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The Department of Labor’s 2016 Final Fiduciary and Conflict of Interest Rule: The Best Interest Contract Exemption

Last month the U.S. Department of Labor published a suite of final regulations governing the fiduciary status of, and prescribing conflict of interest rules that apply to, persons who provide investment advice to ERISA-covered retirement plans and Individual Retirement Accounts (IRAs). (For a list of, and links to, these final regulations, please see our April 11, 2016 post). As we explained previously, the final regulations will have important and far reaching consequences for financial advisors of all stripes (e.g., broker-dealers/registered representatives, Registered Investment Advisors (RIAs), and insurance agents and brokers, among others) who advise retirement plans and IRA investors.

In an earlier post we examined the new and greatly expanded definition of an “investment advice fiduciary,” which is of central importance to the Department’s new regulatory scheme.  In this post, we explain the “Best Interest Contract” (or “BIC”) exemption, which allows advisors to receive commission-based compensation that would be barred under the new fiduciary standard, subject to strict new rules intended to protect investors.


The Employee Retirement Income Security Act protects participants and beneficiaries in employee benefit plans, including most private sector retirement plans, by obligating plan fiduciaries to comply with fundamental obligations rooted in the law of trusts.  In particular, plan fiduciaries must manage plan assets prudently and with undivided loyalty to the plans and their participants and beneficiaries.  In addition to conforming to the ERISA fiduciary standards, fiduciaries must also refrain from engaging in “prohibited transactions,” i.e., transactions that Congress viewed as posing unacceptable risks to retirement security.  When fiduciaries violate ERISA’s fiduciary duties or the prohibited transaction rules, they may be held personally liable for the breach.  Nearly identical fiduciary and prohibited transaction rules are found in both ERISA and the Internal Revenue Code (the “Code”).

The Code also prescribes rules governing fiduciary conduct and prohibited transactions that apply to tax-favored accounts not covered by ERISA, such as IRAs.  Violations of these rules result in the imposition of an excise tax.  But in contrast to participants in ERISA-covered retirement plans, IRA investors do not have a statutory right to bring suit against fiduciaries for violations.

Many of ERISA’s and the Code’s protections, duties, and liabilities hinge on fiduciary status.  For purposes of the fiduciary rule and the BIC exemption, a person is a fiduciary with respect to a plan or IRA to the extent he or she:

[R]enders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan or IRA, or has any authority or responsibility to do so . . . .

The Department’s final fiduciary rule casts a wide net in assigning fiduciary responsibility with respect to ERISA-covered plans and IRA assets alike.  In contrast to a narrow, 1975 rule, any persons who render “investment advice for a fee or other compensation, direct or indirect’’ are now fiduciaries, regardless of whether they have direct control over the plan’s or IRA’s assets and regardless of their status as an investment adviser or broker under the federal securities laws.

The regulatory scheme set out in the final regulation governing investment advice fiduciaries cover ERISA-regulated plans, IRAs, and other plans not covered by ERISA, such as Keogh plans, and health savings accounts. As we explained in our earlier post, a person renders investment advice with respect to assets of a plan or IRA if, among other things, the person provides the following types of advice, for a fee or other compensation, whether direct or indirect:

  • A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred or distributed from the plan or IRA; and
  • A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, types of investment account arrangements (brokerage versus advisory), or recommendations with respect to rollovers, transfers or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer or distribution should be made.

A person is treated as a fiduciary to the extent the person either directly or indirectly (e.g., through or together with any affiliate):

  • Represents or acknowledges that the person is acting as a fiduciary;
  • Renders advice pursuant to a written or verbal agreement, arrangement or understanding that the advice is based on the particular investment needs of the advice recipient; or
  • Directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

As a consequence of this newly expanded definition, many retirement advisors who previously were able to circumvent fiduciary status are no longer able to do so.

ERISA and the Code generally prohibit fiduciaries from receiving payments from third parties and from acting on conflicts of interest, including using their authority to affect or increase their own compensation, in connection with transactions involving a plan or IRA.  This prohibition includes certain types of fees and compensation common in the retail market, e.g., brokerage or insurance commissions, 12b–1 fees and revenue sharing payments.  (We will refer to these various types of compensation collectively as “commissions.”)  As a consequence, absent relief, the receipt of commissions by an advisor who, or a financial institution that, provides investment recommendations to a plan or IRA (including rollover recommendations) would result in a prohibited transaction.

The Best Interest Contract (BIC) Exemption—Requirements

The BIC exemption provides relief for the receipt of compensation by advisers and financial institutions, and their affiliates and related entities, “as a result of their provision of investment advice to a ‘retirement investor.’”

The newly issued investment advice fiduciary standards vastly expand the class of individuals deemed to be investment advice fiduciaries, thereby imperiling most forms of commission-based compensation.  The BIC exemption broadly (though not universally) acts to preserve access to commissions provided that the advice is not conflicted and is in the “best interest” of the investor.  The exemption is available to advisers and financial institutions that make investment recommendations to retail “retirement investors,” including plan participants and beneficiaries, IRA owners, and non-institutional (or “retail”) fiduciaries.  In addition to covering asset recommendations, an adviser and financial institution is permitted to provide investment advice regarding the rollover or distribution of assets of a plan or IRA; the hiring of a person to advise on or manage the assets; and the advisability of acquiring, holding, disposing, or exchanging certain common investments.  The exemption permits advisors and financial institutions to continue to receive commissions for providing fiduciary advice, provided that the financial institution/advisor acts in the retirement investor’s best interest, does not receive unreasonable compensation, observes anti-conflict policies, and makes certain required disclosures.

The BIC exemption is not available, however, where a financial institution or advisor is a named fiduciary or plan administrator with respect to an ERISA-covered retirement plan.  Thus, for example, the exemption is not available to in-house plans.  Nor is the exemption available to compensation received as a result of a “principal transaction” (a separate exemption is provided for principal transactions); to compensation received as a result of investment advice by an interactive Web site (i.e., “robo-advice”), unless the advice provider is a “level fee fiduciary” (discussed below); or if the adviser has or exercises any discretionary authority or discretionary control over the investment.

Unlike the proposed rule, the final regulation does not prescribe a list of approved assets.  The Department concluded that it was not competent enough to distinguish between approved asset classes and those that are suspect, but it nevertheless said that it “intends to pay special attention to recommendations involving such products . . . to ensure adherence to the Impartial Conduct Standards and verify that the exemption is sufficiently protective.”  By dropping the limits on asset classes, the Department should not, as a consequence, be seen as endorsing investments that are complex, illiquid, or risky.

The Impartial Conduct Standard

To rely on the BIC exemption, financial institutions generally must:

  • Acknowledge fiduciary status with respect to investment advice to the retirement investor;
  • Adhere to “Impartial Conduct Standards” requiring them to:
    • Give advice that is in the retirement investor’s best interest (i.e., prudent advice that is based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor, without regard to financial or other interests of the adviser, financial Institution, or their affiliates, related entities or other parties);
    • Charge no more than reasonable compensation; and
    • Make no misleading statements about investment transactions, compensation, and conflicts of interest;
  • Implement policies and procedures reasonably and prudently designed to prevent violations of the Impartial Conduct Standards;
  • Refrain from giving or using incentives for Advisers to act contrary to the customer’s best interest; and
  • Fairly disclose the fees, compensation, and material conflicts of interest, associated with their recommendations.
  • Notify the Department of Labor in advance if relying on the BIC exemption. Financial institutions must also retain records that can be made available to the Department and retirement investors for the purpose of evaluating compliance with the exemption.

These requirements are referred to collectively as the Impartial Conduct Standard, which is at the heart not only of the BIC exemption but has also been grafted onto a series of other, previously existing prohibited transaction exemptions that will be the subject of future posts.

Special rule—level fee advisors

Under a special rule, so-called “level fee” fiduciaries and their affiliates that receive only a level fee in connection with advisory or investment management services are provided with a more streamlined compliance process.  Level-fee fiduciaries are not subject to the written contract requirement.  They must, however, prior to or at the same time as the execution of the recommended transaction, confirm their fiduciary status in writing, and they must also comply with the Impartial Conduct Standards and provide written documentation of the reasons for their recommendations in the case of a rollover from an ERISA-covered plan to an IRA.  This documentation must include consideration of the investor’s alternatives to a rollover, including leaving the money in his or her current employer’s plan (if permitted), and it must also take into account, among other things, the fees and expenses associated with both the plan and the IRA.

Proprietary products and third party payments

In response to concerns raised in comments to the proposed regulations, the BIC exemption provides relief to financial institutions that limit investment recommendations to proprietary products and/or investments that generate third party payments.  Financial institutions are permitted to restrict their advisers’ investment recommendations to investments in proprietary products or products that generate third party payments, provided certain requirements are satisfied.  “Proprietary products” are defined to mean “products that are managed, issued or sponsored by the Financial Institution or any of its Affiliates.  And “third party payments” are defined to include:

[S]ales charges that are not paid directly by the plan, participant or beneficiary account, or IRA; gross dealer concessions; revenue sharing payments; 12b–1 fees; distribution, solicitation or referral fees; volume-based fees; fees for seminars and educational programs; and any other compensation, consideration or financial benefit provided to the Financial Institution or an Affiliate or Related Entity by a third party as a result of a transaction involving a plan, participant or beneficiary account, or IRA.

To qualify for the exemption in the case of proprietary products and third party payments, a financial institution must, in addition to satisfying the general BIC exemption requirements, do the following:

  • Inform the plan or retirement investor, in writing, that the financial institution offers proprietary products or receives third party payments. The plan or retirement investor must also be advised of the limitations placed on the universe of investments that the adviser may recommend. The notice is insufficient if it merely states that the financial institution or adviser “may” limit investment recommendations based on whether the investments are proprietary products or generate third party payments, absent specific disclosure of the extent to which recommendations are, in fact, limited on that basis;
  • Fully and fairly inform the retirement investor (in writing) of, among other things, any material conflicts of interest;
  • Document the limitations on the universe of recommended investments; the associated material conflicts of interest; and any services it will provide to retirement investors in exchange for third party payments; and reasonably conclude that the limitations on the universe of recommended investments and material conflicts of interest will not result in the receipt compensation that is not reasonable;
  • Adopt, monitor, implement, and adhere to certain policies and procedures and incentive practices that are specified in the exemption; refrain from using of relying on quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause the adviser to make imprudent investment recommendations;
  • Place the retirement investor’s interests above those of the adviser’s own interests; make recommendations based on the investment objectives, risk tolerance, financial circumstances, and needs of the investor; and
  • Ensure that, at the time of the recommendation, the amount of compensation and other consideration reasonably anticipated to be paid, directly or indirectly, to the adviser, financial institution, or any affiliate or related party is not in excess of reasonable compensation.
  • Ensure that the adviser’s recommendation reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor; and that the adviser’s recommendation is not based on the financial or other interests of the adviser or on the adviser’s consideration of any factors or interests other than the retirement investor’s needs.


When financial institutions or their advisers breach their obligations under the BIC exemption thereby causing losses to retirement investors, the investor is provided a remedy to redress the injury.  In the case of IRAs and non-ERISA plans, the exemption’s enforceable contract requirement provides retirement investors with a right of action under the contract.  While financial institutions generally remain free to require arbitration for individual claims, the BIC exemption confers on IRA investors the right to pursue class action claims in the courts.

Financial institutions and advisers may not rely on the BIC exemption if they include contractual provisions disclaiming liability for compensatory remedies or waiving or qualifying retirement investors’ right to pursue a class action in court.  The exemption does, however, permit financial Institutions to include provisions waiving the right to punitive damages or rescission as contract remedies to the extent permitted by other applicable laws.  As a consequence, the retirement investor is limited to “make-whole relief,” which puts the investor in roughly the same place as the ERISA investor, since ERISA too denies access punitive damages, rescission, and other forms of “extra-contractual” relief.

In the case of ERISA investors (e.g., retirement plan participants, beneficiaries, and fiduciaries), the financial institution need only acknowledge its fiduciary status and that of its advisers.  Unlike with IRAs, no separate contract is required.  ERISA investors can directly enforce their rights to proper fiduciary conduct under the ERISA civil enforcement scheme.

For new customers, the BIC exemption permits the required contract terms to be incorporated in the financial institution’s account opening documents and similar commonly-used agreements. The financial institution may also rely on negative consent process for existing contract holders, provided that the consent does not include new contractual provisions.  Nor (as contemplated by the proposed rule) must the contract be signed at start of retirement investors’ conversations with advisers, as long as it is entered into before or at the same time as the recommended investment transaction.

Effective Dates, Applicable Dates and Grandfathering

The Final Fiduciary and Conflict of Interest Rule is effective as of June 7, 2016.  Recognizing that it will take some time for financial institutions to come into compliance, however, the Department has provided a grandfather rule under which it will apply the BIC exemption to “transactions occurring on or after April 10, 2017.”  The Department refers to this as the rule’s Applicability Date. Among other thing, investments made on or after April 10, 2017, or under a systematic purchase program established before that date based on advice given before that date, are grandfathered.  As a consequence, the receipt of compensation related to the advice is not treated as a prohibited transaction. In contrast, ongoing (e.g., advice to hold) and new advice provided under a grandfathered arrangements is subject to the new requirements. Grandfather status also lapses prospectively with the expiration of the contract under which the grandfathered advice is being provided.

Grandfathered relief for compensation associated with investments made prior to the regulation’s Applicability Date is further extended in the case of the BIC exemption to the period between the Applicability Date and January 1, 2018, subject to more limited conditions.  During this period, firms and advisers must adhere to the impartial conduct standards, provide notice to their retirement investors that, among other things, acknowledges their fiduciary status and describes their material conflicts of interest, and designates a person responsible for addressing material conflicts of interest and monitoring advisers’ adherence to the impartial conduct standards.  Full compliance with the BIC exemption will be required as of January 1, 2018.

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Next week’s installment will examine the first of the five remaining prohibited transactions exemptions created or modified in the DOL’s suite of final fiduciary and conflict of interest rules, i.e., the Class Exemption for Principal Transactions.

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