Written by Benjamin M. Litchfield, Regulatory Compliance Counsel
Happy Monday to all of you out there in regulatory compliance land. Since our May 13, 2016 blog, we have received some questions from our members regarding whether the U.S. Department of Labor’s Fiduciary Duty Rule applies to credit unions. Since the rule is somewhat complex and guidance from the Department of Labor is still forthcoming, this blog breaks down some of the more apparent ways that credit unions can find themselves subject to the requirements of the rule.
Before diving into the rule, it is important to dispel a major misconception that may cause some confusion. NCUA has traditionally stated that federal credit unions may not act as broker-dealers in securities or provide investment advice of the type that would render them “investment advisers” under state or federal securities laws. See, NCUA Letter to Federal Credit Unions 10-FCU-03 (Dec. 2010) (broker-dealers); NCUA Legal Opinion Letter 09-0511 (June 3, 2009) (investment advisers). While the Fiduciary Duty Rule covers these types of activities, it also covers transactions and relationships that have traditionally escaped scrutiny under federal securities laws, including a significant number of transactions and relationships relating to individual retirement accounts (IRAs).
It is also important to note that not every communication will rise to the level of fiduciary investment advice. The requirements of the rule are triggered when an individual provides a “recommendation” regarding certain specified activities. The rule defines a “recommendation” as “a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.” 29 C.F.R. § 2510.3-21(b)(1). Our May 13, 2016 blog discusses the exceptions to this definition, some of which are also provided below, including an exception for generalized marketing materials. All of that being said, here are some of the more common ways that credit unions may be subject to the Fiduciary Duty Rule.
Finder’s Fees. One of the most likely circumstances where a credit union might find itself owing a fiduciary duty to a member is if the credit union recommends an investment advisory CUSO to the member to either set up an IRA or create an employee welfare benefit plan (if the member is a business) and receives a finder’s fee or any other compensation from the CUSO for the referral. This is because the Fiduciary Duty Rule defines “investment advice” to include “a recommendation as to the…selection of other persons to provide investment advice or investment management services.” 29 U.S.C. § 2510.3-21(a)(1)(ii). The Department explained its rationale for this requirement in the preamble to the final rule:
The Department continues to believe that the recommendation of another person to be entrusted with investment advice or investment management authority over retirement assets is often critical to the proper management and investment of those assets and should be fiduciary in nature. Recommendations of investment advisers or managers are no different than recommendations of investments that the plan or IRA may acquire and are often, by virtue of the track record or information surrounding the capabilities and strategies that are employed by the recommended fiduciary, inseparable from the types of investments that the plan or IRA will acquire. For example, the assessment of an investment fund manager or management is often a critical part of the analysis of which fund to pick for investing plan or IRA assets. That decision thus is clearly part of a prudent investment analysis, and advice on that subject is, in the Department’s view, fairly characterized as investment advice. Failing to include such advice within the scope of the final rule carries the risk of creating a significant gap or loophole.
81 Fed. Reg. 20964, 20968 (Apr. 8, 2016). One thing to note is that under this new fiduciary duty regime, many traditional compensation structures used by financial institutions and investment advisory affiliates would be prohibited. In order to preserve some of these, the Department created the Best Interest Contract Exemption which was also published in the Federal Register on the same day as the Fiduciary Duty Rule. More details about this exemption are covered in our May 13, 2016 blog.
Recommending Rollovers. Another common circumstance where a credit union might find itself owing a fiduciary duty to a member is if the credit union recommends that the member rollover an existing IRA into a product offered by the credit union or recommend a transfer. This is because an individual is also considered to be providing “investment advice” under the Fiduciary Duty Rule if he or she makes recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, “including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made.” 29 C.F.R. § 2510.3-21(a)(1)(ii). The Department also explained its rationale with respect to this requirement in the preamble:
The Department continues to believe that decisions to take a benefit distribution or engage in rollover transactions are among the most, if not the most, important financial decisions that plan participants and beneficiaries, and IRA owners are called upon to make. The Department also continues to believe that advice provided at this juncture, even if not accompanied by a specific recommendation on how to invest assets, should be treated as investment advice under the final rule. The final rule thus adopts the provision in the proposal and supersedes Advisory Opinion 2005–23A. The advisory opinion failed to consider that advice to take a distribution of assets from a plan is actually advice to sell, withdraw, or transfer investment assets currently held in a plan. Thus, a distribution recommendation involves either advice to change specific investments in the plan or to change fees and services directly affecting the return on those investments. Even if the assets will not be covered by ERISA or the Code when they are moved outside the plan or IRA, the recommendation to change the plan or IRA investments is investment advice under ERISA and the Code. Thus, recommendations on distributions (including rollovers or transfers into another plan or IRA) or recommendations to entrust plan or IRA assets to a particular IRA provider would fall within the scope of investment advice in this regulation, and would be covered by Title I of ERISA, including the enforcement provisions of section 502(a). Further, in the Department’s view, recommendations to take a distribution or rollover to an IRA and recommendations not to take a distribution or to keep assets in a plan should be treated the same in terms of evaluating whether the communication constitutes fiduciary investment advice.
81 Fed. Reg. at 20964. Since many discussions regarding rollovers or transfers may begin at the teller line, this means that credit unions may want to consider what sorts of marketing strategies they employ when trying to offer these types of products to members. Furthermore, the fact that a credit union making a recommendation to rollover or transfer an IRA may be considered a fiduciary under the Department’s rule may require a larger conversation regarding what sorts of products are marketed to members through mailings or other publications and what sorts of products are offered at the teller line as part of a daily member-teller encounter.
Exceptions. As I discussed above, not every communication will subject a credit union to the requirements of the rule. For example, investment education services offered to a plan, plan fiduciary, plan participant or beneficiary, an IRA or IRA owner are not typically considered “recommendations” provided that they do not include investment advice regarding specific investment products. 29 C.F.R. § 2510.3-21(b)(2)(iv). General plan information; financial, investment, and retirement information; information about asset allocation models; and some interactive investment materials such as questionnaires, worksheets, and software typically fall within this exception. 29 C.F.R. § 2510.3-21(b)(2)(iv)(A)-(D). Therefore, credit unions that offer these services as a member service can continue to offer these types of education materials without being considered to have offered investment advice under either ERISA or the Code.
These are some of the more common ways that credit unions can become fiduciaries under the Department of Labor’s new rule. Luckily, the rule is not effective until next year so credit unions have some time to review compensation structures and arrangements now to determine how this rule will impact credit union operations and relationships with affiliates. The rule becomes effective on April 10, 2017.