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News May 14, 2018 Issue

DOL Won’t Enforce Prohibited Transactions Claims in Light of Court Action

The last rites for the Department of Laborís Fiduciary Rule are turning out to be an extended affair.

First there were the delays initiated in 2017 as to when the Rule or its related†exemptions would take effect (ACA Insight, 12/4/17). Then there was the SECís April proposal of its own Best Interest Rule and related proposals (ACA Insight, 4/23/18), followed by the May 2 ruling of a federal appellate court vacating the entire DOL Rule and the exemptions. The latest is a May 7 bulletin from the DOL informing investment adviser fiduciaries that the Department will not enforce prohibited transactions claims against them until further regulations, exemptions or guidance are issued.

"The Department will not pursue prohibited transactions claims against investment advice fiduciaries who are working diligently and in good faith to comply with the impartial conduct standards for transactions that would have been exempted in the Best Interest Contract Exemption and Principal Transactions Exemption, or treat such fiduciaries as violating the applicable prohibited transaction rules," the DOL said in Field Assistance Bulletin No. 2018-02.

In taking this step, the Department noted that the U.S. Court of Appeals for the Fifth Circuit had issued an opinion "vacating the entire Fiduciary Rule, the BIC Exemption, the Principal Transactions Exemption, and related amendments. . . . The Department understands that financial institutions, advisers and retirement†investors may have questions regarding the investment advice fiduciary definition and related exemptive relief following the courtís order." The DOL added that it "plans to provide appropriate guidance in the future."

Non-enforcement for vacated standards

There may appear to be a potential problem in the DOLís statement that it will not take enforcement action against financial advisers that violate the impartial conduct standards. Those standards were created as part of the BIC Exemption Ė which was vacated by the appellate court. So if the Exemption and its impartial conduct standards no longer exist, why is a non-enforcement policy needed?

"Some financial firms may have restructured their†relationships and contracts to rely on the Best Interest Contract Exemption," said Mayer Brown partner Lennine Occhino. "But now that the exemption has been retroactively vacated, they may feel at risk of liability for conflicting conduct that could have been fiduciary in†nature even under the fiduciary definition that preceded the DOL Fiduciary Rule. So the DOLís non-enforcement position appears to be intended to address that potential gap. The DOL is giving such firms the benefit of the BIC Exemption based on their good faith compliance with the standard, even though the exemption has been vacated."

The field assistance bulletin "is designed to allay concerns and confusion over just what needs to be done to avoid a prohibited transaction based on non-discretionary advice," said Stradley Ronon partner George Michael Gerstein. "Since last year, many firms have been fashioning their own ways to adhere to the impartial conduct standards for this very reason.†FAB 2018-02 allows firms to continue relying upon such a compliance approach until the DOL decides to issue more formal guidance."

"While the impartial conduct standards were an essential part of the Best Interest Contract Exemption, they have been effectively decoupled from that exemption because of the Fifth Circuit decision," he said. "One can now consider the impartial conduct standards as a standalone compliance strategy for certain prohibited transactions."

The DOL said that it is "aware that some financial†institutions may be uncertain as to the breadth of the prohibited transaction exemptions that remain available for investment advice fiduciaries following the courtís order. The uncertainty about fiduciary obligations and the scope of exemptive relief could disrupt†existing investment advice arrangements to the detriment of retirement plans, retirement investors, and†financial institutions."

"Further," the Department continued, "some financial institutions have devoted significant resources to comply . . . and may prefer to continue to rely upon the new compliance structures."

The future

In terms of future regulation, exemption or guidance, the DOL said that it "is evaluating the need for other temporary or permanent prohibited transaction relief for investment advice fiduciaries, including possible prospective and retroactive prohibitive transaction relief."

That said, it should be noted that Labor secretary Alexander Acosta, not long after taking office,†expressed a willingness to work with the SEC on†developing best interest standards for broker-dealers. He and SEC chairman Jay Clayton reportedly conferred at least once, and both government entities, according to Claytonís testimony before Congress in September 2017, were working together over the steps to take (ACA Insight, 10/2/17).

After some months, the SEC proposed its own Best Interest Rule for broker-dealers, an interpretation of the existing fiduciary duty that advisers have been working under, and more. The proposals apply to all asset managers that are fiduciaries, not just those handling retirement accounts, as the DOLís Rule did. Whatever the DOL proposes in the future, it is expected to fit into whatever final rules the SEC comes up with.

The current situation, with the DOL Rule vacated and the SEC proposals a long way from being adopted, is that the definition of what constitutes a fiduciary, at least for ERISA purposes, will return to the 1975 ERISA five-part definition, said Skadden Arps ERISA counsel Jeffrey Lieberman. Under that definition an adviser was considered a fiduciary if it:

  • provides advice as to the value of securities or other property,
  • on a regular basis,
  • pursuant to a mutual agreement or understanding with the plan or plan fiduciary
  • that the advice will serve as a primary basis for investment decisions, and
  • the advice is individualized to the particular needs of the plan or IRA.

One possibility of what the DOL might attempt in the†future is to "refine its thinking of elements of the five-part test," Lieberman said. "One of the DOLís concerns that led to the now-vacated Fiduciary Rule was that some advisers and brokers tried to position themselves so they would not be defined as fiduciaries. Changes to the test might allow more people to be classified as fiduciaries."

These efforts might occur even if an SEC Best Interest Rule for broker-dealers is adopted because Commission rules apply only to advisers and broker-dealers, and only to securities, he said. "Changes to interpretation of elements of the five-part test might encompass a wider group of service providers."