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DOL’s October 31, 2023, Proposed Retirement Security Rule: Definition of an Investment Advice Fiduciary guidance package also included amendments to Prohibited Transaction Exemption PTE 2020-02 (the advice fiduciary PTE).
In this article we review the proposed revised PTE 2020-02, beginning with a discussion of why this PTE is a fundamental part of DOL’s changes to the regulation of advice and its program to change what advice may be given, how it may be given, and how advisers may be compensated.
Why a PTE and why does it matter?
Repeating what we said in our article on the new proposed advice fiduciary definition, that proposal (if finalized) would turn a lot of persons into fiduciaries who are not fiduciaries under the (current) five-part test. If one of these “new fiduciaries” then gives advice for which she has a conflict (e.g., an incentive payment from her employer to favor certain investment products), that advice may be prohibited self-dealing. That is a prohibited transaction, triggering an excise tax, and may be an ERISA fiduciary breach by plan fiduciaries.
Taking what may be the most salient example for many sponsors/sponsor fiduciaries, current call center operators (provided, e.g., by the plan’s recordkeeper) may currently be operating as “mere service providers” and not as fiduciaries. They may, however, be giving one-time advice to retiring participants about rollovers. Under the proposal, that one-time rollover advice is likely to turn those call center operators into fiduciaries. And if they are compensated by an affiliated financial institution (e.g., a mutual fund operator affiliated with the recordkeeper) for giving that advice, they may have engaged in a prohibited transaction.
PTE 2020-02 provides an exemption from that prohibited transaction. If the fiduciary adviser and related financial institution comply with the PTE, they may engage in the transaction without penalty, and the plan fiduciary who caused the plan to enter into the transaction will not have committed an ERISA fiduciary breach.
To get this relief from prohibited transaction treatment, the adviser (e.g., the call center operator) and the related financial institution must comply with a detailed set of conditions requiring:
Compliance with “Impartial Conduct Standards:” providing advice in the advisee’s best interest, charging only reasonable compensation, and making no materially misleading statements.
With respect to rollovers, prior to the rollover, producing documentation of the reasons a recommended rollover is in the advisee’s best interest.
The affiliated financial institution acknowledging fiduciary status and describing the services it provides and material conflicts of interest.
The affiliated financial institution adopting policies to ensure compliance with the Impartial Conduct Standards and conducting a “retrospective review” of compliance certified by a senior executive officer.
Why this matters to sponsors
Sponsor fiduciaries will be required to monitor an advice fiduciary’s compliance with these conditions; failure to do so (where the PTE is needed avoid a prohibited transaction) may result in a fiduciary breach by plan/sponsor fiduciaries. In this regard, see our article on the recent Ninth Circuit decision in Bugielski v. AT&T, holding that sponsor fiduciaries had, under the terms of the applicable PTE (there, the service provider PTE), a fiduciary obligation to monitor the reasonableness of a service provider’s compensation (which is a condition of the availability of that PTE).
To be clear, at this point, the exact extent of the sponsor’s duty-to-monitor is unclear. In the abstract it means: the plan/sponsor fiduciary must be reasonably satisfied that adviser fiduciaries that it has retained (e.g., call center operators) are complying with, e.g., the impartial conduct standards and rollover disclosures.
PTE 2020-02 and proposed amendments
While the revision of the definition of advice fiduciary would fundamentally change/expand who is a fiduciary, the PTE had (in 2020) already largely anticipated this expansion, and the (2023) proposed changes to it are more in the nature of “tweaks,” often reflecting issues that have arisen since 2020. In what follows, we review (in some detail) both the terms of the current PTE 2020-02 (many of which are unchanged by the new DOL proposal) and the amendments DOL is proposing to make to it.
Conditions
In order to take advantage of the PTE (and the relief it provides from prohibited transaction treatment), the advisor and related financial institution must satisfy the following conditions each discussed in more detail below.
Impartial conduct standard
Required policies and procedures
Retrospective review/certification
Impartial Conduct
The adviser must comply 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.”
The proposed revisions to the PTE would simply add (for clarification) an example:
For example, in choosing between two investments offered and available to the Retirement Investor from the [adviser’s related] Financial Institution, it is not permissible for the Investment Professional [i.e., the adviser] to advise investing in the one that is worse for the Retirement Investor but better or more profitable for the Investment Professional or the Financial Institution.
Disclosures
Fiduciary status: The Financial Institution must acknowledge in writing its fiduciary status. The proposal would make this requirement more explicit.
Best interest standard: The proposal would add a requirement that the financial institution provide the advisee with a written statement of the best interest standard.
Services provided/conflicts: The current PTE requires the Financial Institution provide “[a] written description of the services to be provided and the Financial Institution’s and Investment Professional’s material Conflicts of Interest that is accurate and not misleading in all material respects.” The proposal would expand on and clarify this requirement by adding the following:
This description will include a statement on whether the Retirement Investor will pay for such services, directly or indirectly, including through Third-Party Payments. If, for example, the Retirement Investor will pay through commissions or transaction-based payments, the written statement must clearly disclose that fact.
DOL is also proposing a new definition of “Third-Party Payments” to make clear the how broad their concept of “indirect” pay for services is:
“Third-Party Payments” include sales charges when not paid directly to the Financial Institution by the Plan, from a participant or beneficiary’s account, or from an IRA; gross dealer concessions; revenue sharing payments; 12b-1 fees; distribution, solicitation or referral fees; volume-based fees; fees for seminars and educational programs; and any other compensation, consideration, or financial benefit provided to the Financial Institution or an Affiliate or Related Entity by a third party as a result of a transaction involving a Plan, participant or beneficiary account, or IRA.
Right to obtain information: The proposal would add a requirement that the financial institution provide:
A written statement that the Retirement Investor has the right to obtain specific information regarding costs, fees, and compensation, described in dollar amounts, percentages, formulas, or other means reasonably designed to present full and fair disclosure that is materially accurate in scope, magnitude, and nature, with sufficient detail to permit the Retirement Investor to make an informed judgment about the costs of the transaction and about the significance and severity of the Conflicts of Interest, and that describes how the Retirement Investor can get the information, free of charge.
Disclosures with respect to rollovers: The current PTE requires the Financial Institution “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 proposal would expand on and clarify this requirement:
Rollover disclosure. Before the rollover, “the Financial Institution and Investment Professional must consider and document the basis for their conclusions as to whether a rollover is in the Retirement Investor’s Best Interest, and must provide that documentation to the Retirement Investor.” In this regard, relevant factors must include:
Alternatives, including leaving the money in the plan or current “account type.”
Fees/expenses under the plan vs. under the recommended investment/ account.
Whether the employer (or other party) pays plan fees/expenses.
Levels of services/available under the plan vs. under the recommended investment/account.
Required policies and procedures
The current PTE requires the Financial Institution to adopt “policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and conduct a retrospective review of compliance.” The Financial Institution must adopt a “culture of compliance,” going into detail as to which sorts of, e.g., broker compensation arrangements may or may not be appropriate, in what circumstances. In this regard, the proposal would explicitly target certain practices, providing that:
Financial Institutions may not use quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation, or other similar actions or incentives that are intended, or that a reasonable person would conclude are likely, to result in recommendations that are not in Retirement Investors’ Best Interest.
Retrospective review
The current PTE requires the financial institution to conduct an annual retrospective review of compliance with these requirements. A senior executive officer must review a written report of the review and certify that compliance.
The proposal would:
Require that these policies and procedures be regularly updated “as business, regulatory, and legislative changes and events dictate” and “ensure they remain prudently designed, effective, and compliant with [the PTE].”
Require that the senior executive officer certify that the financial institution has properly reported (or will report) any non-exempt prohibited transactions that have been discovered, has corrected them, and has paid any resulting excise taxes.
Enforcement
Breaches of the conditions of the PTE would generally be enforceable under ERISA’s and the Internal Revenue Code’s prohibited transaction rules. Prohibited transactions themselves would (as noted) trigger excise taxes (enforceable by IRS). Fiduciary breaches (by, e.g., the plan/sponsor fiduciary who caused the plan to enter into the prohibited transaction) would be enforceable generally, with respect to ERISA plans, under ERISA’s fiduciary remedies provisions.
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Two other items included in the proposal: The current PTE does not cover Pooled Employer Plans (PEPs); the proposal would extend it to them. And the proposal expands somewhat the current ineligibility provisions, which “identif[y] circumstances under which an Investment Professional or Financial Institution will become ineligible to rely on the exemption for a period of 10 years” (because of, e.g., certain criminal violations).
Comments on the proposal are due within 60 days; there is likely to be a public hearing, probably as part of the hearing on the proposed redefinition of advice fiduciary.
We will continue to follow this issue.