviser to lose the broker-dealer exception. Under
the Regulation and this exemption, the primary import of fiduciary
status is that the broker has to act in the customer's best interest
when making recommendations; receive no more than reasonable
compensation; and refrain from making misleading statements. Certainly,
nothing in the securities laws precludes brokers from adhering to these
basic standards, or forbids them from working for firms that implement
appropriate policies and procedures to ensure that these standards are
met.
The Department changed the fiduciary acknowledgment provision in
response to several comments requesting revisions to clarify the
required extent of the fiduciary acknowledgment. Accordingly, the
Department has clarified that the acknowledgment can be limited to
investment recommendations subject to the contract or, in the case of
an ERISA plan, any investment recommendations regarding the plan or
beneficiary or participant account. As discussed in more detail below,
the exemption (including the required fiduciary acknowledgment) does
not in and of itself, impose an ongoing duty to monitor on the Adviser
or Financial Institution. However, there may be some investments which
cannot be prudently recommended to the individual Retirement Investor,
in the first place, without a mechanism in place for the ongoing
monitoring of the investment.
4. Impartial Conduct Standards--Section II(c)
Section II(c) of the exemption requires that the Adviser and
Financial Institution comply with fundamental Impartial Conduct
Standards. Generally stated, the Impartial Conduct Standards require
that Advisers and Financial Institutions provide investment advice in
the Retirement Investor's Best Interest, not recommend transactions
that they anticipate will result in more than reasonable compensation,
and not make misleading statements to the Retirement Investor about
recommended transactions. As defined in the exemption, a Financial
Institution and Adviser act in the Best Interest of a Retirement
Investor when they provide investment advice ``that reflects the care,
skill, prudence, and diligence under the circumstances then prevailing
that a prudent person acting in a like capacity and familiar with such
matters would use in the conduct of an enterprise of a like character
and with like aims, based on the investment objectives, risk tolerance,
financial circumstances, and needs of the Retirement Investor, without
regard to the financial or other interests of the Adviser, Financial
Institution or any Affiliate, Related Entity, or other party.''
The Impartial Conduct Standards represent fundamental obligations
of fair dealing and fiduciary conduct. The concepts of prudence,
undivided loyalty and reasonable compensation are all deeply rooted in
ERISA and the common law of agency and trusts.\42\ These longstanding
concepts of law and equity were developed in significant part to deal
with the issues that arise when agents and persons in a position of
trust have conflicting loyalties, and accordingly, are well-suited to
the problems posed by conflicted investment advice. The phrase
``without regard to'' is a concise expression of ERISA's duty of
loyalty, as expressed in section 404(a)(1)(A) of ERISA and applied in
the context of advice. It is consistent with the formulation stated in
the common law, and it is consistent with the language used by Congress
in Section 913(g)(1) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the Dodd-Frank Act),\43\ and cited in the Staff of U.S.
Securities and Exchange Commission ``Study on Investment Advisers and
Broker-Dealers, As Required by Section 913 of the Dodd-Frank Wall
Street Reform and Consumer Protection Act'' (Jan. 2011) \44\ (SEC staff
Dodd-Frank Study). The Department notes, however, that the standard is
not intended to outlaw Financial Institutions' provision of advice from
investment menus that are restricted on the basis of Proprietary
Products or generation of Third Party Payments; accordingly, in Section
IV, the Department specifically operationalizes how such Financial
Institutions can comply with the standard in those circumstances.
Finally, the ``reasonable compensation'' obligation is already required
under ERISA section 408(b)(2) and Code section 4975(d)(2)of service
providers, including financial services providers, whether fiduciaries
or not.\45\
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\42\ See generally ERISA sections 404(a), 408(b)(2); Restatement
(Third) of Trusts section 78 (2007), and Restatement (Third) of
Agency section 8.01.
\43\ Section 913(g) governs ``Standard of Conduct'' and
subsection (1) provides that ``The Commission may promulgate rules
to provide that the standard of conduct for all brokers, dealers,
and investment advisers, when providing personalized investment
advice about securities to retail customers (and such other
customers as the Commission may by rule provide), shall be to act in
the best interest of the customer without regard to the financial or
other interest of the broker, dealer, or investment adviser
providing the advice.''
\44\ Available at https://www.sec.gov/news/studies/2011/913studyfinal.pdf.
\45\ ERISA section 408(b)(2) and Code section 4975(d)(2) exempt
certain arrangements between ERISA plans, IRAs, and non-ERISA plans,
and service providers, that otherwise would be prohibited
transactions under ERISA section 406 and Code section 4975.
Specifically, ERISA section 408(b)(2) and Code section 4975(d)(2)
provide relief from the prohibited transaction rules for service
contracts or arrangements if the contract or arrangement is
reasonable, the services are necessary for the establishment or
operation of the plan or IRA, and no more than reasonable
compensation is paid for the services.
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Under ERISA section 408(a) and Code section 4975(c)(2), the
Department cannot grant an exemption unless it first finds that the
exemption is administratively feasible, in the interests of plans and
their participants and beneficiaries and IRA owners, and protective of
the rights of participants and beneficiaries of plans and IRA owners.
An exemption permitting transactions that violate the Impartial Conduct
Standards would fail these standards.
The Impartial Conduct Standards are conditions of the exemption for
the provision of advice with respect to all Retirement Investors. For
advice to Retirement Investors on investments in IRAs and non-ERISA
plans, the Impartial Conduct Standards must also
[[Page 21027]]
be included as contractual commitments on the part of the Financial
Institution and its Advisers. As noted above, there is no contract
requirement for advice to Retirement Investors with respect to
investments in ERISA plans or for Level Fee Fiduciaries.
Comments on each of the Impartial Conduct Standards are discussed
below. Additionally, in response to commenters' assertion that the
exemption is not administratively feasible due to uncertainty regarding
some terms and requests for additional clarity, the Department has
clarified some key terms in the text and provides additional
interpretative guidance in the preamble discussion that follows.
Finally, the Department discusses comments on whether the Impartial
Conduct Standards should serve as both exemption conditions for all
Retirement Investors as well as contractual representations with
respect to IRAs and non-ERISA plans.
a. Best Interest Standard
Under Section II(c)(1), the Financial Institution must state that
it and its Advisers will comply with a Best Interest standard when
providing investment advice to the Retirement Investor, and, in fact,
adhere to the standard. Advice in the Retirement Investor's Best
Interest means advice that, at the time of the recommendation reflects:
the care, skill, prudence, and diligence under the circumstances
then prevailing that a prudent person acting in a like capacity and
familiar with such matters would use in the conduct of an enterprise
of a like character and with like aims, based on the investment
objectives, risk tolerance, financial circumstances, and needs of
the Retirement Investor, without regard to the financial or other
interests of the Adviser, Financial Institution or any Affiliate,
Related Entity, or other party.
The Best Interest standard set forth in the final exemption is
based on longstanding concepts derived from ERISA and the law of
trusts. It is meant to express the concept, set forth in ERISA section
404, that a fiduciary is required to act ``solely in the interest of
the participants . . . with the care, skill, prudence, and diligence
under the circumstances then prevailing that a prudent man acting in a
like capacity and familiar with such matters would use in the conduct
of an enterprise of a like character and with like aims.'' Similarly,
both ERISA section 404(a)(1)(A) and the trust-law duty of loyalty
require fiduciaries to put the interests of trust beneficiaries first,
without regard to the fiduciaries' own self-interest. Under this
standard, for example, an Adviser, in choosing between two investments,
could not select an investment because it is better for the Adviser's
or Financial Institution's bottom line, even though it is a worse
choice for the Retirement Investor.\46\
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\46\ The standard does not prevent Advisers and Financial
Institutions from restricting their recommended investments to
Proprietary Products or products that generate Third Party Payments.
Section IV of the exemption specifically addresses how the standard
may be satisfied under such circumstances.
---------------------------------------------------------------------------
A wide range of commenters indicated support for a broad ``best
interest'' standard. Some comments indicated that the best interest
standard is consistent with the way advisers provide investment advice
to clients today. However, a number of these commenters expressed
misgivings as to the definition used in the proposed exemption, in
particular, the ``without regard to'' formulation. The commenters
indicated uncertainty as to the meaning of the phrase, including:
Whether it permitted the Adviser and Financial Institution to be paid
and whether it permitted investment advice on Proprietary Products.
Other commenters asked the Department to use a different definition
of Best Interest, or simply use the exact language from ERISA's section
404 duty of loyalty. Others suggested definitional approaches that
would require that the Adviser and Financial Institution ``not
subordinate'' their customers' interests to their own interests, or
that the Adviser and Financial Institution ``put their customers'
interests ahead of their own interests,'' or similar constructs.\47\
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\47\ The alternative approaches are discussed in a separate
section of the preamble, below.
---------------------------------------------------------------------------
FINRA suggested that the federal securities laws should form the
foundation of the Best Interest standard. Specifically, FINRA urged
that the Best Interest definition in the exemption incorporate the
``suitability'' standard applicable to investment advisers and broker
dealers under federal securities laws. According to FINRA, this would
facilitate customer enforcement of the Best Interest standard by
providing adjudicators with a well-established basis on which to find a
violation.
Other commenters found the Best Interest Standard to be an
appropriate statement of the obligations of a fiduciary investment
advice provider and believed it would provide concrete protections
against conflicted recommendations. These commenters asked the
Department to maintain the Best Interest definition as proposed. One
commenter wrote that the term ``best interest'' is commonly used in
connection with a fiduciary's duty of loyalty and cautioned the
Department against creating an exemption that failed to include the
duty of loyalty. Others urged the Department to avoid definitional
changes that would reduce current protections to Retirement Investors.
Some commenters also noted that the ``without regard to'' language is
consistent with the recommended standard in the SEC staff Dodd-Frank
Study, and suggested that it had the added benefit of potentially
harmonizing with a future securities law standard for broker-dealers.
The final exemption retains the Best Interest definition as
proposed, with minor adjustments. The first prong of the standard was
revised to more closely track the statutory language of ERISA section
404(a), and, is consistent with the Department's intent to hold
investment advice fiduciaries to a prudent investment professional
standard. Accordingly, the definition of Best Interest now requires
advice that ``reflects the care, skill, prudence, and diligence under
the circumstances then prevailing that a prudent person acting in a
like capacity and familiar with such matters would use in the conduct
of an enterprise of a like character and with like aims, based on the
investment objectives, risk tolerance, financial circumstances, and
needs of the Retirement Investor . . .'' The exemption adopts the
second prong of the proposed definition, ``without regard to the
financial or other interests of the Adviser, Financial Institution or
any Affiliate, Related Entity, or other party,'' without change. The
Department continues to believe that the ``without regard to'' language
sets forth the appropriate, protective standard under which a fiduciary
investment adviser should act. Although the exemption provides broad
relief for Advisers and Financial Institutions to receive commissions
and other payments based on their advice, the standard ensures that the
advice will not be tainted by self-interest. Many of the alternative
approaches suggested by commenters pose their own ambiguities and
interpretive challenges, and lower standards run the risk of
undermining this regulatory initiative's goal of reducing the impact of
conflicts of interest on Retirement Investors.
The Department has not specifically incorporated the suitability
obligation as an element of the Best Interest standard, as suggested by
FINRA but many aspects of suitability are also elements of the Best
Interest standard. An investment recommendation that is not suitable
under the securities laws would not meet the Best Interest standard.
[[Page 21028]]
Under FINRA's rule 2111(a) on suitability, broker-dealers ``must have a
reasonable basis to believe that a recommended transaction or
investment strategy involving a security or securities is suitable for
the customer.'' The text of rule 2111(a), however, does not do any of
the following: Reference a best interest standard, clearly require
brokers to put their client's interests ahead of their own, expressly
prohibit the selection of the least suitable (but more remunerative) of
available investments, or require them to take the kind of measures to
avoid or mitigate conflicts of interests that are required as
conditions of this exemption.
The Department recognizes that FINRA issued guidance on rule 2111
in which it explains that ``in interpreting the suitability rule,
numerous cases explicitly state that a broker's recommendations must be
consistent with his customers' best interests,'' and provided examples
of conduct that would be prohibited under this standard, including
conduct that this exemption would not allow.\48\ The guidance goes on
to state that ``[t]he suitability requirement that a broker make only
those recommendations that are consistent with the customer's best
interests prohibits a broker from placing his or her interests ahead of
the customer's interests.'' The Department, however is reluctant to
adopt as an express standard such guidance, which has not been
formalized as a clear rule and that may be subject to change.
Additionally, FINRA's suitability rule may be subject to
interpretations which could conflict with interpretations by the
Department, and the cases cited in the FINRA guidance, as read by the
Department, involved egregious fact patterns that one would have
thought violated the suitability standard, even without reference to
the customer's ``best interest.'' The scope of the guidance also is
different than the scope of this exemption. For example, insurance
providers who decide to accept conflicted compensation will need to
comply with the terms of this exemption, but, in many instances, may
not be subject to FINRA's guidance.
---------------------------------------------------------------------------
\48\ FINRA Regulatory Notice 12-25, p. 3 (2012).
---------------------------------------------------------------------------
Moreover, suitability under SEC practice differs somewhat from the
FINRA approach. According to the SEC staff Dodd-Frank Study, the SEC
requirements are based on the anti-fraud provisions of the Securities
Act Section 17(a), the Exchange Act Section 10(b) and Rule 10b-5
thereunder.\49\ As a general matter, SEC Rule 10b-5 prohibits any
person, directly or indirectly, from: (a) Employing any device, scheme,
or artifice to defraud; (b) making untrue statements of material fact
or omitting to state a material fact necessary in order to make the
statements made, in the light of the circumstances, not misleading; or
(c) engaging in any act or practice or course of business which
operates or that would operate as a fraud or deceit upon any person in
connection with the purchase or sale of any security. FINRA does not
require scienter, but the weight of authority holds that violations of
the Self-Regulatory Organization (SRO) rules, standing alone, do not
give right to a private cause of action. Courts, however, allow private
claims for violations of SEC Rule 10b-5 for fraud claims, including,
among others unsuitable recommendations. The private plaintiff must
establish that the broker's unsuitable recommendation involved a
misrepresentation (or material omission) made with scienter.
Accordingly, after review of the issue, the Department has decided not
to accept the comment. The Department has concluded that its
articulation of a clear loyalty standard within the exemption, rather
than by reference to the FINRA guidance, will provide clarity and
certainty to investors and better protect their interests.
---------------------------------------------------------------------------
\49\ SEC staff Dodd-Frank Study at 61.
---------------------------------------------------------------------------
The Best Interest standard, as set forth in the exemption, is
intended to effectively incorporate the objective standards of care and
undivided loyalty that have been applied under ERISA for more than
forty years. Under these objective standards, the Adviser must adhere
to a professional standard of care in making investment recommendations
that are in the Retirement Investor's Best Interest. The Adviser may
not base his or her recommendations on the Adviser's own financial
interest in the transaction. Nor may the Adviser recommend the
investment, unless it meets the objective prudent person standard of
care. Additionally, the duties of loyalty and prudence embodied in
ERISA are objective obligations that do not require proof of fraud or
misrepresentation, and full disclosure is not a defense to making an
imprudent recommendation or favoring one's own interests at the
Retirement Investor's expense.
A few commenters also questioned the requirement in the Best
Interest standard that recommendations be made without regard to the
interests of the Adviser, Financial Institution, Affiliates, Related
Entities, or ``other parties.'' The commenters indicated they did not
know the purpose of the reference to ``other parties'' and asked that
it be deleted. The Department intends the reference to make clear that
an Adviser and Financial Institution operating within the Impartial
Conduct Standards should not take into account the interests of any
party other than the Retirement Investor--whether the other party is
related to the Adviser or Financial Institution or not--in making a
recommendation. For example, an entity that may be unrelated to the
Adviser or Financial Institution but could still constitute an ``other
party,'' for these purposes, is the manufacturer of the investment
product being recommended.
Other commenters asked for confirmation that the Best Interest
standard is applied based on the facts and circumstances as they
existed at the time of the recommendation, and not based on hindsight.
Consistent with the well-established legal principles that exist under
ERISA today, the Department confirms that the Best Interest standard is
not a hindsight standard, but rather is based on the facts as they
existed at the time of the recommendation. Thus, the courts have
evaluated the prudence of a fiduciary's actions under ERISA by focusing
on the process the fiduciary used to reach its determination or
recommendation--whether the fiduciary, ``at the time they engaged in
the challenged transactions, employed the proper procedures to
investigate the merits of the investment and to structure the
investment.'' \50\ The standard does not measure compliance by
reference to how investments subsequently performed or turn Advisers
and Financial Institutions into guarantors of investment performance,
even though they gave advice that was prudent and loyal at the time of
transaction.\51\
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\50\ Donovan v. Mazzola, 716 F.2d 1226, 1232 (9th Cir. 1983).
\51\ One commenter requested an adjustment to the ``prudence''
component of the Best Interest Standard, under which the standard
would be that of a ``prudent person serving clients with similar
retirement needs and offering a similar array of products.'' In this
way, the commenter sought to accommodate varying perspectives and
opinions on particular investment products and business practices.
The Department disagrees with the comment, which could be read as
qualifying the stringency of the prudence obligation based on the
Financial Institution's or Adviser's independent decisions on which
products to offer, rather than on the needs of the particular
Retirement Investor. Therefore, the Department did not adopt this
suggestion.
---------------------------------------------------------------------------
This is not to suggest that the ERISA section 404 prudence
standard, or Best Interest standard, are solely procedural standards.
Thus, the prudence standard, as incorporated in the Best Interest
standard, is an objective standard of care that requires investment
advice fiduciaries to investigate and evaluate
[[Page 21029]]
investments, make recommendations, and exercise sound judgment in the
same way that knowledgeable and impartial professionals would. ``[T]his
is not a search for subjective good faith--a pure heart and an empty
head are not enough.'' \52\ Whether or not the fiduciaries is actually
familiar with the sound investment principles necessary to make
particular recommendations, the fiduciary must adhere to an objective
professional standard. Additionally, fiduciaries are held to a
particularly stringent standard of prudence when they have a conflict
of interest.\53\ For this reason, the Department declines to provide a
safe harbor based on ``procedural prudence'' as requested by a
commenter.
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\52\ Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir. 1983),
cert. denied, 467 U.S. 1251 (1984); see also DiFelice v. U.S.
Airways, Inc., 497 F.3d 410, 418 (4th Cir. 2007) (``Good faith does
not provide a defense to a claim of a breach of these fiduciary
duties; 'a pure heart and an empty head are not enough.'').
\53\ Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982)
(``the[] decisions [of the fiduciary] must be made with an eye
single to the interests of the participants and beneficiaries'') see
also Bussian v. RJR Nabisco, Inc., 223 F.3d 286, 298 (5th Cir.
2000); Leigh v. Engle, 727 F.2d 113, 126 (7th Cir. 1984).
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The Department additionally confirms its intent that the phrase
``without regard to'' be given the same meaning as the language in
ERISA section 404 that requires a fiduciary to act ``solely in the
interest of'' participants and beneficiaries, as such standard has been
interpreted by the Department and the courts. Therefore, the standard
would not, as some commenters suggested, foreclose the Adviser and
Financial Institution from being paid. In response to concerns about
the satisfaction of the standard in the context of Proprietary Product
recommendations or investment menus limited to Proprietary Products
and/or investments that generate Third Party Payments, the Department
has revised Section IV of the exemption to provide additional clarity
and specific guidance on this issue.
Section IV specifically provides that Financial Institutions and
Advisers that restrict their recommendations, in whole or in part, to
Proprietary Products or to investments that generate Third Party
Payments may rely on the exemption provided that the recommendation is
prudent, the fees reasonable, the conflicts disclosed (so that the
customer can fairly be said to have knowingly assented to the
compensation arrangement), and the conflicts are managed through
stringent policies and procedures that keep the Adviser's focus on the
customer's Best Interest, rather than any competing financial interest
of the Adviser or others.
In response to commenter concerns, the Department also confirms
that the Best Interest standard does not impose an unattainable
obligation on Advisers and Financial Institutions to somehow identify
the single ``best'' investment for the Retirement Investor out of all
the investments in the national or international marketplace, assuming
such advice were even possible. Instead, as discussed above, the best
interest standard set out in the exemption, incorporates two
fundamental and well-established fiduciary obligations: The duties of
prudence and loyalty. Thus, the advice fiduciary's obligation under the
Best Interest standard is to give advice that adheres to professional
standards of prudence, and to put the Retirement Investor's financial
interests in the driver's seat, rather than the competing interests of
the Adviser or other parties.
Finally, in response to questions regarding the extent to which the
Best Interest standard or other provisions of the exemption impose an
ongoing monitoring obligation on Advisers or Financial Institutions,
the Department has added specific language in Section II(e) regarding
monitoring. The text does not impose a monitoring requirement, but
instead requires clarity. As suggested by FINRA, Section II(e) requires
Advisers and Financial Institutions to disclose whether or not they
will monitor the Retirement Investor's investments and alert the
Retirement Investor to any recommended changes to those investments
and, if so, the frequency with which the monitoring will occur and the
reasons for which the Retirement Investor will be alerted. This is
consistent with the Department's interpretation of an investment advice
fiduciary's monitoring responsibility as articulated in the preamble to
the Regulation.
The terms of the contract or disclosure along with other
representations, agreements, or understandings between the Adviser,
Financial Institution and Retirement Investor, will govern whether the
nature of the relationship between the parties is ongoing or not. The
preamble to the proposed exemption stated that adherence to a Best
Interest standard did not mandate an ongoing or long-term relationship,
but instead left that the determination of whether to enter into such a
relationship to the parties.\54\ The final exemption builds upon this
and requires that the contract clearly state the nature of the
relationship and whether there is any duty to monitor on the part of
the Adviser or Financial Institution. Whether the Adviser and Financial
Institution, in fact, have an obligation to monitor the investment and
provide long-term advice depends on the parties' reasonable
understandings, arrangements, and agreements in that regard.
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\54\ 80 FR 21969 (Apr. 20, 2015).
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b. Reasonable Compensation
The Impartial Conduct Standards also include the reasonable
compensation standard, set forth in Section II(c)(2). Under this
standard, the Financial Institution and its Advisers must not recommend
a transaction that will cause the Financial Institution, Adviser, or
their Affiliates or Related Entities, to receive, directly or
indirectly, compensation for their services that is in excess of
reasonable compensation within the meaning of ERISA section 408(b)(2)
and Code section 4975(d)(2).
The obligation to pay no more than reasonable compensation to
service providers is long recognized under ERISA and the Code. ERISA
section 408(b)(2) and Code section 4975(d)(2) require that services
arrangements involving plans and IRAs result in no more than reasonable
compensation to the service provider. Accordingly, Advisers and
Financial Institutions--as service providers--have long been subject to
this requirement, regardless of their fiduciary status. At bottom, the
standard simply requires that compensation not be excessive, as
measured by the market value of the particular services, rights, and
benefits the Adviser and Financial Institution are delivering to the
Retirement Investor. Given the conflicts of interest associated with
the commissions and other payments covered by the exemption, and the
potential for self-dealing, it is particularly important that Advisers
and Financial Institutions adhere to these statutory standards, which
are rooted in common law principles.\55\
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\55\ See generally Restatement (Third) of Trusts section 38
(2003).
---------------------------------------------------------------------------
Several commenters supported this standard. The requirement that
compensation be limited to what is reasonable is an important
protection of the exemption and a well-established standard, they said.
One commenter made the point that the reasonable compensation standard
is particularly important in this exemption because it provides relief
for Third Party Payments which may not be transparent to Retirement
Investors. The commenter asserted that under current market
[[Page 21030]]
conditions, there can be large differences in compensation for
identical services.
A number of other commenters requested greater specificity as to
the meaning of the reasonable compensation standard. As proposed, the
standard stated:
When providing investment advice to the Retirement Investor
regarding the Asset, the Adviser and Financial Institution will not
recommend an Asset if the total amount of compensation anticipated
to be received by the Adviser, Financial Institution, Affiliates and
Related Entities in connection with the purchase, sale or holding of
the Asset by the Plan, participant or beneficiary account, or IRA,
will exceed reasonable compensation in relation to the total
services they provide to the Retirement Investor.
Some commenters stated that the proposed reasonable compensation
standard was too vague. Because the language of the proposal did not
reference ERISA section 408(b)(2) and Code section 4975(d)(2),
commenters asked whether the standard differed from those statutory
provisions. In particular, some commenters questioned the meaning of
the proposed language ``in relation to the total services they provide
to the Retirement Investor.'' The commenters indicated that the
proposal did not adequately explain this formulation of the reasonable
compensation standard.
There was concern that the standard could be applied retroactively
rather than based on the parties' reasonable beliefs as to the
reasonableness of the compensation at the time of the recommendation.
Commenters also indicated uncertainty as to how to comply with the
condition and asked whether it would be necessary to survey the market
to determine market rates. Some commenters requested that the
Department include the words ``and customary'' in the reasonable
compensation definition, to specifically permit existing compensation
arrangements. One commenter raised the concern that the reasonable
compensation determination raised antitrust concerns because it would
require investment advice fiduciaries to agree upon a market rate and
result in anti-competitive behavior.
Commenters also asked the Department to provide examples of
scenarios that met the reasonable compensation standard and safe
harbors and others requested examples of scenarios that would fail to
meet these standards. FINRA and other commenters suggested that the
Department incorporate existing FINRA rules 2121 and 2122, and NASD
rule 2830 regarding the reasonableness of compensation for broker-
dealers.\56\
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\56\ FINRA's comment letter described NASD rule 2830 as imposing
specific caps on compensation with respect to investment company
securities that broker-dealers may sell. While the Department views
this cap as an important protection of investors, it establishes an
outside limit rather than a standard of reasonable compensation.
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Commenters also asked how the standard would be satisfied for
Proprietary Products, particularly insurance and annuity contracts. In
such a case, commenters indicated, the Retirement Investor is not only
paying for a service, but also for insurance guarantees; a standard
that appeared to focus solely on services appeared inapposite.
Commenters asked about the treatment of the insurance company's spread,
which was described, in the case of a fixed annuity, or the fixed
component of a variable annuity, as the difference between the fixed
return credited to the contract holder and the insurer's general
account investment experience. One commenter indicated that the
calculation should not include affiliates' or related entities'
compensation as this would appear to put them at a comparative
disadvantage.
Finally, a few commenters took the position that the reasonable
compensation determination should not be a requirement of the exemption
(or the contract). In their view, a plan fiduciary that is not the
Adviser or Financial Institution should decide the reasonableness of
the compensation. Another commenter suggested that if an independent
plan fiduciary sets the menu this should be sufficient to comply with
the reasonable compensation standard.
In response to comments on this requirement, the Department has
retained the reasonable compensation standard as a condition of the
exemption, and requires Financial Institutions to include the standard
in their contracts with IRA and non-ERISA plan Retirement Investors. As
noted above, the ``reasonable compensation'' obligation is a feature of
ERISA and the Code under current law that has long applied to financial
services providers, whether fiduciaries or not. The standard is also
applicable to fiduciaries under the common law of agency and trusts. It
is particularly important that Advisers and Financial Institutions
adhere to these standards when engaging in the transactions covered
under this exemption, so as to avoid exposing Retirement Investors to
harms associated with conflicts of interest.
Although some commenters suggested that the reasonable compensation
determination be made by another plan fiduciary, the contractual
commitment (like the statutory obligation) obligates investment advice
fiduciaries to avoid overcharging their Retirement Investor customers,
despite the conflicts of interest associated with their compensation.
Fiduciaries and other services providers may not charge more than
reasonable compensation regardless of whether another fiduciary has
signed off on the compensation. Nothing in the exemption, however,
precludes Financial Institutions or others from seeking impartial
review of their fee structures to safeguard against abuse, and they may
well want to include such reviews in their policies and procedures.
Further, the Department disagrees that the requirement is
inconsistent with antitrust laws. Nothing in the exemption contemplates
or requires that Advisers or Financial Institutions agree upon a price
with their competitors. The focus of the reasonable compensation
condition is on preventing overcharges to Retirement Investors, not
promoting anti-competitive practices. Indeed, if Advisers and Financial
Institutions consulted with competitors to set prices, the agreed-upon
prices could well violate the condition.
In response to comments, however, the operative text of the final
exemption was clarified to adopt the well-established reasonable
compensation standard, as set out in ERISA section 408(b)(2) and Code
section 4975(d)(2), and the regulations thereunder. The reasonableness
of the fees depends on the particular facts and circumstances at the
time of the recommendation. Several factors inform whether compensation
is reasonable including, inter alia, the market pricing of service(s)
provided and the underlying asset(s), the scope of monitoring, and the
complexity of the product. No single factor is dispositive in
determining whether compensation is reasonable; the essential question
is whether the charges are reasonable in relation to what the investor
receives. Consistent with the Department's prior interpretations of
this standard, the Department confirms that an Adviser and Financial
Institution do not have to recommend the transaction that is the lowest
cost or that generates the lowest fees without regard to other relevant
factors. In this regard, the Department declines to specifically
reference FINRA's standard in the exemption, but rather relies on
ERISA's own longstanding reasonable compensation formulation.
In response to concerns about application of the standard to
investment products that bundle together services and investment
[[Page 21031]]
guarantees or other benefits, such as annuities, the Department
responds that the reasonable compensation condition is intended to
apply to the compensation received by the Financial Institution,
Adviser, Affiliates, and Related Entities in same manner as the
reasonable compensation condition set forth in ERISA section 408(b)(2)
and Code section 4975(d)(2). Accordingly, the exemption's reasonable
compensation standard covers compensation received directly from the
plan or IRA and indirect compensation received from any source other
than the plan or IRA in connection with the recommended
transaction.\57\ In the case of a charge for an annuity or insurance
contract that covers both the provision of services and the purchase of
the guarantees and financial benefits provided under the contract, it
is appropriate to consider the value of the guarantees and benefits in
assessing the reasonableness of the arrangement, as well as the value
of the services. When assessing the reasonableness of a charge, one
generally needs to consider the value of all the services and benefits
provided for the charge, not just some. If parties need additional
guidance in this respect, they should refer to the Department's
interpretations under ERISA section 408(b)(2) and Code section
4975(d)(2) and the Department will provide additional guidance if
necessary.
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\57\ Such compensation includes, for example charges against the
investment, such as commissions, sales loads, sales charges,
redemption fees, surrender charges, exchange fees, account fees and
purchase fees, as well as compensation included in operating
expenses and other ongoing charges, such as wrap fees, mortality,
and expense fees. For purposes of this exemption, the ``spread'' is
not treated as compensation. A commenter described the ``spread,''
in the case of a fixed annuity, or the fixed component of a variable
annuity, as the difference between the fixed return credited to the
contract holder and the insurer's general account investment
experience.
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A commenter urged the Department to provide that compensation
received by an Affiliate or Related Entity would not have to be
considered in applying the reasonable compensation standard. According
to the commenter, including such compensation in the assessment of
reasonable compensation would place Proprietary Products at a
disadvantage. The Department disagrees with the proposition that a
Proprietary Product would be disadvantaged merely because more of the
compensation goes to affiliated parties than in the case of competing
products, which allocate more of the compensation to non-affiliated
parties. The availability of this Best Interest Contract Exemption,
however, does not turn on how compensation is allocated between
affiliates and non-affiliates. Certainly, the Department would not
expect that a Proprietary Product would be at a disadvantage in the
marketplace because it carefully ensures that the associated
compensation is reasonable. As part of this exemption, the Department
has provided specific provisions describing how Proprietary Products
can meet the Best Interest standard. Assuming the Best Interest
standard is satisfied and the compensation is reasonable, the exemption
should not impede the recommendation of proprietary products.
Accordingly, the Department disagrees with the commenter. The
Department declines suggestions to provide specific examples of
``reasonable'' amounts or specific safe harbors. Ultimately, the
``reasonable compensation'' standard is a market based standard. As
noted above, the standard incorporates the familiar ERISA section
408(b)(2) and Code section 4975(d)(2) standards. The Department is
unwilling to condone all ``customary'' compensation arrangements and
declines to adopt a standard that turns on whether the agreement is
``customary.'' For example, it may in some instances be ``customary''
to charge customers fees that are not transparent or that bear little
relationship to the value of the services actually rendered, but that
does not make the charges reasonable. Finally, the Department notes
that all recommendations are subject to the overarching Best Interest
standard, which incorporates the fundamental fiduciary obligations of
prudence and loyalty. An imprudent recommendation for an investor to
overpay for an investment transaction would violate that standard,
regardless of whether the overpayment was attributable to compensation
for services, a charge for benefits or guarantees, or something else.
c. Misleading Statements
The final Impartial Conduct Standard, set forth in Section
II(c)(3), requires that statements by the Financial Institution and its
Advisers to the Retirement Investor about the recommended transaction,
fees and compensation, Material Conflicts of Interest, and any other
matters relevant to a Retirement Investor's investment decisions, may
not be materially misleading at the time they are made. In response to
commenters, the Department adjusted the text to clarify that the
standard is measured at the time of the representations, i.e., the
statements must not be misleading ``at the time they are made.''
Similarly, the Department added a materiality standard in response to
comments.
The Department did not accept certain other comments, however. One
commenter requested that the Department add a qualifier providing that
the standard is violated only if the statement was ``reasonably
relied'' on by the Retirement Investor. The Department rejected the
comment. The Department's aim is to ensure that Financial Institutions
and Advisers uniformly adhere to the Impartial Conduct Standards,
including the obligation to avoid materially misleading statements,
when they give advice. Whether a Retirement Investor relied on a
particular statement may be relevant to the question of damages in
subsequent arbitration or court proceedings, but it is not and should
not be relevant to the question of whether the advice fiduciary
violated the exemption's standards in the first place. Moreover,
inclusion of a ``reasonable reliance'' standard runs the risk of
inviting boilerplate disclaimers of reliance in contracts and
disclosure documents precisely so the Adviser can assert that any
reliance is unreasonable.
One commenter asked the Department to require only that the Adviser
``reasonably believe'' the statements are not misleading. The
Department is concerned that this standard too could undermine the
protections of this condition, by requiring Retirement Investors or the
Department to prove the Adviser's actual belief rather than focusing on
whether the statement is objectively misleading. However, to address
commenters' concerns about the risks of engaging in a prohibited
transaction, as noted above, the Department has clarified that the
standard is measured at the time of the representations and has added a
materiality standard.
The Department believes that Retirement Investors are best served
by statements and representations that are free from material
misstatements. Financial Institutions and Advisers best avoid
liability--and best promote the interests of Retirement Investors--by
ensuring that accurate communications are a consistent standard in all
their interactions with their customers.
A commenter suggested that the Department adopt FINRA's
``Frequently Asked Questions regarding Rule 2210'' in this
connection.\58\ FINRA's Rule 2210, Communications with the Public, sets
forth a number of procedural rules and standards that are designed to,
[[Page 21032]]
among other things, prevent broker-dealer communications from being
misleading. The Department agrees that adherence to FINRA's standards
can promote materially accurate communications, and certainly believes
that Financial Institutions and Advisers should pay careful attention
to such guidance documents. After review of the rule and FAQs, however,
the Department declines to simply adopt FINRA's guidance, which
addresses written communications, since the condition of the exemption
is broader in this respect. In the Department's view, the meaning of
the standard is clear, and is already part of a plan fiduciary's
obligations under ERISA. If, however, issues arise in implementation of
the exemption, the Department will consider requests for additional
guidance.
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\58\ Currently available at http://www.finra.org/industry/finra-rule-2210-questions-and-answers.
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d. Other Interpretive Issues
Some commenters asserted that some of the exemption's terms were
too vague and would result in the exemption failing to meet the
``administratively feasible'' requirement under ERISA section 408(a)
and Code section 4975(c)(2). The Department disagrees with these
commenters' suggestion that ERISA section 408(a) and Code section
4975(c)(2) fail to be satisfied by this exemption's principles-based
approach, or that the exemption's standards are unduly vague. It is
worth repeating that the Impartial Conduct Standards are built on
concepts that are longstanding and familiar in ERISA and the common law
of trusts and agency. Far from requiring adherence to novel standards
with no antecedents, the exemption primarily requires adherence to
basic, well-established obligations of fair dealing and fiduciary
conduct. Moreover, as discussed above, the exemption's reliance on
these familiar fiduciary standards is precisely what enables the
Department to apply the exemption to the wide variety of investment and
compensation practices that characterize the market for retail
retirement advice, rather than to a far narrower category of
transactions subject to much more detailed and highly-proscriptive
conditions.
This section is designed to provide specific interpretations and
responses to a number of specific issues raised in connection with a
number of the Impartial Conduct Standards. In response to commenters,
the Department specifically notes that the Impartial Conduct Standards
(either as proposed or finalized) are not properly interpreted to
foreclose the recommendation of Proprietary Products. The Department
has revised Section IV of the exemption, in particular, as discussed
below, to specifically address the application of the Best Interest
Standard in the context of Proprietary Products and products that
generate Third Party Payments. As Section IV makes clear, the exemption
is fully available to such recommendations, provided that the Financial
Institutions and Advisers adhere to appropriate standards and implement
specified safeguards.
The Impartial Conduct Standards also are not properly interpreted
to foreclose the receipt of commissions or other transaction-based
payments. To the contrary, a significant purpose of granting this
exemption is to continue to permit such payments, as long as Financial
Institutions and Advisers are willing to adhere to Best Interest
standards. The discussion of the policies and procedures in Section
II(d) provides guidance on satisfying the exemption while preserving
differential payments structures. In particular, the Department
confirms that the receipt of a commission on an annuity product does
not result in a per se violation of any of the Impartial Conduct
Standards, or warranties or other conditions of the exemption, even
though such a commission may be greater than the commission on a mutual
fund purchase of the same amount as long as the commission meets the
requirement of ``reasonable compensation'' and other applicable
conditions.
One commenter asked that the Department make an explicit statement
that ``offering products on which there are varying opinions within the
industry (e.g., variable annuities) does not violate the best interest
standard.'' In response, the Department notes that it has not specified
that any particular investment product or category is illegal or per se
imprudent, or otherwise violates the Best Interest standard in the
exemption. This includes, but is not limited to, the recommendation of
a variable annuity. Instead, each recommendation is measured by the
Impartial Conduct Standards set forth in the exemption.
Finally, the Department notes that the exemption, and in particular
the requirement to adhere to a Best Interest Standard, does not mandate
an ongoing or long-term advisory relationship, but rather leaves the
duration of the relationship to the parties. The terms of the contract
(if applicable), along with other representations, agreements, or
understandings between the Adviser, Financial Institution and
Retirement Investor, will govern whether the relationship between the
parties is ongoing or not. Additionally, compliance with the
exemption's conditions is necessary only with respect to transactions
that otherwise would constitute prohibited transactions under ERISA and
the Code. The exemption does not purport to impose conditions on the
management of investments held outside of plans or IRAs covered by
ERISA and defined in the Code. Accordingly, the conditions in the
exemption are mandatory only with respect to investments held by ERISA
plans, IRAs and non-ERISA plans.
e. Contractual Representation Versus Exemption Condition
Commenters expressed a variety of views on whether violations of
the Impartial Conduct Standards with respect to advice to Retirement
Investors regarding IRAs and non-ERISA plans should result in loss of
the exemption, violation of the contract, or both.\59\ Some commenters
objected to the incorporation of the Impartial Conduct Standards as
contract terms, generally, on the basis that the requirement would
contribute to litigation risk. Some commenters preferred that the
Impartial Conduct Standards only be required as a condition of the
exemption, and not give rise to contract claims.
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\59\ Commenters also asserted that the Department did not have
the authority to condition the exemption on the Impartial Conduct
Standards. Comments on the Department's jurisdiction are discussed
in a separate Section E. of this preamble.
---------------------------------------------------------------------------
Other commenters advocated for the opposite result, asserting that
the Impartial Conduct Standards should be required for contractual
promises only, and not treated as exemption conditions. These
commenters asserted that the Impartial Conduct Standards are too vague
and would result in uncertainty as to whether an excise tax under the
Code, which is self-assessed, is owed. There were also suggestions to
limit the contractual representation to the Best Interest standard
alone. One commenter asserted that the reasonable compensation
requirement and the obligation not to make misleading statements fall
within a Best Interest standard, and do not need to be stated
separately. There were also suggestions that the Impartial Conduct
Standards not apply to ERISA plans because fiduciaries to these plans
already are required to adhere to similar statutory fiduciary
obligations. In these commenters' view, requiring these standards in an
exemption is redundant and inappropriately increases the consequences
of any fiduciary breach by imposing an excise tax.
In response to comments, the Department has revised the language of
the Impartial Conduct Standards and provided interpretive guidance to
[[Page 21033]]
alleviate the commenters' concerns about uncertainty and litigation
risk. However, the Department has concluded that failure to adhere to
the Impartial Conduct Standards should be both a violation of the
contract (where required) and the exemption. Accordingly, the
Department has not eliminated any of the conduct standards or, for IRAs
and non-ERISA plans, restricted them just to conditions of the
exemption. In the Department's view, all the Impartial Conduct
Standards form the baseline standards that should be applicable to
fiduciaries relying on the exemption; therefore, the Department has not
accepted comments suggesting that the contract representation be
limited to the Best Interest standard. Making all the Impartial Conduct
Standards required contractual promises for dealings with IRAs and
other non-ERISA plans creates the potential for contractual liability,
incentivizes Financial Institutions to comply, and gives injured
Retirement Investors a remedy if those Financial Institutions do not
comply. This enforceability is critical to the safeguards afforded by
the exemption.
As previously discussed, the Impartial Conduct Standards are not
unduly vague or unknown, but rather track longstanding concepts in law
and equity. In response to interpretive questions posed in the
comments, the Department has provided a series of requested
interpretations in the preceding preamble section. Also, the Department
has simplified execution of the contract, streamlined disclosure, and
made certain language changes, such as the revisions discussed above to
the reasonable compensation standard, to address legitimate concerns.
Similarly, the Department has not accepted the comment that the
Impartial Conduct Standards should apply only to IRAs and non-ERISA
plans. One of the Department's goals is to ensure equal footing for all
Retirement Investors. The SEC staff Dodd-Frank Study found that
investors were frequently confused by the differing standards of care
applicable to broker-dealers and registered investment advisers. The
Department hopes to minimize such confusion in the market for
retirement advice by holding Advisers and Financial Institutions to
similar standards, regardless of whether they are giving the advice to
an ERISA plan, IRA, or a non-ERISA plan.
Moreover, inclusion of the standards in the exemption's conditions
adds an important additional safeguard for ERISA and IRA investors
alike because the party engaging in a prohibited transaction has the
burden of showing compliance with an applicable exemption, when
violations are alleged.\60\ In the Department's view, this burden-
shifting is appropriate because of the dangers posed by conflicts of
interest, as reflected in the Department's Regulatory Impact Analysis
and because of the difficulties Retirement Investors have in
effectively policing such violations.\61\ One important way for
Financial Institutions to ensure that they can meet this burden is by
implementing strong anti-conflict policies and procedures, and by
refraining from creating incentives to violate the Impartial Conduct
Standards. Thus, treating the Impartial Conduct Standards as exemption
conditions creates an important incentive for Financial Institutions to
carefully monitor and oversee their Advisers' conduct for adherence
with fiduciary norms.
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\60\ See e.g., Fish v. GreatBanc Trust Company, 749 F.3d 671
(7th Cir. 2014).
\61\ See Regulatory Impact Analysis.
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Moreover, as noted repeatedly, the language for the Impartial
Conduct Standards borrows heavily from ERISA and the law of trusts,
providing sufficient clarity to alleviate the commenters' concerns.
Ensuring that fiduciary investment advisers adhere to the Impartial
Conduct Standards and that all Retirement Investors have an effective
legal mechanism to enforce the standards are central goals of this
regulatory project.
5. Sales Incentives and Anti-Conflict Policies and Procedures--Section
II(d)
Under Section II(d) of the exemption, the Financial Institution is
required to adopt and comply with certain anti-conflict policies and
procedures and to insulate Advisers from incentives to violate the Best
Interest standard. In order for relief to be available under the
exemption, a Financial Institution that meets the definition set forth
in the exemption must provide oversight of Advisers' recommendations,
as described in this section.
The Financial Institution must prepare a written document
describing the Financial Institution's policies and procedures and make
copies of the document readily available to Retirement Investors, free
of charge, upon request as well as on the Financial Institution's Web
site.\62\ The written description must accurately describe or summarize
key components of the policies and procedures relating to conflict-
mitigation and incentive practices in a manner that permits Retirement
Investors to make an informed judgment about the stringency of the
Financial Institution's protections against conflicts of interest. The
Department opted against requiring disclosure of the full policies and
procedures to Retirement Investors to avoid giving them a potentially
overwhelming amount of information that could run contrary to its
purpose by alerting Advisers to the particular surveillance mechanisms
employed by Financial Institutions. However, the exemption requires
that the full policies and procedures must be made available to the
Department upon request.
---------------------------------------------------------------------------
\62\ See Section III(b)(1)(iv) of the exemption.
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The policies and procedures obligations have several important
components. First, the Financial Institution must adopt and comply with
written policies and procedures reasonably and prudently designed to
ensure that its Advisers adhere to the Impartial Conduct Standards set
forth in Section II(c). Second, the Financial Institution in
formulating its policies and procedures, must specifically identify and
document its Material Conflicts of Interest; adopt measures reasonably
and prudently designed to prevent Material Conflicts of Interest from
causing violations of the Impartial Conduct Standards set forth in
Section II(c); and designate a person or persons, identified by name,
title or function, responsible for addressing Material Conflicts of
Interest and monitoring Advisers' adherence to the Impartial Conduct
Standards. For purposes of the exemption, a Material Conflict of
Interest exists when an Adviser or Financial Institution has a
financial interest that a reasonable person would conclude could affect
the exercise of its best judgment as a fiduciary in rendering advice to
a Retirement Investor.
Finally, the Financial Institution's policies and procedures must
require that neither the Financial Institution nor (to the best of its
knowledge) its Affiliates or Related Entities use or rely on quotas,
appraisals, performance or personnel actions, bonuses, contests,
special awards, differential compensation or other actions or
incentives that are intended or would reasonably be expected to cause
Advisers to make recommendations that are not in the Best Interest of
the Retirement Investor.
In this respect, however, the exemption makes clear that that
requirement does not prevent the Financial Institution or its
Affiliates, or Related Entities from providing Advisers with
differential compensation (whether in type or amount, and including,
but not limited to, commissions) based on investment
[[Page 21034]]
decisions by plans, participant or beneficiary accounts, or IRAs, to
the extent that the Financial Institution's policies and procedures and
incentive practices, when viewed as a whole, are reasonably and
prudently designed to avoid a misalignment of the interests of Advisers
with the interests of the Retirement Investors they serve as
fiduciaries.
The anti-conflict policies and procedures will safeguard the
interests of Retirement Investors by causing Financial Institutions to
consider the conflicts of interest affecting the provision of advice to
Retirement Investors and to take action to mitigate the impact of such
conflicts. In particular, under the final exemption, Financial
Institutions must not use compensation and other employment incentives
to the extent they are intended to or would reasonably be expected to
cause Advisers to make recommendations that are not in the Best
Interest of the Retirement Investor. Financial Institutions must also
establish a supervisory structure reasonably and prudently designed to
ensure the Advisers will adhere to the Impartial Conduct Standards.
This includes consideration of the incentives of branch managers and
supervisors and their potential effect on Advisers' recommendations.
Mitigating conflicts of interest by requiring greater alignment of the
interests of the Adviser and Financial Institution, and the Retirement
Investor, is necessary for the Department to make the findings under
ERISA section 408(a) and Code section 4975(c)(2) that the exemption is
in the interests of, and protective of, Retirement Investors. This
warranty gives the Financial Institution a powerful incentive to ensure
advice is provided in accordance with fiduciary norms, rather than risk
litigation, including class litigation and liability.
Like the proposal, the final exemption does not specify the precise
content of the anti-conflict policies and procedures, but rather sets
out the overarching standards for assessing their adequacy. This
flexibility is intended to allow Financial Institutions to develop
policies and procedures that are effective for their particular
business models, while prudently ensuring compliance with their and
their Advisers' fiduciary obligations and the Impartial Conduct
Standards. The policies and procedures requirement, if taken seriously,
can also reduce Financial Institutions' litigation risk by minimizing
incentives for Advisers to provide advice that is not in Retirement
Investors' Best Interest.
As adopted in the final exemption, the policies and procedures
requirement is a condition of the exemption for all Retirement
Investors--in ERISA plans, IRAs and non-ERISA plans. Failure to comply
could result in liability under ERISA for engaging in a prohibited
transaction and the imposition of an excise tax under the Code, payable
to the Treasury. Additionally, with respect to Retirement Investors in
IRAs and non-ERISA plans, the requirement takes the form of a
contractual warranty. The Financial Institution must warrant that it
has adopted and will comply with the anti-conflict policies and
procedures (including the obligation to avoid misaligned incentives).
Failure to comply with the warranty could result in contractual
liability.
Comments on the proposed policies and procedures requirement are
discussed below.
a. Policies and Procedures Requirement Generally
Under the policies and procedures requirement, described in greater
detail above, Financial Institutions must adopt and comply with anti-
conflict policies and procedures. In addition, neither the Financial
Institution nor (to the best of its knowledge) its Affiliates or
Related Entities may use or rely on quotas, appraisals, performance or
personnel actions, bonuses, contests, special awards, differential
compensation or other actions or incentives that are intended or would
reasonably be expected to cause Advisers to make recommendations that
are not in the Best Interest of the Retirement Investor.
Some commenters were extremely supportive of the policies and
procedures requirement as proposed. They expressed the view that the
policies and procedures requirement, and in particular the restrictions
on compensation and other employment incentives, was one of the most
critical investor protections in the proposal because it would cause
Financial Institutions to make specific and necessary changes to their
compensation arrangements that would result in significant protections
to Retirement Investors.
Some commenters believed the Department did not go far enough.
These commenters indicated that flat compensation arrangements should
be required, or at least that the rules applicable to differential
compensation arrangements should be more specific and stringent. A few
commenters also indicated that, in addition to focusing on the Adviser,
the Financial Institution's policies and procedures need to consider
the impact of compensation practices on branch managers. A commenter
indicated that branch managers have responsibilities under FINRA's
supervisory rules to ensure suitability and possibly approve individual
transactions. The commenter asserted that branch managers financially
benefit from Advisers' recommendations and have a variety of methods of
influencing Adviser behavior.
Many others objected to the policies and procedures warranty, and
requested that it be eliminated in the final exemption. Some commenters
believed that compliance would require drastic changes to current
compensation arrangements or could possibly result in the complete
prohibition of commissions and other transaction-based compensation.
Other commenters suggested that the requirement should be eliminated as
it would be unnecessary in light of the exemption's Best Interest
standard, and because it would unnecessarily increase litigation risk
to Financial Institutions. Alternatively, there were requests to
clarify specific provisions and provide safe harbors in the policies
and procedures requirement.
In the final exemption, the Department has retained the general
approach of the proposal. The Department concurs with commenters who
view the policies and procedures requirement as an important safeguard
for Retirement Investors, and as a necessary condition for the
Department to make the findings under ERISA section 408(a) and Code
section 4975(c)(2) that the exemption is in the interests of, and
protective of, Retirement Investors. This provision will require
Financial Institutions to take concrete and specific steps to ensure
that its individual Advisers adhere to the Impartial Conduct Standards,
and in particular, forego compensation practices and employment
incentives (quotas, appraisals, performance or personnel actions,
bonuses, contests, special awards, differential compensation or other
actions or incentives) that are intended or would reasonably be
expected to cause Advisers to make recommendations that are not in the
Best Interest of the Retirement Investor. Strong policies and
procedures reduce the temptation (conscious or unconscious) to violate
the Best Interest standard in the first place by ensuring that the
Advisers' incentives are appropriately aligned with the interests of
the customers they serve, and by ensuring appropriate monitoring and
supervision of individual Advisers' conduct. While the Department views
[[Page 21035]]
the Best Interest standard as critical to the protections of the
exemption, the policies and procedures requirement is equally critical
as a means of supporting Best Interest advice and protecting Retirement
Investors from having to enforce the Best Interest standard after the
advice has already been rendered and the damage done.
The Department has not made the requirements more stringent, as
suggested by some commenters, so as to require completely level
compensation. Different payments for different classes of investments
may be appropriate based on differences in the time and expertise
necessary to recommend them. Similarly, transaction-based compensation
can be more cost effective for some investors who do not trade
frequently. The exemption was designed to preserve commissions and
other transaction-based compensation structures, thereby allowing
Retirement Investors to choose the payment structure that works best
for them.
In response to commenters who expressed the view that the exemption
did not provide a clear path for the payment of differential
compensation, the Department has elaborated below on its example of
policies and procedures and compensation practices that could satisfy
the requirement. In addition, the examples address branch manager
incentives.
The Department also adopted the suggestion of one commenter that
the exemption require the Financial Institution to designate a specific
person to address Material Conflicts of Interest and monitor Advisers'
adherence to the Impartial Conduct Standards.\63\ In the proposal, the
Department had already suggested that Financial Institutions consider
this approach; however, the commenter suggested that it should be a
specific requirement and indicated that most Financial Institutions
already have a designated compliance officer. The Department concurs
with the commenter and has included that requirement in the final
exemption, based on the view that formalizing the process for
identifying and monitoring these issues will result in increased
protections to Retirement Investors.
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\63\ One important consideration in addressing conflicts of
interest is the Financial Institution's attentiveness to the
qualifications and disciplinary history of the persons it employs to
provide such advice. See Egan, Mark, Gregor Matvos and Amit Seru,
The Market for Financial Adviser Misconduct, at 3 (February 26,
2016) (``Past offenders are five times more likely to engage in
misconduct than the average adviser, even compared with other
advisers in the same firm at the same point in time. The large
presence of repeat offenders suggests that consumers could avoid a
substantial amount of misconduct by avoiding advisers with
misconduct records.'').
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b. Specific Language of Policies and Procedures Requirement
There were also questions and comments on the specific language of
the proposed policies and procedures requirement. As proposed, the
components of the policies and procedures requirement read as follows:
The Financial Institution has adopted written policies
and procedures reasonably designed to mitigate the impact of
Material Conflicts of Interest and ensure that its individual
Advisers adhere to the Impartial Conduct Standards set forth in
Section II(c);
In formulating its policies and procedures, the
Financial Institution has specifically identified Material Conflicts
of Interest and adopted measures to prevent the Material Conflicts
of Interest from causing violations of the Impartial Conduct
Standards set forth in Section II(c); and
Neither the Financial Institution nor (to the best of
its knowledge) any Affiliate or Related Entity uses quotas,
appraisals, performance or personnel actions, bonuses, contests,
special awards, differential compensation or other actions or
incentives to the extent they would tend to encourage individual
Advisers to make recommendations that are not in the Best Interest
of the Retirement Investor.
A few commenters asked the Department to explain the difference
between the first and second prongs of the policies and procedures
requirement, as proposed. In response, the first prong of the
requirement was intended to establish a general standard, while the
second (and third) prongs provided specific rules regarding the
policies and procedures requirement. This approach was also adopted in
the final exemption. In addition, the language of Section II(d)(3)
specifically provides that the third prong of the requirement,
requiring Financial Institutions to insulate Advisers from incentives
to violate the Best Interest standard, is part of the policies and
procedures requirement.
There were also comments on (i) the definition and use of the term
``Material Conflicts of Interest;'' (ii) the language requiring the
policies and procedures to be ``reasonably designed'' to mitigate the
impact of such conflicts of interest, and (iii) the meaning of
incentives that ``tend to encourage'' individual Advisers to make
recommendations that are not in the Best Interest of the Retirement
Investor. In addition, comments from the insurance industry requested
guidance on certain industry practices regarding employee benefits for
statutory employees. These comments are discussed below.
i. Materiality
A number of commenters focused on the definition of Material
Conflict of Interest used in the proposal. Under the definition as
proposed, a Material Conflict of Interest exists when an Adviser or
Financial Institution ``has a financial interest that could affect the
exercise of its best judgment as a fiduciary in rendering advice to a
Retirement Investor.'' Some commenters took the position that the
proposal did not adequately explain the term ``material'' or
incorporate a ``materiality'' standard into the definition. A commenter
wrote that the proposed definition was so broad that it would be
difficult for Financial Institutions to comply with the various aspects
of the exemption related to Material Conflicts of Interest, such as
provisions requiring disclosures of Material Conflicts of Interest.
Another commenter indicated that the Department should not use the
term ``material'' in defining conflicts of interest. The commenter
believed that it could result in a standard that was too subjective
from the perspective of the Adviser and Financial Institution, and
could undermine the protectiveness of the exemption.
After consideration of the comments, the Department adjusted the
definition of Material Conflict of Interest. In the final exemption, a
Material Conflict of Interest exists when an Adviser or Financial
Institution has a ``financial interest that a reasonable person would
conclude could affect the exercise of its best judgment as a fiduciary
in rendering advice to a Retirement Investor.'' This language responds
to concerns about the breadth and potential subjectivity of the
standard. The Department did not, as some commenters suggested, include
the word ``material'' in the definition of Material Conflict of
Interest, to avoid the potential circularity of that approach.
ii. ``Reasonably Designed''
One commenter asked that the Department more broadly use the
modifier ``reasonably designed'' in describing the standard the
policies and procedures must meet so as to avoid a construction that
required standards that ensured perfect compliance, a potentially
unattainable standard. The Department has accepted the comment and
adjusted the language in Sections II(d)(1) and (2) to generally use the
phrase ``reasonably and prudently designed.'' Other commenters asked
for guidance on the proposed phrasing ``reasonably designed to
mitigate'' the impact of Material Conflicts of Interest.
[[Page 21036]]
The Department provides additional guidance in this respect in this
preamble, which gives examples of some possible approaches to policies
and procedures.
iii. ``Tend to Encourage''
A number of commenters asked for clarification or revision of the
proposed exemption's prohibition of incentives that ``tend to
encourage'' violation of the Best Interest standard, generally to
require a tight link between the incentives and the Advisers'
recommendations. Commenters argued that the ``tend to encourage''
language established a standard that could be impossible to meet in the
context of differential compensation. Accordingly, they requested that
the Department use language such as ``intended to encourage,'' ``does
encourage'' ``causes,'' or similar formulations.
In response to these commenters the Department has adjusted the
condition's language as follows:
The Financial Institution's policies and procedures require that
neither the Financial Institution nor (to the best of its knowledge)
any Affiliate or Related Entity use or rely on quotas, appraisals,
performance or personnel actions, bonuses, contests, special awards,
differential compensation or other actions or incentives that are
intended or would reasonably be expected to cause Advisers to make
recommendations that are not in the Best Interest of the Retirement
Investor (emphasis added).
This language more accurately captures the Department's intent,
which was to require that procedures reasonably address Advisers'
incentives, not guarantee perfection. The Department disagrees,
however, with the suggestion that Financial Institutions should be
permitted to tolerate or create incentives that would ``reasonably be
expected to cause such violations'' unless the Retirement Investor can
actually prove the Financial Institution's intent to cause violations
of the standard or the Adviser's improper motivation in making the
recommendation. The aim of the policies and procedures requirement is
to require the Financial Institution to take prophylactic measures to
ensure that Retirement Advisers adhere to the Impartial Conduct
Standards, a goal completely at odds with the creation of incentives to
violate the Best Interest Standard. In exchange for its continuing
receipt of compensation that would otherwise be prohibited by ERISA and
the Code, the Financial Institution's responsibility under the
exemption is to protect Retirement Investors from conflicts of
interest, not to promote or continue to offer incentives to violate the
Best Interest standard. Moreover, absent extensive discovery or the
ability to prove the motivations of individual Advisers, Retirement
Investors would generally be in a poor position to prove such ill
intent.
Similar adjustments were made to the language of the proposal that
provided that the policies and procedures requirement does not:
[P]revent the Financial Institution or its Affiliates and
Related Entities from providing Advisers with differential
compensation based on investments by Plans, participant or
beneficiary accounts, or IRAs, to the extent such compensation would
not encourage advice that runs counter to the Best Interest of the
Retirement Investor (e.g., differential compensation based on such
neutral factors as the difference in time and analysis necessary to
provide prudent advice with respect to different types of
investments would be permissible).
Accordingly, in this final exemption, the language now provides
that the policies and procedures requirement does not:
[P]revent the Financial Institution or its Affiliates or Related
Entities from providing Advisers with differential compensation
(whether in type or amount, and including, but not limited to,
commissions) based on investment decisions by Plans, participant or
beneficiary accounts, or IRAs, to the extent that the Financial
Institution's policies and procedures and incentive practices, when
viewed as a whole, are reasonably and prudently designed to avoid a
misalignment of the interests of Advisers with the interests of the
Retirement Investors they serve as fiduciaries (such compensation
practices can include differential compensation paid based on
neutral factors tied to the differences in the services delivered to
the investor with respect to the different types of investments, as
opposed to the differences in the amounts of Third Party Payments
the Financial Institution Receives in connection with particular
investment recommendations).
This language is designed to make clear that differential
compensation is permitted but only if the Financial Institution's
policies and procedures, as a whole are reasonably designed to avoid a
misalignment of interests between Advisers and Retirement Investors. As
discussed in greater detail below, the Financial Institution's payment
of differential compensation should be based only on neutral factors.
iv. Insurance Company Statutory Employees
A number of commenters from the insurance industry asked for
clarification or revision of the policies and procedures provision as
applicable to statutory employees of insurance companies. Insurance
companies explained that they often rely on the statutory employee
rules of the Internal Revenue Code, specifically Code section 3121 and
the regulations thereunder. Under these rules, an independent
contractor is treated as a full-time employee if that individual ``is
devoted to the solicitation of life insurance or annuity contracts, or
both, primarily for one life insurance company.'' \64\ Insurance
companies indicated that they often look at an agent's sales of
Proprietary Products to determine whether the agent is acting primarily
for one company, which in turn determines whether the agent is eligible
for certain tax-qualified employee benefits, such as health insurance
and access to retirement plans. Insurance companies were concerned that
these benefits would be considered impermissible incentives under the
Best Interest Contract Exemption.
---------------------------------------------------------------------------
\64\ 26 CFR 31.3121(d)-1(d)(3)(ii).
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These commenters requested clarification that the provision of
employee benefits based on status as a statutory employee under the
Internal Revenue Code (which, as explained, may involve evaluation of
the amount of Proprietary Products sold) would not violate the
exemption, and in particular, the policies and procedures requirement.
The Department did not intend the exemption to effectively prohibit the
receipt of these benefits. Accordingly, the Department confirms that
the receipt by an Adviser who is an insurance agent of reasonable and
customary deferred compensation or subsidized health or pension benefit
arrangements such as typically provided to an ``employee'' as defined
in Code section 3121(d)(3) does not, in and of itself, violate the
policies and procedures requirement or the Impartial Conduct Standards.
However, consistent with the standard, such Financial Institutions must
ensure that their policies and procedures and incentive practices, when
viewed as a whole, are reasonably and prudently designed to avoid a
misalignment of the interests of Advisers with the interests of the
Retirement Investors they serve as fiduciaries. In the Department's
view, the satisfaction of the requirement involves an evaluation of the
relevant facts and circumstances.
c. Substance of the Policies and Procedures Requirement
Under the exemption, a Financial Institution must have policies and
procedures in place that are reasonably and prudently designed to
ensure compliance with the Impartial Conduct Standards, and the
Financial Institution is prohibited from relying on incentive
structures that are intended or would
[[Page 21037]]
reasonably be expected to cause Advisers to make recommendations that
are not in the Best Interest of the Retirement Investor. Consistent
with the general approach outlined in the proposal, the exemption does
not mandate level fees or require any particular compensation or
employment structure, as long as the Financial Institution complies
with these overarching standards. Certainly, one approach to satisfying
the exemption's requirements would be to adopt a compensation
structure, in which Advisers' compensation does not vary based on the
Adviser's particular investment recommendation. Under this approach,
even if the Financial Institution received varying payments for
different investment recommendations, individual Advisers could, for
example, be compensated by a salary or on an hourly basis. The
exemption is not limited to this one approach, however. Instead, it
permits a wide range of practices, subject to the overarching
obligation to comply with the Impartial Conduct Standards and to avoid
misaligned incentives that are intended or could reasonably be expected
to cause violations of the Best Interest standard.
Despite the Department's intent to permit a variety of commission
and compensation structures many commenters questioned how a
compensation structure that permitted differential compensation could
be in compliance with the exemption's standards as proposed. For
example, insurance industry commenters questioned whether Advisers
could continue to receive different (typically higher) commissions for
annuity contracts than for comparable mutual funds, which do not have
an insurance component. The exemption was not intended to bar
commissions or all forms of differential compensation. Accordingly, the
Department has specifically revised the exemption's text to make clear
that differential compensation is permissible, and has changed the
prohibition on incentive structures that would ``tend to encourage''
violations of the Best Interest Standard to a prohibition on incentive
structures ``intended'' or ``reasonably expected'' to cause such
violations.
Thus, the final exemption specifically states that differential
compensation is permissible, subject to policies and procedures
``reasonably and prudently designed to prevent Material Conflicts of
Interest from causing violations of the Impartial Conduct Standards,''
and subject to the requirement that the differentials are not
``intended'' and would not ``reasonably be expected to cause Advisers
to make recommendations that are not in the Best Interest of the
Retirement Investor. Compensation structures should be prudently
designed to avoid a misalignment if the interests of Advisers and the
Retirement Investors they serve, but may nevertheless provide for
differential compensation. The exemption's goal is not to wring out
every potential conflict, no matter how slight, but rather to ensure
that Financial Institutions and Advisers put Retirement Investors'
interests first, take care to minimize incentives to act contrary to
investors' interests, and carefully police those conflicts that remain.
Within this best interest framework, the exemption is designed to
preserve commissions and other transaction-based compensation
structures, thereby allowing Retirement Investors to choose the payment
structure that works best for them.
The Department intends that Financial Institutions will identify
Material Conflicts of Interest applicable to its and its Advisers'
provision of investment advice and reasonably and prudently design
policies and procedures to prevent those particular conflicts from
causing violations of the Impartial Conduct Standards. The extent and
contours of the policies and procedures will depend on the type of and
pervasiveness of the conflicts in the Financial Institution's business.
If, for example, the chief conflict of interest is a discrete conflict
associated with advice on the rollover or distribution of plan assets,
the Financial Institution's policies and procedures should focus on
that conflict. In that context, the Financial Institution would
exercise special care to ensure that the Adviser gives sufficient
weight to consideration and documentation of any factors supporting
leaving the investments in the plan, and not just any benefits of
taking the distribution, which would generate fees for the Financial
Institution and Adviser. On the other hand, a Financial Institution
that compensates Advisers through a wide variety of commissions and
other transaction-based payments and incentives would need to exercise
great care in designing and policing the differential compensation
structure. For example, the Financial Institution should give special
attention to ensuring that supervisory mechanisms and procedures
protect investors from recommendations to make excessive trades, or to
buy investment products, annuities, or riders that are not in the
customer's best interest or that tie up too much of the customer's
wealth in illiquid or risky investments. In general, Financial
Institutions should carefully focus on the particular aspects of their
business model that potentially create misaligned incentives.
Accordingly, a Financial Institution could retain a structure in
which Advisers receive differential compensation for different
categories of investments, but are subject to policies and procedures
that safeguard against the conflicts caused by the differential
categories. For example, in many circumstances, it may require more
time to explain the features of a complex annuity product than a
relatively simpler mutual fund investment. Based on such neutral
considerations, the Financial Institution's policies and procedures
could permit the payment of greater commissions in connection with
annuity sales, subject to appropriate controls and oversights as
described below, including that the neutral factors be neutral in
operation as well as selection. Differential compensation between
categories of investments could be permissible as long as the
compensation structure and lines between categories were drawn based on
neutral factors that were not tied to the Financial Institution's own
conflicts of interest, such as the time or complexity of the advisory
work, rather than on promoting sales of the most lucrative products. In
such cases, the policies and procedures would focus with particular
care on adopting supervisory and monitoring mechanisms to police
adviser's recommendations as they relate to investment products in
differential categories, but the exemption would not prohibit the
differentials. The Department also expects that Advisers and Financial
Institutions providing advice will exercise special care when assets
are hard to value, illiquid, complex, or particularly risky. Financial
Institutions responsible for overseeing recommendations of these
investments must give special attention to the policies and procedures
surrounding such investments and their oversight of Advisers'
recommendations.
As noted above, Financial Institutions also must pay attention to
the incentives of branch managers and supervisors, and how the
incentives potentially impact Adviser recommendations. Certainly,
Financial Institutions must not provide incentives to branch managers
or other supervisors that are intended to, or would reasonably be
expected to cause such entities, in turn, to incentivize Advisers to
make recommendations that do not meet the Best Interest standard.
Financial
[[Page 21038]]
Institutions, therefore, should not compensate branch managers and
other supervisors, or award bonuses or trips to such entities based on
sales of certain investments, if such awards could not be made directly
to Advisers under the standards set forth in the exemption. But even in
the absence of such incentives, the standards of reasonableness and
prudence set forth in the policies and procedures condition require the
Financial Institution to affirmatively oversee the incentives that may
be placed on Advisers by such entities to ensure that they do not
undermine the protections of the exemption.
i. Examples
The examples set forth below are intended to illustrate some
possible approaches that Financial Institutions could take to managing
Adviser incentives. They are not intended to provide detailed
descriptions of all the attributes of strong and effective policies and
procedures, but rather to describe broad approaches to mitigating
conflicts of interest. The examples are not intended to be an
exhaustive list of permissible approaches or mutually exclusive, and
range from examples that focus on eliminating or nearly eliminating
compensation differentials to examples that permit, but police, the
differentials. Moreover, these examples and the policies and procedures
are not intended as mere ``check the box'' exercises, but rather must
involve the adoption and monitoring of meaningful policies and
procedures reasonably and prudently designed to ensure Advisers'
adherence to the Impartial Conduct Standards. While the examples are
intended to provide guidance regarding the design of policies and
procedures, whether a specific set of policies and procedures is
sufficient will depend on the specific facts and circumstances.
The preamble to the proposed exemption also included a series of
examples. A number of commenters requested additional specificity, more
examples and safe harbors with respect to the policies and procedures
requirement. A few commenters made specific suggestions for safe
harbors or additional examples. For example, one commenter suggested
that compliance with policies and procedures requirements under
existing securities laws should suffice. Another suggested a series of
components of a safe harbor approach, based on controls and parameters
to limit conflicts of interest (including a potential cap on fees for
different product types) and other supervisory oversight. Another
offered an example under which the Financial Institution would permit
Advisers to receive either a commission that generally did not exceed
the average commission for similar products, or asset-based
compensation, but not both, with respect to any investment product,
with additional limitations and requirements. Another offered an
example focused on compliance with the terms of the exemption, but did
not offer any specific provisions addressing compensation and other
employment incentives.
The Department considered all the requests for additional examples
and safe harbors. The Department views commenters' suggestions as
outlining useful components of a Financial Institution's policies and
procedures. However, the Department views the limitations on
compensation and other employments incentives as a critical aspect of a
Financial Institution's policies and procedures, and the examples
offered by commenters generally did not demonstrate, in and of
themselves, sufficient mitigation of Adviser-level conflicts of
interest. Therefore, the Department did not adopt them as additional
examples or safe harbors.
To the extent Financial Institutions decide they need additional
guidance as to the adequacy of their policies and procedures as they
move forward with implementation of the exemption's requirements, the
Department is available to provide guidance on particular approaches.
Each of the examples below assumes that the Financial Institution
otherwise complies with all of the exemption's requirements; ensures
that any compensation paid to the Firm and the Adviser (whether
directly by the investor or indirectly by third parties) is reasonable
in relation to the services delivered to the investor; and that it
carefully supervises and oversees its Advisers' compliance with the
Impartial Conduct Standards, disclosure obligations, and other
requirements of the exemption.
Example 1: Independently certified computer models. The Adviser
interacts directly with the Retirement Investor, but makes
investment recommendations in accordance with an unbiased computer
model created by an independent third party. Under this example, the
Adviser could receive any form or amount of compensation so long as
the advice is rendered in strict accordance with the model.\65\
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\65\ As previously noted, this exemption is not available for
advice generated solely by a computer model and provided to the
Retirement Investor electronically without live advice.
Nevertheless, this exemption remains available in the hypothetical
because the advice is delivered by a live Adviser. This example
should not be read as retracting views the Department expressed in
prior Advisory Opinions regarding how an investment advice fiduciary
could avoid prohibited transactions that might result from
differential compensation arrangements. Specifically, in Advisory
Opinion 2001-09A, the Department concluded that the provision of
fiduciary investment advice would not result in prohibited
transactions under circumstances where the advice provided by the
fiduciary is the result of the application of methodologies
developed, maintained and overseen by a party independent of the
fiduciary in accordance with the conditions set forth in the
Advisory Opinion. A computer model also can be used as part of an
advice arrangement that satisfies the conditions under the
prohibited transaction exemption in ERISA section 408(b)(14) and
(g), described above.
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Example 2: Asset-based compensation. The Financial Institution
accepts differential compensation but pays the Adviser a percentage,
which does not vary based on the types of investments, of the dollar
amount of assets invested by the plans, participant and beneficiary
accounts, and IRAs with the Adviser. The Adviser earns the same
percentage on the same payment schedule, regardless of how the
Retirement Investor's assets are allocated between different
investments (e.g., equity securities, proprietary mutual funds, and
bonds underwritten by non-Related Entities), and the Financial
Institution gives particular attention to recommendations that
increase the Adviser's base (e.g., advice to roll money out of a
plan into IRA investments that generate fees for the Adviser).
Example 3: Fee offset. The Financial Institution establishes a
fee schedule for its services and the services of its Advisers. The
fees are competitive and reasonable in relation to the services
provided to the Retirement Investor and are not themselves intended
to nor would they reasonably be expected to cause Advisers to
violate the Impartial Conduct Standards. The Financial Institution
accepts transaction-based payments directly from the plan,
participant or beneficiary account, or IRA, and/or from third party
investment providers. To the extent the payments from third party
investment providers exceed the established fee, the additional
amounts are rebated to the plan, participant or beneficiary account,
or IRA. To the extent Third Party Payments do not satisfy the
established fee, the plan, participant or beneficiary account, or
IRA is charged directly for the remaining amount due.\66\ Regardless
of the investment chosen, the Financial Institution and the Adviser
retain only the compensation set forth in the fee schedule, which is
not in excess of reasonable compensation.
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\66\ Certain types of fee-offset arrangements may result in
avoidance of prohibited transactions altogether. In Advisory Opinion
Nos. 97-15A and 2005-10A, the Department explained that a fiduciary
investment adviser could provide investment advice to a plan with
respect to investment funds that pay it or an affiliate additional
fees without engaging in a prohibited transaction if those fees are
offset against fees that the plan otherwise is obligated to pay to
the fiduciary.
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Example 4: Commissions and stringent supervisory structure.\67\
The Financial
[[Page 21039]]
Institution establishes a commission-based compensation schedule for
Advisers in which all variation in commissions is eliminated for
recommendations of investments within reasonably designed
categories.\68\ The Financial Institution establishes supervisory
mechanisms to protect against conflicts of interest created by the
transaction-based model and takes special care to ensure that any
differentials that are retained are based on neutral factors, such
as the time or complexity of the work involved, and that the
differentials do not incentivize Advisers to violate the Impartial
Conduct Standards or operate to transmit firm-level conflicts of
interest to the Adviser (e.g., by increasing compensation based on
how much revenue or profits the investment products generate for the
Financial Institution).\69\ Accordingly, the Financial Institution
does not provide an incentive for the Adviser to recommend one
mutual fund over another, or to recommend one category of
investments over another, based on the greater compensation the
Financial Institution would receive. But it might, for example, draw
a distinction between variable annuities and mutual funds based on
the additional time it has determined is necessary for client
communications and oversight with respect to these annuities. The
Financial Institution adopts a stringent supervisory structure to
ensure that Advisers' recommendations are based on the customer's
financial interest, and not on the additional compensation the
Adviser stands to make by recommending, for example, more frequent
transactions or products for which greater compensation is provided.
Examples of components of a prudent supervisory structure include:
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\67\ All three of the examples above could be used in connection
with commission-based payment structures, as well as in connection
with other compensation arrangements.
\68\ As noted in the text, none of these examples are meant to
be exclusive. For example, the exemption might also be satisfied if
a Financial Institution adopted an arrangement under which Advisers
are compensated by commissions with no variation at all, regardless
of the category of investment.
\69\ FINRA's ``Report on Conflicts of Interest'' (Oct. 2013)
suggested that firms could use `neutral compensation grids.' In
constructing such grids, however, the firm would need to be careful
to ensure that it was not simply transmitting firm-level conflicts
to the Adviser by tying the Adviser's compensation directly to the
profitability of a recommendation to the firm. Under the terms of
this exemption, the firm may not use compensation practices that a
reasonable person would view as encouraging persons to violate the
best interest standard by, for example, favoring the firm's
financial interest at the customers' expense.
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Establishment of a comprehensive system to monitor and
supervise Adviser recommendations, evaluate the quality of the
advice individual customers receive, properly train Advisers, and
correct any identified problems. Particular attention is given to
recommendations associated with higher compensation and
recommendations at key liquidity events of an investor (e.g.,
rollovers).
Systems to evaluate whether Advisers recommend
imprudent reliance on investment products sold by or through the
Financial Institution. If the conditions of section IV(b)(3) of the
exemption apply (relating to Proprietary Products and Third Party
Payments), systems to assess the validity of any assumptions
underlying the required written determination and mechanisms to
ensure that Advisers provide advice consistent with the analysis,
with particular attention to any assumptions or conclusions about
how much money a prudent investor would invest in particular classes
of products or products with certain features.
The use of metrics for behavior (e.g., red flags),
comparing an Adviser's behavior against those metrics, and basing
compensation in part on them. These metrics include measures aimed
at preventing conflicts from transaction-based fees from biasing
advice (e.g., churning measures).
Penalizing Advisers and supervisors (including the
branch manager) by reducing compensation based on the receipt of
customer complaints or indications that conflicts are not being
carefully managed, and/or using clawback provisions to revoke some
or all of deferred compensation based on the failure to properly
manage conflicts of interest.
Appointment of a committee to assess the risks and
conflicts associated with new investment products, determine the
prudence of the products for retirement investors, and assess the
adequacy of the Financial Institution's procedures to police any
associated conflicts of interest.
Ensuring that no Adviser nor any supervisor (including
the branch manager) participates in any revenue sharing from a
``preferred provider,'' earns more for the sale of a product issued
by a ``preferred provider,'' or earns more for the sale of a
Proprietary Product over other comparable products, and ensuring
that the Adviser discloses to customers the payments that the
Financial Institution and its Affiliates have received from a
preferred provider or for a Proprietary Product.
The Financial Institution periodically reviews, and
revises as necessary, the policies and procedures to ensure that
they are appropriately safeguarding proper fiduciary conduct, and
that the factors used to justify any compensation differentials
(e.g., time) remain appropriate, that they reflect neutral factors
tied to differences in the services delivered to the investor (as
opposed to differences in the amounts paid to the Financial
Institution by different mutual fund complexes), and that they are
neutral in application as well as selection. In this regard, the
Financial Institution needs to take special care in defining the
categories to ensure that they reflect the application of such
neutral factors to genuine differences in the nature of the advice
relationship.
Example 5: Rewards for Best Interest Advice. The Financial
Institution's policies and procedures establish a compensation
structure that is reasonably designed to reward Advisers for giving
advice that adheres to the Impartial Conduct Standards. For example,
this might include compensation that is primarily asset-based, as
discussed in Example 2, with the addition of bonuses and other
incentives paid to promote advice that is in the Best Interest of
the Retirement Investor. While the compensation would be variable,
it would align with the customer's best interest.
As indicated above, these examples are meant to be illustrative,
not exhaustive, and many other compensation and employment arrangements
may satisfy the contractual warranties. The exemption imposes a broad
standard for the warranty and policies and procedures requirement, not
an inflexible and highly-prescriptive set of rules. The Financial
Institution retains the latitude necessary to design its compensation
and employment arrangements, provided that those arrangements promote,
rather than undermine, the Best Interest and other Impartial Conduct
Standards. Whether a Financial Institution adopts one of the specific
approaches taken in the examples above or a different approach, the
Department expects that it will engage in a prudent process to
establish and oversee policies and procedures that will effectively
mitigate conflicts of interest and ensure adherence to the Impartial
Conduct Standards. It is important that the Financial Institution
carefully monitor whether the policies and procedures are, in fact,
working to prevent the provision of biased advice. The Financial
Institution must correct isolated or systemic violations of the
Impartial Conduct Standards and reasonably revise policies and
procedures when failures are identified.
ii. Neutral Factors
A number of commenters addressed Example 4 in the preamble to the
proposed exemption, which, like Example 4 above, illustrated a
compensation structure for differential payments, such as commissions.
In the proposal the example suggested a model permitting payment of
differential compensation based on neutral factors, such as ``a
reasonable assessment of the time and expertise necessary to provide
prudent advice on the product or other reasonable and objective neutral
factors.'' \70\
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\70\ See Preamble to the proposed Best Interest Contract
Exemption, 80 FR at 21971 (April 20, 2015).
---------------------------------------------------------------------------
Some commenters expressed significant support for this approach and
urged the Department to clearly limit the receipt of differential
compensation in the final exemption to differential compensation based
only on neutral factors. A commenter stated that a limitation to
differential compensation based on neutral factors would be a
significant improvement over the status quo. Other commenters indicated
the
[[Page 21040]]
view that differential compensation based on non-neutral factors would
be likely to encourage advice that is not in Retirement Investors' Best
Interest. Some of these commenters urged that the exemption explicitly
prohibit differential compensation based on non-neutral factors, and
that the Department make clear that the neutral factors had to be based
on empirical assessments so as to ensure that the exemption afforded
the desired protections to Retirement Investors.
Some industry commenters took issue with the neutral factors
example. FINRA and other commenters asserted that while the exemption
applied to differential compensation such as trailing commissions, 12b-
1 fees and revenue sharing, it would not be easy for Financial
Institutions to demonstrate that such payments are based on neutral
factors. Commenters expressed the view that the example appeared to
establish a subjective standard that could expose them to class action
litigation, and there were requests for more certainty or a safe harbor
regarding the compliance with the exemption for differential
compensation. One commenter stated that prices are established by third
party product manufacturers and the neutral factors analysis would
require a complete overhaul of existing practices. The commenter
indicated there might be antitrust concerns with such an approach.
FINRA further suggested that the proposal permit Financial Institutions
to choose between adopting stringent policies and procedures that
address the conflicts of interest arising from differential
compensation, or pay only neutral compensation to Advisers.
The Department has considered these competing comments and
determined for purposes of this preamble to limit the example regarding
differential compensation to one based on neutral factors. The
Department agrees with the commenters that suggested that differential
compensation based on non-neutral factors is likely to encourage advice
that is not in Retirement Investors' Best Interest. While the policies
and procedures requirement is intended to give necessary flexibility to
Financial Institutions, the Department emphasizes that the policies
must be reasonably and prudently designed to ensure that Advisers
adhere to the Impartial Conduct Standards, and the compensation
structures must be prudently designed to avoid an inappropriate
misalignment of the Advisers' interests with the interests of the
Retirement Investors they serve a fiduciaries. Thus, for example, it
would be impermissible for a Financial Institution to use or permit
ratcheted compensation thresholds that enable an Adviser to
disproportionately increase the amount of his or her compensation based
on a specific recommendation to an individual investor. Similarly, the
Financial Institution and related parties could not use or permit the
use of bonuses, prizes, travel, entertainment, cash or noncash
compensation that a reasonable person would expect to cause the
preferential recommendation of a specific investment product or
feature, without regard to the best interest of the Retirement Investor
(e.g., by setting quotas or awarding trips or prizes for the sale of
particular products or of investments in a particular mutual fund
complex). After consideration, the Department does not agree that
differential compensation based on neutral factors raises antitrust
concerns. Such a compensation structure does not restrict the amount
that a Financial Institution may receive from a third party product
manufacturer, only the manner in which the Financial Institution
compensates its Advisers. Nothing would require third party product
manufacturers to collude, or even to pay Financial Institutions
identically. Financial Institutions may pick different neutral factors
as compared to other Financial Institutions, and may weigh such factors
differently. Such unilateral business decisions do not require
Financial Institutions to violate antitrust laws.
While differential payments are permitted, the differentials must
reflect neutral factors, not the higher compensation the Financial
Institution stands to gain by recommending one investment rather than
another. Therefore, while pure mathematical precision is not necessary
to justify differential payments, it would not be permissible to draw
categories based on the differential compensation the Financial
Institution receives from different mutual fund complexes, or
differences in the amounts paid to the firm for different annuities or
riders. Financial Institutions should be prepared to justify the
reasons for differential payments to Advisers, to demonstrate that they
are not based on what is more lucrative to the Financial Institution.
In addition, the neutral factors must be neutral in application as well
as in selection. Differentials based on neutral factors that operate in
practice to encourage Advisers to violate the Impartial Conduct
Standards are not permissible.
In addition to basing differential compensation on neutral factors,
it is important for Financial Institutions that pay differential
compensation to employ supervisory oversight structures. This is
particularly necessary to ensure that Advisers are making
recommendations between different categories based on the customer's
financial interest, and not on the differential compensation the
Adviser stands to make. But more fundamentally, Financial Institutions
will not be able to ensure that their Advisers are providing advice in
accordance with the Impartial Conduct Standards without appropriate
supervision. Accordingly, the final exemption does not adopt FINRA's
suggestion that the proposal permit Financial Institutions to choose
between adopting stringent policies and procedures that address the
conflicts of interest arising from differential compensation, or pay
only neutral compensation to Advisers. Both are required.
d. Contractual Warranty Versus Exemption Condition
In the proposal, both the Adviser and Financial Institution had to
give a warranty to the Retirement Investor about the adoption and
implementation of anti-conflict policies and procedures. A few
commenters indicated that the Adviser should not be required to give
the warranty, and questioned whether the Adviser would always be in a
position to speak to the Financial Institution's incentive and
compensation arrangements. The Department agrees that the Financial
Institution has the primary responsibility for design and
implementation of the policies and procedures requirement and,
accordingly, has limited the warranty requirement to the Financial
Institution.
Some commenters believed that even if the Department included a
policies and procedure requirement in the exemption, it should not
require a warranty on implementation and compliance with the
requirement. According to some of these commenters the warranty was
unnecessary in light of the Best Interest standard, and would unduly
contribute to litigation risk. A few commenters also suggested that a
Financial Institution's failure to comply with the contractual warranty
could give rise to a cause of action to Retirement Investors who had
suffered no injuries from failure to implement or comply with
appropriate policies and procedures. A few other commenters expressed
concern that the provision of a ``warranty'' could result in tort
liability, rather than just contractual liability.
Other commenters argued that the Department should require
Financial Institutions not only to make an enforceable warranty as a
condition of
[[Page 21041]]
the exemption, but also require actual compliance with the warranty as
a condition of the exemption. One such commenter argued that it would
be difficult for Retirement Investors to prove that policies and
procedures were not ``reasonably designed'' to achieve the required
purpose.
As noted above, the final exemption adopts the required policies
and procedures as a condition of the exemption. The policies and
procedures requirement is a critical part of the exemption's
protections. The risk of liability associated with a non-exempt
prohibited transaction gives Financial Institutions a strong incentive
to design protective policies and procedures in a way that is
consistent with the purposes and requirements of this exemption.
In addition, the final exemption requires the Financial Institution
to make a warranty regarding the policies and procedures in contracts
with Retirement Investors regarding IRAs and other non-ERISA plans. The
warranty, and potential liability associated with that warranty, gives
Financial Institutions both the obligation and the incentive to tamp
down harmful conflicts of interest and protect Retirement Investors
from misaligned incentives that encourage Advisers to violate the Best
Interest standard and other fiduciary obligations and ensures that
there is a means to redress the failure to do so. While the warranty
exposes Financial Institutions and Advisers to litigation risk, these
risks are circumscribed by the availability of binding arbitration for
individual claims and the legal restrictions that courts generally use
to police class actions.
The Department does not share a commenter's view that it would be
too difficult for Retirement Investors to prove that the policies and
procedures were not ``reasonably designed'' to achieve the required
purpose. The final exemption requires the Financial Institution to
disclose Material Conflicts of Interest to Retirement Investors and to
describe its policies and procedures for safeguarding against those
conflicts of interest. These disclosures should assist Retirement
Investors in assessing the care with which Financial Institutions have
designed their procedures, even if they are insufficient to fully
convey how vigorously the Financial Institution implements the
protections. In some cases, a systemic violation, or the possibility of
such a violation, may be apparent on the face of the policies. In other
cases, normal discovery in litigation may provide the information
necessary. Certainly, if a Financial Institution were to provide
significant prizes or bonuses for Advisers to push investments that
were not in the Best Interest of Retirement Investors, Retirement
Investors would often be in a position to pursue the claim. Most
important, however, the enforceable obligation to maintain and comply
with the policies and procedures as set forth herein, and to make
relevant disclosures of the policies and procedures and of Material
Conflicts of Interest, should create a powerful incentive for Financial
Institutions to carefully police conflicts of interest, reducing the
need for litigation in the first place.
In response to commenters that expressed concern about the specific
use of the term ``warranty,'' the Department intends the term to have
its standard meaning as a ``promise that something in furtherance of
the contract is guaranteed by one of the contracting parties.'' \71\
The Department merely requires that the contract with IRA and non-ERISA
plan investors include an express enforceable promise of compliance
with the policies and procedures condition. As previously discussed,
the potential liability for violation of the warranty is cabined by the
availability of non-binding arbitration in individual claims, and the
ability to waive claims for punitive damages and rescission to the
extent permitted by applicable law.
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\71\ Black's Law Dictionary 10th ed. 2014.
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Additionally, although the policies and procedure requirement
applies equally to ERISA plans, the final exemption does not require
Financial Institutions to make a warranty with respect to ERISA plans,
just as it does not require the execution of a contract with respect to
ERISA plans. For these plans, a separate warranty is unnecessary
because Title I of ERISA already provides an enforcement mechanism for
failure to comply with the policies and procedures requirement. Under
ERISA sections 502(a), plan participants, fiduciaries, and the
Secretary of Labor have ready means to enforce any failure to meet the
conditions of the exemption, including a failure to comply with the
policies and procedure requirement. A Financial Institution's failure
to comply with the exemption's policies and procedure requirements
would result in a non-exempt prohibited transaction under ERISA section
406 and would likely constitute a fiduciary breach under ERISA section
404. As a result, a plan participant or beneficiary, plan fiduciary,
and the Secretary would be able to sue under ERISA section 502(a) to
recover any loss in value to the plan (including the loss in value to
an individual account), or to obtain disgorgement of any wrongful
profits or unjust enrichment. Accordingly, the warranty is unnecessary
in the context of ERISA plans.
e. Compliance With Laws Proposed Warranty
The proposed exemption also contained a requirement for the Adviser
and Financial Institution to warrant that they and their Affiliates
would comply with all applicable federal and state laws regarding the
rendering of the investment advice, the purchase, sale or holding of
the Asset and the payment of compensation related to the purchase, sale
and holding. While the Department did receive some support for this
condition in comments, several commenters opposed this warranty
proposal as being overly broad, and urged that it be deleted. These
commenters argued that the warranty could create contract claims based
on a wide variety of state and federal laws, without regard to the
limitations imposed on individual actions under those laws. In
addition, commenters suggested that many of the violations associated
with these laws could be quite minor or unrelated to the Department's
concerns about conflicts of interest. In response to these concerns,
the Department has eliminated this warranty from the final exemption.
6. Ineligible Provisions--Section II(f)
Under Section II(f) of the final exemption, relief is not available
if a Financial Institution's contract with Retirement Investors
regarding investments in IRAs and non-ERISA plans contains the
following:
(1) Exculpatory provisions disclaiming or otherwise limiting
liability of the Adviser or Financial Institution for a violation of
the contract's terms;
(2) Except as provided in paragraph (f)(4), a provision under
which the Plan, IRA or Retirement Investor waives or qualifies its
right to bring or participate in a class action or other
representative action in court in a dispute with the Adviser or
Financial Institution, or in an individual or class claim agrees to
an amount representing liquidated damages for breach of the
contract; provided that, the parties may knowingly agree to waive
the Retirement Investor's right to obtain punitive damages or
rescission of recommended transactions to the extent such a waiver
is permissible under applicable state or federal law; or
(3) Agreements to arbitrate or mediate individual claims in
venues that are distant or that otherwise unreasonably limit the
ability of the Retirement Investors to assert the claims safeguarded
by this exemption.
Section II(f)(4), provides that, in the event the provision on pre-
dispute
[[Page 21042]]
arbitration agreements for class or representative claims in paragraph
(f)(2) is ruled invalid by a court of competent jurisdiction, the
provision shall not be a condition of the exemption with respect to
contracts subject to the court's jurisdiction unless and until the
court's decision is reversed, but all other terms of the exemption
shall remain in effect.
The purpose of Section II(f) is to ensure that Retirement Investors
receive the full benefit of the exemption's protections by preventing
them from being contracted away. If an Adviser makes a recommendation,
for a fee or other compensation, within the meaning of the Regulation,
he or she may not disclaim the duties or liabilities that flow from the
recommendation. For similar reasons, the exemption is not available if
the contract includes provisions that purport to waive a Retirement
Investor's right to bring or participate in class actions. However,
contract provisions in which Retirement Investors agree to arbitrate
any individual disputes are allowed to the extent permitted by
applicable state law. Moreover, Section II(f) does not prevent
Retirement Investors from voluntarily agreeing to arbitrate class or
representative claims after the dispute has arisen.
The Department's approach in this respect is consistent with
FINRA's rules permitting mandatory pre-dispute arbitration for
individual claims, but not for class action claims.\72\ This rule was
adopted in 1992, in response to a directive, articulated by former SEC
Chairman David Ruder, that investors have access to courts in
appropriate cases.\73\ Section 12000 of the FINRA manual establishes a
Code of Arbitration Procedure for Customer Disputes which sets forth
rules on, inter alia, filing claims, amending pleadings, prehearing
conferences, discovery, and sanctions for improper behavior.
---------------------------------------------------------------------------
\72\ FINRA Rule 12204(a) provides that class actions may not be
arbitrated under the FINRA Code of Arbitration Procedures. FINRA
Rule 2268(d)(3) provides that no predispute arbitration agreement
may limit the ability of a party to file any claim in court
permitted to be filed in court under the rules of the forums in
which a claim may be filed under the agreement. The FINRA Board of
Governors has ruled that a broker's predispute arbitration agreement
with a customer may not include a waiver of the right to file or
participate in a class action in court. In Dept. of Enforcement v.
Charles Schwab & Co., Complaint No. 2011029760201 (Apr. 24, 2014).
\73\ NASD Notice 92-65 SEC Approval of Amendments Concerning the
Exclusion of Class-Action Matters from Arbitration Proceedings and
Requiring that Predispute Arbitration Agreements Include a Notice
That Class-Action Matters May Not Be Arbitrated, available at http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=1660.
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A number of commenters addressed the proposed approach to
arbitration and the other ineligible provisions in Section II(f). A
discussion of the comments and the Department's responses follow.
a. Exculpatory Provisions
The Department included Section II(f)(1) in the final exemption
without changes from the proposal. Commenters did, however, raise a few
questions on the provision. In particular, commenters asked whether the
contract could disclaim liability for acts or omissions of third
parties, and whether there could be venue selection clauses. In
addition, commenters asked whether the contract could require
exhaustion of arbitration or mediation before filing in court.
Section II(f)(1) does not prevent a Financial Institution's
contract with IRA and non-ERISA plan investors from disclaiming
liability for acts or omissions of third parties to the extent
permissible under applicable law. In addition, for individual claims,
reasonable arbitration and mediation requirements are not prohibited.
In response to questions about venue selection, the final exemption
includes a new Section II(f)(3), which provides that investors may not
be required to arbitrate or mediate their individual claims in
unreasonable or distant venues that are distant or that otherwise
unreasonably limit their ability to assert the claims safeguarded by
this exemption.
The Department has not revised Section II(f) to address every
provision that may or may not be included in the contract. While some
commenters submitted specific requests regarding specific contract
language, and others suggested the Department provide model contracts
for Financial Institutions to use, the Department has declined to make
these changes in the exemption. The Department notes that Section
II(f)(1) prohibits all exculpatory provisions disclaiming or otherwise
limiting liability of the Adviser or Financial Institution for a
violation of the contract's terms, and Section II(g)(5) prohibits
Financial Institutions and Advisers from purporting to disclaim any
responsibility or liability for any responsibility, obligation, or duty
under Title I of ERISA to the extent the disclaimer would be prohibited
by Section 410 of ERISA. Therefore, in response to comments regarding
choice of law provisions, modifying ERISA's statute of limitations, and
imposing obligations on the Retirement Investor, the Financial
Institutions must determine whether their specific provisions are
exculpatory and would disclaim or limit their liability under ERISA, or
that of their Advisers. If so, they are not permitted. The Department
will provide additional guidance in response to questions and
enforcement proceedings.
b. Arbitration
Section II(f)(2) of the final exemption adopts the approach, as
proposed, that individual claims may be the subject of contractual pre-
dispute binding arbitration. Class or other representative claims,
however, must be allowed to proceed in court. The final exemption also
provides that contract provisions may not limit recoveries to an amount
representing liquidated damages for breach of the contract. However,
the final exemption expressly permits Retirement Investors to knowingly
waive their rights to obtain punitive damages or rescission of
recommended transactions to the extent such waivers are permitted under
applicable law.
Commenters on the proposed exemption were divided on the approach
taken in the proposal, as discussed below. Some commenters objected to
limiting Retirement Investors' right to sue in court on individual
claims and specifically focused on FINRA's arbitration procedures.
These commenters described FINRA's arbitration as an unequal playing
field, with insufficient protections for individual investors. They
asserted that arbitrators are not required to follow federal or state
laws, and so would not be required to enforce the terms of the
contract. In addition, commenters complained that the decision of an
arbitrator generally is not subject to appeal and cannot be overturned
by any court. According to these commenters, even when the arbitrators
find in favor of the consumer, the consumers often receive
significantly smaller recoveries than they deserve. Moreover, some
asserted that binding pre-dispute arbitration may be contrary to the
legislative intent of ERISA, which provides for ``ready access to
federal courts.''
Some commenters opposed to arbitration indicated that preserving
the right to bring or participate in class actions in court would not
give Retirement Investors sufficient access to courts. According to
these commenters, allowing Financial Institutions to require resolution
of individual claims by arbitration would impose additional and
unnecessary hurdles on investors seeking to enforce the Best Interest
standard. One commenter warned that the Regulation would make it more
difficult for Retirement Investors to pursue class actions because the
[[Page 21043]]
individualized requirements for proving fiduciary status could
undermine any claims about commonality. Commenters said that class
action lawsuits tend to be expensive and protracted, and even where
successful, investors often recover only a small portion of their
losses.
Other commenters just as forcefully supported pre-dispute binding
arbitration agreements. Some asserted that arbitration is generally
quicker and less costly than judicial proceedings. They argued that
FINRA has well-developed protections in place to protect the interests
of aggrieved investors. One commenter pointed out that FINRA requires
that the arbitration provisions of a contract be highlighted and
disclosed to the customer, and that customers be allowed to choose an
``all-public'' panel of arbitrators.\74\ FINRA rules also impose larger
filing fees on the industry party than on the investor. Commenters also
cited evidence that investors are as likely to prevail in arbitration
proceedings as they are in court, and even argued that permitting
mandatory arbitration for all disputes would be in investors' best
interest.
---------------------------------------------------------------------------
\74\ The term ``Public Arbitrator'' is defined in FINRA Rule
12100(u). According to FINRA, non-``Public Arbitrators'' are often
referred to as ``industry'' arbitrators. See Final Report and
Recommendations of the FINRA Dispute Resolution Task Force, released
December 16, 2015.
---------------------------------------------------------------------------
A number of commenters argued that arbitration should be available
for all disputes that may arise under the exemption, including class or
representative claims. Some of these commenters favored arbitration of
class claims due to concerns about costs and potentially greater
liability associated with class actions brought in court. Some
commenters took the position that the ability of the Retirement
Investor to participate in class actions could deter Financial
Institutions from relying on the exemption at all.
After consideration of the comments on this subject, the Department
has decided to adopt the general approach taken in the proposal.
Accordingly, contracts with Retirement Investors may require pre-
dispute binding arbitration of individual disputes with the Adviser or
Financial Institution. The contract, however, must preserve the
Retirement Investor's right to bring or participate in a class action
or other representative action in court in such a dispute in order for
the exemption to apply.
The Department recognizes that for many claims, arbitration can be
more cost-effective than litigation in court. Moreover, the exemption's
requirement that Financial Institutions acknowledge their own and their
Advisers' fiduciary status should eliminate an issue that frequently
arises in disputes over investment advice. In addition, permitting
individual matters to be resolved through arbitration tempers the
litigation risk and expense for Financial Institutions, without
sacrificing Retirement Investors' ability to secure judicial relief for
systemic violations that affect numerous investors through class
actions.
On the other hand, the option to pursue class actions in court is
an important enforcement mechanism for Retirement Investors. Class
actions address systemic violations affecting many different investors.
Often the monetary effect on a particular investor is too small to
justify pursuit of an individual claim, even in arbitration. Exposure
to class claims creates a powerful incentive for Financial Institutions
to carefully supervise individual Advisers, and ensure adherence to the
Impartial Conduct Standards. This incentive is enhanced by the
transparent and public nature of class proceedings and judicial
opinions, as opposed to arbitration decisions, which are less visible
and pose less reputational risk to firms or Advisers found to have
violated their obligations.
The ability to bar investors from bringing or participating in such
claims would undermine important investor rights and incentives for
Advisers to act in accordance with the Best Interest standard. As one
commenter asserted, courts impose significant hurdles for bringing
class actions, but where investors can surmount these hurdles, class
actions are particularly well suited for addressing systemic breaches.
Although by definition communications to a specific investor generally
must have a degree of specificity in order to constitute fiduciary
advice, a class of investors should be able to satisfy the requirements
of commonality, typicality and numerosity where there is a systemic or
wide-spread problem, such as the adoption or implementation of non-
compliant policies and procedures applicable to numerous Retirement
Investors, the systematic use of prohibited or misaligned financial
incentives, or other violations affecting numerous Retirement Investors
in a similar way. Moreover, the judicial system ensures that disputes
involving numerous retirement investors and systemic issues will be
resolved through a well-established framework characterized by
impartiality, transparency, and adherence to precedent. The results and
reasoning of court decisions serve as a guide for the consistent
application of that law in future cases involving other Retirement
Investors and Financial Institutions.
This is consistent with the approach long adopted by FINRA and its
predecessor self-regulatory organizations. FINRA Arbitration rule 12204
specifically bars class actions from FINRA's arbitration process and
requires that pre-dispute arbitration agreements between brokers and
customers contain a notice that class action matters may not be
arbitrated. In addition, it provides that a broker may not enforce any
arbitration agreement against a member of certified or putative class
action, until the certification is denied, the class action is
decertified, the class member is excluded from, or elects not
participate in, the class. This rule was adopted by the National
Association of Securities Dealers and approved by the SEC in 1992.\75\
In the release announcing this decision, the SEC stated:
---------------------------------------------------------------------------
\75\ SEC Release No. 34-31371 (Oct. 28, 1992), 1992 WL 324491.
[T]he NASD believes, and the Commission agrees, that the
judicial system has already developed the procedures to manage class
action claims. Entertaining such claims through arbitration at the
NASD would be difficult, duplicative and wasteful. . . . The
Commission agrees with the NASD's position that, in all cases, class
actions are better handled by the courts and that investors should
have access to the courts to resolve class actions efficiently.\76\
---------------------------------------------------------------------------
\76\ Id.
In 2014, the FINRA Board of Governors upheld this rule in reviewing an
enforcement action.\77\
---------------------------------------------------------------------------
\77\ FINRA Decision, Department of Enforcement v. Charles Schwab
& Co. (Complaint 2011029760201), p. 14 (Apr. 24, 2014).
---------------------------------------------------------------------------
Additional Protections
One commenter suggested that if the Department preserved the
ability of a Financial Institution to require arbitration of claims, it
should consider requiring a series of additional safeguards for
arbitration proceedings permitted under the exemption. The commenter
suggested that the conditions could state that (i) the arbitrator must
be qualified and independent; (ii) the arbitration must be held in the
location of the person challenging the action; (iii) the cost of the
arbitration must be borne by the Financial Institution; (iv) the
Financial Institution's attorneys' fees may not be shifted to the
Retirement Investor, even if the challenge is unsuccessful; (v)
statutory remedies may not be limited or altered by the contract; (vi)
access to adequate discovery must be permitted; (vii) there must be a
written record and a written decision; (viii) confidentiality
[[Page 21044]]
requirements and protective orders which would prohibit the use of
evidence in subsequent cases must be prohibited. The commenter said
that some, but not all, of these procedures are currently required by
FINRA.
The Department declines to mandate additional procedural safeguards
for arbitration beyond those already mandated by other applicable
federal and state law, or self-regulatory organizations. In the
Department's view, the FINRA arbitration rules, in particular, provide
significant safeguards for fair dispute resolution, notwithstanding the
concerns raised by some commenters. FINRA's Code of Arbitration
Procedures for Customer Disputes applies when required by written
agreement between the FINRA member and the customer, or if the customer
requests arbitration. The rules cover any dispute between the member
and the customer that arises from the member's business activities,
except for disputes involving insurance business activities of a member
that is an insurance company.\78\ FINRA's code of procedures also
provide detailed instructions for initiating and pursuing an
arbitration, including rules for selection of arbitrators (Rule 12400),
for discovery of evidence (Rule 12505), and expungement of customer
dispute information (Rule 12805), which are designed to allow access by
investors and preserve fairness for the parties. In addition, Rule
12213 specifies that FINRA will generally select the hearing location
closest to the customer. To the extent that the contracts provide for
binding arbitration in individual claims, the Department defers to the
judgment of FINRA and other regulatory bodies, such as state insurance
regulators, responsible for determining the safeguards applicable to
arbitration proceedings.
---------------------------------------------------------------------------
\78\ FINRA Rule 12200.
---------------------------------------------------------------------------
One commenter focused on dispute resolution processes engaged in by
entities licensed as fraternal benefit societies under the laws of a
State and exempt from federal income taxation under code section
501(c)(8). The commenter requested that these entities be carved out
from the prohibitions of Section II(f) if they provided laws or rules
for grievance or complaint procedures for members. The Department has
declined to provide special provisions for specific parties based on
mission or tax exempt status. Nothing in the legal structure relating
to such organizations uniformly requires that their dispute-resolution
processes adhere to stringent protective standards. Nevertheless, the
Department notes that as long as Section II(f) and Section II(g)(5) are
satisfied, the exemption would not be violated by a Financial
Institution's adoption of additional protections for customers beyond
the requirements of applicable regulators, such as payment of
administrative costs of mediation and/or arbitration, as is the
practice of some fraternal benefit societies.
Federal Arbitration Act
Some commenters asserted that the Department does not have the
authority to include the exemption's provisions on class action waivers
under the Federal Arbitration Act (FAA), which they said protects
enforceable arbitration agreements and expresses a federal policy in
favor of arbitration over litigation. Without clear statutory authority
to restrict arbitration, these commenters said, the Department cannot
include the provisions on class action waivers.
These comments misconstrue the effect of the FAA on the
Department's authority to grant exemptions from prohibited
transactions. The FAA protects the validity and enforceability of
arbitration agreements. Section 2 of the FAA states: ``[a] written
provision in any . . . contract . . . to settle by arbitration a
controversy thereafter arising out of such contract . . . shall be
valid, irrevocable, and enforceable, save upon such grounds as exist at
law or in equity for the revocation of any contract.'' \79\ This Act
was intended to reverse judicial hostility to arbitration and to put
arbitration agreements on an equal footing with other contracts.\80\
---------------------------------------------------------------------------
\79\ 9 U.S.C. 2.
\80\ See AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 342
(2011).
---------------------------------------------------------------------------
Section II(f)(2) of the exemption is fully consistent with the FAA.
The exemption does not purport to render an arbitration provision in a
contract between a Financial Institution and a Retirement Investor
invalid, revocable, or unenforceable. Nor, contrary to the concerns of
one commenter, does Section II(f)(2) prohibit such waivers. Both
Institutions and Advisers remain free to invoke and enforce arbitration
provisions, including provisions that waive or qualify the right to
bring a class action or any representative action in court. Instead,
such a contract simply does not meet the conditions for relief from the
prohibited transaction provisions of ERISA and the Code. As a result,
the Financial Institution and Adviser would remain fully obligated
under both ERISA and the Code to refrain from engaging in prohibited
transactions. In short, Section II(f)(2) does not affect the validity,
revocability, or enforceability of a class-action waiver in favor of
individual arbitration. This regulatory scheme is thus a far cry from
the State judicially created rules that the Supreme Court has held
preempted by the FAA,\81\ and the National Labor Relations Board's
attempt to prohibit class-action waivers as an ``unfair labor
practice.'' \82\
---------------------------------------------------------------------------
\81\ See American Express Co. v. Italian Colors Restaurant, 133
S. Ct. 2304 (2013); AT&T Mobility LLC v. Concepcion, 563 U.S. 333
(2011).
\82\ See D.R. Horton, Inc. v. NLRB, 737 F.3d 344 (5th Cir.
2013).
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The Department has broad discretion to craft exemptions subject to
its overarching obligation to ensure that the exemptions are
administratively feasible, in the interests of plan participants,
beneficiaries, and IRA owners, and protective of their rights. In this
instance, the Department has concluded that the enforcement rights and
protections associated with class action litigation are important to
safeguarding the Impartial Conduct Standards and other anti-conflict
provisions of the exemption. If a Financial Institution enters into a
contract requiring binding arbitration of class claims, the Department
would not purport to invalidate the provision, but rather would insist
that the Financial Institution fully comply with statutory provisions
prohibiting conflicted fiduciary transactions in its dealings with its
Retirement Investment customers. The FAA is not to the contrary. It
neither limits the Department's express grant of discretionary
authority over exemptions, nor entitles parties that enter into
arbitration agreements to a pass from the prohibited transaction rules.
While the Department is confident that its approach in the
exemption does not violate the FAA, it has carefully considered the
position taken by several commenters that the Department exceeded its
authority in including provisions in the exemption on waivers of class
and representative claims, and the possibility that a court might rule
that the condition regarding arbitration of class claims in Section
II(f)(2) of the exemption is invalid based on the FAA. Accordingly, in
an abundance of caution, the Department has specifically provided that
Section II(f)(2) can be severable if a court finds it invalid based on
the FAA. Specifically, Section II(f)(4) provides that:
In the event that the provision on pre-dispute arbitration
agreements for class or representative claims in paragraph (f)(2) of
this Section is ruled invalid by a court of
[[Page 21045]]
competent jurisdiction, this provision shall not be a condition of
this exemption with respect to contracts subject to the court's
jurisdiction unless and until the court's decision is reversed, but
all other terms of the exemption shall remain in effect.
The Department is required to find that the provisions of an
exemption are administratively feasible, in the interests of plans and
their participants and beneficiaries and IRA owners, and protective of
the rights of participants and beneficiaries and IRA owners. The
Department finds that the exemption with Section II(f)(2) satisfies
these requirements. The Department believes, consistent with the
position of the SEC and FINRA, that the courts are generally better
equipped to handle class claims than arbitration procedures and that
the prohibition on contractual provisions mandating arbitration of such
claims helps the Department makes the requisite statutory findings for
granting an exemption.
Nevertheless, the Department has determined that, based on all the
exemption's other conditions, it can still make the necessary findings
to grant the exemption even without the condition prohibiting pre-
dispute agreements to arbitrate class claims. In particular, if a court
were to invalidate the condition, the Department would still find that
the exemption is administratively feasible, in the interests of plans
and their participants and beneficiaries, and protective of the rights
of the participants and beneficiaries. It would be less protective, but
still sufficient to grant the exemption.
The Department's adoption of the specific severability provision in
Section II(f)(4) of the exemption should not be viewed as evidence of
the Department's intent that no other conditions of this or the other
exemptions granted today are severable if a court were to invalidate
them. Instead, the Department intends that invalidated provisions of
the rule and exemptions may be severed when the remainder of the rule
and exemptions can function sensibly without them.\83\
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\83\ See Davis County Solid Waste Management v. United States
Environmental Protection Agency, 108 F.3d 1454, 1459 (D.C. Cir.
1997) (finding that severability depends on an agency's intent and
whether the provisions can operate independently of one another).
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c. Remedies
Some commenters asked whether the proposal's prohibition of
exculpatory clauses would affect the parties' ability to limit remedies
under the contract, particularly regarding liquidated damages, punitive
damages, consequential damages and rescission. In response, the
Department has added text to Section II(f)(2) in the final exemption
clarifying that the parties, in an individual or class claim, may not
agree to an amount representing liquidated damages for breach of the
contract. However, the exemption, as finalized, expressly permits the
parties to knowingly agree to waive the Retirement Investor's right to
obtain punitive damages or rescission of recommended transactions to
the extent such a waiver is permissible under applicable state or
federal law.
In the Department's view, it is sufficient to the exemptions'
protective purposes to permit recovery of actual losses. The
availability of such a remedy should ensure that plaintiffs can be made
whole for any losses caused by misconduct, and provide an important
deterrent for future misconduct. Accordingly, the exemption does not
permit the contract to include liquidated damages provisions, which
could limit Retirement Investors' ability to obtain make-whole relief.
On the other hand, the exemption permits waiver of punitive damages
to the extent permissible under governing law. Similarly, rescission
can result in a remedy that's disproportionate to the injury. In cases
where an advice fiduciary breached its obligations, but there was no
injury to the participant, a rescission remedy can effectively make the
fiduciary liable for losses caused by market changes, rather than its
misconduct. These new provisions in section II(f)(2) only apply to
waiver of the contract claims; they do not qualify or limit statutory
enforcement rights under ERISA. Those statutory remedies generally
provide for make-whole relief and to rescission in appropriate cases,
but they do not provide for punitive damages.
7. Disclosure Requirements
The exemption requires disclosure of Material Conflicts of Interest
and basic information relating to those conflicts and the advisory
relationship in Sections II and III. The exemption requires contract
disclosures (Section II(e)), pre-transaction (or point of sale)
disclosures (Section III(a)), and web-based disclosures (Section
III(b)). One of the chief aims of the disclosures is to ensure that the
Retirement Investor is fairly informed of the Adviser's and Financial
Institution's conflicts of interest. The final exemption adopts a
tiered approach, generally providing for automatic disclosure of basic
information on conflicts of interest and the advisory relationship, but
requiring more detailed disclosure, free of charge, upon request. As
discussed below, the final exemption requires disclosure of the
information Retirement Investors need to assess conflicts of interest
and compensation structures, while reducing compliance burden.
Section II(e) obligates the Financial Institution to make specified
disclosures to Retirement Investors. For advice to Retirement Investors
regarding investments in IRAs and non-ERISA plans, the disclosures must
be provided prior to or at the same time as the execution of the
recommended transaction, either as part of the contract or in a
separate written disclosure provided to the Retirement Investor with
the contract. For advice to Retirement Investors regarding investments
in ERISA plans, the disclosures must be provided prior to or at the
same time as the execution of the recommended transaction. The
disclosures require the provision of more general information upfront
to the Retirement Investor accompanied by notice that more specific
information is available free of charge, upon request. If the
Retirement Investor makes a request for more specific information prior
to the transaction, the information must be provided prior to the
transaction. For requests made after the transaction, the information
must be provided within 30 business days. Although the contract
disclosure is a one-time disclosure, the Financial Institution must
also post model disclosures on its Web site, and on a quarterly basis
review and update the model disclosures as necessary for accuracy.
The pre-transaction disclosure in Section III(a) supplements the
contract disclosure, and must be provided to all Retirement Investors
(whether regarding an ERISA plan, non-ERISA plan or IRA) prior to or at
the same time as the execution of a recommended transaction. The pre-
transaction disclosure repeats certain information in the contract
disclosure to ensure that the Retirement Investor has received the
information sufficiently close to the time of the transaction, when the
information is most relevant. Such disclosure is particularly important
when the advisory relationship extends over time. To minimize burden,
however, the Financial Institution does not need to repeat the pre-
transaction disclosure more frequently than annually after the initial
contract disclosure, or other transaction disclosures, with respect to
additional recommendations regarding the same investment product.
The web-based disclosure in Section III(b) is intended to provide
information about the Financial Institutions' arrangements with product
[[Page 21046]]
manufacturers and other parties for Third Party Payments in connection
with specific investments or classes of investments that are
recommended to Retirement Investors, as well as a description of the
Financial Institution's business model and its compensation and
incentive arrangements with Advisers. The web disclosure is not limited
to individual Retirement Investors with whom the Financial Institution
has a contractual relationship, but rather is publicly available to
promote comparison shopping and the overall transparency of the
marketplace for retirement investment advice. Thus, financial services
companies, consultants, and intermediaries may analyze the information
and provide information to plan and IRA investors comparing the
practices of different Financial Institutions.
The Department significantly revised the disclosures from the
proposed exemption. Commenters responded to the Department's disclosure
proposals and specific requests for comment with feedback on the cost,
feasibility and utility of the proposed disclosures. The Department
carefully considered the comments in order to formulate an approach in
the final exemption that responded to commenters' legitimate concerns,
while ensuring fair disclosure of important information to Retirement
Investors.
In broad outline, the final exemption takes a ``two-tier''
approach, as suggested by some commenters,\84\ under which the
Financial Institution automatically gives simple disclosures of basic
information with more specific information available on the web or upon
request. Retirement Investors will be provided with information about
their Advisers' and Financial Institutions' Material Conflicts of
Interest both upon entering into an advisory relationship, and again,
prior to or at the same time as, the execution of recommended
transactions. They will not be overwhelmed by the amount of disclosure
provided, which can render the disclosure ineffective. To the extent
individual Retirement Investors wish to review additional information,
the details will be available to them. This approach minimizes the
burden on both the Financial Institution and the Retirement Investor,
without reducing the protections of the disclosure.
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\84\ See Financial Services Institute, Fidelity Investments, and
the Consumer Federation of America.
---------------------------------------------------------------------------
The specific content requirements of the disclosure provisions,
comments received on the proposals and the Department's responses are
discussed below.
a. Contractual Disclosures--Section II(e)
Under Section II(e) of the exemption, the Financial Institution
must clearly and prominently, in a single written disclosure:
(1) State the Best Interest standard of care owed by the Adviser
and Financial Institution to the Retirement Investor; inform the
Retirement Investor of the services provided by the Financial
Institution and the Adviser; and describe how the Retirement
Investor will pay for services, directly or through Third Party
Payments. If, for example, the Retirement Investor will pay through
commissions or other forms of transaction-based payments, the
contract or writing must clearly disclose that fact;
(2) Describe Material Conflicts of Interest; disclose any fees
or charges the Financial Institution, its Affiliates, or the Adviser
imposes upon the Retirement Investor or the Retirement Investor's
account; and state the types of compensation that the Financial
Institution, its Affiliates, and the Adviser expect to receive from
third parties in connection with investments recommended to
Retirement Investors;
(3) Inform the Retirement Investor that the Investor has the
right to obtain copies of the Financial Institution's written
description of its policies and procedures adopted in accordance
with Section II(d), as well as specific disclosure of costs, fees,
and compensation, including Third Party Payments regarding
recommended transactions, as set forth in Section III(a) of the
exemption, described in dollar amounts, percentages, formulas or
other means reasonably designed to present materially accurate
disclosure of their scope, magnitude, and nature in sufficient
detail to permit the Retirement Investor to make an informed
judgment about the costs of the transaction and about the
significance and severity of the Material Conflicts of Interest, and
describe how the Retirement Investor can get the information, free
of charge; provided that if the Retirement Investor's request is
made prior to the transaction, the information must be provided
prior to the transaction, and if the request is made after the
transaction, the information must be provided within 30 business
days after the request;
(4) Include a link to the Financial Institution's Web site as
required by Section III(b), and inform the Retirement Investor that:
(i) The model contract disclosures updated as necessary on a
quarterly basis for accuracy are maintained on the Web site, and
(ii) the Financial Institution's written description of its policies
and procedures adopted in accordance with Section II(d) are
available free of charge on the Web site;
(5) Disclose to the Retirement Investor whether the Financial
Institution offers Proprietary Products or receives Third Party
Payments with respect to any recommended transaction; and to the
extent the Financial Institution or Adviser limits investment
recommendations, in whole or part, to Proprietary Products or
investments that generate Third Party Payments, notify the
Retirement Investor of the limitations placed on the universe of
investments that the Adviser may offer for purchase, sale, exchange,
or holding by the Retirement Investor. The notice is insufficient if
it merely states that the Financial Institution or Adviser ``may''
limit investment recommendations based on whether the investments
are Proprietary Products or generate Third Party Payments, without
specific disclosure of the extent to which recommendations are, in
fact, limited on that basis.
(6) Provide contact information (telephone and email) for a
representative of the Financial Institution that the Retirement
Investor can use to contact the Financial Institution with any
concerns about the advice or service they have received; and, if
applicable, a statement explaining that the Retirement Investor can
research the Financial Institution and its Advisers using FINRA's
BrokerCheck database or the Investment Adviser Registration
Depository (IARD), or other database maintained by a governmental
agency or instrumentality, or self-regulatory organization; and
(7) Describe whether or not the Adviser and Financial
Institution will monitor the Retirement Investor's investments and
alert the Retirement Investor to any recommended change to those
investments and, if so, the frequency with which the monitoring will
occur and the reasons for which the Retirement Investor will be
alerted.
By ``clearly and prominently in a single written disclosure,'' the
Department means that the Financial Institution may provide a document
prepared for this purpose containing only the required information, or
include the information in a specific section of the contract in which
the disclosure information is provided, rather than requiring the
Retirement Investor to locate the relevant information in several
places throughout a larger disclosure or series of disclosures.
Section II(e)(8) provides a mechanism for correcting disclosure
errors, without losing the exemption. It provides that the Financial
Institution will not fail to satisfy Section II(e), or violate a
contractual provision based thereon, solely because it, acting in good
faith and with reasonable diligence, makes an error or omission in
disclosing the required information, provided the Financial Institution
discloses the correct information as soon as practicable, but not later
than 30 days after the date on which it discovers or reasonably should
have discovered the error or omission. Section II(e)(8) further
provides that to the extent compliance with the contract disclosure
requires Advisers and Financial Institutions to obtain information from
entities that are not closely affiliated with them, they may rely in
good faith on information
[[Page 21047]]
and assurances from the other entities, as long as they do not know
that the materials are incomplete or inaccurate. This good faith
reliance applies unless the entity providing the information to the
Adviser and Financial Institution is (1) a person directly or
indirectly through one or more intermediaries, controlling, controlled
by, or under common control with the Adviser or Financial Institution;
or (2) any officer, director, employee, agent, registered
representative, relative (as defined in ERISA section 3(15)), member of
family (as defined in Code section 4975(e)(6)) of, or partner in, the
Adviser or Financial Institution.
The proposal contained three elements of the contractual disclosure
set forth in Section II(e). The Financial Institution would have been
required to: Identify and disclose any Material Conflicts of Interest;
inform the Retirement Investor of his or her right to obtain complete
information about all the fees currently associated with Assets in
which he or she is invested; and disclose to the Retirement Investor
whether the Financial Institution offers Proprietary Products or
receives Third Party Payments with respect to the purchase, sale or
holding of any Asset, and of the address of the required Web site that
discloses the Financial Institutions' and Advisers' compensation
arrangements.
Several commenters supported the proposed disclosures. Commenters
recognized that well-designed disclosure can serve multiple purposes,
including facilitating informed investment decisions. However, even if
investors do not carefully review the disclosures they receive,
commenters perceived a benefit to investors from the greater
transparency of public disclosure. For example, firms may change
practices that run contrary to Retirement Investors' interests rather
than disclose them publicly. The Department received a few questions
and requests for clarification of these proposed disclosure
requirements. One commenter requested that the Department clarify that,
for purposes of the disclosure provisions, ``direct'' and ``indirect''
compensation had the same meanings as they did in ERISA section
408(b)(2). Several other commenters suggested that the Department rely
to a greater extent on existing conflicts disclosure requirements
applicable to investment advisers registered under the Investment
Advisers Act of 1940. Additionally, there were questions as to how the
information in the contractual disclosure should be updated.
As noted above, the Department modeled the final exemption's
disclosure provisions, in part, on comments suggesting adoption of a
``two-tier'' approach, under which an investor would receive a ``first
tier'' disclosure at the time of account opening, with a ``second
tier'' of more in-depth information available on the Financial
Institution's Web site and in other formats upon request. The
Department adopted a number of these commenters' suggestions as part of
the contractual disclosure set forth in Section II(e), viewing the
contractual disclosure as similar to the first tier approach suggested
by the commenters.
Specifically, the Department adopted commenters' suggestions that
the disclosures: State the standard of care owed to the Retirement
Investor; inform the Retirement Investor of the services to be
provided; and inform the Retirement Investor of how he or she will pay
for services. A commenter also suggested that the disclosure include
any significant limitations on services provided by the Financial
Institution, such as the sale of only propriety products. The
suggestion was adopted in Section II(e)(5).
A commenter further suggested that the disclosure provide
information on a representative of the Financial Institution that the
Retirement Investor can contact with complaints, and a statement
explaining that the Retirement Investor can research the Financial
Institution and its Advisers using FINRA's BrokerCheck database or the
Investment Adviser Registration Depository (IARD). The Department
incorporated this suggestion in Section II(e)(6). Further, the
commenter's suggestion that Retirement Investors should be informed of
their ability to obtain additional more detailed information, free of
charge, was adopted in Section II(e)(3).
FINRA's suggestion that the parties agree on the extent of
monitoring of the Retirement Investor's investments was adopted, in
Section II(e)(7). In making this determination, Financial Institutions
should carefully consider whether certain investments can be prudently
recommended to the individual Retirement Investor, in the first place,
without a mechanism in place for the ongoing monitoring of the
investment. Finally, a number of commenters requested relief for good
faith inadvertent failures to comply with the exemption. A specific
provision applicable to the Section II(e) disclosures is included in
Section II(e)(8).
In response to a commenter's question regarding the meaning of
direct versus indirect expenses, the Department has generally revised
the exemption to refer to ``Third Party Payments,'' rather than
indirect expenses. The phrase ``Third Party Payments'' is a defined
term in the exemption.
The Department has also addressed how the contractual disclosure
must be updated. Under the exemption, the contract provides one-time
disclosure, but the information must be maintained on the Web site and
updated quarterly as necessary for accuracy. Additionally, the
transaction disclosure required under Section III(a) must be accurate
at the time it is provided, which will serve to provide the Retirement
Investor with the most current information prior to or at the same time
as the execution of a recommended transaction, essentially updating the
contractual disclosure.
b. Transaction Disclosure
Section III(a) of the exemption requires that, prior to or at the
same time as the execution of a recommended investment transaction, the
Financial Institution must provide the Retirement Investor a disclosure
that clearly and prominently, in a single written document:
(1) States the Best Interest standard of care owed by the
Adviser and Financial Institution to the Retirement Investor; and
describes any Material Conflicts of Interest;
(2) Informs the Retirement Investor that the Retirement Investor
has the right to obtain copies of the Financial Institution's
written description of its policies and procedures adopted in
accordance with Section II(d), as well as specific disclosure of
costs, fees and other compensation including Third Party Payments
regarding recommended transactions. The costs, fees, and other
compensation may be described in dollar amounts, percentages,
formulas, or other means reasonably designed to present materially
accurate disclosure of their scope, magnitude, and nature in
sufficient detail to permit the Retirement Investor to make an
informed judgment about the costs of the transaction and about the
significance and severity of the Material Conflicts of Interest. The
information required under this section must be provided to the
Retirement Investor prior to the transaction, if requested prior to
the transaction, and if the request occurs after the transaction,
the information must be provided within 30 business days after the
request; and
(3) Includes a link to the Financial Institution's Web site as
required by Section III(b), and informs the Retirement Investor
that: (i) Model contract disclosures updated as necessary on a
quarterly basis are maintained on the Web site, and (ii) the
Financial Institution's written description of its policies and
procedures adopted in accordance with Section II(d) are available
free of charge on the Web site.
This disclosure is required only at the time an investment is made,
and does not have to be repeated if there is a recommendation to hold
or sell the
[[Page 21048]]
investment. By ``clearly and prominently, in a single written
document,'' the Department means that the Financial Institution must
provide the information in a single document prepared for this purpose
with only the required information, or a specific section in a larger
document, in which the disclosure information is provided, rather than
requiring the Retirement Investor to locate the relevant information in
several places throughout a larger disclosure or series of disclosures.
To reduce compliance burden, Section III(a)(4) provides that these
disclosures do not have to be repeated for subsequent recommendations
by the Adviser and Financial Institution of the same investment product
within one year after the provision of the contract disclosure required
by Section II(e) or a prior disclosure required by Section III(a),
unless there are material changes in the subject of the disclosure.
Additionally, in the final exemption, the Department makes clear that
the Financial Institution is responsible for the required disclosures.
This is consistent with a commenter that indicated that it is not
industry practice for individual Advisers to prepare disclosures.
The Department revised the transaction disclosure in the final
exemption based on input from commenters. In the proposed exemption,
the transaction disclosure in Section III(a) would have required the
provision to the Retirement Investor of a chart setting forth the
``total cost'' of the recommended investment for 1-, 5- and 10-year
periods, expressed as a dollar amount, assuming an investment of the
dollar amount recommended by the Adviser and reasonable assumptions
about investment performance. In addition, an annual disclosure
proposed under Section III(b) would have required an annual disclosure
of investments purchased during the year, the total dollar amount of
all fees and expenses paid by the investor and the total dollar amount
of all compensation received by the Adviser and Financial Institution,
directly or indirectly, from any party as a result of the investments.
The disclosure was to be provided within 45 days of the end of the
applicable year.
A few commenters indicated their support for a point of sale
disclosure to Retirement Investors, which the commenters said is not
currently required in many cases. Some commenters highlighted the
importance of alerting Retirement Investors to the costs of an
investment over time, which was the intent of the proposed transaction
disclosure. Other commenters described the benefit of the annual
disclosure as a means of showing actual costs paid, rather than the
projections provided in the proposed transaction disclosure.
Nonetheless, many supporters of the disclosures took the position that
the disclosure requirements would be secondary in importance to the
Impartial Conduct Standards and policies and procedures requirement set
forth in Section II.
A number of other commenters raised significant objections to the
disclosures proposed in Section III(a) and (b). These commenters
generally indicated the disclosures would be costly to implement and
Financial Institutions would need an extensive transition period in
order to comply. In this vein, several commenters stated that Financial
Institutions do not currently assemble or maintain all of the required
information and that current systems could not deliver the disclosures.
Commenters expressed concerns that the logistics of providing the
disclosures were unduly burdensome. These logistics included the
application of the disclosure provisions to all investment products,
including annuities and insurance products, the specific formatting and
wording of the disclosure, the acceptable means of providing the
disclosure (whether verbal or electronic communications would be
permitted), and the allocation of responsibilities between the
Financial Institution and Adviser. One commenter stated that the burden
was so great that only very large Financial Institutions would be able
to continue to provide investment advice to Retirement Investors.
Some commenters questioned the substance of the proposed disclosure
requirements. According to some commenters, it would be difficult to
provide specific dollar amounts of indirect compensation received on an
account or transaction level. Comments from the insurance industry
stated that the transactional disclosures were a poor fit for insurance
transactions, in particular. Commenters also specifically objected to
the obligation to project investment performance for purposes of
calculating costs over 1-, 5-, and 10-year holding periods. Commenters,
including FINRA, stated that requirement would conflict with FINRA Rule
2210, which generally prohibits broker-dealers from including
projections of performance in communications with the public. A few
comments suggested that the Department could instead proceed with the
proposed point of sale disclosure using hypothetical amounts that would
comply with the FINRA rule.
A number of commenters urged the Department to rely on existing
disclosure requirements, including required disclosures under ERISA
sections 404 and 408(b)(2), state insurance law, the SEC's Form ADV for
registered investment advisers, or product-specific information such as
a prospectus or summary prospectus. Several commenters observed that
the Department recently implemented a series of disclosure requirements
under ERISA sections 404 and 408(b)(2), and relying on these
disclosures would avoid additional investment in costly technology and
procedures.
Other commenters suggested specific alternative disclosures that
are not currently required by law. For example, a commenter suggested a
so-called ``20/20 disclosure,'' showing the effect of fees on a $20,000
initial investment over a 20-year period. The commenter further
suggested an ``annual retirement receipt,'' that indicates the
percentage and dollar amount of fees by fund in addition to
compensation received.\85\ Another commenter suggested the Department
rely on a ``consumer warning'' and short form disclosure. Another
offered disclosure of direct compensation, a narrative disclosure of
indirect compensation and a cigarette-style warning (discussed below).
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\85\ This same commenter suggested the disclosures should be
required for all retirement savings products, even beyond the scope
of the Regulation and this exemption. As explained above, the
Department selected the two-tier approach to appropriately allow the
Retirement Investor to focus on the most important information about
the Financial Institution's and Adviser's conflicts of interest in a
way that is neither too technical nor overwhelming. The commenter's
suggestion to expand the disclosures beyond the exemption is beyond
the scope of this project.
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Other commenters took the position that the disclosures would not
be helpful to Retirement Investors or would contribute to information
overload. In this connection, one commenter noted the Department's own
skepticism in its Regulatory Impact Analysis of the effectiveness of
disclosure. According to one commenter, regarding the annual
disclosure, customers' accounts typically include a mix of investments
and reflect a range of transactions, only some of which are the result
of a recommendation, and it may not be possible to distinguish the two.
Therefore, the annual statement would reflect all transactions in the
account, and would not provide meaningful information about
compensation or Material Conflicts of Interest with respect to
investment advice.
[[Page 21049]]
Several commenters raised questions about the timing of the
disclosures. Some commenters argued that transaction disclosure should
be provided sufficiently in advance of the transaction (or before
entering into the relationship at all) so that the Retirement Investor
has the time needed to review the materials provided. Other commenters
expressed concern that the proposal would have required the disclosure
to be provided too early; as a result, the transaction disclosure
requirements could the delay the investment or cause the Retirement
Investor to miss the opportunity entirely. Some commenters warned that
the specific prices required to be disclosed may not be knowable at the
time of the required disclosure. Regarding the annual disclosure,
commenters were also concerned that 45 days following the end of the
applicable year was not enough time to collect a detailed accounting of
the dollars attributable to each asset and prepare the disclosure.
In response to commenters, the Department has significantly revised
the disclosure requirements to reduce the burden, focus on pre-
transaction disclosure of the most salient information about the
contractual relationship and conflicts of interest, and facilitate more
detailed disclosure, upon request, to Retirement Investors specifically
interested in more detail. The contract and transaction disclosures
provide basic information that is critical to the Retirement Investor's
understanding of the nature of the relationship and the scope of the
conflicts of interest. Without these disclosures, it cannot be fairly
said that the Investor has entered into the investment or the advisory
relationship with eyes open.
It is true that the final exemption does not chiefly rely on
disclosure as a means of protection, but rather on the imposition of
fiduciary standards of conduct, anti-conflict policies and procedures,
and the prohibition of misaligned incentive structures. Nevertheless,
disclosure can serve a salutary purpose in the right circumstances and
is critical to obtaining the Retirement Investor's knowing assent to
the conflicted advisory relationship. In addition, the public web
disclosure is intended as much for intermediaries, consumer watchdogs,
and other third parties who can use it to force competitive forces to
work on conflicted structures. Similarly, the Department has calibrated
the contract and transaction disclosures to focus on the most important
information about conflicts of interest and the contractual
relationship in a way that is neither too technical nor overwhelming.
Thus, more detailed information is available upon request for consumers
who are interested in digging deeper and who are presumably better able
to use the information.
In this regard, the Department has limited the individual
disclosures under Section III to a transaction-based disclosure,
focusing on the Financial Institution's Material Conflicts of Interest
with respect to the recommended transaction, and the availability upon
request, free of charge, of more specific information about the costs,
fees and other compensation associated with the investment. The
Department has intentionally provided flexibility on the timing of
disclosure, as long as it is provided prior to or at the same time as
the execution of the recommended investment. Similarly, while the
Department proposed a specific model form for the transaction
disclosure, in this final exemption it has determined to provide
flexibility on the format. In response to concerns about burden, cost,
and utility, discussed above, the Department did not adopt the annual
disclosure requirement in the final exemption.
The Department did not attempt to revise the transaction disclosure
to use hypotheticals, permitted under FINRA rule 2210, because such
disclosure would not achieve the desired goal of informing Retirement
Investors in a specific way of the costs of the investment over time.
The Department also declined to merely duplicate existing disclosure
requirements under ERISA sections 404 and 408(b)(2), but rather to
focus on the specific disclosures related to the anti-conflict goals of
this project. The Department also did not adopt the other specific
disclosure suggestions by commenters, as it was persuaded that the two-
tier approach most efficiently achieved the Department's objectives. As
noted above, the disclosure requirements in the final exemption
minimize the burden on both the Financial Institution and the
Retirement Investor, without reducing the protections of the
disclosure. Additionally, in response to commenters, the Department has
included a good faith compliance provision applicable to the Section
III disclosures. Section III(c) provides that the Financial Institution
will not fail to satisfy the transaction disclosure requirement if,
acting in good faith and with reasonable diligence, it makes an error
or omission in disclosing the required information, provided the
Financial Institution discloses the correct information as soon as
practicable, but not later than 30 days after the date on which it
discovers or reasonably should have discovered the error or omission.
This approach enables and incentivizes the Financial Institution to
correct good faith errors without losing the benefit of the exemption.
Section III(c) further provides that, to the extent compliance with
the Section III disclosures requires Advisers and Financial
Institutions to obtain information from entities that are not closely
affiliated with them, they may rely in good faith on information and
assurances from the other entities, as long as they do not know that
the materials are incomplete or inaccurate. This good faith reliance
applies unless the entity providing the information to the Adviser and
Financial Institution is (1) a person directly or indirectly through
one or more intermediaries, controlling, controlled by, or under common
control with the Adviser or Financial Institution; or (2) any officer,
director, employee, agent, registered representative, relative (as
defined in ERISA section 3(15)), member of family (as defined in Code
section 4975(e)(6)) of, or partner in, the Adviser or Financial
Institution.
Some commenters also responded to the suggestion in the proposal
that the transaction disclosure could be replaced with a ``cigarette
warning''-style disclosure, such as the following:
Investors are urged to check loads, management fees, revenue-
sharing, commissions, and other charges before investing in any
financial product. These fees may significantly reduce the amount
you are able to invest over time and may also determine your
adviser's take-home pay. If these fees are not reported in marketing
materials or made apparent by your investment adviser, do not forget
to ask about them.
Several commenters wrote that this, perhaps in combination with an
existing disclosure, would be preferable to the specific proposed
requirements. Other commenters opposed the proposal. Some were
concerned that such a general disclosure would not provide Retirement
Investors with the information they needed to understand their
investments. The Department is similarly skeptical about the utility of
such a general warning, and believes that the goals of the warning are
better served by the contract and transaction disclosures contained in
the final exemption. Accordingly, the Department declines to mandate
the additional disclosure.
[[Page 21050]]
c. Web Disclosure
Under Section III(b) of the exemption, the Financial Institution is
required to maintain a Web site, freely accessible to the public and
updated no less than quarterly, which contains:
(i) A discussion of the Financial Institution's business model
and the Material Conflicts of Interest associated with that business
model;
(ii) A schedule of typical account or contract fees and service
charges;
(iii) A model contract or other model notice of the contractual
terms (if applicable) and required disclosures described in Section
II(b)-(e), which are reviewed for accuracy no less frequently than
quarterly and updated within 30 days if necessary;
(iv) A written description of the Financial Institution's
policies and procedures that accurately describes or summarizes key
components of the policies and procedures relating to conflict-
mitigation and incentive practices in a manner that permits
Retirement Investors to make an informed judgment about the
stringency of the Financial Institution's protections against
conflicts of interest;
(v) To the extent applicable, a list of all product
manufacturers and other parties with whom the Financial Institution
maintains arrangements that provide Third Party Payments to either
the Adviser or the Financial Institution with respect to specific
investment products or classes of investments recommended to
Retirement Investors; a description of the arrangements, including a
statement on whether and how these arrangements impact Adviser
compensation, and a statement on any benefits the Financial
Institution provides to the product manufacturers or other parties
in exchange for the Third Party Payments; and
(vi) Disclosure of the Financial Institution's compensation and
incentive arrangements with Advisers including, if applicable, any
incentives (including both cash and non-cash compensation or awards)
to Advisers for recommending particular product manufacturers,
investments or categories of investments to Retirement Investors, or
for Advisers to move to the Financial Institution from another firm
or to stay at the Financial Institution, and a full and fair
description of any payout or compensation grids, but not including
information that is specific to any individual Adviser's
compensation or compensation arrangement.
Section III(b)(1)(vii) clarifies that the Web site may describe the
above arrangements with product manufacturers, Advisers, and others by
reference to dollar amounts, percentages, formulas, or other means
reasonably calculated to present a materially accurate description of
the arrangements. Similarly, the Web site may group disclosures based
on reasonably defined categories of investment products or classes,
product manufacturers, Advisers, and arrangements, and it may disclose
reasonable ranges of values, rather than specific values, as
appropriate. By permitting Financial Institutions to present
information in reasonably-defined categories and in reasonable ranges
of values, the Department does not intend to permit disclosures that
are so broad as to obscure significant conflicts of interest. A broad
category covering all mutual funds, or insurance products, for example,
would not be sufficiently detailed unless the Financial Institution
maintained the same compensation arrangement with all such mutual funds
or insurance products. Likewise, disclosing a very broad range of
compensation structures applicable to all the Financial Institution's
Advisers would not be sufficient if in fact there are material
differences among adviser compensation. However constructed, the Web
site must fairly disclose the scope, magnitude, and nature of the
compensation arrangements and Material Conflicts of Interest in
sufficient detail to permit visitors to the Web site to make an
informed judgment about the significance of the compensation practices
and Material Conflicts of Interest with respect to transactions
recommended by the Financial Institution and its Advisers. Section
III(b)(1)(vi) clarifies that the disclosure also must include
incentives the Financial Institution offers to Advisers to move to or
stay the firm. These disclosures need not contain amounts paid to
specific individuals, but instead should be a reasonable description of
the incentives paid and factors considered by the Financial
Institution. This change is intended to clarify and narrow the
requirement in the proposal that the Web site include ``indirect
material compensation payable to the Adviser.''
Additionally, Section III(b)(2) makes clear that, to the extent the
information required by this section is provided in other disclosures
which are made public, including those required by the SEC and/or the
Department such as a Form ADV, Part II, the Financial Institution may
satisfy Section III(b) by posting such disclosures to its Web site with
an explanation that the information can be found in the disclosures and
a link to precisely where it can be found. Further, Section III(b)(3)
provides that the Financial Institution is not required to disclose
information on the web if such disclosure is otherwise prohibited by
law. Section III(b)(4) requires that, in addition to providing the
written descriptions of the Financial Institution's policies and
procedures on its Web site, as required by under Section III(b)(1)(iv),
Financial Institutions must provide their complete policies and
procedures, adopted pursuant to Section II(d), to the Department upon
request. Finally, Section III(b)(5) requires that, in the event that a
Financial Institution determines to group disclosures as described
above, it must retain the data and documentation supporting the group
disclosure during the time that it is applicable to the disclosure on
the Web site, and 6 years after that, and make the data and
documentation available to the Department within 90 days of the
Department's request.
Finally, Section III(c) contains a good faith exception in the
event of an error or omission in disclosing the required information,
or if the Web site is temporarily inaccessible. The Financial
Institution will not fail to satisfy the exemption provided it
discloses the correct information as soon as practicable, but, in the
case of an error or omission on the web, not later than 7 days after
the date on which it discovers or reasonably should have discovered the
error or omission, and in the case of an error or omission with respect
to the transaction disclosure, not later than 30 days after the date on
which it discovers or reasonably should have discovered the error or
omission. The periods differ because of the likelihood that errors or
omissions on the Web site will have a greater impact than an error in
an individual disclosure, due to the wider audience. Moreover, the Web
site should be able to be updated more quickly than an individual
disclosure; the 30-day period for correction of transaction disclosures
builds in time to provide the corrected disclosure to the Retirement
Investor through a variety of means, including mailing.
In addition, to the extent compliance with the disclosure requires
Advisers and Financial Institutions to obtain information from entities
that are not closely affiliated with them, the exemption provides that
they may rely in good faith on information and assurances from the
other entities, as long as they do not know that the materials are
incomplete or inaccurate. This good faith reliance applies unless the
entity providing the information to the Adviser and Financial
Institution is (1) a person directly or indirectly through one or more
intermediaries, controlling, controlled by, or under common control
with the Adviser or Financial Institution; or (2) any officer,
director, employee, agent, registered representative, relative (as
defined in ERISA section 3(15)), member of family (as defined in Code
section 4975(e)(6))
[[Page 21051]]
of, or partner in, the Adviser or Financial Institution.
The good faith provisions apply to the requirement that the
Financial Institution retain the data and documentation supporting the
disclosure during the time that it is applicable to the disclosure on
the Web site and provide it to the Department upon request. In
addition, if such records are lost or destroyed due to circumstances
beyond the control of the Financial Institution, then no prohibited
transaction will be considered to have occurred solely on the basis of
the unavailability of those records; and no party, other than the
Financial Institution responsible for complying with subsection
(b)(1)(vii) will be subject to the civil penalty that may be assessed
under ERISA section 502(i) or the taxes imposed by Code section 4975(a)
and (b), if applicable, if the records are not maintained or provided
to the Department within the required timeframes.
In the proposed exemption, the Web site disclosure focused on the
direct and indirect material compensation payable to the Adviser,
Financial Institution and any Affiliate for services provided in
connection with recommended investments available for purchase, holding
or sale within the last 365 days, as well as the source of the
compensation, and how the compensation varied within and among Assets.
The proposal indicated that the compensation disclosure could be
expressed as a monetary amount, formula or percentage of the assets
involved in the purchase, sale or holding. Under the proposal, the
Financial Institution's Web site was required to provide access to the
information in a machine readable format.
The Department's intent in proposing the web disclosure was to
provide broad transparency about the pricing and compensation
structures adopted by Financial Institutions and Advisers. The
Department contemplated that the data could be used by financial
information companies to analyze and provide information comparing the
practices of different Advisers and Financial Institutions. This
information would allow Retirement Investors to evaluate and compare
the practices of particular Advisers and Financial Institutions. A few
commenters expressed support for the proposed web disclosure as an
effort to increase transparency and use market forces to positively
affect industry practices.
A number of other commenters viewed the proposed web disclosure as
too costly, burdensome, and unlikely to be used by individual
Retirement Investors, or expressed confidentiality and privacy
concerns. In particular, commenters opposed disclosure of Adviser-level
compensation. A few commenters misinterpreted the proposal to require
disclosure of the precise total compensation amounts earned by each
individual Adviser, and strongly opposed such disclosure. Other
commenters took the position that the requirements of the proposed web
disclosure would violate other legal or regulatory requirements
applicable to advertising and antitrust law.
Other commenters expressed concerns about the logistics of the Web
site. For example, they argued that the requirement that the Financial
Institution describe compensation received in connection with each
asset available for purchase, holding or sale within the past 365 days
could require constant updating. Some commenters also raised questions
about the meaning of the requirement that the data on the site be
``machine readable,'' although others expressed support for the
requirement, which could have made the information more easily
accessible to the public.
In the final exemption, the web disclosure requirement has been
reworked as a more principles-based approach to avoid commenters'
concerns. The Department accepted the suggestion of a commenter that
the web disclosure should contain: A schedule of typical account or
contract fees and service charges, and a list of product manufacturers
with whom the Financial Institution maintains arrangements that provide
payments to the Adviser and Financial Institution, including whether
the arrangements impact Adviser compensation. Another commenter
suggested that the Department require disclosure of the Financial
Institution's business model and the Material Conflicts of Interest
associated with the model. The commenter further suggested the
Department should require disclosure of the Financial Institution's
compensation practices with respect to Advisers, including payout grids
and non-cash compensation and rewards. The Department has adopted these
suggestions as well. However, with respect to the level of detail
required, the Department has qualified the requirements of Section
III(b) by giving the Financial Institution considerable flexibility on
how best to present the information subject to the following principle:
The Web site must ``fairly disclose the scope, magnitude, and nature of
the compensation arrangements and Material Conflicts of Interest in
sufficient detail to permit visitors to the Web site to make an
informed judgment about the significance of the compensation practices
and Material Conflicts of Interest with respect to transactions
recommended by the Financial Institution and its Advisers.''
The approach in the final exemption addresses many of the
commenters' concerns about the burdens of the proposed web disclosure.
To that end, the Department made the changes described above and also
eliminated the proposed requirement that the information on the web be
made available in machine readable format. However, the Department did
not accept comments that suggested only general information be required
on the web, or that no information on Adviser compensation arrangements
should be provided. Certainly, the Financial Institution need not
itemize or otherwise disclose the specific compensation it pays to an
individual Adviser on its public Web site. However, the information on
the Financial Institution's arrangements, including its compensation
arrangements with Advisers, should be provided with enough specificity
to inform users of the significance of these arrangements with respect
to the transactions recommended by the Financial Institution and its
Advisers. Consistent with the Department's initial goals, the web
disclosure in the final exemption will create a mechanism for
Retirement Investors and financial information companies to evaluate
and compare compensation practices and Material Conflicts of Interests
among different Financial Institutions and Advisers.
The final disclosure requirement responds to other comments as
well. Permitting Financial Institutions to rely on other public
disclosures, as set forth in Section III(b)(2), responds to several
requests that the Department incorporate existing disclosures to ease
the burden on the Financial Institutions. These commenters argued that
the information required to be disclosed as part of the exemption may
already be part of other existing disclosures, such as those provided
pursuant to ERISA sections 404(a)(5) and 408(b)(2) and the SEC's
required mutual fund summary prospectuses and Form ADV. The Department
has accepted these comments insofar as the information required
disclosed pursuant to other requirements also satisfies the conditions
of the exemption, and so long as the Financial Institution provides an
explanation that the information can be found in the
[[Page 21052]]
disclosures and a link to where it can be found.
Other commenters were concerned that these Web sites would be
considered advertising, and therefore become subject to additional
requirements under other federal and state laws, or that disclosure of
certain arrangements would violate antitrust laws. Section III(b)(3) of
the exemption provides that the Financial Institution is not required
to disclose information on the web if such disclosure is otherwise
prohibited by law. However, this provision does not excuse a Financial
Institution from seeking approval from a regulator under established
procedures for such approval, such as for review of advertising
material, if such procedures exist.
Commenters also raised antitrust concerns, specifically with regard
to the information that the proposed exemptions required Financial
Institutions to post on their Web site. The Department believes that
the Web site disclosure requirements of the final exemption avoids
these concerns by providing Financial Institutions considerable
flexibility as to how the information is published on the Web site as
long as the Financial Institutions compensation arrangements are
described in sufficient detail to allow visitors to the Web site to
make an informed judgment about the significance of compensation
practice and Material Conflicts of Interest. Additionally, this
exemption permits the Financial Institution to group disclosures based
on reasonable-defined categories and to disclose reasonable range of
values rather than specific numbers. The purpose of the information on
the Web site is to allow investors to make informed decisions about
their advisers, not to promote anticompetitive arrangements. Moreover,
the exemption makes clear that Financial Institutions are not required
to disclose information if such disclosure is otherwise prohibited by
law.
A commenter also asked for clarification on the requirement that
the Web site be ``freely accessible to the public,'' and whether a Web
site that requires a visitor to create a user name and password to gain
access would comply. The Department clarifies that such requirements
are permissible assuming that they impose no additional constraints or
conditions on free public access to the Web site, so that the site can
serve its purpose of providing transparency in the marketplace,
promoting competition, and facilitating the work of financial
information companies to review and analyze such information. Another
commenter cautioned that many small financial advisers do not maintain
a Web site and this disclosure requirement would impose a significant
burden on them. In the Department's view, however, the modest cost of
maintaining a Web site is more than offset by the need to ensure that
the information is freely and easily accessible to the general public,
so that the disclosure can serve its competitive and protective
purposes. Accordingly, the Department has decided to retain the
requirement to provide disclosures through a Web site.
Finally, the correction procedure in Section III(c) addresses the
risk to the Financial Institution, raised by commenters, that minor
mistakes in the published disclosures could cause large numbers of
transactions to become non-exempt prohibited transactions subject to
excise tax and rescission.
8. Proprietary Products and Third Party Payments (Section IV)
Section IV of the exemption applies to Financial Institutions that
restrict their Advisers' investment recommendations, in whole or in
part, to investments that are Proprietary Products or that generate
Third Party Payments. Section IV is intended to clarify that such
Financial Institutions and Advisers may rely on the exemption. This
responds to a number of comments asking the Department to provide
certainty as to the treatment of Proprietary Products and limited
menus.
Specifically, Section IV(a) of the final exemption provides that a
Financial Institution that at the time of the transaction restricts its
Advisers' investment recommendations, in whole or in part, to
Proprietary Products or to investments that generate Third Party
Payments, may rely on the exemption provided all of the applicable
conditions are satisfied. Proprietary Products are defined in the
exemption as products that are managed, issued or sponsored by the
Financial Institution or any of its Affiliates. Third Party Payments
are defined to include sales charges that are not paid directly by the
plan, participant or beneficiary account, or IRA; gross dealer
concessions; revenue sharing payments; 12b-1 fees; distribution,
solicitation or referral fees; volume-based fees; fees for seminars and
educational programs; and any other compensation, consideration or
financial benefit provided to the Financial Institution or an Affiliate
or Related Entity by a third party as a result of a transaction
involving a plan, participant or beneficiary account, or IRA.
Section IV(b) describes how a Financial Institution that limits its
Advisers' investment recommendations, in whole or part, based on
whether the investments are Proprietary Products or generate Third
Party Payments, and an Adviser making recommendations subject to such
limitations, will be deemed to satisfy the Best Interest standard.
Some, but not all, of the conditions are already applicable to
Financial Institutions and Advisers under other provisions of the
exemption. Nevertheless, the text sets out each condition in detail
rather than by reference so that the section provides a clear statement
in one place of the components of the Best Interest standard for such
Financial Institutions and Advisers.
Section IV does contain additional conditions for such Financial
Institutions, however. In particular, as described in greater detail
below, under Section IV(b)(3), Financial Institutions must document the
limitations they place on their Advisers' investment recommendations,
the Material Conflicts of Interest associated with proprietary or third
party arrangements, and the services that will be provided both to
Retirement Investors as well as third parties in exchange for payments.
Such Financial Institutions must then reasonably conclude that the
limitations will not cause the Financial Institution or its Advisers to
receive compensation in excess of reasonable compensation, and, after
consideration of their policies and procedures, reasonably determine
that the limitations and associated conflicts of interest will not
cause the Financial Institution or its Advisers to recommend imprudent
investments. Financial Institutions must document the bases for their
conclusions in these respects and retain the documentation pursuant to
the recordkeeping requirements in Section V of the exemption, for
examination upon request by the Department and other parties set forth
in that section.
The condition in Section IV(b)(3) reflects the Departments' deep
and continuing concern regarding the Financial Institutions' own
conflicts of interest in limiting products available for investment
recommendations. The purpose of Section IV(b)(3) is to require
Financial Institutions to carefully consider their business models and
form a reasonable conclusion about the impact of conflicts of interest
associated with these particular limitations on Advisers' advice. The
exemption will be available only if the Financial Institution
reasonably concludes that these limitations, in conjunction with the
anti-conflict policies and
[[Page 21053]]
procedures, will not result in advice that violates the standards set
forth in the exemption. Of course, the Adviser and the Financial
Institution must also comply with the other conditions of the exemption
as well.
Specifically, under Section IV(b) such Financial Institutions and
Advisers shall be deemed to satisfy the Best Interest standard of
Section VIII(d) if:
(1) Prior to or at the same time as the execution of a
transaction based on the advice, the Retirement Investor is clearly
and prominently informed in writing that the Financial Institution
offers Proprietary Products or receives Third Party Payments with
respect to the purchase, sale, exchange, or holding of recommended
investments; and the Retirement Investor is informed in writing of
the limitations placed on the universe of investments that the
Adviser may recommend to the Retirement Investor. The notice is
insufficient if it merely states that the Financial Institution or
Adviser ``may'' limit investment recommendations based on whether
the investments are Proprietary Products or generate Third Party
Payments, without specific disclosure of the extent to which
recommendations are, in fact, limited on that basis;
(2) Prior to or at the same time as the execution of a
recommended transaction, the Retirement Investor is fully and fairly
informed in writing of any Material Conflicts of Interest that the
Financial Institution or Adviser have with respect to the
recommended transaction, and the Adviser and Financial Institution
comply with the disclosure requirements set forth in Section III
(providing for web and transaction-based disclosure of costs, fees,
compensation, and Material Conflicts of Interest);
(3) The Financial Institution documents in writing its
limitations on the universe of recommended investments; documents in
writing the Material Conflicts of Interest associated with any
contract, agreement, or arrangement providing for its receipt of
Third Party Payments or associated with the sale or promotion of
Proprietary Products; documents any services it will provide to
Retirement Investors in exchange for the Third Party Payments, as
well as any services or consideration it will furnish to any other
party, including the payor, in exchange for Third Party Payments;
reasonably concludes that the limitations on the universe of
recommended investments and Material Conflicts of Interest will not
cause the Financial Institution or its Advisers to receive
compensation in excess of reasonable compensation for Retirement
Investors as set forth in Section II(c)(2); reasonably determines,
after consideration of the policies and procedures established
pursuant to Section II(d), that these limitations and Material
Conflicts of Interest will not cause the Financial Institution or
its Advisers to recommend imprudent investments; and documents the
bases for its conclusions;
(4) The Financial Institution adopts, monitors, implements, and
adheres to policies and procedures and incentive practices that meet
the terms of Section II(d)(1) and (2); and, in accordance with
Section II(d)(3), neither the Financial Institution nor (to the best
of its knowledge) any Affiliate or Related Entity uses or relies
upon quotas, appraisals, performance or personnel actions, bonuses,
contests, special awards, differential compensation or other actions
or incentives that are intended or would reasonably be expected to
cause the Adviser to make imprudent investment recommendations, to
subordinate the interests of the Retirement Investor to the
Adviser's own interests, or to make recommendations based on the
Adviser's considerations of factors or interests other than the
investment objectives, risk tolerance, financial circumstances, and
needs of the Retirement Investor;
(5) At the time of the recommendation, the amount of
compensation and other consideration reasonably anticipated to be
paid, directly or indirectly, to the Adviser, Financial Institution,
or their Affiliates or Related Entities for their services in
connection with the recommended transaction is not in excess of
reasonable compensation within the meaning of ERISA section
408(b)(2) and Code section 4975(d)(2); and
(6) The Adviser's recommendation with respect to the transaction
reflects the care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent person acting in a like
capacity and familiar with such matters would use in the conduct of
an enterprise of a like character and with like aims, based on the
investment objectives, risk tolerance, financial circumstances, and
needs of the Retirement Investor; and the Adviser's recommendation
is not based on the financial or other interests of the Adviser or
on the Adviser's consideration of any factors or interests other
than the investment objectives, risk tolerance, financial
circumstances, and needs of the Retirement Investor.
The purpose of Section IV, as proposed, was to establish conditions
that help ensure that the particular conflicts of interest associated
with proprietary business models or the receipt of Third Party Payments
did not undermine Advisers' ability to provide advice in Retirement
Investors' Best Interest.
Some commenters on Section IV of the proposed exemption focused in
large part on the structure of the section. In the proposal, Section
IV(a) provided a general requirement that the Financial Institution
offer a ``range of Assets that is broad enough to enable the Adviser to
make recommendations with respect to all of the asset classes
reasonably necessary to serve the Best Interests of the Retirement
Investor in light of its investment objectives, risk tolerance, and
specific financial circumstances.'' Section IV(b) then provided
specific conditions for Financial Institutions that could not satisfy
Section IV(a).
Commenters expressed uncertainty as to the meaning of proposed
Section IV(a). They requested clarity on the terms ``asset classes''
and ``range of Assets.'' Some pointed out that all Financial
Institutions limit their products in some ways, and so it may be that
no Financial Institution would be able to satisfy Section IV(a). A few
commenters described this requirement as a penalty for certain
investment specialists who offer only a limited set of investments.
Particular concerns were raised by insurance companies, many of which
sell Proprietary Products.
Several commenters were concerned that Section IV would prohibit
advice relating to Proprietary Products. Some commenters requested that
Section IV be replaced with a disclosure requirement, so that any
Financial Institution which disclosed its Proprietary Products could
provide advice relating to those products without satisfying the other
conditions of the exemption. Some commenters raised specific concerns
about insurance products and fraternal organizations, and whether they
would be able to continue to sell their Proprietary Products.
In response to all of these comments, the Department has revised
Section IV(a) to clarify that Financial Institutions may limit the
products their Advisers offer to Proprietary Products and those that
generate Third Party Payments. The Department has revised Section IV(b)
to clarify how a Financial Institution that limits its products in this
way, in whole or in part, can be deemed to satisfy the Best Interest
standard, in light of concerns that the Financial Institutions and
their Advisers would otherwise be held to violate the Best Interest
standard's requirement that recommendations be made ``without regard to
the financial or other interests of the Adviser, Financial Institution,
or any Affiliate, Related Entity, or other party.'' The standard
provides that such Financial Institutions and Advisers are deemed to
meet the Best Interest standard if they satisfy the particular
requirements set forth in Section IV(b), which require, inter alia,
full disclosure of the restrictions on investment recommendations and
associated conflicts of interest, the adoption of specified measures to
protect investors from conflicts of interest, prudent investment
recommendations, and insulation of the Adviser from conflicts of
interest when making recommendations from the restricted menu.
In response to a commenter that indicated that the proprietary
status of products can change over time, the Department notes that the
conditions of Section IV must be satisfied at the time of the
transaction with the Retirement
[[Page 21054]]
Investor. Subsequent changes in the status of products to non-
proprietary, or vice versa, will not cause the exemption to fail to
apply.
The sections below discuss the conditions of Section IV and the
comments that the Department received on the proposal, including (a)
the general conditions, (b) the written findings, (c) the reasonable
compensation condition, and (d) the notification condition.
a. Best Interest Conditions Common to All Financial Institutions and
Advisers
Section IV responds to concerns expressed by Financial Institutions
that limit Advisers' recommendations to Proprietary Products or to
products that generate Third Party Payments, as to whether they could
ever be said to act ``without regard to'' their own interests, as
required by the general definition of ``Best Interest.'' This section
makes clear that such Financial Institutions can satisfy the standard,
provided that the recommendation is prudent, the fees reasonable, the
conflicts disclosed (so that the customer can fairly be said to have
knowingly assented to them) and the conflicts managed through stringent
policies and procedures that keep the Adviser's focus on the customer's
Best Interest.
Commenters on this issue expressed significant concern about their
ability to recommend Proprietary Products under the exemption. They
asked for assurance that the ``without regard to'' language would not
effectively prohibit advice regarding Proprietary Products because of
an implication that the Financial Institution could not have any
interest in the transaction. As a result, the commenters feared that
the exemption effectively foreclosed proprietary investment providers
from receiving compensation under the exemption.
As noted above, Section IV has been crafted to provide a specific
definition of Best Interest applicable to Financial Institutions and
Advisers that recommend investments from a restricted menu that
includes Proprietary Products or investments that generate Third Party
Payments, while protecting Retirement Investors from the harmful impact
of conflicts of interest. A number of the conditions of this specific
definition are already required elsewhere in the exemption, and should
not impose any special or additional burden beyond what is required of
all Advisers and Financial Institutions subject to the exemption. Thus,
Section IV(b)(1) requires that, prior to or at the same time as the
execution of a recommended transaction, the Financial Institution
provide notice to the Retirement Investor that it offers Proprietary
Products or receives Third Party Payments, and inform the Retirement
Investor of the limitations placed on the universe of investments
available for Advisers to recommend, in accordance with the required
contractual disclosure in Section II(e)(5). The notice to the
Retirement Investor regarding Proprietary Products must inform the
Retirement Investor that a Proprietary Product is a product managed,
issued or sponsored by the Financial Institution and that the Adviser
or Financial Institution may have a greater conflict of interest when
recommending Proprietary Products due to the benefit to the Financial
Institution.
Section IV(b)(2) requires that, prior to or at the same time as the
execution of the recommended transaction, the Retirement Investor be
informed of Material Conflicts of Interest with respect to the
recommended transaction, in accordance with the requirements of Section
III. Section IV(b)(4) generally requires that the Financial Institution
adopt, implements and adhere to policies and procedures that meet the
terms of Section II(d). When Advisers make recommendations from a
restricted menu, the Financial Institution may not incentivize Advisers
to preferentially recommend those products on the menu that are most
lucrative to the Financial Institution.
Section IV(b)(6) places a requirement on the Adviser to recommend
investments that are prudent. In addition, when making recommendations
from the universe of investments offered by the Financial Institution,
the Adviser's recommendations may not be based on the financial or
other interests of the Adviser or on the Adviser's consideration of any
factors or interests other than the investment objectives, risk
tolerance, financial circumstances, and needs of the Retirement
Investor. This is an articulation of the Adviser's Best Interest
obligation in the context of Proprietary Products or investments that
generate Third Party Payments.
b. Written Finding and Documentation
In addition to the sections described above, Section IV(b)(3)
retains a requirement of a written finding regarding the effect of
these arrangements on advice to Retirement Investors. Some commenters
on the proposal objected to a similar provision in proposed Section
IV(b)(1) that a Financial Institution which offered a limited range of
investment options make a specific written finding that the limitations
it has placed would not prevent the Adviser from providing advice that
is the Best Interest of the Retirement Investor or otherwise adhering
to the Impartial Conduct Standards. A few commenters questioned whether
the written finding, as proposed, had to be made with respect to each
Retirement Investor individually. A number of commenters more generally
objected to the requirement as overly burdensome and of questionable
protective value to Retirement Investors.
After consideration of the comments, the Department has restated
the condition in Section IV(b)(3) and included specific documentation
requirements. The written documentation required in this condition is
not individualized and does not have to be provided to Retirement
Investors, addressing commenters' concerns that the written finding
might have to be made on an individual Retirement Investor basis. But
the Department remains convinced of the importance of ensuring that the
Financial Institution safeguard against conflicts in the manner
proposed. While other provisions of the definition and the exemption
create strong limitations on conflicted conduct by individual Advisers,
this condition focuses specifically on firm-level conflicts, and for
that reason is important to protecting Retirement Investors from harm.
As revised, the exemption now imposes the following condition:
(3) The Financial Institution documents in writing its
limitations on the universe of recommended investments; documents in
writing the Material Conflicts of Interest associated with any
contract, agreement, or arrangement providing for its receipt of
Third Party Payments or associated with the sale or promotion of
Proprietary Products; documents any services it will provide to
Retirement Investors in exchange for Third Party Payments, as well
as any services or consideration it will furnish to any other party,
including the payor, in exchange for Third Party Payments;
reasonably concludes that the limitations on the universe of
recommended investments and Material Conflicts of Interest will not
cause the Financial Institution or its Advisers to receive
compensation in excess of reasonable compensation for Retirement
Investors as set forth in Section II(c)(2); reasonably determines,
after consideration of the policies and procedures established
pursuant to Section II(d), that these limitations and Material
Conflicts of Interest will not cause the Financial Institution or
its Advisers to recommend imprudent investments; and documents the
bases for its conclusions;
The purpose of this requirement is to ensure that the Financial
Institution reasonably safeguards Retirement Investors from dangerous
conflicts of
[[Page 21055]]
interest, notwithstanding its decision to provide a restricted menu of
investment options. Accordingly, the Financial Institution must
carefully evaluate and document the conflicts of interest associated
with the limited menu; reasonably conclude that the practices will not
cause the payment of excess compensation to the Advisers or the
Financial Institution; reasonably determine, in light of the Financial
Institution's policies and procedures, that the limitations will not
cause Advisers to make imprudent recommendations; and document the
reasoning for all its conclusions. These documents must be retained
under the recordkeeping provisions of the exemption discussed below,
and would be available to the Department and Retirement Investors.
These requirements of Section IV(b)(3), together with the
disclosure and other requirements of Section IV(b) and the rest of the
exemption, were carefully crafted to protect the interests of
Retirement Investors. The Department has made the requirements more
specific in response to comments, but it declines requests to provide
greater exemptive relief to Financial Institutions that make conflicted
recommendations of Proprietary Products or investments that generate
Third Party Payments. In such cases, it is particularly important that
conflicts of interest be carefully addressed at the level of the
Financial Institution, not just at the level of the Adviser. Section
IV(b)(3) adds clarity and substance to the Financial Institutions'
important obligations to their Retirement Investor customers.
c. Reasonable Compensation
Section IV(b)(5) retains a reasonable compensation requirement for
Financial Institutions that fall within the parameters of Section IV.
The proposal had departed, in some respects, from the formulation of
the reasonable compensation standard under ERISA section 408(b)(2) and
in Section II(c)(2) of the exemption. In particular, rather than
looking at the reasonableness of the aggregate compensation for all of
the services to the Retirement Investor, the test required that each
instance of compensation be reasonable in relation to the fair market
value of the specific service that generated the compensation. The
Department's intent in this regard was to ensure that any additional
payments, such as Third Party Payments, received in connection with
advice, where advice is limited to certain products, were tied to
specific services of equivalent value.
Some commenters questioned the need for a special reasonable
compensation standard in this context. In particular, they complained
that it would be difficult to comply with the test, or to match up
particular payments with particular investors. A commenter explained
that some investors may pay slightly more due to the funds they select
while others may pay slightly less even though the services are
basically the same. In addition, higher net-worth clients with larger
account balances subsidize those with more modest lower account
balances, according to the commenter. Another commenter described the
requirement as a departure from prior Department guidance, which
focused on the reasonableness of compensation in the aggregate, and did
not require that each stream of compensation be determined to be
reasonable in relation to the specific services provided.
After considering the comments, the Department has decided to use
the same reasonable compensation standard throughout the exemption as
set forth in Section II(c)(2), rather than a special standard for
Financial Institutions making recommendations from a limited menu.
Accordingly, Section IV(b)(5) now states the following condition:
At the time of the recommendation, the amount of compensation
and other consideration reasonably anticipated to be paid, directly
or indirectly, to the Adviser, Financial Institution, or their
Affiliates or Related Entities for their services in connection with
the recommended transaction is not in excess of reasonable
compensation within the meaning of ERISA section 408(b)(2) and Code
section 4975(d)(2);
This condition, used throughout the exemption, applies the familiar
reasonable compensation standard applicable to service providers
(fiduciary or non-fiduciary) under ERISA and the Code. Although the
standard is a fair market standard, there is no requirement to allocate
specific compensation to specific services.
The Department stresses the importance of Financial Institutions'
obligations in this regard, particularly when limiting their
recommendations to Proprietary Products or products that generate Third
Party Payments. In such cases, the Financial Institution's conflicts of
interest are acute, and the additional compensation generated by their
recommendations often are not transparent to the Retirement Investor.
Accordingly, Financial Institutions should give special care to meeting
their obligations under Section IV(b)(3) to reasonably conclude that
the limitations and conflicts of interest associated with Proprietary
Products and Third Party Payments will not cause the Financial
Institution or its Advisers to receive compensation in excess of
reasonable compensation, and to document the bases for their findings.
d. Notification
Section IV(b)(4) of the proposal contained a provision requiring
the Adviser to notify the Retirement Investor if the Adviser does not
recommend a sufficiently broad range of Assets to meet the Retirement
Investor's needs. Some commenters requested that the Department clarify
the purpose of the notice, in part to confirm that it is not punitive.
Others asked about the specifics of the wording of the notice and
whether it could be phrased to emphasize what is offered instead of
what is not. A commenter also suggested it was unnecessary in light of
some of the initial disclosures regarding the limitations placed on
recommendations.
As explained above, Section IV was re-worked in the final exemption
to clarify that Financial Institutions and Advisers may limit the
products they offer to Proprietary Products and those that generate
Third Party Payments and to specify how a Financial Institution that
limits its products in this way, in whole or in part, can satisfy the
Best Interest standard. After consideration of the comments, the
Department has deleted the specific disclosure provision from the text
of the exemption condition. It should be emphasized, however, that an
Adviser must take special care to comply with the exemption's
conditions when making recommendations from a very limited menu. The
fact that the menu does not offer an investment that meets the prudence
and loyalty standards with respect to the particular customer, and in
light of that customer's needs, is not a basis for ignoring those
standards. Moreover, Advisers that recommend a limited set of products
must consider the share of the portfolio that such products account
for, when recommending them to a Retirement Investor. If another type
of investment would be in the Retirement Investor's Best Interest, the
Adviser may not, consistent with the Best Interest obligation,
recommend a product from its limited menu.
9. Disclosure to the Department and Recordkeeping (Section V)
Section V of the exemption establishes record retention and
disclosure conditions that a Financial Institution must satisfy for the
[[Page 21056]]
exemption to be available for compensation received in connection with
recommended transactions.
a. EBSA Notice
Before receiving compensation in reliance on the exemption, the
Financial Institution must notify the Employee Benefits Security
Administration (EBSA) of the Department of Labor of its intention to
rely on the exemption. The notice will remain in effect until revoked
in writing by the Financial Institution. The notice need not identify
any plan or IRA.
The Department received several requests to delete the EBSA notice
requirement. One commenter complained this would be a ``foot fault''
for Financial Institutions trying to comply, placing a burden on the
Financial Institutions without adding significant protections for the
Retirement Investors. According to the comment, the EBSA notice would
not be useful for Retirement Investors or the Department because almost
all Financial Institutions would make the one-time filing. The
commenter also raised questions about the logistics of the notice;
whether each separate legal entity would be required to file the notice
and if Financial Institutions would be required to amend their notices
when restructuring operations.
The Department has retained the notice requirement in the final
exemption. The EBSA notice, while imposing a minimal obligation on the
Financial Institution, serves a valuable function by enabling the
Department to determine which and which type of Financial Institutions
intend to rely on the exemption, and by facilitating the Department's
audit and compliance assistance programs. These efforts promote
compliance with the exemption's terms and redound to the benefit of
Retirement Investors. The Department has kept the notice requirement
simple to avoid placing an undue burden on Financial Institutions, but
it confirms that each Financial Institution relying on the exemption
must file the notice, and, if operations are restructured and a new
legal entity becomes the Financial Institution, the new entity must
file prior to reliance on the exemption.
The Department has clarified the manner of service in response to
comments. The notice must be provided by email to the Department of
Labor, Employee Benefits Security Administration, Office of Exemption
Determinations at e-BICE@dol.gov. One commenter suggested that the
Department should create an online submission form with mandatory
identification fields and a web address for submitting the form. The
Department has not accepted this comment, but notes that the
notification need not contain much detailed information. It must simply
identify the Financial Institution and its intent to rely on the
exemption.
The same commenter also suggested that the notices be provided to
the Employee Benefits Security Administration, Office of Enforcement,
to allow the Department's investigators to target those Financial
Institutions for compliance evaluations. The Department has rejected
this comment, however, because the notice serves broader purposes than
just enforcement, and the information will be readily available to
EBSA's Office of Enforcement regardless of the initial recipient of the
information within EBSA.
Other commenters suggested the Department share the information
more broadly. One commenter requested that the Department create a
mechanism to share the notices with other regulators, including the
states, the SEC and FINRA to promote investor protection. Another
suggested a publicly accessible registry where filings could be
electronically verified and viewed. In addition to providing increased
transparency, this would also provide a way for Financial Institutions
to confirm that their notification has been received. The Department
has declined to accept these comments. This is a notice provision only
and the Department does not intend to require any approval or finding
by the Department that the Financial Institution is eligible for the
exemption. As in the proposal, once a Financial Institution has sent
the notice, it can immediately begin to rely on the exemption, provided
the conditions are satisfied. However, the Department notes that
Financial Institutions should retain documentation of having provided
the notification in accordance with Section V(b) discussed below.
One commenter requested a change in the timing of the notification,
so that it would be required at the time an investment advice program
is implemented, rather than before implementation. The Department has
not made this change in the text, but notes that the notification need
not be provided significantly in advance of any recommendations and
that it is effective upon sending. Therefore, a Financial Institution
could send the Department its notice immediately prior to receiving
compensation in reliance on the Best Interest Contract Exemption and
this condition would be satisfied.
b. Data Request
Section V(b) of the proposal would have required the Financial
Institution to collect and maintain data relating to inflows, outflows,
holdings, and returns for retirement investments for six years from the
date of the applicable transactions and to provide that data to the
Department upon request within six months. The Department reserved the
right to publicly disclose the information provided on an aggregated
basis, although it made clear it would not disclose any individually
identifiable financial information regarding Retirement Investor
accounts.
The Department eliminated the data request in its entirety in
response to comments. While the Department received some comments
supporting the requirement, a large number of commenters requested
elimination of the requirement. Commenters expressed concerned about
the burden and costs of maintaining the necessary materials and
responding to the Department within the timeframe. They also raised
concerns about coordinating with other regulatory requirements, as well
as privacy and security, including trade secrets, especially in light
of the provision that would potentially have allowed the Department to
make portfolio returns and other information public. One commenter
asserted that the provision may violate federal banking law. Still
other commenters raised questions regarding the purpose and necessity
of the requirement, and the consequences of failure to comply.
While the proposed data collection requirement was not adopted as
part of the final exemption, the separate proposed general
recordkeeping requirement was adopted, with some modifications, as
Section V(b) and (c). The requirement to maintain the records necessary
to determine compliance with the exemption both encourages thoughtful
compliance and provides an important means for the Department and
Retirement Investors to assess whether Financial Institutions and their
Advisers are, in fact, complying with the exemption's conditions and
fiduciary standards. Although the requirement does not lend itself to
the same sorts of statistical and quantitative analyses that would have
been promoted by the data collection requirement, it too assists the
Department and Retirement Investors in evaluating compliance with the
exemption, but at substantially less cost.
c. General Recordkeeping
Under Section V(b) and (c) of the exemption, the Financial
Institution
[[Page 21057]]
must maintain for six years records necessary for the Department and
certain other entities, including plan fiduciaries, participants,
beneficiaries and IRA owners, to determine whether the conditions of
the exemption have been satisfied. These records would include, for
example, records concerning the Financial Institution's incentive and
compensation practices for its Advisers, the Financial Institution's
policies and procedures, any documentation governing the application of
the policies and procedures, the documents prepared under Section IV
(Proprietary Products and Third Party Payments), contracts entered into
with Retirement Investors, and disclosure documentation.
Some commenters objected that these proposed recordkeeping
requirements were too burdensome, and expressed concern about required
disclosure of trade secrets. One commenter indicated that the exemption
should not allow parties such as plan fiduciaries, participants,
beneficiaries and IRA owners, to obtain information about a transaction
involving another plan or IRA. Another raised concerns that the
Department's right to review a bank's records could conflict with
federal banking laws that prohibit agencies other than the Office of
the Comptroller of the Currency (OCC) from exercising ``visitorial''
powers over national banks and federal savings associations. The
commenter asserted that such visitorial powers, governed by 12 U.S.C.
484, include the power of a regulator to inspect, examine, supervise,
and regulate the affairs of an entity.
After consideration of the comments, the Department has modified
the recordkeeping provision in the following ways. The Department has
clarified which parties may view the records that are maintained by the
Financial Institution. Plan fiduciaries, participants, beneficiaries,
contributing employers, employee organizations with members covered by
the plan, and IRA owners are not authorized to examine records
regarding a recommended transaction involving another Retirement
Investor. Financial Institutions are not required to disclose
privileged trade secrets or privileged commercial or financial
information to any of the parties other than the Department, as was
also true of the proposal. Financial Institutions are also not required
to disclose records if such disclosure would be precluded by 12 U.S.C.
484. As revised, the exemption requires the records be ``reasonably''
available, rather than ``unconditionally'' available.
The recordkeeping provision in the exemption is necessary to
demonstrate compliance with the terms of the exemption and therefore
should represent prudent business practices in any event. The
Department notes that similar language is used in many other exemptions
and has been the Department's standard recordkeeping requirement for
exemptions for some time.
C. Exclusions (Section I(c))
Although Section I(b) broadly permits the receipt of compensation
resulting from investment advice within the meaning of ERISA section
3(21)(A)(ii) and Code section 4975(e)(3)(B) to a Retirement Investor,
the exemption is subject to some specific exclusions, as discussed
below.
1. In-House Plans
Section I(c)(1) provides that the exemption does not apply to the
receipt of compensation from a transaction involving an ERISA plan if
the Adviser, Financial Institution or any Affiliate is the employer of
employees covered by the plan. Industry commenters requested
elimination of this exclusion. In particular, they said that Financial
Institutions in the business of providing investment advice should not
be compelled to hire a competitor to provide services to the Financial
Institution's own plan. They warned that the exclusion could
effectively prevent these Financial Institutions from providing any
investment advice to their employees. Some commenters additionally
stated that for compliance reasons, employees of a Financial
Institution are often required to maintain their financial assets with
that firm. As a result, they argued employees of Financial Institutions
could be denied access to investment advice on their retirement
savings.
In general, the Department has not scaled back the exclusion. The
Department continues to be concerned that the danger of abuse is
compounded when the advice recipient receives recommendations from the
employer, upon whom he or she depends for a job, to make investments in
which the employer has a financial interest. To protect employees from
abuse, employers generally should not be in a position to use their
employees' retirement benefits as potential revenue or profit sources,
without stringent safeguards. See, e.g., ERISA section 403(c)(1)
(generally providing that ``the assets of a plan shall never inure to
the benefit of any employer''). Employers can always render advice and
recover their direct expenses in transactions involving their employees
without need of an exemption. In addition, ERISA section 408(b)(5)
provides a statutory exemption for the purchase of life, health
insurance, or annuities provided that the plan pays no more than
adequate consideration.
In accordance with this condition, the exemption is not available
for compensation received in a rollover from such a plan to an IRA,
where the compensation is derived from transactions involving the plan,
not the IRA. Additionally, the exclusion in Section I(c) does not apply
in the case of an IRA or other similar plan that is not covered by
Title I of ERISA. The decision to open an IRA account or obtain IRA
services from the employer is much more likely to be entirely voluntary
on the employees' part than would be true of their interactions with
the retirement plan sponsored and designed by their employer for its
employee benefit program. Accordingly, an Adviser or Financial
Institution may provide advice to the beneficial owner of an IRA who is
employed by the Adviser, its Financial Institution or an Affiliate, and
receive prohibited compensation as a result, provided the IRA is not
covered by Title I of ERISA, and the conditions of this exemption are
satisfied.
Section I(c)(1) further provides that the exemption is unavailable
if the Adviser or Financial Institution is a named fiduciary or plan
administrator, as defined in ERISA section 3(16)(A)) with respect to an
ERISA plan, or an affiliate thereof, that was selected to provide
advice to the plan by a fiduciary who is not independent of them. This
provision is intended to disallow the selection of Advisers and
Financial Institutions by named fiduciaries or plan administrators that
have a significant financial stake in the selection and was adopted in
the final exemption unchanged from the proposal.\86\
---------------------------------------------------------------------------
\86\ The definition of ``independent'' was adjusted in response
to comments, as discussed below, to permit circumstances in which
the person selecting the Adviser and Financial Institution could
receive no more than 2% of its compensation from the Financial
Institution.
---------------------------------------------------------------------------
2. Principal Transactions
Section I(c)(2) excludes compensation earned in ``principal
transactions'' from the scope of the exemption. In a ``principal
transaction,'' the Financial Institution engages in a purchase or sale
transaction with a Retirement Investor for the Financial Institution's
own account (or for the account of a person directly or indirectly,
through one or more intermediaries, controlling,
[[Page 21058]]
controlled by, or under common control with the Financial Institution).
As discussed above, this restriction does not include riskless
principal transactions. In addition, the exemption does not treat sales
of insurance or annuity contracts, or mutual fund shares, as principal
transactions.
In the proposal for this Best Interest Contract Exemption, the
Department stated that principal transactions would be excluded from
the relief provided, but did not define the term ``principal
transaction.'' The Department received several requests for
clarification of the term, particularly with respect to recommendations
of proprietary insurance products. After considering the comments, the
Department defined ``principal transaction'' to clarify that purchases
and sales of insurance and annuity contracts will not be treated as
principal transactions.
Other commenters asked about the treatment of unit investment
trusts (UITs). UITs are generally traded on a principal basis,
according to commenters, but are sold in ways that are similar to
mutual funds sales. Commenters noted that in the proposal, the
Department specifically indicated that mutual fund transactions were
not treated as excluded principal transactions because they are traded
on a riskless principal basis. Commenters asked for confirmation that
UITs would receive the same treatment. The Department concurs that to
the extent UITs are sold in riskless principal transactions, they can
be recommended under this exemption. They are also included within the
types of investments that can be recommended under the Principal
Transactions Exemption.
3. ``Robo-Advice''
Section I(c)(3) generally provides that the exemption does not
cover compensation that is received as a result of investment advice
generated solely by an interactive Web site in which computer software-
based models or applications provide investment advice to Retirement
Investors based on personal information the investor supplies through
the Web site without any personal interaction or advice from an
individual Adviser. Such computer derived advice is often referred to
as ``robo-advice.'' A statutory prohibited transaction exemption at
ERISA section 408(b)(14) covers computer-generated investment advice
and is available for robo-advice involving prohibited transactions if
its conditions are satisfied. See 29 CFR 2550.408g-1.
The exclusion does not apply, however, to robo-advice providers
that are Level Fee Fiduciaries. Such providers may rely on the
exemption with respect to investment advice to engage the robo-advice
provider for advisory or investment management services with respect to
the Plan or IRA assets, provided they comply with the conditions
applicable to Level Fee Fiduciaries.
The Department received several requests to include robo-advice in
this exemption or provide a separate streamlined exemption for robo-
advice. Commenters argued that all advice should be treated the same,
regardless of whether it is provided through a computer or through a
human Adviser. Some commenters thought that by excluding robo-advice
from the exemption, the Department was limiting options for Retirement
Investors. In addition, some commenters stated that robo-advice can be
difficult to define, and many Financial Institutions and Advisers may
use hybrid programs that rely on both computer software-based models
and personal advice. One commenter was concerned that excluding robo-
advice from the exemption could leave Retirement Investors who rely on
robo-advice without any legal remedy, and may force more Retirement
Investors to rely on an untested alternative.
The Department is of the view that the marketplace for robo-advice
is still evolving in ways that both appear to avoid conflicts of
interest that would violate the prohibited transaction rules and
minimize cost. Therefore, the Department included robo-advice in the
exemption only if the advice is provided by a Level Fee Fiduciary to
enter into the arrangement for robo-advice, including by means of a
rollover from an ERISA plan to an IRA, and if the conditions applicable
to Level Fee Fiduciaries are satisfied. Accordingly, the fiduciary and
its Affiliates must receive only a Level Fee, as defined in the
exemption. In addition, the Department notes that hybrid programs in
which the Adviser relies upon or works in tandem with such interactive
materials are not excluded under the language of Section I(c)(3),
regardless if they utilize a level fee arrangement. However, the
Department determined against providing relief for robo-advice
providers acting purely through the web to receive non-level
compensation after being retained by the Retirement Investor. Including
such relief in this exemption could adversely affect the incentives
currently shaping the market for robo-advice.
The Department further notes that to the extent robo-advice is not
covered under exemption, it does not mean that Retirement Investors
have no protections with respect to their interactions with such advice
providers; to the contrary, it means that the robo-advice providers
that are fiduciaries under the Regulation must provide advice under
circumstances that do not constitute a prohibited transaction, or rely
on another exemption, including ERISA section 408(g).
4. Discretion
Finally, Section I(c)(4) provides that the exemption is not
available if the Adviser has or exercises any discretionary authority
or discretionary control with respect to the recommended transaction.
This has been revised from the proposal in response to comments. Under
the proposal, relief would not have been available if an Adviser
exercised discretionary authority or control respecting management of
the plan or IRA assets involved in the transaction, exercised any
authority or control respecting management or disposition of the
assets, or had any discretionary authority or responsibility in the
administration of the Plan or IRA. Commenters expressed concern that
the exclusion was too broad. For example, some commenters asserted that
it could be read to exclude an Adviser who had no discretionary or
authority with respect to the assets at the time of the transaction,
but subsequently acquired such control (e.g., an Adviser who
recommended that the investor roll the money out of an IRA into an
account to be managed by the Adviser). This was not the Department's
intent, and the Department has revised the provision to make clear that
the Adviser must have had or exercised discretionary authority to
engage in the recommended transaction.
Commenters additionally requested that the exemption apply to
discretionary asset management, as well as advice, so that Financial
Institutions offering both discretionary and non-discretionary services
could comply with the same set of rules. The commenters stated that, as
part of this regulatory package, there were proposed amendments that
would change some prohibited transaction class exemptions previously
relied on by discretionary managers.
The Department has considered these comments but has determined not
to broaden the exemption to include relief for fiduciaries with
investment discretion over the recommended transactions. These
fiduciaries are currently subject to a robust regulatory regime,
developed over decades, which specifically addresses the issues raised
[[Page 21059]]
when a fiduciary is given the discretionary authority to manage assets.
Including discretionary fiduciaries in the relief provided by the
exemption would expose discretionary fiduciaries--and the Retirement
Investors they serve as fiduciaries--to conflicts that they are
currently not exposed to. The conditions of this exemption are tailored
to the conflicts that arise in the context of the provision of
investment advice, not the conflicts that could arise with respect to
discretionary money managers. Moreover, the Department's decision to
amend other exemptions that are applicable to discretionary managers
does not alter the Department's view of the proper scope of this Best
Interest Contract Exemption. The amendments to other exemptions
applicable to discretionary fiduciaries, also published in this issue
of the Federal Register, are limited; they primarily incorporate the
Impartial Conduct Standards as conditions of those exemptions and
clarify issues of scope. The purpose of those amendments too is to
reduce the harmful impact of conflicts of interest, not expand the
scope of their operation.
D. Good Faith Compliance
Commenters requested that the exemption continue to apply in the
event of a Financial Institution's or Adviser's good faith failure to
comply with one or more of the conditions. In the commenters' views,
the exemption was sufficiently complex and the implementation timeline
sufficiently short to justify such a provision. For example, FINRA
suggested that the Department include a provision for continued
application of the exemption despite a failure to comply with ``any
term, condition or requirement of this exemption . . . if the failure
to comply was insignificant and a good faith and reasonable attempt was
made to comply with all applicable terms, conditions and
requirements.'' Several commenters specifically supported FINRA's
suggestion.
There were other specific suggestions regarding good faith
compliance. For example, one commenter suggested that there be a
provision to bar litigation concerning ``de minimis'' claims, including
accounts of $5,000 or less, if the Adviser and Financial Institution
acted in good faith. Another suggested the Department adopt a
``Compliance Program Safe Harbor,'' which would provide a safe harbor
from litigation if the Financial Institution adopted and implemented a
compliance program. The suggested compliance program included, among
other features, diligence, training, oversight, annual certification of
the compliance program by the Chief Compliance Officer of the Financial
Institution or a Related Entity, and an annual audit (by internal or
external auditors) of the operation of the compliance program. Other
commenters were less specific. One suggested a ``principles-based
approach'' to the penalties and corrections to match the principles-
based approach to the conditions. Several other commenters pointed to
other good faith compliance provisions in the Department's regulations
under ERISA sections 404 and 408(b)(2).
The Department has reviewed the exemption's requirements with these
comments in mind and has included a good faith correction mechanism for
the disclosure requirements in Section II(e) and Section III. These
provisions take a similar approach to the provisions in the
Department's regulations under ERISA sections 404 and 408(b)(2). In
addition, as discussed above, the Department has eliminated a condition
requiring compliance with other federal and state laws, which many
commenters had argued could expose them to loss of the exemption based
on small or technical violations. The Department has also facilitated
compliance by streamlining the contracting process (and eliminating the
contract requirement for ERISA plans), reducing the disclosure burden,
expanding the scope of the grandfather provision, and extending the
time for compliance with many of the exemption's conditions. These and
other changes should reduce the need for a self-correction process for
excusing violations.
The Department declines to permanently adopt a broader unilateral
good faith provision for Financial Institutions and their Advisers
because it could undermine fiduciaries' long-run incentive to comply
with the fundamental standards imposed by the exemption. The
exemption's primary purpose is to combat harmful conflict of interest.
If the exemption is too forgiving of abusive conduct, however, it runs
the risk of permitting those same conflicts of interest to play a role
in the design of policies and procedures, the use and oversight of
adviser-incentives, the supervision of Adviser conduct, and the
substance of investment recommendations. At the very least, it could
encourage Financial Institutions and Advisers to resolve doubts on such
questions in favor of their own financial interests rather than the
interests of the Retirement Investor. Given the dangers posed by
conflicts, the Department has deliberately structured this exemption to
provide a strong counter-incentive to such conduct.
Additionally, many of the exemption's standards, such as the Best
Interest standard and the reasonable compensation standard, already
have a built-in reasonableness or prudence standard governing
compliance. It would be inappropriate, in the Department's view, to
create a self-correction mechanism for conduct that was imprudent or
unreasonable. For example, the Best Interest standard requires that the
Adviser and Financial Institution providing the advice act with the
care, skill, prudence, and diligence under the circumstances then
prevailing that a prudent person acting in a like capacity and familiar
with such matters would use in the conduct of an enterprise of a like
character and with like aims, based on the investment objectives, risk
tolerance, financial circumstances, and needs of the Retirement
Investor, without regard to the financial or other interests of the
Adviser, Financial Institution or any Affiliate, Related Entity, or
other party. Similarly, the policies and procedures requirement under
Section II(d) turns to a significant degree on adherence to standards
of prudence and reasonableness. Thus, under Section II(d)(1), the
Financial Institution is required to adopt and comply with written
policies and procedures reasonably and prudently designed to ensure
that its individual Advisers adhere to the Impartial Conduct Standards
set forth in Section II(c).
The considerations above apply to large and small investor accounts
alike. The Department does not intend for Financial Institutions be
less sensitive or careful about adherence to fiduciary norms with
respect to small investors, and declines the suggestion that it adopt a
special provision to bar litigation for ``de minimis'' claims.
Additionally, the provision allowing mandatory arbitration of
individual claims is also responsive to the practicalities of resolving
disputes over small claims. The Department also stresses that
violations of the exemption's conditions with respect to a particular
Retirement Investor or transaction, eliminates the availability of the
exemption for that investor or transaction. Such violations do not
render the exemption unavailable with respect to other Retirement
Investors or other transactions.
E. Jurisdiction
The Department received a number of comments questioning the
Department's jurisdiction and legal authority to proceed with the
proposal. A number of commenters focused on the Department's authority
to impose
[[Page 21060]]
certain conditions as part of this exemption, specifically including
the contract requirement and the Impartial Conduct Standards.
Some commenters asserted that by requiring a contract for all
Retirement Investors, and thereby facilitating contract claims by such
parties, the proposal would expand upon the remedies established by
Congress under ERISA and the Code. Commenters stated that ERISA
preempts state law actions, including breach-of-contract actions. With
respect to IRAs and non-ERISA plans, commenters stated that Congress
provided that the enforcement of the prohibited transaction rules
should be carried out by the Internal Revenue Service, not private
plaintiffs. These commenters argued that the Department's proposal
would impermissibly create a private right of action in violation of
Congressional intent.
Commenters' arguments regarding the Impartial Conduct Standards
were based generally on the fact that the standards, as noted above,
are consistent with longstanding principles of prudence and loyalty set
forth in ERISA section 404, but which have no counterpart in the Code.
Commenters took the position that because Congress did not choose to
impose the standards of prudence and loyalty on fiduciaries with
respect to IRAs and non-ERISA plans, the Department exceeded its
authority in proposing similar standards as a condition of relief in a
prohibited transaction exemption.
With respect to ERISA plans, commenters stated that Congress'
separation of the duties of prudence and loyalty (in ERISA section 404)
from the prohibited transaction provisions (in ERISA section 406),
showed an intent that the two should remain separate. Commenters
additionally questioned why the conduct standards were necessary for
ERISA plans, when such plans already have an enforceable right to
fiduciary conduct that is both prudent and loyal. Commenters asserted
that imposing the Impartial Conduct Standards as conditions of the
exemption improperly created strict liability for prudence violations.
Some commenters additionally took the position that Congress, in
the Dodd-Frank Act, gave the SEC the authority to establish standards
for broker-dealers and investment advisers and therefore, the
Department did not have the authority to act in that area.
The Department disagrees that the exemption exceeds its authority.
The Department has clear authority under ERISA section 408(a) and the
Reorganization Plan \87\ to grant administrative exemptions from the
prohibited transaction provisions of both ERISA and the Code. Congress
gave the Department broad discretion to grant or deny exemptions and to
craft conditions for those exemptions, subject only to the overarching
requirement that the exemption be administratively feasible, in the
interests of plans, plan participants and beneficiaries and IRA owners,
and protective of their rights.\88\ Nothing in ERISA or the Code
suggests that, in exercising its express discretion to fashion
appropriate conditions, the Department cannot condition exemptions on
contractual terms or commitments, or that, in crafting exemptions
applicable to fiduciaries, the Department is forbidden to borrow from
time-honored trust-law standards and principles developed by the courts
to ensure proper fiduciary conduct.
---------------------------------------------------------------------------
\87\ See fn. 1, supra, discussing of Reorganization Plan No. 4
of 1978 (5 U.S.C. app. at 214 (2000)).
\88\ See ERISA section 408(a) and Code section 4975(c)(2).
---------------------------------------------------------------------------
In addition, this exemption does not create a cause of action for
plan fiduciaries, participants or IRA owners to directly enforce the
prohibited transaction provisions of ERISA and the Code in a federal or
state-law contract action. Instead, with respect to ERISA plans and
participants and beneficiaries, the exemption facilitates the existing
statutory enforcement framework by requiring Financial Institutions to
acknowledge in writing their fiduciary status and the fiduciary status
of their Advisers. With respect to IRAs and non-ERISA plans, the
exemption requires Advisers and Financial Institutions to make certain
enforceable commitments to the advice recipient. Violation of the
commitments can result in contractual liability to the Adviser and
Financial Institution separate and apart from the legal consequences of
a non-exempt prohibited transaction (e.g., an excise tax).
There is nothing new about a prohibited transaction exemption
requiring certain written documentation between the parties. The
Department's widely-used exemption for Qualified Professional Asset
Managers (QPAM), requires that an entity acting as a QPAM acknowledge
in a written management agreement that it is a fiduciary with respect
to each plan that has retained it.\89\ Likewise, PTE 2006-16, an
exemption applicable to compensation received by fiduciaries in
securities lending transactions, requires the compensation to be paid
in accordance with the terms of a written instrument.\90\ Surely, the
terms of these documents can be enforced by the parties. In this
regard, the statutory authority permits, and in fact requires, that the
Department incorporate conditions in administrative exemptions designed
to protect the interests of plans, participants and beneficiaries, and
IRA owners. The Department has determined that the contract requirement
in the final exemption serves a critical protective function.
---------------------------------------------------------------------------
\89\ See Section VI(a) of PTE 84-14, 49 FR 9494, March 13, 1984,
as amended at 70 FR 49305 (August 23, 2005) and as amended at 75 FR
38837 (July 6, 2010).
\90\ See Section IV(c) of PTE 2006-16, 71 FR 63786 (Oct. 31,
2006).
---------------------------------------------------------------------------
Likewise, the Impartial Conduct Standards represent, in the
Department's view, baseline standards of fundamental fair dealing that
must be present when fiduciaries make conflicted investment
recommendations to Retirement Investors. After careful consideration,
the Department determined that broad relief should be provided to
investment advice fiduciaries receiving conflicted compensation only if
such fiduciaries provided advice in accordance with the Impartial
Conduct Standards--i.e., if they provided prudent advice without regard
to the interests of such fiduciaries and their Affiliates and Related
Entities, in exchange for reasonable compensation and without
misleading investors. These Impartial Conduct Standards are necessary
to ensure that Advisers' recommendations reflect the best interest of
their Retirement Investor customers, rather than the conflicting
financial interests of the Advisers and their Financial Institutions.
As a result, Advisers and Financial Institutions bear the burden of
showing compliance with the exemption and face liability for engaging
in a non-exempt prohibited transaction if they fail to provide advice
that is prudent or otherwise in violation of the standards. The
Department does not view this as a flaw in the exemption, as commenters
suggested, but rather as a significant deterrent to violations of
important conditions under an exemption that accommodates a wide
variety of potentially dangerous compensation practices.
The Department similarly disagrees that Congress' directive to the
SEC in the Dodd-Frank Act limits its authority to establish appropriate
and protective conditions in the context of a prohibited transaction
exemption. Section 913 of that Act directs the SEC to conduct a study
on the standards of care applicable to brokers-dealers and investment
advisers, and issue a report containing, among other things:
[[Page 21061]]
an analysis of whether [sic] any identified legal or regulatory
gaps, shortcomings, or overlap in legal or regulatory standards in
the protection of retail customers relating to the standards of care
for brokers, dealers, investment advisers, persons associated with
brokers or dealers, and persons associated with investment advisers
for providing personalized investment advice about securities to
retail customers.\91\
\91\ Dodd-Frank Act section 913(d)(2)(B).
---------------------------------------------------------------------------
Section 913 authorizes, but does not require, the SEC to issue
rules addressing standards of care for broker-dealers and investment
advisers for providing personalized investment advice about securities
to retail customers.\92\ Nothing in the Dodd-Frank Act indicates that
Congress meant to preclude the Department's regulation of fiduciary
investment advice under ERISA or its application of such a regulation
to securities brokers or dealers. To the contrary, Dodd-Frank in
directing the SEC study specifically directed the SEC to consider the
effectiveness of existing legal and regulatory standards of care under
other federal and state authorities.\93\ The Dodd-Frank Act did not
take away the Department's responsibility with respect to the
definition of fiduciary under ERISA and in the Code; nor did it qualify
the Department's authority to issue exemptions that are
administratively feasible, in the interests of plans, participants and
beneficiaries, and IRA owners, and protective of the rights of
participants and beneficiaries of the plans and IRA owners. If the
Department were unable to rely on contract conditions and trust-law
principles, it would be unable to grant broad relief under this
exemption from the rigid application of the prohibited transaction
rules. This enforceable standards-based approach enabled the Department
to grant relief to a much broader range of practices and compensation
structures than would otherwise have been possible.
---------------------------------------------------------------------------
\92\ 15 U.S.C. 80b-11(g)(1).
\93\ Dodd-Frank Act section 913(b)(1) and (c)(1).
---------------------------------------------------------------------------
Additionally, the Department notes that nothing in ERISA or the
Code requires any Adviser or Financial Institution to use this
exemption. Exemptions, including this class exemption, simply provide a
means to engage in a transaction otherwise prohibited by the statutes.
The conditions to an exemption are not equivalent to a regulatory
mandate that conflicts with or changes the statutory remedial scheme.
If Advisers or Financial Institutions do not want to be subject to
contract claims, they can (1) change their compensation structure and
avoid committing a prohibited transaction, (2) use the statutory
exemptions in ERISA section 408(b)(14) and section 408(g), or Code
section 4975(d)(17) and (f)(8), or (3) apply to the Department for
individual exemptions tailored to their particular situations.
F. Alternatives
A number of commenters suggested complete alternatives to the
approach taken in the proposed exemption. As an initial matter, some
suggestions were aimed at streamlining and simplifying the exemption to
reduce compliance burdens. The Department reviewed the exemption with
these comments in mind and has made changes to reduce complexity and
compliance burden without sacrificing significant protections. For
example, the Department eliminated the proposed contract requirement
for advice to Retirement Investors regarding investments in ERISA
plans, adopted a less burdensome approach to disclosure, and eliminated
the proposed annual disclosure and the proposed data collection
requirement.
For all the reasons set forth in the preceding sections, however,
the Department remains convinced of the critical importance of the core
requirements of the exemption, including an up-front commitment to act
as a fiduciary; enforceable adherence to the Impartial Conduct
Standards; the adoption of policies and procedures to reasonably assure
compliance with the Impartial Conduct Standards; a prohibition on
incentives to violate the Best Interest Standard; and fair disclosure
of fees, conflicts of interest, and Material Conflicts of Interest. The
Impartial Conduct Standards simply require adherence to basic fiduciary
norms and standards of fair dealing--rendering prudent and loyal advice
that is in the best interest of the customer, receiving no more than
reasonable compensation, and refraining from making misleading
statements. These fundamental standards enable the Department to grant
an exemption that flexibly covers a broad range of compensation
structures and business models, while safeguarding the interest of
Retirement Investors against dangerous conflicts of interest. The
conditions were critical to the Secretary of Labor's ability to make
the required findings under ERISA section 408(a) and Code section
4975(c)(2) that the exemption is in the interests of plans, their
participants and beneficiaries, and IRAs, that the exemption is
protective of their interests, and that the exemption is
administratively feasible.
Alternative Best Interest Formulations
Some commenters suggested alternative approaches that included a
standard characterized as a ``best interest'' standard of conduct,
combined with certain of the other safeguards that the Department had
proposed, including reasonable compensation, disclosures, or anti-
conflict policies and procedures. As a general matter, however, none of
the suggested alternative approaches incorporated all the components of
the proposal that the Department viewed as essential to making the
required findings for granting an exemption, or provided alternatives
that included conditions that would appropriately safeguard the
interests of Retirement Investors in light of the exemption's broad
relief from the conflicts of interest and self-dealing prohibitions
under ERISA and the Code.
In some instances, commenters indicated that a different best
interest standard would be appropriate but failed to provide an
alternative to the Department's definition. Others suggested a
definition of ``best interest'' that did not include a duty of loyalty
constraining Advisers from making recommendations based on their own
financial interests. Some of these definitions focused exclusively on
the fiduciary obligation of prudence, while excluding the equally
fundamental fiduciary duty of loyalty. A number of commenters expressed
particular concern about the application of the Department's Best
Interest requirement that the recommendation be made ``without regard
to the financial or other interests of the Adviser, Financial
Institution'' or other parties. Some of these commenters suggested that
the Department use different formulations that were similar to the
Department's, but might be construed to less stringently forbid the
consideration of the financial interests of persons other than the
Retirement Investor. For example, commenters suggested a standard
providing that the Adviser and Financial Institution ``not
subordinate'' their customers' interests to their own interests, or
that the Adviser and Financial Institution put their customers'
interests ahead of their own interests, or similar constructs.
In response to commenter concerns, the Department created a
specific ``Best Interest'' test for Advisers and Financial Institutions
that make recommendations from a restricted range of investments,
including Proprietary Products or investments that generate Third Party
Payments. In that circumstance, the test ensures that the Retirement
Investor receives full and fair disclosure of the
[[Page 21062]]
restricted menu and Material Conflicts of Interest: The Financial
Institution takes specified steps to ensure advice is prudent, the
compensation is reasonable, and the Adviser is appropriately insulated
from conflicts of interest; and the Adviser makes recommendations that
are prudent and that are not based upon factors other than the needs of
the Retirement Investor. Outside of this context, the Department has
retained the ``without regard to'' language as best capturing the
exemption's intent that the Adviser's recommendations be based on the
Investor's interest. This approach also accords with ERISA section
404(a)(1)'s requirement that plan fiduciaries act ``solely in the
interest'' of plan participants and beneficiaries.
In addition, in many of the alternatives suggested by commenters,
the Best Interest standard appeared to lack a clear means of
enforcement. A number of commenters suggested they could abide by a
Best Interest standard but at the same time objected to the enforcement
mechanisms that the Department proposed, particularly in the IRA
market. As discussed above, the Department does not believe that the
exemption can serve its participant protective purposes, or that
Financial Institutions and their Advisers will be properly incentivized
to comply with its terms, if Retirement Investors do not have an
enforceable entitlement to compliance.
Disclosure
Other alternative approaches stressed disclosure as a means of
protecting Retirement Investors. Some commenters indicated that
additional disclosures, alone, would address many of the Department's
concerns. Full and fair disclosure of material conflicts and informed
consent are, in the Department's view, important elements of exemptive
relief but are not sufficient on their own to form the basis of an
exemption that is this broad and flexible.
Disclosure alone has proven ineffective to mitigate conflicts in
advice. Extensive research has demonstrated that most investors have
little understanding of their advisers' conflicts of interest, and
little awareness of what they are paying via indirect channels for the
conflicted advice. Even if they understand the scope of the advisers'
conflicts, many consumers are not financial experts and therefore,
cannot distinguish good advice or investments from bad. The same gap in
expertise that makes investment advice necessary and important
frequently also prevents investors from recognizing bad advice or
understanding advisers' disclosures. Indeed, some research suggests
that even if disclosure about conflicts could be made simple and clear,
it could be ineffective--or even harmful.\94\
---------------------------------------------------------------------------
\94\ See Regulatory Impact Analysis.
---------------------------------------------------------------------------
Defer to the Securities and Exchange Commission
Many commenters suggested that a uniform standard applicable to all
retail accounts would be preferable to the Department's proposal, and
that the Department should work with other regulators, such as the SEC
and FINRA, to fashion such an approach. Others suggested that the
Department should wait and defer to the SEC's determination of an
appropriate standard for broker-dealers under the Dodd-Frank Act. Still
others suggested that the Department should provide exemptions based on
fiduciary status under securities laws, or based on compliance with
other applicable laws or regulations. FINRA indicated that the proposal
should be based on existing principles in federal securities laws and
FINRA rules but acknowledged that additional rulemaking would be
required.
The Department disagrees with the commenters, and believes it is
important to move forward with this proposal to remedy the ongoing
injury to Retirement Investors as a result of conflicted advice
arrangements. ERISA and the Code create special protections applicable
to investors in tax qualified plans. The fiduciary duties established
under ERISA and the Code are different from those applicable under
securities laws, and would continue to differ even if both regimes were
interpreted to attach fiduciary status to exactly the same parties and
activities. Reflecting the special importance of plan and IRA
investments to retirement and health security, this statutory regime
flatly prohibits fiduciaries from engaging in transactions involving
self-dealing and conflicts of interest unless an exemption applies.
Under ERISA and the Code, the Department of Labor has the authority to
craft exemptions from these stringent statutory prohibitions, and the
Department is specifically charged with ensuring that any exemptions it
grants are in the interests of Retirement Investors and protective of
these interests. Moreover, the fiduciary provisions of ERISA and the
Code broadly protect all investments by Retirement Investors, not just
those regulated by the SEC. As a consequence, the Department uniquely
has the ability to assure that these fiduciary rules work in harmony
for all Retirement Investors, regardless of whether they are investing
in securities, insurance products that are not securities, or others
type of investment.
The Department has taken very seriously its obligation to harmonize
its regulation with other applicable laws, including the securities
laws. In pursuing its consultations with other regulators, the
Department aimed to coordinate and minimize conflicting or duplicative
provisions between ERISA, the Code and federal securities laws. The
Department has coordinated--and will continue to coordinate--its
efforts with other federal agencies to ensure that the various legal
regimes are harmonized to the fullest extent possible. The resulting
exemption provides Advisers and Financial Institutions with a choice to
provide advice that does not involve prohibited conflicted transactions
or comply with this exemption or another exemption, which now all
require advice to be provided in accordance with basic fiduciary norms.
Likewise, the exemption preserves Retirement Investors' ability to
choose the method of payment that works best for them. Far from
confusing investors, the standards set forth in the exemption ensure
that Retirement Investors can uniformly expect to receive advice that
is in their best interest with respect to their retirement investments.
Moreover, the best interest standard reflects what many investors have
believed they were entitled to all along, even though it was not
legally required.
In this regard, waiting for the SEC to act, as some commenters
suggested, would delay the implementation of these important, updated
safeguards to plan and IRA investors investing in a wide variety of
products, and impose substantial costs on them as current harms from
conflicted advice would continue.
Provide No Additional Exemptions
A few commenters opposed the grant of any exemption at all. One
commenter suggested that the exemption sunset after 5 years, to permit
a transition to investment advice that does not raise prohibited
transaction issues at all. The Department did not accept these
comments. The Department shares these commenters' concerns about
conflicted advice, but nevertheless believes that simply banning all
commissions, transaction-based payments, and other forms of conflicted
payments could have serious adverse unintended consequences. These
forms of compensation are commonplace in today's marketplace for
retirement
[[Page 21063]]
advice, and often support beneficial advice arrangements. Accordingly,
the Department is concerned about the disruptive impact of simply
barring all conflicts after 5 years, assuming that were even possible,
and about the potential impact that such dramatic action would have on
the availability of advice. Instead, the Department has worked to
fashion exemptions that mitigate conflicts of interest, and that ensure
that Financial Institutions and Advisers adhere to fundamental
fiduciary standards, while permitting a wide range of compensation
practices and business models.
Special Exemptions
Finally, the Department acknowledges requests for special,
streamlined exemptions for certain circumstances or certain products.
For example, some commenters requested special treatment for certain
parties based on mission or tax-exempt status; certain products such as
target date funds, employer securities, or products that qualify as
default investment alternatives under 29 CFR 2550.404c-5; and
circumstances in which investment advice to Retirement Investors is
``ancillary'' to advice on non-investment insurance products. The
Department has fashioned this exemption to apply broadly to advice
arrangements in the retail market by taking a standards-based approach,
rather than by focusing on particular highly-specific investments,
advisory arrangements, or business models subject to highly-
proscriptive conditions. Additionally, as described in detail in
preceding sections, the Department has carefully considered comments on
how to make the exemption more workable and less burdensome. The
Department's goal was to create an exemption that could broadly apply
to a wide universe of investments and practices, rather than to write
special rules for particular subcategories or special circumstances,
such as those requested by these commenters in this class exemption.
The fiduciary norms, standards, and conditions set forth in the
exemption serve an important protective purpose, which should benefit
investors across the board including the arrangements identified by the
commenters. If, however, the commenters still believe additional relief
is necessary for special categories of investments or practices, the
Department invites the commenters to apply for an individual or
additional class exemption.
G. Consideration of a Low-Fee Streamlined Exemption
In the proposal, the Department indicated that it was considering a
separate streamlined exemption that would allow compensation to be
received in connection with recommendations of certain high-quality
low-fee investments. The Department sought comments on how to
operationalize such an exemption, which might minimize the compliance
burdens for Advisers offering high-quality low-fee investment products
with minimal potential for Material Conflicts of Interest. Products
that met the conditions of the streamlined exemption could be
recommended to plans, participants and beneficiaries, and IRA owners,
and the Adviser could receive variable and third-party compensation as
a result of those recommendations, without satisfying some or all of
the conditions of this exemption. The streamlined exemption could
reward and encourage best practices with respect to optimizing the
quality, amount, and combined, all-in cost of recommended financial
products, financial advice, and other related services. In particular,
a streamlined exemption could be useful in enhancing access to quality,
affordable financial products and advice by savers with smaller account
balances. Additionally, because it would be premised on a fee
comparison, it would apply only to investments with relatively simple
and transparent fee structures.
In the proposal, the Department noted that it had been unable to
operationalize such an exemption in a way that would achieve the
Department's Retirement Investor-protective objectives and therefore
did not propose text for such an exemption. Instead, the Department
sought public input to assist in the consideration of the merits and
possible design of such an exemption. The Department asked a number of
specific questions, including which products should be included, how
the fee calculations should be established, performed, communicated and
updated, what, if any additional conditions should apply, and how a
streamlined exemption would affect the marketplace for investment
products.
The vast majority of commenters were opposed to creating a
streamlined exemption for low-fee products. Commenters expressed the
view that the approach over-emphasized the importance of fees, despite
prior Department guidance noting that fees were not the sole factor for
investors to consider. Commenters also raised many of the same
operational concerns the Department had raised in the preamble, such as
identifying the appropriate fee cut off, as well as the potential for
undermining suitability and fiduciary obligations under securities
laws, with a sole focus on products with low fees.
The Department did receive a few comments in support of a low-fee
streamlined exemption. These commenters generally recommended that the
exemption be limited to certain investments, most commonly mutual
funds, and perhaps just those with fees in the bottom five or ten
percent. One commenter requested a carve-out from the Regulation's
definition of ``fiduciary,'' or a streamlined exemption, for retirement
investments in high-quality, low-cost financial institutions savings
products, like CDs, when a direct fee is not charged and a commission
is not earned by the bank employee. Other commenters were willing to
consider a low fee streamlined exemption, but argued that more
information was necessary and any such exemption would need to be
proposed separately.
The commenters' concerns as described above echoed the Department's
concerns regarding the low-fee streamlined exemption. Despite some
limited support, the Department has determined not to proceed with a
low fee streamlined exemption. The Department did not receive enough
information in the comments to address the significant conceptual and
operational concerns associated with the approach. For example, after
consideration of the comments, the Department was unable to conclude
that the streamlined exemption would result in meaningful cost savings.
Most Financial Institutions and Advisers would likely only be able to
rely on such a streamlined exemption in part. They would still need to
comply with this exemption for many of the investments recommended
outside of the streamlined exemption. Many of the costs associated with
this exemption are upfront costs (e.g., policies and procedures,
contracts) that the Financial Institution would have to incur whether
or not it used the streamlined exemption. As a result, the streamlined
exemption may not have resulted in significant cost savings. In
addition, the Department was unable to overcome the challenges it saw
in using a low-fee threshold as a mechanism to jointly optimize
quality, quantity, and cost. Fundamentally, it is unclear how to set a
``low-fee'' threshold that achieves these all of aims. A single
threshold could be too low for some investors' needs and too high for
others'. Further,
[[Page 21064]]
any threshold might encourage the lowest existing prices to rise to the
threshold, potentially harming investors.
H. Exemption for Purchases and Sales, Including Insurance and Annuity
Contracts (Section VI)
Section VI provides an exemption, which is supplemental to Section
I, for certain prohibited transactions commonly associated with
investment advice. Section I permits Advisers and Financial
Institutions to receive compensation that would otherwise be prohibited
by the self-dealing and conflicts of interest provisions of ERISA
section 406(a)(1)(D) and 406(b), and Code section 4975(c)(1)(D)-(F).
However, Section I does not extend to any other prohibited transaction
sections of ERISA and the Code. ERISA section 406(a) and Code section
4975(c)(1)(A)-(D) contain additional prohibitions on certain specific
transactions between plans and IRAs and ``parties in interest'' and
``disqualified persons,'' including service providers. These additional
prohibited transactions include: (i) The purchase or sale of an asset
between a plan/IRA and a party in interest/disqualified person, and
(ii) the transfer of plan/IRA assets to a party in interest/
disqualified person. These prohibited transactions are subject to
excise tax and personal liability for the fiduciary.
A number of transactions that may occur as a result of an Adviser's
or Financial Institution's advice involve a prohibited transaction
under ERISA section 406(a)(1)(A) and Code section 4975(c)(1)(A). The
entity that causes a plan or IRA to enter into the transaction would
not be the Adviser or Financial Institution, but would instead be a
plan fiduciary or IRA owner acting on the Adviser's or Financial
Institution's advice. Because the party requiring relief for this
prohibited transaction is separate from the Adviser and Financial
Institution, the Department is granting this exemption subject to
discrete conditions. As a result, the Adviser's or Financial
Institution's failure to comply with any of the conditions of Section I
would not result in the authorizing plan fiduciary or IRA owner having
engaged in a non-exempt prohibited transaction.
In this regard, a plan's or IRA's purchase of an insurance or
annuity product would be a prohibited transaction if the insurance
company is a service provider to the plan or IRA, or is otherwise a
party in interest or disqualified person. A plan's or IRA's purchase of
a security from a Financial Institution in a Riskless Principal
Transaction would involve a prohibited transaction if the Financial
Institution also provides advice to the plan or IRA. A plan's or IRA's
purchase of a proprietary investment product from a Financial
Institution also may involve this type of prohibited transaction. These
prohibited transactions are not included in the exemption provided
under Section I, which contains conditions that an Adviser and
Financial Institution must follow. However, in the Department's view,
these circumstances are common enough in connection with
recommendations by Advisers and Financial Institutions to warrant a
supplemental exemption for these types of transactions in conjunction
with the relief provided in Section I. This Section VI establishes the
conditions applicable to the entity that causes the plan or IRA to
enter into the transaction.
Therefore, relief is provided in Section VI for the purchase of an
investment product by a plan, or a participant or beneficiary account,
or IRA, from a Financial Institution that is a party in interest or
disqualified person. Relief is provided solely from the prohibitions of
ERISA section 406(a)(1)(A) and (D), and the sanctions imposed by Code
section 4975(a) and (b), by reason of Code section 4975(c)(1)(A) and
(D).
This relief is particularly necessary as part of this exemption
because of the amendment to and partial revocation of an existing
exemption, PTE 84-24, elsewhere in this issue of the Federal Register.
Pursuant to the final amendment and revocation, PTE 84-24 no longer
provides relief for transactions involving the purchase of variable
annuity contracts, or indexed annuity contracts or similar contracts.
Therefore, to the extent relief is required from ERISA section
406(a)(1)(A) and Code section 4975(c)(1)(A) for transactions involving
such annuities, the relief is provided in Section VI.
The conditions for the exemptions in this Section VI are that the
transaction must be effected by the Financial Institution in its
ordinary course of its business; the transaction may not result in
compensation, direct or indirect, to the Financial Institution and its
Affiliates that exceeds reasonable compensation within the meaning of
ERISA section 408(b)(2) and Code section 4975(d)(2); and the terms of
the transaction are at least as favorable to the Plan, participant or
beneficiary account, or IRA as the terms generally available in an
arm's length transaction with an unrelated party.
The scope of the exemption in Section VI is broader than the
proposal. The proposed exemption was limited to transactions involving
insurance or annuity contracts. However, in connection with certain
other changes made in the final exemption, the Department determined
that broader relief in this area is necessary. In particular, the
expansion beyond insurance or annuity contracts was necessary to
provide relief for transactions involving investments not within the
original definition of ``Asset'' that may be Proprietary Products
purchased and sold with a Financial Institution, and to include
investments purchased or sold in Riskless Principal Transactions with
Financial Institutions. Of course, the exemption remains available for
insurance and annuity products as well.
One commenter requested broader supplemental relief for extensions
of credit for bank deposits, certificates of deposit and debt
instruments that may be recommended pursuant to Section I. The final
exemption does not include such relief. The Department believes that
the requested relief is generally available in existing statutory
exemptions. For example, relief for extensions of credit in connection
with bank deposits and CDs is available under ERISA section 408(b)(4)
and Code section 4975(d)(4). Relief for extensions of credit in
connection with a plan's or IRA's purchase of a debt security is
available in ERISA section 408(b)(17) and Code section 4975(d)(20),
provided that extension of credit is not from a fiduciary with respect
to the plan or IRA. This would cover the circumstance in which a plan
or IRA purchases a debt security, through the Financial Institution, if
the issuer of the debt security is a party in interest or disqualified
person with respect to the plan or IRA, but not a fiduciary. If relief
is sought for the circumstance in which the issuer of the debt security
is a fiduciary with respect to the plan or IRA, the Department believes
that such transactions should be considered on an individual basis and
invites Financial Institutions that wish to recommend their own debt
securities to apply for an individual exemption.
The Department made certain changes to the conditions proposed for
this exemption, in response to comments. As proposed, the exemption in
Section VI was limited to transactions for cash. A few commenters ask
that the Department reconsider, and permit in-kind purchases, on the
basis that these purchases can result in advantageous pricing to the
investor. Other commenters expressed concern that the proposed
restriction to cash transactions would exclude a purchase via rollover.
The Department concurs with these
[[Page 21065]]
commenters, and the final exemption does not contain the limitation to
cash transactions. The Department also confirms that the exemption
covers transactions that occur through a rollover.
In addition, the Department eliminated the approach in the proposed
exemption that would have limited relief to small plans (in addition to
IRAs, plan participants and beneficiaries). As explained above, under
the companion amendment to and partial revocation of PTE 84-24, that
exemption no longer provides relief from ERISA section 406(a)(1)(A) and
Code section 4975(c)(1)(A) for transactions involving variable annuity
contracts and indexed annuity contracts and similar contracts. In light
of this restriction of PTE 84-24, there was a broader need for relief
from ERISA section 406(a)(1)(A) and Code section 4975(c)(1)(A) for
transactions involving plans of all sizes. The final exemption in
Section VI provides such relief.
A few commenters requested that Section VI be expanded to provide a
broad exemption similar to Section I, that would be specifically
tailored to insurance and annuity purchases but would provide relief
for Advisers and Financial Institutions from the self-dealing and
conflict of interests restrictions in ERISA section 406(b) and Code
section 4975(c)(1)(E) and (F). The Department has declined to accept
this suggestion, opting instead to make changes regarding insurance
products to the various provisions of Section I. The Department is
concerned about creating a special less-protective set of conditions
available just for insurers with respect to transactions prohibited by
ERISA section 406(b) and Code section 4975(c)(1)(E) and (F). Such an
approach could encourage Advisers and Financial Institutions, for
example, to potentially recommend variable or indexed annuities based
on their preference for a less protective regulatory regime rather than
on the basis of the Retirement Investor's Best Interest. However, in
response to commenters, the Department has revised the reasonable
compensation standard in accordance with Section II(c)(2) to avoid
unnecessary complexity.
I. Exemption for Pre-Existing Transactions (Section VII)
Section VII provides a supplemental exemption for pre-existing
transactions. The exemption permits continued receipt of compensation
based on investment transactions that occurred prior to the
Applicability Date as well as receipt of compensation for
recommendations to continue to adhere to a systematic purchase program
established before the Applicability Date. The exemption also
explicitly covers compensation received as a result of a recommendation
to hold an investment that was entered into prior to the Applicability
Date. In this regard, some Advisers and Financial Institutions did not
consider themselves fiduciaries before the Applicability Date. Other
Advisers and Financial Institutions entered into transactions involving
plans, participant or beneficiary accounts, or IRAs before the
Applicability Date, in accordance with the terms of a prohibited
transaction exemption that has since been amended. The exemption
provides relief from the restrictions of ERISA section 406(a)(1)(A),
(D) and 406(b) and the sanctions imposed by Code section 4975(a) and
(b), by reason of Code section 4975(c)(1)(A), (D), (E) and (F).
This exemption is conditioned on the following:
(1) The compensation is received pursuant to an agreement,
arrangement or understanding that was entered into prior to the
Applicability Date and that has not expired or come up for renewal
post-Applicability Date;
(2) The purchase, exchange, holding or sale of the securities or
other investment property was not otherwise a non-exempt prohibited
transaction pursuant to ERISA section 406 and Code section 4975 on
the date it occurred;
(3) The compensation is not received in connection with the
plan's, participant or beneficiary account's or IRA's investment of
additional amounts in the previously acquired investment vehicle;
except that for avoidance of doubt, the exemption does apply to a
recommendation to exchange investments within a mutual fund family
or variable annuity contract pursuant to an exchange privilege or
rebalancing program that was established before the Applicability
Date, provided that the recommendation does not result in the
Adviser and Financial Institution, or their Affiliates or Related
Entities receiving more compensation (either as a fixed dollar
amount or a percentage of assets) than they were entitled to receive
prior to the Applicability Date;
(4) The amount of the compensation paid, directly or indirectly,
to the Adviser, Financial Institution, or their Affiliates or
Related Entities in connection with the transaction is not in excess
of reasonable compensation within the meaning of ERISA section
408(b)(2) and Code section 4975(d)(2); and
(5) Any investment recommendations made after the Applicability
Date by the Financial Institution or Adviser with respect to the
securities or other investment property reflect the care, skill,
prudence, and diligence under the circumstances then prevailing that
a prudent person acting in a like capacity and familiar with such
matters would use in the conduct of an enterprise of a like
character and with like aims, based on the investment objectives,
risk tolerance, financial circumstances, and needs of the Retirement
Investor, and are made without regard to the financial or other
interests of the Adviser, Financial Institution or any Affiliate,
Related Entity, or other party.
The Department's intent in proposing the exemption for pre-existing
investments was to provide certainty that Advisers and Financial
Institutions could continue to receive revenue streams based on
transactions that occurred prior to the Applicability Date. Under the
proposal, the relief for pre-existing transactions was limited, so that
any additional advice would have had to occur under the conditions of
Section I of the exemption. The Department also proposed that the pre-
existing transaction relief should be limited only to limited
categories of Assets as defined in the proposed exemption.
Commenters identified the need for broader grandfathering relief in
these respects. They stated that limiting the relief to investments
within the proposed definition of ``Asset'' and disallowing additional
advice would cut off the ability of plans, participants and
beneficiaries, and IRAs to receive advice on a broader range of
investments that may already be held in their accounts. They reasoned
that in many cases, an investor that has already purchased an
investment may already be entitled to continued advice or services
based on existing compensation arrangements.
Commenters also indicated that the proposal's approach of
restricting any additional advice for investments that were not on the
list of Assets could, in some circumstances, create an especially
difficult situation for Financial Institutions and Advisers regulated
by FINRA. According to commenters, FINRA has been clear that ongoing
advice may be a requirement of suitability. Thus, commenters asserted,
Financial Institutions and Advisers could be faced with the decision to
risk either a prohibited transaction or a suitability violation.
Similarly, commenters expressed concern that Financial Institutions
would require all Retirement Investors to invest through fee-based
accounts--raising concerns about ``reverse churning''--if no
differential payments with respect to existing investments could be
received after the Applicability Date.
The Department concurs with commenters that it is appropriate to
provide broader grandfathering relief as a means of affording the
industry time to transition to the new regulatory structure, and to
minimize disruption of existing arrangements. Consistent with
[[Page 21066]]
the broadening of the scope of Section I to cover all investment
products, not just those within the proposed definition of Asset, the
final exemption also includes a grandfathering provision that it is not
limited to Assets, and the provision permits additional advice on pre-
existing investments to be provided after the Applicability Date. The
exemption specifically applies to a hold recommendation.
The exemption does provide, however, that the compensation received
must satisfy the reasonable compensations standard, and additional
advice must reflect the care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent person acting in a like
capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims, based on the
investment objectives, risk tolerance, financial circumstances, and
needs of the Retirement Investor, and must be made without regard to
the financial or other interests of the Adviser, Financial Institution
or any Affiliate, Related Entity, or other party.
The exemption is limited to compensation received as a result of
investment advice on securities or other property purchased prior to
the Applicability Date and as a result of investment advice to continue
to adhere to a systematic purchase program established before the
Applicability Date. Section VII(b)(3) provides that the compensation
covered under the exemption may not be in connection with the
Retirement Investor's investment of additional assets in the previously
acquired investment vehicle. This is intended to preclude, for example,
advice on additional contributions to a variable annuity product
purchased prior to the Applicability Date, or recommending additional
investments in a particular mutual fund or asset pool. Although
commenters requested broader relief in this area, the Department has
declined to permit advice on additional contributions to existing
investments without compliance with the protective conditions
applicable to Section I. The primary purpose of the exemption for pre-
existing investments is to preserve compensation for services already
rendered and to permit orderly transition from past arrangements, not
to exempt future advice and investments from the important protections
of the Regulation and this Best Interest Contract Exemption. Permitting
Advisers to recommend additional investments in an existing investment
vehicle, without the safeguards provided by the fiduciary norms and
other conditions of the exemption, would permit conflicts to flourish
unchecked.
Section VII(b)(3) makes clear that the exemption extends to
exchanges of investments within a mutual fund family or variable
annuity pursuant to exchange privileges or rebalancing programs
established prior the Applicability Date.
Several commenters requested even broader relief, asking that the
Department grandfather all existing Retirement Investors or Retirement
Investor accounts or all IRAs. Some argued that it would not be fair
for Retirement Investors who entered into agreements with their
Financial Institutions and Advisers that were compliant at the time to
have the terms of those agreements change over the course of the
investment. The Department declines to provide broader relief. When
Advisers make recommendations to make new investments after the
Applicability Date, Retirement Investors should be able to expect that
the recommendations will adhere to the basic fiduciary standards and
conditions set out in this exemption. The Retirement Investor who had a
pre-existing relationship is no less in need of protection from
conflicts of interest--and no less deserving of adherence to a best
interest standard--than the investor who has no such pre-existing
relationship. The failure to implement safeguards against conflicts of
interest would result in the continued injury of these Retirement
Investors, as they invested still more money based on recommendations
subject to dangerous conflicts of interest.
A few commenters requested clarification of the circumstances under
which the relief in Section VII would be necessary. The fact that the
Department proposed an exemption for compensation received in
connection with pre-existing investments caused concern among some
commenters that the Regulation might apply retroactively to
circumstances that occurred prior to the Applicability Date. Therefore,
the commenters sought confirmation that compliance with the exemption
would not be necessary unless fiduciary investment advice is provided
after the Applicability Date with respect to the pre-existing
investments.
In response, the Department confirms that the Regulation does not
apply retroactively to circumstances that occurred before the
Applicability Date. The exemption is only necessary for non-exempt
prohibited transactions occurring after the Applicability Date. By
providing an exemption for compensation received for investments made
prior to the Applicability Date, the Department is not suggesting
otherwise; the exemption merely provides transitional relief to avoid
uncertainty relating to compensation received after the Applicability
Date.
J. Definitions (Section VIII)
Section VIII of the exemption provides definitions of the terms
used in the exemption. The Department received comments on certain
definitions and has addressed them as described below. Additional
comments on definitions, such as ``Retirement Investor,'' ``Best
Interest,'' and ``Material Conflict of Interest,'' are discussed above
in their respective sections.
1. Adviser
Section VIII(a) defines the term ``Adviser'' as an individual who:
(1) is a fiduciary of the Plan or IRA solely 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, agent, or registered
representative of a Financial Institution; and
(3) satisfies the federal and state regulatory and licensing
requirements of insurance, banking, and securities laws with respect
to the covered transaction, as applicable.
The Department received some comments on this definition, but has
maintained the definition unchanged from the proposal. One commenter
asked the Department to treat branch managers in the same manner as
Advisers. The Department has declined to expand the definition of
Adviser to cover branch managers, but notes that, as discussed above in
Section II, the incentives of branch managers should generally be
considered as part of the Financial Institution's policies and
procedures. Another commenter expressed concern that, because of the
requirement to satisfy applicable federal and state laws, call center
employees might be required to register with the SEC as ``advisers''
under the Investment Advisers Act of 1940. The Department notes that
the requirement in Section VIII(a)(3) is limited to applicable
regulatory and licensing requirements. Nothing in this exemption would
require call center employees to register under the Investment Advisers
Act of 1940 unless they would otherwise be required to do so.
2. Affiliate
Section VIII(b) defines ``Affiliate'' of an Adviser or Financial
Institution as:
[[Page 21067]]
(1) any person directly or indirectly through one or more
intermediaries, controlling, controlled by, or under common control
with the Adviser or Financial Institution. For this purpose,
``control'' means the power to exercise a controlling influence over
the management or policies of a person other than an individual;
(2) any officer, director, partner, employee, or relative (as
defined in ERISA section 3(15)), of the Adviser or Financial
Institution; and
(3) any corporation or partnership of which the Adviser or
Financial Institution is an officer, director, or partner.
The Department received a comment requesting that this definition
adopt a securities law definition. The commenter expressed the view
that use of a separate definition would make compliance more difficult
for broker-dealers. The Department did not accept this comment.
Instead, the Department made minor adjustments so that the definition
is identical to the affiliate definition incorporated in prior
exemptions under ERISA and the Code, that are applicable to broker
dealers,\95\ as well as the definition that is used in the Regulation.
Therefore, the definition should not be new to the broker-dealer
community, and is consistent with other applicable laws. In addition,
the Department notes that not all entities relying on this exemption
are subject to securities laws.
---------------------------------------------------------------------------
\95\ See e.g., PTE 75-1, Part II, 40 FR 50845 (Oct. 31, 1975),
as amended at 71 FR 5883 (Feb. 3, 2006).
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3. Financial Institution
Section VIII(e) defines ``Financial Institution'' as the entity
that employs the Adviser or otherwise retains such individual as an
independent contractor, agent or registered representative, and that is
one of the following:
(1) registered as an investment adviser under the Investment
Advisers Act of 1940 or under the laws of the state in which the
adviser maintains its principal office and place of business;
(2) a bank or similar financial institution supervised by the
United States or state, or a savings association (as defined in
section 3(b)(1) of the Federal Deposit Insurance Act);
(3) an insurance company qualified to do business under the laws
of a state, provided that such insurance company: (i) Has obtained a
Certificate of Authority from the insurance commissioner of its
domiciliary state which has neither been revoked nor suspended, (ii)
has undergone and shall continue to undergo an examination by an
Independent certified public accountant for its last completed
taxable year or has undergone a financial examination (within the
meaning of the law of its domiciliary state) by the state's
insurance commissioner within the preceding 5 years, and (iii) is
domiciled in a state whose law requires that actuarial review of
reserves be conducted annually by an Independent firm of actuaries
and reported to the appropriate regulatory authority; or (4) a
broker or dealer registered under the Securities Exchange Act of
1934.
Congress identified these entities as advice providers in the statutory
exemption for investment advice under ERISA section 408(g) and Code
section 4975(f)(8).
The Department received several comments on this definition and has
made certain modifications. One commenter said that the proposed
definition did not reflect the variety of channels in which financial
products and services are marketed. The commenter, and a few other
commenters, recommended that the Department delete the requirement in
the proposed Section VIII(e)(2) that required that advice from banks
and similar institutions be provided through a trust department. The
Department has accepted this change in the final exemption.
The Department also received several questions about the
applicability of the exemption when more than one ``Financial
Institution'' is involved in the sale of a financial product. This may
occur, for example, if there is a product manufacturer that is an
insurance company, and a broker-dealer or registered investment adviser
recommending the product to clients. Commenters asked for assurances
that the product manufacturer in that example would not have to satisfy
the conditions of the exemption applicable to Financial Institutions.
As explained earlier, under the exemption, a Financial Institution must
acknowledge fiduciary status, and the Adviser's recommendations must be
subject to oversight by a Financial Institution that meets the
definition set forth in the exemption. The exemption does not condition
relief on acknowledgment of fiduciary status or execution of the
contract or oversight by more than one Financial Institution. However,
the Financial Institution exercising supervisory authority must adhere
to the conditions of the exemption, including the policies and
procedures requirement and the obligation to insulate the Adviser from
incentives to violate the Best Interest Standard, including incentives
created by any other Financial Institution. The Department notes that
if the product manufacturer is the only entity that satisfies the
``Financial Institution'' definition with respect to a particular
transaction, the product manufacturer must acknowledge fiduciary status
and exercise the required supervisory authority with respect to the
exemption, including entering into the contract in the case of IRAs and
non-ERISA plans.
In a related example, commenters asked about marketing or
distribution affiliates and intermediaries that would not meet the
definition of Financial Institution, as proposed. One commenter
specifically requested that the definition of Financial Institution be
revised to include all entities within an insurance group that arrange
for the marketing of financial products. The commenter stated that an
insurance company, with its representatives and agents, may market the
products of a second financial institution and the contractual
arrangements that allow for this marketing frequently are with an
entity that is affiliated with the insurance company, but which does
not itself meet the proposed definition of a ``Financial Institution.''
The Department declines to expand the categories of Financial
Institutions to such intermediaries, but rather limits the definition
of Financial Institution to the regulated entities included in the
proposed definition which are subject to well-established regulatory
conditions and oversight. However, the Department has made provision to
add entities to the definition of Financial Institution through the
grant of an individual exemption. Accordingly, the definition of
Financial Institution includes ``[a]n entity that is described in the
definition of Financial Institution in an individual exemption granted
by the Department under section 408(a) of ERISA and section 4975(c) of
the Code, after the date of this 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 this class exemption.'' If 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. If a marketing
intermediary or other entity which does not meet the definition of
Financial Institution, wishes to obtain the relief provided in this
class exemption, the Department will consider such a request in an
application for an individual exemption.
4. Independent
Section VIII(f) defines ``Independent'' as a person that:
[[Page 21068]]
(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.
The term Independent is used in Section I(c)(1)(ii), which
precludes Financial Institutions and Advisers from relying on the
exemption if they are the named fiduciary or plan administrator, as
defined in ERISA section 3(16)(A), with respect to an ERISA-covered
plan, unless such Financial Institutions or Advisers are selected to
provide advice to the plan by a plan fiduciary that is Independent of
the Financial Institutions or Advisers. The term Independent is also
used in the definitions section, in describing the types of entities
that may be Financial Institutions. Insurance companies that are
Financial Institutions must have been examined by Independent certified
public accountants and be domiciled in a state whose law requires that
actuarial review of reserves be conducted annually by an Independent
firm of actuaries.
In the proposed exemption, the definition of Independent provided
that the person (e.g., the independent fiduciary appointing the Adviser
or Financial Institution under Section I(c)(1)(ii), or the certified
public accountant or firm of actuaries acting with respect to an
insurance company) could not receive any compensation or other
consideration for his or her own account from the Adviser, the
Financial Institution or an Affiliate. A commenter indicated that as a
result, a number of parties providing services to the Financial
Institution, and receiving compensation in return, could not satisfy
the Independence requirement. The commenter suggested defining entities
that receive less than 5% of their gross income from the fiduciary as
Independent.
In response, the Department revised the definition of Independent
so that it provides that the person's compensation in the current tax
year from the Financial Institution may not be in excess of 2% of the
person's annual revenues based on the prior year. This approach is
consistent with the Department's general approach to fiduciary
independence. For example, the Department's prohibited transaction
exemption procedures regulation provide a presumption of independence
for appraisers and fiduciaries if the revenue they receive from a party
is not more than 2% of their total annual revenue.\96\ The Department
has revised the definition accordingly.\97\
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\96\ 29 CFR 2570.31(j).
\97\ The same commenter also requested clarification that an IRA
owner will not be deemed to fail the Independence requirement simply
because he or she is an employee of the Financial Institution.
However, the Independence requirement is not applicable to IRA
owners.
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5. Individual Retirement Account
Section VIII(g) defines ``Individual Retirement Account'' or
``IRA'' as any account or annuity described in Code section
4975(e)(1)(B) through (F), including, for example, an individual
retirement account described in section 408(a) of the Code and a health
savings account described in section 223(d) of the Code. This
definition is unchanged from the proposal.
The Department received comments on both the application of the
proposed Regulation and the exemption proposals to other non-ERISA
plans covered by Code section 4975, such as Health Savings Accounts
(HSAs), Archer Medical Savings Accounts and Coverdell Education Savings
Accounts. The Department notes that these accounts are given tax
preferences as are IRAs. Further, some of the accounts, such as HSAs,
can be used as long term savings accounts for retiree health care
expenses. These types of accounts also are expressly defined by Code
section 4975(e)(1) as plans that are subject to the Code's prohibited
transaction rules. Thus, although they generally may hold fewer assets
and may exist for shorter durations than IRAs, there is no statutory
reason to treat them differently than other conflicted transactions and
no basis for suspecting that the conflicts are any less influential
with respect to advice on these arrangements. Accordingly, the
Department does not agree with the commenters that the owners of these
accounts are entitled to less protection than IRA investors. The
Regulation continues to include advisers to these ``plans,'' and this
exemption provides relief to them in the same manner it does for
individual retirement accounts described in section 408(a) of the Code.
6. Proprietary Product
Section VIII(l) defines ``Proprietary Product'' as a product that
is managed, issued or sponsored by the Financial Institution or any of
its Affiliates. This is revised from the proposal, which defined a
Proprietary Product as one that is ``managed'' by the Financial
Institution or an Affiliate. One commenter specifically addressed the
proposed definition, and recommended that the definition use the terms
``issued'' or ``sponsored'' instead of managed, in order to better
match how the industry determines whether a product is proprietary. It
is the Department's understanding that a variety of terms can be used
to describe a proprietary relationship, particularly depending on the
nature of the investment product. Therefore, in the final exemption,
the Department has retained the word ``managed,'' but has also added
the words ``issued'' and ``sponsored'' as suggested by the commenter.
7. Related Entity
Section VIII(m) defines ``Related Entity'' as any entity other than
an Affiliate in which the Adviser or Financial Institution has an
interest which may affect the exercise of its best judgment as a
fiduciary. This definition is unchanged from the proposal.
The Department received one comment requesting that this be made
more specific with respect to the types of relationships the Department
envisions. In response the Department explains that the intent behind
the Related Entity concept is to provide relief for fiduciary
investment advisers that is co-extensive with the scope of the
prohibited transactions provisions under ERISA and the Code. As stated
in the Department's regulation under ERISA section 408(b)(2):
The prohibitions [of Section 406(b)] are imposed upon
fiduciaries to deter them from exercising the authority, control, or
responsibility which makes such persons fiduciaries when they have
interests which may conflict with the interests of the plans for
which they act. In such cases, the fiduciaries have interests in the
transactions which may affect the exercise of their best judgment as
fiduciaries. Thus, a fiduciary may not use the authority, control,
or responsibility which makes such a person a fiduciary to cause a
plan to pay an additional fee to such fiduciary (or to a person in
which the fiduciary has an interest which may affect the exercise of
such fiduciary's best judgment as a fiduciary) to provide a service.
Therefore, the exemption's definition of Related Entity is not intended
to identify specific relationships but rather to extend coverage to any
entity that has a relationship with the Adviser or Financial
Institution that could cause a prohibited transaction. The provisions
of the exemption that address Related Entities are generally
permissive, and do not require any action on the part of the Related
Entity. The purpose is to allow
[[Page 21069]]
these entities to receive compensation that would otherwise be
prohibited, as long as the conditions of the exemption are satisfied by
the Financial Institution and Adviser.
K. Applicability Date and Transition Rules
The Regulation will become effective June 7, 2016 and this Best
Interest Contract Exemption is issued on that same date. The Regulation
is effective at the earliest possible date under the Congressional
Review Act. For the exemption, the issuance date serves as the date on
which the exemption is intended to take effect for purposes of the
Congressional Review Act. This date was selected to provide certainty
to plans, plan fiduciaries, plan participants and beneficiaries, IRAs,
and IRA owners that the new protections afforded by the final rule are
now officially part of the law and regulations governing their
investment advice providers, and to inform financial services providers
and other affected service providers that the rule and exemption are
final and not subject to further amendment or modification without
additional public notice and comment. The Department expects that this
effective date will remove uncertainty as an obstacle to regulated
firms allocating capital and other resources toward transition and
longer term compliance adjustments to systems and business practices.
The Department has also determined that, in light of the importance
of the Regulation's consumer protections and the significance of the
continuing monetary harm to retirement investors without the rule's
changes, an Applicability Date of April 10, 2017, is appropriate for
plans and their affected service providers to adjust to the basic
change from non-fiduciary to fiduciary status. This exemption has the
same Applicability Date; parties may rely on it as of the Applicability
Date.
Section IX provides a transition period under which relief from the
prohibited transaction provisions of ERISA and the Code is available
for Financial Institutions and Advisers during the period between the
Applicability Date and January 1, 2018 (the ``Transition Period''). For
the Transition Period, full relief under the exemption will be
available for Financial Institutions and Advisers subject to more
limited conditions than the full set of conditions described above.
This period is intended to give Financial Institutions and Advisers
time to prepare for compliance with the conditions of Section II-V set
forth above, while safeguarding the interests of Retirement Investors.
The Transition Period conditions set forth in Section IX are subject to
the same exclusions in Section I(c), for advice rendered in connection
with Principal Transactions, advice from fiduciaries with discretionary
authority over the customer's investments, robo-advice, and specified
advice concerning in-house plans.
The transitional conditions of Section IX require the Financial
Institution and its Advisers to comply with the Impartial Conduct
Standards when making recommendations to Retirement Investors. The
Impartial Conduct Standards required in Section IX are the same as
required in Section II(c) but are repeated for ease of use.
During the Transition Period, the Financial Institution must
additionally provide a written notice to the Retirement Investor prior
to or at the same time as the execution of the recommended transaction,
which may cover multiple transactions or all transactions taking place
within the Transition Period, acknowledging its and its Adviser(s)
fiduciary status under ERISA or the Code or both with respect to the
recommended transaction. The Financial Institution also must state in
writing that it and its Advisers will comply with the Impartial Conduct
Standards and disclose its Material Conflicts of Interest.
Further, the Financial Institution's notice must disclose whether
it recommends Proprietary Products or investments that generate Third
Party Payments; and, to the extent the Financial Institution or Adviser
limits investment recommendations, in whole or part, to Proprietary
Products or investments that generate Third Party Payments, the
Financial Institution must notify the Retirement Investor of the
limitations placed on the universe of investment recommendations. The
notice is insufficient if it merely states that the Financial
Institution or Adviser ``may'' limit investment recommendations based
on whether the investments are Proprietary Products or generate Third
Party Payments, without specific disclosure of the extent to which
recommendations are, in fact, limited on that basis. The disclosure may
be provided in person, electronically or by mail. It does not have to
be repeated for any subsequent recommendations during the Transition
Period.
Similar to the disclosure provisions of Section II(e) and III, the
transition exemption in Section IX provides for exemptive relief to
continue despite errors and omissions with respect to the disclosures,
if the Financial Institution acts in good faith and with reasonable
diligence.
In addition, the Financial Institution must designate a person or
persons, identified by name, title or function, responsible for
addressing Material Conflicts of Interest and monitoring Advisers'
adherence to the Impartial Conduct Standards.
Finally, the Financial Institution must comply with the
recordkeeping provision of Section V(b) and (c) of the exemption
regarding the transactions entered into during the Transition Period.
After the Transition Period, however, the limited conditions
provided in Section IX for the exemption will no longer be available.
After that date, Financial Institutions and Advisers must satisfy all
of the applicable conditions described in Sections II-V for the relief
in Section I(b) to be available for any prohibited transactions
occurring after that date. This includes the requirement to enter into
a contract with a Retirement Investor, where required. Financial
Institutions relying on the negative consent procedure set forth in
Section II(a)(1)(ii) must provide the contractual provisions to
Retirement Investors with existing contracts prior to January 1, 2018,
and allow those Retirement Investors 30 days to terminate the contract.
If the Retirement Investor does terminate the contract within that 30-
day period, this exemption will provide relief for 14 days after the
date on which the termination is received by the Financial Institution.
In that event, the Retirement Investor's account generally should be
able to fall within the provisions of Section VII for pre-existing
transactions. The provisions in Sections VI and VII of this Best
Interest Contract Exemption, providing exemptions for certain purchase
and sale transactions, including insurance and annuity contracts, and
pre-existing transactions, respectively, are also available on the
Applicability Date. The transition relief does not extend to the
transactions described in Section VI which provides an exemption for
purchase and sales of investments including insurance and annuity
contracts, and Section VII, which provides an additional exemption for
pre-existing transactions. Compliance with these exemptions does not
require an extended transition period because they have relatively few
conditions, which are largely based on meeting well-known standards
such as reasonable compensation, arm's length terms, and prudence.
The proposed Best Interest Contract Exemption, with the proposed
Regulation and other exemption
[[Page 21070]]
proposals, generally set forth an Applicability Date of eight months,
although the proposal sought comment on a phase in of conditions. Some
commenters, concerned about the ongoing harm to Retirement Investors,
urged the Department to implement the Regulation and related exemptions
quickly. However, the majority of industry commenters requested a two-
to three-year transition period. These commenters requested time to
enter into contracts with Retirement Investors (including developing
and implementing the policies and procedures and incentive practices
that meet the terms of Section II(d)(1) and (2); and, in accordance
with Section II(d)(3)), create systems needed to provide the required
disclosures, and receive any required state approvals for insurance
products. Some commenters requested the Department allow good faith
compliance during the transition period. Others requested the
Department phase in the requirements over time. One commenter requested
the best interest standard become effective immediately, with the other
conditions becoming effective within one year. Another comment
expressed concern about phasing in the conditions over time, referring
to this as ``piecemeal'' approach, which would not be helpful to
implementing a system to protect Retirement Investors. Other commenters
wrote that the Department should re-propose the exemption or adopt it
as an interim final exemption and seek additional comments.
The transition provisions in Section IX of the final exemption
respond to commenters' concerns about ongoing economic harm to
Retirement Investors during the period in which Financial Institutions
develop systems to comply with the exemption. The provisions require
prompt implementation of certain core protections of the exemption in
the form of the acknowledgment of fiduciary status, compliance with the
Impartial Conduct Standards, and certain important disclosures, to
safeguard Retirement Investors' interests. The provisions recognize,
however, that the Financial Institutions will need time to develop
policies and procedures and supervisory structures that fully comport
with the requirements of the final exemption. Accordingly, during the
Transition Period, Financial Institutions are not required to execute
the contract or give Retirement Investors warranties or disclosures on
their anti-conflict policies and procedures. While the Department
expects that Advisers and Financial Institutions will, in fact, adopt
prudent supervisory mechanisms to prevent violations of the Impartial
Conduct Standards (and potential liability for such violations), the
exemption will not require the Financial Institutions to make specific
representations on the nature or quality of the policies and procedures
during this Transition Period. The Department will be available to
respond to Financial Institutions' request for guidance during this
period, as they develop the systems necessary to comply with the
exemption's conditions.
The transition provisions also accommodate Financial Institutions'
need for time to prepare for full compliance with the exemption, and
therefore full compliance with all the final exemption's applicable
conditions is delayed until January 1, 2018. The Department selected
that period, rather than two to three years, as requested by some
commenters, in light of the adjustments in the final exemption that
significantly eased compliance burdens. Although the Department
believes that the conditions of the exemption set forth in Section II-V
are required to support the Department's findings required under ERISA
section 408(a), and Code section 4975(c)(2) over the long term, the
Department recognizes that Financial Institutions may need time to
achieve full compliance with these conditions. The Department therefore
finds that the provisions set forth in Section IX satisfy the criteria
of ERISA section 408(a) and Code section 4975(c)(2) for the Transition
Period because they provide the significant protections to Retirement
Investors while providing Financial Institutions with time necessary to
achieve full compliance. A similar transition period is provided for
the companion Principal Transactions Exemption due to the corresponding
provisions in that exemption that may require time for Financial
Institutions to begin compliance.
The Department considered but declined delaying the application of
the rule defining fiduciary investment advice until such time as
Financial Institutions could make the changes to their practices and
compensation structures necessary to comply with Sections II through V
of this exemption. The Department believed that delaying the
application of the new fiduciary rule would inordinately delay the
basic protections of loyalty and prudence that the rule provides.
Moreover, a long period of delay could incentivize Financial
Institutions to increase efforts to provide conflicted advice to
Retirement Investors before it becomes subject to the new rule. The
Department understands that many of the concerns regarding the
applicability date of the rule are related to the prohibited
transaction provisions of ERISA and the Code rather than the basic
fiduciary standards. This transition period exemption addresses these
concerns by giving Financial Institutions and Advisers necessary time
to fully comply with Sections II-V of the exemption.
The Department also considered the views of commenters that
requested re-proposal of the regulation and exemptions, or issuing the
rule and exemptions as interim final rules with requests for additional
comment. After reviewing all the comments on the 2015 proposal, which
was itself a re-proposal, the Department has concluded that it is in a
position to publish a final rule and exemptions. It has carefully
considered and responded to the significant issues raised in the
comments in drafting the final rule and exemptions. Moreover, the
Department has concluded that the difference between the final
documents and the proposals are also responsive to the commenters'
concerns and could be reasonably foreseen by affected parties.
The amendments to and partial revocations of existing exemptions
finalized elsewhere in this issue of the Federal Register will be
issued June 7, 2016 and will become applicable on the Applicability
Date. Specifically, this includes amendments to and partial revocations
PTEs 86-128, 84-24, 75-1, 77-4, 80-83 and 83-1. The conditions of these
amended exemptions are largely standards-based, or contain only minimal
additional disclosure requirements, and therefore Financial
Institutions should not require a transition period longer than through
the Applicability Date, to comply. For the avoidance of doubt, no
revocation will be applicable prior to the Applicability Date.
No Relief From ERISA Section 406(a)(1)(C) or Code Section 4975(c)(1)(C)
for the Provision of Services
This exemption does not provide relief from a transaction
prohibited by ERISA section 406(a)(1)(C), or from the taxes imposed by
Code section 4975(a) and (b) by reason of Code section 4975(c)(1)(C),
regarding the furnishing of goods, services or facilities between a
plan and a party in interest. The provision of investment advice to a
plan under a contract with a plan fiduciary is a service to the plan
and compliance with this exemption will not relieve an Adviser or
Financial Institution of the need to comply with ERISA section
408(b)(2), Code section 4975(d)(2), and applicable regulations
thereunder.
[[Page 21071]]
Paperwork Reduction Act Statement
In accordance with the requirements of the Paperwork Reduction Act
of 1995 (PRA) (44 U.S.C. 3506(c)(2)), the Department solicited comments
on the information collections included in the proposed Best Interest
Contract Exemption. 80 FR 21960, 21980-83 (Apr. 20, 2015). The
Department also submitted an information collection request (ICR) to
OMB in accordance with 44 U.S.C. 3507(d), contemporaneously with the
publication of the proposal, for OMB's review. The Department received
two comments from one commenter that specifically addressed the
paperwork burden analysis of the information collections. Additionally
many comments were submitted, described elsewhere in the preamble to
the accompanying final rule, which contained information relevant to
the costs and administrative burdens attendant to the proposals. The
Department took into account such public comments in connection with
making changes to the prohibited transaction exemption, analyzing the
economic impact of the proposals, and developing the revised paperwork
burden analysis summarized below.
In connection with publication of this final prohibited transaction
exemption, the Department is submitting an ICR to OMB requesting
approval of a new collection of information under OMB Control Number
1210-0156. The Department will notify the public when OMB approves the
ICR.
A copy of the ICR may be obtained by contacting the PRA addressee
shown below or at http://www.RegInfo.gov. PRA ADDRESSEE: G. Christopher
Cosby, Office of Policy and Research, U.S. Department of Labor,
Employee Benefits Security Administration, 200 Constitution Avenue NW.,
Room N-5718, Washington, DC 20210. Telephone: (202) 693-8410; Fax:
(202) 219-4745. These are not toll-free numbers.
As discussed in detail below, the final class exemption will
require Financial Institutions to enter into a contractual arrangement
with Retirement Investors regarding investments in IRAs and plans not
subject to Title I of ERISA (non-ERISA plans), adopt written policies
and procedures and make disclosures to Retirement Investors (including
with respect to ERISA plans), the Department, and on a publicly
accessible Web site, in order to receive relief from ERISA's and the
Code's prohibited transaction rules for the receipt of compensation as
a result of a Financial Institution's and its Adviser's advice (i.e.,
prohibited compensation). Financial Institutions that limit
recommendations in whole or in part to Proprietary Products or
investments that generate Third Party Payments will have to prepare a
written documentation regarding these limitations. Financial
Institutions will be required to maintain records necessary to prove
that the conditions of the exemption have been met. Financial
Institutions that are Level Fee Fiduciaries will be required to make
disclosures to Retirement Investors acknowledging fiduciary status and,
if recommending a rollover from an ERISA plan to an IRA, from an IRA to
another IRA, or a switch from a commission-based account to a fee-based
account, document the reasons for the recommendation, but will not be
subject to any of the other paperwork conditions of the exemption. In
addition, the exemption provides a transition period from the
Applicability Date, to January 1, 2018. As a condition of relief during
the transition period, Financial Institutions must make a disclosure
(transition disclosure) to all Retirement Investors (in ERISA plans,
IRAs, and non-ERISA plans) prior to or at the same time as the
execution of recommended transactions. These requirements are ICRs
subject to the Paperwork Reduction Act.
The Department has made the following assumptions in order to
establish a reasonable estimate of the paperwork burden associated with
these ICRs:
51.8 percent of disclosures to ERISA plans and plan
participants \98\ and 44.1 percent of contracts with and disclosures to
IRAs and non-ERISA plans \99\ will be distributed electronically via
means already used by respondents in the normal course of business and
the costs arising from electronic distribution will be negligible,
while the remaining contracts and disclosures will be distributed on
paper and mailed at a cost of $0.05 per page for materials and $0.49
for first class postage;
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\98\ According to data from the National Telecommunications and
Information Agency (NTIA), 33.4 percent of individuals age 25 and
over have access to the internet at work. According to a Greenwald &
Associates survey, 84 percent of plan participants find it
acceptable to make electronic delivery the default option, which is
used as the proxy for the number of participants who will not opt
out that are automatically enrolled (for a total of 28.1 percent
receiving electronic disclosure at work). Additionally, the NTIA
reports that 38.9 percent of individuals age 25 and over have access
to the internet outside of work. According to a Pew Research Center
survey, 61 percent of internet users use online banking, which is
used as the proxy for the number of internet users who will opt in
for electronic disclosure (for a total of 23.7 percent receiving
electronic disclosure outside of work). Combining the 28.1 percent
who receive electronic disclosure at work with the 23.7 percent who
receive electronic disclosure outside of work produces a total of
51.8 percent who will receive electronic disclosure overall.
\99\ According to data from the NTIA, 72.4 percent of
individuals age 25 and older have access to the internet. According
to a Pew Research Center survey, 61 percent of internet users use
online banking, which is used as the proxy for the number of
internet users who will opt in for electronic disclosure. Combining
these data produces an estimate of 44.1 percent of individuals who
will receive electronic disclosures.
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Financial Institutions will use existing in-house
resources to distribute required disclosures and to create
documentations for transactions recommended by Level Fee Fiduciaries.
Tasks associated with the ICRs performed by in-house
personnel will be performed by clerical personnel at an hourly wage
rate of $55.21 and financial advisers at an hourly wage rate of
$198.58.\100\
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\100\ For a description of the Department's methodology for
calculating wage rates, see http://www.dol.gov/ebsa/pdf/labor-cost-inputs-used-in-ebsa-opr-ria-and-pra-burden-calculations-march-2016.pdf. The Department's methodology for calculating the overhead
cost input of its wage rates was adjusted from the proposed PTE to
the final PTE. In the proposed PTE, the Department based its
overhead cost estimates on longstanding internal EBSA calculations
for the cost of overhead. In response to a public comment stating
that the overhead cost estimates were too low and without any
supporting evidence, the Department incorporated published US Census
Bureau survey data on overhead costs into its wage rate estimates.
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Financial Institutions will hire outside service providers
to assist with nearly all other compliance costs;
Outsourced legal assistance will be billed at an hourly
rate of $335.00.\101\
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\101\ This rate is the average of the hourly rate of an attorney
with 4-7 years of experience and an attorney with 8-10 years of
experience, taken from the Laffey Matrix. See http://www.justice.gov/sites/default/files/usao-dc/legacy/2014/07/14/Laffey%20Matrix_2014-2015.pdf.
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Approximately 7,000 broker-dealers, RIAs that are
ineligible to be Level Fee Fiduciaries, and insurance companies will
use this exemption. Additionally, approximately 13,000 Level Fee
Fiduciary RIAs will use of this exemption under level fee
conditions.\102\ All of these Financial
[[Page 21072]]
Institutions will use this exemption in conjunction with transactions
involving nearly all of their clients in the retirement market.
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\102\ One commenter questioned the basis for the Department's
assumption regarding the number of Financial Institutions likely to
use the exemption. According to the ``2015 Investment Management
Compliance Testing Survey,'' Investment Adviser Association, cited
in the regulatory impact analysis for the accompanying rule, 63
percent of Registered Investment Advisers service ERISA-covered
plans and IRAs. The Department conservatively interprets this to
mean that all of the 113 large Registered Investment Advisers
(RIAs), 63 percent of the 3,021 medium RIAs (1,903), and 63 percent
of the 24,475 small RIAs (15,419) work with ERISA-covered plans and
IRAs. The Department assumes that all of the 42 large broker-
dealers, and similar shares of the 233 medium broker-dealers (147)
and the 3,682 small broker-dealers (2,320) work with ERISA-covered
plans and IRAs. According to SEC and FINRA data, cited in the
regulatory impact analysis, 18 percent of broker-dealers are also
registered as RIAs. Removing these firms from the RIA counts
produces counts of 105 large RIAs, 1,877 medium RIAs, and 15,001
small RIAs that work with ERISA-covered plans and IRAs and are not
also registered as broker-dealers. SNL Financial data show that 398
life insurance companies reported receiving either individual or
group annuity considerations in 2014, of which 22 companies are
large, 175 companies are medium, and 201 companies are small. The
Department has used these data as the count of insurance companies
working in the ERISA-covered plan and IRA markets. Further,
according to Hung et al. (2008) (see Regulatory Impact Analysis for
complete citation), approximately 13 percent of RIAs report
receiving commissions. Additionally, 20 percent of RIAs report
receiving performance based fees; however, at least 60 percent of
these RIAs are likely to be hedge funds. Thus, as much as 8 percent
of RIAs providing investment advice receive performance based fees.
Combining the 8 percent of RIAs receiving performance based fees
with the 13 percent of RIAs receiving commissions creates an
estimate of the number of RIAs that could be ineligible to be Level
Fee Fiduciaries (21 percent). The remaining RIAs could be Level Fee
Fiduciaries. In total, the Department estimates that 2,509 broker-
dealers, 3,566 RIAs ineligible to be Level Fee Fiduciaries, 13,417
Level Fee Fiduciary RIAs, and 398 insurance companies will use this
exemption. As described in detail in the regulatory impact analysis,
the Department believes a de minimis number of banks may also use
the exemption.
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Compliance Costs for Financial Institutions That Are Not Level Fee
Fiduciaries
The Department believes that nearly all Financial Institutions that
are not Level Fee Fiduciaries will contract with outside service
providers to implement the various compliance requirements of this
exemption. As described in the regulatory impact analysis, per-firm
costs for BDs were calculated by allocating the total cost reductions
in the medium assumptions scenario across the firm size categories, and
then subtracting the cost reductions from the per-firm average costs
derived from the Oxford Economics study. The methodology for
calculating the per-firm costs for RIAs and Insurance Companies is
described in detail in the regulatory impact analysis. The Department
is attributing 50 percent of the compliance costs for BDs and RIAs to
this exemption and 50 percent of the compliance costs for BDs and RIAs
to the Class Exemption for Principal Transactions in Certain Assets
between Investment Advice Fiduciaries and Employee Benefit Plans and
IRAs (Principal Transactions Exemption) published elsewhere in today's
Federal Register. The Department is attributing all of the compliance
costs for insurance companies to this exemption.\103\ With the above
assumptions, the per-firm costs are as follows:
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\103\ The Department changed its methodology for estimating
costs in an attempt to be responsive to public comments. Many of the
comments received on the costs of the rule and exemptions suggested
that much of the compliance burden for the rule results from the
information collections in the accompanying exemptions. Therefore,
the Department believes that a more accurate depiction of the costs
of the rule and exemptions can be created by integrating the cost
estimates.
Start-Up Costs for Large BDs: $3.7 million
Start-Up Costs for Large RIAs: $3.2 million
Start-Up Costs for Large Insurance Companies: $6.6 million
Start-Up Costs for Medium BDs: $889,000
Start-Up Costs for Medium RIAs: $662,000
Start-Up costs for Medium Insurance Companies: $1.4 million
Start-Up Costs for Small BDs: $278,000
Start-Up Costs for Small RIAs: $219,000
Start-Up Costs for Small Insurance Companies: $464,000
Ongoing Costs for Large BDs: $918,000
Ongoing Costs for Large RIAs: $803,000
Ongoing Costs for Large Insurance Companies: $1.7 million
Ongoing Costs for Medium BDs: $192,000
Ongoing Costs for Medium RIAs: $143,000
Ongoing Costs for Medium Insurance Companies: $306,000
Ongoing Costs for Small BDs: $60,000
Ongoing Costs for Small RIAs: $47,000
Ongoing Costs for Small Insurance Companies: $100,000
In order to receive compensation covered under this exemption
(other than under level fee conditions, which is discussed separately
below), Section II requires Financial Institutions to acknowledge, in
writing, their fiduciary status and adopt written policies and
procedures designed to ensure compliance with the Impartial Conduct
Standards. Financial Institutions and Advisers must make certain
disclosures to Retirement Investors. Financial Institutions must
generally enter into a written contract with Retirement Investors with
respect to investments in IRAs and non-ERISA plans with certain
required provisions, including affirmative agreement to adhere to the
Impartial Conduct Standards.
Sections III and V require Financial Institutions and Advisers to
make certain disclosures. These disclosures include: (1) A pre-
transaction disclosure, stating the best interest standard of care,
describing any Material Conflicts of Interest with respect to the
transaction, disclosing the recommendation of proprietary products and
products that generate third party payments (where applicable), and
informing the Retirement Investor of disclosures available on the
Financial Institution's Web site and informing the Retirement Investor
that the investor may receive specific disclosure of the costs, fees,
and other compensation associated with the transaction; (2) a
disclosure, on request, describing in detail the costs, fees, and other
compensation associated with the transaction; (3) a web-based
disclosure; and (4) a one-time disclosure to the Department.
Under Section IV, Financial Institutions that limit recommendations
in whole or in part to Proprietary Products or investments that
generate Third Party Payments will have to prepare a written
documentation regarding these limitations.
Section IX requires Financial Institutions to make a transition
disclosure, acknowledging their fiduciary status and that of their
Advisers with respect to the advice, stating the Best Interest standard
of care, and describing the Financial Institution's Material Conflicts
of Interest and any limitations on product offerings, prior to or at
the same time as the execution of any transactions during the
transition period from the Applicability Date to January 1, 2018. The
transition disclosure can cover multiple transactions, or all
transactions occurring in the transition period.
Financial Institutions will also be required to maintain records
necessary to prove that the conditions of the exemption have been met.
The Department is able to disaggregate an estimate of many of the
legal costs from the costs above; however, it is unable to disaggregate
any of the other costs. The Department received a comment on the
proposed PTE stating that the estimates for legal professional time to
draft disclosures were not supported by any empirical evidence. The
Department also received multiple comments on the proposed PTE stating
that its estimate of 60 hours of legal professional time during the
first year a financial institution used the exemption and then no legal
professional time in subsequent years was too low.
In response to a recommendation made during the Department's August
2015, public hearing on the proposed
[[Page 21073]]
rule and exemptions, and in an attempt to create estimates with a
clearer empirical evidentiary basis, the Department drafted certain
portions of the required disclosures, including a sample contract, the
one-time disclosure to the Department, and the transition disclosure.
The Department believes that the time spent updating existing contracts
and disclosures in future years would be no longer than the time
necessary to create the original disclosure. The Department did not
attempt to draft the complete set of required disclosures because it
expects that the amount of time necessary to draft such disclosures
will vary greatly among firms. For example the Department did not
attempt to draft sample policies and procedures, disclosures describing
in detail the costs, fees, and other compensation associated with the
transaction, documentation of the limitations regarding proprietary
products or investments that generate third party payments, or a sample
web disclosure. The Department expects the amount of time necessary to
complete these disclosures will vary significantly based on a variety
of factors including the nature of a firm's compensation structure, and
the extent to which a firm's policies and procedures require review and
signatures by different individuals.
Considered in conjunction with the estimates provided in the
proposal, the Department estimates that outsourced legal assistance to
draft standard contracts, contract disclosures, pre-transaction
disclosures, the one-time disclosure to the Department, and the
transition disclosures will cost an average of $3,857 per firm for a
total of $25.0 million during the first year. In subsequent years, it
will cost an average of $3,076 per firm for a total of $19.9 million
annually to update the contracts, contract disclosures, and pre-
transaction disclosures.
The legal costs of these disclosures were disaggregated from the
total compliance costs because these disclosures are expected to be
relatively uniform. Although the tested disclosures generally took less
time than many of the commenters said they would, the Department
acknowledges that the disclosures that were not tested are those that
are expected to be the most time consuming. Importantly, as explained
in greater detail in section 5.3 of the regulatory impact analysis, the
Department is primarily relying on cost data provided by the Securities
Industry and Financial Markets Association (SIFMA) and the Financial
Services Institute (FSI) to calculate the total cost of the legal
disclosures, rather than its own internal drafting of disclosures.
Accordingly, in the event that any of the Department's estimates
understate the time necessary to create and update the disclosures, it
does not impact the total burden estimates. The total burden estimates
were derived from SIFMA and FSI's all-inclusive costs. Therefore, in
the event that legal costs are understated, other cost estimates in
this analysis would be overstated in an equal manner.
In addition to legal costs for creating the contracts and
disclosures, the start-up cost estimates include the costs of
implementing and updating the IT infrastructure, creating the web
disclosures, gathering and maintaining the records necessary to produce
the various disclosures and to prove that the conditions of the
exemption have been met, developing policies and procedures,
documenting any limitations regarding proprietary products or
investments that generate third party payments, addressing material
conflicts of interest, monitoring Advisers' adherence to the Impartial
Conduct Standards, and any other steps necessary to ensure compliance
with the conditions of the exemption not described elsewhere. In
addition to legal costs for updating the contracts and disclosures, the
ongoing cost estimates include the costs of updating the IT
infrastructure, updating the web disclosures, reviewing processes for
gathering and maintaining the records necessary to produce the various
disclosures and to prove that the conditions of the exemption have been
met, reviewing the policies and procedures, producing the detailed
transaction disclosures on request, documenting any limitations
regarding proprietary products or investments that generate third party
payments, monitoring investments as agreed upon with the Retirement
Investor, addressing material conflicts of interest, monitoring
Advisers' adherence to the Impartial Conduct Standards, and any other
steps necessary to ensure compliance with the conditions of the
exemption not described elsewhere. These costs total $2.4 billion
during the first year and $520.4 million in subsequent years. These
costs do not include the costs of distributing disclosures and
contracts or the costs of operating under level fee conditions, all of
which are discussed below.
Distribution of Disclosures and Contracts
The Department estimates that 1.1 million Retirement Investors with
respect to ERISA plans and 29.9 million Retirement Investors with
respect to IRAs and non-ERISA plans will receive a three-page
transition disclosure during the first year. Additionally, 1.1 million
Retirement Investors with respect to ERISA plans will receive a
fifteen-page contract disclosure, and 29.9 million Retirement Investors
with respect to IRAs and non-ERISA plans will receive a fifteen-page
contract during the first year. In subsequent years, 320,000 million
Retirement Investors with respect to ERISA plans will receive a
fifteen-page contract disclosure and 6.0 million Retirement Investors
with respect to IRAs and non-ERISA plans will receive a fifteen-page
contract. To the extent that Financial Institutions use both the Best
Interest Contract Exemption and the Principal Transactions Exemption,
these estimates may represent overestimates because significant overlap
exists between the requirements of the transition disclosure and the
contract for both exemptions. If Financial Institutions choose to use
both exemptions with the same clients, they will probably combine the
documents.
The transition disclosure will be distributed electronically to
51.8 percent of ERISA plan investors and 44.1 percent of IRAs and non-
ERISA plan investors during the first year. Paper disclosures will be
mailed to the remaining 48.2 percent of ERISA plan investors and 55.9
percent of IRAs and non-ERISA plan investors. The contract disclosure
will be distributed electronically to 51.8 percent of ERISA plan
investors during the first year or during any subsequent year in which
the plan begins a new advisory relationship. Paper contract disclosures
will be mailed to the remaining 48.2 percent of ERISA plan investors.
The contract will be distributed electronically to 44.1 percent of IRAs
and non-ERISA plan investors during the first year or during any
subsequent year in which the investor enters into a new advisory
relationship. Paper contracts will be mailed to the remaining 55.9
percent of IRAs and non-ERISA plan investors. The Department estimates
that electronic distribution will result in de minimis cost, while
paper distribution will cost approximately $32.5 million during the
first year and $4.3 million during subsequent years. Paper distribution
will also require two minutes of clerical time to print and mail the
disclosure or contract,\104\ resulting in 1.2 million
[[Page 21074]]
hours at an equivalent cost of $63.6 million during the first year and
117,000 hours at an equivalent cost of $6.4 million during subsequent
years.
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\104\ One commenter questioned the basis for this estimate. The
Department worked with clerical staff to determine that most notices
and disclosures can be printed and prepared for mailing in less than
one minute per disclosure. Therefore, an estimate of two minutes per
disclosure is a conservative estimate.
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The Department assumes that ERISA plans that do not allow
participants to direct investments will engage in two transactions per
month that require pre-transaction disclosures. The Department assumes
that ERISA plan participants and IRA holders will engage in two
transactions per year that require pre-transaction disclosures.
Therefore, the Department estimates that plans and IRAs will receive
62.9 million three page pre-transaction disclosures during the second
year and all subsequent years. The pre-transaction disclosures will be
distributed electronically for 51.8 percent of the ERISA plan investors
and 44.1 percent of the IRA holders and non-ERISA plan participants.
The remaining 34.9 million disclosures will be mailed. The Department
estimates that electronic distribution will result in de minimis cost,
while paper distribution will cost approximately $22.4 million. Paper
distribution will also require two minutes of clerical time to print
and mail the statement, resulting in 1.2 million hours at an equivalent
cost of $64.3 million annually.
The Department estimates that Financial Institutions will receive
ten requests per year for more detailed information on the fees, costs,
and compensation associated with the transaction during the second year
and all subsequent years. The detailed disclosures will be distributed
electronically for 51.8 percent of the ERISA plan investors and 44.1
percent of the IRA holders and non-ERISA plan participants. The
Department believes that requests for additional information will be
proportionally likely with each Retirement Investor type. Therefore,
approximately 36,000 detailed disclosures will be distributed on paper.
The Department estimates that electronic distribution will result in de
minimis cost, while paper distribution will cost approximately $27,000.
Paper distribution will also require two minutes of clerical time to
print and mail the statement, resulting in 1,000 hours at an equivalent
cost of $66,000 annually.
Finally, the Department estimates that all of the 7,000 Financial
Institutions that are not Level Fee Fiduciaries will submit the
required one-page disclosure to the Department electronically at de
minimis cost during the first year.
Option for Level Fee Fiduciaries Operating Under Level Fee Conditions
The Department estimates that 13,000 Level Fee Fiduciaries will
make recommendations to 3.0 million Retirement Investors with respect
to ERISA plans, IRAs, and non-ERISA plans annually under level fee
conditions.
Based on consultation with its legal staff, the Department
estimates that the standard fiduciary acknowledgements required by
Level Fee Fiduciaries will take 1 hour and 25 minutes to draft.\105\
The Department believes that the time spent updating existing fiduciary
acknowledgements in future years would be no longer than the time
necessary to create the original acknowledgement. The Department
estimates that outsourced legal assistance to draft and/or update
fiduciary acknowledgements will cost $6.4 million annually.
---------------------------------------------------------------------------
\105\ This estimate does not include the time the Level Fee
Fiduciaries will spend documenting the reason or reasons the
recommendation was consistent with this exemption.
---------------------------------------------------------------------------
The fiduciary acknowledgements will be distributed electronically
for 51.8 percent of ERISA plan investors and 44.1 percent of the IRA
holders and non-ERISA plan investors. The remaining 1.6 million
acknowledgements will be mailed. The Department estimates that
electronic distribution will result in de minimis cost, while paper
distribution will cost approximately $888,000. Paper distribution will
also require two minutes of clerical time to print and mail the
acknowledgement, resulting in 55,000 hours at an equivalent cost of
$3.0 million annually.
The Department estimates that it will take financial advisers
thirty minutes to record the documentation for each recommendation.
This results in 1.5 million hours annually at an equivalent cost of
$296.9 million.
Overall Summary
Overall, the Department estimates that in order to meet the
conditions of this class exemption, Financial Institutions and Advisers
will distribute approximately 74.6 million disclosures and contracts
during the first year and 73.3 million disclosures and contracts during
subsequent years. Distributing these disclosures and contracts, and
maintaining records that the conditions of the exemption have been
fulfilled will result in a total of 2.5 million hours of burden during
the first year and 2.5 million hours of burden in subsequent years. The
equivalent cost of this burden is $201.5 million during the first year
and $201.2 million in subsequent years. This exemption will result in
an outsourced labor, materials, and postage cost burden of $1.6 billion
during the first year and $380.7 million during subsequent years.
These paperwork burden estimates are summarized as follows:
Type of Review: New collection.
Agency: Employee Benefits Security Administration, Department of
Labor.
Titles: (1) Best Interest Contract Exemption and (2) Final
Investment Advice Regulation.
OMB Control Number: 1210-0156.
Affected Public: Businesses or other for-profits; not for profit
institutions.
Estimated Number of Respondents: 19,890.
Estimated Number of Annual Responses: 65,095,501 during the first
year and 72,282,441 during subsequent years.
Frequency of Response: When engaging in exempted transaction.
Estimated Total Annual Burden Hours: 2,701,270 during the first
year and 2,832,369 in subsequent years.
Estimated Total Annual Burden Cost: $2,479,541,143 during the first
year and $574,302,408 during subsequent years.
Regulatory Flexibility Act
This exemption, which is issued pursuant to section 408(a) of ERISA
and section 4975(c)(2) of the IRC, is part of a broader rulemaking that
includes other exemptions and a final regulation published in today's
Federal Register. The Regulatory Flexibility Act (5 U.S.C. 601 et seq.)
imposes certain requirements with respect to Federal rules that are
subject to the notice and comment requirements of section 553(b) of the
Administrative Procedure Act (5 U.S.C. 551 et seq.), or any other laws.
Unless the head of an agency certifies that a final rule is not likely
to have a significant economic impact on a substantial number of small
entities, section 604 of the RFA requires that the agency present a
final regulatory flexibility analysis (FRFA) describing the rule's
impact on small entities and explaining how the agency made its
decisions with respect to the application of the rule to small
entities.
The Secretary has determined that this rulemaking, including this
exemption, will have a significant economic impact on a substantial
number of small entities. The Secretary has separately published a
Regulatory Impact Analysis (RIA) which contains the complete economic
analysis for this rulemaking including the Department's FRFA for the
rule and the related prohibited transaction exemptions. This section of
this preamble sets forth a
[[Page 21075]]
summary of the FRFA. The RIA is available at www.dol.gov/ebsa.
As noted in section 6.1 of the RIA, the Department has determined
that regulatory action is needed to mitigate conflicts of interest in
connection with investment advice to retirement investors. The
regulation is intended to improve plan and IRA investing to the benefit
of retirement security. In response to the proposed rulemaking,
organizations representing small businesses submitted comments
expressing particular concern with three issues: The carve-out for
investment education, the best interest contract exemption, and the
carve-out for persons acting in the capacity of counterparties to plan
fiduciaries with financial expertise. Section 2 of the RIA contains an
extensive discussion of these concerns and the Department's response.
As discussed in section 6.2 of the RIA, the Small Business
Administration (SBA) defines a small business in the Financial
Investments and Related Activities Sector as a business with up to
$38.5 million in annual receipts. In response to a comment received
from the SBA's Office of Advocacy on our Initial Regulatory Flexibility
Analysis, the Department contacted the SBA, and received from them a
dataset containing data on the number of firms by NAICS codes,
including the number of firms in given revenue categories. This dataset
would allow the estimation of the number of firms with a given NAICS
code that fall below the $38.5 million threshold and therefore be
considered small entities by the SBA. However, this dataset alone does
not provide a sufficient basis for the Department to estimate the
number of small entities affected by the rule. Not all firms within a
given NAICS code would be affected by this rule, because being an ERISA
fiduciary relies on a functional test and is not based on industry
status as defined by a NAICS code. Further, not all firms within a
given NAICS code work with ERISA-covered plans and IRAs.
Over 90 percent of broker-dealers, registered investment advisers,
insurance companies, agents, and consultants are small businesses
according to the SBA size standards (13 CFR 121.201). Applying the
ratio of entities that meet the SBA size standards to the number of
affected entities, based on the methodology described at greater length
in the RIA, the Department estimates that the number of small entities
affected by this rule is 2,438 BDs, 16,521 RIAs, 496 Insurers, and
3,358 other ERISA service providers.
For purposes of the RFA, the Department continues to consider an
employee benefit plan with fewer than 100 participants to be a small
entity. Further, while some large employers may have small plans, in
general small employers maintain most small plans. The definition of
small entity considered appropriate for this purpose differs, however,
from a definition of small business that is based on size standards
promulgated by the SBA. These small pension plans will benefit from the
rule, because as a result of the rule, they will receive non-conflicted
advice from their fiduciary service providers. The 2013 Form 5500
filings show nearly 595,000 ERISA covered retirement plans with less
than 100 participants.
Section 6.5 of the RIA summarizes the projected reporting,
recordkeeping, and other compliance costs of the rule and exemptions,
which are discussed in detail in section 5 of the RIA. Among other
things, the Department concludes that it is likely that some small
service providers may find that the increased costs associated with
ERISA fiduciary status outweigh the benefits of continuing to service
the ERISA plan market or the IRA market. The Department does not
believe that this outcome will be widespread or that it will result in
a diminution of the amount or quality of advice available to small or
other retirement savers, because some firms will fill the void and
provide services to the ERISA plan and IRA market. It is also possible
that the economic impact of the rule and exemptions on small entities
would not be as significant as it would be for large entities, because
anecdotal evidence indicates that small entities do not have as many
business arrangements that give rise to conflicts of interest.
Therefore, they would not be confronted with the same costs to
restructure transactions that would be faced by large entities.
Section 5.3.1 of the RIA includes a discussion of the changes to
the proposed rule and exemptions that are intended to reduce the costs
affecting both small and large business. These include elimination of
data collection and annual disclosure requirements in the Best Interest
Contract Exemption, and changes to the implementation of the contract
requirement in the exemption. Section 7 of the RIA discusses
significant regulatory alternatives considered by the Department and
the reasons why they were rejected.
Congressional Review Act
This exemption, along with related exemptions and a final rule
published elsewhere in this issue of the Federal Register, is part of a
rulemaking that is subject to the Congressional Review Act provisions
of the Small Business Regulatory Enforcement Fairness Act of 1996 (5
U.S.C. 801, et seq.) and, will be transmitted to Congress and the
Comptroller General for review. This rulemaking, including this
exemption is treated as a ``major rule'' as that term is defined in 5
U.S.C. 804, because it is likely to result in an annual effect on the
economy of $100 million or more.
General Information
The attention of interested persons is directed to the following:
(1) The fact that a transaction is the subject of an exemption
under section 408(a) of ERISA and section 4975(c)(2) of the Code does
not relieve a fiduciary, or other party in interest or disqualified
person with respect to a plan, from certain other provisions of ERISA
and the Code, including any prohibited transaction provisions to which
the exemption does not apply and the general fiduciary responsibility
provisions of section 404 of ERISA which require, among other things,
that a fiduciary act prudently and discharge his or her duties
respecting the plan solely in the interests of the participants and
beneficiaries of the plan. Additionally, the fact that a transaction is
the subject of an exemption does not affect the requirement of section
401(a) of the Code that the plan must operate for the exclusive benefit
of the employees of the employer maintaining the plan and their
beneficiaries;
(2) The Department finds that the exemption is administratively
feasible, in the interests of the plan and of its participants and
beneficiaries, and protective of the rights of participants and
beneficiaries of the plan;
(3) The exemption is applicable to a particular transaction only if
the transaction satisfies the conditions specified in the exemption;
and
(4) The exemption is supplemental to, and not in derogation of, any
other provisions of ERISA and the Code, including statutory or
administrative exemptions and transitional rules. Furthermore, the fact
that a transaction is subject to an administrative or statutory
exemption is not dispositive of whether the transaction is in fact a
prohibited transaction.
Exemption
Section I--Best Interest Contract Exemption
(a) In general. ERISA and the Internal Revenue Code prohibit
fiduciary advisers to employee benefit plans
[[Page 21076]]
(Plans) and individual retirement plans (IRAs) from receiving
compensation that varies based on their investment advice. Similarly,
fiduciary advisers are prohibited from receiving compensation from
third parties in connection with their advice. This exemption permits
certain persons who provide investment advice to Retirement Investors,
and associated Financial Institutions, Affiliates and other Related
Entities, to receive such otherwise prohibited compensation as
described below.
(b) Covered transactions. This exemption permits Advisers,
Financial Institutions, and their Affiliates and Related Entities, to
receive compensation as a result of their 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.
As defined in Section VIII(o) of the exemption, a Retirement
Investor is: (1) A participant or beneficiary of a Plan with authority
to direct the investment of assets in his or her Plan account or to
take a distribution; (2) the beneficial owner of an IRA acting on
behalf of the IRA; or (3) a Retail Fiduciary with respect to a Plan or
IRA.
As detailed below, Financial Institutions and Advisers seeking to
rely on the exemption must adhere to Impartial Conduct Standards in
rendering advice regarding retirement investments. In addition,
Financial Institutions must adopt policies and procedures designed to
ensure that their individual Advisers adhere to the Impartial Conduct
Standards; disclose important information relating to fees,
compensation, and Material Conflicts of Interest; and retain records
demonstrating compliance with the exemption. Level Fee Fiduciaries that
will receive only a Level Fee in connection with advisory or investment
management services must comply with more streamlined conditions
designed to target the conflicts of interest associated with such
services. The exemption provides relief from the restrictions of ERISA
section 406(a)(1)(D) and 406(b) and the sanctions imposed by Code
section 4975(a) and (b), by reason of Code section 4975(c)(1)(D), (E)
and (F). The Adviser and Financial Institution must comply with the
applicable conditions of Sections II-V to rely on this exemption. This
document also contains separate exemptions in Section VI (Exemption for
Purchases and Sales, including Insurance and Annuity Contracts) and
Section VII (Exemption for Pre-Existing Transactions).
(c) Exclusions. This exemption does not apply if:
(1) The Plan is covered by Title I of ERISA, and (i) the Adviser,
Financial Institution or any Affiliate is the employer of employees
covered by the Plan, or (ii) the Adviser or Financial Institution is a
named fiduciary or plan administrator (as defined in ERISA section
3(16)(A)) with respect to the Plan, or an affiliate thereof, that was
selected to provide advice to the Plan by a fiduciary who is not
Independent;
(2) The compensation is received as a result of a Principal
Transaction;
(3) The compensation is received as a result of investment advice
to a Retirement Investor generated solely by an interactive Web site in
which computer software-based models or applications provide investment
advice based on personal information each investor supplies through the
Web site without any personal interaction or advice from an individual
Adviser (i.e., ``robo-advice'') unless the robo-advice provider is a
Level Fee Fiduciary that complies with the conditions applicable to
Level Fee Fiduciaries; or
(4) The Adviser has or exercises any discretionary authority or
discretionary control with respect to the recommended transaction.
Section II--Contract, Impartial Conduct, and Other Requirements
The conditions set forth in this section include certain Impartial
Conduct Standards, such as a Best Interest Standard, that Advisers and
Financial Institutions must satisfy to rely on the exemption. In
addition, Section II(d) and (e) requires Financial Institutions to
adopt anti-conflict policies and procedures that are reasonably
designed to ensure that Advisers adhere to the Impartial Conduct
Standards, and requires disclosure of important information about the
Financial Institutions' services, applicable fees and compensation.
With respect to IRAs and other Plans not covered by Title I of ERISA,
the Financial Institutions must agree that they and their Advisers will
adhere to the exemption's standards in a written contract that is
enforceable by the Retirement Investors. To minimize compliance
burdens, the exemption provides that the contract terms may be
incorporated into account opening documents and similar commonly-used
agreements with new customers, permits reliance on a negative consent
process with respect to existing contract holders, and provides a
method of meeting the exemption requirement in the event that the
Retirement Investor does not open an account with the Adviser but
nevertheless acts on the advice through other channels. Advisers and
Financial Institutions need not execute the contract before they make a
recommendation to the Retirement Investor. However, the contract must
cover any advice given prior to the contract date in order for the
exemption to apply to such advice. There is no contract requirement for
recommendations to Retirement Investors about investments in Plans
covered by Title I of ERISA, but the Impartial Conduct Standards and
other requirements of Section II(b)-(e), including a written
acknowledgment of fiduciary status, must be satisfied in order for
relief to be available under the exemption, as set forth in Section
II(g). Section II(h) provides conditions for recommendations by Level
Fee Fiduciaries, which, with their Affiliates, will receive only a
Level Fee in connection with advisory or investment management services
with respect to the Plan or IRA assets. Section II(i) provides
conditions for referral fees received by banks and bank employees
pursuant to Bank Networking Arrangements. Section II imposes the
following conditions on Financial Institutions and Advisers:
(a) Contracts with Respect to Investments in IRAs and Other Plans
Not Covered by Title I of ERISA. If the investment advice concerns an
IRA or a Plan that is not covered by Title I of ERISA, the advice is
subject to an enforceable written contract on the part of the Financial
Institution, which may be a master contract covering multiple
recommendations, that is entered into in accordance with this Section
II(a) and incorporates the terms set forth in Section II(b)-(d). The
Financial Institution additionally must provide the disclosures
required by Section II(e). The contract must cover advice rendered
prior to the execution of the contract in order for the exemption to
apply to such advice and related compensation.
(1) Contract Execution and Assent--(i) New Contracts. Prior to or
at the same time as the execution of the recommended transaction, the
Financial Institution enters into a written contract with the
Retirement Investor acting on behalf of the Plan, participant or
beneficiary account, or IRA, incorporating the terms required by
Section II(b)-(d). The terms of the contract may appear in a standalone
document or they may be incorporated into an investment advisory
agreement, investment program agreement, account opening agreement,
insurance or annuity contract or application, or similar document, or
amendment thereto. The contract must be enforceable against the
Financial
[[Page 21077]]
Institution. The Retirement Investor's assent to the contract may be
evidenced by handwritten or electronic signatures.
(ii) Amendment of Existing Contracts by Negative Consent. As an
alternative to executing a contract in the manner set forth in the
preceding paragraph, the Financial Institution may amend Existing
Contracts to include the terms required in Section II(b)-(d) by
delivering the proposed amendment and the disclosure required by
Section II(e) to the Retirement Investor prior to January 1, 2018, and
considering the failure to terminate the amended contract within 30
days as assent. An Existing Contract is an investment advisory
agreement, investment program agreement, account opening agreement,
insurance contract, annuity contract, or similar agreement or contract
that was executed before January 1, 2018, and remains in effect. If the
Financial Institution elects to use the negative consent procedure, it
may deliver the proposed amendment by mail or electronically, but it
may not impose any new contractual obligations, restrictions, or
liabilities on the Retirement Investor by negative consent.
(iii) Failure to enter into contract. Notwithstanding a Financial
Institution's failure to enter into a contract as required by
subsection (i) above with a Retirement Investor who does not have an
Existing Contract, this exemption will apply to the receipt of
compensation by the Financial Institution, or any Adviser, Affiliate or
Related Entity thereof, as a result of the Adviser's or Financial
Institution's investment advice to such Retirement Investor regarding
an IRA or non-ERISA Plan, provided:
(A) The Adviser making the recommendation does not receive
compensation, directly or indirectly, that is reasonably attributable
to the Retirement Investor's purchase, holding, exchange or sale of the
investment;
(B) The Financial Institution's policies and procedures prohibit
the Financial Institution and its Affiliates and Related Entities from
providing compensation to their Advisers in lieu of compensation
described in subsection (iii)(A), including, but not limited to bonuses
or prizes or other incentives, and the Financial Institution reasonably
monitors such policies and procedures;
(C) The Adviser and Financial Institution comply with the Impartial
Conduct Standards set forth in Section II(c), the policies and
procedures requirements of Section II(d) (except for the requirement of
a warranty with respect to those policies and procedures), the web
disclosure requirements of Section III(b) and, as applicable, the
conditions of Sections IV(b)(3)-(6) (Conditions for Advisers and
Financial Institution that restrict recommendations, in whole or part,
to Proprietary Products or to investments that generate Third Party
Payments) with respect to the recommendation; and
(D) The Financial Institution's failure to enter into the contract
is not part of an effort, attempt, agreement, arrangement or
understanding by the Adviser or the Financial Institution designed to
avoid compliance with the exemption or enforcement of its conditions,
including the contractual conditions set forth in subsections (i) and
(ii).
(2) Notice. The Financial Institution maintains an electronic copy
of the Retirement Investor's contract on its Web site that is
accessible by the Retirement Investor.
(b) Fiduciary. The Financial Institution affirmatively states in
writing that it and the Adviser(s) act as fiduciaries under ERISA or
the Code, or both, with respect to any investment advice provided by
the Financial Institution or the Adviser subject to the contract or, in
the case of an ERISA plan, with respect to any investment
recommendations regarding the Plan or participant or beneficiary
account.
(c) Impartial Conduct Standards. The Financial Institution
affirmatively states that it and its Advisers will adhere to the
following standards and, they in fact, comply with the standards:
(1) When providing investment advice to the Retirement Investor,
the Financial Institution and the Adviser(s) provide investment advice
that is, at the time of the recommendation, in the Best Interest of the
Retirement Investor. As further defined in Section VIII(d), such advice
reflects the care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent person acting in a like
capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims, based on the
investment objectives, risk tolerance, financial circumstances, and
needs of the Retirement Investor, without regard to the financial or
other interests of the Adviser, Financial Institution or any Affiliate,
Related Entity, or other party;
(2) The recommended transaction will not cause the Financial
Institution, Adviser or their Affiliates or Related Entities to
receive, directly or indirectly, compensation for their services that
is in excess of reasonable compensation within the meaning of ERISA
section 408(b)(2) and Code section 4975(d)(2).
(3) Statements by the Financial Institution and its Advisers to the
Retirement Investor about the recommended transaction, fees and
compensation, Material Conflicts of Interest, and any other matters
relevant to a Retirement Investor's investment decisions, will not be
materially misleading at the time they are made.
(d) Warranties. The Financial Institution affirmatively warrants,
and in fact complies with, the following:
(1) The Financial Institution has adopted and will comply with
written policies and procedures reasonably and prudently designed to
ensure that its Advisers adhere to the Impartial Conduct Standards set
forth in Section II(c);
(2) In formulating its policies and procedures, the Financial
Institution has specifically identified and documented its Material
Conflicts of Interest; adopted measures reasonably and prudently
designed to prevent Material Conflicts of Interest from causing
violations of the Impartial Conduct Standards set forth in Section
II(c); and designated a person or persons, identified by name, title or
function, responsible for addressing Material Conflicts of Interest and
monitoring their Advisers' adherence to the Impartial Conduct
Standards.
(3) The Financial Institution's policies and procedures require
that neither the Financial Institution nor (to the best of its
knowledge) any Affiliate or Related Entity use or rely upon quotas,
appraisals, performance or personnel actions, bonuses, contests,
special awards, differential compensation or other actions or
incentives that are intended or would reasonably be expected to cause
Advisers to make recommendations that are not in the Best Interest of
the Retirement Investor. Notwithstanding the foregoing, this Section
II(d)(3) does not prevent the Financial Institution, its Affiliates or
Related Entities from providing Advisers with differential compensation
(whether in type or amount, and including, but not limited to,
commissions) based on investment decisions by Plans, participant or
beneficiary accounts, or IRAs, to the extent that the Financial
Institution's policies and procedures and incentive practices, when
viewed as a whole, are reasonably and prudently designed to avoid a
misalignment of the interests of Advisers with the interests of the
Retirement Investors they serve as fiduciaries (such compensation
practices can include differential compensation based on neutral
factors tied to the differences in the services delivered to the
Retirement Investor
[[Page 21078]]
with respect to the different types of investments, as opposed to the
differences in the amounts of Third Party Payments the Financial
Institution receives in connection with particular investment
recommendations).
(e) Disclosures. In the Best Interest Contract or in a separate
single written disclosure provided to the Retirement Investor with the
contract, or, with respect to ERISA plans, in another single written
disclosure provided to the Plan prior to or at the same time as the
execution of the recommended transaction, the Financial Institution
clearly and prominently:
(1) States the Best Interest standard of care owed by the Adviser
and Financial Institution to the Retirement Investor; informs the
Retirement Investor of the services provided by the Financial
Institution and the Adviser; and describes how the Retirement Investor
will pay for services, directly or through Third Party Payments. If,
for example, the Retirement Investor will pay through commissions or
other forms of transaction-based payments, the contract or writing must
clearly disclose that fact;
(2) Describes Material Conflicts of Interest; discloses any fees or
charges the Financial Institution, its Affiliates, or the Adviser
imposes upon the Retirement Investor or the Retirement Investor's
account; and states the types of compensation that the Financial
Institution, its Affiliates, and the Adviser expect to receive from
third parties in connection with investments recommended to Retirement
Investors;
(3) Informs the Retirement Investor that the Investor has the right
to obtain copies of the Financial Institution's written description of
its policies and procedures adopted in accordance with Section II(d),
as well as the specific disclosure of costs, fees, and compensation,
including Third Party Payments, regarding recommended transactions, as
set forth in Section III(a), below, described in dollar amounts,
percentages, formulas, or other means reasonably designed to present
materially accurate disclosure of their scope, magnitude, and nature in
sufficient detail to permit the Retirement Investor to make an informed
judgment about the costs of the transaction and about the significance
and severity of the Material Conflicts of Interest, and describes how
the Retirement Investor can get the information, free of charge;
provided that if the Retirement Investor's request is made prior to the
transaction, the information must be provided prior to the transaction,
and if the request is made after the transaction, the information must
be provided within 30 business days after the request;
(4) Includes a link to the Financial Institution's Web site as
required by Section III(b), and informs the Retirement Investor that:
(i) Model contract disclosures updated as necessary on a quarterly
basis are maintained on the Web site, and (ii) the Financial
Institution's written description of its policies and procedures
adopted in accordance with Section II(d) are available free of charge
on the Web site;
(5) Discloses to the Retirement Investor whether the Financial
Institution offers Proprietary Products or receives Third Party
Payments with respect to any recommended investments; and to the extent
the Financial Institution or Adviser limits investment recommendations,
in whole or part, to Proprietary Products or investments that generate
Third Party Payments, notifies the Retirement Investor of the
limitations placed on the universe of investments that the Adviser may
offer for purchase, sale, exchange, or holding by the Retirement
Investor. The notice is insufficient if it merely states that the
Financial Institution or Adviser ``may'' limit investment
recommendations based on whether the investments are Proprietary
Products or generate Third Party Payments, without specific disclosure
of the extent to which recommendations are, in fact, limited on that
basis;
(6) Provides contact information (telephone and email) for a
representative of the Financial Institution that the Retirement
Investor can use to contact the Financial Institution with any concerns
about the advice or service they have received; and, if applicable, a
statement explaining that the Retirement Investor can research the
Financial Institution and its Advisers using FINRA's BrokerCheck
database or the Investment Adviser Registration Depository (IARD), or
other database maintained by a governmental agency or instrumentality,
or self-regulatory organization; and
(7) Describes whether or not the Adviser and Financial Institution
will monitor the Retirement Investor's investments and alert the
Retirement Investor to any recommended change to those investments,
and, if so monitoring, the frequency with which the monitoring will
occur and the reasons for which the Retirement Investor will be
alerted.
(8) The Financial Institution will not fail to satisfy this Section
II(e), or violate a contractual provision based thereon, solely because
it, acting in good faith and with reasonable diligence, makes an error
or omission in disclosing the required information, provided the
Financial Institution discloses the correct information as soon as
practicable, but not later than 30 days after the date on which it
discovers or reasonably should have discovered the error or omission.
To the extent compliance with this Section II(e) requires Advisers and
Financial Institutions to obtain information from entities that are not
closely affiliated with them, they may rely in good faith on
information and assurances from the other entities, as long as they do
not know that the materials are incomplete or inaccurate. This good
faith reliance applies unless the entity providing the information to
the Adviser and Financial Institution is (1) a person directly or
indirectly through one or more intermediaries, controlling, controlled
by, or under common control with the Adviser or Financial Institution;
or (2) any officer, director, employee, agent, registered
representative, relative (as defined in ERISA section 3(15)), member of
family (as defined in Code section 4975(e)(6)) of, or partner in, the
Adviser or Financial Institution.
(f) Ineligible Contractual Provisions. Relief is not available
under the exemption if a Financial Institution's contract contains the
following:
(1) Exculpatory provisions disclaiming or otherwise limiting
liability of the Adviser or Financial Institution for a violation of
the contract's terms;
(2) Except as provided in paragraph (f)(4) of this Section, a
provision under which the Plan, IRA or Retirement Investor waives or
qualifies its right to bring or participate in a class action or other
representative action in court in a dispute with the Adviser or
Financial Institution, or in an individual or class claim agrees to an
amount representing liquidated damages for breach of the contract;
provided that, the parties may knowingly agree to waive the Retirement
Investor's right to obtain punitive damages or rescission of
recommended transactions to the extent such a waiver is permissible
under applicable state or federal law; or
(3) Agreements to arbitrate or mediate individual claims in venues
that are distant or that otherwise unreasonably limit the ability of
the Retirement Investors to assert the claims safeguarded by this
exemption.
(4) In the event that the provision on pre-dispute arbitration
agreements for class or representative claims in paragraph (f)(2) of
this Section is ruled invalid by a court of competent jurisdiction,
this provision shall not be
[[Page 21079]]
a condition of this exemption with respect to contracts subject to the
court's jurisdiction unless and until the court's decision is reversed,
but all other terms of the exemption shall remain in effect.
(g) ERISA plans. Section II(a) does not apply to recommendations to
Retirement Investors regarding investments in Plans that are covered by
Title I of ERISA. For such investment advice, relief under the
exemption is conditioned upon the Adviser and Financial Institution
complying with certain provisions of Section II, as follows:
(1) Prior to or at the same time as the execution of the
recommended transaction, the Financial Institution provides the
Retirement Investor with a written statement of the Financial
Institution's and its Advisers' fiduciary status, in accordance with
Section II(b).
(2) The Financial Institution and the Adviser comply with the
Impartial Conduct Standards of Section II(c).
(3) The Financial Institution adopts policies and procedures
incorporating the requirements and prohibitions set forth in Section
II(d)(1)-(3), and the Financial Institution and Adviser comply with
those requirements and prohibitions.
(4) The Financial Institution provides the disclosures required by
Section II(e).
(5) The Financial Institution and Adviser do not in any contract,
instrument, or communication: purport to disclaim any responsibility or
liability for any responsibility, obligation, or duty under Title I of
ERISA to the extent the disclaimer would be prohibited by ERISA section
410; purport to waive or qualify the right of the Retirement Investor
to bring or participate in a class action or other representative
action in court in a dispute with the Adviser or Financial Institution,
or require arbitration or mediation of individual claims in locations
that are distant or that otherwise unreasonably limit the ability of
the Retirement Investors to assert the claims safeguarded by this
exemption.
(h) Level Fee Fiduciaries. Sections II(a), (d), (e), (f), (g) III
and V do not apply to recommendations by Financial Institutions and
Advisers that are Level Fee Fiduciaries. For such investment advice,
relief under the exemption is conditioned upon the Adviser and
Financial Institution complying with certain other provisions of
Section II, as follows:
(1) Prior to or at the same time as the execution of the
recommended transaction, the Financial Institution provides the
Retirement Investor with a written statement of the Financial
Institution's and its Advisers' fiduciary status, in accordance with
Section II(b).
(2) The Financial Institution and Adviser comply with the Impartial
Conduct Standards of Section II(c).
(3)(i) In the case of a recommendation to roll over from an ERISA
Plan to an IRA, the Financial Institution documents the specific reason
or reasons why the recommendation was considered to be in the Best
Interest of the Retirement Investor. This documentation must include
consideration of the Retirement Investor's alternatives to a rollover,
including leaving the money in his or her current employer's Plan, if
permitted, and must take into account the fees and expenses associated
with both the Plan and the IRA; whether the employer pays for some or
all of the plan's administrative expenses; and the different levels of
services and investments available under each option; and (ii) in the
case of a recommendation to rollover from another IRA or to switch from
a commission-based account to a level fee arrangement, the Level Fee
Fiduciary documents the reasons that the arrangement is considered to
be in the Best Interest of the Retirement Investor, including,
specifically, the services that will be provided for the fee.
(i) Bank Networking Arrangements. An Adviser who is a bank
employee, and a Financial Institution that is a bank or similar
financial institution supervised by the United States or a state, or a
savings association (as defined in section 3(b)(1) of the Federal
Deposit Insurance Act (12 U.S.C. 1813(b)(1)), may receive compensation
pursuant to a Bank Networking Arrangement as defined in Section
VIII(c), in connection with their provision of investment advice to a
Retirement Investor, provided the investment advice adheres to the
Impartial Conduct Standards set forth in Section II(c). The remaining
conditions of the exemption do not apply.
Section III--Web and Transaction-Based Disclosure
The Financial Institution must satisfy the following conditions
with respect to an investment recommendation, to be covered by this
exemption:
(a) Transaction Disclosure. The Financial Institution provides the
Retirement Investor, prior to or at the same time as the execution of
the recommended investment in an investment product, the following
disclosure, clearly and prominently, in a single written document,
that:
(1) States the Best Interest standard of care owed by the Adviser
and Financial Institution to the Retirement Investor; and describes any
Material Conflicts of Interest;
(2) Informs the Retirement Investor that the Retirement Investor
has the right to obtain copies of the Financial Institution's written
description of its policies and procedures adopted in accordance with
Section II(d), as well as specific disclosure of costs, fees and other
compensation including Third Party Payments regarding recommended
transactions. The costs, fees, and other compensation may be described
in dollar amounts, percentages, formulas, or other means reasonably
designed to present materially accurate disclosure of their scope,
magnitude, and nature in sufficient detail to permit the Retirement
Investor to make an informed judgment about the costs of the
transaction and about the significance and severity of the Material
Conflicts of Interest. The information required under this Section must
be provided to the Retirement Investor prior to the transaction, if
requested prior to the transaction, and, if the request is made after
the transaction, the information must be provided within 30 business
days after the request; and
(3) Includes a link to the Financial Institution's Web site as
required by Section III(b) and informs the Retirement Investor that:
(i) Model contract disclosures or other model notices, updated as
necessary on a quarterly basis, are maintained on the Web site, and
(ii) the Financial Institution's written description of its policies
and procedures as required under Section III(b)(1)(iv) are available
free of charge on the Web site.
(4) These disclosures do not have to be repeated for subsequent
recommendations by the Adviser and Financial Institution of the same
investment product within one year of the provision of the contract
disclosure in Section II(e) or a previous disclosure pursuant to this
Section III(a), unless there are material changes in the subject of the
disclosure.
(b) Web Disclosure. For relief to be available under the exemption
for any investment recommendation, the conditions of Section III(b)
must be satisfied.
(1) The Financial Institution maintains a Web site, freely
accessible to the public and updated no less than quarterly, which
contains:
(i) A discussion of the Financial Institution's business model and
the Material Conflicts of Interest associated with that business model;
(ii) A schedule of typical account or contract fees and service
charges;
[[Page 21080]]
(iii) A model contract or other model notice of the contractual
terms (if applicable) and required disclosures described in Section
II(b)-(e), which are reviewed for accuracy no less frequently than
quarterly and updated within 30 days if necessary;
(iv) A written description of the Financial Institution's policies
and procedures that accurately describes or summarizes key components
of the policies and procedures relating to conflict-mitigation and
incentive practices in a manner that permits Retirement Investors to
make an informed judgment about the stringency of the Financial
Institution's protections against conflicts of interest;
(v) To the extent applicable, a list of all product manufacturers
and other parties with whom the Financial Institution maintains
arrangements that provide Third Party Payments to either the Adviser or
the Financial Institution with respect to specific investment products
or classes of investments recommended to Retirement Investors; a
description of the arrangements, including a statement on whether and
how these arrangements impact Adviser compensation, and a statement on
any benefits the Financial Institution provides to the product
manufacturers or other parties in exchange for the Third Party
Payments;
(vi) Disclosure of the Financial Institution's compensation and
incentive arrangements with Advisers including, if applicable, any
incentives (including both cash and non-cash compensation or awards) to
Advisers for recommending particular product manufacturers, investments
or categories of investments to Retirement Investors, or for Advisers
to move to the Financial Institution from another firm or to stay at
the Financial Institution, and a full and fair description of any
payout or compensation grids, but not including information that is
specific to any individual Adviser's compensation or compensation
arrangement.
(vii) The Web site may describe the above arrangements with product
manufacturers, Advisers, and others by reference to dollar amounts,
percentages, formulas, or other means reasonably calculated to present
a materially accurate description of the arrangements. Similarly, the
Web site may group disclosures based on reasonably-defined categories
of investment products or classes, product manufacturers, Advisers, and
arrangements, and it may disclose reasonable ranges of values, rather
than specific values, as appropriate. But, however constructed, the Web
site must fairly disclose the scope, magnitude, and nature of the
compensation arrangements and Material Conflicts of Interest in
sufficient detail to permit visitors to the Web site to make an
informed judgment about the significance of the compensation practices
and Material Conflicts of Interest with respect to transactions
recommended by the Financial Institution and its Advisers.
(2) To the extent the information required by this Section is
provided in other disclosures which are made public, including those
required by the SEC and/or the Department such as a Form ADV, Part II,
the Financial Institution may satisfy this Section III(b) by posting
such disclosures to its Web site with an explanation that the
information can be found in the disclosures and a link to where it can
be found.
(3) The Financial Institution is not required to disclose
information pursuant to this Section III(b) if such disclosure is
otherwise prohibited by law.
(4) In addition to providing the written description of the
Financial Institution's policies and procedures on its Web site, as
required under Section III(b)(1)(iv), Financial Institutions must
provide their complete policies and procedures adopted pursuant to
Section II(d) to the Department upon request.
(5) In the event that a Financial Institution determines to group
disclosures as described in subsection (1)(vii), it must retain the
data and documentation supporting the group disclosure during the time
that it is applicable to the disclosure on the Web site, and for six
years after that, and make the data and documentation available to the
Department within 90 days of the Department's request.
(c)(1) The Financial Institution will not fail to satisfy the
conditions in this Section III solely because it, acting in good faith
and with reasonable diligence, makes an error or omission in disclosing
the required information, or if the Web site is temporarily
inaccessible, provided that, (i) in the case of an error or omission on
the Web site, the Financial Institution discloses the correct
information as soon as practicable, but not later than seven (7) days
after the date on which it discovers or reasonably should have
discovered the error or omission, and (ii) in the case of an error or
omission with respect to the transaction disclosure, the Financial
Institution discloses the correct information as soon as practicable,
but not later than 30 days after the date on which it discovers or
reasonably should have discovered the error or omission.
(2) To the extent compliance with the Section III disclosures
requires Advisers and Financial Institutions to obtain information from
entities that are not closely affiliated with them, they may rely in
good faith on information and assurances from the other entities, as
long as they do not know that the materials are incomplete or
inaccurate. This good faith reliance applies unless the entity
providing the information to the Adviser and Financial Institution is
(i) a person directly or indirectly through one or more intermediaries,
controlling, controlled by, or under common control with the Adviser or
Financial Institution; or (ii) any officer, director, employee, agent,
registered representative, relative (as defined in ERISA section
3(15)), member of family (as defined in Code section 4975(e)(6)) of, or
partner in, the Adviser or Financial Institution.
(3) The good faith provisions of this Section apply to the
requirement that the Financial Institution retain the data and
documentation supporting the group disclosure during the time that it
is applicable to the disclosure on the Web site and provide it to the
Department upon request, as set forth in subsection (b)(1)(vii) and
(b)(5) above. In addition, if such records are lost or destroyed, due
to circumstances beyond the control of the Financial Institution, then
no prohibited transaction will be considered to have occurred solely on
the basis of the unavailability of those records; and no party, other
than the Financial Institution responsible for complying with
subsection (b)(1)(vii) and (b)(5) will be subject to the civil penalty
that may be assessed under ERISA section 502(i) or the taxes imposed by
Code section 4975(a) and (b), if applicable, if the records are not
maintained or provided to the Department within the required
timeframes.
Section IV--Proprietary Products and Third Party Payments
(a) General. A Financial Institution that at the time of the
transaction restricts Advisers' investment recommendations, in whole or
part, to Proprietary Products or to investments that generate Third
Party Payments, may rely on this exemption provided all the applicable
conditions of the exemption are satisfied.
(b) Satisfaction of the Best Interest standard. A Financial
Institution that limits Advisers' investment recommendations, in whole
or part, based on whether the investments are Proprietary Products or
generate Third Party Payments, and an Adviser making recommendations
subject to such
[[Page 21081]]
limitations, shall be deemed to satisfy the Best Interest standard of
Section VIII(d) if:
(1) Prior to or at the same time as the execution of the
recommended transaction, the Retirement Investor is clearly and
prominently informed in writing that the Financial Institution offers
Proprietary Products or receives Third Party Payments with respect to
the purchase, sale, exchange, or holding of recommended investments;
and the Retirement Investor is informed in writing of the limitations
placed on the universe of investments that the Adviser may recommend to
the Retirement Investor. The notice is insufficient if it merely states
that the Financial Institution or Adviser ``may'' limit investment
recommendations based on whether the investments are Proprietary
Products or generate Third Party Payments, without specific disclosure
of the extent to which recommendations are, in fact, limited on that
basis;
(2) Prior to or at the same time as the execution of the
recommended transaction, the Retirement Investor is fully and fairly
informed in writing of any Material Conflicts of Interest that the
Financial Institution or Adviser have with respect to the recommended
transaction, and the Adviser and Financial Institution comply with the
disclosure requirements set forth in Section III above (providing for
web and transaction-based disclosure of costs, fees, compensation, and
Material Conflicts of Interest);
(3) The Financial Institution documents in writing its limitations
on the universe of recommended investments; documents in writing the
Material Conflicts of Interest associated with any contract, agreement,
or arrangement providing for its receipt of Third Party Payments or
associated with the sale or promotion of Proprietary Products;
documents in writing any services it will provide to Retirement
Investors in exchange for Third Party Payments, as well as any services
or consideration it will furnish to any other party, including the
payor, in exchange for the Third Party Payments; reasonably concludes
that the limitations on the universe of recommended investments and
Material Conflicts of Interest will not cause the Financial Institution
or its Advisers to receive compensation in excess of reasonable
compensation for Retirement Investors as set forth in Section II(c)(2);
reasonably determines, after consideration of the policies and
procedures established pursuant to Section II(d), that these
limitations and Material Conflicts of Interest will not cause the
Financial Institution or its Advisers to recommend imprudent
investments; and documents in writing the bases for its conclusions;
(4) The Financial Institution adopts, monitors, implements, and
adheres to policies and procedures and incentive practices that meet
the terms of Section II(d)(1) and (2); and, in accordance with Section
II(d)(3), neither the Financial Institution nor (to the best of its
knowledge) any Affiliate or Related Entity uses or relies upon quotas,
appraisals, performance or personnel actions, bonuses, contests,
special awards, differential compensation or other actions or
incentives that are intended or would reasonably be expected to cause
the Adviser to make imprudent investment recommendations, to
subordinate the interests of the Retirement Investor to the Adviser's
own interests, or to make recommendations based on the Adviser's
considerations of factors or interests other than the investment
objectives, risk tolerance, financial circumstances, and needs of the
Retirement Investor;
(5) At the time of the recommendation, the amount of compensation
and other consideration reasonably anticipated to be paid, directly or
indirectly, to the Adviser, Financial Institution, or their Affiliates
or Related Entities for their services in connection with the
recommended transaction is not in excess of reasonable compensation
within the meaning of ERISA section 408(b)(2) and Code section
4975(d)(2); and
(6) The Adviser's recommendation reflects the care, skill,
prudence, and diligence under the circumstances then prevailing that a
prudent person acting in a like capacity and familiar with such matters
would use in the conduct of an enterprise of a like character and with
like aims, based on the investment objectives, risk tolerance,
financial circumstances, and needs of the Retirement Investor; and the
Adviser's recommendation is not based on the financial or other
interests of the Adviser or on the Adviser's consideration of any
factors or interests other than the investment objectives, risk
tolerance, financial circumstances, and needs of the Retirement
Investor.
Section V--Disclosure to the Department and Recordkeeping
This Section establishes record retention and disclosure conditions
that a Financial Institution must satisfy for the exemption to be
available for compensation received in connection with recommended
transactions.
(a) EBSA Disclosure. Before receiving compensation in reliance on
the exemption in Section I, the Financial Institution notifies the
Department of its intention to rely on this exemption. The notice will
remain in effect until revoked in writing by the Financial Institution.
The notice need not identify any Plan or IRA. The notice must be
provided by email to e-BICE@dol.gov.
(b) Recordkeeping. The Financial Institution maintains for a period
of six (6) years, in a manner that is reasonably accessible for
examination, the records necessary to enable the persons described in
paragraph (c) of this Section to determine whether the conditions of
this exemption have been met with respect to a transaction, except
that:
(1) If such records are lost or destroyed, due to circumstances
beyond the control of the Financial Institution, then no prohibited
transaction will be considered to have occurred solely on the basis of
the unavailability of those records; and
(2) No party, other than the Financial Institution responsible for
complying with this paragraph (c), will be subject to the civil penalty
that may be assessed under ERISA section 502(i) or the taxes imposed by
Code section 4975(a) and (b), if applicable, if the records are not
maintained or are not available for examination as required by
paragraph (c), below.
(c)(1) Except as provided in paragraph (c)(2) of this Section or
precluded by 12 U.S.C. 484, and notwithstanding any provisions of ERISA
section 504(a)(2) and (b), the records referred to in paragraph (b) of
this Section are reasonably available at their customary location for
examination during normal business hours by:
(i) Any authorized employee or representative of the Department or
the Internal Revenue Service;
(ii) Any fiduciary of a Plan that engaged in an investment
transaction pursuant to this exemption, or any authorized employee or
representative of such fiduciary;
(iii) Any contributing employer and any employee organization whose
members are covered by a Plan described in paragraph (c)(1)(ii), or any
authorized employee or representative of these entities; or
(iv) Any participant or beneficiary of a Plan described in
paragraph (c)(1)(ii), IRA owner, or the authorized representative of
such participant, beneficiary or owner; and
(2) None of the persons described in paragraph (c)(1)(ii)-(iv) of
this Section are authorized to examine records regarding a recommended
transaction involving another Retirement Investor, privileged trade
secrets or privileged
[[Page 21082]]
commercial or financial information of the Financial Institution, or
information identifying other individuals.
(3) Should the Financial Institution refuse to disclose information
on the basis that the information is exempt from disclosure, the
Financial Institution must, by the close of the thirtieth (30th) day
following the request, provide a written notice advising the requestor
of the reasons for the refusal and that the Department may request such
information.
(4) Failure to maintain the required records necessary to determine
whether the conditions of this exemption have been met will result in
the loss of the exemption only for the transaction or transactions for
which records are missing or have not been maintained. It does not
affect the relief for other transactions.
Section VI--Exemption for Purchases and Sales, Including Insurance and
Annuity Contracts
(a) In general. In addition to prohibiting fiduciaries from
receiving compensation from third parties and compensation that varies
based on their investment advice, ERISA and the Internal Revenue Code
prohibit the purchase by a Plan, participant or beneficiary account, or
IRA of an investment product, including insurance or annuity product
from an insurance company that is a service provider to the Plan or
IRA. This exemption permits a Plan, participant or beneficiary account,
or IRA to engage in a purchase or sale with a Financial Institution
that is a service provider or other party in interest or disqualified
person to the Plan or IRA. This exemption is provided because
investment transactions often involve prohibited purchases and sales
involving entities that have a pre-existing party in interest
relationship to the Plan or IRA.
(b) Covered transactions. The restrictions of ERISA section
406(a)(1)(A) and (D), and the sanctions imposed by Code section 4975(a)
and (b), by reason of Code section 4975(c)(1)(A) and (D), shall not
apply to the purchase of an investment product by a Plan, participant
or beneficiary account, or IRA, from a Financial Institution that is a
party in interest or disqualified person.
(c) The following conditions are applicable to this exemption:
(1) The transaction is effected by the Financial Institution in the
ordinary course of its business;
(2) The compensation, direct or indirect, for any services rendered
by the Financial Institution and its Affiliates and Related Entities is
not in excess of reasonable compensation within the meaning of ERISA
section 408(b)(2) and Code section 4975(d)(2); and
(3) The terms of the transaction are at least as favorable to the
Plan, participant or beneficiary account, or IRA as the terms generally
available in an arm's length transaction with an unrelated party.
(d) Exclusions, The exemption in this Section VI does not apply if:
(1) The Plan is covered by Title I of ERISA and (i) the Adviser,
Financial Institution or any Affiliate is the employer of employees
covered by the Plan, or (ii) the Adviser and Financial Institution is a
named fiduciary or plan administrator (as defined in ERISA section
3(16)(A)) with respect to the Plan, or an affiliate thereof, that was
selected to provide advice to the plan by a fiduciary who is not
Independent.
(2) The compensation is received as a result of a Principal
Transaction;
(3) The compensation is received as a result of investment advice
to a Retirement Investor generated solely by an interactive Web site in
which computer software-based models or applications provide investment
advice based on personal information each investor supplies through the
Web site without any personal interaction or advice from an individual
Adviser (i.e., ``robo-advice'') unless the robo-advice provider is a
Level Fee Fiduciary that complies with the conditions applicable to
Level Fee Fiduciaries; or
(4) The Adviser has or exercises any discretionary authority or
discretionary control with respect to the recommended transaction.
Section VII--Exemption for Pre-Existing Transactions
(a) In general. ERISA and the Internal Revenue Code prohibit
Advisers, Financial Institutions and their Affiliates and Related
Entities from receiving compensation that varies based on their
investment advice. Similarly, fiduciary advisers are prohibited from
receiving compensation from third parties in connection with their
advice. Some Advisers and Financial Institutions did not consider
themselves fiduciaries within the meaning of 29 CFR 2510-3.21 before
the applicability date of the amendment to 29 CFR 2510-3.21 (the
Applicability Date). Other Advisers and Financial Institutions entered
into transactions involving Plans, participant or beneficiary accounts,
or IRAs before the Applicability Date, in accordance with the terms of
a prohibited transaction exemption that has since been amended. This
exemption permits Advisers, Financial Institutions, and their
Affiliates and Related Entities, to receive compensation, such as 12b-1
fees, in connection with a Plan's, participant or beneficiary account's
or IRA's purchase, sale, exchange, or holding of securities or other
investment property that was acquired prior to the Applicability Date,
as described and limited below.
(b) Covered transaction. Subject to the applicable conditions
described below, the restrictions of ERISA section 406(a)(1)(A),
406(a)(1)(D), and 406(b) and the sanctions imposed by Code section
4975(a) and (b), by reason of Code section 4975(c)(1)(A), (D), (E) and
(F), shall not apply to the receipt of compensation by an Adviser,
Financial Institution, and any Affiliate and Related Entity, as a
result of investment advice (including advice to hold) provided to a
Plan, participant or beneficiary or IRA owner in connection with the
purchase, holding, sale, or exchange of securities or other investment
property (i) that was acquired before the Applicability Date, or (ii)
that was acquired pursuant to a recommendation to continue to adhere to
a systematic purchase program established before the Applicability
Date. This Exemption for Pre-Existing Transactions is conditioned on
the following:
(1) The compensation is received pursuant to an agreement,
arrangement or understanding that was entered into prior to the
Applicability Date and that has not expired or come up for renewal
post-Applicability Date;
(2) The purchase, exchange, holding or sale of the securities or
other investment property was not otherwise a non-exempt prohibited
transaction pursuant to ERISA section 406 and Code section 4975 on the
date it occurred;
(3) The compensation is not received in connection with the Plan's,
participant or beneficiary account's or IRA's investment of additional
amounts in the previously acquired investment vehicle; except that for
avoidance of doubt, the exemption does apply to a recommendation to
exchange investments within a mutual fund family or variable annuity
contract) pursuant to an exchange privilege or rebalancing program that
was established before the Applicability Date, provided that the
recommendation does not result in the Adviser and Financial
Institution, or their Affiliates or Related Entities, receiving more
compensation (either as a fixed dollar amount or a percentage of
assets) than they were entitled to receive prior to the Applicability
Date;
[[Page 21083]]
(4) The amount of the compensation paid, directly or indirectly, to
the Adviser, Financial Institution, or their Affiliates or Related
Entities in connection with the transaction is not in excess of
reasonable compensation within the meaning of ERISA section 408(b)(2)
and Code section 4975(d)(2); and
(5) Any investment recommendations made after the Applicability
Date by the Financial Institution or Adviser with respect to the
securities or other investment property reflect the care, skill,
prudence, and diligence under the circumstances then prevailing that a
prudent person acting in a like capacity and familiar with such matters
would use in the conduct of an enterprise of a like character and with
like aims, based on the investment objectives, risk tolerance,
financial circumstances, and needs of the Retirement Investor, and are
made without regard to the financial or other interests of the Adviser,
Financial Institution or any Affiliate, Related Entity, or other party.
Section VIII--Definitions
For purposes of these exemptions:
(a) ``Adviser'' means an individual who:
(1) Is a fiduciary of the Plan or IRA solely 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, agent, or registered
representative of a Financial Institution; and
(3) Satisfies the federal and state regulatory and licensing
requirements of insurance, banking, and securities laws with respect to
the covered transaction, as applicable.
(b) ``Affiliate'' of an Adviser or Financial Institution means--
(1) Any person directly or indirectly through one or more
intermediaries, controlling, controlled by, or under common control
with the Adviser or Financial Institution. For this purpose,
``control'' means the power to exercise a controlling influence over
the management or policies of a person other than an individual;
(2) Any officer, director, partner, employee, or relative (as
defined in ERISA section 3(15)), of the Adviser or Financial
Institution; and
(3) Any corporation or partnership of which the Adviser or
Financial Institution is an officer, director, or partner.
(c) A ``Bank Networking Arrangement'' is an arrangement for the
referral of retail non-deposit investment products that satisfies
applicable federal banking, securities and insurance regulations, under
which employees of a bank refer bank customers to an unaffiliated
investment adviser registered under the Investment Advisers Act of 1940
or under the laws of the state in which the adviser maintains its
principal office and place of business, insurance company qualified to
do business under the laws of a state, or broker or dealer registered
under the Securities Exchange Act of 1934, as amended. For purposes of
this definition, a ``bank'' is a bank or similar financial institution
supervised by the United States or a state, or a savings association
(as defined in section 3(b)(1) of the Federal Deposit Insurance Act (12
U.S.C. 1813(b)(1)),
(d) Investment advice is in the ``Best Interest'' of the Retirement
Investor when the Adviser and Financial Institution providing the
advice act with the care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent person acting in a like
capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims, based on the
investment objectives, risk tolerance, financial circumstances, and
needs of the Retirement Investor, without regard to the financial or
other interests of the Adviser, Financial Institution or any Affiliate,
Related Entity, or other party. Financial Institutions that limit
investment recommendations, in whole or part, based on whether the
investments are Proprietary Products or generate Third Party Payments,
and Advisers making recommendations subject to such limitations are
deemed to satisfy the Best Interest standard when they comply with the
conditions of Section IV(b).
(e) ``Financial Institution'' means an entity that employs the
Adviser or otherwise retains such individual as an independent
contractor, agent or registered representative and that is:
(1) Registered as an investment adviser under the Investment
Advisers Act of 1940 (15 U.S.C. 80b-1 et seq.) or under the laws of the
state in which the adviser maintains its principal office and place of
business;
(2) A bank or similar financial institution supervised by the
United States or a state, or a savings association (as defined in
section 3(b)(1) of the Federal Deposit Insurance Act (12 U.S.C.
1813(b)(1));
(3) An insurance company qualified to do business under the laws of
a state, provided that such insurance company:
(i) Has obtained a Certificate of Authority from the insurance
commissioner of its domiciliary state which has neither been revoked
nor suspended,
(ii) Has undergone and shall continue to undergo an examination by
an Independent certified public accountant for its last completed
taxable year or has undergone a financial examination (within the
meaning of the law of its domiciliary state) by the state's insurance
commissioner within the preceding 5 years, and
(iii) Is domiciled in a state whose law requires that actuarial
review of reserves be conducted annually by an Independent firm of
actuaries and reported to the appropriate regulatory authority;
(4) A broker or dealer registered under the Securities Exchange Act
of 1934 (15 U.S.C. 78a et seq.); or
(5) An entity that is described in the definition of Financial
Institution in an individual exemption granted by the Department under
ERISA section 408(a) and Code section 4975(c), after the date of this
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 this class exemption.
(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.
(g) ``Individual Retirement Account'' or ``IRA'' means any account
or annuity described in Code section 4975(e)(1)(B) through (F),
including, for example, an individual retirement account described in
section 408(a) of the Code and a health savings account described in
section 223(d) of the Code.
(h) A Financial Institution and Adviser are ``Level Fee
Fiduciaries'' if the only fee received by the Financial Institution,
the Adviser and any
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Affiliate in connection with advisory or investment management services
to the Plan or IRA assets is a Level Fee that is disclosed in advance
to the Retirement Investor. A ``Level Fee'' is a fee or compensation
that is provided on the basis of a fixed percentage of the value of the
assets or a set fee that does not vary with the particular investment
recommended, rather than a commission or other transaction-based fee.
(i) A ``Material Conflict of Interest'' exists when an Adviser or
Financial Institution has a financial interest that a reasonable person
would conclude could affect the exercise of its best judgment as a
fiduciary in rendering advice to a Retirement Investor.
(j) ``Plan'' means any employee benefit plan described in section
3(3) of the Act and any plan described in section 4975(e)(1)(A) of the
Code.
(k) A ``Principal Transaction'' means a purchase or sale of an
investment product if an Adviser or Financial Institution is purchasing
from or selling to a Plan, participant or beneficiary account, or IRA
on behalf of the Financial Institution's own account or the account of
a person directly or indirectly, through one or more intermediaries,
controlling, controlled by, or under common control with the Financial
Institution. For purposes of this definition, a Principal Transaction
does not include the sale of an insurance or annuity contract, a mutual
fund transaction, or a Riskless Principal Transaction as defined in
Section VIII(p) below.
(l) ``Proprietary Product'' means a product that is managed, issued
or sponsored by the Financial Institution or any of its Affiliates.
(m) ``Related Entity'' means any entity other than an Affiliate in
which the Adviser or Financial Institution has an interest which may
affect the exercise of its best judgment as a fiduciary.
(n) A ``Retail Fiduciary'' means a fiduciary of a Plan or IRA that
is not described in section (c)(1)(i) of the Regulation (29 CFR 2510.3-
21(c)(1)(i)).
(o) ``Retirement Investor'' means--
(1) A participant or beneficiary of a Plan subject to Title I of
ERISA or described in section 4975(e)(1)(A) of the Code, with authority
to direct the investment of assets in his or her Plan account or to
take a distribution,
(2) The beneficial owner of an IRA acting on behalf of the IRA, or
(3) A Retail Fiduciary with respect to a Plan subject to Title I of
ERISA or described in section 4975(e)(1)(A) of the Code or IRA.
(p) A ``Riskless Principal Transaction'' is a transaction in which
a Financial Institution, after having received an order from a
Retirement Investor to buy or sell an investment product, purchases or
sells the same investment product for the Financial Institution's own
account to offset the contemporaneous transaction with the Retirement
Investor.
(q) ``Third-Party Payments'' include sales charges when not paid
directly by the Plan, participant or beneficiary account, or IRA; gross
dealer concessions; revenue sharing payments; 12b-1 fees; distribution,
solicitation or referral fees; volume-based fees; fees for seminars and
educational programs; and any other compensation, consideration or
financial benefit provided to the Financial Institution or an Affiliate
or Related Entity by a third party as a result of a transaction
involving a Plan, participant or beneficiary account, or IRA.
Section IX--Transition Period for Exemption
(a) In general. ERISA and the Internal Revenue Code prohibit
fiduciary advisers to Plans and IRAs from receiving compensation that
varies based on their investment advice. Similarly, fiduciary advisers
are prohibited from receiving compensation from third parties in
connection with their advice. This transition period provides relief
from the restrictions of ERISA section 406(a)(1)(D), and 406(b) and the
sanctions imposed by Code section 4975(a) and (b) by reason of Code
section 4975(c)(1)(D), (E), and (F) for the period from April 10, 2017,
to January 1, 2018 (the Transition Period) for Advisers, Financial
Institutions, and their Affiliates and Related Entities, to receive
such otherwise prohibited compensation subject to the conditions
described in Section IX(d).
(b) Covered transactions. This provision permits Advisers,
Financial Institutions, and their Affiliates and Related Entities to
receive compensation as a result of their 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, during the Transition Period.
(c) Exclusions. This provision does not apply if:
(1) The Plan is covered by Title I of ERISA, and (i) the Adviser,
Financial Institution or any Affiliate is the employer of employees
covered by the Plan, or (ii) the Adviser or Financial Institution is a
named fiduciary or plan administrator (as defined in ERISA section
3(16)(A)) with respect to the Plan, or an Affiliate thereof, that was
selected to provide advice to the Plan by a fiduciary who is not
Independent;
(2) The compensation is received as a result of a Principal
Transaction;
(3) The compensation is received as a result of investment advice
to a Retirement Investor generated solely by an interactive Web site in
which computer software-based models or applications provide investment
advice based on personal information each investor supplies through the
Web site without any personal interaction or advice from an individual
Adviser (i.e., ``robo-advice''); or
(4) The Adviser has or exercises any discretionary authority or
discretionary control with respect to the recommended transaction.
(d) Conditions. The provision is subject to the following
conditions:
(1) The Financial Institution and Adviser adhere to the following
standards:
(i) When providing investment advice to the Retirement Investor,
the Financial Institution and the Adviser(s) provide investment advice
that is, at the time of the recommendation, in the Best Interest of the
Retirement Investor. As further defined in Section VIII(d), such advice
reflects the care, skill, prudence, and diligence under the
circumstances then prevailing that a prudent person acting in a like
capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims, based on the
investment objectives, risk tolerance, financial circumstances, and
needs of the Retirement Investor, without regard to the financial or
other interests of the Adviser, Financial Institution or any Affiliate,
Related Entity, or other party;
(ii) The recommended transaction does not cause the Financial
Institution, Adviser or their Affiliates or Related Entities to
receive, directly or indirectly, compensation for their services that
is in excess of reasonable compensation within the meaning of ERISA
section 408(b)(2) and Code section 4975(d)(2).
(iii) Statements by the Financial Institution and its Advisers to
the Retirement Investor about the recommended transaction, fees and
compensation, Material Conflicts of Interest, and any other matters
relevant to a Retirement Investor's investment decisions, are not
materially misleading at the time they are made.
(2) Disclosures. The Financial Institution provides to the
Retirement Investor, prior to or at the same time as, the execution of
the recommended transaction, a single written disclosure, which may
cover multiple transactions or all transactions occurring within the
Transition Period, that clearly and prominently:
[[Page 21085]]
(i) Affirmatively states that the Financial Institution and the
Adviser(s) act as fiduciaries under ERISA or the Code, or both, with
respect to the recommendation;
(ii) Sets forth the standards in paragraph (d)(1) of this Section
and affirmatively states that it and the Adviser(s) adhered to such
standards in recommending the transaction;
(iii) Describes the Financial Institution's Material Conflicts of
Interest; and
(iv) Discloses to the Retirement Investor whether the Financial
Institution offers Proprietary Products or receives Third Party
Payments with respect to any investment recommendations; and to the
extent the Financial Institution or Adviser limits investment
recommendations, in whole or part, to Proprietary Products or
investments that generate Third Party Payments, notifies the Retirement
Investor of the limitations placed on the universe of investment
recommendations. The notice is insufficient if it merely states that
the Financial Institution or Adviser ``may'' limit investment
recommendations based on whether the investments are Proprietary
Products or generate Third Party Payments, without specific disclosure
of the extent to which recommendations are, in fact, limited on that
basis.
(v) The disclosure may be provided in person, electronically or by
mail. It does not have to be repeated for any subsequent
recommendations during the Transition Period.
(vi) The Financial Institution will not fail to satisfy this
Section IX(d)(2) solely because it, acting in good faith and with
reasonable diligence, makes an error or omission in disclosing the
required information, provided the Financial Institution discloses the
correct information as soon as practicable, but not later than 30 days
after the date on which it discovers or reasonably should have
discovered the error or omission. To the extent compliance with this
Section IX(d)(2) requires Financial Institutions to obtain information
from entities that are not closely affiliated with them, they may rely
in good faith on information and assurances from the other entities, as
long as they do not know, or unless they should have known, that the
materials are incomplete or inaccurate. This good faith reliance
applies unless the entity providing the information to the Adviser and
Financial Institution is (1) a person directly or indirectly through
one or more intermediaries, controlling, controlled by, or under common
control with the Adviser or Financial Institution; or (2) any officer,
director, employee, agent, registered representative, relative (as
defined in ERISA section 3(15)), member of family (as defined in Code
section 4975(e)(6)) of, or partner in, the Adviser or Financial
Institution.
(3) The Financial Institution designates a person or persons,
identified by name, title or function, responsible for addressing
Material Conflicts of Interest and monitoring Advisers' adherence to
the Impartial Conduct Standards; and
(4) The Financial Institution complies with the recordkeeping
requirements of Section V(b) and (c).
Signed at Washington, DC, this 1st day of April, 2016.
Phyllis C. Borzi,
Assistant Secretary, Employee Benefits Security Administration,
Department of Labor.
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[FR Doc. 2016-07925 Filed 4-6-16; 11:15 am]
BILLING CODE 4510-29-C