The U.S. Department of Labor (DOL) issued updated guidance on the so-called “Fiduciary Rule,” which will be enforceable beginning Dec. 20, 2021. The DOL set out the steps investment advice professionals should take to satisfy the prohibited transaction exemption (PTE), which allows them to offer investment advice. The guidance also clarified that recommendations around out-of-plan rollovers could be considered fiduciary advice.
The definition of who is a fiduciary when providing advice to defined contribution (DC) plan participants has fluctuated over the past decade. Broadly speaking, a party that provides “investment advice” and receives direct or indirect compensation is considered a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA).
Last December, the DOL reinstated the 1975 five-part test meant to determine if an interaction was considered investment advice, in which the person:
- Renders advice as to the value of a security or other property, or makes a recommendation to invest, buy, or sell;
- On a regular basis;
- Pursuant to a mutual understanding that;
- The advice will be a primary basis for investment decisions; and
- It will be individualized based on the needs of the retirement investor.
Under the new guidance, distribution and rollover recommendations may be considered investment advice under ERISA when the five-part test requirements are met. With respect to rollover advice, the DOL indicated that a single, discrete instance of advice to roll assets out of a DC plan to an IRA would not meet the “regular basis” prong of the five-part test. However, if the advice occurred as part of an ongoing relationship or at the beginning of an intended future relationship with the investment advice provider, the advice to roll over DC plan assets may satisfy the “regular basis” prong of the test.
When making a recommendation to take a rollover, the advice provider should consider alternatives to a rollover (e.g., leaving the money in the DC plan), the fees and expenses associated with both the DC plan and the IRA, whether the employer pays some or all of the plan’s administrative expenses, and the different levels of services and investments available under the DC plan and the IRA. The investment advice provider should make diligent and prudent efforts to obtain information about the existing DC plan and the participant’s interests in it.
To utilize the PTE, the adviser must meet the following requirements:
- Compliance with Impartial Conduct Standards: Fiduciaries must act prudently when making recommendations, with undivided loyalty to retirement investors. Fiduciaries are limited to reasonable compensation, must comply with federal securities laws regarding “best execution,” and must not include misleading statements.
- Written documentation: The adviser should provide new disclosures to the investor, acknowledging the provider’s fiduciary status, disclosing services offered and conflicts of interest, and documenting the specific reasons why the rollover recommendations are in the best interest of the investor.
- Conflict mitigation: Fiduciaries must adopt policies and procedures designed to ensure compliance with the Impartial Conduct Standards and to mitigate conflicts of interest.
- Demonstrate compliance: The institution should complete an annual review to ensure compliance with the PTE conditions. Additionally, the financial institution must retain the report, certification, and supporting data for six years.
Additionally, the financial institution cannot create a compensation structure that a reasonable person would view as creating incentives for investment professionals to place their interests ahead of the retirement investor.
In an effort to curb unwelcome behavior, the guidance clearly sets out that an investment advice provider that does not want to use PTE cannot avoid the two prongs of the test requiring a “mutual” understanding that the advice will serve as “a primary basis for investment decisions” simply by providing a written statement disclaiming a “mutual” understanding or barring the investor from relying on the advice in making the investment decisions.
While there is little doubt that this area will see continued attention and refinement, plan sponsors should proactively review any advice services available to confirm that the party providing advice is meeting the PTE requirements in advance of the enforcement date. This may require modifying contractual agreements, service level agreements, or the vendor’s policies and procedures. Additionally, plan sponsors may wish to review a sampling of advice interactions on an ongoing basis to ensure compliance.
For more information, please find the DOL’s FAQ here.