DOL publishes additional guidance on the fiduciary advice PTE

On April 13, 2021, the Department of Labor released “New Fiduciary Advice Exemption: PTE 2020-02 Improving Investment Advice for Workers & Retirees Frequently Asked Questions,” providing additional guidance with respect to DOL’s fiduciary advice prohibited transaction exemption (published December 16, 2020).

For sponsor fiduciaries, a big question for 2021 will be: how will DOL’s policy with respect to fiduciary advice affect the plan, the sponsor, and the plan’s service providers?

The new FAQs, while generally recapitulating guidance in the PTE, clarify and expand on that guidance in some ways.

In this article we discuss some of the highlights of the new FAQs. We begin, however, with some background on the PTE and its relevance to plan fiduciaries.

The PTE in brief

The PTE provides relief from possible prohibited transactions when an advice fiduciary makes a recommendation in connection with which, e.g., the advice fiduciary or a related entity will receive compensation (e.g., investment management fees). Example: a broker recommends that a participant roll over plan assets to an IRA at the broker’s financial services firm.

The PTE conditions relief on the fiduciary providing advice in accordance with “Impartial Conduct Standards,” which consist of (1) a best interest standard, (2) a reasonable compensation standard, and (3) a no “misleading statement” requirement. It also requires that affected financial institutions and investment professionals acknowledge their fiduciary status and describe (in writing) the services they offer and material conflicts of interest. 

In addition, affected financial institutions must “adopt policies and procedures prudently designed to ensure compliance” with these requirements and conduct a “retrospective review” of compliance that is “reduced to a written report” that must be certified by a senior executive officer. 

Enforcement of violations of these rules is under ERISA’s and the Internal Revenue Code’s fiduciary and prohibited transaction provisions.

In connection with the (June 2020) PTE proposal, DOL reinstated the 1975 “five-part test” for who is an “investment advice fiduciary.” While that “reinstatement” is not the subject of the PTE, the PTE includes an extensive “interpretation” (or reinterpretation) of that test that in significant ways broadens it beyond prior law and practice and articulates principles for its application to plan-to-IRA rollovers.

Our article on the PTE provides an extensive discussion of these issues.

Why this matters to plan sponsors and plan fiduciaries

The PTE is primarily targeted at financial institutions. But the new rule – via its reinterpretation of the 1975 fiduciary advice regulation – is generally intended to in many cases make, e.g., call center operators affiliated with financial institutions “advice fiduciaries.” This will likely require plan fiduciaries to monitor those advice fiduciaries’ compliance with the PTE. 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 reinterpreted five-part test and the PTE.

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What follows are selected highlights of the further guidance with respect to the PTE included in the FAQs.

New fiduciary policy with respect to rollovers effective February 16, 2021 

While the PTE itself is subject to a (limited) good faith enforcement policy until December 20, 2021, the position taken in the preamble – that certain rollover recommendations would trigger fiduciary status – was effective (and will begin to be enforced) on the effective date of the PTE, February 16, 2021. Putting these rules together, rollover recommendations that meet the “fiduciary advice test” (as reinterpreted by DOL) will trigger fiduciary status, and advice fiduciaries that as a result are involved in prohibited transactions must comply with the requirements of the PTE, subject to a (temporary) good faith standard. 

(We discuss DOL’s good faith enforcement policy in our article DOL provides temporary enforcement relief for possible prohibited transactions resulting from the Fifth Circuit decision.)

DOL anticipates further action on fiduciary advice

DOL stated that it “anticipates taking further regulatory and sub-regulatory actions, as appropriate, including amending the investment advice fiduciary regulation, amending PTE 2020-02, and amending or revoking some of the other existing class exemptions available to investment advice fiduciaries.” The “investment advice fiduciary regulation” DOL is anticipating amending is the 1975 five-part test, as reinstated and then reinterpreted (in the PTE) by DOL.

Obviously, we will have to wait to see whether DOL is prepared to re-litigate the positions it took (e.g., requiring a contract that may be enforced by a participant) in the 2015-16 regulation project that was struck down by the Fifth Circuit.

Clarification that disclaimers will not avoid fiduciary status

Repeating what it had said in the PTE, DOL states (in the FAQs) that “boilerplate” written statements disavowing fiduciary status “are insufficient to defeat the [five-part] test,” as reinterpreted by DOL. Quoting from the FAQs: 

When firms and investment professionals hold themselves out in their oral communications, marketing materials, or interactions with retirement investors as making individualized recommendations that the investor can rely upon to make an investment decision that is in the best interest of the investor, and the investor, accordingly, relies upon the recommendation to make an investment decision, the 1975 [five-part] test’s requirement for a “mutual agreement, arrangement, or understanding” is satisfied. In applying the 1975 test, the Department intends to consider the reasonable understandings of the parties based on the totality of the circumstances. 

Clarification of required documentation with respect to rollover advice

DOL went into more detail about what sorts of documentation an adviser should provide with respect to a recommendation that a rollover is in a participant’s best interest.

Generally, advice fiduciaries must document “their prudent analysis of why a rollover recommendation is in a retirement investor’s best interest.” Relevant factors to be addressed in this document include: alternatives to a rollover (including leaving the money in the plan); plan and IRA fees/expenses; employer payment of plan expenses (if applicable); and services/investment alternatives under the plan vs. under the IRA.

Advice fiduciaries also have a duty to get information about the participant’s plan. If the participant doesn’t supply that information (“even after a full explanation of its significance”), and it is not otherwise readily available, the advice fiduciary must “make a reasonable estimation of expenses, asset values, risk, and returns based on publicly available information” (documenting and explaining the assumptions used).

Focus on compensation policy

As it has in the past, DOL (in the FAQs) goes into considerable detail on the financial institution’s obligation to structure compensation policy to promote compliance with the impartial conduct standards.

The general standard here is that the financial institution’s policies would “mitigate conflicts of interest ‘to the extent that a reasonable person reviewing the policies and procedures and incentive practices as a whole’ [quoting the PTE] would conclude that they do not create an incentive for a financial institution or investment professional to place their interests ahead of the interest of the retirement investor.” 

The FAQs detail what this means: the financial institution “must identify and carefully focus on the conflicts of interest associated with their business models and practices that create incentives for the financial institution or investment professional to place their interests ahead of the retirement investor’s interest.”

They must “be careful not to use quotas, bonuses, prizes, or performance standards as incentives that a reasonable person would conclude are likely to encourage investment professionals to make recommendations that are not in retirement investors’ best interest.” 

Mitigation of these conflicts may involve:

Leveling compensation for investment/asset recommendations that fall within reasonably defined investment categories (e.g., mutual funds).

Exercising heightened supervision (1) where there are compensation differences between investment categories (e.g., between mutual funds and fixed annuities), (2) at compensation thresholds (e.g., where the broker’s share of commission increases when sales reach a threshold), and (3) at key participant liquidity events (e.g., rollovers).

Using compensation grids “with one or several modest or gradual increases” rather than “grids characterized by large increases.”

Financial institutions should avoid compensation/commission structures (e.g., a fixed percentage of the firm’s commission on a transaction) that “simply pass … along firm-level conflicts to their investment professionals” and “should work to align the interests of their investment professionals and retirement investors, and to root out misaligned incentives to the extent possible.”

(We’ve gone into detail on these issues to give sponsors a flavor of how much DOL intends to change financial firm compensation policy via this PTE.)

The annual retrospective review is intended to drive compensation policy changes

According to the FAQs, DOL “expects financial institutions to use the results of the review to find more effective ways to help ensure that investment professionals are providing investment advice in accordance with the Impartial Conduct Standards and to correct any deficiencies in existing policies and procedures.”

Where a sponsor-fiduciary has a monitoring responsibility for compliance with the PTE (e.g., where the financial institution provides plan call center operators who may also make rollover recommendations), the sponsor-fiduciary may want to consider requesting (annually) a copy of this review.

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As DOL states in the FAQs, it is likely to provide further guidance, including (perhaps) a new fiduciary advice regulation.

We will continue to follow this issue.