On December 16, 2020, the Department of Labor released a final class Prohibited Transaction Exemption (PTE) allowing “investment advice fiduciaries … to receive compensation, including as a result of advice to roll over assets from a Plan to an IRA, … that would otherwise violate the prohibited transaction provisions of [ERISA] and the Code.” Briefly:
The final PTE contains minimal modifications to the proposal. It conditions relief on the fiduciary providing advice in accordance with “Impartial Conduct Standards” and requires that affected financial institutions and investment professionals acknowledge their fiduciary status and describe (in writing) the services they offer and material conflicts of interest.
Affected financial institutions must “adopt policies and procedures prudently designed to ensure compliance” with these requirements and conduct a “retrospective review” of compliance that is “reduced to a written report” that must be certified by a senior executive officer.
Enforcement of violations of these rules would be under ERISA’s and the Internal Revenue Code’s fiduciary and prohibited transaction provisions.
In connection with the (June 2020) proposal, DOL reinstated the “five-part test” for who is an “investment advice fiduciary.” While that “reinstatement” is not the subject of the PTE, the PTE includes an extensive “interpretation” (or reinterpretation) of that test that in significant ways broadens it beyond prior law and practice and articulates principles for its application to plan-to-IRA rollovers.
The PTE is effective 60 days after publication in the Federal Register. That will be after the incoming Biden Administration takes office. A number of Democratic commenters objected to the reinstatement of the five-part test, the reinterpretation of that test, and the terms of the PTE. It is possible, arguably likely, that per Executive Order the Biden Administration will put a hold on the effect of this PTE and go back to the drawing board on fiduciary advice generally. (See our article, Biden Administration agency agenda.)
Why this matters to plan sponsors and plan fiduciaries
The PTE is primarily targeted at financial institutions. But the new rule – via its reinterpretation of the 1975 fiduciary advice regulation – is generally intended to in many cases make, e.g., call center operators affiliated with financial institutions “advice fiduciaries.” This will likely require plan fiduciaries to monitor those advice fiduciaries’ compliance with the PTE. Sponsors will want to review the extent and scope of that monitoring obligation with their counsel and discuss with their providers how they intend to comply with the reinterpreted five-part test and the PTE.
Background: why is a PTE necessary?
There are two reasons why a PTE is needed with respect to fiduciary advice.
First, prior to DOL’s failed Fiduciary Rule, most “advisers” either took the position that they were not fiduciaries under the 1975 five-part test or complied as necessary with applicable prohibited transaction rules. After the Fiduciary Rule and the related Best Interest Contract PTE were finalized, and before they were vacated by the Fifth Circuit (see the article linked above), many providers “adapted” to the Fiduciary Rule by explicitly committing to fiduciary status, relying on the BIC for an exemption from resulting prohibited transaction treatment. When the Fiduciary Rule and the BIC were vacated by the Fifth Circuit, these providers were left with a prohibited transaction problem.
Second, by reinterpreting the (now reinstated) 1975 regulation’s five-part test to cover many more provider-participant interactions (critically, with respect to rollovers), the PTE will – unless they take action to avoid fiduciary status – be turning many providers into fiduciaries who thought that, under previous interpretations of the five-part test, they were not fiduciaries. And as fiduciaries they will now also have a prohibited transaction issue.
In all of this, as noted, a critical element of the PTE is DOL’s reinterpretation of its 1975 advice fiduciary regulation.
Who is an “advice fiduciary?”
The PTE only applies to “advice fiduciaries,” defined under the “old” (and now reinstated) 1975 regulation’s “five-part test.” In 2015, DOL summarized this test as follows:
[F]or advice to constitute “investment advice,” an adviser who is not a fiduciary under another provision of the statute must – (1) render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property (2) on a regular basis (3) pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary that (4) the advice will serve as a primary basis for investment decisions with respect to plan assets, and that (5) the advice will be individualized based on the particular needs of the plan or IRA.
The preamble to the final PTE includes a “Final Interpretation” of this regulation, “interpret[ing] aspects of the five-part test, including by providing a new interpretation as to how it applies to rollovers.” Summarizing:
Per the proposal (and notwithstanding objections by some commenters), DOL has revoked the position it took in a 2005 Opinion Letter (the “Deseret Letter”) that “advice to roll assets out of a Plan did not generally constitute investment advice.” The final PTE, however, states that “the Department will not pursue claims for breach of fiduciary duty or prohibited transactions against any party, or treat any party as violating the applicable prohibited transaction rules, for the period between 2005, when the Deseret Letter was issued, and [the PTE’s effective date], based on a rollover recommendation that would have been considered non-fiduciary conduct under the reasoning in the Deseret Letter.”
The “regular basis” requirement of the five-part test is satisfied with respect to “advice to roll assets out of a Title I Plan into an IRA where the investment advice provider has not previously provided advice but will be regularly giving advice regarding the IRA in the course of a more lengthy financial relationship.” That is, the relationship between the adviser and the participant after the participant leaves the plan (and, as it were, leaves ERISA) may be used to satisfy the “regular basis” requirement.
With respect to the “mutual agreement” requirement, “the Department intends to consider the reasonable understanding of each of the parties, if no mutual agreement or arrangement is demonstrated. Written statements disclaiming a mutual understanding or forbidding reliance on the advice as a primary basis for investment decisions will not be determinative, although such statements will be appropriately considered in determining whether a mutual understanding exists. Similarly, after consideration of the comments, the Department also intends to consider marketing materials in which Financial Institutions and Investment Professionals hold themselves out as trusted advisers, in evaluating the parties’ reasonable understandings with respect to the relationship.”
While this is a considerably broader/more relaxed interpretation of the mutual agreement requirement, it does appear that a provider may disclaim agreement if its disclaimer is sufficiently emphatic and its marketing materials don’t claim “trusted adviser” status.
The PTE, very briefly
What’s covered by the PTE?
The PTE is available to certain Financial Institutions (e.g., registered investment advisers and broker-dealers) and Investment Professionals (the Financial Institutions’ employees and agents) that provide fiduciary investment advice to participants, IRA owners, and plan and IRA fiduciaries. Under the exemption, Financial Institutions and Investment Professionals could receive payments in what might otherwise be prohibited transactions. The PTE explicitly covers PTs arising out of advice with respect to rollovers.
Relief is conditioned on compliance with Impartial Conduct Standards, summarized as “providing advice that is in Retirement Investors’ best interest, charging only reasonable compensation, and making no materially misleading statements about the investment transaction and other relevant matters,” and obtaining “best execution.”
With respect to rollovers, Financial Institutions are required “to provide Retirement Investors, prior to engaging in a rollover recommended pursuant to the exemption, with documentation of the specific reasons that the recommendation to roll over assets is in the best interest of the Retirement Investor.”
The Financial Institution must acknowledge in writing its fiduciary status and describe in writing the services provided and material conflicts of interest.
And the Financial Institution must adopt “policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and conduct a retrospective review of compliance.” In this regard, the PTE intends the adoption by Financial Institutions of a “culture of compliance” and goes into detail as to which sorts of, e.g., broker compensation arrangements may or may not be appropriate, in what circumstances.
The Financial Institution must conduct an annual retrospective review of compliance with these requirements, and a senior executive officer of the Financial Institution must review a written report of the review and certify compliance.
The final PTE also added a self-correction procedure.
Breaches of the conditions of the PTE would generally be enforceable under ERISA’s and the Internal Revenue Code’s prohibited transaction rules. Fiduciary breaches (e.g., under the reinterpreted five-part test) would be enforceable generally, with respect to ERISA plans, under ERISA’s fiduciary remedies provisions.
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Simply repeating what we said at the top: The PTE is effective 60 days after publication in the Federal Register. That will be after the incoming Biden Administration takes office. A number of Democratic commenters objected to the reinstatement of the five-part test, the reinterpretation of that test, and the terms of the PTE. It is possible, arguably likely, that per Executive Order the Biden Administration will put a hold on the effect of this PTE and go back to the drawing board on fiduciary advice generally. (See our article, Biden Administration agency agenda.)
We will continue to follow this issue.