Outdated Definition of "Investment Advice" Prompted New Rule
Under ERISA, broker-dealers are fiduciaries if, among other things, they “render investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of [a plan], or has any authority or responsibility to do so[.]” 29 U.S.C. § 1002(21)(A)(ii). The threshold determination of fiduciary status is critical because ERISA safeguards employee benefit plan participants by imposing trust law standards of care and undivided loyalty on plan fiduciaries. A breach of such standards exposes the fiduciary to personal liability.
Since 1975, the DOL has employed a five-part test to determine when an individual’s “investment advice” renders them a fiduciary under ERISA. Pursuant to 29 C.F.R. § 2510.3-21(c), fiduciary status applies if a person:
The DOL felt the rule was outdated, noting that it was created “prior to the existence of participant-directed 401(k) plans, widespread investments in IRAs, and the now commonplace rollover of plan assets from fiduciary-protected plans to IRAs.”3
The DOL also was frustrated with the five-part test, feeling that it undermined the purpose of ERISA by erecting a “multi-part series of technical impediments to fiduciary responsibility.”4 It did not believe fiduciary liability should be contingent upon the frequency with which a person advises the plan or plan participant but envisioned a scenario in which a plan relies upon an adviser for one investment decision of “hundreds of millions of dollars,” yet, the adviser would escape fiduciary liability.
Also of concern were the requirements that the advice be the product of a mutual understanding, and that it serve as the primary basis for the investment decision. Generally, broker-dealers do not hold themselves out as investment advisers, and they believe that any “advice” offered to their clients is merely incidental to their brokerage services. Accordingly, broker-dealers tend to avoid fiduciary liability because there is no mutual agreement that their advice will serve as the primary basis for a given investment decision.
The New Definition of Investment Advice
The DOL's Final Rule wholly rewrites 29 C.F.R. § 2510.3-21(c), replacing it with a functional approach intended to better capture the perceived realities of current retirement investment strategies. Pursuant to the Final Rule, a person renders investment advice if such advice is provided directly to a plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner for a fee or other compensation (direct or indirect) in one of the following categories5:
Such advice will warrant fiduciary status, if the recommendation is made by a person who, directly or indirectly:
Moreover, the Final Rule explains that a “recommendation” for purposes of investment advice means that, under the circumstances, the communication would “reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.”7 The more “individually tailored” the communication is to a particular recipient, the more likely the communication will be viewed as a recommendation.
The New Definition's Impact on Wisconsin Broker-Dealers
Wisconsin broker-dealers currently operate under a “suitability” standard—a lesser standard than that applicable to a fiduciary. Unlike registered investment advisers, who are held to a fiduciary standard under the Investment Advisers Act of 1940, broker-dealers need only to “reasonably believe” that their recommendations are suitable in terms of their clients’ financial needs, objectives, and circumstances.8
Because the Final Rule eliminates the technical requirement that investment advice be the product of a mutual understanding that the advice will serve as the primary basis of a given investment decision, broker-dealers will no longer escape fiduciary liability merely because their advice is arguably incidental to their brokerage services. The Final Rule expressly states that “the parties need not have a subjective meeting of the minds on the extent to which the advice recipient will actually rely on the advice.”9 Instead, broker-dealers’ recommendations will usually satisfy the new definition of investment advice, and they will owe their clients a fiduciary duty.
Accordingly, effective April 10, 2017, broker-dealers offering such investment advice must discharge their duties solely in the interest of the plan or plan participant with the care, skill, prudence, and diligence of a prudent man10, and they must refrain from ERISA’s prohibited transactions11 to the extent they do not satisfy any available exemption.12
*This article does not constitute legal advice and should not be relied upon as such. Readers should consult an attorney regarding any legal concerns.1 See Merrill Lynch v. Boeck, 127 Wis. 2d 127, 134, 377 N.W.2d 605, 608 (1985) (holding that “a broker does not have a fiduciary duty to a customer with a nondiscretionary account absent an express contract placing a greater obligation on the broker or other special circumstances”).
___________________________Eric L. Maassen