The Department of Labor’s “Fiduciary Rule,” PTE 2020-02: The FAQs
This series focuses on the DOL’s new fiduciary “rule”, which was effective on February 16. This, and the next several, articles look at the Frequently Asked Questions (FAQs) issued by the DOL to explain the fiduciary definition and the exemption for conflicts of interest.
The DOL’s prohibited transaction exemption (PTE) 2020-02 (Improving Investment Advice for Workers & Retirees) allows investment advisers, broker-dealers, banks, and insurance companies (“financial institutions”), and their representatives (“investment professionals”), to receive conflicted compensation resulting from non-discretionary fiduciary investment advice to retirement plans, participants and IRA owners (“retirement investors”).
In addition, , the DOL announced, in the preamble to the PTE, an expanded definition of fiduciary advice, meaning that many more financial institutions and investment professionals will be fiduciaries and therefore will need the protections afforded by the exemption. The relief provided by the exemption is conditional, that is, the “conditions” in the exemption must be satisfied in order to obtain relief from the prohibited transaction rules in ERISA and the Internal Revenue Code. For the period from February 16 until December 20, a DOL and IRS non-enforcement policy based on the Impartial Conduct Standards will be available.
In April, the DOL issued FAQs that explain its reasons for issuing the guidance. The FAQs also go into detail about the fiduciary definition and the conditions of the exemption. This article discusses FAQ 1–the reason why 2020-02 was issued:
Q1. Why did the Department grant PTE 2020-02?
PTE 2020-02 is designed to promote investment advice that is in the best interest of retirement investors (e.g., plan participants and beneficiaries, and IRA owners). The exemption conditions emphasize mitigating conflicts of interest and ensuring retirement investors are receiving advice that is prudent and loyal. The exemption offers a compliance option to investment advisers, broker-dealers, banks, and insurance companies (financial institutions) and their employees, agents, and representatives (investment professionals) that is broader and more flexible than preexisting prohibited transaction exemptions. In particular, the exemption expressly provides relief for a variety of transactions and compensation that may not have been covered by prior exemptions. The preamble to the new exemption makes clear that the 1975 fiduciary regulation can extend to advice to roll assets out of a plan to an IRA and the exemption provides relief for prohibited transactions resulting from such advice.
Comment: The expanded definition of fiduciary advice and the focus on conflicts of interest apply to advice to ERISA retirement plans, participants and IRA owners. But, realistically, most investment advice to plans and to participants (about how to invest their accounts) is already fiduciary advice and subject to the prohibited transaction rules. So there appears to be little need for additional regulation on those scenarios…but, what else does the DOL think needs enhanced regulation? The answers are (i) rollover recommendations and (ii) recommendations about investing in individual retirement accounts and individual retirement annuities (IRAs). And, therein lies the reason for the “rule”…greater regulation of the treatment of benefits that have been accumulated in retirement plans, but are moving to the retail world of IRAs, with its lower standards of care and more conflicts of interest. The DOL is trying to regulate the “decumulation” of retirement benefits.
An important aim of the exemption is to make sure that fiduciary advice providers adhere to stringent standards designed to ensure that their investment recommendations reflect the best interest of plan and IRA investors. In addition to other requirements, financial institutions and investment professionals relying on the exemption must:
- acknowledge their fiduciary status in writing,
- disclose their services and material conflicts of interest,
- adhere to Impartial Conduct Standards requiring that they
- investigate and evaluate investments, provide advice, and exercise sound judgment in the same way that knowledgeable and impartial professionals would (i.e., their recommendations must be “prudent”),
- act with undivided loyalty to retirement investors when making recommendations (in other words, they must never place their own interests ahead of the interests of the retirement investor, or subordinate the retirement investor’s interests to their own),
- charge no more than reasonable compensation and comply with federal securities laws regarding “best execution,” and
- avoid making misleading statements about investment transactions and other relevant matters,
- adopt policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and to mitigate conflicts of interest that could otherwise cause violations of those standards;
- document and disclose the specific reasons that any rollover recommendations are in the retirement investor’s best interest; and
- conduct an annual retrospective compliance review.
Comment: The progression of thinking in the DOL guidance is (i) the DOL has greater jurisdiction over financial service firms and their representatives (“investment professionals’ in 2020-02) if they are fiduciaries than if they are not; (ii) while the DOL can investigate advice to plans and participants, it does not have jurisdiction to enforce the prohibited transaction (PT) rules in the Internal Revenue Code that govern individual retirement accounts and annuities; (iii) but the DOL has expansive authority to write PT exemptions under both ERISA and the Code, and the prohibited transactions applicable to fiduciary advice are more demanding that the non-fiduciary PT rules. And, there you go…if more financial institutions are fiduciaries, their “fiduciary” advice that involves conflicts of interest is prohibited…but an exemption could allow that conflicted compensation (e.g., commissions). As a result, the DOL can regulate advice about rollovers (which almost involves a conflict of interest, i.e., the fees or commissions in the rollover IRA) and conflicted advice to IRAs….through the conditions in exemptions. The bullet points preceding this Comment summarize the conditions. They are demanding. (By the way, I will discuss those “conditions” in subsequent articles).
PTE 2020-02’s preamble includes an interpretation of when recommendations to roll over assets from an employee benefit plan to an IRA will be considered fiduciary investment advice. Rollover recommendations are a primary concern of the Department, as financial services providers often have a strong economic incentive to recommend that retirement investors roll assets out of ERISA-protected plans into one of their institution’s IRAs. The decision to roll over assets from a plan to an IRA is often the single most important financial decision a plan participant makes, involving a lifetime of retirement savings. In the preamble to PTE 2020-02, the Department reiterated the conclusion it had reached in its 2016 rulemaking that the Deseret Letter, Advisory Opinion 2005-23A, was incorrect in its conclusion that the 1975 fiduciary rule did not extend to rollover advice. Advice to roll assets out of a plan is advice as to the sale, withdrawal, or transfer of plan assets and, therefore, is covered as fiduciary advice to the extent that the other conditions of the 1975 fiduciary advice definition are satisfied.
Comment: There you go. Rollover recommendations “are a primary concern of the Department”. As a result, the DOL has reversed its long-standing position expressed in the Deseret Advisory Opinion (where investment professionals would not ordinarily be fiduciaries for rollover recommendations), and instead opined in the preamble to PTE 2020-02 that investment professionals (and their financial institutions) who recommend rollovers will ordinarily be fiduciaries. (Other articles, both previous and subsequent, explain what I mean by “ordinarily”.) This is not a small change; it completely reshapes the landscape of rollover recommendations. Broker-dealers and investment advisers (and other financial institutions) should be taking steps to comply because prior practices almost certainly won’t satisfy the new rules. For the time being (until December 21), those firms must comply with the Impartial Conduct Standards, if they satisfy the newly defined 5-part fiduciary test. Then, on December 21, all of the conditions must be satisfied for those rollover recommendations.
And, of course, as night follows day, IRAs follow rollover recommendations; so, the DOL wrote its new fiduciary “rule” to apply to IRAs as well.
My next several articles will continue the discussion of the DOL’s FAQs.