Marcia S. Wagner, Esq.

Washington Update:New DOL and

Governmental Initiatives

Introduction – Transformative Changes

Accelerating Pace of Regulatory Change◦Participant investment advice rule◦Plan-level fee disclosures◦Participant-level investment disclosures

Proposals from Lifetime Income Project◦ Lifetime income illustrations◦ Longevity annuities

Watershed: DOL fiduciary proposal◦New fiduciaries◦Stricter compliance◦Rollovers become a fiduciary act

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Agenda

1. Fiduciary Proposal2. Rollovers3. Tax Reform4. Regulatory Initiatives

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Background for DOL Proposal

Evolution of Retirement Marketplace◦Existing “fiduciary” definition was issued in 1975◦Many financial advisors (including brokers) are

not fiduciaries under existing definition

DOL’s Initial Proposal (2010)◦Withdrawn amidst controversy◦DOL releases new proposal on April 20, 2015

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Existing ERISA Definition

Fiduciary Status◦Person who provides “investment advice” relating

to plan assets for compensation◦Not a fiduciary if no investment advice is given

5-Prong Definition for “Investment Advice”◦Making investment recommendations◦On regular basis◦Mutual understanding◦Primary basis for plan’s decisions◦ Individualized to plan’s needs

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Proposed Fiduciary Definition

Fiduciary Status◦Person who provides “investment advice” for

compensation to plans, plan fiduciaries, participants, IRAs and IRA owners

4-Prong Definition for “Investment Advice”◦Making covered recommendations◦Understanding (does not need to be mutual)◦ Individualized or specifically directed to recipient◦ For consideration by recipient (need not be

primary basis)

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Scope of Investment Advice

Covered Recommendations◦ Investment recommendations, including

taking/investing rollovers◦ Investment management recommendations,

including management of rollover assets◦Giving appraisal or fairness opinion◦Recommending person who provides any of

above services for compensation

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Acknowledging Fiduciary Status

Deemed “Investment Advice”◦Advisor makes covered recommendations◦Represents or acknowledges that it is a fiduciary

with respect to advice◦No written acknowledgement is required◦ Fiduciary status applies automatically, even if

proposed 4-prong definition is not met

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Observations on Proposed Definition

Proposed Changes to “Investment Advice”◦ Includes one-time advice (without “regular basis”

condition)◦No need for "mutual understanding” of parties◦Advice merely needs to be specifically directed to

recipient (and does not need to be individualized)◦Recipient merely needs to consider advice when

making decision (even if not “primary basis”)◦Expressly revises definition to cover investment

management recommendations

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Carve-Out for Investment Education

Similar to Current Safe Harbor (IB 96-1)◦Plan Information◦General Financial/Retirement Information◦Asset Allocation Models◦ Interactive Investment Materials

Observations◦Carve-out applies to both plan and IRA clients◦Expanded to include retirement income guidance◦Education must not refer to specific investment

products◦Asset allocation models and interactive materials

cannot reference plan’s investment alternatives10

Proposed Exemption

Need for “ERISA 406(b)” Exemptive Relief◦Proposed “investment advice” definition confers

fiduciary status on all types of advisors◦Prohibited transaction rules ban advisors from

earning variable compensation (commissions)◦Exemption required for brokers and insurance

agents, including advisors to IRAs◦DOL proposed Best Interest Contract Exemption

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Best Interest Contract Exemption (BICE)

Retail Scope of Proposed Exemption◦Permits fiduciary advisor to earn variable

compensation (commissions) for services to: Participants IRA owners Sponsors of small, non-participant-directed plans

(less than 100 participants)

Observations◦No exemptive relief for small, participant-directed

plans (DOL requesting comments)◦No exemptive relief for large plan sponsors

(participant-directed or otherwise)

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Products Covered by BICE

Covered Products◦Bank deposits and CDs◦Mutual funds, ETFs, CIFs and insurance

company separate accounts◦Exchange-traded REITs◦Corporate bonds (registered offering) and equity

securities (exchange-traded)◦ Treasury and agency debt securities◦ Insurance/annuity contracts and GICs

Observations◦No exemptive relief for privately placed debt,

non-traded REITs and alternative investments13

BICE’s Required Contract

Mandatory Terms for Written Contract◦Must state that advisor is fiduciary for

ERISA/Code purposes with respect to advice◦ Impartial Conduct Standard

Advice is in “best interest” of client Reasonable compensation No misleading statements

◦Warranties Compliance with law Policies reasonably designed to mitigate conflicts No incentives to provide improper advice

◦No Liability Limit for Contract Violations Arbitration permitted (with class action rights)

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BICE Disclosures

Disclosures in Written Contract◦Must identify conflicts◦Client’s right to obtain complete fee information◦Whether advisor offers proprietary products or

receives third party payments◦Address of webpage disclosing compensation

Transaction Disclosures◦Upfront chart with cost of investing for 1-, 5- and

10-year periods (model chart may be used)◦Annual disclosures of investment and fee activity

Webpage disclosure of compensation

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Observations on BICE

Regulatory Jurisdiction◦DOL lacks enforcement authority over IRAs◦Required contract gives enforcement authority to

clients◦Violation of Impartial Conduct Standard will

breach contract (but not BIC Exemption)

Impact on Brokers and Insurance Agents◦Will regulate advisors without plan clients (having

only personal IRA clients)◦May be difficult for firms to eliminate incentives

that encourage improper advice

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Timeline for Rulemaking

Initial 75-Day Comment Period◦Proposal released April 20, 2015◦ Initial comment period ended July 21st

Public Hearing◦August 10th – 13th◦ Final comment period after transcripts released

Delayed Applicability Date for Final Rule◦ Final rule effective 60 days after publication◦Requirements of final rule generally not

applicable until 8 months after publication◦Obama Administration’s second terms ends in

January 201717

Concluding Comments: DOL Proposal

Moving to Universal Fiduciary Standard◦DOL is seeking to impose “best interest” fiduciary

standard on all types of advisors to plans/IRAs◦Proposal leverages off of existing “principles-

based” regulatory approach for RIAs

Expected Impact on Advisors◦DOL proposal will affect most advisors because

of reach to IRA assets◦Costly for broker-dealers and insurance agencies ◦ Little or no impact on RIAs, but certain advisors

may decide to join or become RIAs

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Recommendation

Next Steps and Following up◦Be sure to stay abreast of rulemaking process

and consult ERISA counsel as appropriate◦Advisors may wish to re-examine their client

service models and documentation ◦Expect plan sponsors to request confirmation of

fiduciary status of advisors, and whether DOL proposal will impact services or fees

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TOC

1. Fiduciary Proposal2. Rollovers3. Tax Reform4. Regulatory Initiatives

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Agenda

Potential Abuses of Cross-Selling

Issues arising from cross-selling◦Potential conflicts of interest◦Exploiting trust to sell at unfavorable terms

Capturing rollover assets◦Advisor develops relationships with plan sponsor

and participants◦Potential conflict if advisor’s fees on rollover

assets are higher than fees on plan assets

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DOL Guidance

Potential for abuse◦DOL policy concern ◦DOL interpretive guidance for cross-selling of

rollover IRA services◦Starting point: ERISA prohibition against self-

dealing◦Advisor cannot provide fiduciary advice

increasing its compensation

Example◦Advisor’s fiduciary advice steers participants to

fund with highest 12b-1 fee◦Advice is tainted even if provided in good faith

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DOL Rollover Opinion

Advisory Opinion 2005-23A◦Broadly suggests that if an advisor is fiduciary,

any rollover advice to participants may trigger PT◦DOL does not fully explain reasoning◦ If Advisor is not fiduciary, rollover advice will not

trigger PT

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Consequences of DOL Rollover Opinion

Advisors appointed as fiduciaries◦ Fiduciary advisor accepting fiduciary status

generally cannot capture rollover assets

Other advisors◦ If advisor provides “accidental” fiduciary advice,

this advisor becomes a fiduciary◦Advisors accidentally becoming a fiduciary are

subject to restrictions of Rollover Opinion

Proposed definition of fiduciary advice includes rollover recommendations

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Effect of Fiduciary Proposal on Rollover Opinion

Impact on Advisory Opinion 2005-23A◦ If adopted, DOL fiduciary proposal would replace

this Advisory Opinion guidance◦As proposed, any rollover advice would be

fiduciary advice◦Non-fiduciary advisors providing rollover advice

would automatically become plan/IRA fiduciaries

Relief under Proposed Exemption (BICE)◦Advisors would be able to provide rollover advice

and earn higher compensation on rollover assets◦Proposed exemption entails numerous

requirements25

Protective Measures

BICE Relief for IRA Rollovers◦Necessary for advisors earning variable

commission-based compensation◦Also necessary for fee-based advisors if higher

compensation is earned after rollover

Written Contract Requirement◦Best interest standard◦Policy mitigating effects of differential compensation

Disclosures◦Upfront disclosure of projected investment costs◦Annual disclosure of investment and fee activity◦Webpage disclosures on compensation

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Further Protective Measures

Competitive Pricing Information◦Gather pricing data to demonstrate that pricing

for similar clients is competitive

Limiting Scope of Advice◦Draft plan client’s agreement to reduce

parameters of advice ◦Example: Only actively managed mutual funds

will be recommended◦Only funds with 12b-1 fees from 25 to 50 bps will

be considered

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FINRA Regulatory Notice 13-45

Rollover recommendations must be suitable

Factors to be considered by advisor◦ Investment options◦ Fees and expenses◦Services◦Withdrawal penalties◦Creditor protection◦Application of RMD rules

Written Policies ◦Must mitigate conflicts◦ Training for reps◦Policies will need to be revised to comply with

DOL fiduciary proposal and BICE28

TOC

1. Fiduciary Proposal2. Rollovers3. Tax Reform4. Regulatory Initiatives

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Agenda

Administration Push to Increase Access through IRAs

Administration pushing automatic IRAs:◦Mandatory for employers with 10 employees but

no retirement plan◦ 3% default contribution rate◦Choice of traditional pre-tax IRA or after-tax Roth◦Employees allowed to opt out◦Multiple alternatives for selecting IRA provider◦Government designated default investments

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myRA Initiative

myRA Starter IRAs◦Starter program does not require legislative

authorization◦Contributions to Roth accounts◦Permits small investments ($25 / $5)◦ Low rate of return from Treasury bonds◦Maximum $15,000 balance

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How Retirement Plans Affect the Deficit

Impact of retirement plans on federal deficit◦DC / 401(k)

$61 billion (2015) $414 billion (2015 – 2019)

◦DB $42 billion (2015) $235 billion (2015 – 2019)

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Affect of Limiting Contributions 2015 Plan limitations that can be reduced to

limit deficit:◦Annual additions from all sources - $53,000◦Elective deferrals - $18,000◦Plan sponsor deduction - 25% participant

compensation◦Compensation limit to determine

benefits/contributions - $265,000

Limits proposed by Tax Reform Act of 2014◦ Freezes DC limits until 2024◦ $63.4 billion revenue gain over 10 years◦Additional $144 billion from treating half of 401(k)

deferrals as Roth33

General Limits on Exclusions and Deductions

Obama FY 2016 proposed $3.4 million cap on aggregate lifetime contributions◦Cap to vary based on age◦Double tax if prohibited amount not withdrawn

Obama proposal limiting tax deductions for plan contributions◦ 11.6% tax on employer & employee plan

contributions◦ For high earners only◦Basis adjustment for extra tax

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USA Retirement Funds Proposal

USA Retirement Funds proposed by Sen. Tom Harkin

Plan features:◦ Automatic/universal enrollment required by employers

with no plan◦ Regular stream of income starting at retirement age◦ No lump sum withdrawals◦ Financed by employee payroll contributions &

government credits◦ Privately managed investment by new entities: USA

Retirement Funds◦ Limited employer involvement; no fiduciary

responsibility◦ Unspecified level of required employer contributions◦ Employees can raise/lower contributions or opt out

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State Proposals

State-managed plans for private-sector workers◦ Intended to expand access to retirement saving◦States would mange investments◦DOL directed to clarify preemption issue by end

of 2015

California Secure Choice◦Mandatory auto-IRA◦Pooled investments managed by state and

guaranteed returns

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NCPERS Proposal

NCPERS Proposal◦Private-sector workers to be covered by plan

established by state government◦State managed investment and guaranteed

returns◦ Lifetime benefits◦Employer and employee contributions◦Questions as to sufficiency of funding

(backstopped by taxpayers)

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Summing Up Legislative ProposalsSignificant Transformation of Private

Retirement System Possible

Tax Reform◦Reducing tax incentives will shrink system◦ Lower contributions at all income levels result if

tax exclusions cut back

Obama proposal for general limit on benefit from tax exclusions◦Does not focus directly on 401(k) contributions◦Provides political cover◦Same effect on contributions as direct cutback on

excludible amount38

Summing Up Legislative Proposals (cont’d)

Advocacy for Centralization◦Mandated benefits◦Guaranteed benefits and/or investment results◦Creation of new interest groups ◦Government influence over investments could

drive firms out of retirement industry

State-Sponsored Initiatives◦State-level programs may cause breakdown in

uniformity of pension laws◦ Inflection point regarding the types of retirement

schemes nation wants 39

TOC

1. Fiduciary Proposal2. Rollovers3. Tax Reform4. Regulatory Initiatives

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Agenda

Goals of Lifetime Income Initiatives

Help retirees take plan distributions without outliving them◦Motivate retirees to annuitize accounts◦Retirement paycheck for life

Encourage plan sponsors to voluntarily offer annuity options◦Permit longevity annuities◦Remove regulatory hurdles◦ Facilitate default annuities◦Promote education and disclosures

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Current Fiduciary Standard for Selecting Annuities

Selection of Annuity Provider and Annuities◦Subject to ERISA fiduciary standards

Safe harbor: DC Plan Distribution Annuities

◦Procedural prudence ◦ Insurer’s ability to pay◦Cost ◦Draw appropriate conclusions◦Seek expert advice

2015 guidance ◦ Limits period for monitoring and statute of

limitations42

Promoting Longevity Annuities

New IRS regulation relaxes required minimum distribution rules◦RMD rules mandate start at age 70 ½ but

longevity annuities provide income stream for later in life

◦ Final Regulation provides:◦RMD exception for investment in QLAC◦ Investment in QLAC capped at $125,000 or 25%

of account◦QLAC payments to start no later than age 85◦Applies to annuity purchases on/after July 2,

201443

DOL Proposal for Lifetime Income Disclosures

Advance Notice of Proposed Rulemaking◦ Lifetime income illustration in participant

statements ◦Must provide estimated income streams based on:

(1) current account, and

(2) projected account at NRA

Safe Harbor for Projected Account◦Assume 7% investment return◦Assume current contribution level, with 3%

increase◦Use 3% discount rate to convert to current dollars

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In Conclusion:

 Issues driving change◦Asset preservation◦Mitigating longevity risk◦Access to system

 Simplify proposed changes

Avoid changes that downsize system

 Address systemic issues with incentives, not mandates

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Marcia S. Wagner, Esq.

99 Summer Street, 13th FloorBoston, MA 02110(617) 357-5200

www.wagnerlawgroup.commarcia@wagnerlawgroup.com

Washington Update:New DOL and

Governmental Initiatives

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