Fiduciary Issues

A Department of Labor proposed rule restating the Voluntary Fiduciary Correction Program (VFCP) has left the Federal Office of Management and Budget—suggesting that official release may come soon.

The VFCP is a voluntary enforcement program that allows plan officials to identify and correct certain transactions, such as delinquent participant contributions, sales and exchanges, improper loans, and improper plan expenses. The VFCP was last updated in 2006.

The Securities and Exchange Commission (SEC) has released a final rule to amend requirements for shareholder reports for mutual funds and exchange-traded funds (ETFs) and rules for investment company advertisements. The SEC has identified in its press release several highlights of the final rule.

Shareholder Reports Tailored to the Needs of Retail Shareholders

The Commission’s final rule amendments will require mutual funds and ETFs that are registered on Form N-1A (“open-end funds” or “funds”) to transmit to shareholders concise and visually engaging annual and semi-annual reports that highlight information that is particularly important for retail shareholders. The final rule amendments also facilitate funds’ ability to make electronic versions of their shareholder reports more user-friendly and interactive.

Availability of Additional Information on Form N-CSR and Online

The new rules will require that funds make available online certain information that may be more relevant to investors and financial professionals who desire more in-depth information. This information also must be delivered free of charge upon request and filed on a semiannual basis on Form N-CSR. This information includes, for example, a fund’s schedule of investments and other financial statement elements.

Amendments to the Scope of Rule 30e-3 to Exclude Open-End Funds

The SEC adopted amendments to exclude open-end funds from the scope of rule 30e-3, which generally permits certain registered investment companies to satisfy shareholder report transmission requirements by making these reports and other materials available online and providing a notice of the reports’ online availability, instead of directly providing the reports to shareholders.

Fee and Expense Information in Investment Company Advertisements

The final rule amendments require that presentations of investment company fees and expenses in advertisements and sales literature by registered investment companies and business development companies be consistent with relevant prospectus fee table presentations and be reasonably current. The rule amendments also address representations of fees and expenses that could be materially misleading.

The final rule amendments will become effective 60 days after publication in the Federal Register. The SEC is providing an 18-month transition period after the effective date of the final rule amendments to allow open-end funds adequate time to adjust their shareholder reports and comply with the rule 30e-3 changes. The SEC is also providing an 18-month transition period after the effective date to comply with the final rule amendments to the advertising rules. The final rule amendments that address representations of fees and expenses that could be materially misleading apply on the effective date.

The Securities and Exchange Commission (SEC) has released a proposed rule to prohibit investment advisers from outsourcing certain services or functions without first meeting due diligence and ongoing monitoring requirements related to the “covered function”. A covered function is a function or service that is

• necessary to provide advisory services in compliance with federal securities laws, and
• if not performed or performed negligently, would be reasonably likely to cause a material negative impact on the adviser’s clients or on the adviser’s ability to provide investment advisory services.

The SEC is providing examples of potential covered function categories an adviser may wish to consider in the amendments they are proposing to Form ADV, Section 7.C of Schedule D. Covered functions listed would include: Adviser/Subadviser; Client Services; Cybersecurity; Investment Guideline/Restriction Compliance; Investment Risk; Portfolio Management; Portfolio Accounting; Pricing; Reconciliation; Regulatory Compliance; Trading Desk; Trade Communication and Allocation; and Valuation.

The proposal would also require advisers to obtain reasonable assurances that a third party recordkeeper will meet four standards which address the third party’s ability to

• adopt and implement internal processes for making and/or keeping records that meet recordkeeping rule requirements applicable to the books and records being maintained on behalf of the adviser;
• make and/or keep records that meet all of the requirements of the recordkeeping rule applicable to the adviser;
• provide access to electronic records; and
• ensure the continued availability of records if the third party’s relationship with the adviser or its operations cease.

Comments should be received on or before 30 days after publication in the Federal Register or December 27, 2022, whichever is later.  

Representative Greg Murphy (R-NC), along with co-sponsor Representatives Carol Miller (R-WV), David Schweikert (R-AZ), and Lloyd Smucker (R-PA) have introduced HR 9198, the Safeguarding Investment Options for Retirement Act.

The bill would require plan fiduciaries to base investment decisions on only pecuniary factors. A fiduciary is not prohibited from considering an investment option that promotes nonpecuniary benefits so long as participant interests are not subordinated to other objectives or additional financial risks related to nonpecuniary factors. Additionally, such investment cannot be a default investment for the plan. The term pecuniary factor means a factor that a fiduciary prudently determines is expected to have a material effect on the risk and return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy established under ERISA.

The bill would further amend the Internal Revenue Code to require that if a trust contains investment options with nonpecuniary factors, such trust shall also include investment options based solely on pecuniary factors in order to be qualified.

FINRA has issued a $5,000 fine and six-month suspension against a former registered representative for “recommending a series of transactions in the account of one retail customer that was excessive in light of the customer’s investment profile and therefore not in the customer’s best interest."

The Office of Management and Budget has received a proposed rule from the Department of Labor (DOL) titled “Adoption of Amended and Restated Voluntary Fiduciary Correction Program”. The Voluntary Fiduciary Correction Program (VFCP) is a voluntary enforcement program that allows plan officials to identify and correct certain transactions, such as delinquent participant contributions, sales and exchanges, improper loans, and improper plan expenses. The VFCP was last updated in 2006.

A plaintiff in a 401(k) plan sponsored by Colgate-Palmolive Co. has filed a lawsuit against several parties after an unknown individual defrauded the plan of her entire $750,000 account. The plaintiff has named the plan sponsor, the recordkeeper Alight Solutions, and the plan trustee Mellon Bank, as defendants in the lawsuit. The plaintiff alleges the parties breached their fiduciary duty by failing to safeguard her assets.

The Department of Labor (DOL) has issued Compliance Assistance Release 2022-01 pertaining to the use of cryptocurrencies as plan investments in 401(k) plans. In it, the DOL cautions fiduciaries to exercise extreme care before considering the addition of cryptocurrency options in a plan’s investment menu and elaborates that the failure to remove an imprudent investment option from a menu of options is a breach of fiduciary duty.

The DOL expresses concerns about significant risks and challenges related to fraud, theft, and loss due the following factors

• Speculative and volatile investments due to early stage of development
• Ability for participants to make informed investment decisions due to the unique nature of cryptocurrencies and lack of investor knowledge
• Custodial and recordkeeping concerns related to the asset not being held in a trust or custodial account but rather, stored as “lines of computer code in a digital wallet”
• Valuation concerns with reliability and accuracy, citing disagreements by experts
• Evolving regulatory environment that could result in unlawful transactions or inadequate disclosures

The DOL intends to conduct an investigative program aimed at plans that offer participant investments in cryptocurrencies and related products—including those within brokerage windows and take “appropriate action” to protect the interests of plan participants and beneficiaries.

December 22, 2021 – The Department of Labor’s Employee Benefit Security Administration (EBSA) has issued a supplemental statement to a June 2020 Information Letter. The letter addressed whether plan fiduciaries should offer private equity investments as investment options in individual account defined contribution plans. The 2020 letter indicated that such plans could potentially include managed asset allocation funds with a private equity component, but pointed out that a plan fiduciary should take into account whether it is prudent to include such an investment, particularly if it is a component of a plan’s qualified default investment alternative (QDIA).

The Department of Labor (DOL) has extended the transitional relief under Field Assistance Bulletin (FAB) 2018-02 and provided additional temporary non-enforcement guidance related to specific provisions of Prohibited Transaction Exemption (PTE) 2020-02 in FAB 2021-02.