On June 29, 2020, the U.S. Department of Labor (DOL) issued its much-anticipated reproposal of a fiduciary rule to regulate “investment advice fiduciaries” under the Employee Retirement Income Security Act of 1974, as amended (ERISA). The proposed rule is meant to replace the DOL’s previous rule on this topic, which was promulgated in 2016 but vacated in 2018 by the U.S. Court of Appeals for the Fifth Circuit.
The proposed rule has two major features. First, the rule reaffirms the five-part test for determining whether a person renders investment advice for purposes of ERISA. Second, the rule sets forth a new prohibited transaction class exemption for investment advice fiduciaries that is based on the “impartial conduct standards,” which were generally adopted as a temporary policy after the prior iteration of the fiduciary rule was vacated. The proposed exemption also provides information on the DOL’s view regarding rollovers from employee benefit plans to individual retirement accounts (IRAs).
The proposed rule amends the text of the Code of Federal Regulations to reinstate the five-part test for determining whether a person renders investment advice, which was included in the original 1975 regulation. Under the DOL’s five-part test, a financial institution or investment professional who is not otherwise a fiduciary under ERISA will be deemed to provide investment advice if such person
- renders advice to a plan as to the value of securities or other property or makes recommendations as to the advisability of investing in, purchasing or selling securities or other property
- on a regular basis
- pursuant to a mutual agreement, arrangement or understanding with the plan or plan fiduciary that
- the advice serves as a primary basis for investment decisions with respect to such plan assets and
- the advice will be individualized based on the particular needs of the plan
In the proposal, the DOL also notes that a person’s status as an investment advice fiduciary will be informed by surrounding facts and circumstances. If a financial institution or investment professional meets this five-part test and receives a fee or other compensation (directly or indirectly), it will be deemed an investment advice fiduciary under ERISA and the U.S. Internal Revenue Code of 1986, as amended (IRC), and, if it provides investment advice to an employee benefit plan subject to ERISA, will be subject to ERISA fiduciary duties.
New Proposed Class Exemption
An investment advice fiduciary is subject to the prohibited transaction provisions of ERISA and the IRC, which restrict fiduciaries from engaging in certain transactions involving plans unless an exemption applies. The DOL has proposed a new class exemption as part of its proposed rule, and such exemption would be available to registered investment advisers, broker-dealers, insurance companies, banks and their respective employees or agents who are investment professionals. The proposed class exemption would allow an investment advice fiduciary to receive compensation for providing fiduciary investment advice and to engage in certain principal transactions, in each case that otherwise would be restricted under the prohibited transaction rules.
The proposed class exemption would require fiduciary investment advice to be provided in accordance with the “impartial conduct standards,” which comprise the following:
- Best interest standard: Investment advice fiduciaries would be required to provide advice in the best interest of retirement investors. There are two features of this requirement, each of which must be satisfied:
- Prudence: The advice must reflect the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances and needs of the retirement investor.
- Loyalty: The advice must not place the interests of the investment professional, financial institution or any other party ahead of the interests of the retirement investor.
- Reasonable compensation standard: Investment advice fiduciaries must charge only reasonable compensation for providing investment advice, consistent with the general rules on fiduciary compensation under ERISA and the IRC.
- No materially misleading statements: Investment advice fiduciaries must not make any statements about recommended investment transactions and other relevant matters that are materially misleading at the time they are made.
Additional DOL Analysis
In the proposed rule, the DOL provides additional insight regarding certain topics that may be affected by the proposed rule or covered by the proposed exemption.
Determination of “Mutual Agreement”
One prong of the five-part test is that investment advice must be provided pursuant to a mutual agreement, arrangement or understanding with the plan or plan fiduciary. In the preamble to the proposed rule, the DOL states that the determination of whether there is such a mutual agreement, arrangement or understanding is appropriately based on the reasonable understanding of each of the parties, if no mutual agreement or arrangement is demonstrated. Furthermore, the DOL cautions 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 in determining whether a mutual understanding exists.
Determination of “Primary Basis”
The DOL explained that advice does not have to serve as “the” primary basis for an investment decision to meet the five-part test, but, instead, it is sufficient if the advice serves as “a” primary basis for an investment decision. According to the DOL, a one-time sales transaction generally “does not by itself confer fiduciary status under ERISA or the Code, even if accompanied by a recommendation that the product is well-suited to the investor and would be a valuable purchase.”
Rollovers to IRAs
The preamble to the proposed rule clarifies the DOL’s view on rollovers from employee benefit plans to IRAs. According to the DOL, advice to roll over assets from an employee benefit plan to an IRA should be considered advice to sell, withdraw or transfer investment assets and therefore, depending on the facts and circumstances, may be covered by the five-part test. As a result, any financial institution or investment professional who makes such a rollover recommendation that satisfies the requirements of the five-part test described above will likely be considered an investment advice fiduciary. According to the DOL, advice to roll over assets could be provided as part of an ongoing relationship with a plan advice provider. Note, however, that the proposed exemption described above would specifically cover compensation received as a result of investment advice to roll over assets from a plan to an IRA.
Best Interest Standard
In the preamble to the proposed rule, the DOL states that the best interest standard (described above) would allow financial institutions and investment professionals to provide investment advice with respect to a transaction despite having a financial or other interest in such transaction, so long as they do not place their own interests ahead of those of the retirement investor or subordinate the retirement investor’s interests to their own. The DOL also indicated that this standard is to be interpreted and applied consistent with the standard set forth in the Securities and Exchange Commission’s Regulation Best Interest (Reg BI), signaling the intent that the DOL exemption and Reg BI be consistently applied. Reg BI, which is now effective, generally imposes a best-interest obligation on broker-dealers when making investment recommendations to retail customers.
The proposed rule will be published in the Federal Register for notice and comment in the near future.
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