Complying with the DOL's New "IRA" Fiduciary Definition
and the New Prohibited Transaction Exemption

On April 7, 2016, the Department of Labor (DOL) issued over 800 pages of new rules and guidance for IRAs and pension plans. The DOL changed the definition of who is a fiduciary for purposes of applying the prohibited transaction rules found in the tax and labor provisions of ERISA. These new rules are effective as of April 10, 2017. There are interim rules applying for April 10, 2017 to January 1, 2018.

If your institution is an IRA custodian which limits the IRA investments to the institution’s own time deposits and savings accounts, then your institution will be able to comply with the DOL’s new fiduciary and prohibited transaction rules with minimal difficulty.Some of the DOL’s new IRA rules (e.g. rollovers) are going to cause minor aggravations, but they should not substantially change your institution’s liability risks or your current business model. Next month we will write another article discussing the impact of these new rules for those institutions allowing IRA funds to be invested in non-deposit investments.

IRA plan agreement forms and related disclosure statements will need to be revised to set forth the new definition of fiduciary and those provisions needed to comply with the best interest contract exemption. An IRA amendment will need to be furnished. The deadline to furnish such an amendment is January 1, 2018. Many institutions will choose to furnish their comprehensive IRA amendment by January 31, 2017 and maybe sooner.

The DOL had a number of goals when it decided to change the definition of fiduciary and also various prohibited transaction exemptions. The DOL had concluded that some IRA custodians and trustees were engaged in benefiting themselves to too large a degree rather than the IRA owner or the plan participant. Transactions are to be made which are in the best interest of the individual.

The general tax rule is that an IRA custodian/trustee is not allowed to receive compensation from a third party as a result of its serving as the IRA custodian. The receipt of such compensation is generally a prohibited transaction unless an exemption would apply to the situation. For example, there is a exemption which allows the IRA custodian to limit the IRA investments it offers to its own savings and time deposits. There is an exemption allowing an IRA custodian to charge reasonable fees for“ ancillary” services.

The DOL has created a new exemption called the Best Interest Contract Exemption (BICE). It is designed to allow an IRA custodian to provide investment advice in the best interest of the individual, while allowing the IRA custodian to receive certain types of compensation and fees from the individual and third parties. An IRA custodian qualifies to use this new exemption only if certain conditions as discussed below are met. These rules are long and complicated with many special rules.

In general, the IRA custodian (and its employees) must enter into an enforceable contract with the IRA owner wherein both the IRA custodian and any adviser must acknowledge being a fiduciary.This enforceable contract must be signed prior to or at the same time the first recommended investment is made. The contract may be signed in writing or electronically. Such contract cannot include provisions limiting the liability of the IRA custodian or its employees, requiring forfeiture of class action lawsuits, mandatory use of arbitration and liquidated damage provisions. These contract provisions may be set forth in standard account opening forms or documents.

The IRA custodian must affirmatively state in the contract that it has established and that it and its advisers will follow the Impartial Conduct Standards as discussed below and comply with various disclosure and record keeping requirements. The requirements differ for IRA owners with existing contracts and those without an existing contract.

IRA owners without an existing contract must:

1. Provide investment advice that at the time of the recommendation is in the IRA owner’s best interest;
2. Such advice must reflect the care, skill, prudence,and diligence that a prudent person acting in a like capacity and familiar with the current situation would use after considering the investment objectives, risk tolerance, financial circumstances, and needs of the individual without regard to the needs or desires of any other person or party, including the IRA custodian or any adviser of the IRA custodian.
3. The recommended transaction will not cause the payment of any unreasonable compensation to the IRA custodian, any affiliate or any adviser for services.

Statements must not be materially misleading at the time they are made regarding the recommended transaction, fees and compensation, material conflicts of interest and any other information relevant to making the investment decision.

The IRS custodian is entitled to receive fees or compensation on account of this BICE only if it has complied with the record keeping requirements and it previously notified the DOL of its intention to use the BICE.

IRA owners without an existing contract must meet the same requirements, but they are not required to sign the new and revised contract. Such owners will be deemed to have consented to the new contract terms if they are furnished an amendment and given the opportunity to terminate the contract. They have 30 days to terminate the contract. If the contract is not so terminated, the amended or revised contract becomes effective.

The old five part test to be a fiduciary has been repealed and replaced with a new test. Now an “invest-met advice fiduciary” is a person (or entity) who renders investment advice for a fee or other compensation with respect to an IRA or a pension plan. A person can render investment advice in three different ways:

1. Acknowledge or represent that he or she is acting as a fiduciary when he or she provides the investment advice;
2. Provides the investment advice to the individual after considering the particular investment needs of the individual pursuant to a joint agreement or under-standing (may be written or verbal) ; or
3. Provides the investment advice to a specific individual after considering the advisability of a particular investment or management decision with respect to the IRA assets.

Investment advice will be found to exist if the IRA custodian furnishes one of the following four communications:

1. A “recommendation” related to any distribution, rollover or transfer from an IRA or plan including consideration of whether it should be done, in what amount and to what destination.
2. A “recommendation” how to invest the IRA assets after decision has been made to take a distribution, or do a rollover or transfer.
3. A “recommendation” how to invest the IRA assets in general - what assets should be acquired, retained, disposed, exchanged, etc .
4. A “recommendation” how to invest/manage the IRA assets, considering recommendations on investment policies/strategies, portfolio composition, the possible selection of hiring a third person to provide investment advice, management services or to have brokerage versus advisory arrangements.

An IRA custodian which does not make an investment recommendation should not have concerns arising from the investment advice rules. That is, the individual makes his or her investment decision without the receipt of any investment advice recommendation.

The final regulation defines a “recommendation” as a communication that based on its content and context would reasonably be understood that the recipient should act or refrain from taking a particular course of action. The more the communication is individually tailored the more likely it will viewed as a recommendation. Furnishing investment educational materials is not a “recommendation.”

There are at least two situations where not all of the standard conditions must be met to qualify for the Best Interest Contract exemption. In these two situations fewer and different conditions must be met. Many IRA custodians will want to use or both of these special situations.

The first situation is where a bank employee who is an adviser or the bank itself may receive compensation pursuant to a Bank Networking Arrangement related to providing investment advice to an IRA owner as long as the advice complies with the Impartial Conduct Standards. The IRA custodian must affirmatively state that it and its advisers will in actuality follow the following standards:

1. Provide investment advice that at the time of the recommendation is in the IRA owner’s best interest;
2. Such advice reflects the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with the current situation would use after considering the investment objectives, risk tolerance, financial circumstances, and needs of the individual without regard to the needs or desires of any other person or party, including the IRA custodian or any adviser of the IRA custodian.
3. The recommended transaction will not cause the payment of any unreasonable compensation to the IRA custodian, any affiliate or any adviser for services.
4. Statements must not be materially misleading at the time they are made regarding the recommended transaction, fees and compensation, material conflicts of interest and any other information relevant to making the investment decision.

The second situation is where the IRA custodian qualifies as a level fee fiduciary. A“level fee” is a fee or compensation associated with advisory or investment management services that is provided on the basis of a fixed percentage of the value of the IRA assets or a set fee that does not vary based on a particular investment. A fee or compensation which is transaction-based is not a level fee. This “level fee” must be disclosed in advance of any transaction.

The IRA custodian and its advisers must also comply with the Impartial Conduct Rules as discussed above.

The IRA custodian must acknowledge or represent that he or she is acting as a fiduciary prior to when he or she provides the investment advice. If there is a recommendation by the IRA custodian that the individual should roll over funds from an ERISA plan to an IRA, then the IRA custodian must document the specific reason reasons why the recommendation was considered to be in the best interest of the individual. An explanation is to be made as to what options existed for the individual the possibility of leaving the funds in the plan, discussion of the amount of fees and other costs and who pays them under the plan versus the IRA and discussion of the investment option available under the plan versus the IRA.

If there is a recommendation by the IRA custodian that the individual should roll over funds from one IRA to another IRA or to switch from a commission-based fee account to a level fee arrangement, the IRA custodian must document in writing why the new arrangement is in the best interest of the individual, including specifying the services that will be provided for the fee.

The reason for these less strict conditions when the IRA custodian is a level fee fiduciary is that neither the IRA custodian or is adviser would be exercising discretion in a manner that varies fee income or compensation. However, the DOL sees a conflict of interest when the IRA custodian or its adviser recommends a plan participant roll money out of a plan into a fee based IRA account that will have on-going fees, level or not. .

The DOL issued its new fiduciary rules and conflict of interest rules on April 8, 2016. These rules are complex.It will take time to determine the many ramifications of these new rules. These rules go into effect on April 10,2017. If the Republicans would retain control of the House of Representatives and the U.S. Senate and Donald Trump would be elected President, it might well be these new DOL rules would never go into effect as they would be repealed.