On June 29, 2020, DOL released a proposed class Prohibited Transaction Exemption that would allow “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.” The proposed PTE would retain the 1975 “five-part test” for who is an “investment advice fiduciary,” but the PTE includes an extensive “interpretation” (or re-interpretation) of that test that in many ways broadens it beyond prior law and practice and articulates principles for its application to plan-to-IRA rollovers.
The proposed PTE would condition 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.” Enforcement of violations of these rules would be under ERISA’s and the Internal Revenue Code’s fiduciary and prohibited transaction provisions.
We begin with a discussion of why this proposal may be relevant to plan sponsors, and then provide a brief summary of it.
Why this matters to plan sponsors and plan fiduciaries
The proposed PTE is primarily targeted at providers. But there are at least two issues it raises that may affect plan sponsors.
First, as discussed further below, the preamble to the PTE “re-interprets” DOL’s 1975 regulation defining “advice fiduciary.” DOL’s focus is primarily on financial institutions advising participants about rollovers, and it does not address the question of whether a sponsor official, e.g., advising participants in a retirement preparation presentation, might be an “advice fiduciary” under this new interpretation. Hopefully DOL will provide some clarification (and relief) with respect to this issue.
Second, more broadly and more significantly, the new rule – again via its re-interpretation of the 1975 fiduciary advice regulation – is generally intended to in many cases make, e.g., call center operators “advice fiduciaries.” To what extent do plan fiduciaries have a legal obligation to monitor their compliance with the PTE? The PTE does not address this issue. This is an issue that has for some time been lurking in the background, behind the more “hot button” issues with respect to the treatment of providers. We discuss this issue at length in our article Fiduciary Rule vacated: significance for plan sponsors.
Now let’s turn to the proposal, beginning with a couple of critical preliminary issues.
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 re-interpreting the (now reinstated) 1975 regulation’s five-part test to cover many more provider-participant interactions (critically, with respect to rollovers), the proposed PTE will be turning many providers into fiduciaries who thought that, under previous interpretations, they were not fiduciaries. And as fiduciaries, if the PTE is finalized, they will also have a prohibited transaction problem.
In all this, as noted, a critical element of the proposed PTE is DOL’s re-interpretation of its 1975 advice fiduciary regulation, so let’s turn to that part of the proposal.
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.
In the preamble to the proposed PTE, however, the application of this rule is expanded in a number of respects beyond the understanding and practice with respect to it that have developed since 1975, including:
DOL is revoking the position it took in a 2005 Opinion Letter that “advice to roll assets out of a Plan did not generally constitute investment advice.” Indeed, critical portions of the PTE are premised on an interpretation that such advice would be covered.
The “regular basis” requirement would be satisfied where the adviser advises a participant “to roll assets out of the Plan into an IRA where the advice provider will be regularly giving financial 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.
“[T]he determination of whether there is a mutual agreement, arrangement, or understanding that the investment advice will serve as a primary basis for investment decisions is appropriately based on the reasonable understanding of each of the parties, if no mutual agreement or arrangement is demonstrated.” [Emphasis in the original.] And, in this regard, “[w]ritten statements disclaiming a mutual understanding or forbidding reliance on the advice as a primary basis for investment decisions are not determinative.” Finally: “it is more than reasonable … that the advice provider would anticipate that advice about rolling over Plan assets would be ‘a primary basis for [those] investment decisions.’” All of this sounds like “advice” by a Financial Institution about a rollover is, in DOL’s view, probably going to be fiduciary advice.
The proposal, very briefly
What’s covered by the PTE? The proposed PTE would be 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.
Conditions. Relief would be conditioned on compliance with Impartial Conduct Standards, summarized as “providing advice that is in [the participant’s] 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 “would be required to document the specific reason or reasons why the recommendation [e.g., to rollover rather than leave money in the plan] was considered to be in the best interest of the [participant].”
The Financial Institution would have to acknowledge in writing its fiduciary status and describe in writing the services provided and material conflicts of interest.
And the Financial Institution would have to 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 preamble states that “[t]he exemption requires Financial Institutions to adopt a culture of compliance” and goes into detail as to which sorts of, e.g., broker compensation arrangements may or may not be appropriate. The Financial Institution’s CEO would have to review and certify compliance with these requirements.
Enforcement. The preamble states:
ERISA section 502(a) provides a cause of action for fiduciary breaches and prohibited transactions with respect to ERISA-covered Plans (but not IRAs). Code section 4975 imposes a tax on disqualified persons participating in a prohibited transaction involving Plans and IRAs (other than a fiduciary acting only as such). These are the sole remedies for engaging in non-exempt prohibited transactions.
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DOL’s proposed PTE is likely to provoke a wide variety of comments, and we expect to revisit the proposal more than once as additional questions about its application are identified.
We will continue to follow this issue.