Written by Shereefat Balogun, Regulatory Compliance Counsel
As many of you know, the Department of Labor recently issued its Fiduciary Duty final rule. Generally, the rule imposes a fiduciary standard of care on broker-dealers and investment advisers that provide investment advice to retirement plan investors. “But credit unions are prohibited from offering investment advice, why is this important to me?” you ask. Great question! The rule affects investment advisory services provided through vendors and credit union service organizations. As such, a credit union that offers investment advisory services through a third-party arrangement or through a CUSO may want to consider how it structures its agreements, and ensure that its third party brokers are compliant. Moreover, while credit unions may not offer investment advice directly, credit unions may at times provide general education on retirement savings. Therefore, it is important to understand what type of communications a credit union may have with its members about retirement accounts without triggering a fiduciary duty.
First things first. Federal credit unions are not authorized to sell nondeposit securities directly to their members. 12 C.F.R. § 721.3(g) states that a credit union may provide investment services to its members through a third party vendor as a finder activity. Moreover, § 721.6 explains that a credit union may earn income for such services. Also, NCUA Letter to Federal Credit Unions 10-FCU-03 reaffirms that credit unions are not authorized to sell nondeposit investments directly to their members. However, the letter explains that while credit unions cannot sell these investments directly to their members, credit unions may offer these services by employing third party brokerage arrangements. Generally, there are three ways to structure these arrangements: (i) CUSOs; (ii) shared employee arrangements with a third party brokerage firm; and (iii) credit union can act as a finder.
Now moving on to the final rule. We’ll break up the Final Rule to make it easier to digest and create a series of usable tools as you delve into it.
- Here’s a link to the Final Rule. This final regulation defines who is a fiduciary, and includes the preamble with rulemaking background, and a section-by section analysis with the provisions of the final rule and public comments.
- There’s a 3-page summary of the major changes which gives a high-level discussion of the major provisions of the rule. View the overview here.
- The actual regulatory text, which is just 6 pages, can be found here.
- Best Interest Contract Exemption. This document contains an exemption from the general prohibition on fiduciaries receiving compensation from third parties in connection with retirement plans and IRAs.
Here’s our general overview of the rule and its regulatory compliance impact on credit unions. The final rule expands the definition of “fiduciary,” and now includes any person who provides recommendations for compensation with respect to a retirement plan or IRA. It is important to note that only recommendations are subject to the rule. A “recommendation” is any communication that would reasonably be viewed as a suggestion that the investor engage in or refrain from taking a particular course of action. The more narrowly tailored the advice is, the more likely the communication will be considered a recommendation. Notably, the rule does delineate activities that are not considered recommendations, and thus are not subject to the fiduciary requirements, such as education. For instance, financial institutions, including credit unions, can provide general education on retirement savings without triggering fiduciary duties under the rule. Similarly, general circulation newsletters and general marketing materials would not fall into the category of recommendations, and are also excluded from the rule’s scope.
As compliance professionals, we understand the importance of rules. We also appreciate the relief that comes with the exceptions to the rules. The final rule provides the “Best Interest Contract Exemption”, which allows a financial institution to continue to use certain compensation arrangements if it meets certain conditions. For example, the exemption requires the financial institution and the adviser to sign a contract with the investor: (i) acknowledging fiduciary status; (ii) committing to adhere to basic standards of impartial conduct; (iii) committing to adopt anti-conflict policies and procedures; and (iv) disclosing any conflicts of interest and the cost of their advice. Credit unions were concerned about the rule’s impact on situations where a credit union shares employees with a broker-dealer. The preamble appears to suggest that in these circumstances, a credit union would not be required to comply with the exemption requirements. Specifically, the text says that the credit union would not have to act as the financial institution, but the broker-dealer would. Credit unions should remember that a shared employee may provide investment advice when doing so exclusively on behalf of the third-party broker-dealer; but not in the employee’s capacity as an employee of a federal credit union. Accordingly, any third-party arrangement should be structured to clearly outline when a shared employee is acting on behalf of the broker-dealer and not as a credit union employee.
For most credit unions offering brokerage services through a third party broker-dealer, compliance with this rule will rest on the third party broker-dealer. The third party offering retirement or IRA services will be responsible for their own compliance with applicable laws and compliance standards. However, credit unions want to ensure that contracts with their third party vendors specifically and clearly outline the duties, responsibilities, and liabilities of each party in the arrangement. Similarly, credit unions may want to make sure that it monitors the vendor’s compliance, as with any third party vendor management relationship. For more information on this rule, NAFCU has issued a Final Regulation which may be helpful.
Also, in case you need a refresher course on NCUA’s guidance concerning credit unions’ ability to offer investment services, please refer to the NCUA letters below:
- NCUA Letter to Credit Unions 10-FCU-03Re: Sales of Nondeposit Investments
- NCUA Legal Opinion Letter 09-0511 Re: Investment Advice Services
- NCUA Legal Opinion Letter 03-0308 Re: Investment Advice and Financial Counseling
- NCUA Legal Opinion Letter 11-0124 Re: Sales of Nondeposit Investments
- NCUA Legal Opinion Letter 03-0736 Re: Providing Investment Services to Nonmembers