DOL Proposed Best Interest Contract Exemption

8/20/2019 DOL Proposed Best Interest Contract Exemption

1/30

21960 Federal Register / Vol. 80, No. 75/ Monday, April 20, 2015/ Proposed Rules

(e) Internal Revenue Code. Section4975(e)(3) of the Code containsprovisions parallel to section 3(21)(A) ofthe Act which define the term‘‘fiduciary’’ for purposes of theprohibited transaction provisions inCode section 4975. Effective December31, 1978, section 102 of theReorganization Plan No. 4 of 1978, 5

U.S.C. App. 237 transferred theauthority of the Secretary of theTreasury to promulgate regulations ofthe type published herein to theSecretary of Labor. All references hereinto section 3(21)(A) of the Act should beread to include reference to the parallelprovisions of section 4975(e)(3) of theCode. Furthermore, the provisions ofthis section shall apply for purposes ofthe application of Code section 4975with respect to any plan described inCode section 4975(e)(1).

(f) Definitions. For purposes of thissection—

(1) ‘‘Recommendation’’ means acommunication that, based on itscontent, context, and presentation,would reasonably be viewed as asuggestion that the advice recipientengage in or refrain from taking aparticular course of action.

(2)(i) ‘‘Plan’’ means any employee benefit plan described in section 3(3) ofthe Act and any plan described insection 4975(e)(1)(A) of the Code, and

(ii) ‘‘IRA’’ means any trust, account orannuity described in Code section4975(e)(1)(B) through (F), including, forexample, an individual retirementaccount described in section 408(a) of

the Code and a health savings accountdescribed in section 223(d) of the Code.

(3) ‘‘Plan participant’’ means for aplan described in section 3(3) of the Act,a person described in section 3(7) of theAct.

(4) ‘‘IRA owner’’ means with respectto an IRA either the person who is theowner of the IRA or the person forwhose benefit the IRA was established.

(5) ‘‘Plan fiduciary’’ means a persondescribed in section (3)(21) of the Actand 4975(e)(3) of the Code.

(6) ‘‘Fee or other compensation, director indirect’’ for purposes of this section

and section 3(21)(A)(ii) of the Act,means any fee or compensation for theadvice received by the person (or by anaffiliate) from any source and any fee orcompensation incident to thetransaction in which the investmentadvice has been rendered or will berendered. The term fee or othercompensation includes, for example,

brokerage fees, mutual fund andinsurance sales commissions.

(7) ‘‘Affiliate’’ includes: Any persondirectly or indirectly, through one ormore intermediaries, controlling,

controlled by, or under common controlwith such person; any officer, director,partner, employee or relative (as definedin section 3(15) of the Act) of suchperson; and any corporation orpartnership of which such person is anofficer, director or partner.

(8) ‘‘Control’’ for purposes ofparagraph (f)(7) of this section means

the power to exercise a controllinginfluence over the management orpolicies of a person other than anindividual.

Signed at Washington, DC, this 14th day ofApril, 2015.

Phyllis C. Borzi,

Assistant Secretary, Employee BenefitsSecurity Administration, Department ofLabor.

[FR Doc. 2015–08831 Filed 4–15–15; 11:15 am]

BILLING CODE 4510–29–P

DEPARTMENT OF LABOR

Employee Benefits SecurityAdministration

29 CFR Part 2550

[Application No. D–11712]

ZRIN 1210–ZA25

Proposed Best Interest ContractExemption

AGENCY: Employee Benefits SecurityAdministration (EBSA), U.S.Department of Labor.

ACTION: Notice of Proposed Class

Exemption.

SUMMARY: This document contains anotice of pendency before the U.S.Department of Labor of a proposedexemption from certain prohibitedtransactions provisions of the EmployeeRetirement Income Security Act of 1974(ERISA) and the Internal Revenue Code(the Code). The provisions at issuegenerally prohibit fiduciaries withrespect to employee benefit plans andindividual retirement accounts (IRAs)from engaging in self-dealing andreceiving compensation from third

parties in connection with transactionsinvolving the plans and IRAs. Theexemption proposed in this noticewould allow entities such as broker-dealers and insurance agents that arefiduciaries by reason of the provision ofinvestment advice to receive suchcompensation when plan participantsand beneficiaries, IRA owners, andcertain small plans purchase, hold orsell certain investment products inaccordance with the fiduciaries’ advice,under protective conditions to safeguardthe interests of the plans, participants

and beneficiaries, and IRA owners. Theproposed exemption would affectparticipants and beneficiaries of plans,IRA owners and fiduciaries with respectto such plans and IRAs.DATES: Comments: Written commentsconcerning the proposed classexemption must be received by theDepartment on or before July 6, 2015.

A pplicability: The Departmentproposes to make this exemptionavailable eight months after publicationof the final exemption in the FederalRegister. We request comment below onwhether the applicability date of certainconditions should be delayed.ADDRESSES: All written commentsconcerning the proposed classexemption should be sent to the Officeof Exemption Determinations by any ofthe following methods, identified byZRIN: 1210–ZA25:

Federal eRulemaking Portal: http:// www.regulations.gov at Docket ID

number: EBSA–2014–0016. Follow theinstructions for submitting comments.Email to: [email protected]. Fax to: (202) 693–8474.Mail: Office of Exemption

Determinations, Employee BenefitsSecurity Administration, (Attention: D–11712), U.S. Department of Labor, 200Constitution Avenue NW., Suite 400,Washington DC 20210.

Hand Delivery/Courier: Office ofExemption Determinations, EmployeeBenefits Security Administration,(Attention: D–11712), U.S. Departmentof Labor, 122 C St. NW., Suite 400,Washington DC 20001.

Instructions. All comments must bereceived by the end of the commentperiod. The comments received will beavailable for public inspection in thePublic Disclosure Room of theEmployee Benefits SecurityAdministration, U.S. Department ofLabor, Room N–1513, 200 ConstitutionAvenue NW., Washington, DC 20210.Comments will also be available onlineat www.regulations.gov, at Docket IDnumber: EBSA–2014–0016 andwww.dol.gov/ebsa, at no charge.

Warning: All comments will be madeavailable to the public. Do not includeany personally identifiable information(such as Social Security number, name,address, or other contact information) orconfidential business information thatyou do not want publicly disclosed. Allcomments may be posted on the Internetand can be retrieved by most Internetsearch engines.FOR FURTHER INFORMATION CONTACT:Karen E. Lloyd or Brian L. Shiker, Officeof Exemption Determinations, EmployeeBenefits Security Administration, U.S.Department of Labor (202) 693–8824(this is not a toll-free number).

VerDate Sep2014 20:05 Apr 17, 2015 Jkt 235001 PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 E:\FR\FM\20APP2.SGM 20APP2

http://www.regulations.gov/http://www.regulations.gov/mailto:[email protected]://www.regulations.gov/http://www.dol.gov/ebsamailto:[email protected]://www.dol.gov/ebsahttp://www.regulations.gov/http://www.regulations.gov/http://www.regulations.gov/


2/30

21961Federal Register / Vol. 80, No. 75/ Monday, April 20, 2015/ Proposed Rules

1Code section 4975(c)(2) authorizes the Secretaryof the Treasury to grant exemptions from theparallel prohibited transaction provisions of theCode. Reorganization Plan No. 4 of 1978 (5 U.S.C.app. at 214 (2000)) generally transferred theauthority of the Secretary of the Treasury to grantadministrative exemptions under Code section 4975to the Secretary of Labor. This proposed exemptionwould provide relief from the indicated prohibitedtransaction provisions of both ERISA and the Code.

2By using the term ‘‘adviser,’’ the Departmentdoes not intend to limit the exemption toinvestment advisers registered under theInvestment Advisers Act of 1940 or under state law.As explained herein, an adviser is an individualwho can be a representative of a registeredinvestment adviser, a bank or similar financialinstitution, an insurance company, or a broker-dealer.

SUPPLEMENTARY INFORMATION: TheDepartment is proposing this classexemption on its own motion, pursuantto ERISA section 408(a) and Codesection 4975(c)(2), and in accordancewith the procedures set forth in 29 CFRpart 2570 (76 FR 66637 (October 27,2011)).

Public Hearing: The Department plans

to hold an administrative hearing within30 days of the close of the commentperiod. The Department will ensureample opportunity for public comment

by reopening the record following thehearing and publication of the hearingtranscript. Specific informationregarding the date, location andsubmission of requests to testify will bepublished in a notice in the FederalRegister.

Executive Summary

Purpose of Regulatory Action

The Department is proposing this

exemption in connection with itsproposed regulation under ERISAsection 3(21)(A)(ii) and Code section4975(e)(3)(B) (Proposed Regulation),published elsewhere in this issue of theFederal Register. The ProposedRegulation would amend the definitionof a ‘‘fiduciary’’ under ERISA and theCode to specify when a person is afiduciary by reason of the provision ofinvestment advice for a fee or othercompensation regarding assets of a planor IRA. If adopted, the ProposedRegulation would replace an existingregulation dating to 1975. The Proposed

Regulation is intended to take intoaccount the advent of 401(k) plans andIRAs, the dramatic increase in rollovers,and other developments that havetransformed the retirement planlandscape and the associatedinvestment market over the four decadessince the existing regulation was issued.In light of the extensive changes inretirement investment practices andrelationships, the Proposed Regulationwould update existing rules todistinguish more appropriately betweenthe sorts of advice relationships thatshould be treated as fiduciary in nature

and those that should not.The exemption proposed in thisnotice (‘‘the Best Interest ContractExemption’’) was developed to promotethe provision of investment advice thatis in the best interest of retail investorssuch as plan participants and

beneficiaries, IRA owners, and smallplans. ERISA and the Code generallyprohibit fiduciaries from receivingpayments from third parties and fromacting on conflicts of interest, includingusing their authority to affect or increasetheir own compensation, in connection

with transactions involving a plan orIRA. Certain types of fees andcompensation common in the retailmarket, such as brokerage or insurancecommissions, 12b-1 fees and revenuesharing payments, fall within theseprohibitions when received byfiduciaries as a result of transactionsinvolving advice to the plan participants

and beneficiaries, IRA owners and smallplan sponsors. To facilitate continuedprovision of advice to such retailinvestors and under conditionsdesigned to safeguard the interests ofthese investors, the exemption wouldallow certain investment advicefiduciaries, including broker-dealersand insurance agents, to receive thesevarious forms of compensation that, inthe absence of an exemption, would not

be permitted under ERISA and theCode.

Rather than create a set of highlyprescriptive transaction-specific

exemptions, which has generally beenthe regulatory approach to date, theproposed exemption would flexiblyaccommodate a wide range of current

business practices, while minimizingthe harmful impact of conflicts ofinterest on the quality of advice. TheDepartment has sought to preserve

beneficial business models by taking astandards-based approach that will

broadly permit firms to continue to relyon common fee practices, as long asthey are willing to adhere to basicstandards aimed at ensuring that theiradvice is in the best interest of their

customers.ERISA section 408(a) specificallyauthorizes the Secretary of Labor togrant administrative exemptions fromERISA’s prohibited transactionprovisions.1 Regulations at 29 CFR2570.30 to 2570.52 describe theprocedures for applying for anadministrative exemption. Beforegranting an exemption, the Departmentmust find that the exemption isadministratively feasible, in theinterests of plans and their participantsand beneficiaries and IRA owners, andprotective of the rights of participantsand beneficiaries of plans and IRAowners. Interested parties are permittedto submit comments to the Departmentthrough July 6, 2015. The Departmentplans to hold an administrative hearing

within 30 days of the close of thecomment period.

Summary of the Major Provisions

The proposed exemption would applyto compensation received by investmentadvice fiduciaries—both individual‘‘advisers’’2 and the ‘‘financialinstitutions’’ that employ or otherwise

contract with them—and their affiliatesand related entities that is provided inconnection with the purchase, sale orholding of certain assets by plans andIRAs. In particular, the exemptionwould apply when prohibitedcompensation is received as a result ofadvice to retail ‘‘retirement investors’’including plan participants and

beneficiaries, IRA owners, and plansponsors (or their employees, officers ordirectors) of plans with fewer than 100participants making investmentdecisions on behalf of the plans andIRAs.

In order to protect the interests of theplan participants and beneficiaries, IRAowners, and small plan sponsors, theexemption would require the adviserand financial institution to contractuallyacknowledge fiduciary status, commit toadhere to basic standards of impartialconduct, warrant that they have adoptedpolicies and procedures reasonablydesigned to mitigate any harmful impactof conflicts of interest, and disclose

basic information on their conflicts ofinterest and on the cost of their advice.The adviser and firm must commit tofundamental obligations of fair dealingand fiduciary conduct—to give advicethat is in the customer’s best interest;avoid misleading statements; receive nomore than reasonable compensation;and comply with applicable federal andstate laws governing advice. Thisstandards-based approach aligns theadviser’s interests with those of the planor IRA customer, while leaving theadviser and employing firm theflexibility and discretion necessary todetermine how best to satisfy these

basic standards in light of the uniqueattributes of their business. All financialinstitutions relying on the exemptionwould be required to notify the

Department in advance of doing so.Finally, all financial institutions makinguse of the exemption would have tomaintain certain data, and make itavailable to the Department, to help



3/30


3ERISA section 404(a).4ERISA section 406. ERISA also prohibits certain

transactions between a plan and a ‘‘party ininterest.’’

5ERISA section 409; see also ERISA section 405.

evaluate the effectiveness of theexemption in safeguarding the interestsof the plan participants and

beneficiaries, IRA owners, and smallplans.

Executive Order 12866 and 13563Statement

Under Executive Orders 12866 and

13563, the Department must determinewhether a regulatory action is‘‘significant’’ and therefore subject tothe requirements of the Executive Orderand subject to review by the Office ofManagement and Budget (OMB).Executive Orders 13563 and 12866direct agencies to assess all costs and

benefits of available regulatoryalternatives and, if regulation isnecessary, to select regulatoryapproaches that maximize net benefits(including potential economic,environmental, public health and safetyeffects, distributive impacts, andequity). Executive Order 13563emphasizes the importance ofquantifying both costs and benefits, ofreducing costs, of harmonizing andstreamlining rules, and of promotingflexibility. It also requires federalagencies to develop a plan under whichthey will periodically review theirexisting significant regulations to makeregulatory programs more effective orless burdensome in achieving theirregulatory objectives.

Under Executive Order 12866,‘‘significant’’ regulatory actions aresubject to the requirements of theExecutive Order and review by the

Office of Management and Budget(OMB). Section 3(f) of Executive Order12866, defines a ‘‘significant regulatoryaction’’ as an action that is likely toresult in a rule (1) having an annualeffect on the economy of $100 millionor more, or adversely and materiallyaffecting a sector of the economy,productivity, competition, jobs, theenvironment, public health or safety, orState, local or tribal governments orcommunities (also referred to as an‘‘economically significant’’ regulatoryaction); (2) creating seriousinconsistency or otherwise interfering

with an action taken or planned byanother agency; (3) materially alteringthe budgetary impacts of entitlementgrants, user fees, or loan programs or therights and obligations of recipientsthereof; or (4) raising novel legal orpolicy issues arising out of legalmandates, the President’s priorities, orthe principles set forth in the ExecutiveOrder. Pursuant to the terms of theExecutive Order, OMB has determinedthat this action is ‘‘significant’’ withinthe meaning of Section 3(f)(4) of theExecutive Order. Accordingly, the

Department has undertaken anassessment of the costs and benefits ofthe proposed exemption, and OMB hasreviewed this regulatory action.

Background

Proposed Regulation Defining aFiduciary

As explained more fully in thepreamble to the Department’s ProposedRegulation under ERISA section3(21)(A)(ii) and Code section4975(e)(3)(B), also published in thisissue of the Federal Register, ERISA isa comprehensive statute designed toprotect the interests of plan participantsand beneficiaries, the integrity ofemployee benefit plans, and the securityof retirement, health, and other critical

benefits. The broad public interest inERISA-covered plans is reflected in itsimposition of fiduciary responsibilitieson parties engaging in important planactivities, as well as in the tax-favored

status of plan assets and investments.One of the chief ways in which ERISAprotects employee benefit plans is byrequiring that plan fiduciaries complywith fundamental obligations rooted inthe law of trusts. In particular, planfiduciaries must manage plan assetsprudently and with undivided loyalty tothe plans and their participants and

beneficiaries.3 In addition, they mustrefrain from engaging in ‘‘prohibitedtransactions,’’ which ERISA does notpermit because of the dangers posed bythe fiduciaries’ conflicts of interest withrespect to the transactions.4 When

fiduciaries violate ERISA’s fiduciaryduties or the prohibited transactionrules, they may be held personally liablefor the breach.5 In addition, violationsof the prohibited transaction rules aresubject to excise taxes under the Code.

The Code also has rules regardingfiduciary conduct with respect to tax-favored accounts that are not generallycovered by ERISA, such as IRAs.Although ERISA’s general fiduciaryobligations of prudence and loyalty donot govern the fiduciaries of IRAs, thesefiduciaries are subject to the prohibitedtransaction rules. In this context,fiduciaries engaging in the prohibited

transactions are subject to an excise taxenforced by the Internal RevenueService. Unlike participants in planscovered by Title I of ERISA, IRA ownersdo not have a statutory right to bringsuit against fiduciaries for violation ofthe prohibited transaction rules andfiduciaries are not personally liable to

IRA owners for the losses caused bytheir misconduct. Nor can the Secretaryof Labor bring suit to enforce theprohibited transactions rules on behalfof IRA owners. The exemption proposedherein, as well as the Proposed ClassExemption for Principal Transactions inCertain Debt Securities betweenInvestment Advice Fiduciaries and

Employee Benefit Plans and IRAs,published elsewhere in this issue of theFederal Register, would createcontractual obligations for fiduciaries toadhere to certain standards (theImpartial Conduct Standards) if theywant to take advantage of theexemption. IRA owners would have aright to enforce these new contractualrights.

Under the statutory framework, thedetermination of who is a ‘‘fiduciary’’ isof central importance. Many of ERISA’sand the Code’s protections, duties, andliabilities hinge on fiduciary status. In

relevant part, ERISA section 3(21)(A)and Code section 4975(e)(3) provide thata person is a fiduciary with respect toa plan or IRA to the extent he or she (i)exercises any discretionary authority ordiscretionary control with respect tomanagement of such plan or IRA, orexercises any authority or control withrespect to management or disposition ofits assets; (ii) renders investment advicefor a fee or other compensation, director indirect, with respect to any moneysor other property of such plan or IRA,or has any authority or responsibility todo so; or, (iii) has any discretionaryauthority or discretionary responsibility

in the administration of such plan orIRA.

The statutory definition deliberatelycasts a wide net in assigning fiduciaryresponsibility with respect to plan andIRA assets. Thus, ‘‘any authority orcontrol’’ over plan or IRA assets issufficient to confer fiduciary status, andany persons who render ‘‘investmentadvice for a fee or other compensation,direct or indirect’’ are fiduciaries,regardless of whether they have directcontrol over the plan’s or IRA’s assetsand regardless of their status as aninvestment adviser or broker under the

federal securities laws. The statutorydefinition and associatedresponsibilities were enacted to ensurethat plans, plan participants, and IRAowners can depend on persons whoprovide investment advice for a fee toprovide recommendations that areuntainted by conflicts of interest. In theabsence of fiduciary status, theproviders of investment advice areneither subject to ERISA’s fundamentalfiduciary standards, nor accountable forimprudent, disloyal, or tainted adviceunder ERISA or the Code, no matter



4/30


6The Department of Treasury issued a virtuallyidentical regulation, at 26 CFR 54.4975–9(c), whichinterprets Code section 4975(e)(3).

7Advisory Opinion 76–65A (June 7, 1976).

8The Department initially proposed anamendment to its regulation defining a fiduciaryunder ERISA section 3(21)(A)(ii) and Code section4975(e)(3)(B) on October 22, 2010, at 75 FR 65263.It subsequently announced its intention towithdraw the proposal and propose a new rule,consistent with the President’s Executive Orders12866 and 13563, in order to give the public a fullopportunity to evaluate and comment on the newproposal and updated economic analysis.

9See NASD Notice to Members 01–23 and FINRARegulatory Notices 11–02, 12–25 and 12–55.

10Although the preamble adopts the phrase‘‘seller’s carve-out’’ as a shorthand way of referring

Continued

how egregious the misconduct or howsubstantial the losses. Retirementinvestors typically are not financialexperts and consequently must rely onprofessional advice to make criticalinvestment decisions. In the years sincethen, the significance of financial advicehas become still greater with increasedreliance on participant directed plans

and IRAs for the provision of retirement benefits.

In 1975, the Department issued aregulation, at 29 CFR 2510.3–21(c)(1975), defining the circumstancesunder which a person is treated asproviding ‘‘investment advice’’ to anemployee benefit plan within themeaning of ERISA section 3(21)(A)(ii)(the ‘‘1975 regulation’’).6 The 1975regulation narrowed the scope of thestatutory definition of fiduciaryinvestment advice by creating a five-parttest that must be satisfied before aperson can be treated as rendering

investment advice for a fee. Under the1975 regulation, for advice to constitute‘‘investment advice,’’ an adviser whodoes not have discretionary authority orcontrol with respect to the purchase orsale of securities or other property of theplan must (1) render advice as to thevalue of securities or other property, ormake recommendations as to theadvisability of investing in, purchasingor selling securities or other property (2)on a regular basis (3) pursuant to amutual agreement, arrangement orunderstanding, with the plan or a planfiduciary that (4) the advice will serveas a primary basis for investmentdecisions with respect to plan assets,and that (5) the advice will beindividualized based on the particularneeds of the plan. The regulationprovides that an adviser is a fiduciarywith respect to any particular instanceof advice only if he or she meets eachand every element of the five-part testwith respect to the particular advicerecipient or plan at issue. A 1976Department of Labor Advisory Opinionfurther limited the application of thestatutory definition of ‘‘investmentadvice’’ by stating that valuations ofemployer securities in connection with

employee stock ownership plan (ESOP)purchases would not be consideredfiduciary advice.7

As the marketplace for financialservices has developed in the yearssince 1975, the five-part test may nowundermine, rather than promote, thestatutes’ text and purposes. Thenarrowness of the 1975 regulation

allows advisers, brokers, consultantsand valuation firms to play a centralrole in shaping plan investments,without ensuring the accountability thatCongress intended for persons havingsuch influence and responsibility. Evenwhen plan sponsors, participants,

beneficiaries and IRA owners clearlyrely on paid consultants for impartial

guidance, the regulation allows manyadvisers to avoid fiduciary status andthe accompanying fiduciary obligationsof care and prohibitions on disloyal andconflicted transactions. As aconsequence, under ERISA and theCode, these advisers can steer customersto investments based on their own self-interest, give imprudent advice, andengage in transactions that wouldotherwise be prohibited by ERISA andthe Code.

In the Department’s ProposedRegulation defining a fiduciary underERISA section 3(21)(A)(ii) and Code

section 4975(e)(3)(B), the Departmentseeks to replace the existing regulationwith one that more appropriatelydistinguishes between the sorts ofadvice relationships that should betreated as fiduciary in nature and thosethat should not, in light of the legalframework and financial marketplace inwhich IRAs and plans currentlyoperate.8 Under the ProposedRegulation, plans include IRAs.

The Proposed Regulation describesthe types of advice that constitute‘‘investment advice’’ with respect toplan or IRA assets for purposes of the

definition of a fiduciary at ERISAsection 3(21)(A)(ii) and Code section4975(e)(3)(B). The proposal provides,subject to certain carve-outs, that aperson renders investment advice withrespect to assets of a plan or IRA if,among other things, the personprovides, directly to a plan, a planfiduciary, a plan participant or

beneficiary, IRA or IRA owner, one ofthe following types of advice:

(1) A recommendation as to theadvisability of acquiring, holding,disposing or exchanging securities orother property, including arecommendation to take a distributionof benefits or a recommendation as tothe investment of securities or otherproperty to be rolled over or otherwisedistributed from a plan or IRA;

(2) A recommendation as to themanagement of securities or otherproperty, including recommendations asto the management of securities or otherproperty to be rolled over or otherwisedistributed from the plan or IRA;

(3) An appraisal, fairness opinion orsimilar statement, whether verbal orwritten, concerning the value of

securities or other property, if providedin connection with a specifictransaction or transactions involving theacquisition, disposition or exchange ofsuch securities or other property by theplan or IRA; and

(4) a recommendation of a person whois also going to receive a fee or othercompensation in providing any of thetypes of advice described in paragraphs(1) through (3), above.

In addition, to be a fiduciary, suchperson must either (i) represent oracknowledge that it is acting as afiduciary within the meaning of ERISA

(or the Code) with respect to the advice,or (ii) render the advice pursuant to awritten or verbal agreement,arrangement or understanding that theadvice is individualized to, or that suchadvice is specifically directed to, theadvice recipient for consideration inmaking investment or managementdecisions with respect to securities orother property of the plan or IRA.

In the Proposed Regulation, theDepartment refers to FINRA guidanceon whether particular communicationsshould be viewed as‘‘recommendations’’9 within the

meaning of the fiduciary definition, andrequests comment on whether theProposed Regulation should adhere toor adopt some or all of the standardsdeveloped by FINRA in definingcommunications which rise to the levelof a recommendation. For more detailedinformation regarding the ProposedRegulation, see the Notice of theProposed Regulation published in thisissue of the Federal Register.

For advisers who do not representthat they are acting as ERISA or Codefiduciaries, the Proposed Regulationprovides that advice rendered inconformance with certain carve-outswill not cause the adviser to be treatedas a fiduciary under ERISA or the Code.For example, under the seller’s carve-out, counterparties in arm’s lengthtransactions with plans may makeinvestment recommendations withoutacting as fiduciaries if certainconditions are met.10 The proposal also



5/30


to the carve-out and its terms, the regulatory carve-out is not limited to sellers but rather applies more broadly to counterparties in arm’s lengthtransactions with plan investors with financialexpertise.

11Subsequent to the issuance of these regulations,Reorganization Plan No. 4 of 1978, 5 U.S.C. App.(2010), divided rulemaking and interpretiveauthority between the Secretaries of Labor and theTreasury. The Secretary of Labor was providedinterpretive and rulemaking authority regarding thedefinition of fiduciary in both Title I of ERISA andthe Internal Revenue Code.

1229 CFR 2550.408b–2(e); 26 CFR 54.4975–6(a)(5).

contains a carve-out from fiduciarystatus for providers of appraisals,fairness opinions, or statements of valuein specified contexts (e.g., with respectto ESOP transactions). The proposaladditionally includes a carve-out fromfiduciary status for the marketing ofinvestment alternative platforms toplans, certain assistance in selecting

investment alternatives and otheractivities. Finally, the ProposedRegulation carves out the provision ofinvestment education from thedefinition of an investment advicefiduciary.

Prohibited Transactions

The Department anticipates that theProposed Regulation will cover manyinvestment professionals who do notcurrently consider themselves to befiduciaries under ERISA or the Code. Ifthe Proposed Regulation is adopted,these entities will become subject to theprohibited transaction restrictions inERISA and the Code that applyspecifically to fiduciaries. ERISAsection 406(b)(1) and Code section4975(c)(1)(E) prohibit a fiduciary fromdealing with the income or assets of aplan or IRA in his own interest or hisown account. ERISA section 406(b)(2)provides that a fiduciary shall not ‘‘inhis individual or in any other capacityact in any transaction involving the planon behalf of a party (or represent aparty) whose interests are adverse to theinterests of the plan or the interests ofits participants or beneficiaries.’’ As thisprovision is not in the Code, it does not

apply to transactions involving IRAs.ERISA section 406(b)(3) and Codesection 4975(c)(1)(F) prohibit a fiduciaryfrom receiving any consideration for hisown personal account from any partydealing with the plan or IRA inconnection with a transaction involvingassets of the plan or IRA.

Parallel regulations issued by theDepartments of Labor and the Treasuryexplain that these provisions impose onfiduciaries of plans and IRAs a duty notto act on conflicts of interest that mayaffect the fiduciary’s best judgment on

behalf of the plan or IRA.11 The

prohibitions extend to a fiduciarycausing a plan or IRA to pay an

additional fee to such fiduciary, or to aperson in which such fiduciary has aninterest that may affect the exercise ofthe fiduciary’s best judgment as afiduciary. Likewise, a fiduciary isprohibited from receiving compensationfrom third parties in connection with atransaction involving the plan or IRA, orfrom causing a person in which the

fiduciary has an interest which mayaffect its best judgment as a fiduciary toreceive such compensation.12 Giventhese prohibitions, conferring fiduciarystatus on particular investment adviceactivities can have importantimplications for many investmentprofessionals.

In particular, investmentprofessionals typically receivecompensation for services to retirementinvestors in the retail market through avariety of arrangements. These includecommissions paid by the plan,participant or beneficiary, or IRA, or

commissions, sales loads, 12b–1 fees,revenue sharing and other paymentsfrom third parties that provideinvestment products. The investmentprofessional or its affiliate may receivesuch fees upon the purchase or sale bya plan, participant or beneficiaryaccount, or IRA of the product, or whilethe plan, participant or beneficiaryaccount, or IRA, holds the product. Inthe Department’s view, receipt by afiduciary of such payments wouldviolate the prohibited transactionprovisions of ERISA section 406(b) andCode section 4975(c)(1)(E) and (F)

because the amount of the fiduciary’s

compensation is affected by the use ofits authority in providing investmentadvice, unless such payments meet therequirements of an exemption.

Prohibited Transaction Exemptions

ERISA and the Code counterbalancethe broad proscriptive effect of theprohibited transaction provisions withnumerous statutory exemptions. Forexample, ERISA section 408(b)(14) andCode section 4975(d)(17) specificallyexempt transactions in connection withthe provision of fiduciary investmentadvice to a participant or beneficiary of

an individual account plan or IRAowner where the advice, resultingtransaction, and the adviser’s fees meetcertain conditions. The Secretary ofLabor may grant administrativeexemptions under ERISA and the Codeon an individual or class basis if theSecretary finds that the exemption is (1)administratively feasible, (2) in theinterests of plans and their participantsand beneficiaries and IRA owners, and

(3) protective of the rights of theparticipants and beneficiaries of suchplans and IRA owners.

Over the years, the Department hasgranted several conditionaladministrative class exemptions fromthe prohibited transactions provisions ofERISA and the Code. The exemptions

focus on specific types of compensationarrangements. Fiduciaries relying onthese exemptions must comply withcertain conditions designed to protectthe interests of plans and IRAs. Inconnection with the development of theProposed Regulation, the Departmenthas considered comments suggesting theneed for additional prohibitedtransaction exemptions for the widevariety of compensation structures thatexist today in the marketplace forinvestments. Some commentators havesuggested that the lack of such reliefmay cause financial professionals to cut

back on the provision of investmentadvice and the availability of productsto plan participants and beneficiaries,IRAs, and smaller plans.

After consideration of the issue, theDepartment has determined to proposethe new class exemption described

below, which applies to investmentadvice fiduciaries providing advice toplan participants and beneficiaries,IRAs, and certain employee benefitplans with fewer than 100 participants(referred to as ‘‘retirement investors’’).The exemption would apply broadly tomany common types of otherwise

prohibited compensation that suchinvestment advice fiduciaries mayreceive, provided the protectiveconditions of the exemption aresatisfied. The Department is alsoseeking public comment on whether itshould issue a separate streamlinedexemption that would allow advisers toreceive otherwise prohibitedcompensation in connection withadvice to invest in certain high-qualitylow-fee investments, subject to fewerconditions.

Elsewhere in this issue of the Federal

Register, the Department is alsoproposing a new class exemption for‘‘principal transactions’’ for investmentadvice fiduciaries selling certain debtsecurities out of their own inventories toplans and IRAs.

Lastly, the Department is alsoproposing, elsewhere in this issue of theFederal Register, amendments to thefollowing existing class prohibitedexemptions, which are particularlyrelevant to broker-dealers and otherinvestment advice fiduciaries.



6/30


13Class Exemption for Securities TransactionsInvolving Employee Benefit Plans and Broker-Dealers, 51 FR 41686 (Nov. 18, 1986), amended at67 FR 64137 (Oct. 17, 2002).

14Exemptions from Prohibitions RespectingCertain Classes of Transactions Involving EmployeeBenefit Plans and Certain Broker-Dealers, ReportingDealers and Banks, 40 FR 50845 (Oct. 31, 1975), asamended at 71 FR 5883 (Feb. 3, 2006).

15Class Exemption for Certain TransactionsInvolving Insurance Agents and Brokers, PensionConsultants, Insurance Companies, InvestmentCompanies and Investment Company PrincipalUnderwriters, 49 FR 13208 (Apr. 3, 1984), amendedat 71 FR 5887 (Feb. 3, 2006).

Prohibited Transaction Exemption(PTE) 86–128 13 currently allows aninvestment advice fiduciary to cause aplan or IRA to pay the investmentadvice fiduciary or its affiliate a fee foreffecting or executing securitiestransactions as agent. To preventchurning, the exemption does not applyif such transactions are excessive in

either amount or frequency. Theexemption also allows the investmentadvice fiduciary to act as the agent for

both the plan and the other party to thetransaction (i.e., the buyer and the sellerof securities), and receive a reasonablefee. To use the exemption, the fiduciarycannot be a plan administrator oremployer, unless all profits earned bythese parties are returned to the plan.The conditions of the exemption requirethat a plan fiduciary independent of theinvestment advice fiduciary receivecertain disclosures and authorize thetransaction. In addition, the

independent fiduciary must receiveconfirmations and an annual ‘‘portfolioturnover ratio’’ demonstrating theamount of turnover in the accountduring that year. These conditions arenot presently applicable to transactionsinvolving IRAs.

The Department is proposing toamend PTE 86–128 to require allfiduciaries relying on the exemption toadhere to the same impartial conductstandards required in the Best InterestContract Exemption. At the same time,the proposed amendment wouldeliminate relief for investment advicefiduciaries to IRA owners; instead theywould be required to rely on the BestInterest Contract Exemption for anexemption for such compensation. Inthe Department’s view, the provisions inthe Best Interest Contract Exemption

better address the interests of IRAs withrespect to transactions otherwisecovered by PTE 86–128 and, unlike planparticipants and beneficiaries, there isno separate plan fiduciary in the IRAmarket to review and authorize thetransaction. Investment advicefiduciaries to plans would remaineligible for relief under the exemption,as would investment managers with full

investment discretion over theinvestments of plans and IRA owners,

but they would be required to complywith all the protective conditions,described above. Finally, theDepartment is proposing that PTE 86–128 extend to a new coveredtransaction, for fiduciaries to sellmutual fund shares out of their own

inventory (i.e. acting as principals,rather than agents) to plans and IRAsand to receive commissions for doingso. This transaction is currently thesubject of another exemption, PTE 75–1, Part II(2) (discussed below) that theDepartment is proposing to revoke.

Several changes are proposed withrespect to PTE 75–1, a multi-part

exemption for securities transactionsinvolving broker-dealers and banks, andplans and IRAs.14 Part I(b) and (c)currently provide relief for certain non-fiduciary services to plans and IRAs.The Department is proposing to revokethese provisions, and require personsseeking to engage in such transactions torely instead on the existing statutoryexemptions provided in ERISA section408(b)(2) and Code section 4975(d)(2),and the Department’s implementingregulations at 29 CFR 2550.408b–2. Inthe Department’s view, the conditions ofthe statutory exemption are more

appropriate for the provision of services.PTE 75–1, Part II(2), currentlyprovides relief for fiduciaries to receivecommissions for selling mutual fundshares to plans and IRAs in a principaltransaction. As described above, theDepartment is proposing to providerelief for these types of transactions inPTE 86–128, and so is proposing torevoke PTE 75–1, Part II(2), in itsentirety. As discussed in more detail inthe notice of proposed amendment/revocation, the Department believes theconditions of PTE 86–128 are moreappropriate for these transactions.

PTE 75–1, Part V, currently permits

broker-dealers to extend credit to a planor IRA in connection with the purchaseor sale of securities. The exemptiondoes not permit broker-dealers that arefiduciaries to receive compensationwhen doing so. The Department isproposing to amend PTE 75–1, Part V,to permit investment advice fiduciariesto receive compensation for lendingmoney or otherwise extending credit toplans and IRAs, but only for the limitedpurpose of avoiding a failed securitiestransaction.

PTE 84–24 15 covers transactionsinvolving mutual fund shares, orinsurance or annuity contracts, sold toplans or IRAs by pension consultants,insurance agents, brokers, and mutualfund principal underwriters who are

fiduciaries as a result of advice they givein connection with these transactions.The exemption allows these investmentadvice fiduciaries to receive a salescommission with respect to productspurchased by plans or IRAs. Theexemption is limited to salescommissions that are reasonable underthe circumstances. The investment

advice fiduciary must providedisclosure of the amount of thecommission and other terms of thetransaction to an independent fiduciaryof the plan or IRA, and obtain approvalfor the transaction. To use thisexemption, the investment advicefiduciary may not have certain roleswith respect to the plan or IRA such astrustee, plan administrator, or fiduciarywith written authorization to managethe plan’s assets and employers.However it is available to investmentadvice fiduciaries regardless of whetherthey expressly acknowledge their

fiduciary status or are simply functionalor ‘‘inadvertent’’ fiduciaries that havenot expressly agreed to act as fiduciaryadvisers, provided there is no writtenauthorization granting them discretionto acquire or dispose of the assets of theplan or IRA.

The Department is proposing toamend PTE 84–24 to require allfiduciaries relying on the exemption toadhere to the same impartial conductstandards required in the Best InterestContract Exemption. At the same time,the proposed amendment would revokePTE 84–24 in part so that investment

advice fiduciaries to IRA owners wouldnot be able to rely on PTE 84–24 withrespect to (1) transactions involvingvariable annuity contracts and otherannuity contracts that constitutesecurities under federal securities laws,and (2) transactions involving thepurchase of mutual fund shares.Investment advice fiduciaries wouldinstead be required to rely on the BestInterest Contract Exemption forcompensation received in connectionwith these transactions. The Department

believes that investment advicetransactions involving annuity contracts

that are treated as securities andtransactions involving the purchase ofmutual fund shares should occur underthe conditions of the Best InterestContract Exemption due to thesimilarity of these investments,including their distribution channelsand disclosure obligations, to otherinvestments covered in the Best InterestContract Exemption. Investment advicefiduciaries to ERISA plans wouldremain eligible for relief under theexemption with respect to transactionsinvolving all insurance and annuity



7/30


16See Section VIII(c) of the proposed exemption,defining the term ‘‘Asset,’’ and the preamblediscussion in the ‘‘Scope of Relief in the BestInterest Contract Exemption’’ section below.

17See Section VIII(c) of the proposed exemption.18While the Department uses the term

‘‘Retirement Investor’’ throughout this document,the proposed exemption is not limited only toinvestment advice fiduciaries of employee pension benefit plans and IRAs. Relief would be availablefor investment advice fiduciaries of employeewelfare benefit plans as well.

19See Section VIII(a) of the proposed exemption.20See Section VIII(e) of the proposed exemption.

21See Section VIII(b) and (k) of the proposedexemption.

22See Section VIII(l) of the proposed exemption.

contracts and mutual fund shares andthe receipt of commissions allowableunder that exemption. Investmentadvice fiduciaries to IRAs could stillreceive commissions for transactionsinvolving non-securities insurance andannuity contracts, but they would berequired to comply with all theprotective conditions, described above.

Finally, the Department is proposingamendments to certain other existingclass exemptions to require adherenceto the impartial conduct standardsrequired in the Best Interest ContractExemption. Specifically, PTEs 75–1,Part III, 75–1, Part IV, 77–4, 80–83, and83–1, would be amended. Other thanthe amendments described above,however, the existing class exemptionswill remain in place, affordingadditional flexibility to fiduciaries whocurrently use the exemptions or whowish to use the exemptions in thefuture. The Department seeks comment

on whether additional exemptions areneeded in light of the ProposedRegulation.

Proposed Best Interest ContractExemption

As noted above, the exemptionproposed in this notice provides relieffor some of the same compensationpayments as the existing exemptionsdescribed above. It is intended,however, to flexibly accommodate awide range of current businesspractices, while minimizing the harmfulimpact of conflicts of interest on thequality of advice. The exemptionpermits fiduciaries to continue toreceive a wide variety of types ofcompensation that would otherwise beprohibited. It seeks to preserve

beneficial business models by taking astandards-based approach that will

broadly permit firms to continue to relyon common fee practices, as long asthey are willing to adhere to basicstandards aimed at ensuring that theiradvice is in the best interest of theircustomers. This standards-basedapproach stands in marked contrast toexisting class exemptions that generallyfocus on very specific types of

investments or compensation and take ahighly prescriptive approach tospecifying conditions. The proposedexemption would provide relief forcommon investments 16 of retirementinvestors under the umbrella of oneexemption. It is intended that thisupdated approach will ease compliancecosts and reduce complexity while

promoting the provision of investmentadvice that is in the best interest ofretirement investors.

Section I of the proposed exemptionwould provide relief for the receipt ofprohibited compensation by ‘‘Advisers,’’‘‘Financial Institutions,’’ ‘‘Affiliates’’and ‘‘Related Entities’’ for servicesprovided in connection with a purchase,

sale or holding of an ‘‘Asset’’ 17 by aplan or IRA as a result of the Adviser’sadvice. The exemption also uses theterm ‘‘Retirement Investor’’ to describethe types of persons who can be advicerecipients under the exemption.18 Theseterms are defined in Section VIII of thisproposed exemption. The followingsections discuss these key definitionalterms of the exemption as well as thescope and conditions of the proposedexemption.

Entities Defined

1. Adviser

The proposed exemptioncontemplates that an individual person,an Adviser, will provide advice to theRetirement Investor. An Adviser must

be an investment advice fiduciary of aplan or IRA who is an employee,independent contractor, agent, orregistered representative of a ‘‘FinancialInstitution’’ (discussed in the nextsection), and the Adviser must satisfythe applicable federal and stateregulatory and licensing requirements ofinsurance, banking, and securities lawswith respect to the receipt of thecompensation.19 Advisers may be, for

example, registered representatives of broker-dealers registered under theSecurities Exchange Act of 1934, orinsurance agents or brokers.

2. Financial Institutions

For purposes of the proposedexemption, a Financial Institution is theentity that employs an Adviser orotherwise retains the Adviser as anindependent contractor, agent orregistered representative.20 FinancialInstitutions must be registeredinvestment advisers, banks, insurancecompanies, or registered broker-dealers.

3. Affiliates and Related EntitiesRelief is also proposed for the receipt

of otherwise prohibited compensation by ‘‘Affiliates’’ and ‘‘Related Entities’’

with respect to the Adviser or FinancialInstitution.21 Affiliates are (i) anyperson directly or indirectly throughone or more intermediaries, controlling,controlled by, or under common controlwith the Adviser or FinancialInstitution; (ii) any officer, director,employee, agent, registeredrepresentative, relative, member of

family, or partner in, the Adviser orFinancial Institution; and (iii) anycorporation or partnership of which theAdviser or Financial Institution is anofficer, director or employee or in whichthe Adviser or Financial Institution is apartner. For this purpose, ‘‘control’’means the power to exercise acontrolling influence over themanagement or policies of a personother than an individual. RelatedEntities are entities other than Affiliatesin which an Adviser or FinancialInstitution has an interest that mayaffect their exercise of their best

judgment as fiduciaries.4. Retirement Investor

The proposed exemption uses theterm ‘‘Retirement Investor’’ to describethe types of persons who can beinvestment advice recipients under theexemption. The Retirement Investormay be a plan participant or beneficiarywith authority to direct the investmentof assets in his or her plan account orto take a distribution; in the case of anIRA, the beneficial owner of the IRA(i.e., the IRA owner); or a plan sponsor(or an employee, officer or directorthereof) of a non-participant-directedERISA plan that has fewer than 100participants.22

Scope of Relief in the Best InterestContract Exemption

The Best Interest Contract Exemptionset forth in Section I would provideprohibited transaction relief for thereceipt by Advisers, FinancialInstitutions, Affiliates and RelatedEntities of a wide variety ofcompensation forms as a result ofinvestment advice provided to theRetirement Investors, if the conditionsof the exemption are satisfied.

Specifically, Section I(b) of theproposed exemption provides that theexemption would permit an Adviser,Financial Institution and their Affiliatesand Related Entities to receivecompensation for services provided inconnection with the purchase, sale orholding of an Asset by a plan,participant or beneficiary account, orIRA, as a result of an Adviser’s or



8/30


23Relief is also proposed from ERISA section406(a)(1)(D) and Code section 4975(c)(1)(D), whichprohibit transfer of plan assets to, or use of planassets for the benefit of, a party in interest(including a fiduciary). 24See Section VIII(c) of the proposed exemption.

Financial Institution’s investmentadvice to a Retirement Investor.

The proposed exemption would applyto the restrictions of ERISA section406(b) and the sanctions imposed byCode section 4975(a) and (b), by reasonof Code section 4975(c)(1)(E) and (F).These provisions prohibit conflict ofinterest transactions and receipt of

third-party payments by investmentadvice fiduciaries.23 For relief to beavailable under the exemption, theAdviser and Financial Institution mustcomply with the applicable conditions,including entering into a contract thatacknowledges fiduciary status andrequires adherence to certain ImpartialConduct Standards.

The types of compensation paymentscontemplated by this proposedexemption include commissions paiddirectly by the plan or IRA, as well ascommissions, trailing commissions,sales loads, 12b–1 fees, and revenuesharing payments paid by theinvestment providers or other thirdparties to Advisers and FinancialInstitutions. The exemption also wouldcover other compensation received bythe Adviser, Financial Institution ortheir Affiliates and Related Entities as aresult of an investment by a plan,participant or beneficiary account, orIRA, such as investment managementfees or administrative services fees froman investment vehicle in which theplan, participant or beneficiary account,or IRA invests.

As proposed, the exemption is limitedto otherwise prohibited compensation

generated by investments that arecommonly purchased by plans,participant and beneficiary accounts,and IRAs. Accordingly, the exemptiondefines the ‘‘Assets’’ that can be soldunder the exemption as bank deposits,CDs, shares or interests in registeredinvestment companies, bank collectivefunds, insurance company separateaccounts, exchange-traded REITs,exchange-traded funds, corporate bondsoffered pursuant to a registrationstatement under the Securities Act of1933, agency debt securities as definedin FINRA Rule 6710(l) or its successor,

U.S. Treasury securities as defined inFINRA Rule 6710(p) or its successor,insurance and annuity contracts (bothsecurities and non-securities),guaranteed investment contracts, andequity securities within the meaning of17 CFR 230.405 that are exchange-traded securities within the meaning of17 CFR 242.600. However, the

definition does not encompass anyequity security that is a security futureor a put, call, straddle, or any otheroption or privilege of buying an equitysecurity from or selling an equitysecurity to another without being boundto do so.24

Prohibited compensation received forinvestments that fall outside the

definition of Asset would not becovered by the exemption. Limiting theexemption in this manner ensures thatthe investments needed to build a basicdiversified portfolio are available toplans, participant and beneficiaryaccounts, and IRAs, while limiting theexemption to those investments that arerelatively transparent and liquid, manyof which have a ready market price. TheDepartment also notes that manyinvestment types and strategies thatwould not be covered by the exemptioncan be obtained through pooledinvestment funds, such as mutual funds,

that are covered by the exemption.Request for Comment. TheDepartment requests comment on theproposed definition of Assets, inparticular:

• Do commenters agree we haveidentified all common investments ofretail investors?

• Have we defined individualinvestment products with enoughprecision that parties will know if theyare complying with this aspect of theexemption?

• Should additional investments beincluded in the scope of the exemption?Commenters urging addition of other

investment products should fullydescribe the characteristics and feestructures associated with the products,as well as data supporting their positionthat the product is a commoninvestment for retail investors.

The Department encourages parties toapply to the Department for individualor class exemptions for types ofinvestments not covered by theexemption to the extent that they

believe the proposed package ofexemptions does not adequately cover

beneficial investment practices forwhich appropriate protections could be

crafted in an exemption.Limitation to Prohibited CompensationReceived As a Result of Advice toRetirement Investors

The Department proposed thisexemption to promote the provision ofinvestment advice to retail investorsthat is in their best interest anduntainted by conflicts of interest. Theexemption would permit receipt byAdvisers and Financial Institutions of

otherwise prohibited compensationcommonly received in the retail market,such as commissions, 12b–1 fees, andrevenue sharing payments, subject toconditions designed specifically toprotect the interests of the investors. Forconsistency with these objectives, theexemption would apply to the receipt ofsuch compensation by Advisers,

Financial Institutions and theirAffiliates and Related Entities onlywhen advice is provided to retailRetirement Investors, including planparticipants and beneficiaries, IRAowners, and plan sponsors (includingthe sponsor’s employees, officers, anddirectors) acting on behalf of non-participant-directed plans that havefewer than 100 participants. Asdiscussed in the preamble to theProposed Regulation and in theassociated Regulatory Impact Analysis,these investors are particularlyvulnerable to abuse. The proposed

exemption is designed to protect theseinvestors from the harmful impact ofconflicts of interest, while minimizingthe potential disruption to a retailmarket that relies upon many forms ofcompensation that ERISA wouldotherwise prohibit.

The Department believes thatinvestment advice in the institutionalmarket is best addressed through otherapproaches. Accordingly, the proposedexemption does not extend totransactions involving certain largerERISA plans—those with more than 100participants. Advice providers to theseplans are already accustomed to

operating in a fiduciary environmentand within the framework of existingprohibited transaction exemptions,which tightly constrain the operation ofconflicts of interest. As a result,including large plans within thedefinition of Retirement Investor couldhave the undesirable consequence ofreducing protections provided underexisting law to these investors, withoutoffsetting benefits. In particular, it couldhave the undesirable effect of increasingthe number and impact of conflicts ofinterest, rather than reducing ormitigating them.

While the Department believes thatthe Best Interest Contract Exemption isnot the appropriate way to address anypotential concerns about the impact ofthe expanded fiduciary definition onlarge plans, the Department agrees thatan adjustment is necessary toaccommodate arm’s length transactionswith plan investors with financialexpertise. Accordingly, as part of thisregulatory project, the Department hasseparately proposed a seller’s carve-outin the Proposed Conflict of InterestRegulation. Under the terms of that



9/30


25The Department notes that plan participantsand beneficiaries in ERISA plans can be RetirementInvestors regardless of the number of participantsin such plan. Therefore, the 100-participantlimitation does not apply when advice is provideddirectly to the participants and beneficiaries.

26See Section VIII(f), defining the term‘‘Independent.’’

27For purposes of this proposed exemption,however, the Department does not view a risklessprincipal transaction involving mutual fund sharesas an excluded principal transaction.

carve-out, persons who providerecommendations to certain ERISA planinvestors with financial expertise (butnot to plan participants or beneficiaries,or IRA owners) can avoid fiduciarystatus altogether. The seller’s carve-outwas developed to avoid the applicationof fiduciary status to a plan’scounterparty in an arm’s length

commercial transaction in which theplan’s representative has no reasonableexpectation of impartial advice. Whenthe carve-out’s terms are satisfied, it isavailable for transactions with plansthat have more than 100 participants.

The Department recognizes, however,that there are smaller non-participant-directed plans for which the plansponsor (or an employee, officer ordirector thereof) is responsible forchoosing the specific investments andallocations for their participatingemployees. The Department believesthat these small plan fiduciaries are

appropriately categorized with planparticipants and beneficiaries and IRAowners, as retail investors. For thisreason, the proposed exemption’sdefinition of Retirement Investorincludes plan sponsors (or employees,officers and directors thereof) of planswith fewer than 100 participants.25 Asa result, the exemption would extend toadvice providers to such smaller plans.

The proposed threshold of fewer than100 participants is intended toreasonably identify plans that will most

benefit from both the flexibilityprovided by this exemption and theprotections embodied in its conditions.

The threshold also mirrors the ProposedRegulations’ 100-or-more participantthreshold for the seller’s carve-out. Thatthreshold recognizes the generallygreater sophistication possessed bylarger plans’ discretionary fiduciaries, aswell as the greater vulnerability of retailinvestors, such as small plans. Asexplained in more detail in thepreamble to the Proposed Regulation,investment recommendations to smallplans, IRA owners and plan participantsand beneficiaries do not fit the ‘‘armslength’’ characteristics that the seller’scarve-out is designed to preserve.

Recommendations to retail investors areroutinely presented as advice,consulting, or financial planningservices. In the securities markets,

brokers’ suitability obligations generallyrequire a significant degree ofindividualization, and research hasshown that disclaimers are ineffective in

alerting typically unsophisticatedinvestors to the dangers posed byconflicts of interest, and may evenexacerbate the dangers. Most retailinvestors lack financial expertise, areunaware of the magnitude and impact ofconflicts of interest, and are unableeffectively to assess the quality of theadvice they receive.

The 100 or more threshold is alsoconsistent with that applicable forsimilar purposes under existing rulesand practices. The RegulatoryFlexibility Act (5 U.S.C. 601 et seq.)(RFA) imposes certain requirementswith respect to Federal rules that aresubject to the notice and commentrequirements of section 553(b) of theAdministrative Procedure Act (5 U.S.C.551 et seq.) and which are likely to havea significant economic impact on asubstantial number of small entities. Forpurposes of the RFA, the Departmentconsiders a small entity to be an

employee benefit plan with fewer than100 participants. The basis of thisdefinition is found in section 104(a)(2)of ERISA that permits the Secretary ofLabor to prescribe simplified annualreports for pension plans that coverfewer than 100 participants. Undercurrent Department rules, such smallplans generally are eligible forstreamlined reporting and relieved ofrelated audit requirements.

The Department invites comment onthe proposed exemption’s limitation toprohibited compensation received as aresult of advice to Retirement Investors.In particular, we ask whether

commenters support the limitation ascurrently formulated, whether thedefinitions should be revised, orwhether there should not be anexclusion with respect to such largerplans at all. Commenters on this subjectare also encouraged to address theinteraction of the exemption’s limitationwith the scope of the seller’s carve-outin the Proposed Regulation. Finally, werequest comment on whether theexemption should be expanded to coveradvice to plan sponsors (including thesponsor’s employees, officers, anddirectors) of participant-directed plans

with fewer than 100 participants on thecomposition of the menu of investmentoptions available under such plans, andif so, whether additional or differentconditions should apply.

Exclusions in Section I(c) of theProposed Exemption

Section I(c) of the proposal sets forthadditional exclusions from theexemption. Section I(c)(1) provides thatthe exemption would not apply to thereceipt of prohibited compensation froma transaction involving an ERISA plan if

the Adviser, Financial Institution orAffiliate is the employer of employeescovered by the ERISA plan. TheDepartment believes that due to thespecial nature of the employer/employee relationship, an exemptionpermitting an Adviser and FinancialInstitution to profit from investments byemployees in their employer-sponsored

plan would not be in the interest of, orprotective of, the plans and theirparticipants and beneficiaries. Thisrestriction does not apply, however, inthe case of an IRA or other similar planthat is not covered by Title I of ERISA.Accordingly, an Adviser or FinancialInstitution may provide advice to the

beneficial owner of an IRA who isemployed by the Adviser, its FinancialInstitution or an Affiliate, and receiveprohibited compensation as a result,provided the IRA is not covered by TitleI of ERISA.

Section I(c)(1) further provides that

the exemption does not apply if theAdviser or Financial Institution is anamed fiduciary or plan administrator,as defined in ERISA section 3(16)(A))with respect to an ERISA plan, or anaffiliate thereof, that was selected toprovide advice to the plan by a fiduciarywho is not independent of them.26 Thisprovision is intended to disallowselection of Advisers and FinancialInstitutions by named fiduciaries orplan administrators that have an interestin them.

Section I(c)(2) provides that theexemption does not extend toprohibited compensation received when

the Adviser engages in a principaltransaction with the plan, participant or

beneficiary account, or IRA.27 Aprincipal transaction is a transaction inwhich the Adviser engages in atransaction with the plan, participant or

beneficiary account, or IRA, on behalf ofthe account of the Financial Institutionor another person directly or indirectly,through one or more intermediaries,controlling, controlled by, or undercommon control with the FinancialInstitution. Principal transactionsinvolve conflicts of interest notaddressed by the safeguards of this

proposed exemption. Elsewhere intoday’s Federal Register, theDepartment is proposing an exemptionfor investment advice fiduciaries toengage in principal transactionsinvolving certain debt securities. Theproposed exemption for principaltransactions contains conditions



10/30


28See also Section VIII(a), defining the term‘‘Adviser.’’

specific to those transactions but isdesigned to align with this proposedexemption so as to ease parties’ abilityto comply with both exemptions withrespect to the same investor.

Section I(c)(3) provides that theexemption would not cover prohibitedcompensation that is received by anAdviser or Financial Institution as a

result of investment advice that isgenerated solely by an interactive Website in which computer software-basedmodels or applications provideinvestment advice to RetirementInvestors based on personal informationeach investor supplies through the Website without any personal interaction oradvice from an individual Adviser.Such computer derived advice is oftenreferred to as ‘‘robo-advice.’’ While theDepartment believes that computergenerated advice that is delivered in thismanner may be very useful toRetirement Investors, relief will not be

included in the proposal. As themarketplace for such advice is stillevolving in ways that both appear toavoid conflicts of interest that wouldviolate the prohibited transaction rules,and minimize cost, the Department

believes that inclusion of such advice inthis exemption could adversely modifythe incentives currently shaping themarket for robo-advice. Furthermore, astatutory prohibited transactionexemption at ERISA section 408(g)covers computer-generated investmentadvice and is available for robo-adviceinvolving prohibited transactions if itsconditions are satisfied. See 29 CFR2550.408g–1.

Finally, Section I(c)(4) provides thatthe exemption is limited to Adviserswho are fiduciaries by reason ofproviding investment advice.28 Adviserswho have full investment discretionwith respect to plan or IRA assets orwho have discretionary authority overthe administration of the plan or IRA,for example, are not affected by theProposed Regulation and are thereforenot the subject of this exemption.

Conditions of the Proposed Exemption

Sections II–V of the proposal list the

conditions applicable to the BestInterest Contract Exemption describedin Section I. All applicable conditionsmust be satisfied in order to avoidapplication of the specified prohibitedtransaction provisions of ERISA and theCode. The Department believes thatthese conditions are necessary for theSecretary to find that the exemption isadministratively feasible, in theinterests of plans and of their

participants and beneficiaries, and IRAowners and protective of the rights ofthe participants and beneficiaries ofsuch plans and IRA owners. UnderERISA section 408(a)(2), and Codesection 4975(c)(2), the Secretary maynot grant an exemption without makingsuch findings. The proposed conditionsof the exemption are described below.

Contractual Obligations Applicable tothe Best Interest Contract Exemption(Section II)

Section II(a) of the proposal requiresthat an Adviser and FinancialInstitution enter into a written contractwith the Retirement Investor prior torecommending that the plan, participantor beneficiary account, or IRA,purchase, sell or hold an Asset. Thecontract must be executed by both theAdviser and the Financial Institution aswell as the Retirement Investor. In thecase of advice provided to a planparticipant or beneficiary in aparticipant-directed individual accountplan, the participant or beneficiaryshould be the Retirement Investor thatis the party to the contract, on behalf ofhis or her individual account.

The contract may be part of a masteragreement with the Retirement Investorand does not require execution prior toeach additional recommendation topurchase, sell or hold an Asset. Theexemption, in particular therequirement to adhere to a best intereststandard, does not mandate an ongoingor long-term advisory relationship, butrather leaves that to the parties. The

terms of the contract, along with otherrepresentations, agreements, orunderstandings between the Adviser,Financial Institution and RetirementInvestor, will govern whether the natureof the relationship between the partiesis ongoing or not.

The contract is the cornerstone of theproposed exemption, and theDepartment believes that by requiring acontract as a condition of the proposedexemption, it creates a mechanism bywhich a Retirement Investor can bealerted to the Adviser’s and FinancialInstitution’s obligations and be provided

with a basis upon which its rights can be enforced. In order to comply with theexemption, the contract must containevery required element set forth inSection II(b)–(e) and also must notinclude any of the prohibited provisionsdescribed in Section II(f). It is intendedthat the contract creates actionableobligations with respect to both theImpartial Conduct Standards and thewarranties, described below. Inaddition, failure to satisfy the ImpartialConduct Standards will result in loss ofthe exemption.

It should be noted, however, thatcompliance with the exemption’sconditions is necessary only withrespect to transactions that otherwisewould constitute prohibitedtransactions under ERISA and the Code.The exemption does not purport toimpose conditions on the managementof investments held outside of ERISA-

covered plans and IRAs. Accordingly,the contract and its conditions aremandatory only with respect toinvestments held by plans and IRAs.

1. Fiduciary Status

The proposal sets forth multiplecontractual requirements. The first andmost fundamental contractualrequirement, which is set out in SectionII(b) of proposal, is that that both theAdviser and Financial Institution mustacknowledge fiduciary status underERISA or the Code, or both, with respectto any recommendations to theRetirement Investor to purchase, sell orhold an Asset. If this acknowledgmentof fiduciary status does not appear in acontract with a Retirement Investor, theexemption is not satisfied with respectto transactions involving thatRetirement Investor. This fiduciaryacknowledgment is critical to ensuringthat there is no uncertainty—before orafter investment advice is given withregard to the Asset—that both theAdviser and Financial Institution areacting as fiduciaries under ERISA andthe Code with respect to that advice.

The acknowledgment of fiduciarystatus in the contract is nonetheless

limited to the advice to the RetirementInvestor to purchase, sell or hold theAsset. The Adviser and FinancialInstitution do not become fiduciarieswith respect to any other conduct byvirtue of this contractual requirement.

2. Standards of Impartial Conduct

Building upon the requiredacknowledgment of fiduciary status, theproposal additionally requires that boththe Adviser and the FinancialInstitution contractually commit toadhering to certain specificallydelineated Impartial Conduct Standards

when providing investment advice tothe Retirement Investor regardingAssets, and that they in fact do adhereto such standards. Therefore, if anAdviser and/or Financial Institution failto comply with the Impartial ConductStandards, relief under the exemption isno longer available and the contract isviolated.

Specifically, Section II(c)(1) of theproposal requires that under thecontract the Adviser and FinancialInstitution provide advice regardingAssets that is in the ‘‘best interest’’ of



11/30


29See Section VIII(h) of the proposed exemption.

the Retirement Investor. Best interest isdefined to mean that the Adviser andFinancial Institution act with the care,skill, prudence, and diligence under thecircumstances then prevailing that aprudent person would exercise based onthe investment objectives, risktolerance, financial circumstances, andthe needs of the Retirement Investor,

when providing investment advice tothem. Further, under the best intereststandard, the Adviser and FinancialInstitution must act without regard tothe financial or other interests of theAdviser, Financial Institution or theirAffiliates or any other party. Under thisstandard, the Adviser and FinancialInstitution must put the interests of theRetirement Investor ahead of thefinancial interests of the Adviser,Financial Institution or their Affiliates,Related Entities or any other party.

The best interest standard set forth inthis exemption is based on longstanding

concepts derived from ERISA and thelaw of trusts. For example, ERISAsection 404 requires a fiduciary to act‘‘solely in the interest of the participants. . . with the care, skill, prudence, anddiligence under the circumstances thenprevailing that a prudent man acting ina like capacity and familiar with suchmatters would use in the conduct of anenterprise of a like character and withlike aims.’’ Similarly, both ERISAsection 404(a)(1)(A) and the trust-lawduty of loyalty require fiduciaries to putthe interests of trust beneficiaries first,without regard to the fiduciaries’ ownself-interest. Accordingly, the

Department would expect the standardto be interpreted in light of forty yearsof judicial experience with ERISA’sfiduciary standards and hundreds morewith the duties imposed on trusteesunder the common law of trusts. Ingeneral, courts focus on the process thefiduciary used to reach itsdetermination or recommendation—whether the fiduciaries, ‘‘at the timethey engaged in the challengedtransactions, employed the properprocedures to investigate the merits ofthe investment and to structure theinvestment.’’ Donovan v. Mazzola, 716

F.2d 1226, 1232 (9th Cir. 1983).Moreover, a fiduciary’s investmentrecommendation is measured based onthe circumstances prevailing at the timeof the transaction, not on how theinvestment turned out with the benefitof hindsight.

In this regard, the Department notesthat while fiduciaries of plans covered

by ERISA are subject to the ERISAsection 404 standards of prudence andloyalty, the Code contains no provisionsthat hold IRA fiduciaries to thesestandards. However, as a condition of

relief under the proposed exemption, both IRA and plan fiduciaries wouldhave to agree to, and uphold, the bestinterest and Impartial ConductStandards, as set forth in Section II(c).The best interest standard is defined toeffectively mirror the ERISA section 404duties of prudence and loyalty, asapplied in the context of fiduciary

investment advice.In addition to the best interest

standard, the exemption imposes otherimportant standards of impartialconduct in Section II(c) of the proposal.Section II(c)(2) requires that the Adviserand Financial Institution agree that theywill not recommend an Asset if the totalamount of compensation anticipated to

be received by the Adviser, FinancialInstitution, and their Affiliates andRelated Entities in connection with thepurchase, sale or holding of the Asset bythe plan, participant or beneficiaryaccount, or IRA, will exceed reasonable

compensation in relation to the totalservices they provide to the applicableRetirement Investor. The obligation topay no more than reasonablecompensation to service providers islong recognized under ERISA. SeeERISA section 408(b)(2), 29 CFR2550.408b–2(a)(3), and 29 CFR2550.408c–2. The reasonableness of thefees depends on the particular facts andcircumstances. Finally, Section II(c)(3)requires that the Adviser’s andFinancial Institution’s statements aboutAssets, fees, material conflicts ofinterest, and any other matters relevantto a Retirement Investor’s investment

decisions, not be misleading.Under ERISA section 408(a) and Code

section 4975(c), the Department cannotgrant an exemption unless it first findsthat the exemption is administrativelyfeasible, in the interests of plans andtheir participants and beneficiaries andIRA owners, and protective of the rightsof participants and beneficiaries ofplans and IRA owners. An exemptionpermitting transactions that violate therequirements of Section II(c) would beunlikely to meet these standards.

3. Warranty—Compliance WithApplicable Law

Section II(d) of the proposal requiresthat the contract include certainwarranties intended to be protective ofthe rights of Retirement Investors. Inparticular, to satisfy the exemption, theAdviser, and Financial Institution mustwarrant that they and their Affiliateswill comply with all applicable federaland state laws regarding the renderingof the investment advice, the purchase,sale or holding of the Asset and thepayment of compensation related to thepurchase, sale and holding. Although

this warranty must be included in thecontract, the exemption is notconditioned on compliance with thewarranty. Accordingly, the failure tocomply with applicable federal or statelaw could result in contractual liabilityfor breach of warranty, but it would notresult in loss of the exemption, as longas the breach did not involve a violation

of one of the exemption’s otherconditions (e.g., the best intereststandard). De minimis violations of stateor federal law would be unlikely toviolate the exemption’s otherconditions, such as the best intereststandard, and would not typically resultin the loss of the exemption.

4. Warranty—Policies and Procedures

The Financial Institution must alsocontractually warrant that it hasadopted written policies and proceduresthat are reasonably designed to mitigatethe impact of material conflicts ofinterest that exist with respect to theprovision of investment advice toRetirement Investors and ensure thatindividual Advisers adhere to theImpartial Conduct Standards describedabove. For purposes of the exemption, amaterial conflict of interest is deemed toexist when an Adviser or FinancialInstitution has a financial interest thatcould affect the exercise of its bestjudgment as a fiduciary in renderingadvice to a Retirement Investorregarding an Asset.29 Like the warrantyon compliance with applicable law,discussed above, this warranty must bein the contract but the exemption is not

conditioned on compliance with thewarranty. Failure to comply with thewarranty could result in contractualliability for breach of warranty.

As part of the contractual warranty onpolicies and procedures, the FinancialInstitution must state that informulating its policies and procedures,it specifically identified materialconflicts of interest and adoptedmeasures to prevent those materialconflicts of interest from causingviolations of the Impartial ConductStandards. Further, the FinancialInstitution must state that neither it nor

(to the best of its knowledge) itsAffiliates or Related Entities will usequotas, appraisals, performance orpersonnel actions, bonuses, contests,special awards, differentiatedcompensation or other actions orincentives to the extent they would tendto encourage individual Advisers tomake recommendations that are not inthe best interest of Retirement Investors.

While these warranties must be partof the contract between the Adviser and



12/30


30

These examples should not be read asretracting views the Department expressed in priorAdvisory Opinions regarding how an investmentadvice fiduciary could avoid prohibitedtransactions that might result from differentialcompensation arrangements. Specifically, inAdvisory Opinion 2001–09A, the Departmentconcluded that the provision of fiduciaryinvestment advice would not result in prohibitedtransactions under circumstances where the adviceprovided by the fiduciary with respect toinvestment funds that pay additional fees to thefiduciary is the result of the application ofmethodologies developed, maintained and overseen by a party independent of the fiduciary inaccordance with the conditions set forth in theAdvisory Opinion. A computer model also can be

used as part of an advice arrangement that satisfiesthe conditions under the prohibited transactionexemption in ERISA section 408(b)(14) and (g),described above.

31As previously noted, this exemption is not

available for advice generated solely by a computermodel and provided to the Retirement Investorelectronically without live advice. Nevertheless,this exemption remains available in thehypothetical because the advice is delivered by alive Adviser.

32See footnote 31 supra. Certain types of fee-offset arrangements may result in avoidance ofprohibited transactions altogether. In AdvisoryOpinion Nos. 97–15A and 2005–10A, theDepartment explained that a fiduciary investmentadviser could provide investment advice to a planwith respect to investment funds that pay it or anaffiliate additional fees without engaging in aprohibited transaction if those fees are offset againstfees that the plan otherwise is obligated to pay tothe fiduciary.

Financial Institution and the RetirementInvestor, the proposal does not mandatethe specific content of the policies andprocedures. This flexibility is intendedto allow Financial Institutions todevelop policies and procedures that areeffective for their particular businessmodels, within the constraints of theirfiduciary obligations and the Impartial

Conduct Standards.Under the proposal, a Financial

Institution’s policies and proceduresmust not authorize compensation orincentive systems that would tend toencourage individual Advisers to makerecommendations that are not in the

best interest of Retirement Investors.Consistent with the general approach inthe proposal to the FinancialInstitution’s policies and procedures,however, there are no particularrequired compensation or employmentstructures. Certainly, one way for aFinancial Institution to comply is to

adopt a ‘‘level-fee’’ structure, in whichcompensation for Advisers does notvary based on the particular investmentproduct recommended. But theexemption does not mandate such astructure. The Department believes thatthe specific implementation of thisrequirement is best determined by theFinancial Institution in light of itsparticular circumstances and businessmodels.

For further clarification, theDepartment sets forth the followingexamples of broad approaches tocompensation structures that could helpsatisfy the contractual warrantyregarding the policies and procedures.In connection with all these examples,it is important that the FinancialInstitution carefully monitor whetherthe policies and procedures are, in fact,working to prevent the provision of

biased advice. The Financial Institutionmust correct isolated or systemicviolations of the Impartial ConductStandards and reasonably revisepolicies and procedures when failuresare identified.

Example 1: Independently certifiedcomputer models.30 The Adviser provides

investment advice that is in accordance withan unbiased computer model created by anindepe

Documents

DOL Proposed Best Interest Contract Exemption