The definition of a fiduciary under ERISA has fluctuated in the past decade.
In 2016, the Department of Labor (DOL) issued a rule redefining the meaning of the term fiduciary as it applies to investment professionals by replacing the five-part test originally specified in the Employee Retirement Income Security Act of 1974 (ERISA). In 2018, before the rule was fully in effect, a federal court vacated it on the grounds that the DOL had overstepped its authority in writing the rule. Consequently, DOL reinstated the five-part test to determine whether a retirement investment advisor is acting as a fiduciary under ERISA and the Internal Revenue Code (IRC). Meanwhile, the focus had shifted to the Securities and Exchange Commission (SEC), which adopted final rules that impose a best interest standard of conduct on broker-dealers (Reg BI) effective September 2019.
On June 29, 2020, DOL proposed a best interest standard in a new proposed class exemption that would be designed to align with SEC Reg BI. Specifically, the DOL proposal would reinstate the five-part test originally specified in ERISA for investment advisor fiduciary status and add impartial conduct standards.
What’s the status right now?
If DOL’s new proposed class exemption is finalized, then the existing five-part test originally spelled out in ERISA still applies to determine whether a retirement investment advisor is acting as an ERISA fiduciary under ERISA, and investment advice fiduciaries also may be required to follow impartial conduct standards.
Note: The prohibited transaction provisions of ERISA and IRC prohibit investment advice fiduciaries from self-dealing—i.e., causing themselves or related entities to receive additional compensation from transactions involving plans and individual retirement accounts (IRAs)—unless an exemption applies. The proposed prohibited transaction exemption would be a new exemption; it would not change or remove other prohibited transaction exemptions currently in place.
Who is an ERISA fiduciary?
The easiest fiduciary to identify is the one named in the benefit plan document. ERISA requires every benefit plan to designate at least one fiduciary in the plan document. The named fiduciary is often identified by job title or position, not by the person’s name, so the plan document doesn’t need to be modified when a new person rotates into or out of that position.
Fiduciary status can also be triggered by a person’s actions or responsibilities. A person is a fiduciary under ERISA Section 3(21) to the extent that that person:
- Has or exercises any discretionary (decision-making) authority or control over the management or administration of the plan
- Has any discretionary authority over the management or disposition of the plan’s assets, or
- Gives investment advice regarding plan assets for direct or indirect compensation or has the authority to do so.
Many people involved with a benefit plan, such as plan administrators, trustees, directors and investment managers, are fiduciaries due to having discretionary authority or control over management of the plan or its assets as outlined in the first two numbered items above. Some investment professionals do not have this discretionary authority. However, the third numbered item above gives fiduciary status to financial professionals who give investment advice regarding plan assets for compensation. This means there are two ways financial professionals could become fiduciaries. They could have discretionary authority over the management or disposition of the plan’s assets, or they could give investment advice regarding plan assets. Either one triggers fiduciary status.
What type of investment advice makes someone a fiduciary?
ERISA established a five-part test to determine whether someone is giving investment advice in a fiduciary capacity.
Financial professionals giving advice regarding plan assets are considered fiduciaries if they do all five of these things:
- Render advice to a plan as to the value of securities or other property or make recommendations as to the advisability of investing in, purchasing or selling other property
- on a regular basis
- pursuant to a mutual understanding
- that such advice will be the primary basis for investment decisions and
- that the advice is individualized to the plan.
Unfortunately, it is not always clear whether all five of the above tests are met. For example, the meanings of “regular basis” and “primary basis” have been subject to debate. Any of the five tests could be open to interpretation. Attorneys specializing in ERISA law can provide guidance when there is a question of interpretation.
If a person is indeed an ERISA fiduciary, what are their obligations?
The key duties of a fiduciary as defined by ERISA are as follows:
Duty of Loyalty
All ERISA fiduciaries must act solely in the interest of plan participants (members) and plan beneficiaries, with the exclusive purpose of providing benefits and paying reasonable plan expenses. This fulfills the duty of loyalty and is sometimes called the “exclusive benefit rule.”
Duty to Act Prudently
ERISA requires fiduciaries to 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. In other words, the duty to act prudently doesn’t mean “do the best you can.” Instead, it’s closer to “come to a decision using a similar method an ethical expert in the same field would use in similar circumstances.” Acting as a prudent expert is a very high standard to meet. This is a compelling reason to educate fiduciaries on their responsibilities and how to fulfill them.
Duty to Diversify Plan Assets
If the fiduciary is involved in any way with directing or managing plan assets or hiring a service provider that manages plan assets, the fiduciary must make sure the plan assets are diversified in a way that minimizes the risk of large losses, unless it is clearly prudent not to do so. For a defined contribution plan like a 401(k) that lets participants choose their own investments from a menu, the options available on the menu must be diverse.
Duty to Act in Accordance with Plan Documents
In addition to loyalty, prudence and diversification of plan assets, ERISA fiduciaries must act according to the terms of the benefit plan documents. As long as plan document provisions are not contrary to ERISA, the plan provisions must always be followed.
These are the specific duties fiduciaries take on. Failing to carry them out faithfully can directly expose fiduciaries and the benefit plan to penalties and lawsuits.
What did DOL propose about rollover investment advice?
DOL stated that amounts accrued in an employee benefit plan often comprise the largest sum of money a worker has at retirement. The decision to roll over ERISA-covered retirement plan assets to an IRA is potentially a very consequential financial decision for a plan participant. Investment advice fiduciaries relying on the new proposed exemption would have to provide advice in the best interest of retirement investors. The required “impartial conduct standards” would include a best interest standard, a reasonable compensation standard, a best execution standard and a requirement to make no materially misleading statements about recommendations.
If finalized, the best interest standard would be satisfied if the advice is:
- Prudent: The 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.
- Loyal: The advice does not place the financial or other interests of the investment professional, financial institution or any affiliate, related entity or other party ahead of the interests of the retirement investor nor does it subordinate the retirement investor’s interests to their own.
If finalized, the proposed exemption would permit investment advice fiduciaries to receive compensation as a result of providing fiduciary investment advice to roll over a participant’s account balance from an employee benefit plan to an IRA.
- Investment advice fiduciaries who recommend such a rollover would need to document the specific reasons that the recommendation is in the best interest of the plan participant.
- The new proposed class exemption would also permit investment advice fiduciaries to enter into “principal transactions” (in which they could sell or purchase certain investments from their own inventories) to or from plans and IRAs.
Conflicts of Interest Policies and Procedures
The proposed exemption would require financial institutions to establish, maintain, and enforce policies and procedures prudently designed to:
- Ensure compliance with the impartial conduct standards in connection with covered fiduciary investment advice
- Avoid misalignment of the interests of the financial institution and investment professional with the interests of retirement investors.
Investment advice rules have had a long history filled with ups, downs and mixed support. Support of this new proposal is mixed as well. If finalized, DOL intends to align fiduciary duties with respect to employee benefit plans under ERISA with the fiduciary duties of registered investment advisers under securities laws (Reg BI).
Note: SEC Reg BI requires a broker-dealer, when making a recommendation, to act in a retail customer’s best interest and not place its own interests ahead of the customer’s interests. It applies to any recommendations about securities transactions or investment strategies, including recommendations to roll over assets from a workplace retirement plan account to an IRA and recommendations to take a plan distribution. Reg BI is not a fiduciary standard.
The regulatory alignment idea is that, regardless of whether retail investors choose broker-dealers or investment advisors, investors will be entitled to advice that is in their best interest.
Those opposed to the proposal—often those focused on consumer protection—question alignment altogether and say DOL is deferring to SEC, but insurance regulation is different than securities regulation. Some have suggested that DOL should provide additional alternative conditions for insurance transactions such as annuities. Also, those opposed say DOL should wait on final rulemaking until Reg BI effectiveness can be determined.
DOL and supporters of the proposal say it would benefit retirement investors by allowing a wide range of investment advice in service to ERISA plans and IRA investors and ensure that retirement investors receiving advice under the exemption get advice that is in their best interest.
The rule-making process is moving quickly. Public comments on this proposal closed in August, and a public hearing was held in September. DOL has declined requests to reopen the comment period or hold another hearing. It is unclear if and when the proposal will be finalized.
At the time of this blog post, the definition and responsibilities of benefit plan fiduciaries stand as originally spelled out in ERISA. While sometimes difficult to interpret, these rules must be followed. Fiduciaries can be held personally liable for breaching fiduciary duties. The benefit plan itself is also exposed to liability and penalties when fiduciaries fail to fulfill their duties. If finalized, investment advice fiduciaries also may be required to follow impartial conduct standards.
Educating fiduciaries on their duties and how to fulfill them is always wise. Consulting legal counsel experienced in ERISA law is recommended when questions arise.
Learn more and watch for updates from the International Foundation on our Fiduciary Investment Advice webpage.
- Improving Investment Advice for Workers & Retirees [DOL]
- Retirement Plan Fiduciary Responsibilities [IRS]
- FAQs on Regulation Best Interest [SEC]
- DOL Take Three: ‘Five-Part Test’ Officially Reinstated; Proposed Investment Advice Exemption [Morgan Lewis]
- DOL Proposes a New Fiduciary Investment Advice Exemption [Groom]
Jenny Lucey, CEBS
Manager, Reference/Research Services at the International Foundation
Developed by International Foundation of Employee Benefit Plans staff. This does not constitute legal advice. Consult your plan professionals for legal advice.
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