Ralph C. Derbyshire

Senior Vice President &

Deputy General Counsel

FMR LLC Legal Department

Mail: 200 Seaport Blvd., V7A Boston, MA 02109

Office: 245 Summer Street, Boston, MA 02210

Phone: 617-563-0296 Fax: 508-357-8568

Email: ralph.derbyshire@fmr.com

SUBMITTED ELECTRONICALLY

July 21, 2015

Office of Regulations and Interpretations

Employee Benefits Security Administration

U.S. Department of Labor

Attention: Conflict of Interest Rule, Room N-5655

200 Constitution Avenue, NW

Washington, D.C. 20210

Office of Exemption Determinations

Employee Benefits Security Administration

U.S. Department of Labor

Attention: D-11712 and D-11713

200 Constitution Avenue, NW

Suite 400

Washington, D.C. 20210

Re: Definition of the Term Fiduciary: Conflict of Interest Rule (RIN 1210-AB32);

Proposed Best Interest Contract Exemption and Principal Transactions in Debt

Securities Exemption (ZRIN: 1210-ZA25)

Ladies and Gentlemen:

Fidelity Investments1 (“Fidelity”) appreciates the opportunity to comment on the

proposed rule (“Proposed Regulation”) published by the Department of Labor (“Department”)

relating to the definition of investment advice under section 3(21)(A)(ii) of the Employee

Retirement Income Security Act of 1974 (“ERISA”) and section 4975(e)(3)(B) of the Internal

Revenue Code (“Code”). The Proposed Regulation is accompanied by a proposed class

exemption that would be based in part on a best interest contract commitment (“BIC

Exemption”), a proposed class exemption regarding principal transactions involving certain debt

securities (“Principal Transactions Exemption”) 2 and amendments to several existing class

exemptions. Taken together, the Proposed Regulation and the proposed exemptions would

create a new regulatory structure for assisting retirement plans, participants and IRA owners with

investment decisions.

1 Fidelity was founded in 1946 and is one of the world’s largest providers of financial services. 2 Definition of the Term “Fiduciary”; Conflict of Interest Rule – Retirement Investment Advice; Proposed Rule 80

FR 21928 (April 20, 2015); Proposed Best Interest Contract Exemption; Proposed Rule 80 FR 21960 (April 20,

2015); Proposed Class Exemption for Principal Transactions in Certain Debt Securities between Investment Advice

Fiduciaries and Employee Benefit Plans and IRAs 80 FR 21989 (April 20, 2015). Capitalized terms not otherwise

defined have the meaning ascribed to them in the Proposed Regulation or proposed exemptions.
Office of Regulations and Interpretations

Office of Exemption Determinations

Employee Benefits Security Administration

July 21, 2015

Page 2

As one of the nation’s leading retirement services providers, Fidelity has a deep and longstanding commitment to working with the Department on its rulemaking in the area of

investment education and advice. Fidelity provides recordkeeping, investment management,

brokerage and custodial/trustee services to thousands of Code section 401(k), 403(b) and other

retirement plans covering approximately 25 million participants and beneficiaries. Fidelity is the

nation’s largest provider of services to individual retirement accounts (“IRA”) with more than 7

million accounts under administration. Fidelity also provides brokerage, operational and

administrative support to approximately 5,000 third-party, unaffiliated financial services firms

(including investment advisors, broker-dealers, banks, insurance companies and third party

administrators) that may in turn provide investment advice to plans, participants and IRA

owners. Since the Department’s investment advice proposal would make fundamental changes

in the way investment advice is regulated, it could dramatically affect the services Fidelity and its

financial services clients provide to a significant portion of the nation’s retirement investors.

Rule as Proposed is Unworkable

The new regulatory structure proposed by the Department would greatly expand the

range of activities that constitute fiduciary-level investment advice subject to both a best interest

standard and, more significantly, the prohibited transaction rules of ERISA and the Code. To

address the prohibited transaction issue, the Department purports to create broad, principlesbased exemptions for regulated financial services firms that comply with the best interest

standard.

We support an appropriate expansion of the range of advice activities subject to a best

interest standard so long as it is accompanied by broad prohibited transaction relief. Fidelity

believes that it acts in the best interest of its customers and is willing to be legally accountable to

that standard when it provides investment advice. Unfortunately, the proposal fails to meet its

objectives through an overly broad definition of advice accompanied by exemptive relief that is

unnecessarily narrowed through complex limitations and conditions. As a result, the rule is

unworkable and will prevent firms like Fidelity from providing investment assistance that plans,

participants and IRA owners need to invest successfully for retirement.

We believe that the activities of firms like Fidelity are more appropriately regulated

through the primary financial services regulators and that the Department’s effort to create an

entirely new regulatory framework for investment advice services under ERISA is misguided.

However, since the Department seems committed to regulatory action in this area, we believe

there is a workable alternative that would better accomplish the Department’s objectives. In the

body of this letter, we outline a new best interest paradigm and highlight the significant problems

with the proposal that it addresses. Since understanding both our proposed paradigm and the

problems with the proposal requires analysis of the interaction between the proposed definition

of investment advice and the exemptions, we are submitting this letter to both the Office of

Regulations and Interpretations (which has responsibility for the rule itself) and the Office of
Office of Regulations and Interpretations

Office of Exemption Determinations

Employee Benefits Security Administration

July 21, 2015

Page 3

Exemption Determinations (which has responsibility for the prohibited transaction exemptions).

More detailed comments are set forth in three attachments to this letter – Attachment A outlines

in more detail our new best interest paradigm (including suggested language for the rule and

exemption), Attachment B comments on the Proposed Regulation and Attachment C comments

on the proposed exemptions.

A New Best Interest Paradigm

Assuming the Department intends to move forward with rulemaking in this area, there is

a workable way to ensure that advice is provided in the investor’s best interest while preserving

existing business models that provide valuable assistance to retirement investors. Our proposed

best interest paradigm addresses the two foundational problems with the proposal – the overly

broad definition of investment advice under the Proposed Regulation and the limitations and

conditions of the BIC Exemption which make it ineffective in addressing the prohibited

transaction problems created by the overly broad advice definition.

The fundamental problem with the overly broad definition of investment advice under the

Proposed Regulation is that it conflates two separate acts – an investor’s engagement of an

advisor3 to provide advice and the advisor’s recommendation of investment products and

services pursuant to such engagement – and treats both as a single “recommendation” subject to

fiduciary conduct standards. By so doing, the rule proposal makes an advisor a fiduciary with

respect to establishment of its own services and compensation. This is both unprecedented in

fiduciary law and not commercially viable, potentially requiring an advisor to recommend its

competitors over itself even if its own services are wholly appropriate for the investor.

The Proposed Regulation attempts to deal with this problem in part through a limited

seller's carve-out for large plans. While we believe the carve-out approach makes sense for true

sales activity and should be applied to all investors in that context, the carve-out is an “all or

nothing” approach. When it applies under the Proposed Regulation, neither the advisor’s sales of

its own services nor the advisor’s actual investment recommendations would be held to a

fiduciary standard. Because the best interest standard does not apply to the actual investment

recommendation when the carve-out applies, the carve-out defeats the purpose of the rule. Thus,

the Department’s proposal either imposes a fiduciary duty on the sale of an advisor’s own

services (where it does not belong) or removes a fiduciary standard with respect to an investment

recommendation (where it does). We refer to this as the “sales dilemma” that is created by the

proposal. Notably, the proposal creates this dilemma not only with respect to advisors with

transaction-based compensation but also for advisors selling fee-based advisory services.

This dilemma can be avoided by separating the advisor’s establishment of its own

services and compensation – that is, the otherwise conflicted components of the relationship –

3 We generally use the term “advisor” to refer to both the regulated financial institution and/or its individual

representative, but provide greater specificity where the context requires.
Office of Regulations and Interpretations

Office of Exemption Determinations

Employee Benefits Security Administration

July 21, 2015

Page 4

from the actual recommendations about investment products and services. These are inherently

distinct activities subject to fundamentally different duties. Following appropriate disclosure, an

investor would agree to the scope of the advice to be provided, the amount of compensation

payable to the advisor in connection with an investment recommendation or over a range of

recommendations, restrictions on the advice (such as limitations to proprietary products or

products that generate revenue sharing), and other terms and conditions of the engagement. The

investor’s agreement with respect to the service and compensation terms would be established at

arm’s length outside of the fiduciary relationship, as it historically has been in every comparable

fiduciary context. Once the terms of the engagement are established, all investment

recommendations within that framework must be in the investor’s best interest.

It is important to note that this approach of separating the terms of the engagement from

the actual investment recommendation does not apply solely at the initiation of the advisory

relationship. The terms of the engagement can later be renegotiated by the parties, or indeed can

be established on a transaction-by-transaction basis.

This approach of separating the terms of the engagement from the actual investment

advice is conceptually identical to a long-standing regulation of the Department addressing

application of the prohibited transaction exemption under ERISA section 408(b)(2) for payment

of service providers. This regulation provides that if a person who is already providing

investment advice to a plan “persuades” a plan fiduciary to extend his contract at a higher fee,

the advisor has not engaged in a prohibited transaction because the advisor has not used any of

the authority, control or responsibility which makes it a fiduciary to cause the plan to pay an

additional fee. There is no reason why this concept should not apply where the advisor’s

compensation varies based on the transactions and services recommended by the advisor, or to

other limitations and conditions on the scope of the advisor’s services.

The second foundational problem with the proposal is that its proposed exemption

structure is laden with complex limitations and conditions which narrow both the scope and

practicality of the exemptions and make them unworkable. Most of this problem can be solved

by implementing what the Department said it was going to do – create a broad, principles-based

approach to exemptions for regulated financial institutions that act in the investor’s best interest.

Notably, although the Department did not stay true to this commitment in proposing the BIC

Exemption, it does follow this approach through the "Standards of Impartial Conduct" that are

proposed as amendments to several existing exemptions in other parts of the rule proposal. For

example, the Department has proposed this approach in the amendments to PTE 77-4 which

allows a discretionary manager to invest in its own proprietary mutual funds – often cited as one

of the most conflicted transactions for an advisor. If this simple, straightforward approach is

sufficiently protective of the interests of plans, participants and IRA owners in the context of a

discretionary investment manager, it is certainly sufficient in the context of nondiscretionary

advice.
Office of Regulations and Interpretations

Office of Exemption Determinations

Employee Benefits Security Administration

July 21, 2015

Page 5

Accordingly, our new best interest paradigm would apply this approach to the BIC

Exemption by modifying it to create a broad exemption that would reflect each of the three key

Standards of Impartial Conduct for regulated financial services firms:

• a legally enforceable commitment to act in the best interest of the investor;

• a requirement that compensation be reasonable in light of the services provided;

and

• disclosure of material conflicts, including compensation payable to the financial

institution.

No further limitations or conditions on the exemption are needed.

Problems with the Proposal that Must Be Addressed

Adopting the new best interest paradigm set forth above and in Attachment A will

address most of the key problems with the proposal and preserve access to investment advice.

These key problems include:

1. Do Not Treat the Advisor’s Own Engagement as Fiduciary Advice.

The tension in the proposal between permitting routine sales activity and subjecting

investment recommendations to a best interest standard is evident throughout the rule. As

proposed, the rule attempts to address this sales dilemma through several disparate avenues,

including the creation of a limited seller’s carve-out, a platform provider carve-out that would be

of limited use and an extremely confusing provision in the BIC Exemption that permits

investment advice to be provided only with respect to a “limited range of investment options”.

None of these avenues alone or together solves the problem. As described above and in

Attachment A, the dilemma can be resolved through a new paradigm that clearly separates

compensation and other conflicted aspects of establishing the investor-advisor relationship from

the actual investment recommendation. That way the investor can agree to the framework

through which advice will be provided outside the fiduciary context and receive advice subject to

a best interest standard within that agreed-upon framework. This paradigm is consistent with the

historical treatment of the fiduciary relationship in other fields of law, and would avoid the

complex problems created by the proposal’s current approach.

2. Eliminate the Written Contract Requirement.

The ultimate objective of the regulatory effort is to ensure that investment advice is

provided in the best interest of the investor. Fiduciary status under ERISA creates an

enforceable best interest standard by operation of law. However, in the case of IRAs not subject

to ERISA, no substantive standard of conduct applies under the Code. To hold all fiduciaries

accountable to the best interest standard, both the BIC Exemption and the Principal Transactions
Office of Regulations and Interpretations

Office of Exemption Determinations

Employee Benefits Security Administration

July 21, 2015

Page 6

Exemption would require a written contract between the individual Adviser, the Financial

Institution and the Retirement Investor.

This written contract requirement is extremely burdensome, costly and in some cases

unworkable. It requires separate written contracts between thousands of different individual

representatives with millions of plan participants and IRA owners, along with recordkeeping

systems accessible to representatives in all channels to determine whether a written contract was

signed. Contracts would need to be signed at the initiation of any interaction where investments

or distributions are discussed, including discussions with prospects who are merely inquiring

about services that may be offered. It also introduces a written contract between plan service

providers and participants where there is otherwise no contractual relationship.

A best interest standard is legally imposed and enforceable under Title I of ERISA so that

a contract is unnecessary for plans and participants in any event. With respect to IRAs, we

believe that an enforceable best interest standard can be established by much less onerous means

– a unilateral contract offer by the financial services firm, reflecting the scope of the advisory

relationship and the fees to be charged, which would be enforceable as a contract or through the

doctrine of promissory estoppel. There is no need to require a signed, written document nor

must the individual representatives be involved. Attachment C provides a more detailed legal

analysis of this approach. In short, the class exemption should require legal enforceability, but

allow reasonable flexibility with respect to the manner in which the commitment is documented.

3. Simplify and Improve Disclosure.

A key component of the exemptions is full and meaningful disclosure of all material

conflicts of interest, including compensation payable to the advisor. The BIC Exemption

contemplates a three-tiered approach involving a point-of-sale disclosure of the projected cost of

recommended investments, an annual statement summarizing in dollar amounts the

compensation actually paid to the advisor during the preceding year and a publicly available

website listing every investment the advisor might recommend and the compensation associated

with each. In addition, the contract includes warranties requiring disclosure of material conflicts,

including fees payable to the financial institution. While we fully support meaningful disclosure

of cost, compensation and material conflicts, the manner in which they are disclosed is critically

important to both the usefulness of the information to the investor and workability from the

perspective of the financial services firm.

We believe a simpler two-tiered approach would make the disclosure regime both

workable and more meaningful to investors. The first tier would be a "static" disclosure that

would explain the scope of the financial institution’s services, describe its conflicts of interest

(including potentially different compensation based on the investments recommended and

selected by the investor), and include a link to a website. This website is the second tier and

would enable the investor to obtain more detailed information about the cost and compensation

associated with all products and services offered. The website could also allow the investor to
Office of Regulations and Interpretations

Office of Exemption Determinations

Employee Benefits Security Administration

July 21, 2015

Page 7

estimate costs and compensation over time based on assumptions input by the investor about the

amount to be invested, projected returns, etc. Under this two-tiered approach, the critical

information required by the BIC Exemption is provided but in a format that is more meaningful

for the investor and more workable for the financial institution.

In the context of our new best interest paradigm, this disclosure would be made in

establishing or changing the terms and conditions of the advice relationship. It could also

accompany, or be a component of, a unilateral contract that includes a commitment by the

advisor to act in the investor’s best interest and constitute agreement to the reasonable

compensation to be paid to the advisor, thus meeting the best interest contract requirement

contemplated by the BIC Exemption.

4. Give Small Plan Sponsors Access to Advice.

The proposal leaves the vast majority of small plans with no access to advice services

when the advisor's compensation depends in any way on the plan's investments. The seller's

carve-out is only available to plans with more than 100 participants or $100 million in assets, and

the BIC Exemption does not apply to participant-directed plans of any size. The platform

provider carve-out is simply insufficient to provide meaningful assistance on its own. Failing to

permit investment advice by the financial services firms that are involved in providing

investment and recordkeeping services to these plans will stifle plan formation in the very market

segment where the lack of plan coverage is the biggest impediment to retirement savings for

millions of American workers. The new best interest paradigm outlined above avoids this

problem by creating a single exemption that would cover advice to plans of any size as well as

individuals.

5. Preserve the Ability to Identify Investment Funds as Education.

The carve-out for investment education under the Proposed Regulation would be a

significant step back from current law under Interpretive Bulletin 96-1 ("Bulletin") because it

makes the identification of specific investment alternatives in connection with a model asset

allocation fiduciary-level investment advice. We believe that without identifying investment

alternatives, the asset allocation discussion permitted under the education carve-out is largely an

exercise in investment theory and it is not concrete enough to be useful for most individuals.

When the Bulletin was adopted, the Department understood the potential conflict of

interest that could arise in identifying investment alternatives but felt that participants’ need for

this information (with certain disclosures) outweighed the potential conflict. We do not believe

that almost twenty years of experience under the Bulletin suggests any reason to change the

balance struck between protecting against conflicts and meeting participants’ needs for more

specific information. This is particularly true in the plan context where the plan sponsor or

another independent fiduciary has usually selected the available investment funds.
Office of Regulations and Interpretations

Office of Exemption Determinations

Employee Benefits Security Administration

July 21, 2015

Page 8

We recommend preserving the ability to identify specific investment funds within the

education carve-out. To the extent the Department has identified abuses under IB 96-1, those

could be addressed by requiring identification of several funds, if available, rather than a single

fund.

6. Extend the Effective Date.

The eight month “applicability date” is grossly insufficient to implement a regulatory

change of this magnitude. The time required will obviously depend on the complexity of the

final rule. If finalized as proposed, we believe that a minimum of three years would be necessary

to implement the rule.

************

We would be pleased to respond to any questions or comments regarding this submission,

including the points covered in the Attachments.

Sincerely,

Ralph C. Derbyshire

cc: United States Securities and Exchange Commission

The Honorable Mary Jo White, Chair

The Honorable Luis A. Aguilar, Commissioner

The Honorable Daniel M. Gallagher, Commissioner

The Honorable Kara M. Stein, Commissioner

The Honorable Michael S. Piwowar, Commissioner

Financial Industry Regulatory Authority

Mr. Richard Ketchum, Chairman and Chief Executive Officer, FINRA

Mr. Robert Colby, Chief Legal Officer, FINRA

Treasury Department

J. Mark Iwry, Deputy Assistant Secretary for Retirement and Health Policy

National Economic Council

Jeffrey Zients, Director

Elizabeth A. Kelly, Senior Policy Advisor
A-1

Attachment A

A New Best Interest Paradigm

Much of the length and complexity of the proposal derives from the overly broad

definition of investment advice and the limitations and conditions of the exemptions. Since the

new best interest paradigm suggested in the body of this letter directly addresses these two

foundational problems, it would greatly simplify both the Proposed Regulation and the proposed

exemptions. This Attachment A outlines the paradigm in more detail and suggests language for

the Proposed Regulation and BIC Exemption that could be used to implement this new

paradigm.4

Narrowing the Definition of Advice

The broad definition of investment advice under the Proposed Regulation does not

distinguish between an advisor’s discussion and sale of its own services and the advisor’s actual

recommendation of investment products and services. The rule therefore treats the advisor as a

fiduciary with respect to its own services and compensation, in some cases before a fiduciary

relationship even exists. This would be the case both for advisors with transaction-based

compensation and advisors selling fee-based advisory services. That approach is both

unprecedented in fiduciary law and not commercially viable, potentially requiring an advisor to

recommend its competitors over itself even if its own services are wholly appropriate for the

investor.

The Proposed Regulation deals with this problem in part through a limited seller's carveout for “expert plan investors”.5 We fully support the notion of a seller’s carve-out for true sales

activity and suggest that it should be applied to all investors (see comments in Attachment B).

However, the seller’s carve-out does not address the problem of a fiduciary advisor selling its

own products and services because it is an “all or nothing” approach. When it applies under the

Proposed Regulation, neither the advisor’s negotiation and sale of its own services and

compensation, nor the advisor’s actual investment recommendations would be held to a fiduciary

standard. Because the best interest standard does not apply to the actual investment

recommendation when the carve-out applies, the carve-out defeats the purpose of the rule. Thus,

the Department’s proposal either imposes a fiduciary duty on the sale of an advisor’s own

services (where it does not belong) or removes a fiduciary standard with respect to an investment

recommendation (where it does). We refer to this as the “sales dilemma” that is created by the

proposal.

The sales dilemma is not limited to transaction-based compensation like that typically

payable to a broker-dealer. The Proposed Regulation broadly defines fiduciary investment

4 Note that with respect to the provisions of the Proposed Regulation and proposed exemptions that are not covered

in this Attachment A, the Department should make the modifications/clarifications recommended in Attachments B

and C. 5 In addition to the seller’s carve-out, the Proposed Regulation also includes a platform provider carve-out that is

essentially a seller’s carve-out with respect to a specific type of investment offering for employee benefit plans.
A-2

advice to include a recommendation of an investment advisor or manager.6 Under the

Department's historical view, the compensation received by the advisor or manager for its

services is treated as being in exchange for the recommendation. At the point of the

recommendation, all such compensation – even if it were formulated as a fixed dollar amount

that does not vary based upon the advice or investment management services to be provided –

would vary based on the recommendation to hire the advice provider or investment manager,

since the compensation would be paid only if the recommendation was adopted and the advisor

or manager was hired. ERISA prohibits a fiduciary from using its authority or control as a

fiduciary to cause itself to be paid an additional fee or other compensation. Accordingly, under

the Department’s proposal, all investment advisors and managers in the process of selling their

own services would be engaging in a prohibited self-dealing transaction. It is hard to believe that

the Department intended this result.

A conceptually simple and straightforward solution to the sales dilemma is to separate the

terms of engagement of the advisor – that is, the otherwise conflicted components of the

transaction – from the underlying investment recommendation. The framework for engaging the

advisor is agreed to by the investor after full disclosure which permits that framework to be

established outside of the fiduciary relationship. However, once that fiduciary relationship is

established, all recommendations within the framework must be in the investor’s best interest.

An advisor’s engagement has two main components: (i) the scope and nature of the

advisor’s services, and (ii) the advisor’s compensation. The first component could include

agreement about the scope of the advice to be provided (such as one-time recommendations

versus continuous advice over time), restrictions on the investments taken into account when

providing advice (such as limitations to proprietary products, products that generate revenue

sharing, or investments that are available in a plan’s fund lineup), and other terms and conditions

of the engagement, including the potential disclosure of, and the client’s consent to, the existence

of any potential conflicts of interest in the advisor’s business model. The second component

would include the amount of compensation payable to the advisor in connection with an

investment recommendation or range of recommendations. As is common in the investment

advisor sphere today, these terms of the engagement would be established at the initiation of the

advisory relationship, and could be amended with consent of the client from time to time

throughout the relationship, including on a transaction-by-transaction basis.

The BIC Exemption hints at this solution in the “Limited Range of Investment Options”

provision in Section IV(b) of the BIC Exemption. The specific limitations contemplated by

Section IV(b) of the BIC Exemption include the ability to restrict recommendations to

proprietary products or products that generate revenue sharing. Section IV(b) also includes the

requirement that the financial institution make a written finding that these limitations will not

prevent it from acting in the best interest of the investor. However, that best interest standard

requires that the advice be rendered without regard to the financial interests of the advisor. How

can that requirement be met when the very limitation is based on the advisor’s financial

6 The preamble to the Proposed Regulation characterizes this as a clarification of existing law, but the current

regulatory definition in effect only refers to recommendations with respect to securities or other assets. It is

important that the Department correct the preamble characterization to avoid any possibility of retroactive fiduciary

or prohibited transaction exposure for activity that is non-fiduciary in nature under current law.
A-3

interests? The only way to make sense of this provision is to assume that the structuring of the

limitation itself is not subject to the best interest standard. While Section IV(b) applies this

concept only with respect to the range of Assets that may be recommended, there is no reason

this concept should not extend to other aspects of the relationship that can give rise to potential

conflicts.

This engagement concept is also analogous to a long-standing regulation of the

Department (adopted in 1977) addressing application of the exemption under ERISA section

408(b)(2) for payment of service providers. An example from this regulation is instructive:

E, an employer whose employees are covered by plan P, is a fiduciary with respect to P.

A, who is not a party in interest with respect to P, persuades E that the plan needs the

services of a professional investment adviser and that A should be hired to provide the

investment advice. Accordingly, E causes P to hire A to provide investment advice of the

type which makes A a fiduciary under § 2510.3-21(c)(1)(ii)(B). Prior to the expiration of

A's first contract with P, A persuades E to cause P to renew A's contract with P to provide

the same services for additional fees in view of the increased costs in providing such

services. During the period of A's second contract, A provides additional investment

advice services for which no additional charge is made. Prior to the expiration of A's

second contract, A persuades E to cause P to renew his contract for additional fees in

view of the additional services A is providing. A has not engaged in an act described in

section 406(b)(1) of the Act, because A has not used any of the authority, control or

responsibility which makes A a fiduciary (the provision of investment advice) to cause

the plan to pay additional fees for A's services.7

In this example, the advisor is not just informing the plan fiduciary about these terms but

persuades the fiduciary to extend the contract at a higher fee. So clearly the advisor is selling

investment advice services at a point in time when the advisor is in fact already a fiduciary with

respect to investment recommendations. However, there is no prohibited transaction because the

advisor is not causing the plan to pay an additional fee. This can only be true if the terms of the

engagement of the advisor are outside the scope of the fiduciary relationship.

This paradigm is also consistent with the determination of “independent control” under

the Department’s regulation under ERISA section 404(c). Section 404(c) relieves a plan

fiduciary from responsibility and liability for a participant’s investment decisions so long as the

participant has sufficient information and is offered sufficient breadth of investment options to

exercise independent control over his or her investments. The regulation provides that a

participant’s exercise of control is not independent if the participant is subjected to “improper

influence” by a plan fiduciary, or if the fiduciary has concealed material non-public facts

regarding the investment or accepts instructions from the participant knowing him or her to be

legally incompetent. The preamble makes clear that disclosure of material terms, including any

material conflicts of the fiduciary, will avoid improper influence and concealment and, together

7 DOL Reg. § 2550.408b-2(f), Example 4.
A-4

with fair and reasonable transaction terms, will result in the participant exercising independent

control.8

The concept of separating the terms of engagement from the actual investment

recommendation is entirely consistent with how many advisers, including fee-based investment

advisors, negotiate their compensation today; the terms and fees associated with the relationship,

along with any potential conflicts of interest embedded in those arrangements, are fully disclosed

at the outset of the relationship with the client. At this point, the client has the opportunity to

evaluate that fee structure and associated conflicts before deciding to enter into a fiduciary

relationship with the adviser. Indeed, the seminal case articulating the scope of an investment

adviser’s fiduciary duty, SEC v. Capital Gains Research Bureau9, makes clear that a potential

client could agree to enter into a fiduciary relationship with an adviser whose business model

included certain potential conflicts, so long as those conflicts were fairly and adequately

disclosed to the client before the client agreed to engage the adviser as a fiduciary. Once so

established, the advisor provides fiduciary advice within the agreed-upon framework.

There is no principled reason why this concept should not also apply in situations where

the advisor’s compensation varies based on the transactions and services recommended by the

advisor. Whether its compensation is transaction-based or fee-based, the advisor should be free

to determine the terms of its engagement and, accompanied by appropriate disclosure, persuade

the investor that it should enter into an advice relationship under those terms and conditions.

That activity is simply not fiduciary in nature.

Once the terms and conditions of the fiduciary relationship are established,

recommendations by the advisor must be in the investor’s best interest within the framework.

The definition of “Best Interest” could remain as proposed by the Department, including the

requirement that advice be provided “without regard to the financial or other interests of the

Adviser, Financial Institution or any Affiliate, Related Entity, or other party.” This would not

impinge on the parties’ ability to agree to the advisor’s compensation or other terms of

engagement that would affect the advisor’s compensation because establishing the framework

for engaging the advisor is not itself fiduciary conduct subject to the best interest standard. For

example, following full and fair disclosure, the advisor and investor could agree that its

investment advice will be limited to proprietary funds. As this would be a term and condition of

8 Preamble to Final Regulation Regarding Participant Directed Individual Account Plans (ERISA 404(c) plans),

footnote 25, quoting the Restatement (Second) of Trusts section 216 (1959):

“(1) Except as stated in Subsections (2) and (3), a beneficiary cannot hold the trustee liable for omission of

the trustee as a breach of trust if the beneficiary prior to or at the time of the act or omission consented to it.

(2) The consent of the beneficiary does not preclude him from holding the trustee liable for a breach of

trust, if – (a) the beneficiary was under an incapacity at the time of such consent or of such act or omission;

or (b) the beneficiary, when he gave his consent, did not know of his rights and of the material facts which

the trustee did not reasonably believe that the beneficiary knew; or (c) the consent of the beneficiary was

induced by improper conduct of the trustee.

(3) Where the trustee has an adverse interest in the transaction, the consent of the beneficiary does not

preclude him from holding the trustee liable for a breach of trust not only under the circumstances stated in

Subsection (2), but also if the transaction to which the beneficiary consented involved a bargain which was

not fair and reasonable.” 9 375 U.S. 180 (1963).
A-5

the agreed-upon advice relationship, the advisor’s subsequent recommendation of a proprietary

fund on that basis (assuming the recommended fund is otherwise in the investor’s best interest)

would not violate the best interest requirement that the advice be “without regard to” the

advisor’s compensation or other financial interests.

At the same time, the general obligations of a fiduciary would still prevent a

recommendation by the advisor of an investment within the framework that is not appropriate for

the investor. The notion of establishing the framework for the relationship outside of the

fiduciary context is similar to the trust law notion that has historically permitted beneficiaries to

waive conflicts of interest and permit a trustee to engage in acts of self-dealing. However, it is

well-settled that “no matter how broad the provisions of a trust may be in conferring power to

engage in self-dealing or other transactions involving a conflict of fiduciary and personal

interests, a trustee violates the duty of loyalty to the beneficiaries by acting in bad faith or

unfairly.”10 Similarly, a trustee is not exonerated “for a breach of trust committed in bad faith or

with indifference to the fiduciary duties of the trustee, the terms or purposes of the trust, or the

interests of the beneficiaries.”11 The framework allows the investor to waive the inherent

conflict where the fiduciary structures the terms and conditions of its engagement without

providing the fiduciary free license to recommend products and services that are clearly

inappropriate.12

This concept of a baseline fairness test for investors runs throughout the laws otherwise

applicable to regulated financial services providers, which laws themselves form an important

additional layer of protection for investors – often in circumstances where there is no explicit

fiduciary relationship. With respect to broker-dealers, the Securities and Exchange Commission

(“SEC”) states:

Under the antifraud provisions of the federal securities laws and SRO [self-regulatory

organization] rules, including SRO rules relating to just and equitable principles of trade

and high standards of commercial honor, broker-dealers are required to deal fairly with

their customers. While broker-dealers are generally not subject to a fiduciary duty under

the federal securities laws, courts have found broker-dealers to have a fiduciary duty

under certain circumstances. Moreover, broker-dealers are subject to statutory,

Commission and SRO requirements that are designed to promote business conduct that

protects customers from abusive practices, including practices that may be unethical but

may not necessarily be fraudulent.”13

In fact, these rules go far beyond the general trust standard of bad faith or unfairness. For

example, FINRA Rule 2010 requires: “A member, in the conduct of its business, shall observe

10 Restatement (Third) of Trusts § 78 cmt. c(2) (2007). 11 Restatement (Third) of Trusts § 96(1)(a) (2007). 12 See Sitkoff, An Economic Theory of Fiduciary Law (2014) at 10-12 (discussing the concept of mandatory rules in

fiduciary law that cannot be overridden by agreement) (published in Gold and Miller, Philisophical Foundations of

Fiduciary Law (2014) at 197 and available at

http://www.law.harvard.edu/programs/olin_center/papers/pdf/Sitkoff_769.pdf). 13 Study on Investment Advisers and Broker-Dealers, as Required by Section 913 of the Dodd-Frank Wall Street

Reform and Consumer Protection Act, a study by the Staff of the U.S. Securities and Exchange Commission,

January 2011, at iv.
A-6

high standards of commercial honor and just and equitable principles of trade.”14 Similar

principles apply under the Investment Advisers Act,15 under insurance solicitation regulations,16

and under regulatory guidance applicable to banks advising retail customers in a non-brokerdealer capacity.17 The framework we propose thus would allow the advisor and investor to

structure the terms of the advisor’s engagement but would not allow the advisor to recommend

products and services that are inappropriate for the investor.

Our proposed paradigm solves the sales dilemma because, within the terms of the

engagement, the actual investment recommendation must still be in the investor’s best interest.

However, the overall framework for the engagement, including compensation payable to the

advisor, can be freely negotiated. This approach accomplishes the objectives of the

Department’s proposal, including preserving freedom of choice.

Moreover, the fact that all advisors must disclose and obtain consent of the investor to the

terms and conditions of engagement as a condition of excluding those terms and conditions from

the scope of their fiduciary responsibility should result in much better understanding by investors

about the nature of the advice they receive. Under this new paradigm, all advisors must be clear

about their business model, compensation and potential conflicts as a condition of excluding

other products and services from the scope of their best interest obligation. Every investor will

better understand the scope and context of the advice received and an advisor may provide only

investment recommendations that are in the investor’s best interest within that framework

notwithstanding the fact that the advisor may receive variable compensation in connection with

those recommendations.

Modification to Proposed Regulation: Our new best interest paradigm would provide

that the establishment of the terms of engagement between the advisor and investor is

non-fiduciary in nature by modifying section 2510.3-21(c) of the Proposed Regulation as

follows:

(c) Scope of fiduciary duty—investment advice.

(1) A person who is a fiduciary with respect to an employee benefit plan or IRA

by reason of rendering investment advice (as defined in paragraph (a) of this section)

for a fee or other compensation, direct or indirect, with respect to any securities or

other property of such plan, or having any authority or responsibility to do so, shall not

be deemed to be a fiduciary with respect to :

(i) the terms and conditions of engagement of the person, including

the scope of the obligation to provide advice, the products or services with

14 FINRA Manual, Rule 2010. Standards of Commercial Honor and Principles of Trade. 15 See generally Investment Advisors Act Release No. 1406 (March 16, 1994). 16 See generally National Association of Insurance Commissions (NAIC) Annuities/Variable Contracts Suitability in

Annuity Transactions Model Regulation and NAIC Annuities/Variable Contracts Disclosure Model Regulation,

applying suitability rules to transactions involving IRAs. 17 See generally OCC Bulletin 2015-2, Revised Comptroller's Handbook Booklet and Rescissions on "Retail

Nondeposit Investment Products".
A-7

respect to which advice is provided and the compensation payable to the

person, provided the plan fiduciary, participant or beneficiary, or IRA

owner has consented to the terms and conditions of the engagement after

disclosure of all material aspects of such terms and conditions, including

potential conflicts of interest; or

(ii) any assets of the plan or IRA with respect to which such person

does not have any discretionary authority, discretionary control or

discretionary responsibility, does not exercise any authority or control, does

not render investment advice (as defined in paragraph (a)(1) of this section)

for a fee or other compensation, and does not have any authority or

responsibility to render such investment advice.

(2) Nothing in this paragraph shall be deemed to:

(i) exempt such person from the provisions of section 405(a) of the

Act concerning liability for fiduciary breaches by other fiduciaries with

respect to any assets of the plan; or

(ii) exclude such person from the definition of the term “party in

interest” (as set forth in section 3(14)(B) of the Act or “disqualified person”

as set forth in section 4975(e)(2) of the Code) with respect to a plan.

Broadening the Exemptions

To the extent that an advisor’s compensation varies with the investments it recommends

within the terms and conditions of the engagement, exemptive relief is necessary because a

potential prohibited transaction arises. The Department’s proposal includes two new exemptions

– the BIC Exemption and the Principal Transactions Exemption – and amendments to numerous

existing exemptions. The problem with this approach is that the new exemptions are laden with

complex limitations and conditions which narrow both their scope and practicality and make

them unworkable. This is contrary to the stated intent of the Department:

The Department has also sought to preserve beneficial business models for delivery of

investment advice by separately proposing new exemptions from ERISA’s prohibited

transaction rules that would broadly permit firms to continue common fee and

compensation practices, as long as they are willing to adhere to basic standards aimed at

ensuring that their advice is in the best interest of their customers. 18

18 80 FR 21929 (April 20, 2015). The Department also notes that the BIC Exemption “was developed to promote 

the provision of investment advice that is in the best interest of retail investors such as plan participants and

beneficiaries, IRA owners, and small plans” and “[r]ather than create a set of highly prescriptive transaction-specific

exemptions, which has generally been the regulatory approach to date, the proposed exemption would flexibly

accommodate a wide range of current business practices, while minimizing the harmful impact of conflicts of

interest on the quality of advice.” 80 FR 21960 (April 20, 2015).
A-8

Most of these problems can be solved by adhering to the Department’s stated intention to take a

broad, principles-based approach to exemptions for regulated financial institutions that act in the

investor’s best interest.

We therefore propose a single exemption containing the three key requirements:

• a legally enforceable commitment to act in the best interest of the investor;

• a requirement that compensation be reasonable in light of the services provided;

and

• disclosure of material conflicts, including compensation payable to the financial

institution.

No further limitations or conditions on the exemption are needed to accomplish the Department’s

goals.

Indeed, the Department follows precisely this approach through the "Standards of

Impartial Conduct" that are proposed as amendments to several existing exemptions in other

parts of the rule proposal. For example, the Department proposed this straightforward approach

in the amendments to PTE 77-4 which allows a discretionary manager to invest in its own

proprietary mutual funds – often cited as one of the most conflicted transactions for an advisor.

If this simple approach is sufficiently protective of the interests of plans, participants and IRA

owners in the context of a discretionary investment manager, it is certainly sufficient in the

context of nondiscretionary advice.

We believe that the first requirement – a legally enforceable commitment – would be

satisfied through the unilateral best interest contract described in the main body of our letter and

in Attachment C. The remaining two requirements would be satisfied through simple, two-tiered

disclosure that would be both workable for firms and more useful for investors. The first tier

would be a “static” disclosure provided at the time recommendations are made. This disclosure

would explain the scope of the financial institution’s services, describe its potential conflicts of

interest, including that it may receive different compensation based on the investments

recommended and selected by the investor, and include a link to a website where more detailed

information about the cost and compensation associated with the products and services is

available. This website would act as the second tier of disclosure, and would enable the investor

to obtain specific information about the cost and compensation associated with all products and

services offered at the firm in a format that will allow the investor to make comparisons across

investments. The website could also allow the investor to estimate costs and compensation over

time for specific products based on assumptions input by the investor about the amount to be

invested, projected returns, etc. All of this information could also be made available in writing

upon request.19

19 The Department has repeatedly cited so-called “robo-advisers” as a means of providing advice to plan sponsors,

participants and IRA owners in a manner that meets the Department’s objectives. If a computer-based approach can

satisfy the Department’s goals with respect to an entire advice transaction, it should be reasonable and appropriate

for an advisor to disclose its potential conflicts of interest electronically.
A-9

Modifications to the BIC Exemption: Our new best interest paradigm would simplify the

BIC Exemption to be consistent with the Standards of Impartial Conduct approach

proposed by the Department with respect to PTE 77-4 and other existing exemptions by

making the following modifications:

• Section I would be modified to cover all transactions and related compensation,

including principal transactions and purchases of insurance contracts.

• Section II would be modified to read as follows:

Section II—Standards of Impartial Conduct.

If the fiduciary is a fiduciary within the meaning of ERISA section 3(21)(A)(i)

or (ii), or Code section 4975(e)(3)(A), or (B), with respect to the assets of a

plan or IRA involved in the transaction, the fiduciary must comply with the

following conditions with respect to the transaction:

(a) The fiduciary is subject to a legally binding commitment to

provide advice that is in the best interest of the plan or IRA.

(b) All compensation received by the fiduciary and its Affiliates in

connection with the transaction is reasonable in relation to the total

services the fiduciary and its affiliates provide to the plan or IRA.

(c) The fiduciary's statements about recommended investments,

fees, Material Conflicts of Interest, and any other matters relevant to a

plan's or IRA owner's investment decisions, are not misleading.

• Advisors as a practical matter would have to meet the requirements of Section

II(d) and (e) as proposed but those requirements should not be independent

conditions of the prohibited transaction exemption. Section II(f) could be

preserved as a limitation on the legally binding commitment set forth in (a) above.

• Section III would be replaced with the two-tier disclosure approach described

above.

• Section IV relating to the “Range of Investment Options” would be unnecessary

because every advisor would need to establish this through the terms and

conditions of its engagement in order to define the scope of its fiduciary

responsibility under the definition of advice. Alternatively, the provisions of

Article IV could be reframed as specific disclosures required to be made with

respect to the advisor’s engagement.

• Sections V and IX should be omitted for the reasons set forth in Attachment C.

• Section VI should be omitted as unnecessary.
A-10

Summary

In practice, this new best interest paradigm would be workable for financial institutions

and meaningful for and protective of plans, participants and IRA owners. Before it begins

making investment recommendations, the advisor would provide the two-tiered disclosure

described above to the investor. The two-tiered disclosure would explain the scope of the

financial institution’s services, describe its conflicts of interest (including that it may receive

different compensation based on the investments recommended and selected by the investor),

and include a link to a website where more detailed information about the cost and compensation

associated with the products and services is available.

Accompanying the disclosure would be a unilateral contract pursuant to which the

advisor would agree to recommend only investments within the agreed-upon advice relationship

that are in the best interest of the investor. The unilateral contract could also incorporate the

reasonable compensation of the financial institution and other terms and conditions of the advice

relationship as disclosed through the two-tiered approach described above. The unilateral

contract would bind the advisor and provide a private right of action for the investor without the

need for a signed written contract by the parties, which would be unreasonably burdensome to

obtain.

Once the above disclosures have been made and the unilateral contract established, all

recommendations of the advisor within the agreed-upon advice relationship would be made in

the best interest of the investor. Any prohibited transaction resulting from variations in

compensation associated with the advisor’s best interest recommendations would be within the

modified BIC Exemption by reason of the foregoing disclosures and unilateral contract. If the

parties’ advice relationship evolves over time, any amendments to the terms of the engagement,

including on a transaction-by-transaction basis, would be accomplished through the same

disclosures and unilateral contracting process.
B-1

Attachment B

Comments on Proposed Regulation

The definition of investment advice under the Proposed Regulation encompasses virtually

any communication “specifically directed to” the investor that could reasonably be viewed as a

suggestion to take (or refrain from taking) a specific course of action in making investment

decisions. It includes specific recommendations to buy, sell, hold or manage securities or other

property, recommendations relating to rollovers and distributions, and recommendations to hire

persons who will provide investment advice or management. The advice must be “in exchange

for a fee or other compensation.” However, the Department has made clear that it interprets this

requirement so broadly that it is satisfied if the advisor or any of its affiliates receives any

compensation from any source in connection with the advice transaction. The proposed definition

requires no particular level of reliance by the investor, nor any meeting of the minds betwee 

n the advisor and the investor as to the fiduciary nature of the advice.

The expansive scope of activities encompassed under this definition goes beyond any

previous definition of investment advice made subject to a fiduciary standard under federal or

state law, and it will have significant negative consequences for both investors and financial

services firms unless important modifications and clarifications are made. Fidelity believes that it

acts in the best interest of its customers and is willing to be legally accountable to that standard

when it provides investment advice. However, in order for that standard to work in practice it

must be applied in a way that allows providers to offer the guidance that plan sponsors,

participants and IRA investors need to save and invest for retirement. As currently structured, the

Proposed Regulation is inappropriately expansive and, together with limitations and conditions

under the proposed exemptions on which we comment in Attachment C, will greatly inhibit the

provision of investment assistance and limit choice for retirement investors.

Accordingly, we urge the Department to adopt the new best interest paradigm described

in the main body of this letter and in Attachment A. In addition, following are the key changes

that we urge the Department to make to the Proposed Regulation many of which are inherent in

the paradigm we propose:

1. Require a Reasonable Level of Reliance by the Investor.

The Proposed Regulation would subject investment assistance to a fiduciary standard

even where there is no expectation of reliance on the advice or advisor by the investor and no

understanding or expectation on the part of the investor that such assistance is unbiased and is in

his or her best interest. Rather, there need only be an understanding that the advice “is

specifically directed to the advice recipient for consideration in making investment or

management decisions....” Nor does the Proposed Regulation provide any way for an advisor

and an individual to avoid a fiduciary relationship, even if the parties were to enter into an

express agreement to the contrary. For example, the Proposed Regulation would subject an

explicit sales pitch by a broker-dealer to an IRA owner to fiduciary status, even if both the

advisor and the IRA owner agreed that such communication was not intended to be unbiased

advice in the IRA owner’s best interest.
B-2

Such an all-encompassing definition goes beyond traditional and well-established

principles of fiduciary law. Under common law, a fiduciary duty may arise when “either one of

the parties, in entering [a] transaction, expressly reposes a trust and confidence in the other or

because of the circumstances of the case, the nature of their dealings, or their position towards

each other, such a trust and confidence is necessarily implied.” 20 The Proposed Regulation

would impose a fiduciary duty even where the investor does not expressly or impliedly place

trust and confidence in the advisor by relying on the advice as being unbiased and in the

investor’s best interest.

The Department should align the Proposed Regulation with long-standing principles of

fiduciary law by requiring a reasonable expectation of reliance by the advice recipient. The

Department could accomplish this, for example, by modifying the definition of investment

advice to require that, based on the content, context and presentation of such advice, it is

reasonable for the advice recipient to rely on such advice as being unbiased and in the recipient’s

best interest with respect to such recipient’s investment or management decisions. This

requirement is already effectively included in the definition to the extent that the definition treats

all investment advice as fiduciary in nature where the investment advice provider states that it is

acting as a fiduciary within the meaning of ERISA. Such a statement would render it reasonable

for an advice recipient to rely on the advice as being unbiased and in the recipient’s best interest.

But, as currently proposed, there is no corollary to this rule that would treat conduct as nonfiduciary in nature even where there is an express understanding that a fiduciary relationship is

not intended.

2. Expand the Seller’s Carve-Out.

If reliance is made a component of the definition of investment advice as described

above, there is no need for a seller's carve-out because it would be clear from the context that

there is no expectation that the seller is providing unbiased advice. However, if the Department

does not introduce the component of reliance, it needs to rethink the approach taken to address

the problem the Proposed Regulation creates for any advisor selling investment products or

services. The problem is that statements made in the sales context will almost always constitute

investment advice under the proposal’s current formulation because they are directed to a person

and intended to encourage the purchase of a particular product or service.

The Department recognizes this problem and creates a seller’s carve-out so that the rule

“appropriately distinguishes incidental advice as part of an arm’s length transaction with no

expectation of trust or acting in the customer’s best interest, from those instances of advice

where investors may be expecting unbiased investment advice that is in their best interest.”

However, the seller’s carve-out does not apply to either small plans or individuals. Other aspects

of the proposal attempt to address the seller’s problem inherent in other contexts, including the

carve-out for platform providers and the BIC Exemption provision that allows investment advice

to be provided for a limited range of investment options such as proprietary-only products.

20 See United Jersey Bank v. Kensey, 306 N.J.Super. 540, 551, 704 A.2d 38 (App.Div.1997), citing Berman v.

Gurwicz, 189 N.J.Super. 89, 93, 458 A.2d 1311 (Ch.Div.1981)(internal ellipses omitted).
B-3

As an initial matter, we note there is ambiguity as to whether the proposed seller's carveout covers certain services such as fee-based advisory and managed account services when sold

to plan sponsors. The Department should clarify that the seller's carve-out is available for all

investment products and services where a recommendation with respect to that product or service

would otherwise constitute investment advice.

As proposed, the seller’s carve-out only applies to certain arm’s length transactions with

an “expert plan investor.” The Department has proposed to use the plan’s size, either in terms of

participants or assets, as a proxy for expert plan investor status. As a result, the proposed seller’s

carve-out is effectively available only with respect to transactions involving large plan sponsors.

As the basis for this narrow approach, the Department states that “[r]esearch has shown that

disclaimers are ineffective in alerting retail investors to the potential costs imposed by conflicts

of interest, of the fact that advice is not necessarily in their best interest, and may even

exacerbate these costs.”

We disagree that the disclosures proposed by the Department – i.e., fairly informing the

counterparty of either the existence and nature of the seller’s financial interests in the transaction

or that the seller is not undertaking to provide impartial investment advice or act as a fiduciary –

would not be effective with respect to investors other than large plan sponsors. The conclusion

that retail investors are incapable of understanding this disclosure is contradicted by the

prominent role that disclosures play under the BIC Exemption which is largely intended for use

in connection with transactions involving individuals. Nor are long-standing, well-settled

principles of fiduciary law consistent with such an assumption, as they do not impose fiduciary

status on a person unless there is express or implied trust and reliance on the person by the

investor and they clearly recognize and permit the need for beneficiaries to waive fully and fairly

disclosed self-dealing conflicts.21 While financial products and services may be complex,

understanding the dynamics of a sales transaction is fundamental to the commercial activity that

is part of everyone's daily life and the ability to waive fully and fairly disclosed conflicts is

essential to the establishment and proper functioning of fiduciary relationships.

In addition, the assumption that individuals cannot understand the difference between

impartial advice and statements made in connection with sales is inconsistent with Congress’

own determination on that issue in enacting ERISA section 404(c). Section 404(c) relieves a

plan fiduciary from responsibility and liability for a participant’s investment decisions so long as

the participant has sufficient information and breadth of investment options to exercise control

over his or her investments. Where a participant has maximum investment choice and the

opportunity to obtain investment information from any source, such as in a brokerage window,

the participant necessarily must make decisions about whether the investment information on

which he or she bases investment decisions is educational, part of a sales communication, or

provided as fiduciary advice. Congress must have contemplated in enacting section 404(c) that

participants were capable of assessing those decisions or it would not have relieved the plan’s

fiduciary from liability when those decisions were being made by the participant. The

Department, however, has essentially structured the Proposed Regulation to impose on the

21 See discussion at FN 10-12 supra.
B-4

investment advisor the same fiduciary responsibility for these assessments that Congress

determined not to impose on the plan fiduciary itself. Fixing the seller’s carve-out or imposing a

reliance requirement under the fiduciary definition would eliminate this inconsistency and align

the rule with the judgment Congress made in enacting section 404(c). However, we believe the

new best interest paradigm outlined in the main body of this letter and in Attachment A is the

best manner in which to accomplish this alignment.

3. Preserve the Ability to Identify Investment Funds as Education.

The carve-out for investment education under the Proposed Regulation would be a

significant step back from current law under Interpretive Bulletin 96-122 ("Bulletin") because it

makes the identification of specific investment funds in connection with a model asset allocation

fiduciary-level investment advice. We believe that without identifying investment funds, the

asset allocation discussion permitted under the education carve-out is largely an exercise in

investment theory and it is not concrete enough to be useful for most individuals. Further, in the

plan context, participants and beneficiaries have received communications that describe the asset

class of each investment option. For example, the comparative chart required under the

participant disclosure regulations under ERISA section 404(a) must include the type or category

of each investment option listed.23 Requiring the participant to refer to these other

communications to connect the dots is simply counterproductive.

In proposing this change, the Department appears to rely on “those commenters to the

2010 Proposed Regulation who argued that cautionary disclosures to participants, beneficiaries

and IRA owners may have limited effectiveness in alerting them to the merit and wisdom of

evaluating investment alternatives not used in the model.” The Department also states in

conclusory fashion that “[i]n practice, asset allocation models concerning hypothetical

individuals, and interactive materials which arrive at specific investment products and plan

alternatives, can be indistinguishable to the average retirement investor from individualized

recommendations, regardless of caveats.” Accordingly, this dramatic curtailment of the Bulletin

appears to be based solely on the opinions of certain prior commenters and the Department. It

does not appear to be based on empirical evidence or any record of abuse by retirement

educators.

When the Bulletin was adopted, the Department understood the potential conflict of

interest that could arise in identifying investment funds but felt that participants’ need for this

information (with certain disclosures) outweighed the potential conflict. We do not believe that

almost twenty years of experience under the Bulletin suggests any reason to change the balance

struck between protecting against conflicts and meeting participants’ needs for more specific

information. Therefore, we recommend preserving the ability to identify specific investment

funds within the education carve-out. To the extent the Department has identified abuses under

the Bulletin, those could perhaps be addressed by requiring identification of several funds within

the asset allocation category, if available, rather than just a single fund.

22 DOL reg. § 2509.96-1. 23 DOL reg. § 2550.404a-5(d)(1)(i)(B).
B-5

We also request clarification of the application of the Proposed Regulation’s revised

education carve-out to any discussion about the suitability of an investment option for a specific

purpose. Under the Proposed Regulation, informing eligible employees or participants of the

benefit of a plan’s qualified default investment alternative or other default could be viewed as a

recommendation. To the extent that such investments have been selected by the plan’s fiduciary

as the investment alternative that will apply absent other participant direction, however, it does

not seem appropriate that such information be treated as a recommendation by an advisor other

than the plan’s fiduciary. For this reason, the Proposed Regulation should be clarified to provide

that reference to specific investment alternatives under these circumstances constitutes education

and not fiduciary advice.

Finally, we note that the preamble to the Proposed Regulation states that its education

carve-out “incorporates much of [the Bulletin’s] operative text, but with ... important [identified]

exceptions”. The Proposed Regulation appears to condition applicability of the education

carve-out to plan information materials and communications on there being no “reference to ... a

particular participant or beneficiary or IRA owner...". However, the Bulletin itself does not

contain this condition and it is not called out in the preamble as an important exception.

Therefore, it is unclear whether this language is intended to impose a new requirement that

advisors must meet in order for their plan information related communications to be treated as

non-fiduciary education.

For example, one possible interpretation of this new condition could be as follows. A

statement by an advisor to an employee eligible to participate in a 401(k) plan that “the plan

allows for deferral of income and provides for a 6% employer matching contribution and all

employees should contribute at least enough to receive the full match” is education. A statement

by the advisor to the employee that “you [i.e., the employee] should enroll in the plan and

contribute enough to receive the maximum matching contribution of 6%” is not education

because it refers to a particular participant (i.e., the employee to whom the advisor is speaking).

Interpreting the Proposed Regulation in this manner would represent a significant change

between the Proposed Regulation and the Bulletin. It would also obviously render educational

communications about plan information much more generic and abstract and therefore less

useful to an individual. The Department should therefore modify and/or clarify that the

Proposed Regulation is not to be interpreted as suggested above but is to be applied consistent

with the Bulletin to plan information communications and materials, regardless of whether such

communications or materials refer to the particular person or persons to whom the

communications or materials are being directed.

4. Clarify the Rule’s Application to Rollovers.

The Proposed Regulation provides that a person renders investment advice if the person

provides in exchange for a fee or other compensation “[a] recommendation as to the advisability

of acquiring, holding, disposing or exchanging securities or other property, including ... a

recommendation as to the investment of securities or other property to be rolled over ... from the

plan or IRA” and “a recommendation as to the management of securities or other property,
B-6

including recommendations as to the management of securities or other property to be rolled

over ... from the plan or IRA”. In many cases, however, an advisor might discuss a rollover

with a participant or IRA owner without recommending or even mentioning how amounts that

are rolled over should be invested or managed. For example, the advisor may simply state to a

plan participant that the participant should rollover his or her plan distribution to an IRA

generically or to an IRA offered by the advisor or another specific IRA provider.

It is not clear whether the Proposed Regulation includes within the definition of fiduciary

advice conversations that do not include any reference as to how rolled over securities or other

property should be invested or managed. Clarity on this point is important in part because, if

such a rollover communication were treated as fiduciary investment advice and it was not

covered by the BIC Exemption, it would effectively be prohibited by the proposal. The most

appropriate way to avoid this result is to clarify that rollover communications that do not refer to

investments in specific securities or other property are not fiduciary investment advice. Such

clarification would be consistent with the Proposed Regulation’s general focus on

recommendations with respect to investing in or managing “securities or other property.”

Likewise, the Proposed Regulation appears to acknowledge that recommendations regarding the

factors to be considered in deciding whether to rollover a plan account balance do not constitute

investment advice.24

Moreover, if the Department were to treat such communications as investment advice but

then attempt to expand the scope of the BIC Exemption to cover such advice, it would lead to

confusion and nonsensical results. The BIC Exemption is largely conditioned on an extensive

array of disclosures. All of the disclosures, however, are centered on specific recommended

investments, investments bought, sold or held by the investor, or specific investments offered by

the advisor. None of these disclosures as proposed would have any applicability to a

recommendation that by definition does not refer to any specific investment. Thus, the BIC

Exemption is simply not an appropriate means to permit non-investment specific rollover

communications.

Clarification is also needed on the Proposed Regulation’s application to two other

important transactions. First, the Proposed Regulation’s applicability to conversions from a

traditional IRA or plan to a Roth IRA and on Roth in-plan conversions is unclear. It appears that

conversions from a traditional IRA or plan to a Roth IRA should be treated the same as a rollover

from one IRA to another IRA or rollovers between a plan and traditional IRA. In-plan Roth

conversions, on the other hand, while treated as a distribution and conversion for tax purposes,

typically do not involve any change in the investments in which the participant is invested.

Rather, an in-plan Roth conversion often merely changes the tax treatment of amounts held

within the plan. Accordingly, conversations about in-plan Roth conversions and Roth

24 On the other hand, the Proposed Regulation’s education carve-out provides that information and materials that

describe varying forms of distribution, including rollovers, do not constitute fiduciary investment advice only so

long as such information and materials make no “reference to the appropriateness of ... any individual benefit

distribution option for the plan or IRA, or a particular participant or beneficiary or IRA owner.” Thus, to the extent a

conversation referenced a particular IRA or suggested that a rollover to a specific or generic IRA was appropriate 

for the advice recipient, the education carve-out would arguably be inapplicable.
B-7

conversions in the IRA context which do not refer to specific investments should not constitute

fiduciary investment advice.

Second, the Proposed Regulation’s applicability to non-reportable transfers from one IRA

to another IRA, a so-called Transfer of Assets (“TOA”), should be clarified. Rollovers and

TOAs are treated differently by the IRS in certain important respects. For example, a rollover

must be reported on Form 1099-R, while a TOA is non-reportable. The IRS also recently issued

guidance announcing that, beginning in 2015, an IRA owner can make only one rollover from an

IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs

owned by the IRA owner.25 The guidance makes clear that this limitation does not apply to

TOAs.

TOAs also differ from rollovers insofar as the IRA owner never takes receipt of the IRA

assets in connection with the TOA. Rather, assets are transferred directly from one IRA trustee

or custodian to another IRA trustee or custodian. In that respect, TOAs differ from distributions

as well as rollovers, both of which can involve the IRA owner taking ownership of the assets

outside of the IRA or any other tax-deferred vehicle.

It is unclear whether the Proposed Regulation is intended to include recommendations

about TOAs within the definition of fiduciary investment advice. We recommend that the

Department clarify the Proposed Regulation such that recommendations about TOAs are treated

similarly to our proposed treatment of rollovers. That is, the Proposed Regulation should be

clarified to provide that fiduciary investment advice does not include recommendations about

TOAs if they do not include any reference to how transferred securities or other property should

be invested or managed. However, recommendations about how to invest assets once they have

been transferred through a TOA to another IRA would be fiduciary investment advice, so long as

such recommendations met the other requirements of the fiduciary definition.

5. Clarify the Rule’s Application to Distributions and Loans.

The Proposed Regulation states that a recommendation to take a distribution from a plan

or IRA is fiduciary investment advice but it is not clear whether that is the case if the

recommendation does not refer to the sale or investment of any specific security or other

property. For example, a recommendation to take (or not take) a distribution from a defined

benefit plan is not an investment transaction from the participant’s perspective. Another

example of a transaction that does not have investment implications is a discussion about the

relative merits of a participant loan over a hardship withdrawal.

The Bulletin provides that information and materials that inform a participant or

beneficiary about the benefits of plan participation do not constitute the rendering of investment

advice under ERISA. The rationale is that such information and materials “relate to the plan and

plan participation, without reference to the appropriateness of any individual investment option

for a particular participant or beneficiary under the plan.” The same rationale applies with equal

force as a participant or beneficiary considers whether to leave the plan (take a distribution). Just

25 See Announcement 2014-15 and Announcement 2014-32.
B-8

as a decision to enroll in a plan does not dictate how to invest the resulting contributions, a

decision to leave the plan does not by itself necessarily dictate any change in investments and

thus should not be considered fiduciary investment advice. Accordingly, treating

communications that make specific reference to a plan participant, beneficiary or IRA owner in

connection with distribution discussions as investment advice would not be consistent with the

scope and application of the current Bulletin. Thus, it is necessary to clarify the Proposed

Regulation to provide that both (a) discussions about distributions, rollovers and loans that do

not make reference to any specific investments are not investment advice, and (b) that

communications do not fail to constitute education merely because they refer to a particular plan

participant, beneficiary or IRA owner.

It is also not clear whether the Proposed Regulation is intended to treat participant loans

as distributions. While participant loans are distinct from distributions, they are functionally

similar insofar as they involve the transfer of amounts from the plan. Also, loan discussions, like

distribution discussions, typically do not involve any reference to specific investments and

typically the liquidation of investment options since that is usually dictated by plan rules. So, for

the same reasons that distribution discussions without reference to investments should not be

treated as fiduciary investment advice, the Proposed Regulation should be clarified to provide

that participant loan discussions without reference to investments are not treated as fiduciary

investment advice.

This clarification is essential to prevent significant disruption in the normal

administration of many plans. It is not uncommon for participant loans to be subject to a loan

fee payable to the recordkeeper. Recordkeepers also charge distribution fees in certain

circumstances. Neither transaction appears to be covered by the BIC Exemption. Thus, if either

a loan discussion or a distribution discussion on its own (i.e., without reference to investments)

were considered to be fiduciary investment advice, recordkeepers would effectively be precluded

from discussing loans or distributions with participants, except perhaps in the most generic and

abstract way as would be permitted by the education carve-out as proposed.

6. Expand the Platform Provider Carve-Out.

The Proposed Regulation provides a carve-out for certain persons who merely market or

make available platforms of investments from which plan fiduciaries may select or monitor

investment alternatives for their plans, provided certain disclosure requirements are met. A

similar carve-out is provided that would allow such persons to identify investment alternatives

available through the platform that meet objective criteria specified by the plan fiduciary, or to

provide objective financial data and comparisons with independent benchmarks to the plan

fiduciary. These carve-outs are helpful, but as proposed they only apply with respect to

communications to plan fiduciaries. They do not apply to communications to IRA owners or

plan participants. The rule should extend these carve-outs to both IRA owners and plan

participants.

Both IRA owners and plan participants also have in interest in knowing what investment

alternatives may be available on a provider’s platform, in identifying available investment

alternatives that meet certain objective criteria, and in obtaining objective financial data and
B-9

comparisons with independent benchmarks. IRA owners essentially stand in the same shoes as

the plan fiduciary in this regard, and plan participants should be able to obtain such information

with respect to the investments available in their plan as well as other available investment

alternatives so that they might be able to request that they be added to their plan’s investment

lineup. To the extent the carve-out provides protective disclosures that safeguard a plan

fiduciary, such disclosures should also be sufficient to safeguard an IRA owner or plan

participant.

In addition, insofar as the platform provider carve-out permits the identification of funds

meeting objective criteria or the provision of objective financial data and benchmark

comparisons, it is not clear whether the carve-out is intended to permit purely reactive

communications by platform providers or whether a platform provider may proactively

communicate such information. Requiring that platform providers only communicate this

information in response to questions by plan sponsors would be extremely limiting in practice

and would greatly reduce the efficacy of the proposed carve-out. The Department should

therefore clarify the Proposed Regulation to provide that platform providers may make these

communications either proactively or reactively. At a minimum, the Department should clarify

that the platform provider carve-out permits the offering of an investment screening tool,

including a computerized tool, which enables the user to develop lists of specific investments

available through a provider that meet certain criteria that may be identified through the tool.

Finally, it is unclear what is intended to constitute “objective financial data and

comparisons with independent benchmarks.” For example, is objective financial data different

than the “general financial information” that may be provided under the education carve-out and,

if so, how? Similarly, what comparisons may be made to independent benchmarks? For

example, it is common to select investment alternatives based on criteria such as the tenure of the

fund manager. Would such a selection criteria constitute objective financial data or may it be

compared to the tenure of other fund managers in the absence of an independent benchmark?

Clarity on these terms would be important to enable this carve-out to be used effectively.

7. Clarify the Rule’s Application to Self-Identified Fiduciaries.

The Proposed Regulation provides that a person is a fiduciary if such person “directly or

indirectly (e.g., through or together with any affiliate) ... represents or acknowledges that it is

acting as a fiduciary within the meaning of the Act.” According to the preamble, “advisers who

claim fiduciary status under ERISA or the Code in providing advice would be taken at their

word”. This is a sensible and fair condition. However, it is not clear how literally the

Department intends to apply this component of the rule. It would be helpful for the Department

to clarify whether this condition requires the person to use the word “fiduciary” or to refer to

ERISA or the Code in describing his or her status, or whether it would apply to other

characterizations which may imply fiduciary status, such as “trusted advisor”. If the latter

interpretation is intended, the Department should clarify what terms other than “fiduciary” would

trigger application of this component. The purpose of such clarification is to enable advisors that

wish to avoid fiduciary status (and to not mislead their clients into believing the advisor is acting

as a fiduciary) to confidently describe their status and services without inadvertently becoming a

fiduciary by using the wrong words.
B-10

Note that this provision of the Proposed Regulation is unnecessary if the Department

accepts our recommendation to modify the definition of investment advice to require that, based

on the content, context and presentation of advice, it should be reasonable for the advice

recipient to rely on such advice as being unbiased and in the recipient’s best interest with respect

to such recipient’s investment or management decisions. In that case, a representation of

fiduciary status by an advice provider would create reasonable reliance on the part of the advice

recipient that the advice would be unbiased and in the recipient’s best interest and there would be

no need to separately and additionally provide that such a representation automatically gives rise

to fiduciary status.

8. Address Valuation Issues in a Separate Initiative.

The Proposed Regulation retains a portion of the 2010 Proposed Regulation regarding the

valuation of securities or other property, but only valuations performed in connection with an

investment transaction. However, the Proposed Regulation excludes appraisals regarding

employer securities purchased by an employee stock ownership plan (ESOP). The preamble to

the Proposed Regulation states that “the Department has concluded that its concerns with regard

to ESOP valuations raise unique issues that are more appropriately addressed in a separate

regulatory initiative.” We strongly urge that all valuation issues be considered in the separate

initiative, rather than deferring action only on the situation that may have the greatest impact on

plan participants.

At a minimum, however, the Proposed Regulation should be clarified to provide that the

calculation of the net asset value of a separately managed account or a collective investment trust

or similar “pooled” investment in which only one plan invests (e.g. unitized company stock fund)

does not constitute an appraisal or other valuation. Such calculations are ministerial in nature

and do not involve making the judgments or other determinations typically required for an

appraisal or valuation of property. Moreover, to transform such ministerial calculations into

fiduciary investment advice would cause significant disruption to normal and widespread

recordkeeping practices and create a significant disincentive for plans to hold such investments

or for recordkeepers to support them. As such investments are often, among other things, less

costly to investors than other investments, such disincentives would ultimately be detrimental to

retirement savers.
C-1

Attachment C

Comments on Proposed Exemptions

Many of the problems with the proposal can be solved through a simplified approach to

the prohibited transaction exemption that is consistent with the Department's stated intent of

broad, principles-based relief for regulated financial institutions. We urge the Department to

adopt the new best interest paradigm described in the main body of this letter and in Attachment

A.

In addition, following are the key changes that we urge the Department to make to the

exemptions, many of which are inherent in the paradigm we propose:

The BIC Exemption

1. Expand the Exemption to Cover All Plans.

The BIC Exemption only applies to investment advice provided to plan participants and

beneficiaries, IRA owners, and sponsors of small plans (less than 100 participants) that are not

participant-directed. As a result, the exemption would not be available for investment advice

provided to sponsors of large plans of any type or to small participant-directed plans, which

represent the great majority of small 401(k) and other individual account plans. This is

particularly problematic for small plans because they are also not eligible for the seller's carveout in the Proposed Regulation.

This limitation on the application of the exemption would prevent small plan sponsors

from using consultants, advisors or recordkeepers for assistance in structuring fund line-ups

where the service provider receives any compensation based on the investment funds selected. It

also creates the odd dynamic in which the exemption may be used in cases where the small plan

sponsor has complete investment authority over participant accounts but not where the plan

sponsor has the more limited responsibility to construct the investment menu to be offered to

participants.

We believe this will discourage small plan formation and may result in some sponsors

terminating their plans. The BIC Exemption preamble solicited comments on this aspect of the

proposal, and we strongly recommend that the BIC Exemption be extended to cover investment

advice to small plan sponsors of participant-directed plans. In addition, while the seller's carveout is available to permit discussions with large plan sponsors, we see no reason why the BIC

Exemption should not be available in situations where the plan and the advisor want to engage in

a fiduciary-level relationship.

The preamble commented that the fund lineup could be structured under the carve-out for

platform providers. However, Fidelity offers thousands of funds on its recordkeeping platforms.

Without the ability to provide assistance in selecting funds based on something more than simple

objective criteria, we do not view the platform provider carve-out as a workable alternative.
C-2

2. Expand the Exemption to Cover Online Only Computer Model Advice.

The BIC Exemption would exclude online-only computer model interactions (designated

in the preamble as “robo-advice”) unless an individual advisor is involved in providing the

information generated by the model to the investor. That is, online advice is covered so long as a

human advisor reads the online results to the investor rather than the investor reading the online

results himself or herself. There is no justification for excluding advice in an online format

solely because a human being has not read it out to the investor. On that basis alone, the

Department should simply expand the BIC Exemption to cover online advice outright.

Notwithstanding the foregoing, the BIC Exemption preamble purports to justify the

exclusion of online advice provided directly to an investor by stating that the advisor may rely on

the ERISA section 408(g) statutory exemption added by the Pension Protection Act of 2006

(“PPA”) (or some other approach such as that described in the Sun America advisory opinion) in

order to provide online advice as construed under the new definition. The Proposed Regulation

preamble provides the following insight:

While the Department believes that computer generated advice that is delivered in this

manner may be very useful to Retirement Investors, relief will not be included in the

proposal. As the marketplace for such advice is still evolving in ways that both appear to

avoid conflicts of interest that would violate the prohibited transaction rules, and

minimize cost, the Department believes the inclusion of such advice in this exemption

would adversely modify the incentives currently shaping the market for robo-advice.

The exclusion of online-only advice is designed to favor one business model over another. This

is contrary to the position expressed by Department officials in various public statements and in

the Proposed Regulation and BIC Exemption preambles. Respectfully, we also believe it is

outside the Department’s authority to favor particular business models in this manner, and that

doing so will stifle competition and inhibit innovation. There is no sound reason to deny use of

the BIC Exemption to online-only advice which is by design consistent and easy to monitor for

compliance with the exemption.

Using the PPA computer model rule is not an appropriate solution. Among other issues,

this would force reliance on two separate exemptions in the extremely common situation where

the advice recipient begins the interaction online but then calls to ask for personal assistance

from a phone representative. The legislative history of ERISA section 408(g) evidenced the

intent of Congress not to override regulatory guidance regarding alternative ways of structuring

certain permissible advice arrangements. The exclusion of online-only advice from the BIC

Exemption contradicts that approach.

3. Expand the BIC Exemption to Cover All Investment Products and Services.

The BIC Exemption applies only to “compensation for services provided in connection

with the purchase, sale or holding of an Asset”. The definition of an “Asset” only includes

specific categories of investment products and not services. As a result, it would not cover
C-3

recommendations or suggestions regarding investment services provided to the plan or IRA

owner, including managed account and other discretionary investment management services.

The exemption needs to cover these types of services in order to provide the broad relief needed

for investment services providers. The exemption also needs to cover account fees and other

compensation payable to the financial services firm that may not be directly connected with the

purchase of an Asset.

The proposed definition of an “Asset” also omits plan separate accounts or plan-specific

custom funds from the definition even though these investment options are relatively common in

the large plan market and would warrant consideration by plan participants as an investment for

their plan account. Although these investment options may be limited to a single plan or the

master trust of two or more related plans, they are essentially equivalent to a pooled investment

vehicle from the participant’s perspective so should be within the scope of permitted

investments. In addition, the proposal as written would treat interests in plan-specific insurer

separate accounts as eligible Assets, and treating them differently compared with separate

accounts isn’t warranted.

All of these concerns could readily be addressed by a broad-based exemption as would be

the case with our new best interest paradigm described in the main body of this letter and

Attachment A.

4. Clarify the Exemption’s Application to Distributions and Rollovers.

As discussed in Attachment B, there is considerable uncertainty regarding the inclusion

of interactions regarding distributions and rollovers in the proposed definition of “investment

advice”. For example, if a suggestion regarding the benefits of rolling a plan distribution to an

IRA maintained by an affiliate of the advisor, without any mention of a specific investment, is

included in the definition, the BIC Exemption would not appear to apply to that situation.

Similarly, a suggestion whether to take a distribution may also be included in the proposed

definition, but it does not appear to be covered by the BIC Exemption.

Fidelity representatives provide assistance to many plan participants and IRA owners

regarding a possible plan or IRA distribution, including the tax and financial considerations, and

try to help the participant, beneficiary or IRA owner in his or her personal decision-making. The

breadth of the Proposed Regulation would deem some of these interactions to constitute

investment advice under ERISA and the Code. For the reasons explained in Attachment B, the

Proposed Regulation should not include such non-investment specific interactions within the

definition of fiduciary investment advice. If the Department nevertheless determines that such

interactions are covered, then the Department must include such interactions within the scope of

the BIC Exemption.

This will presumably require considerable modification of the BIC Exemption. The BIC

Exemption is largely conditioned on an extensive array of disclosures. All of the disclosures,

however, are centered on specific recommended investments, investments bought, sold or held

by the investor, or specific investments offered by the advisor. None of these disclosures would
C-4

have any applicability as proposed to a recommendation that by definition does not refer to any

specific investment and would require special modifications with respect to non-investmentspecific related recommendations.

5. Expand Exemption to Cover Participants Employed by Financial Institutions.

The BIC Exemption would not allow a financial institution to rely on the exemption to

provide investment advice to participants in the plans that it maintains for its own employees.

The proposal preamble opines that due to the “special nature” of the employment relationship,

the financial institution should not be permitted to profit from the investments of employees

because that would not be in the best interests of the plan participants.

This approach is inconsistent with the Department's historical treatment of financial

institutions as plan sponsor. For example, the Department stated in the preamble to the ERISA

section 404(c) regulation proposed in 1991:

The Department is persuaded, however, that in the case of plans sponsored by certain

financial institutions which have appropriate professional expertise in investment

management, the designating fiduciary need not be independent. In enacting ERISA,

Congress recognized the need to accommodate such plans by fashioning special rules.

For example, section 408(b)(4) of ERISA permits a bank to invest the assets of an inhouse plan in deposits of that bank and section 408(b)(5) permits an insurance company

to issue contracts to a plan covering its own employees. The stated Congressional policy

underlying these exemptions is that it would be “contrary to normal business practice” for

a bank or insurer to purchase the products of another company of its own in-house plans.

Moreover, the Department has recognized in certain administrative exemptions that it

would be contrary to normal business practice for a company whose business is financial

management to seek financial management services from a competitor, e.g., Prohibited

Transaction Exemptions 77-3 and 82-63.26

There is no reason why these same considerations should not be reflected in the BIC

Exemption to cover investment advice provided to employees of financial institutions. In many

cases, for compliance reasons, those employees are required to maintain their financial assets

with the firm itself. Denying those firms the ability to provide employees investment advice

means they would have no access to advice whatsoever, unless a third party advice provider is

hired at additional expense.

6. Replace the Written Contract Requirement with a Unilateral Contract Requirement.

The BIC Exemption would require the individual advisor and financial institution to enter

into a signed written contract with every potential recipient of investment advice in advance of

any investment recommendation subject to the new definition. The BIC Exemption preamble

describes the contract requirement as the “cornerstone” of the proposed exemption, in part

26 56 FR 10724 (March 13, 1991).
C-5

because it creates a mechanism for alerting the investor to the advisor’s obligations and

providing the basis upon which the investor’s rights can be enforced.

The contract as proposed must include a lengthy list of provisions:

• affirmation of the advisor’s fiduciary status;

• a statement that any investment advice will be in the best interest of the investor;

• a statement that only reasonable compensation would be received by the advisor and

affiliates;

• a commitment that there would be no misleading statements relevant to the investment

matters covered by the exemption;

• a warranty that the advisor will comply with applicable laws;

• a warranty that the financial institution has adopted written policies and procedures

reasonably designed to mitigate conflicts of interest, including the identification of

material conflicts of interest and measures adopted to prevent violation of the impartial

conduct standards;

• a warranty that the financial institution does not use quotas, appraisals, performance or

personnel actions, bonuses, contests, special awards, differential compensation, or other

actions or incentives which would tend to encourage individual advisors to make

recommendations that are not in the investor’s best interest;

• disclosure of any material conflicts of interest;

• notice to the investor that he or she has the right to complete information about fees,

including direct and indirect fees payable to the advisor or financial institution; and

• disclosure as to whether the advisor offers proprietary products or receives payments

from third parties and the address of a public website that discloses all the compensation

arrangements entered into by the advisor or financial institution.

It would be extremely burdensome to re-contract with millions of existing IRA owners,

many of whom would undoubtedly question why they have to enter into a contract with an

individual or institution with whom they already have an existing relationship. Our experience is

that most individuals will not sign and return documentation until such time as they want or need

services. Under a rule requiring a signed written contract, this would mean that the financial

institution would have to create a costly new tracking system (as well as training on it) so that the

firm could implement the contract when a customer first calls and asks for investment assistance.

In addition, the financial institution would need to create a firm-wide data system to ensure that

representatives know whether they can talk to a person who has called with an investment or

distribution question.

Finally, the BIC Exemption seems to assume that an investor will always deal with the

same individual advisor, but that is not the true in most of our service roles. Since Fidelity has

thousands of phone representatives, a plan participant contacting us by phone will generally get a

different representative each time that he or she calls to ask a question about his or her account or

a new product or service recently added to the plan. Even at the financial institution level,

different legal entities may be engaged in providing investment advice depending on the product
C-6

or service involved. This dynamic would simply multiply the adverse impact of the proposed

written contract requirement.

On the plan side, recordkeepers do not have contracts with participants so introducing a

new “best interest contract” into the relationship will undoubtedly be confusing to plan sponsors

and participants alike. In addition, it seems totally unnecessary for plans subject to ERISA

because the fiduciary duty standard already applies as a matter of law. Otherwise it would be

necessary to create a database and “gate” protocol so that phone representatives could check the

system each time a participant calls with a question. Participants would generally talk to a

different representative each time they call, so that each call would be subject to a checking

process. Alternate payees and beneficiaries of deceased participants would have to go through

the same protocol.

We believe that an enforceable best interest standard can be established by much less

onerous means – a unilateral contract offer by the financial institution which would be

enforceable as a contract as well as through the doctrine of promissory estoppel. There is no

need to require a signed, written document nor must the individual Advisers be involved.

In a unilateral contract, only one of the contracting parties makes a promise; the other

party manifests assent by performance.27 Accordingly, “[t]he legal result is that the promisor is

the only party who is under an enforceable legal duty. The other party to this contract is the one

to whom the promise is made, and this promisee is the only one in whom the contract creates an

enforceable legal right.”28 Moreover, no signature is required for a unilateral contract to be

enforceable. Rather, parties may become contractually bound by indicating their assent through

a variety of other means, such as by accepting and acting upon the contract, ratifying the

contract, or accepting the performance by the other.29

The unilateral contract is supported by the same consideration that would support a

signed bilateral contract such as the best interest contract. That is, engagement of the financial

services firm by the investor constitutes sufficient consideration to create a legally binding

relationship.

The principles of the unilateral contract are perfectly-suited to the BIC Exemption, where

the goal should be to hold a single party – the financial services firm – to an enforceable legal

duty. This can be achieved by requiring firms wishing to use the exemption to post a statement

on their website (or other accessible venue) that sets forth the best interest contract standards and

27 Corbin on Contracts § 1.23 (3d ed. 2004); see also United States ex rel. Modern Elec., Inc. v. Ideal Elec. Security

Co., 81 F.3d 240, 241 (D.C. Cir. 1996) (citing the “well-recognized” principle that “in a unilateral contract,

performance constitutes acceptance of an offer”). 28 Corbin on Contracts § 1.23.

29 17A Am. Jur. Contracts § 173; see also Words, Inc. v. Xerox Corp., 205 F.3d 1336, at *1 (4th Cir. 2000) (per

curiam) (“If the party against whom the contract is being enforced has indicated through some unequivocal act or

through performance that it intends to adopt the contract, then a signature by that party is not required for the

contract to be binding.”); In re JetBlue Airways Corp. Privacy Litig., 379 F. Supp. 2d 299, 325-26 (E.D.N.Y. 2005)

(finding a contract where customers “made flight reservations in reliance on express promises contained in

[defendant’s] privacy policy” posted online).
C-7

commits to act in accordance with those standards when providing covered investment services.

The client would be advised of this promise, the standards, and where to review them at the time

covered services were offered. This could be done orally, when the interaction is by telephone or

in person, or in writing, when the interaction is computer-based. The client would accept the

firm’s offer by proceeding to use the firm’s services, thereby forming an enforceable agreement

under basic principles of contract law.30

These principles of contract law would be sufficient to bind financial services firms to the

best interest standard without the unnecessarily cumbersome and costly difficulties associated

with an actual signed written agreement. However, the doctrine of promissory estoppel would

serve as an additional means to enforce the best interest standard. Under promissory estoppel, if

a party changes its position substantially either by acting or forbearing from acting in reliance

upon a clear and unambiguous promise, then that party can enforce the promise even though the

essential elements of a contract are not present.31

In the context of the BIC Exemption, that doctrine would apply if a firm represented to an

investor that it would abide by the best interest standards when providing services, and the

investor accepted those services in reliance on that assurance. In these circumstances, even if a

court were to determine that for some reason no enforceable contract exists, a customer could use

the doctrine of promissory estoppel to enforce the firm’s representations. And here again, the

firm could be bound even more tightly by requiring, as a condition of the exemption, that it

acknowledge on its website (or in some other publicly-accessible format) the enforceability of its

best interest promise, and the client’s reliance on that promise in engaging in the interaction.

For all of these reasons, there is no need for the Department to require a signed written

contract for the BIC Exemption. The proposed exemption should be revised to permit financial

services firms to become legally bound in the manner described above.

7. Simplify and Improve Disclosure Requirements.

A key component of the exemptions is full and meaningful disclosure of all material

conflicts of interest, including compensation payable to the advisor. The BIC Exemption

contemplates a three-tiered approach involving a point-of-sale32 disclosure of the projected cost

30 See Corbin, supra; see also Coulier v. United Airlines, Inc., 2015 WL 2452393, at *5 (S.D. Tex. May 21, 2015)

(the portion of defendant’s website guaranteeing lower price for tickets purchased on the website was a “unilateral

contract that the customer must accept by performance”); Edquist v. Bidz.com, Inc., at *1 (D. Mass. Mar. 29, 2013)

(“[A] person such as the plaintiff who accepts the terms offered by the defendant on its website by participating in

an online auction governed by those terms has entered into a contractual relationship with the defendant.”). 31 Restatement (Second) of Contracts § 90; see also Williston on Contracts § 8:7 (4th ed. 2008) (“[B]oth versions of

the Restatement recognize that in certain circumstances, a promise might be enforced despite the absence of

consideration – and, according to some courts, despite the absence of other elements necessary to form a traditional

contract – based on the promisee’s foreseeable, reasonable, justified and detrimental reliance on the promise”); Allen

v. A.G. Edwards & Sons, Inc., 606 F.2d 84, 87 (5th Cir. 1979) (recognizing promissory estoppel where brokerdealer, “[h]aving benefitted from oral agreements transacted through local agents, [ ] cannot now be heard to

complain of failure to observe formalities”). 32 The BIC Exemption provides for “Transaction Disclosure” which is to occur “prior to the execution of the

purchase of the Asset by the Plan, participant or beneficiary account, or IRA.” However, an advisor will often not
C-8

of recommended investments, an annual statement summarizing in dollar amounts the

compensation actually paid to the advisor during the preceding year and a publicly available

website outlining all investments the advisor might recommend and the compensation associated

with each. While we have no objection in theory to disclosing this information, the manner in

which it is disclosed is critically important to both the usefulness of the information to the

investor and workability from the perspective of the financial services firm.

Point-of-sale disclosures in particular are problematic. If an advisor is recommending

one specific investment product or service a particular customer, it is perhaps feasible to develop

and produce a point-of-sale document for the recommended investment. However, most

discussions with customers cover a wide range of potential products and services as the customer

develops an investment strategy. In many cases, a customer leaves the discussion without

making a decision which means the financial services firm would be required to produce a pointof-sale disclosure for every product or service discussed since the customer may later decide to

implement the investment strategy without further discussion with a representative. More

importantly, the proposed point-of-sale disclosure addresses only the cost of recommended

investments and not the compensation payable to the advisor and therefore does not disclose the

conflict of interest.

We do not believe the proposed annual disclosure will provide meaningful information to

investors about the advisor's potential conflict of interest. An investor's account will typically

include a mix of investments and reflect a range of transactions, some of which may have been

the result of recommendations of the advisor and others of which were entered into by the

investor on their own. As a practical matter, other than transactions entered into immediately

following the recommendation, there is no practical way to distinguish between the two. As a

result, the annual statement must necessarily reflect all transactions in the account so will not in

fact represent compensation payable as a result of recommended investments. In addition,

building a system to keep track of this information at an individual account level would be

extremely costly.

Finally, the public website does not appear to be intended for use by investors and is not

directly related to the investor's decision about the specific transactions being recommended.

With respect to employee plans, the proposed website information would be less helpful than the

information already furnished to participants and beneficiaries in the form of a plan-specific

comparative chart of designated investment options, as required under DOL reg. §2550.404a-5.

Another difference is that the website would provide those investment options in combination

with information about thousands of options not included in a plan’s menu of designated

investment options. In some cases, information may be subject to confidentiality agreements

between the plan sponsor and manager. With respect to IRAs, the website would include

hundreds or thousands of institutional investment options – particularly group trust portfolios,

plan-specific separate accounts and group annuity products - that would not be available to the

retail investor as investment choices. Nevertheless, much of the information provided would be

know if or when a recommended Asset may be purchased by a customer. This means, as a practical matter, such

disclosure would likely be provided at the time the advisor provides the advice to the customer. Accordingly, it is

probably more accurately referred to as a “point-of-recommendation” disclosure.
C-9

available under our new best interest paradigm. We believe the more simplified two-tiered

approach included in that paradiam, as described in the body of our letter and in Attachment A,

will make the disclosure regime both workable and more meaningful to investors.

The more simplified, two-tiered approach would also be far more practical for advisors

who provide advice with respect to investments not held in custody by the advisor. Much of the

information required to be disclosed under the BIC Exemption would not be available to an

advisor who does not have custody of the investor’s account. For example, the annual disclosure

includes information about all investments held in the investor’s account, not just assets

purchased pursuant to the advisor’s recommendation. But an advisor may not have knowledge

of all the investments in an account held by a third-party custodian. Similarly, the website is

required to include information about all investments offered through the advisor, but an advisor

may not have the information required to provide such disclosure about all the investments

available through the advisor on a third-party recordkeeping platform. As a result, the BIC

Exemption’s disclosure requirements could not be met by an advisor with respect to investments

held by a third-party custodian, absent an information sharing arrangement between the advisor

and the third-party custodian.33 The two-tiered disclosure, on the other hand, would only require

disclosure of information that an advisor would have at its disposal regardless of whether it held

custody of recommended investments.

Finally, the BIC Exemption preamble asks whether a “cigarette warning” could be as

effective and less costly. The sample language provided in the preamble discussion warns that

the fees “may determine your adviser’s take home pay”, which seems directly at odds with the

conditions of the BIC Exemption relating to advisor compensation, so presumably any “cigarette

label” warning would take a different form. In any event, the two-tiered approach described

above would more effectively inform the customer about the nature of an advisor's conflicts.

The two-tiered approach is also similar to the Department regulation under the PPA investment

advice exemption which includes model disclosure that would inform the investor of the

fiduciary nature of the advice and that the compensation received by the advisor may vary

(within a range) depending on the investment choices made by the investor. This squarely

addresses the “conflict” issue without inundating the investor with too much information.

8. Eliminate Special Data Production Requirements.

The BIC Exemption would authorize the Department to require the production of six

years of firm-wide aggregate data regarding purchases, sales and holding of each Asset for

retirement investors on a quarterly basis, and in each case the revenue received by the financial

institution for such Asset “disaggregated by source”. The financial institution would also need to

provide data regarding quarterly cash flows and account balances for each retirement investor.

33 Note that creating such information sharing arrangements, which would involve extensive contracting and systems

build-outs among thousands of advisors and third-party custodians or recordkeepers, would be extremely timeconsuming and costly. The proposal does not appear to take any of these costs into account or to allow for the time

necessary to create these information sharing arrangements.
C-10

The proposal preamble states that the required information concerns purchases, sales and

holdings “made pursuant to advice provided by the advisor or financial institution relying on the

exemption.” As an editorial matter, the text of the proposed exemption does not include such

“made pursuant” language. As an even more important practical matter, however, it is

particularly unclear how a firm would be able to track whether each buy, sell or hold decision

was the result of investment advice. For example, if an investor is provided with a model

portfolio illustration that includes a $20,000 investment in fund X, and two months later buys

$30,000 of fund X. how would the advisor know whether the purchase was the result of a

recommendation and, even if it knew that, how much of the purchase should be reflected in the

database as resulting from the advice?

The proposal preamble states that the receipt of such additional data will assist the

Department in assessing the effectiveness of the BIC Exemption. It is difficult to understand,

however, how the aggregate data will be useful in that regard. It seems to indicate a research

agenda (as in the case of the public website) which is unrelated to the furnishing of prohibited

transaction exemption relief.

As a compliance matter, the approach taken in the proposal would mean that a firm

would not be sure that its recommendations in a given year are covered by the BIC Exemption

for another five years, because of the possibility that the firm experiences problems in

responding to the Department’s request for data. This would be true even if the difficulty is with

respect to transactions completed in a different year!

The Department is already authorized under section 504 of ERISA to request the

production of information by a financial institution or other service provider in order to

determine whether there has been a violation of ERISA. It appears that the proposed exemption

information production requirement may be intended to expand Department inquiries into the

IRA world, but the Department has no enforcement authority there pursuant to the

Reorganization Plan No. 4 of 1978. Putting financial institutions at risk of incurring prohibited

transaction penalties if the firm has difficulty producing information unrelated to the

transaction(s) in question would be an inappropriate use of the exemption process.

The Principal Transactions Exemption

As an initial matter, we note that the new best interest paradigm set forth in the main

body of this letter and Attachment A would render the Principal Transactions Exemption

unnecessary. That paradigm would provide for a single, broad, principles-based exemption that

would cover all advice transactions, including principal transactions. We urge the Department to

adopt this paradigm. In the event that the Department does not do so, however, we offer the

following comments with respect to the proposed Principal Transactions Exemption.

Fidelity supports efforts to enhance fixed income price transparency. Pricing

transparency promotes robust competition among diverse market participants, which helps foster

innovation and allows for greater investor choice. However, we do not support the Principal

Transactions Exemption as currently drafted for the following reasons:
C-11

• the extensive restrictions and conditions in the exemption are not necessary if

financial institutions and advisors are held to a fiduciary best interest standard

with respect to the provision of investment advice – the BIC Exemption

(modified as described above) should cover all transactions, including principal

transactions;

• the exemption fails to acknowledge the extensive, existing legal framework for

principal transactions promulgated by the primary regulators of financial

institutions, applicable to both retirement and non-retirement accounts; and

• the extensive restrictions and conditions in the exemption are unnecessarily

burdensome and unworkable for advisors and financial institutions.

As currently drafted, the Principal Transactions Exemption will result in less choice and higher

costs for retirement investors and will impact liquidity in the already fragile fixed income

markets. The Principal Transactions Exemption should be revised to permit advisors to engage

in a wide spectrum of principal transactions, across security types, subject to a fiduciary best

interest standard and compliance with applicable law. Each of these comments is discussed in

more detail below.

In the preamble to the Principal Transactions Exemption, the Department recognizes that

the ability to execute principal transactions is integral to the economically efficient distribution

of fixed income securities but also notes its concern with issues associated with principal

transactions involving liquidity, pricing, transparency and a fiduciary’s possible incentive to

“dump” unwanted assets. As a threshold matter, we wish to highlight the important role of

principal trading in the capital markets. Dealers acting in a principal capacity engage in

activities beneficial to the markets, such as market making, and provide liquidity to the markets.

Regulatory obligations on market makers often require them to engage in transactions in their

own account in order to maintain a fair and orderly market. Any rulemaking that impacts

principal trading should be implemented in a way that does not inadvertently reduce liquidity,

which could increase volatility and risk in the capital markets. Moreover, if significant

disincentives to trading on a principal basis are imposed, fewer dealers may be willing to act as

principal, reducing market liquidity to the detriment of all investors.

Assuming the financial institution commits to act in the best interest of the customer,

the Principal Transactions Exemption’s additional restrictions and conditions on principal trading

are not necessary. Moreover, these restrictions and conditions may even inhibit the financial

institution’s ability to act in the best interest of a retirement investor, in contravention of the

Department’s goals. For example, the Principal Transactions Exemption does not reflect the role

of a financial institution in providing facilitation trades when a retirement investor seeks to sell a

security and cannot obtain a reasonable price from a third party or cannot obtain a ready buyer.

The Proposed Regulation and Principal Transactions Exemption would thus create a situation in

which a financial institution could offer advice in the best interest of the retirement investor to

sell a particular security, but the financial institution could not facilitate the trade in the absence
C-12

of a reasonable price from a third-party or in the absence of other buyers. At best, we believe

this scenario will frustrate retirement investors, and at worst, work against their best interest.

Additionally, the Principal Transactions Exemption’s regulation of principal trading with

respect to the provision of advice is layered onto an already comprehensive existing legal

framework. Under the Principal Transactions Exemption, only three types of financial

institutions may engage in principal trading: (1) registered investment advisers under the

Investment Advisers Act of 1940 (the “Advisers Act”) or under the laws of the state in which the

adviser maintains its principal place of business; (2) a bank or similar financial institution

supervised by the United States or state; and (3) a broker or dealer registered under the Securities

Exchange Act of 1934. This limitation is based on the Department’s understanding that these

entities may commonly sell debt securities out of inventory.

Fidelity has both investment advisory and broker-dealer businesses and clients. We

appreciate from our experiences that both registered investment advisers and broker-dealers are

extensively regulated, supervised, and their compliance with applicable rules enforced by

numerous federal and state financial regulators and self-regulatory organizations.34 The legal

framework established by these regulators, includes rules specific to principal transactions.

Financial regulators have long recognized the potential for conflicts of interest with principal

transactions and have constructed a comprehensive legal framework carefully designed to

minimize those risks. For example:

Registered Investment Advisers: The United States Supreme Court has construed Sections

206(1) and (2) of the Advisers Act as establishing a federal fiduciary standard governing the

conduct of advisers.

35 Thus, registered investment advisers are already subject to a

fiduciary standard to act in their client’s best interest. Moreover, Section 206(3) of the

Advisers Act makes it unlawful for a registered investment adviser, acting as principal for

its own account, to knowingly buy any security from or sell any security to a client,

without disclosing to such client, in writing, before the completion of each such

transaction, the capacity in which she is acting, and obtaining the consent of the client to

the transaction.Written disclosure must be provided and consent must be obtained

separately for each transaction, i.e., blanket consent for transactions is not sufficient. The

Commission staff has also taken the position that the registered investment adviser must

disclose not only the capacity in which the adviser is acting, but also any compensation that

the adviser receives for its role in such transaction.36

Broker-Dealers: Under the federal securities laws and rules of self-regulatory

organizations to which they belong, broker-dealers may engage in principal transactions

34 Fidelity has not commented on existing regulations applicable to principal trading by banks because we do not

have a bank that engages in principal trading within our corporate structure. We believe that this area should be

further explored by those familiar with the subject. 35 SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963). 36 See Applicability of the Investment Advisers Act to Financial Planners, Pension Consultants, and Other Persons

Who Provide Investment Advisory Services as a Component of Other Financial Services, Investment Advisers Act

Release No. 1092 (Oct. 8, 1987).
C-13

with customers, across all security types, subject to a number of requirements. Securities

and Exchange Act (“Exchange Act”) Rule 10b-10 requires a broker-dealer effecting

customer transactions in securities (other than U.S. savings bonds or municipal securities)

to provide written notification to the customer, at or before completion of the transaction,

disclosing information specific to the transaction, including whether the broker-dealer is

acting as agent or principal. Rule 10b-10 also requires broker-dealers to disclose on

confirmations the price of the security that was bought or sold by the customer. The

Municipal Securities Rulemaking Board’s (“MSRB”) Rule G-15 requires similar

disclosures from municipal securities brokers and dealers. Working with the SEC,

FINRA and the MSRB are both currently actively engaged in rulemaking that would

require disclosure of mark-ups in certain principal transactions.37 Additionally, brokerdealers mustseek to obtain best execution for principal transactions when a broker-dealer

accepts an order from a customer38 and may only receive fair compensation in both

agency and principal transactions.39 The SEC has determined that when engaging in

transactions directly with customers on a principal basis, a broker-dealer violates

Exchange Act Rule 10b-5 when it knowingly or recklessly sells a security to a customer

at a price not reasonably related to the prevailing market price and charges excessive

markups, without disclosing the fact to the customer.40

We note that investors often maintain multiple types of accounts and relationships with

financial institutions. The Principal Transactions Exemption will apply to some, but not all,

fixed income transactions in some, but not all, customer accounts held at a financial institution.

The narrow category of accounts and securities covered by the Principal Transactions Exemption

will undoubtedly prompt customer questions and confusion in contravention of the Department’s

goals to increase investors’ understanding, as well as complicate implementation efforts at

financial institutions.

To help promote investor understanding, the Department should defer to, or at a

minimum, consider, the extensive legal framework established for principal trading by the

primary regulators of financial institutions, and work with these regulators to develop consistent,

harmonized requirements and disclosures across both retirement and non-retirement accounts.

This course of action would promote legal certainty, put retirement investors on a level playing

field with other investors, reduce investor confusion, and seek to mitigate the Principal

Transactions Exemption’s potential impact to liquidity in the capital markets.

37 See FINRA Regulatory Notice 14-52; Pricing Disclosure in the Fixed Income Markets (November 2014).

(“FINRA Proposal”) and MSRB Regulatory Notice 2014-20; Request for Comment on Draft Rule Amendments to

Require Dealers to Provide Pricing Reference Information on Retail Customer Confirmations (November 2014)

(“MSRB Proposal”). We urge the Department to allow FINRA and the MSRB to take the lead in rulemaking on this

topic as their rules will apply across retirement and non-retirement accounts. 38 See FINRA Rule 5310 (“Best Execution and Interpositioning”).

39 See FINRA Rule 2121 (“Fair Prices and Commissions”) and associated Supplemental Material.01 (“Mark-Up

Policy”), and Supplemental Material .02 (“Additional Mark-Up Policy For Transactions in Debt Securities, Except

Municipal Securities”). 40 See, e.g., Grandon v. Merrill Lynch & Co., 147 F.3d 184, 189-90 (2d Cir. 1998) as discussed in SEC Staff Study

on Investment Advisers and Broker-Dealers as required by Section 913 of the Dodd-Frank Wall Street Reform and

Consumer Protection Act (January 2011) at page 70.
C-14

Nevertheless, if the Department chooses to proceed with a third layer of regulation of

principal transactions in connection with the provision of advice after (1) already requiring

financial institutions and advisors to contractually commit to a “best interest” standard and

warrant compliance with all applicable federal and state law regarding the rendering of advice

and the purchase and sale of debt securities and (2) in recognition of the numerous rules and

regulations of other federal regulators that already apply to principal trading by financial

institutions, we offer the following specific comments on the Principal Transactions Exemption.

1. Distinguish “Principal Transactions” Executed on a Riskless Principal Basis.

The Principal Transactions Exemption does not distinguish, or even discuss, transactions

executed by a financial institution on a “riskless principal” basis versus traditional “principal”

transactions. There is an important distinction between these two types of transactions. As

described in more detail below, riskless principal transactions are unlike traditional principal

transactions because the broker-dealer does not execute the purchase or sale from the brokerdealer’s own inventory; the “principal” nature of the transaction is purely technical. The

interests of investors would be well protected if the Department permitted broker-dealers who

provide ERISA investment advice to engage in riskless principal transactions, across a broad

range of security types, subject to a fiduciary best interest standard and in compliance with

applicable rules regarding the purchase and sales of securities.

Typically, financial institutions engage in riskless principal transactions as an alternative

method of executing customer orders to buy or sell financial instruments on an agency basis.

Assuming that traditional principal transactions create a possible incentive to “dump” unwanted

assets, as the Department asserts in the preamble to the Principal Transactions Exemption,

riskless principal transactions present no similar incentive. In a typical riskless principal

transaction, a financial institution, after receiving an order to purchase (or sell) a financial

instrument from a customer, purchases (or sells) the financial instrument for its own account to

offset the contemporaneous sale of the financial instrument to (purchase from) the customer.

Because riskless principal transactions are customer-driven and dealer exposure to market risk is

limited by the brief period of actual ownership, investors generally incur lower transaction costs

as compared to pure principal transactions, similar in economic terms to agency transactions.

Benefits accrued to investors from riskless principal transactions are at risk if the

Department’s proposal is approved as drafted. For example, when a broker-dealer executes a

fixed income transaction on a riskless principal basis, the investor has a better understanding of

the true yield of the bond, because the broker-dealer’s mark-up is factored into the yield. In

contrast, when a broker-dealer executes a fixed income transaction on an agency basis, the yield

quoted is not inclusive of the commission, which offers less insight into the “real” yield of the

investment.

Moreover, systems at financial institutions are not typically designed to switch from

agency to riskless principal to principal capacity based on a trade by trade determination. If the

Department determines to treat riskless principal transactions similarly to other principal
C-15

transactions under the Principal Transactions Exemption, broker-dealers may decide that it is

more cost effective to re-design certain systems to execute these orders on an agency basis, than

comply with the Principal Transactions Exemption’s numerous restrictions and conditions for a

limited number of retirement accounts. The cost of converting a financial institution’s systems

from a riskless principal model to a straight agency model may nevertheless be substantial, and

financial institutions may decide to pass these costs along to investors, increasing their

transactions costs, in addition to limiting their choice of execution.41

Concurrent with the Proposed Regulation and the Principal Transactions Exemption, the

Department has proposed amendments to PTE 86-128 and has also proposed to revoke PTE 75-1

Part 2(II). Among other items, the proposed amendments to PTE 86–128 include language that

is currently a component of PTE 75-1, to permit a broker-dealer fiduciary to use its authority to

cause a plan or IRA to purchase shares of a mutual fund from the broker-dealer fiduciary, acting

as principal, where the shares were acquired solely to cover the plan’s (or IRA’s) prior order, and

for the receipt of a commission by such fiduciary in connection with the transaction. The

proposed amendments to PTE 86-128 would not include relief for fiduciaries who provide

investment advice to IRAs, however (such fiduciaries would need to use the BIC Exemption).

The Department’s amendments to PTE 86-128 indicate an awareness of riskless principal

transactions and the Department’s view that the provisions of the BIC Exemption better protect

the interests of investors with respect to investment advice regarding securities transactions. The

interests of investors would be further advanced if the Department permitted broker-dealers who

provide ERISA investment advice to engage in riskless principal transactions under a simplified

BIC Exemption as proposed under our new best interest paradigm or, at a minimum, under the

Principal Transactions Exemption, across a broad range of security types, without numerous

restrictions and conditions, subject to a fiduciary best interest standard and compliance with the

rules of the SEC, FINRA and MSRB on riskless principal trades. We urge the Department to

consider these alternative approaches.

2. Expand Securities Types Covered by the Principal Transactions Exemption.

The Principal Transactions Exemption would permit a financial institution to engage in

principal transactions in connection with the provision of investment advice for only a narrow

category of debt securities. For purposes of the Principal Transactions Exemption, the term

“Debt Security” means “a ‘debt security’ as defined in Rule 10b-10 (d)(4) of the Exchange Act

that is: (1) U.S. dollar denominated, issued by a U.S. corporation and offered pursuant to a

registration statement under the Securities Act of 1933 (‘33 Act’); (2) An ‘Agency Debt

Security’ a defined in FINRA Rule 6701(l) or its successor; or (3) a ‘U.S. Treasury Security’ as

defined in FINRA Rule 6710(p) or its successor.” Our comments and concerns with this

proposed definition follow below.

41 Moreover, given the costs and complexity involved in changing technology systems, firms are unlikely to

eliminate riskless principal transactions only for a “retirement” registration type. That is, the Principal Transactions

Exemption may prompt broker-dealers to stop executing orders on a riskless principal basis across all account types,

retirement and non-retirement, potentially further impacting liquidity in the markets.
C-16

First, only corporate debt registered under the ’33 Act would be permitted to be

principally traded in connection with the offering of investment advice.42 We understand that

there are practical difficulties that will inhibit a dealer to systematically determine whether bonds

trading in the secondary market were issued pursuant to a registration statement. For example,

Section 3(a)(2) bank note offerings (which are generally rated investment grade notes issued by

banks) are often not registered. These notes are commonly held in retirement accounts. We urge

the Department to allow corporate debt to be principally traded in connection with investment

advice regardless of whether it is registered under the ’33 Act as long as it is offered in the best

interest of the investor and in compliance with applicable rules regarding the purchase and sale

of securities.

We also note that there are several additional categories of securities commonly held by

investors and primarily sold in principal transactions that are not included in the Principal

Transactions Exemption. The omission of these security types from the Principal Transactions

Exemption means that financial institutions cannot trade these securities as principal in

connection with the provision of investment advice to retirement accounts. Given the Proposed

Regulation’s extremely broad definition of “investment advice”, we anticipate that virtually any

communication regarding these securities would be considered “investment advice”, prohibiting

the normal purchase and sale processing of these securities. We discuss the specific

characteristics of some of these securities, and proposed safeguards that would apply to an

exemption permitting their sale in a principal transaction, below.

Brokered CDs. The Department has not included brokered certificates of deposit

(“CDs”) in the definition of “Debt Security” in the Principal Transactions Exemption. Brokered

CDs are CDs issued by banks for the customers of brokerage firms. The CDs are usually issued

in large denominations and the brokerage firm divides them into smaller denominations for

resale to its customers. Because the deposits are obligations of the issuing bank, and not the

brokerage firm, FDIC insurance applies. A brokered CD is similar to a bank CD in many ways.

Both pay a set interest rate that is generally higher than a regular savings account. Both are debt

obligations of an issuing bank and both replay principal with interest if they are held to maturity.

More importantly, both are FDIC-insured up to $250,000 (per account owner, per institution).

Unlike a bank CD, a brokered CD can be traded on the secondary market, meaning that investors

don’t necessarily have to hold them to maturity.

Brokered CDs are offered through two main venues – as new issue offerings and from the

secondary market. They are most often sold on a principal basis and are commonly held in

IRAs. We see no clear reason why brokered CDs should be excluded from the definition of Debt

42 FINRA has proposed, and intends to pursue, a proposal that would require disclosure of mark-ups in certain

principal transactions for corporate and agency securities. The FINRA Proposal defines “corporate debt security” as

“a debt security that is United States (U.S.) dollar denominated and issued by a U.S. or foreign private issuer and, if a

“restricted security” as defined in Securities Act Rule 144(a)(3), sold pursuant to Securities Act Rule 144A, but 

does not include a Money Market Instrument as defined in Rule 6710(o).” Given the overlapping obligations of the

Principal Transactions Exemption and FINRA Proposal on Financial institutions, we urge the Department and

FINRA to develop a consistent definition of corporate debt security for purposes of the Principal Transactions

Exemption and FINRA Proposal.
C-17

Security under the Principal Transactions Exemption, particularly since CDs are considered

“Assets” for purposes of the Department’s BIC Exemption. We recommend the Department

correct this oversight.

New Issue Offerings of Equity Securities. The Department has chosen to exclude equity

securities from the Principal Transactions Exemption under the reasoning that “equity

securities...are widely available through agency transactions that do not involve the particular

conflicts of interest associated with principal transactions.” We do not agree with this assertion,

particularly with regard to new issue equity, which is typically traded on a principal basis.

Fidelity invites eligible retirement and non-retirement customers to participate in new

issue offerings, including initial public offerings (“IPOs”) as well as follow-on secondary

offerings. We clearly communicate that customers should read the offering prospectus carefully,

and make their own determination of whether an investment in the offering is consistent with

their investment objectives, financial situation, and risk tolerance. Given the Proposed

Regulation’s extremely broad definition of “investment advice”, we anticipate that virtually any

announcement of the availability of these securities to retirement investors would be considered

“investment advice”. The Department’s limitations on securities that may be principally traded

will prevent retirement investors, who have chosen to seek out new issue offerings of equity

securities for good investment reasons, from purchasing these products.

Ultimately, the interests of investors would be further advanced if the Department simply

permitted financial institutions that provide fiduciary investment advice to engage in principal

transactions, across a broad range of security types, subject to a fiduciary obligation to act in the

best interest of their customer and compliance with applicable rules regarding the purchase and

sale of securities. Moreover, limitations on types of securities that can be principally traded in

retirement accounts, may work against retirement investors’ best interests. We urge the

Department to adopt this alternative approach.

Municipal Securities. The Department has similarly not included municipal securities in

the definition of Debt Securities in the Principal Transactions Exemption. Municipal Securities

are debt obligations issued by states, cities, counties, and other public entities that use the loans

to fund public projects, such as the construction of schools, hospitals, highways, sewers, and

universities. Municipal securities can be bought either as new issues that are sold by

underwriters to investors or can be purchased in the secondary market where they are traded

over-the-counter. Municipal securities are heavily regulated by the SEC, FINRA, IRS and the

MSRB, which is charged under the Securities and Exchange Act to propose rules governing the

municipal securities markets.43

43 The MSRB protects investors, state and local governments and other municipal entities, and the public interest by

promoting a fair and efficient municipal securities market. The MSRB fulfills this mission by regulating the

municipal securities firms, banks and municipal advisors that engage in municipal securities and advisory activities.

To further protect market participants, the MSRB provides market transparency through its Electronic Municipal

Market Access (EMMA®) website, the official repository for information on all municipal bonds. The MSRB also

serves as an objective resource on the municipal market, conducts extensive education and outreach to market

stakeholders, and provides market leadership on key issues. The MSRB is a Congressionally-chartered, self-
C-18

The municipal bond market is a dealer-driven market. The bulk of the bonds offered for

sale via any online bond search are typically owned by dealers. Since the dealers actually own

the bonds, the entire market operates on a principal basis, meaning that dealers buy bonds at one

price and offer them for sale at a higher price, also known as a “spread”. The profit a bond dealer

earns is the difference between what the dealer paid for the bonds and the price at which the

dealer ultimately sells the bond.

Municipal securities can play an important role in retirement accounts, both on a taxable

and non-taxable basis. Taxable municipal bonds, such as the Build America Bonds, are not

exempt from federal, state or local taxes. Depending on a number of factors including, the

interest rate environment, offered yield, potential need for diversification of credit, and

individual tax situation, it may be in the investor’s best interest to hold a taxable municipal bond

in his or her IRA. We acknowledge that taxable municipal bonds are more typically purchased

in retirement accounts as compared to tax-exempt bonds, which are exempt from federal, state or

local taxes. However, on an absolute yield basis, tax-exempt municipal bonds may be

appropriate for retirement investors during certain time periods in the market.

Given that municipal securities are typically principally traded, the Department’s

omission of municipal securities in the Principal Transactions Exemption can be viewed as a

determination that municipal securities are never appropriate for any retirement investor. We

respectfully believe that such a judgment is not an appropriate exercise of the Department’s

regulatory authority, and we recommend that rather than limit retirement investors’ access to

these securities, the determination of whether an investment in a municipal security is in a

retirement investors’ best interest should be left to financial institutions and advisors who have a

better understanding of the individual needs of the retirement investors they serve. We

recommend the Department include municipal securities in the definition of Debt Security in the

Principal Transactions Exemption, subject to a fiduciary best interest standard and in compliance

with applicable rules regarding the purchase and sale of securities.

3. Replace the Written Contract Requirement with a Unilateral Contract Requirement.

For all of the reasons set forth above with respect to the written contract requirement of

the BIC Exemption, we recommend a flexible approach where the contractual commitment can

be established through a unilateral contract offer by the financial services firm which would be

enforceable as a contract or through the doctrine of promissory estoppel. There is no need to

require a signed, written document nor must the individual advisors be involved.

In addition, as part of the proposed written contract, the financial institution must agree

that it will not enter into a principal transaction if the price (including the mark-up/mark-down)

is unreasonable under the circumstances. If this provision is retained, the Department should

regulatory organization governed by a 21-member board of directors that has a majority of public members, in

addition to representatives of regulated entities. The MSRB is subject to oversight by the Securities and Exchange

Commission.
C-19

include its interpretation of circumstances in which a price of a Debt Security is unreasonable to

avoid confusion following FINRA and MSRB guidance on this point.44

4. Eliminate or Clarify Requirements Regarding the Quality of Debt Securities.

Under the Principal Transactions Exemption, an adviser and financial institution may

only recommend debt securities that possess no greater than moderate credit risk and are

sufficiently liquid that the debt security could be sold at or near its fair market value within a

reasonably short period of time. The Department notes that debt securities subject to moderate

credit risk should possess at least average creditworthiness relative to other similar debt issues

and that moderate credit risk would denote current low expectations of default risk, with an

adequate capacity for payment of principal and interest. As reference, the Department notes that

the SEC has established similar standards of creditworthiness applicable to debt securities under

Rule 6a-5 of the Investment Company Act of 1940.45

We disagree that SEC Rule 6a-5 is similar to the Department’s proposal. The SEC’s

amended Rule 6a–5 replaced a credit rating requirement (removed by Congress as part of the

Dodd-Frank Act) applicable to debt securities in which certain business and industrial

development companies (‘‘BIDCOs’’) relying on the Investment Company Act exemption in

section 6(a)(5) may invest. Under amended Rule 6a–5, a BIDCO that relies on the exemption in

section 6(a)(5) may invest in certain debt securities, provided that the BIDCO board determines,

at the time of purchase, that the debt security is (1) of no greater than moderate credit risk and (2)

is sufficiently liquid. The standard for liquidity under the rules is whether the security can be sold

at or near its carrying value within a reasonably short period of time.

The Department has replaced the SEC’s “carrying value” standard for liquidity with a

“fair market value” standard. Fair market value is the price that can be obtained in the market.

Given that the fair market value for a security cannot be ascertained until one attempts to buy or

sell a security, it is difficult to understand how market participants can meet this condition.

Moreover, in making credit quality determinations, the SEC’s rule permits a BIDCO to consider

credit quality reports prepared by outside sources, including ratings of a nationally recognized

statistical rating organization that the board or board members conclude are credible and reliable

for credit quality determinations. The Principal Transactions Exemption contains no such

additional criteria. Given that the financial institution would already be subject to a best interest

standard and applicable law on the purchase and sale of securities when engaging in a Principal

Transaction, detailed requirements on the types of securities that may be principally traded is not

necessary, particularly when the requirements are not workable.

If the Department proceeds with this requirement, the Department should clarify how a

financial institution should determine and measure the degree to which a debt security is

“sufficiently liquid” such that it could be sold at or near its fair market value within a reasonably

44 See discussion of pricing information and a dealer’s best execution obligations infra. 45 See Purchase of Certain Debt Securities by Business and Industrial Development Companies Relying on an

Investment Company Act Exemption, Investment Company Act Release No. 30268 (Nov. 19, 2012) [77 FR 70117

(Nov. 23, 2012)].
C-20

short period of time. The Principal Transactions Exemption requires the advisor and financial

institution, among other items, to obtain a pricing quote for the debt security offered by two

ready and willing counterparties that are not affiliates. We recommend the Department take the

position that if a financial institution or advisor can obtain two independent quotes for a

particular debt security, that debt security is sufficiently liquid for purposes of the Principal

Transactions Exemption.

Moreover, because the financial institution cannot predict the liquidity status of the debt

security at a future point in time, the Department must clarify that any assessment of liquidity

must be based only upon information that is readily available at the time the advice is offered.

The regulatory environment of the past several years has had a significant impact on liquidity in

the trading markets, particularly for debt securities. The Volcker Rule as well as liquidity and

capital requirements included within the Dodd-Frank Act and Basel III have transformed the

structure and functioning of the fixed income markets. These regulatory proposals have served

to reduce risk in the markets, but have also reduced liquidity. Given the uncertainties of liquidity

in future debt markets, we urge the Department to clarify that an assessment of liquidity status is

made at the time the investment advice is offered.

5. Eliminate Pricing Information Requirements.

Section III of the Principal Transactions Exemption provides that the purchase or sale of

the debt security (1) must be executed at a price that the financial institution reasonably believes

is at least as favorable to the investor than the price available to the investor in a transaction that

is not a principal transaction and (2) must be at least as favorable to the investor as the

contemporaneous price for the debt security, or a similar security if a price is not available with

respect to the same debt security, offered by two ready and willing counterparties that are not

affiliates in agency transactions.

The Department notes that when evaluating the price offered by the counterparties, the

financial institution may take into account the resulting price to the investor including

commissions. The Department intends that the proposal should allow a comparison between the

actual cost to the investor of the principal transaction (including the mark-up or mark-down) and

the actual cost to the investor of a non-principal transaction (e.g., an agency transaction) in the

same or a similar debt security, including a commission.

We note several practical difficulties to the Department’s proposed approach. First, the

Principal Transactions Exemption requires that the financial institution obtain two quotes on the

debt security or a similar security offered by two ready and willing counterparties that are not

affiliates in agency transactions. The underlying assumption is that two prices can be obtained.

We anticipate that obtaining two quotes for treasury and agency debt securities may be

achievable; however obtaining two quotes for a corporate debt security may be more difficult.

Currently, corporate debt securities are liquid, but could be less liquid at a future point in time

depending on market conditions.
C-21

Second, the Principal Transactions Exemption requires financial institutions to determine

the commission, including mark-up or mark-down, of a counterparty to compare quotes. From a

practical standpoint, a counterparty may be unwilling to share this information and the financial

institution has limited means to compel it.

Most importantly, the Principal Transactions Exemption may impair a broker-dealer’s

ability to exercise reasonable diligence under FINRA and MSRB rules by adding a significant

hurdle for dealers to act in a principal capacity. FINRA’s Best Execution rule46 and MSRB’s

approved but not yet effective Best Execution rule47 require that dealers exercise reasonable

diligence to ascertain the best market for the subject security and to buy or sell in that market so

that the resultant price to the customer is as favorable as possible under prevailing market

conditions. FINRA and MSRB provide a list of factors that will be considered when determining

whether a dealer exercised reasonable diligence. The duty of best execution applies whether a

broker-dealer is acting as an agent or a principal and applies across retirement and non-retirement

accounts.The Department’s proposed pricing information requirements conflict with a dealer’s

best execution obligations, in that if a dealer has used reasonable diligence and determined that

its own principal inventory is the best available market under prevailing market conditions, under

FINRA and MSRB rules it must execute in that market.

Moreover, given the existing FINRA and MSRB obligations on broker-dealers to obtain

favorable prices for customers, on which regulators regularly perform surveillance and

examinations, and on which financial institutions would be required to warrant compliance, we

question why additional requirements and conditions are necessary to help ensure investors

receive a favorable price for a particular security.

6. Eliminate the Pre-Transaction Disclosure.

The Principal Transactions Exemption provides that the advisor or financial institution

must provide a pre-transaction disclosure to the investor, either orally or in writing. The

disclosure must notify the investor that the trade will be executed on a principal basis and

provide the investor with any available pricing information regarding the debt security, including

46 For example, FINRA Rule 5310 (“Best Execution and Interpositioning”) which provides that in any transaction 

for or with a customer or a customer of another broker-dealer, a member and persons associated with a member shall

use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that 

the resultant price to the customer is as favorable as possible under prevailing market conditions. Among the factors

that will be considered in determining whether a member has used “reasonable diligence” are: (A) the character of

the market for the security, e.g., price, volatility, relative liquidity, and pressure on available communications; (B)

the size and type of transaction; (C) the number of markets checked; (D) accessibility of the quotation; and (E) the

terms and conditions of the order which result in the transaction, as communicated to the member and persons

associated with the member. 47Amendments to MSRB Rule G–18 will require municipal securities dealers to seek the most favorable terms

reasonably available for their retail customers’ transactions. These amendments are added to long-standing MSRB

rules regarding unfair pricing practices and will take effect December 7, 2015.
C-22

the two quotes obtained from unaffiliated third parties. The disclosure would also include the

mark-up or mark-down48 to be charged in connection with the transaction.

From a practical standpoint, assuming that a financial institution can even obtain two

independent quotes from counterparties to fulfil the pre-transaction disclosure requirements, the

financial institution will then need to circle back to the investor to obtain his or her consent prior

to proceeding with the transaction. Given potential delays in this process and the passage of

time, there is a risk that the quoted price may no longer be available, and the entire process

required to be started again, frustrating all parties involved. These types of disclosures will

impede trading and result in timing and opportunity losses for smaller retirement accounts. We

urge the Department to withdraw this portion of the pre-transaction disclosure requirements.

7. Coordinate Written Confirmation Requirements with Other Financial Regulators.

The Principal Transactions Exemption would further require the financial institution to

provide a written confirmation of the principal transaction in accordance with Rule 10b-10 under

the Securities Exchange Act of 1934 that also includes disclosure of the mark-up, mark-down or

other payment to the advisor, financial institution or affiliate in connection with the transaction.

We note that Rule 10b-10 does not currently require disclosure of mark-ups in principal

transactions; however disclosure of mark-ups in principal transactions is a current focus of

several regulatory and legislative efforts. FINRA and the MSRB, at SEC direction, recently

issued concurrent rule proposals concerning disclosure of mark-ups in riskless principal

transactions49 and Senator Mark Warner and Senator Ron Coburn introduced legislation50 in

113th Congress that would require bond dealers to disclose to customer the difference between

the dealer’s price and the customer’s price before completion of a riskless principal transaction.

Changes to disclosure that customers receive should be viewed in totality across

regulatory agencies to help ensure that the sum of such disclosure is coordinated, consistent,

helpful and appropriate. More disclosure does not always result in a more informed investor.

The Principal Transactions Exemption uses different terminology and disclosures from the

FINRA and MSRB Proposals to meet the same regulatory goal. Moreover the Department’s

proposal applies only to retirement accounts in which fiduciary investment advice has been

offered, while the FINRA and MSRB Proposals that would apply across retirement and nonretirement accounts, regardless of whether advice was offered. We urge the Department to

carefully consider retirement investors need for additional disclosure, specific to retirement

48 The Department is considering defining mark-ups and mark-downs as amount in excess or deficit of the

“prevailing market price” that a customer receives for the debt security. The Department is considering whether to

define the “prevailing market price” by reference to FINRA Rule 2121 which sets forth a methodology for

determining the prevailing market price. We encourage the Department use the definition of “prevailing market

price” in FINRA Rule 2121. This approach will help promote legal certainty and reduce confusion over terms used

by different rules in the same context.

49 FINRA Proposal and MSRB Proposal as discussed infra. 50 S.2114 - Bond Transparency Act of 2014; a bill “to amend the Securities Exchange Act of 1934 with respect to

disclosures to investors in municipal and corporate debt securities, and for other purposes.”
C-23

accounts, in light of the comprehensive disclosure proposals currently under consideration for

the same transactions and to coordinate its effort with other financial regulators.

The post–transaction disclosure requirements in the Principal Transactions Exemption

will be operationally challenging for market participants, particularly for clearing broker-dealers.

The Principal Transactions Exemption would require financial institutions to build a significant

new system, at considerable cost, to identify principal trades in retirement accounts executed

pursuant to investment advice versus principal transactions executed at the request of selfdirected investors.

The operational challenges of the proposals are especially significant for clearing brokerdealers that would likely be required to coordinate and rely on third parties for data necessary for

compliance. Fully-disclosed clearing broker-dealers clear and settle millions of securities

transactions each day for thousands of introducing broker-dealers.51 Clearing broker-dealers do

not sell securities to retail customers. Rather, a fully-disclosed clearing broker-dealer provides

routine and ministerial “back office” processing services -- clearance and settlement and custody

services -- to introducing broker-dealers. The relationship between the clearing broker-dealer

and the introducing broker-dealer and the division of responsibilities between them is set forth in

a fully disclosed clearing agreement, which is filed with and approved by FINRA before any

clearing services may begin.

Among other back-office functions, clearing broker-dealers settle fixed income trades

and print and mail end-customer confirmation statements for introducing broker-dealers. Under

the Principal Transactions Exemption, an introducing broker-dealer would need to submit

information on a particular principal trade made pursuant to the provision of investment advice

in a retirement account to its clearing broker-dealer, after the introducing broker-dealer has

marked this information itself. All of this work would need to be performed, without error or

delay, before the established deadlines for passing files to the trade confirmation engine to allow

the clearing broker-dealer to print and mail the statement to the end-customer within established

regulatory timeframes. We anticipate this process to be challenging at best and in some cases

unworkable.

8. Eliminate Duplicative Annual Disclosure Requirement.

In addition to pre-transaction disclosure and post-transaction disclosure confirming the

transaction, the financial institution would further be required to provide the investor with an

annual statement, within 45 days after the end of a calendar year, that lists the principal

transactions engaged in during the year, provides the prevailing market price at which the debt

security was purchased or sold and provides the applicable mark-up or mark-down or other

payment for each debt security.

51 Because many introducing broker-dealers (aka “correspondents”) do not have the net capital, resources,

technology, personnel or expertise to clear and settle their own trades, introducing broker-dealers often contract with

a third-party clearing broker-dealers to carry their proprietary accounts (if any) and its end-customer accounts and

perform back office functions on a fully-disclosed basis (i.e., disclosed to the introducing firm’s end customers).
C-24

The Principal Transactions Exemption’s annual statement requirement is duplicative of

the pre-and post-transaction disclosure requirements and as such does not appear to serve any

practical or useful purpose. Moreover, it makes no distinction between principal transactions

executed in a retirement account versus principal transactions executed in a retirement account

pursuant to the provision of investment advice. We assume that this disclosure only pertains to

those principal transactions executed in a retirement account pursuant to the provision of

investment advice and if the Department determines to proceed with this requirement, we ask the

Department to clarify this point.

Also, the 45 day time period to provide the annual statement is too short a period of time

to provide this information to all of the financial institution’s retirement investors. Given that

retirement investors will have already received this information in pre-transaction disclosure and

in post-transaction confirmation disclosure, we do not believe that a shorter period of time is

necessary. If the Department determines to proceed with this requirement, we request a 90 day

period to provide the annual statement.

High-Quality Low-Fee Streamlined Exemption Concept

The Department has requested comments on whether it should create a streamlined

exemption for "high-quality low-fee" investment options. We strongly encourage the

Department to adopt instead the new best interest paradigm described in the main body of this

letter and in Attachment A which would provide for a single streamlined best interest contract

exemption for all transactions associated with the Proposed Regulation. However, we are

commenting on the specifics of the Department’s proposed high-quality low-fee approach

because we believe it would be extremely problematic and we urge the Department not to move

forward with the concept.

As the Department recognizes, establishing objective criteria to determine what

investments are “high-quality low-fee” would be very difficult, if not impossible. If the

Department determines to proceed with a streamlined exemption approach where specific criteria

are utilized to determine which investments meet the definition for purposes of an exemption, the

Department should first issue a comprehensive Request for Information or proposed exemption

for review and public comment. Given the extraordinary challenges of identifying such options,

there simply is not sufficient time to provide comprehensive analysis for the Department to

review as part of the BIC Exemption.

Following are specific comments outlining our concerns.

1. Challenges in Identifying “Low-Fee” Investments.

The Department is correct that mutual fund operating expenses are highly transparent.

However, a fund’s expense ratio does not always reflect the full cost that an investor may incur

because of the various ways investors may purchase funds. Just as the Department asks how

commissions associated with ETFs could be incorporated into a low-fee calculation, the
C-25

Department should recognize broker-dealers may assess a transaction fee—which is not reflected

in a fund’s expense ratio—for the purchase or sale of a fund. These transaction fees can apply to

very low-cost mutual funds, which are less likely to fully compensate third-parties for the costs

of servicing fund shareholders. Therefore, relying on a fund’s disclosed expenses may not

capture all investor costs.

Even if these external fees are ignored, determining whether a particular fund is “lowfee” still requires a standard against which to measure, yet fees vary significantly by asset class.

Median total expense ratios in 2014 were 1.18% for value equity funds, 1.39% for world equity

funds, 0.86% for bond funds, and 0.10% for money market funds.52 Adopting a single fee

threshold may discourage advisors from recommending a fully diversified portfolio, which

would normally include relatively higher-cost asset classes for which low cost passive options

are few or non-existent, such as high yield, for example.

Abandoning a single “low-fee” threshold and instead devising multiple thresholds that

vary based on asset class, while better, would still present additional challenges. First, there is

no standard methodology for categorizing mutual funds. Even independent mutual fund data

providers such as Morningstar and Lipper categorize funds differently. Second, given the rapid

pace of innovation and evolution in the industry, the number and types of fund categories and the

classification of funds into categories changes frequently. The mutual fund industry has long

wrestled with the challenges of selecting an appropriate fee benchmark for comparison, and that

explains why there is wide variation in the practices that independent mutual fund boards follow

to satisfy their duties with respect to annual renewal of mutual fund management fee contracts.

There is no reason to believe that competitive fee comparisons for purposes of the streamlined

exemption can be standardized and also remain meaningful.

This issue is magnified when other investment products such as ETFs are considered for

inclusion. If ETFs are included, trading fees/commissions would need to be considered as part

of the exemption which adds further complexity. For example, there would be a significant

effective cost difference between a participant investing a large position for a long-term

investment versus a participant making smaller incremental periodic investments in their

retirement plan.

2. Challenges in Identifying “High-Quality” Investments.

While questions posed by the Department seek insight on what might be considered a

“low-fee” investment, it does not similarly inquire into how “high-quality” would be

determined. Fidelity believes that while the quality of a fund is as important a consideration as

its cost, this term is even more murky and elusive than “low-fee”. Clearly, any measure of

“quality” would encompass far more than an investment’s costs, potentially including such

other factors as performance, consistency, portfolio management process, liquidity, risk

management and oversight. Unless the Department were to empower a third-party rating

agency to judge an investment’s quality and thereby exert undue influence on the use of the

52 According to the Investment Company Institute’s 2015 Investment Company Fact Book, Figure 5.7.
C-26

streamlined exemption—which we do not recommend—it is hard to imagine how this can be

put into practice. Removing “high-quality” from the criteria would result in fees being the only

factor used to assess whether a fund qualifies for the exemption which would not result in the

best range of choices available to consumers. Implementing an exemption that makes it easier

to recommend a poorer range of options is not in the best interest of the investors that the

overall rule is meant to serve.

As the Department has recognized, fees should not be the sole criteria for investment

selection. The regulation under ERISA section 404(a) mandates that fiduciaries provide

participants with various disclosures in a participant-directed plan, including a comparative chart

of the plan’s investment options. This regulation requires that a statement be included in the

disclosure that indicates “fees and expenses are only one of several factors that participants and

beneficiaries should consider when making investment decisions.”53

3. Active vs. Passive Investments.

The Department’s proposal correctly acknowledges that an exemption based on fees

would strongly favor passively managed index funds and that there is no consensus in academic

literature that an optimal investment strategy comprises only passively managed funds. Actively

managed funds and passive index funds both offer value to consumers, and a customer-centered

rule should not favor one over the other. In fact, Fidelity’s own research reinforces the view that

actively managed funds can benefit investors more than index funds as explained below.

It is often claimed that on average and in every market, active management after fees

does not add value for investors. Occasionally, this point is extended to say that passive index

funds outperform active funds, on average. The assertion is demonstrably incorrect. Our

analysis of Morningstar data, including the returns of every registered active and passive fund for

more than two decades (to eliminate survivorship bias), shows that in U.S. small-cap equity and

international large-cap equity investing, the average actively managed fund outperformed its

benchmark after fees by 1.11% and 0.86% respectively, while the average passive index fund

underperformed after fees by 0.35% and 0.32% respectively. These results are before any type of

filter for “high-quality” or “low-cost” is applied.

Passive index funds offer low-cost exposure to the return and risk characteristics of an

underlying benchmark index, and as such, are not intended to outperform the index after fees.

Judicious active management offers investors the opportunity to outperform both a benchmark

index and the passive index funds matched to that benchmark. This active outperformance can

aid investors in reaching their financial goals. In addition, there are several investment asset

classes or approaches for which true passive index funds do not exist, such as in the fixed income

asset class which we discuss in more detail below. An exemption that effectively allows only

passive index funds could restrict the recommendation of a diversified portfolio or strategy that

may be in the best interest of the investor. Consequently, we believe that any streamlined

53 DOL reg. § 2550.404a-5(d)(1)(iv)(A)(4).
C-27

exemption designed to benefit investors should be structured to allow for active as well as

passive funds.

Even if, in spite of these facts and the Department’s limited regulatory mandate under

ERISA and the Code, the Department wanted to afford special treatment to passively managed

funds, variations in investment strategies can obfuscate the distinction between active and

passive investment strategies. For example, some funds are designed to adhere closely to the

index but with slight overweights and underweights. Other funds, so-called “strategic beta” or

“smart beta” funds are passively managed to track an index that itself is actively constructed to

emphasize specific factors (e.g., low volatility or high earnings quality). Many fixed-income

index funds seek to track the performance of the Barclays U.S. Aggregate Index, which contains

more than 8,000 securities, many of which are illiquid, making it impossible for funds to

replicate the index. Instead, they adopt an active selection process to mirror the characteristics of

the benchmark index.

4. Use of Streamlined Exemption in Defined Contribution Plans.

It is unclear whether a streamlined exemption would be useful in defined contribution

plans where plan sponsors typically offer to plan participants only a discrete line-up of

investment options. First, many financial advisors believe an investor’s portfolio should

diversify across a variety of asset classes, including large cap equities, small cap equities,

developed international equities, emerging market equities, high yield bonds, investment grade

bonds, short-term bonds or cash equivalents, and perhaps even extended asset classes such as

real estate, commodities, inflation-protected securities, and floating rate loans. If the plan lineup does not include “high-quality low-fee” investment options for each of these asset classes, a

financial advisor would have to choose between abandoning the streamlined exemption or

limiting the scope of its advice. Alternatively, the advisor would need to seek to use another

exemption (e.g., the BIC Exemption) to provide advice on the participant’s entire account which

would result in a confusing and suboptimal customer experience.

Furthermore, many plans offer collective investment trusts or separate accounts instead of

mutual funds. The fees for these unregistered investment products are less transparent than

comparable mutual funds because they are not subject to the same SEC disclosure rules.

However, they are also often less expensive than comparable mutual funds for a variety of

reasons. If these investments are excluded from the streamlined exemption, participants in such

plans could be less likely to receive investment advice.

5. Application of Best Interest Standard in Streamlined Exemption.

The Department contemplates that the best interest standard would not “expressly” be

included in the streamlined exemption. Presumably the Department believes that options that

meet the “high-quality low-fee” criteria would always be in the best interest of an investor. As

discussed above, there are significant challenges for determining what criteria could be used for

such a determination. Even if conditions could be established and a streamlined exemption

created, the advisor should still be required to act in the best interest of the investor when
C-28

providing the recommendation. While an investment may be “high-quality low-fee”, that does

not mean it necessarily is in the best interest of a particular investor. For example, a recent

college graduate at age 21 does not typically need to invest any portion of his or her newly

established 401(k) account in a bond or money market fund. However, without imposing the

best interest standard as a condition of the exemption, advisors could recommend such

investments to a participant and not be held responsible for such advice, so long as they were

considered to be high-quality and low-fee.

6. Additional Considerations in Developing a Streamlined Exemption.

The Department inquires as to what other conditions should be imposed in addition to

low fees as part of the exemption. As discussed above, an assessment of “high-quality” should

be included in addition to “low-fees”. Regarding other potential conditions, the Department

suggests that “broadly diversified” can mean different things in different contexts, and is no

guarantee of minimizing risk for a targeted return. If the goal is to eliminate highly concentrated

or highly specialized funds from a streamlined exemption, this will need to be approached

carefully. A sector fund may be broadly diversified within its sector, but not as diversified as,

for example, a general small-cap stock fund. However, holding that fund as an investor’s only

investment might not represent an optimally diversified portfolio. The implication of the

question, however, is whether the exemption should include only multi-asset class funds (e.g.

“target date,” “lifecycle,” “target risk” or “balanced” funds). Limiting an exemption to such

funds could greatly circumscribe the ability of broker-dealers to recommend responsible and

appropriate diversified portfolios for investors with particular needs and inclinations.

The Department asks whether only investments that meet the definition of a qualified

default investment alternative (“QDIA”) within the meaning of 2550.404c-5 be included in the

streamlined exemption. Presumably, such a requirement would potentially address the concerns

related to diversification if other investments were not available to allow for recommendations

on a plan participant’s entire account. Most plans use a target date fund series as their QDIA54.

We believe target date funds are excellent solutions for many investors. However, with the

Department’s emphasis on low-fee and passive management, we believe there may be some

confusion about the actual structure and implementation of these types of funds and note the

following for consideration:

The “optimal investment strategy” the Department references is sometimes called

“strategic asset allocation.” It involves looking at market inputs (including the historical and

projected return, risk, and correlations of assets) and evaluating the investor’s risk tolerance, in

order to create a portfolio of diversified assets that will maximize the expected investment return

for the desired level of risk. Strategic asset allocation is inherently active – there is no passive

“formula” for optimizing allocation for a given individual or group of individuals, because it

depends on the return objectives and risk tolerance being assumed. Research has shown that for

multi-asset class portfolios, the strategic asset allocation is the main driver of investor outcomes.

54 As of March 2015, nearly 84% of the corporate defined contribution plans recordkept by Fidelity used a target

date fund as the QDIA.
C-29

In other words, simply deciding on the right balance between stocks, bonds, and other asset

classes for a given investor’s needs is more significant than which particular stocks and bonds

are selected.

The view of optimal strategy described in the language is, importantly, theoretical only;

there is no such thing as an investable market portfolio that is a passive “diversified portfolio of

assets calibrated to track the overall performance of financial markets.” Target date funds, rather

than optimizing for an individual investor at a single point in time, set up parameters for strategic

asset allocation that are followed according to a schedule, usually connected to the investor’s

anticipated time until retirement. This schedule of investment allocations is called a “glide path.”

Glide paths vary widely among investment providers, in large part because each glide path is an

active decision based on the manager’s risk management approach, savings behavior/retirement

age assumptions, and the performance expectations for various assets classes, among other

factors. The construction and management of the asset allocation parameters and the glide path

is an inherently active endeavor.

The strategic asset allocation can also be actively managed in response to market

conditions, by tilting the weights of various asset classes in response to periods when they have

become over- or undervalued relative to history or to expectations. This is called “tactical asset

allocation,” and is an inherently active approach.

In addition, the underlying investments in a target date fund or in a balanced fund can be

either actively or passively managed funds. By selecting underlying investments with the

potential to outperform comparable index funds after fees, actively managed multi-asset class

funds can potentially earn more returns for investors.

There are several asset classes that are considered part of a diversified portfolio that do

not have properly representative index fund options (e.g., emerging market equity and debt), or

for which actively managed funds tend to outperform passive (e.g., U.S. small-cap equity). To

optimize a portfolio and achieve the best investment results using these asset classes, many

portfolio managers include actively managed funds in their target date funds.

7. Business Model Implications of a Streamlined Exemption.

The Department asks a series of questions regarding certain business models and how

they would potentially react to a high-quality low-fee exemption. While it is impossible to

predict how such an exemption would be utilized in practice, there are potential concerns based

on an advisor’s business model that could affect use of a streamlined exemption. For example,

as stated above, a broker-dealer may charge an additional fee for a given fund that could be

included in the exemption. Should that fee be considered in a determination of high-quality lowfee funds? That would prevent a “master” list of funds that fall within the exemption and create

the need for advisors to develop a mechanism to screen and track funds. Further, fees for funds

can change over time and thus funds that meet the exemption criteria could change and would

therefore require frequent monitoring.