Financial institutions and advisers that manage retirement plan assets and are subject to the regulations of the Department of Labor (“DOL”) under the Employee Retirement Income Security Act of 1974, as amended, (“ERISA”) regarding fiduciary duties (the “Fiduciary Rule”) may also be subject to state law violations for failure to comply with the Fiduciary Rule. The Enforcement Section of the Massachusetts Division of the Office of the Secretary of the Commonwealth (the “Massachusetts Enforcement Section”) filed an administrative complaint (the “Complaint”) on February 15, 2018 against Scottrade, Inc. (“Scottrade”) claiming violations of a Massachusetts statute due to alleged violations of the Fiduciary Rule.  Given the relief requested in the Complaint and the potential precedent for other states, this action has the potential to be significant, not only for Scottrade, but for other advisers and financial institutions.

Current Status of the Fiduciary Rule

In November 2017, the DOL announced an extension of the applicability date of certain prohibited transaction exemptions under the Fiduciary Rule from January 1, 2018 to July 1, 2019. However, the extension did not apply to the Fiduciary Rule’s “impartial conduct standards” in dealing with retirement investors.  The impartial conduct standards require advisers and financial institutions to give advice that is in the “best interest” of the retirement investor, charge no more than reasonable compensation, and refrain from making misleading statements.

The DOL’s November 2017 announcement also addressed the extension of its temporary enforcement policy through July 1, 2019. Pursuant to the temporary enforcement policy, the DOL will not to pursue claims against fiduciaries who are working diligently and in good faith to comply with the Fiduciary Rule and related exemptions or treat those fiduciaries as being in violation of the Fiduciary Rule and related exemptions.

Contents of the Complaint and Relief Requested

The Complaint alleges that, although Scottrade added new policies to comply with the impartial conduct standards, Scottrade expanded the scale and scope of the sales practices that the new policies were designed to curtail. The new policies stated that “the firm does not use or rely upon . . . contests . . . or other actions or incentives that are intended or reasonably expected to cause associates to make recommendations that are not in the best interests of Retirement Account clients or prospective Retirement Account clients.”  Nevertheless, Scottrade launched two sales contests that ran in violation of these new policies that were designed to ensure compliance with the Fiduciary Rule.  One of the contests placed explicit emphasis on generating retirement assets, which are covered by the Fiduciary Rule.  The Complaint notes that Scottrade “failed to take any meaningful steps to remove retirement assets from the scope of the contests or ensure compliance with the Fiduciary Rule.”

Accordingly, the Complaint charges that Scottrade, by “knowingly violating its own internal policies related to the Fiduciary Rule” and failing to act in good faith to comply with the Fiduciary Rule, violated Section 204(a)(2)(G) of the Massachusetts Uniform Securities Act and the regulations thereunder (the “Act”).  The section of the Act authorizes the imposition of an administrative fine, the suspension or revocation of registration or any other appropriate action if an investment adviser has “engaged in any unethical or dishonest conduct or practices in the securities, commodities or insurance business.”  The Complaint further alleges that Scottrade violated Section 204(a)(2)(J) of the Act because Scottrade “failed reasonably to supervise  . . . investment adviser representatives . . . to assure compliance with this chapter [of the Act].”

The relief requested in the Complaint is extensive. The Massachusetts Enforcement Section requests that an order be entered that, among other things, requires Scottrade  to cease and desist from further conduct in violation of the Act, censures Scottrade, compels Scottrade to disgorge all profits and other remuneration from the alleged violation, and imposes an administrative fine on Scottrade.

Takeaways from the Complaint

The Complaint puts Massachusetts advisers and financial institutions that manage retirement plan assets on notice that state regulators are monitoring compliance with the impartial conduct standards and that the regulators will take action under Massachusetts law to stop conduct that they view as non-compliant. The Complaint should also serve as a warning to all advisers and financial institutions, as regulators in other states may begin to take actions under state law similar to that taken by the Massachusetts Enforcement Section.  Any such actions will be pursuant to state law because the DOL, and not the states, has the authority to enforce ERISA.

To mitigate the risk of a state enforcement action, advisers and financial institutions should first review their internal compliance manuals to ensure that they are consistent with the impartial conduct standards. Second, advisers and financial institutions should review actual practices and procedures to ensure that they comply with the Fiduciary Rule, as well as internal compliance manuals.  Non-conforming manuals and non-compliant practices should be corrected as soon as possible.

Featured on Employment Law This Week: The Department of Labor’s Fiduciary Rule will go into effect on June 9th.

The controversial rule will require financial professionals who advise clients on retirement accounts to promote suitable products and act in the best interests of their clients. Secretary of Labor Alexander Acosta announced in a Wall Street Journal op-ed that there is “no principled legal basis” to delay the rule, although full enforcement won’t begin until 2018. The department intends to issue a Request for Information to seek public opinion on revisions and related exemptions.

Watch the segment below and read our recent post.

The Department of Labor (“DOL”) previously announced the applicability date for the DOL’s fiduciary rule (the “Fiduciary Rule”) will be June 9, 2017.  On May 22, 2017, in an opinion piece for the Wall Street Journal, Labor Secretary Alexander Acosta disclosed that, despite the Administration’s agenda of deregulation, the regulators are required to following existing law and must enforce the Fiduciary Rule.  On the same date, the DOL announced, in Field Assistance Bulletin 2017-02 (“FAB 2017-2”), that during a transition period from June 9, 2017 until January 1, 2018, the DOL will not pursue claims against fiduciaries who are working diligently and in good faith to comply with the Fiduciary Rule and related exemptions or treat those fiduciaries as being in violation of the Fiduciary Rule and related exemptions.  The DOL explained that its general approach to implementation will emphasize assisting plans, plan fiduciaries, and financial institutions with compliance, rather than citing violations and imposing penalties on these parties.

Under FAB 2017-2, during the transition period, financial institutions and advisors are still required to comply with the “impartial conduct standards” in dealing with consumers, which require advisors to follow fiduciary norms and basic standards of fair dealing, which is described in more detail here.

The DOL further stated in FAB 2017-2 that it may still make additional changes to the Fiduciary Rule and the related exemptions. Any such changes would be based on the DOL’s on-going analysis of the issues raised in President Trump’s February 3, 2017 memorandum related to the effect of the Fiduciary Rule on the ability of Americans to gain access to retirement information and financial advice.  The DOL stated that it intends to issue a Request for Information (“RFI”) seeking additional public input on possible changes to the Fiduciary Rule and related exemptions.

In conjunction with FAB 2017-2, the DOL also issued a set of 15 FAQs that cover a variety of topics, including:  implementation of the Fiduciary Rule and related exemptions during the transition period from June 9, 2017 to January 1, 2018; possible future changes to the Fiduciary Rule; robo-advice providers; communications that are not subject to the Fiduciary Rule; and the seller’s carve-out.  A summary of certain of the more significant FAQs follows:

  • The phased implementation schedule applies to the Best Interest Contract Exemption (requiring customers be protected through contractual provisions that advisors will act in the best interests of the customer) and the Principal Transaction Exemption (imposing standards for advice regarding transactions between employer retirement plans and IRAs) during the transition period. Absent further action from the DOL, the transition period ends on January 1, 2018 and full compliance with all of the conditions of these exemptions will be required for financial institutions and advisers.
  • Parties subject to the Fiduciary Rule need not come into compliance until 11:59 PM local time on June 9, 2017 and will not be treated as fiduciaries under the Fiduciary Rule before then.
  • The RFI to be issued by the DOL will ask for comment on whether an additional delay in the January 1, 2018 applicability date would allow for more effective retirement investor assistance and help avoid excessive expense. The DOL notes that, by granting additional time, it may be possible for firms to create a compliance mechanism that is less costly and more effective than the interim measures that that they might otherwise use. By way of example, the DOL mentions that the possible use of “clean shares” in the mutual fund market to mitigate conflicts of interest is likely not going to be ready for implementation by January 1 2018. “Clean shares” sold by the broker would not include any form of distribution-related payment to the broker. Instead, the financial institution could set its own commission levels uniformly across the different mutual funds that advisers may recommend. As long as the compensation is reasonable, the DOL states that this approach would be an optimal means of reducing conflicts of interest with respect to mutual fund recommendations.
  • During the transition period, financial advisers subject to the BIC Exemption will satisfy its requirements by complying with the impartial conduct standards, even if the adviser recommends proprietary products or investments that generate commissions or other payments that vary with the investment recommended. The DOL, however, expects financial institutions to adopt the policies and procedures that they reasonably conclude are necessary to ensure that the advisers comply with the impartial conduct standards during the transition period.

Take-Aways

Financial advisers and institutions that provide investment advice must be in compliance with the Fiduciary Rule as of 11:59 PM on June 9, 2017. For the BIC Exemption, Principal Transaction Exemption and the prohibited transaction exemptions amended by the DOL in connection with the Fiduciary Rule, implementation will be phased, beginning on June 9, 2017 with full compliance on January 1, 2018, subject to further action by the DOL. During the transition period, financial institutions and advisors must work diligently and in good faith to comply with the impartial conduct standards of the Fiduciary Rule.

Advisers and financial institutions that provide fiduciary investment advice have an additional 60 days before having to comply with the final regulations defining who is a fiduciary under the Employee Retirement Income Security Act of 1974, as amended (the “Fiduciary Rule”).  On April 4, 2017, the Department of Labor (“DOL”) issued a final rule (the “Final Rule”), which delays the applicability date of the Fiduciary Rule until June 9, 2017 and also extends for 60 days the applicability dates of the Best Interest Contract Exemption (the “BIC Exemption”) and the Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRA (the “Principal Transaction Exemption” and collectively, the “Exemptions”).  Advisers and financial institutions relying on the Exemptions as of June 9 need only comply with the impartial conduct standards (as explained below), as the remaining conditions of the Exemptions will not become effective until January 1, 2018, if not withdrawn or revised.  The 60-day delay was proposed by the DOL on March 2, 2017, in response to a directive from President Trump to review the Fiduciary Rule (the “President’s Memorandum”), as explained in this article.

In the Final Rule, the DOL explains that, while its review of the Fiduciary Rule is likely to take more than 60 days, a delay in the application of the Fiduciary Rule and impartial conduct standards for an extended period would not be appropriate, given the DOL’s previous findings of ongoing injury to retirement investors. The impartial conduct standards require advisers and financial institutions to:

  • Give advice that is in the “best interest” of the retirement investor. This best interest standard has two chief components – prudence and loyalty;
  • Charge no more than reasonable compensation; and
  • Make no misleading statements about investment transactions, compensation, and conflicts of interest.

For this reason, the DOL concludes that it can best protect the interests of retirement investors in receiving sound advice, provide greater certainty to the public and minimize the risk of unnecessary disruption by extending the applicability date to June 9, 2017 for the Fiduciary Rule and the impartial conduct standards in the Exemptions. Compliance with the other conditions of the Exemptions, such as requirements to make specific disclosures and representations of fiduciary compliance in written communications with investors is not required until January 1, 2018, by which time the DOL intends to complete the examination directed by the Presidential Memorandum.

The DOL cites the following advantage of the approach set forth in the Final Rule:

  • With the June 9,2017 applicability date for the impartial conduct standards, provides retirement investors with the protection of basic fiduciary norms and standards of fair dealing, while honoring the directive in the President’s Memorandum to review any potential undue burdens.
  • By delaying implementation of the other conditions of the Exemptions until January 1, 2018, eliminates or mitigates the risk of litigation in the IRA marketplace, which was one one of the chief concerns expressed by the financial services industry in connection with the Fiduciary Rule and the Exemptions.
  • Addresses concerns of the financial services industry about uncertainty over whether they need to immediately comply with all of the requirements of the Exemptions.

The DOL leaves open the possibility that it may further extend the January 1, 2018 applicability dates or to grant additional interim relief. The DOL states that the Final Rule does not foreclose the DOL from considering and making changes to the Fiduciary Rule and the Exemptions, based on new evidence or analyses developed pursuant to the President’s Memorandum.

Takeaways for Advisers and Financial Institutions

Effective June 9, 2017, advisers and financial institutions that provide fiduciary investment advice to retirement plan investors will have to comply with the Fiduciary Rule and the impartial conduct standards in the Exemptions. Since, in the view of the DOL, these provisions are generally the least controversial aspects of the DOL’s changes to the rules related to fiduciary investment advice, compliance with the June deadline most likely will not be difficult, especially in light of the 60-day delay.

However, advisers and financial institutions should also look past June 9 to the January 1, 2018 deadline and determine if they will delay or adjust their implementation schedule to meet that deadline. Those advisers and institutions that assume the Fiduciary Rule and Exemptions will be significantly revised or rescinded may want to consider significantly delaying the implementation process pending additional guidance from the DOL.  Alternatively, some of these advisers and institutions may want to consider whether they will incorporate all or portions of the Fiduciary Rule and Exemptions into their business practices, even if rescinded by the DOL.

Sharon L.  LippettThe Department of Labor (“DOL”) has issued a proposed rule (the “Proposed Rule”) that would delay for 60 days (the “60-Day Delay”) the April 10, 2017 applicability date of the DOL’s new fiduciary rule (the “Fiduciary Rule”). Given the potential change in the applicability date, financial services institutions will need to determine if they will continue their work toward implementation of the Fiduciary Rule or if they will delay their efforts.

The Proposed Rule provides for a 15-day comment period on the proposed 60-Day Delay and then a 45-day comment period regarding the examination to be conducted by the DOL, as described below.  The 60-Day Delay would become effective on the date that the final version of the Proposed Rule is published in the Federal Register.  Therefore, at this time, the date on which the 60-Day Delay would end is uncertain.

The 60-Day Delay is in response to President Trump’s February 3, 2017 directive to the DOL to examine whether the Fiduciary Rule “may adversely affect the ability of Americans to gain access to retirement information”. The President further directed the DOL to examine whether:

  • The Fiduciary Rule has harmed investors due to a reduction in the availability of retirement savings offerings or financial advice;
  • The anticipated April 10 applicability date has caused disruptions in the retirement services industry that may adversely affect investors or retirees; and
  • The Fiduciary Rule is likely to cause an increase in litigation and in the prices that investors must pay to gain access to retirement services.

Based on the outcome of the examination, the DOL may have to rescind or revise the Fiduciary Rule. If the DOL concludes that the Fiduciary Rule will harm investors in one of the ways described above or is inconsistent with the priority of the Administration to empower Americans to make their own financial decisions, to save for retirement and to withstand unexpected financial emergencies, the Administration has directed the DOL to either rescind or revise the Fiduciary Rule.

The DOL states that it is proposing the 60-Day Delay because the time remaining until April 10 may not be sufficient for the DOL to complete the examination required by the President’s directive. The DOL further explains that, if the Fiduciary Rule is rescinded or revised, the 60-Day Delay would  mitigate disruption for retirement investors and financial advisers, as they would have to face one, rather than two, major changes in the regulatory environment.

Considerations for Financial Institutions

The 60-Day Delay requires financial institutions to decide if they are going to continue to work toward implementation of the changes necessary to comply with the Fiduciary Rule or if they will delay their efforts, pending the outcome of the DOL’s examination. Either approach carries some risks.  Financial institutions that continue work related to implementation may have to revise some of the changes that they have implemented if the DOL revises the Fiduciary Rule.  Financial institutions that delay work on implementing the Fiduciary Rule may find themselves scrambling to meet the new applicability date once it is known.  With either approach, if the DOL rescinds the Fiduciary Rule, financial institutions will need to determine the extent to which they will maintain the changes that they have implemented or are in the process of implementing.