Wisconsin is home to over 10,000 registered broker-dealers, all of whom currently operate without owing federally imposed fiduciary duties. Unlike some of their peers in other states, Wisconsin broker-dealers generally do not owe common law fiduciary duties under the state’s laws¹. However, the U.S. Department of Labor (DOL) recently finalized a rule that will impose fiduciary duties on Wisconsin broker-dealers if they offer investment advice as defined under the Employee Retirement Income Security Act (ERISA) and the tax code — such as employer sponsored retirement plans and IRAs². In light of this development, it is imperative that broker-dealers operating in Wisconsin review their existing business and familiarize themselves with the new rule.

Outdated Definition of "Investment Advice" Promoted New Rule

Under ERISA, broker-dealers are fiduciaries if, among other things, they “render investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of [a plan], or has any authority or responsibility to do so[.]” 29 U.S.C. § 1002(21)(A)(ii). The threshold determination of fiduciary status is critical because ERISA safeguards employee benefit plan participants by imposing trust law standards of care and undivided loyalty on plan fiduciaries. A breach of such standards exposes the fiduciary to personal liability.

Since 1975, the DOL has employed a five-part test to determine when an individual’s “investment advice” renders them a fiduciary under ERISA. Pursuant to 29 C.F.R. § 2510.3-21(c), fiduciary status applies if a person:

1. Renders advice as to the value of securities or other property, or makes a recommendation as to the purchase or sale of securities or other property

2. Provides this advice on a regular basis

3. Advises pursuant to a mutual agreement, arrangement, or understanding between such person and the plan or a plan fiduciary

4. Finds that the advice serves as the primary basis for investment decisions with respect to plan assets

5. Individualizes the advice to the particular needs of the plan

The DOL felt the rule was outdated, noting that it was created “prior to the existence of participant-directed 401(k) plans, widespread investments in IRAs, and the now commonplace rollover of plan assets from fiduciary-protected plans to IRAs.”³

The DOL also was frustrated with the five-part test, feeling that it undermined the purpose of ERISA by erecting a “multi-part series of technical impediments to fiduciary responsibility.”⁴ It did not believe fiduciary liability should be contingent upon the frequency with which a person advises the plan or plan participant but envisioned a scenario in which a plan relies upon an adviser for one investment decision of “hundreds of millions of dollars,” yet, the adviser would escape fiduciary liability.

Also of concern were the requirements that the advice be the product of a mutual understanding, and that it serve as the primary basis for the investment decision. Generally, broker-dealers do not hold themselves out as investment advisers, and they believe that any “advice” offered to their clients is merely incidental to their brokerage services. Accordingly, broker-dealers tend to avoid fiduciary liability because there is no mutual agreement that their advice will serve as the primary basis for a given investment decision.

The New Definition of Investment Advice

The DOLs Final Rule wholly rewrites 29 C.F.R. § 2510.3-21(c), replacing it with a functional approach intended to better capture the perceived realities of current retirement investment strategies. Pursuant to the Final Rule, a person renders investment advice if such advice is provided directly to a plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner for a fee or other compensation (direct or indirect) in one of the following categories⁵:

• Investment recommendations regarding securities or other investment property

• Investment management recommendations regarding securities or other investment property⁶

Such advice will warrant fiduciary status, if the recommendation is made by a person who, directly or indirectly:

• Represents/acknowledges that they are acting as a fiduciary under ERISA or the tax code

• Provides advice pursuant to a written or verbal agreement, arrangement, or understanding that the advice is individualized

• Directs the advice to a specific recipient or recipients regarding the advisability of a particular investment or management decision related to securities or other investment property of the plan or IRA

Moreover, the Final Rule explains that a “recommendation” for purposes of investment advice means that, under the circumstances, the communication would “reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.”⁷ The more “individually tailored” the communication is to a particular recipient, the more likely the communication will be viewed as a recommendation.

The New Definition's Impact on Wisconsin Broker-Dealers

Wisconsin broker-dealers currently operate under a “suitability” standard—a lesser standard than that applicable to a fiduciary. Unlike registered investment advisers, who are held to a fiduciary standard under the Investment Advisers Act of 1940, broker-dealers need only to “reasonably believe” that their recommendations are suitable in terms of their clients’ financial needs, objectives, and circumstances.⁸

Because the Final Rule eliminates the technical requirement that investment advice be the product of a mutual understanding that the advice will serve as the primary basis of a given investment decision, broker-dealers will no longer escape fiduciary liability merely because their advice is arguably incidental to their brokerage services. The Final Rule expressly states that “the parties need not have a subjective meeting of the minds on the extent to which the advice recipient will actually rely on the advice.”⁹ Instead, broker-dealers’ recommendations will usually satisfy the new definition of investment advice, and they will owe their clients a fiduciary duty.

Accordingly, effective April 10, 2017, broker-dealers offering such investment advice must discharge their duties solely in the interest of the plan or plan participant with the care, skill, prudence, and diligence of a prudent man¹⁰, and they must refrain from ERISA’s prohibited transactions¹¹ to the extent they do not satisfy any available exemption.¹²

^{1 See Merrill Lynch v. Boeck, 127 Wis. 2d 127, 134, 377 N.W.2d 605, 608 (1985) (holding that “a broker does not have a fiduciary duty to a customer with a nondiscretionary account absent an express contract placing a greater obligation on the broker or other special circumstances”).}

^{2 Final Rule, Definition of the Term “Fiduciary”; Conflict of Interests Rule—Retirement Investment Advice, 81 Fed. Reg. 20946 (published April 8, 2016) (“Final Rule”).}

^{3 Id.}

^{4 Id. at 20955.}

^{5 This article is not intended to serve as an exhaustive analysis of the Final Rule. Readers are encouraged to read the full text of the rule, available at: https://www.gpo.gov/fdsys/pkg/FR-2016-04-08/pdf/2016-07924.pdf.}

^{6 Final Rule, 20997. Please note that these categories include recommendations regarding rollovers of ERISA plan assets into non-ERISA plan IRAs.}

^{7 Id.}

^{8 FINRA Manual, Rule 2111.}

^{9 Final Rule, 20970.}

^{10 See 29 U.S.C. § 1104(a).}

^{11 See 29 U.S.C. § 1106.}

^{12 Along with redefining “investment advice,” the Department finalized two new exemptions, and amended several others—most notably, the Department created the “Best Interest Contract Exemption” as a new way retirement advisers can receive otherwise prohibited compensation related to their investment advice, while still ensuring that retirement investors receive advice in their best interest.}