Update: As of April 4, 2017, the Department of Labor finalized a 60-day delay to the effective date of the new fiduciary rule (the Rule). The Rule was originally set to take effect April 10, 2017, but as a result of the delay, will become effective June 9, 2017.  The delay is in response to President Trump’s directive that the DOL review and report on how the Rule may negatively impact consumers. 

In April 2016, the U.S. Department of Labor (DOL) released its long-anticipated final rule (the Rule) that expands the “investment advice fiduciary” definition under the Employee Retirement Income Security Act of 1974 (ERISA). The Rule, which will take effect April 2017, targets financial advisors who provide investment advice to retirement plans. Though the Rule focuses on advisors, it will also impact the compliance obligations of employers who sponsor a 401(k) plan.

Expanded Fiduciary Standard

Created in an effort to provide greater protection to investors, the Rule extends fiduciary status to certain advisors who were previously not considered fiduciaries. What, then, is the significance of fiduciary status?

Under ERISA, a fiduciary is one who is required to act in the best interest of the client. In other words, an advisor who is held to a fiduciary standard is prohibited from acting in his or her own self-interest.

There are two general categories of advisors: Brokers and Registered Investment Advisors (RIAs). Currently, a Broker is not a fiduciary. Instead, Brokers are required to provide advice that is merely considered suitable for the client, and they are traditionally compensated by commission they receive from recommended investments. Alternatively, RIAs are presently held to a fiduciary standard, which means an RIA is already required by law to act in the best interest of his or her client. An RIA is not typically paid on commission; rather, an RIA is paid a flat-fee or a fee based on the percentage of plan assets under his or her management.

Come April 2017, Brokers who provide investment advice will be considered fiduciaries – just as RIAs are today. This shift will force Brokers to adopt a different business model, not only in the way they are compensated (fiduciaries are generally prohibited from receiving commission as it is viewed as a conflict of interest), but also in the level of advice they provide. Brokers will be held to a heightened standard and, consequently, face greater liability.

Impact on Employers

 The Rule does not require employers to take any specific action in response to the expanded fiduciary status of Brokers. However, because an employer-sponsor of a 401(k) plan exercises discretion and control, it is the employer’s obligation to understand their relationship with the plan’s financial advisor. Failure to verify that an advisor is working in the plan’s best interest could expose the employer to liability.

Employers who work with a Broker should anticipate a change in their relationship following implementation of the Rule. This change will likely result in higher costs, additional paperwork, and increased oversight. Thus, employers should take this opportunity to evaluate their current relationship with their advisor and determine whether a new arrangement may better serve the plan.

Best Practices

Employers can undertake several proactive measures today to minimize any negative outcomes when the Rule takes effect.

  • Determine whether your advisor is acting as a Broker or as an RIA. Brokers will be significantly impacted by the Rule, as will the plan. On the other hand, RIAs will largely continue to operate as usual, with little-to-no disruption to the plan.
  • Ask your Broker whether they will continue to receive commission. Remember, as a fiduciary, commission payments are prohibited unless a specific exemption applies. One such exemption is where the client enters into a Best Interest Contract Exemption (BICE) with the advisor. The BICE allows the advisor to continue to receive commission so long as several disclosures are made. A BICE may be more advantageous to the advisor than to the plan, so employers should carefully review such an arrangement if proposed.
  • Ask about increased costs that the plan may face as a result of the Broker’s new fiduciary status. If the Broker will no longer receive commission, he or she will likely switch to a flat-fee or percentage-fee arrangement. The reasonableness of all new fees will need to be evaluated.
  • Assess the Broker’s future as a financial advisor to your 401(k) plan. The complexities of the Rule will require Brokers to make costly changes to their business operations. Some Brokers may have the resources to face these changes, whereas others may need to join a larger firm or leave the 401(k) business altogether.
  • Consider finding a new advisor for your plan. RIAs have always operated as a fiduciary, which means the advice they provide has been – and will continue to be – in the plan’s best interest. There is plenty of time before the rule takes effect to explore working with an RIA.

For more information about how the Rule affects you and your 401(k) plan, contact erik@filice.com from Filice Retirement Services. Since 2001, the Registered Investment Advisors at Filice have provided financial and investment advice to 401(k) plans and are proud to be recognized as Accredited Investment Fiduciaries.