DOL finalizes fiduciary advice rule

On April 23, 2024, the Department of Labor released its final “Retirement Security Rule: Definition of an Investment Advice Fiduciary,” a (final) amendment to its Prohibited Transaction Exemption PTE 2020-02 (the advice fiduciary PTE), and amendments to certain other prohibited transaction exemptions.

In this article we review the new regulation redefining “advice fiduciary,” which fundamentally changes current rules. In a follow on article, we will discuss the changes to PTE 2020-02.

Why this matters to plan sponsors

The rule/guidance package is primarily targeted at financial institutions. But it will turn many persons – critically, call center operators affiliated with financial institutions – who previously understood themselves to be “just service providers” into “advice fiduciaries.” This will likely require plan fiduciaries to monitor those advice fiduciaries’ compliance with the associated prohibited transaction exemption (typically, PTE 2020-02).

Sponsors will want to review the extent and scope of that monitoring obligation with their counsel and discuss with their providers how they intend to comply with the new advice fiduciary rule/PTE.

In addition, there may be situations in which sponsor officials themselves, e.g., discussing plan investment decisions with plan participants, might be considered advice fiduciaries. We note, however, that in the final regulation DOL has tried to limit this application of the regulation.

Plan sponsor/fiduciaries will, however, also be included in the class of persons (“retirement investors”) who are the “beneficiaries” of the new rule’s protections – its tighter regulation of investment advice. In this regard, we should note that, while there will be circumstances in which such protection is a benefit – imposing a standard of care and duty of loyalty on the advisor that might not otherwise apply – the advisor’s resultant increased compliance burden (e.g., compliance with PTE 2020-02) may in many cases be effectively passed through, resulting in increased costs to the retirement investor.

The new definition of “advice fiduciary”

Under the final rule, a person would be an ERISA advice fiduciary – and therefore subject to ERISA’s fiduciary standards, critically the prohibition against self-dealing – if:

[T]he person makes a recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property … to [a] plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary or IRA fiduciary (retirement investor);

For a fee or other compensation, direct or indirect; and

The person makes the recommendation in one of the following contexts:

1. The person either directly or indirectly (e.g., through or together with any affiliate) makes professional investment recommendations to investors on a regular basis as part of their business and the recommendation is made under circumstances that would indicate to a reasonable investor in like circumstances that the recommendation is based on review of the retirement investor’s particular needs or individual circumstances, reflects the application of professional or expert judgment to the retirement investor’s particular needs or individual circumstances, and may be relied upon by the retirement investor as intended to advance the retirement investor’s best interest; or

2. The person represents or acknowledges that they are acting as a fiduciary under Title I of ERISA, Title II of ERISA, or both, with respect to the recommendation.

The regulation also explicitly provides that:

Sales pitches are not fiduciary advice: A person does not provide “investment advice” if they make a recommendation but neither paragraph 1. or 2. above is satisfied. Here DOL gives the example of a salesperson who does not hold herself out as a fiduciary and whose “recommendation” is not “based on review of the retirement investor’s particular needs …, etc.”

Disclaimers are not dispositive: Written statements disclaiming fiduciary status or disclaiming the conditions set forth in 1. above, “will not control to the extent they are inconsistent with the person’s oral or other written communications, marketing materials, applicable State or Federal law, or other interactions with the retirement investor.”

Changes from the 2023 proposal:

• A provision in the proposal that advice fiduciary status would apply where the person was also an investment fiduciary (e.g., managed part of a plan’s portfolio) was eliminated. That a person making a recommendation is also, e.g., one of the plan’s investment managers would, however, be one of the elements of the analysis in the more general rule (item 1. above), e.g., as evidence “that the recommendation is based on review of the retirement investor’s particular needs …, etc.”

• The addition of the word “professional” in the phrase “makes professional investment recommendations” is “designed to provide additional certainty that the provision would not be satisfied by the ordinary communications of a human resources employee, who is not an investment professional, in communications with plan participants.”

• The addition of the language “is made under circumstances that would indicate to a reasonable investor in like circumstances” is intended to make the test for fiduciary status objective.

• Providing, with respect to item 2. above, that advice fiduciary status attaches when a person represents/acknowledges they are acting as an ERISA fiduciary; although, e.g., status as a non-ERISA fiduciary may be relevant to the “circumstances” test in item 1.

Some more detail: Why DOL believes it must re-define who is an advice fiduciary

This regulation represents a change in the definition of who is an ERISA advice fiduciary, expanding it to cover broad new classes of persons. To understand exactly what these changes are, let’s briefly review what the “old” rule (known as the “five-part test”) was and why DOL has (literally for decades) wanted to change it.

DOL concerns about the (old) five-part test: DOL describes the five-part test as follows:

Under the five-part test, a person is a fiduciary only if they: (1) render advice 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 or a plan fiduciary 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.

DOL has expressed particular concern about three elements of the five-part test: the “regular basis” requirement and the requirements of “a mutual agreement, arrangement, or understanding” that the investment advice will serve as “a primary basis for investment decisions.” According to DOL, these elements “too often work to defeat legitimate retirement investor expectations of impartial advice and allow some advice relationships to occur where there is no best interest standard.”

We would note that for what is probably DOL’s greatest area of concern, advice with respect to rollovers, the “regular basis” requirement has been particularly problematic, with one court overturning DOL’s attempt to stretch the regular basis requirement under PTE 2020-02.

Changes from the (current) five-part test: Under the final rule, these issues are addressed by:

• Changing the “regular basis” rule to one that simply requires the advice fiduciary to be in the business of providing professional investment advice on regular basis (to its clients/customers). Thus, someone in the “investment advice business” would satisfy this requirement even if the advice in question, e.g., with respect to a rollover, was a one-off.

• Making (as in PTE 2020-02) the question of the advisee’s reliance on the adviser’s recommendation one of fact (the advice need only be “under circumstances that would indicate to a reasonable investor in like circumstances that the recommendation is based on review of the retirement investor’s particular needs or individual circumstances …, etc.”). And providing that disclaimers by the adviser “will not control to the extent they are inconsistent with the person’s oral or other written communications, marketing materials, applicable State or Federal law, or other interactions with the retirement investor.”

• Eliminating the old rule’s “a primary basis” language (the meaning of which is disputed), instead requiring only “that the recommendation is made under circumstances that would indicate … that the recommendation … may be relied upon by the retirement investor as intended to advance the retirement investor’s best interest.”

Highlighted issues

In what follows, we briefly discuss DOL’s treatment of selected advice fiduciary issues.

Some persons/transactions that would not be fiduciary advice under the rule

DOL provides some carve-outs for certain specific circumstances:

A “hire me” “recommendation” would generally not be investment advice under the rule. Recommending to, e.g., a plan committee that it hire a particular (third party) investment adviser, however, would be covered investment advice.

“Platform providers” and Pooled Employer Plans (PEPs) who “who merely identify investment alternatives using objective third-party criteria (e.g., expense ratios, fund size, or asset type specified by the plan fiduciary) to assist plan sponsors and plan fiduciaries in selecting and monitoring investment alternatives, without additional screening or recommendations based on the interests of the retirement investor, would not be considered under the final rule to be making a recommendation.”

“Valuation services, appraisal services, or fairness opinions” are not considered “covered recommendations” under the rule.

“Wholesaling” activity is generally not covered – “[I]t would appear that any communication in this context [of a wholesaler interacting with a financial professional who might also be a plan fiduciary] would not be investment advice under the final rule as it would not be based on the individual needs or particular circumstances of any plan or IRA.”

Recommendation of securities transactions, etc. – rollovers, investment policies, etc.

As in PTE 2020-02, recommendations “of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property” is extended to include advice as to rollovers. And it would also include recommendations as to “how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA.”

Recommendations of “investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., account types such as brokerage versus advisory) or voting of proxies appurtenant to securities” would also be included.

Indirect compensation

Compensation not paid by the advisee is generally considered indirect compensation for the advice if the compensation would not have been paid “but for the recommended transaction or the provision of investment advice.”

No exception for institutional/sophisticated investors

Under the final rule, “plan sponsors acting as fiduciaries” are included in the definition of “retirement investor” – so that a recommendation to a sponsor/fiduciary which meets the definition of fiduciary advice (described above) would be covered by the rule. Thus, there is not a general exception for institutional/sophisticated investors, and DOL notes that many small plan sponsors may in fact not be sophisticated investors. But, DOL believes that its facts and circumstances rule will generally address the “sophisticated investor” issue: “For example, when a financially sophisticated retirement investor engages in an arm’s length transaction with a counterparty who makes an investment recommendation, absent an acknowledgment of fiduciary status under ERISA Title I or Title II, it is appropriate to consider whether a reasonable investor in like circumstances would rely on the recommendation as intended to advance the investor’s best interest.”

How this dynamic plays out in fact will be important to the issue of cost – as noted at the top, “fiduciary advice” is (because of the added compliance burden) likely to cost more than “non-fiduciary advice.”

Prohibited transaction/prohibited transaction exemption

As with DOL’s 2016 advice fiduciary rule, this redefinition of “advice fiduciary” is paired with a prohibited transaction exemption – PTE 2020-02 – imposing significant requirements on advice fiduciaries receiving compensation (particularly those receiving indirect compensation – that is, receiving compensation from someone other than the advisee) in connection with the advice they are giving.

We are going to provide a follow on article discussing DOL’s amendment to PTE 2020-02, released in connection with the new rule. Here, we are just going to sketch it out briefly, as it is an integral part of DOL’s new advice fiduciary regime.

Why is a prohibited transaction exemption necessary? The redefinition of advice fiduciary will turn a lot of persons into fiduciaries who were not fiduciaries under the (old) five-part test. If, with respect to a particular transaction, one of those persons receives compensation that creates a conflict for them – for instance, incentive payments from their employer to favor some products over others – that transaction may be prohibited self-dealing (that is, a prohibited transaction). PTE 2020-02 provides an exemption from that prohibited transaction.

What does PTE 2020-02 require? Briefly, PTE 2020-02 relief from prohibited transaction treatment is conditioned on:

• Compliance with “Impartial Conduct Standards:” providing advice in the advisee’s best interest, charging only reasonable compensation, and making no materially misleading statements.

• With respect to rollovers, prior to the rollover, producing documentation of the reasons a recommended rollover is in the advisee’s best interest.

• The affiliated financial institution acknowledging fiduciary status and describing the services it provides and material conflicts of interest.

• The affiliated financial institution adopting policies to ensure compliance with the Impartial Conduct Standards and conducting a “retrospective review” of compliance certified by a senior executive officer.

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The new rule is effective 150 days after publication in the federal register.

We will continue to follow this issue.