DOL Proposes New Prohibited Transaction Exemption Allowing for Broader Investment Advice Using "Impartial Conduct Standards" and Formally Reinstates 1975 Five-Part Test for Status as an Investment-Advice Fiduciary.
Introduction
On June 29, 2020, the US Department of Labor ("DOL") proposed1 a new prohibited transaction class exemption ("PTE") allowing investment advice fiduciaries to give retirement investment advice using "Impartial Conduct Standards," which are intended to be consistent with the Regulation Best Interest issued by the Securities and Exchange Commission ("SEC") and the fiduciary duty of registered investment advisers under securities laws. The proposed exemption also describes when advice about rollovers to individual retirement accounts ("IRAs") could be considered fiduciary advice under the Employee Retirement Income Security Act ("ERISA") and the Internal Revenue Code (the "Code").
"The Impartial Conduct Standards require investment advice fiduciaries to provide advice in the best interest of retirement investors, charge only reasonable compensation, and make no materially misleading statements."
In addition, the DOL has taken administrative steps to implement2 the 5th Circuit Court of Appeals’ 2018 decision vacating the DOL’s 2016 fiduciary rule3 and accompanying exemptions:
- Reinstating the DOL’s 1975 regulation setting forth a five-part test4 for determining who is an investment advice fiduciary under ERISA and the Code
- Reinstating Interpretive Bulletin 96-1, regarding participant investment education
- Eliminating two 2016 PTEs, the Best Interest Contract Exemption and the Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs, and reversing 2016 amendments to PTEs 75-1, 77-4, 80-83, 83-1, 84-24 and 86-128
Key Aspects of Proposed PTE
The PTE would permit investment advice fiduciaries to receive compensation for their advice, including advice to roll over a participant’s account in a 401(k) plan to an IRA, if the advice complies with impartial conduct standards.
The PTE aims to provide relief that is broader and more flexible than existing PTEs, which provide relief only for specifically identified transactions, and is intended to provide additional certainty regarding compensation arrangements and to avoid the complexity that comes with relying on multiple exemptions to provide investment advice.
Under the PTE, financial institutions and investment professionals could receive a wide variety of payments that would otherwise violate the prohibited transaction rules, including commissions, 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs, and revenue sharing payments from investment providers or third parties. Financial institutions could also engage in certain principal transactions with plans in which the institution buys or sells investments from its own account.
Impartial Conduct Standards
The PTE would require fiduciary investment advice to be provided in accordance with impartial conduct standards, which, as originally outlined in Field Assistance Bulletin 2018-2, have three components: a best interest standard; a reasonable compensation standard; and a requirement to make no materially misleading statements about recommended investment transactions and other relevant matters.
Under the best interest standard, in choosing between two investments equally available to the investor, it would not be permissible for an investment professional to advise investing in the one that is worse for the retirement investor because it is more lucrative for the investment professional or their financial institution.
Financial institutions would be required to document the specific reasons that recommendations to roll over employee benefit plan assets from a plan to an IRA, or from one type of account to another, are in the best interest of the retirement investor.
Compliance with the impartial conduct standards would also require financial institutions and investment professionals to seek to obtain the best execution of the investment transaction reasonably available under the circumstances, as required by federal securities laws.
When is Rollover Advice Considered Fiduciary Advice?
Advice to take a distribution of assets from an employee benefit plan is advice to sell, withdraw or transfer plan assets, and therefore may be fiduciary advice. However, whether all prongs of the five-part test have been satisfied will depend on the facts and circumstances. For example, advice to take a distribution from an employee benefit plan and roll over the assets to an IRA may be an isolated and independent transaction that would fail to meet the regular-basis prong of the test, but advice to roll over employee benefit plan assets can occur as part of an ongoing relationship or an anticipated ongoing relationship between an individual and his or her advisor.
Application to “Robo-Advice”
Advice arrangements that rely only on “robo-advice,” automated investment advice generated by computer models and do not involve any interaction with an investment professional, would not be covered by the PTE; instead, they would continue to be covered by the statutory exemptions in ERISA sections 408(b)(14) and 408(g) and Code sections 4975(d)(17) and 4975(f)(8). However, hybrid robo-advice arrangements that include personal investment advice from an investment professional would be eligible for relief under the PTE.
Compliance and Disclosure
The PTE would require financial institutions, prior to engaging in a transaction under the PTE, to acknowledge their (and their investment professionals’) fiduciary status to retirement investors in writing and to provide an accurate written description of the services to be provided and their material conflicts of interest.
Financial institutions would be required to establish, maintain and enforce policies and procedures designed to ensure that they and their investment professionals comply with the impartial conduct standards in connection with providing fiduciary investment advice. Adopting these policies may require re-evaluation of incentive practices to ensure that the financial institutions’ policies and procedures mitigate conflicts of interest so that the financial institution’s incentive practices, when viewed as a whole, are prudently designed to avoid misalignment of the interests of the financial institution and investment professionals and the interests of retirement investors. For example, in the preamble to the PTE, the DOL notes that sales contests and similar incentives such as sales quotas, bonuses and non-cash compensation that are based on sales of certain investments within a limited period of time create incentives to recommend products that are not in a retirement investor’s best interest, that cannot be effectively mitigated, and financial institutions’ “policies and procedures would not be prudently designed to avoid a misalignment of interests” between investment professionals and retirement investors if they establish or permit these practices. Many financial institutions have already engaged in this evaluation of their incentive arrangements in order to ensure compliance with the 2016 fiduciary rule and the related PTEs.
Financial institutions would be required to conduct an annual review to detect and prevent violations of, and achieve compliance with, the impartial conduct standards and the policies and procedures governing compliance with the PTE. An independent compliance audit is not required.
Ineligibility Due to Criminal Convictions
Fiduciaries could become ineligible to use the exemption for ten years if they (or, in the case of financial institutions, another financial institution in the same control group) are convicted of certain crimes in connection with providing investment advice to retirement investors, engage in systemic or intentional violation of the PTE’s conditions, or provide materially misleading information to the DOL about their conduct under the exemption.
Comment Period
Comments on the proposed PTE may be submitted within the 30-day comment period at www.regulations.gov at Docket ID number: EBSA-2020-0003; comments received will be made available online at www.regulations.gov and https://www.dol.gov/agencies/ebsa.
1 dol.gov/sites/dolgov/files/ebsa/laws-and-regulations/rules-and-regulations/proposed-regulations/investment-advice-fiduciaries/improving-investment-advice-for-workers-and-retirees.pdf
2 dol.gov/sites/dolgov/files/ebsa/laws-and-regulations/rules-and-regulations/proposed-regulations/investment-advice-fiduciaries/coi-retirement-investment-advice-notice-of-court-vacatur.pdf
3 Our discussion of the DOL’s 2016 Fiduciary Rule is available at https://www.whitecase.com/publications/alert/dol-issues-final-fiduciary-rule-defining-investment-advice-under-erisa-and-code. The DOL summarizes the history of the 2016 Fiduciary Rule and related guidance at dol.gov/agencies/ebsa/laws-and-regulations/rules-and-regulations/historical-information-on-regulations/1210-AB32-2-archive and at dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/improving-investment-advice-for-workers-and-retirees.
4 A person or entity is an investment advice fiduciary to a plan or IRA to the extent that they render investment advice for a fee or other compensation, direct or indirect, with respect to any money or other property of the plan, or has any authority or responsibility to do so. Under the reinstated five-part test, for advice to constitute "investment advice," a financial institution or investment professional who is not a fiduciary under another provision of the rule must: (1) render advice to the plan as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property, (2) on a regular basis, (3) pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary or IRA owner, that (4) the advice will serve as a primary basis for investment decisions with respect to plan assets, and that (5) the advice will be individualized based on the particular needs of the plan.
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