Although the DOL Fiduciary Rule and related prohibited transaction exemptions are not officially dead until the Court of Appeals for the Fifth Circuit issues its mandate vacating the rule in toto, an event anxiously awaited by the financial industry, recent attention has been focused on the proposed guidance by the SEC (for our newsletter summary click here) particularly the proposed Regulation Best Interest. Although it will likely be some time before this guidance is issued in final form, and there will likely be some significant changes between the proposed rule and the final rule, it is nonetheless useful to understand the scope of the guidance in its current form.
The Regulation Best Interest is applicable to certain transactions between broker-dealers and a retail customer, defined as “a person, or the legal representative of such person, who: (1) receives a recommendation of any securities transaction or investment strategy involving securities from a broker-dealer or a natural person who is associated with a broker-dealer; and (2) uses the recommendation primarily for personal, family, or household purposes.” Thus, while the definition applies to persons, not simply natural persons, an ERISA plan could qualify as a person, but it could not satisfy the second prong of the definition, and therefore would not be a retail customer.
However, the proposed regulation could apply to a non-ERISA plan, such as a non-ERISA 403(b) plan. While the convergence of 403(b) plans and 401(k) plans may have reduced the number of arrangements in this category, the exclusion under the DOL regulations still exists. Under those regulations, a tax-sheltered annuity program that is funded solely through salary reduction contributions or an agreement to forego a salary increase, is not considered to be established or maintained by an employer and, therefore, is not considered a pension plan under Title I of ERISA if: (i) employee contributions are completely voluntary; (ii) all rights under the contract or annuity are enforceable by the employee; (iii) the employer’s involvement is limited; and (iv) the employer receives no compensation, direct or indirect, in cash or otherwise, other than reasonable reimbursement to cover expenses involved in performing the employer’s obligations under the salary reduction agreement. If these conditions are satisfied, then the employee owning the annuity contract would likely be treated as a “retail customer” and subject to the protections of the Best Interest rules. To that end, although they are treated differently for tax purposes, the participant in the non-ERISA 403(b) plan would seem to be in the analogous position to the owner of an IRA.
As a final thought, fixed annuities and fixed indexed annuities are insurance products, not securities, so the SEC cannot regulate them. Variable annuities are securities and are regulated by the SEC. Since some 403(b) arrangements are funded with fixed and fixed annuity insurance products, state insurance departments might consider adopting the SEC Best Interest standard.