marcia s. wagner, esq. washington update: new dol and governmental initiatives

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

2

Agenda

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

3

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DOL’s Initial Proposal (2010)◦Withdrawn amidst controversy◦DOL releases new proposal on April 20, 2015

4

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

5

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)

6

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

7

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

8

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

9

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

11

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)

12

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)

14

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

15

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

16

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

18

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

19

TOC

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

20

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

21

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

22

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

23

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

24

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

26

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

27

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

29

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

30

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

31

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)

32

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

34

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

35

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

36

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)

37

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

40

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

41

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

44

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

45

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

A0174111