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Capital Group Policy Spotlight
MAY 20, 2016
Frequently Asked Questions: DOL’s Final Fiduciary Rule
The Department of Labor (DOL) released its final fiduciary rule on April 6, greatly expanding the definition of fiduciary investment advice. Capital Group provides answers to frequently asked questions about this new rule.
Please consult with your home office for guidance on the new rule
The word fiduciary refers to a legal standard that holds certain professional advisors — such as doctors and lawyers — to a requirement that they act in their clients’ best interests. Fiduciaries can be held accountable if they do not uphold this standard.
In the investment advisory context, fiduciary advisors must only recommend investments — such as those in 401(k) plans and individual retirement accounts (IRAs) — that are in their clients’ best interests.
The final DOL rule, which goes into effect April 10, 2017, expands the definition of investment advice. To be held to the fiduciary standard, advice will no longer be required to:
Rollover recommendations will also be considered fiduciary advice.
Most significantly, the DOL fiduciary rule allows for a:
Continue to review the Capital Group Policy Spotlight for updates, new developments and insights.
By broadening the definition of investment advice, the DOL is expanding the fiduciary standard to include retirement investment services that have previously been held to the less restrictive suitability standard. The new rule requires that a recommendation must be not only suitable but in the client’s best interest. It treats broker-dealers and their registered representatives as fiduciary investment advisors whenever they provide investment-related recommendations to retirement plans, plan participants and IRA owners.
Registered investment advisors (RIAs) are already subject to a fiduciary standard of care under the securities laws, but will now have to satisfy the fiduciary standard of care under ERISA, including its rules prohibiting certain transactions unless an exemption applies.
The DOL rule treats as fiduciary advice:
The rule applies only to retirement investments — 401(k)s, IRAs and other related plans. The Securities and Exchange Commission (SEC) may also adopt a fiduciary rule for the broader investment industry in the future.
Generally, fiduciary advisors cannot recommend an investment that could affect their compensation. The regulators believe compensation, like commissions, and 12b-1 fees paid by mutual funds can inappropriately affect the advisor’s judgment in making recommendations. (See the Best Interest Contract (BIC) exemption discussion below.)
With the final fiduciary rule, the DOL prohibits firms from using quotas, bonuses, or contests to compensate advisors. Acceptable pay models include:
The DOL rule does include a pathway for advisors to continue receiving commission, through the Best Interest Contract (BIC) exemption.
The final fiduciary rule includes a BIC exemption that allows advisors to continue to be paid on commission. To qualify for the exemption, the advisor’s firm will have to:
Advisors who are considered fiduciaries under the new DOL rule can generally receive a commission or a 12b-1 fee from an IRA or other retirement plan only if they comply with the terms of a prohibited transaction exemption, like the new BIC exemption.
The new rule includes a grandfather provision for preexisting assets, which is effective through April 10, 2017. Current and/or new IRA clients who are invested in A and C shares will be able to continue receiving advice after the effective date without having to comply with the new BIC exemption, provided that the advice falls within the grandfather exception.
The grandfather exception potentially applies to:
The grandfather exception does not require use of a contract or require new disclosures. It is, however, available only if a hold or exchange recommendation is in the best interest of the investor, the investor pays no more than reasonable compensation and the advisor communicates honestly with the investor.
We believe that the vast majority of investment professionals already act in the best interests of their clients.
This final DOL fiduciary rule imposes new compliance requirements, including a BIC, for certain commissionable transactions. The rule exposes advisors to legal liability should they violate the fiduciary standard.
Under the Employee Retirement Income Security Act of 1974 (ERISA), the DOL has jurisdiction over employee benefits and retirement accounts.
The SEC has been considering a fiduciary rule for the broader investment industry and is likely to propose new rules now that the DOL has released its final ruling on employee benefit and retirement accounts.
The new rule allows advisors to continue doing business under current law — without restriction — prior to the rule’s effective date of April 10, 2017. No new requirements will be effective in 2016.
The rule will go into effect in two parts:
During the period between the rule’s and the BIC exemption’s effective dates, financial advisors who receive commissionable compensation will need to satisfy only a streamlined version of the BIC exemption — one that does not require a contract or new disclosures.
No. The DOL has the authority to implement the rule without congressional involvement. It is possible that Congress could try to take some action to block the new rule from going into effect. However, such an effort would face an uphill battle.
The next president could stop the rule from being implemented; however, a crucial factor would be the extent to which the industry has already moved toward a uniform fiduciary standard when the new administration takes office.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
This material is intended for use by financial professionals or in conjunction with the advice of a financial professional.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.