Marcia S. Wagner, Esq. Washington Update: New DOL and Governmental Initiatives

Introduction – Transformative Changes Accelerating Pace of Regulatory Change ◦ Participant investment advice rule ◦ Plan-level fee disclosures ◦ Participant-level investment disclosures Proposals from Lifetime Income Project ◦ Lifetime income illustrations ◦ Longevity annuities Watershed: DOL fiduciary proposal ◦ New fiduciaries ◦ Stricter compliance ◦ Rollovers become a fiduciary act 2

Agenda 1. Fiduciary Proposal 2. Rollovers 3. Tax Reform 4. Regulatory Initiatives 3

Background for DOL Proposal Evolution of Retirement Marketplace ◦ Existing “fiduciary” definition was issued in 1975 ◦ Many financial advisors (including brokers) are not fiduciaries under existing definition DOL’s Initial Proposal (2010) ◦ Withdrawn amidst controversy ◦ DOL releases new proposal on April 20,

Existing ERISA Definition Fiduciary Status ◦ Person who provides “investment advice” relating to plan assets for compensation ◦ Not a fiduciary if no investment advice is given 5-Prong Definition for “Investment Advice” ◦ Making investment recommendations ◦ On regular basis ◦ Mutual understanding ◦ Primary basis for plan’s decisions ◦ Individualized to plan’s needs 5

Proposed Fiduciary Definition Fiduciary Status ◦ Person who provides “investment advice” for compensation to plans, plan fiduciaries, participants, IRAs and IRA owners 4-Prong Definition for “Investment Advice” ◦ Making covered recommendations ◦ Understanding (does not need to be mutual) ◦ Individualized or specifically directed to recipient ◦ For consideration by recipient (need not be primary basis) 6

Scope of Investment Advice Covered Recommendations ◦ Investment recommendations, including taking/investing rollovers ◦ Investment management recommendations, including management of rollover assets ◦ Giving appraisal or fairness opinion ◦ Recommending person who provides any of above services for compensation 7

Acknowledging Fiduciary Status Deemed “Investment Advice” ◦ Advisor makes covered recommendations ◦ Represents or acknowledges that it is a fiduciary with respect to advice ◦ No written acknowledgement is required ◦ Fiduciary status applies automatically, even if proposed 4-prong definition is not met 8

Observations on Proposed Definition Proposed Changes to “Investment Advice” ◦ Includes one-time advice (without “regular basis” condition) ◦ No need for "mutual understanding” of parties ◦ Advice merely needs to be specifically directed to recipient (and does not need to be individualized) ◦ Recipient merely needs to consider advice when making decision (even if not “primary basis”) ◦ Expressly revises definition to cover investment management recommendations 9

Carve-Out for Investment Education Similar to Current Safe Harbor (IB 96-1) ◦ Plan Information ◦ General Financial/Retirement Information ◦ Asset Allocation Models ◦ Interactive Investment Materials Observations ◦ Carve-out applies to both plan and IRA clients ◦ Expanded to include retirement income guidance ◦ Education must not refer to specific investment products ◦ Asset allocation models and interactive materials cannot reference plan’s investment alternatives 10

Proposed Exemption Need for “ERISA 406(b)” Exemptive Relief ◦ Proposed “investment advice” definition confers fiduciary status on all types of advisors ◦ Prohibited transaction rules ban advisors from earning variable compensation (commissions) ◦ Exemption required for brokers and insurance agents, including advisors to IRAs ◦ DOL proposed Best Interest Contract Exemption 11

Best Interest Contract Exemption (BICE) Retail Scope of Proposed Exemption ◦ Permits fiduciary advisor to earn variable compensation (commissions) for services to:  Participants  IRA owners  Sponsors of small, non-participant-directed plans (less than 100 participants) Observations ◦ No exemptive relief for small, participant-directed plans (DOL requesting comments) ◦ No exemptive relief for large plan sponsors (participant-directed or otherwise) 12

Products Covered by BICE Covered Products ◦ Bank deposits and CDs ◦ Mutual funds, ETFs, CIFs and insurance company separate accounts ◦ Exchange-traded REITs ◦ Corporate bonds (registered offering) and equity securities (exchange-traded) ◦ Treasury and agency debt securities ◦ Insurance/annuity contracts and GICs Observations ◦ No exemptive relief for privately placed debt, non-traded REITs and alternative investments 13

BICE’s Required Contract Mandatory Terms for Written Contract ◦ Must state that advisor is fiduciary for ERISA/Code purposes with respect to advice ◦ Impartial Conduct Standard  Advice is in “best interest” of client  Reasonable compensation  No misleading statements ◦ Warranties  Compliance with law  Policies reasonably designed to mitigate conflicts  No incentives to provide improper advice ◦ No Liability Limit for Contract Violations  Arbitration permitted (with class action rights) 14

BICE Disclosures Disclosures in Written Contract ◦ Must identify conflicts ◦ Client’s right to obtain complete fee information ◦ Whether advisor offers proprietary products or receives third party payments ◦ Address of webpage disclosing compensation Transaction Disclosures ◦ Upfront chart with cost of investing for 1-, 5- and 10-year periods (model chart may be used) ◦ Annual disclosures of investment and fee activity Webpage disclosure of compensation 15

Observations on BICE Regulatory Jurisdiction ◦ DOL lacks enforcement authority over IRAs ◦ Required contract gives enforcement authority to clients ◦ Violation of Impartial Conduct Standard will breach contract (but not BIC Exemption ) Impact on Brokers and Insurance Agents ◦ Will regulate advisors without plan clients (having only personal IRA clients) ◦ May be difficult for firms to eliminate incentives that encourage improper advice 16

Timeline for Rulemaking Initial 75-Day Comment Period ◦ Proposal released April 20, 2015 ◦ Initial comment period ended July 21st Public Hearing ◦ August 10th – 13th ◦ Final comment period after transcripts released Delayed Applicability Date for Final Rule ◦ Final rule effective 60 days after publication ◦ Requirements of final rule generally not applicable until 8 months after publication ◦ Obama Administration’s second terms ends in January

Concluding Comments: DOL Proposal Moving to Universal Fiduciary Standard ◦ DOL is seeking to impose “best interest” fiduciary standard on all types of advisors to plans/IRAs ◦ Proposal leverages off of existing “principles- based” regulatory approach for RIAs Expected Impact on Advisors ◦ DOL proposal will affect most advisors because of reach to IRA assets ◦ Costly for broker-dealers and insurance agencies ◦ Little or no impact on RIAs, but certain advisors may decide to join or become RIAs 18

Recommendation Next Steps and Following up ◦ Be sure to stay abreast of rulemaking process and consult ERISA counsel as appropriate ◦ Advisors may wish to re-examine their client service models and documentation ◦ Expect plan sponsors to request confirmation of fiduciary status of advisors, and whether DOL proposal will impact services or fees 19

TOC 1.Fiduciary Proposal 2.Rollovers 3.Tax Reform 4.Regulatory Initiatives 20 Agenda

Potential Abuses of Cross-Selling Issues arising from cross-selling ◦ Potential conflicts of interest ◦ Exploiting trust to sell at unfavorable terms Capturing rollover assets ◦ Advisor develops relationships with plan sponsor and participants ◦ Potential conflict if advisor’s fees on rollover assets are higher than fees on plan assets 21

DOL Guidance Potential for abuse ◦ DOL policy concern ◦ DOL interpretive guidance for cross-selling of rollover IRA services ◦ Starting point: ERISA prohibition against self- dealing ◦ Advisor cannot provide fiduciary advice increasing its compensation Example ◦ Advisor’s fiduciary advice steers participants to fund with highest 12b-1 fee ◦ Advice is tainted even if provided in good faith 22

DOL Rollover Opinion Advisory Opinion A ◦ Broadly suggests that if an advisor is fiduciary, any rollover advice to participants may trigger PT ◦ DOL does not fully explain reasoning ◦ If Advisor is not fiduciary, rollover advice will not trigger PT 23

Consequences of DOL Rollover Opinion Advisors appointed as fiduciaries ◦ Fiduciary advisor accepting fiduciary status generally cannot capture rollover assets Other advisors ◦ If advisor provides “accidental” fiduciary advice, this advisor becomes a fiduciary ◦ Advisors accidentally becoming a fiduciary are subject to restrictions of Rollover Opinion Proposed definition of fiduciary advice includes rollover recommendations 24

Effect of Fiduciary Proposal on Rollover Opinion Impact on Advisory Opinion A ◦ If adopted, DOL fiduciary proposal would replace this Advisory Opinion guidance ◦ As proposed, any rollover advice would be fiduciary advice ◦ Non-fiduciary advisors providing rollover advice would automatically become plan/IRA fiduciaries Relief under Proposed Exemption (BICE) ◦ Advisors would be able to provide rollover advice and earn higher compensation on rollover assets ◦ Proposed exemption entails numerous requirements 25

Protective Measures BICE Relief for IRA Rollovers ◦ Necessary for advisors earning variable commission-based compensation ◦ Also necessary for fee-based advisors if higher compensation is earned after rollover Written Contract Requirement ◦ Best interest standard ◦ Policy mitigating effects of differential compensation Disclosures ◦ Upfront disclosure of projected investment costs ◦ Annual disclosure of investment and fee activity ◦ Webpage disclosures on compensation 26

Further Protective Measures Competitive Pricing Information ◦ Gather pricing data to demonstrate that pricing for similar clients is competitive Limiting Scope of Advice ◦ Draft plan client’s agreement to reduce parameters of advice ◦ Example: Only actively managed mutual funds will be recommended ◦ Only funds with 12b-1 fees from 25 to 50 bps will be considered 27

FINRA Regulatory Notice Rollover recommendations must be suitable Factors to be considered by advisor ◦ Investment options ◦ Fees and expenses ◦ Services ◦ Withdrawal penalties ◦ Creditor protection ◦ Application of RMD rules Written Policies ◦ Must mitigate conflicts ◦ Training for reps ◦ Policies will need to be revised to comply with DOL fiduciary proposal and BICE 28

TOC 1.Fiduciary Proposal 2.Rollovers 3.Tax Reform 4.Regulatory Initiatives 29 Agenda

Administration Push to Increase Access through IRAs Administration pushing automatic IRAs: ◦ Mandatory for employers with 10 employees but no retirement plan ◦ 3% default contribution rate ◦ Choice of traditional pre-tax IRA or after-tax Roth ◦ Employees allowed to opt out ◦ Multiple alternatives for selecting IRA provider ◦ Government designated default investments 30

myRA Initiative myRA Starter IRAs ◦ Starter program does not require legislative authorization ◦ Contributions to Roth accounts ◦ Permits small investments ($25 / $5) ◦ Low rate of return from Treasury bonds ◦ Maximum $15,000 balance 31

How Retirement Plans Affect the Deficit Impact of retirement plans on federal deficit ◦ DC / 401(k)  $61 billion (2015)  $414 billion (2015 – 2019) ◦ DB  $42 billion (2015)  $235 billion (2015 – 2019) 32

Affect of Limiting Contributions 2015 Plan limitations that can be reduced to limit deficit: ◦ Annual additions from all sources - $53,000 ◦ Elective deferrals - $18,000 ◦ Plan sponsor deduction - 25% participant compensation ◦ Compensation limit to determine benefits/contributions - $265,000 Limits proposed by Tax Reform Act of 2014 ◦ Freezes DC limits until 2024 ◦ $63.4 billion revenue gain over 10 years ◦ Additional $144 billion from treating half of 401(k) deferrals as Roth 33

General Limits on Exclusions and Deductions Obama FY 2016 proposed $3.4 million cap on aggregate lifetime contributions ◦ Cap to vary based on age ◦ Double tax if prohibited amount not withdrawn Obama proposal limiting tax deductions for plan contributions ◦ 11.6% tax on employer & employee plan contributions ◦ For high earners only ◦ Basis adjustment for extra tax 34

USA Retirement Funds Proposal USA Retirement Funds proposed by Sen. Tom Harkin Plan features: ◦ Automatic/universal enrollment required by employers with no plan ◦ Regular stream of income starting at retirement age ◦ No lump sum withdrawals ◦ Financed by employee payroll contributions & government credits ◦ Privately managed investment by new entities: USA Retirement Funds ◦ Limited employer involvement; no fiduciary responsibility ◦ Unspecified level of required employer contributions ◦ Employees can raise/lower contributions or opt out 35

State Proposals State-managed plans for private-sector workers ◦ Intended to expand access to retirement saving ◦ States would mange investments ◦ DOL directed to clarify preemption issue by end of 2015 California Secure Choice ◦ Mandatory auto-IRA ◦ Pooled investments managed by state and guaranteed returns 36

NCPERS Proposal ◦ Private-sector workers to be covered by plan established by state government ◦ State managed investment and guaranteed returns ◦ Lifetime benefits ◦ Employer and employee contributions ◦ Questions as to sufficiency of funding (backstopped by taxpayers) 37

Summing Up Legislative Proposals Significant Transformation of Private Retirement System Possible Tax Reform ◦ Reducing tax incentives will shrink system ◦ Lower contributions at all income levels result if tax exclusions cut back Obama proposal for general limit on benefit from tax exclusions ◦ Does not focus directly on 401(k) contributions ◦ Provides political cover ◦ Same effect on contributions as direct cutback on excludible amount 38

Summing Up Legislative Proposals (cont’d) Advocacy for Centralization ◦ Mandated benefits ◦ Guaranteed benefits and/or investment results ◦ Creation of new interest groups ◦ Government influence over investments could drive firms out of retirement industry State-Sponsored Initiatives ◦ State-level programs may cause breakdown in uniformity of pension laws ◦ Inflection point regarding the types of retirement schemes nation wants 39

TOC 1.Fiduciary Proposal 2.Rollovers 3.Tax Reform 4.Regulatory Initiatives 40 Agenda

Goals of Lifetime Income Initiatives Help retirees take plan distributions without outliving them ◦ Motivate retirees to annuitize accounts ◦ Retirement paycheck for life Encourage plan sponsors to voluntarily offer annuity options ◦ Permit longevity annuities ◦ Remove regulatory hurdles ◦ Facilitate default annuities ◦ Promote education and disclosures 41

Current Fiduciary Standard for Selecting Annuities Selection of Annuity Provider and Annuities ◦ Subject to ERISA fiduciary standards Safe harbor: DC Plan Distribution Annuities ◦ Procedural prudence ◦ Insurer’s ability to pay ◦ Cost ◦ Draw appropriate conclusions ◦ Seek expert advice 2015 guidance ◦ Limits period for monitoring and statute of limitations 42

Promoting Longevity Annuities New IRS regulation relaxes required minimum distribution rules ◦ RMD rules mandate start at age 70 ½ but longevity annuities provide income stream for later in life ◦ Final Regulation provides: ◦ RMD exception for investment in QLAC ◦ Investment in QLAC capped at $125,000 or 25% of account ◦ QLAC payments to start no later than age 85 ◦ Applies to annuity purchases on/after July 2,

DOL Proposal for Lifetime Income Disclosures Advance Notice of Proposed Rulemaking ◦ Lifetime income illustration in participant statements ◦ Must provide estimated income streams based on: (1) current account, and (2) projected account at NRA Safe Harbor for Projected Account ◦ Assume 7% investment return ◦ Assume current contribution level, with 3% increase ◦ Use 3% discount rate to convert to current dollars 44

In Conclusion: Issues driving change ◦ Asset preservation ◦ Mitigating longevity risk ◦ Access to system Simplify proposed changes Avoid changes that downsize system Address systemic issues with incentives, not mandates 45

Marcia S. Wagner, Esq. 99 Summer Street, 13th Floor Boston, MA (617) Washington Update: New DOL and Governmental Initiatives A