On October 31, 2023, the US Department of Labor (“DOL”) unveiled a new proposed regulation titled “Retirement Security Rule: Definition of an Investment Advice Fiduciary” (the “2023 Proposed Rule”) and proposed amendments to several prohibited transaction exemptions (“2023 Proposed PTE Amendments”). With these proposals, the DOL aims to expand the criteria for determining who would be an “Investment Advice Fiduciary” for purposes of Section 3(21) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) and force many such “Investment Advice Fiduciaries” to comply with Prohibited Transaction Exemption (“PTE”) 2020-02 for fee and affiliated investment conflicts.
The 2023 Proposed Rule, if finalized, would modify the “Five-Part Test” for determining fiduciary status that has been in effect since 1975. In the preamble to the 2023 Proposed Rule, the DOL stated that the Five-Part Test was no longer suited to address the modern landscape of professional investment advice. In particular, the DOL was concerned that the “regular basis” and “mutual understanding” prongs of the Five-Part Test exclude many circumstances in which a fiduciary of an ERISA plan, plan participant or beneficiary, or IRA owner (each, a “Retirement Investor”) may reasonably assume that they were receiving investment advice based on the Retirement Investor’s best interest.
The 2023 Proposed Rule marks the third attempt since 2010 by the DOL to replace the Five-Part Test. The most recent attempt was an updated regulatory definition of Investment Advice Fiduciary issued on April 8, 2016 (the “2016 Fiduciary Rule”), which was vacated in its entirety by the US Court of Appeals for the Fifth Circuit in 2018. The court’s opinion stated that the 2016 Fiduciary Rule had strayed too far from the common-law definition of the term fiduciary, which turns on the existence of a relationship of “trust and confidence” with the client and does not extend to those who merely sell products to their clients.
2023 Proposed Rule
Under Section 3(21) of ERISA, a person is a fiduciary with respect to a plan to the extent that the person (1) exercises discretionary authority or control over the assets of the plan or (2) renders (or has authority or responsibility to render) investment advice for a fee (direct or indirect) with respect to the asset of the plan (“Investment Advice Fiduciaries”).
Under ERISA’s current Five-Part Test, a broker-dealer or other person is an Investment Advice Fiduciary if the person (1) provides investment advice for a fee, (2) on a regular basis, (3) pursuant to a mutual understanding with the plan fiduciary, (4) that the advice will serve as a primary basis for investment decisions with respect to the assets of the plan, and (5) that the advice is individualized based on the particular needs of the plan.
Under the 2023 Proposed Rule, in lieu of the Five-Part Test, a person would be an Investment Advice Fiduciary when that person makes an investment transaction or strategy recommendation involving securities or other investment property to a Retirement Investor; the advice or recommendation is provided for a fee or other compensation (direct or indirect); and the person meets one of the following requirements:
- (1) The person has any discretionary authority or control, whether or not pursuant to a mutual understanding with respect to the purchasing or selling of securities or other investment property of the investor;
- (2) The person (or any affiliate of such person) is in the business of providing investment recommendations to investors, and the investment advice is individualized to the Retirement Investor based on the particular needs of the Retirement Investor and may be relied on by the Retirement Investor in making investment decisions that are in the Retirement Investor’s best interest; or
- (3) The person has acknowledged that they are a fiduciary in providing the investment recommendations.
The DOL believes that each of the above categories describes circumstances where a relationship of “trust and confidence” has been established between the investment adviser and the Retirement Investor, such that when the adviser makes an investment recommendation regarding the retirement assets of the investor for a fee or other compensation, the adviser should have a fiduciary obligation to the investor under ERISA.
The 2023 Proposed Rule would eliminate the “mutual understanding” and “primary basis” concepts present in the Five-Part Test. The DOL explained that it intends to eliminate these two prongs in order to prevent investment advisers that would otherwise be Investment Advice Fiduciaries from disclaiming any fiduciary status in the “fine print.” To further underscore this principle, the 2023 Proposed Rule explicitly states that any language disclaiming fiduciary status would not be of any force to the extent that the facts and circumstances support a finding of a fiduciary relationship.
A necessary precondition to establishing that fiduciary investment advice has occurred is the presence of an investment “recommendation” regarding either a particular transaction or transactions or an investment strategy involving securities or “other investment property.” The DOL defines a “recommendation” as a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the Retirement Investor engage in or refrain from taking a particular course of action. Eliminating the “regular basis” prong, the DOL stated that whether there has been a recommendation is an objective analysis based on the facts and circumstances and that the more tailored the communication is to a particular investor, the more likely it is that the communication will constitute a recommendation for purposes of the 2023 Proposed Rule. However, the DOL also stated that a communication need not be addressed to one recipient or investor in order to be considered a “recommendation” for purposes of the 2023 Proposed Rule. Additionally, a series of actions, whether made directly, or through or together with an affiliate, may amount to a recommendation when considered together (regardless of whether each action, considered separately, would constitute a recommendation). If a communication is considered a recommendation under the Securities and Exchange Commission’s Best Interest Regulation, it will also be a recommendation under the 2023 Proposed Rule.
The phrase “recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property” includes recommendations concerning:
- The advisability of the acquisition, holding, disposition or exchanging of securities or other investment property, or as to investment strategy
- How securities or other investment property should be invested after rollover, transfer, or distribution from a plan/IRA
- Management of securities or other investment property, and account types (such as brokerage vs. advisory), including recommendations on investment strategies and/or policies and portfolio composition
- Selection of investment advisers or managers
- Proxy voting appurtenant to ownership of shares of corporate stock
- Rollovers, benefit distributions, or transfers from a plan or IRA, including recommendations on whether to engage in the transaction and the amount, the form, and the destination of the rollover, transfer, or distribution
The DOL explained that the inclusion of the phrase “other investment property” is intended to capture virtually any product with an investment component, including variable and fixed annuities, banking products, and digital assets. Because the rule has the potential to turn each interaction or series of interactions with a Retirement Investor into a fiduciary conversation, it will be critical for sales teams to understand the breadth of the rule and the narrow pathways that remain for staying outside of fiduciary investment advice and in the realm of sales or investment education. Materials will need to be reviewed and potentially revised; these include marketing materials as well as transaction, subscription, investment advisory and other services agreements requesting Retirement Investors to represent and warrant that they did not receive or rely on investment advice from the service provider in deciding to hire the service provider or purchase a product from the adviser. To the extent that plan sponsors include fiduciary advice programs for participants in their retirement plans, sponsors should check with their advice providers and obtain representations and warranties that those providers will be in compliance with an applicable prohibited transaction exemption.
2023 Proposed PTE Amendments
Many of the 2023 Proposed PTE Amendments narrow the scope of such PTEs such that Investment Advice Fiduciaries may no longer rely on those exemptions in rendering fiduciary investment advice to a plan. The 2023 Proposed PTE Amendments to PTEs 75-1, 77-4, 80-83, 83-1, and 86-128 (described below) effectively force many Investment Advice Fiduciaries who previously relied on such amended PTEs to instead rely on PTE 2020-02. These PTEs, however, continue to be available for fiduciaries who have full discretion over the covered transactions.
PTE 2020-02 allows Investment Advice Fiduciaries to make rollover recommendations and sell a wide range of investment products, including proprietary products to Retirement Investors. It also provides relief for certain principal transactions. The terms and conditions are onerous requiring compliance with impartial conducts standards, significant disclosure requirements, maintenance of policies and procedures, and retrospective compliance reviews. Proposed amendments to PTE 2020-02 include enhanced disclosure requirements requiring specific disclosure of costs, fees, and compensation the institution receives from the retirement client and other sources as well as broadened criminal disqualification provisions. Similar to the QPAM exemption, a criminal conviction by the financial institution or one of its affiliates could prohibit the institution from relying on PTE 2020-02. We expect the DOL to clarify that it intended the disqualification provisions to apply to convictions received after the date the 2023 Proposed PTE Amendments are finalized.
PTE 84-24 has provided relief from the prohibited transaction rules for the sale of annuity and other insurance contracts from an insurance company to Retirement Investors and the payment of sales commissions with respect to those transactions. The DOL’s proposed amendments to PTE 84-24 include terms and conditions that resemble PTE 2020-02 but would only extend relief to Investment Advice Fiduciaries who are independent agents of the insurance company and can sell the products of at least two insurance companies. The proposed amendments also require the insurance company to assume oversight and compliance responsibility over the independent agent’s activities. Similar to PTE 2020-02, the exemption includes criminal disqualification provisions that would apply to the independent producer or the insurance company and its affiliates that would bar either party from relying on the exemption without obtaining an individual exemption from the DOL. Captive agents who are advice fiduciaries are prohibited from selling not only annuity or other insurance products under PTE 84-24 but also products under PTE 2020-02 as the exemption only covers reasonable compensation and certain principal transactions, which would not extend to the sale of an annuity by an insurance company. Since the DOL stated in the preamble to the amendments to PTEs 84-24 and 2020-02 that captive agents should be able to rely on PTE 2020-02, we hope that the DOL would be willing to consider addressing this issue in the final versions of these exemptions. As currently drafted, the proposed amendments to PTE 84-24 significantly narrow and effectively close important pathways the insurance industry has relied on to sell their products to Retirement Investors over the past 40 years.
PTE 75-1 exempts certain transactions between plans or IRAs and certain broker-dealers, reporting dealers, and banks. Service providers wishing to rely on the exemption to execute transactions on a principal basis on behalf of plans or IRAs would have to comply with the new recordkeeping requirements.
The exemption no longer covers (1) the execution of securities transactions on behalf of Retirement Investors on an agency basis; (2) the performance of clearance, settlement, or custodial functions incidental to effecting such transactions; (3) the furnishing of advice as to the value of securities or other property and related investment matters; and (4) the purchase or sale by a Retirement Investor of mutual fund shares. Parts III and IV of PTE 75-1, which permit fiduciaries to purchase securities in transactions where an affiliate is a member of the underwriting syndicate or a market-maker of the securities, may not be relied on by Investment Advice Fiduciaries. Broker-dealers, reporting dealers, and banks would still be able to use this exemption to receive reasonable compensation for extending credit to a plan or IRA to avoid a failed purchase or sale of securities involving the plan or IRA if (1) the potential failure of the purchase or sale of the securities is not caused by that fiduciary or an affiliate, (2) the terms of the extension of credit are at least as favorable to the plan or IRA as the terms available in an arm’s length transaction between unaffiliated parties, and (3) the disclosure requirements are met.
PTE 86-128 permits, subject to multiple conditions, a fiduciary to engage in and be compensated for certain agency transactions. While fiduciaries that exercise full discretionary authority or control with respect to plans and IRAs may continue to rely on PTE 86-128 to effect or execute securities transactions, the proposed amendments would impose the heavy terms and conditions that have applied to fiduciaries of plans to the fiduciaries executing agency transactions on behalf of IRAs as well. Similar to new recordkeeping requirements of PTE 75-1, the proposed amendments to PTE 86-128 would also require financial institutions to maintain records necessary for the specified parties to determine whether conditions of this exemption have been met for six years after the transaction.
In addition to the proposed amendments to PTE 2020-02, PTE 84-24, PTE 75-1, and PTE 86-128 discussed above, the DOL also proposes to amend the following exemptions to exclude Investment Advice Fiduciaries:
- PTE 77-4, which exempts a plan’s or IRA’s purchase or sale of open-end investment company shares where the investment adviser for the open-end investment company (such as a mutual fund company) is also a fiduciary to the plan or the IRA
- PTE 80-83, which allows banks to purchase, on behalf of a plan or IRA, securities issued by a corporation indebted to the bank that is a party in interest to the plan or IRA
- PTE 83-1, which provides relief for the sale of certificates in an initial issuance of certificates by the sponsor of a mortgage pool to a plan or IRA when the sponsor, trustee, or insurer of the mortgage pool is a fiduciary with respect to the plan or IRA assets invested in the certificates
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There is a 60-day comment period ending on January 2, 2024, and a public, online hearing will be held on December 12 and 13 and if necessary, on December 14. A request to the DOL by several trade groups to extend the comment period by another 60 days was just denied.
While it is important for interested parties to submit comments by January 2, 2024, so that the final rule and exemptions will be workable, we expect that the 2023 Proposed Rule, including the Proposed Amendments, will end up in litigation. It will therefore be up to the courts to ultimately determine whether the DOL has overstepped the boundaries of its authority.