The Labor Department has finally unveiled its much anticipated fiduciary rule, though it’s a mixed bag and has a certain “back to the future” feel, along with some new implications for recordkeepers, Pooled Employer Plans and rollover advice.
Titled “Improving Investment Advice for Workers & Retirees,” the proposal—and it’s just that at this point—proposes a new prohibited transaction class exemption that would be available for investment advice fiduciaries.
As part of what it describes as a “principles-based approach,” the proposal defines retirement investors as plan participants and beneficiaries, IRA owners, and plan and IRA fiduciaries. The Labor Department notes that under the new exemption, financial institutions and investment professionals could receive a wide variety of payments that would otherwise violate the prohibited transaction rules, including but not limited to commissions, 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs, and revenue sharing payments from investment providers or third parties.
Rollover Clarity for Plan Advisors
The proposed exemption would allow investment advice fiduciaries under ERISA 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 rollover issue had loomed large as a concern for retirement plan advisors. “We appreciate the Department including plan fiduciaries in their exemption for rollover transactions,” commented Brian Graff, CEO of the American Retirement Association and Executive Director of the National Association of Plan Advisors. “For many participants, the plan advisor is the only advisor they have ever met, and plan fiduciaries are comfortable complying with ERISA’s fiduciary requirements.”
Significantly, the Labor Department acknowledges that advice to take a distribution of assets from an employee benefit plan is, in fact, “advice to sell, withdraw, or transfer investment assets currently held in the plan, and therefore may be covered by the five-part test.”
That’s right—1975’s five-part test[i]—effectively restored by the 5th Circuit’s 2018 decision vacating the previous fiduciary rule—is front and center in the new proposal. A financial institution or investment professional which meets this five-part test and receives a fee or other compensation, whether direct or indirect, is an investment advice fiduciary under ERISA and the Code. With regard to rollovers, all prongs of the five-part test must be satisfied for a financial institution or investment professional to be an investment advice fiduciary when making a rollover recommendation. The Labor Department notes that under the proposal, “status as an investment advice fiduciary will be informed by all the surrounding facts and circumstances.”
More specifically, as it relates to one of the five parts, the Labor Department says that the 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.”
However, the Labor Department goes on to caution that, “written statements disclaiming a mutual understanding or forbidding reliance on the advice as a primary basis for investment decisions are not determinative, although such statements may be considered to determine whether a mutual understanding exists.”
While the emphasis on the five-part test has a certain familiarity, with regard to rollovers, the Labor Department has given it a new flavor with its disavowal of the "Deseret letter," the Department of Labor’s Advisory Opinion to Deseret Mutual Benefit Administrators. That opinion stated that a person is not a fiduciary when it provides a recommendation regarding whether to roll over plan assets from an ERISA-covered plan to an IRA as long as the person is not a fiduciary with regard to the plan.
Thus, recordkeepers—who weren’t fiduciaries to the plan but provide recommendations regarding rollovers, and drew comfort from the shield previously offered by the Deseret letter—now find that shield removed by the Labor Department’s proposal.
But that’s not the only implication for them. These days recordkeepers are increasingly acting as full or partial fiduciaries (say as a 3(38) fiduciary for a managed account). The preamble of the proposed rule clarifies that when you are giving advice to the plan, you are deemed to be giving advice to the participant, and that you have an ongoing relationship with participants. And that, with the repeal of the Deseret letter, means that the rollover is a covered transaction subject to an ERISA fiduciary standard—an outcome that may well catch some unprepared.
Illustrative of the potential issues that will need to be addressed is a statement on page 31 of the preamble that says: “the Department does not intend for the exemption to be used by a Financial Institution or Investment Professional that is the named fiduciary or plan administrator of a Plan or an affiliate thereof, unless the Financial Institution or Investment Professional is selected as an advice provider by a party that is independent of them.”
Graff notes that this "raises questions as to how it would apply in the context of a Pooled Employer Plan (PEP), where the Pooled Plan Provider is required to be a named fiduciary.”
Impartial Conduct Standards
The Labor Department says the proposal includes Impartial Conduct Standards that are, in its view, “aligned” with those of other regulators, including the Securities and Exchange Commission, and various state “regulators and standards-setting bodies.” The Impartial Conduct Standards have three components:
- A best interest standard
- A reasonable compensation standard
- A requirement to make no misleading statements about investment transactions and other relevant matters
The proposed rule also includes an annual retrospective compliance review, and a caution that investment advice fiduciaries could lose access to the class exemption for a period of 10 years for certain criminal convictions in connection with the provision of investment advice to retirement investors or for egregious conduct with respect to compliance with the class exemption. Those deemed ineligible for the exemption could rely on existing statutory exemptions or seek an individual prohibited transaction exemption from the Department, which says that it would provide financial institutions with the opportunity to be heard before they became ineligible. Financial institutions would have a one-year winding-down period to avoid disruptive transitions.
Prior to engaging in a transaction subject to the proposed exemption, the financial institution and its investment professionals would have to acknowledge that they are fiduciaries, a disclosure that “would be required to provide a written description, accurate in all material respects regarding the services to be provided and the Financial Institution’s and Investment Professional’s material conflicts of interest.”
Moreover, the financial institution would be required to establish, maintain and enforce written policies and procedures prudently “designed to ensure that the Financial Institution and its investment professionals comply with the Impartial Conduct Standards.” Financial institutions would also be required to conduct an annual retrospective review.
In addition, to meet the requirement of the rollover documentation requirement, financial institutions must document the specific reasons that any recommendation to roll over assets is in the best interest of the retirement investor.
The DOL also says that it does not intend the fiduciary acknowledgment or any of the disclosure obligations to create a private right of action as between a financial institution or investment professional and a retirement investor, and it does not believe the exemption would do so.
One element sure to draw criticism is the preamble’s admission its best interest standard “would allow Investment Professionals and Financial Institutions to provide investment advice despite having a financial or other interest in the transaction, so long as they do not place the interests ahead of the interests of the Retirement Investor, or subordinate the Retirement Investor’s interests to their own.”
The preamble explains that “the reasonableness of fees will depend on the particular facts and circumstances at the time of the recommendation,” notes that it would not have to recommend the transaction that is the lowest cost or that generates the lowest fees without regard to other relevant factors, and goes on to explain that “recommendations of the “lowest cost” security or investment strategy, without consideration of other factors, could in fact violate the exemption.”
Robo advice is not covered by the proposed exemption, though it would cover hybrid arrangements that involved personal advice in conjunction with a robo advisor support.
The Labor Department will be soliciting comments on the new proposed class exemption within 30 days of the date of publication in the Federal Register. Comments may be submitted at www.regulations.gov at Docket ID number EBSA-2020-0003.
Comments received will be included in the public record and will be made available online at www.regulations.gov and https://www.dol.gov/agencies/ebsa. The temporary enforcement policy announced in FAB 2018-02 remains in place.
A DOL factsheet regarding the proposal is posted online here.
There’s a lot here to “unpack and unwind”—stay tuned.
[i]For advice to constitute “investment advice,” a financial institution or investment professional who is not a fiduciary under another provision of the statute must: (1) render advice to the plan 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, plan fiduciary or IRA owner, that (4) the advice will serve as a primary basis for investment decisions with respect to plan or IRA assets, and that (5) the advice will be individualized based on the particular needs of the plan or IRA.