In its third attempt to update a 1975 regulation defining when a financial professional is providing fiduciary investment advice to retirement investors, the Department of Labor (DOL) is proposing a new “Retirement Security” rule that would require a uniform standard of conduct for more types of financial transactions and investments, including one-time rollover advice. The DOL believes the existing regulation, established in 1975, should be updated to better protect retirement investors as they rely on the advice of broker-dealers, investment advisers and insurance agents when making complex decisions about managing their retirement savings.
Regulatory agencies, like the DOL, FINRA and SEC, have long been concerned that despite the trust and reliance many investors place in financial professionals, some advice providers who are not subject to a “best interest” standard make recommendations that favor their own financial interests rather than the investor’s best interests. Of particular concern are recommendations to roll over a lifetime of retirement plan savings to an IRA with high fees or retail investment pricing or to purchase an annuity. The DOL’s proposal pulls into its definition of fiduciary advice certain investments and transactions it believes are not subject to fiduciary standards under ERISA or other regulators’ rules, including recommendations to distribute or roll over retirement plan savings to an IRA, recommendations on insurance products and other non-securities investments (e.g., bank products, real estate), and advice that broker-dealers render to plan sponsors at a plan level.
A New Fiduciary Status Test
The proposal would replace the 1975 five-part test for determining when investment advice or recommendations trigger ERISA fiduciary status with a new fiduciary status test. A financial professional would be an investment advice fiduciary under ERISA and the Internal Revenue Code if they
- Make an investment recommendation or provide advice to a retirement investor (plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary or IRA fiduciary),
- Receive a fee or other compensation for the advice or recommendation, and
- Make the recommendation in the context of a professional relationship in which an investor would reasonably expect to receive sound investment recommendations that are in their best interest:
- The person directly or indirectly (e.g., through or together with any affiliate) has discretion over investment decisions for the retirement investor;
- The person directly or indirectly (e.g., through or together with any affiliate) makes investment recommendations to investors on a regular basis as part of their business, and the recommendation is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest; or
- The person represents or acknowledges that they are acting as a fiduciary when making investment recommendations.
No “Regular Basis” Requirement
The proposed definition does not include the requirements from the 1975 regulation that a financial professional provide advice to the investor “on a regular basis” or that there be a “mutual agreement, arrangement or understanding” that the advice will serve as a “primary basis for investment decisions.” The DOL states these elements “worked to defeat retirement investors’ legitimate expectations when they received investment advice from trusted advice providers.” As proposed, fiduciary status for a financial professional providing nondiscretionary advice would be based on whether they make investment recommendations as a regular part of their business and make a personalized recommendation to the investor who reasonably believes the advice is being made in their best interest.
The DOL notes that if fiduciary status is applied to a particular recommendation, the proposed rule does not impose an automatic fiduciary obligation to continue to monitor the investment or the retirement investor to ensure the recommendations remain prudent and appropriate for the plan or IRA.
Only Two PTEs Available
Financial professionals who meet the DOL’s definition of investment fiduciary must satisfy the conditions of a prohibited transaction exemption (PTE) to mitigate conflicts of interests and receive payment that would otherwise be prohibited by law. The DOL is proposing amendments to several of its existing PTEs to ensure all retirement investors receive the same standard of care, regardless of the product or service they receive (including PTEs 75-1, 77-4, 80-83, 83-1, 86 84-24-128 and 2020-02). As a result of these amendments, the only exemptions available for receiving conflicted compensation would be PTE 2020-02 for advice with respect to the wide universe of investments recommended to retirement investors, or PTE 84-24 for recommendations by independent insurance agents.
Although PTE 2020-02 is being amended to include more disclosure and documentation requirements, the DOL states the compliance obligations are generally consistent with those set forth in the SEC’s Regulation Best Interest (Reg. BI) and Interpretation of Conduct for Investment Advisers for advice to retail customers on securities. Therefore, broker-dealers and investment advisers that have already adopted compliance with Reg. BI or the fiduciary obligations under the Advisers Act “should be able to adapt easily to comply with the PTE.”
Other changes to PTE 2020-02 include coverage of pure robo-advice, expanded disqualifications from using the PTE, and additions to the retrospective review and self-correction processes to mandate self-reporting and payment of excise taxes.
The DOL and its proposals have a long road ahead before these rules could become effective, including probable legal challenges from affected industries. The first step in the process will be for the DOL to review comments on its proposal, which must be submitted to the DOL by January 2, 2024.
As always, IRALOGIX continues to vigilantly monitor this regulation. Our platform and procedures will continue to assist our clients in navigating these regulatory requirements with minimal disruptions to their operations. We will provide further updates in the months ahead.