DOL finalizes amendment to fiduciary advice Prohibited Transaction Exemption

DOL’s April 23, 2024, Final Retirement Security Rule: Definition of an Investment Advice Fiduciary guidance package also includes an amendment of Prohibited Transaction Exemption PTE 2020-02 (the advice fiduciary PTE), which provides a prohibited transaction exemption for conflicted fiduciary advice where certain conditions are met.

In this article, we begin with a discussion of why this PTE is a fundamental part of DOL’s changes to the regulation of advice and its program to change what advice may be given, how it may be given, and how advisors may be compensated. We then discuss why this PTE matters to plan sponsors, and then proceed to a review of the PTE as amended.

Why a PTE and why does it matter?

Repeating what we said in our article on the new final advice fiduciary definition, that revision of the definition of ERISA “advice fiduciary” will turn a lot of persons into fiduciaries who may not have been fiduciaries under the (prior) five-part test. If one of these “new fiduciaries” then gives advice for which she has a conflict (e.g., an incentive payment from her employer to favor certain investment products), that advice may be prohibited self-dealing. That is a prohibited transaction, triggering an excise tax, and may be an ERISA fiduciary breach by plan fiduciaries.

Taking what may be the most salient example for many sponsors/sponsor fiduciaries, current call center operators (provided, e.g., by the plan’s recordkeeper) may have previously operated as “mere service providers” and not as fiduciaries. They may, however, be giving one-time advice to retiring participants about rollovers. Under the revised definition of advice fiduciary, that one-time rollover advice is likely to turn those call center operators into fiduciaries. And if they are compensated by an affiliated financial institution (e.g., a mutual fund operator affiliated with the recordkeeper) for giving that advice, they may have engaged in a prohibited transaction.

What PTE 2020-02 does

PTE 2020-02 provides an exemption from these prohibited transactions – conflicted advice by an advice fiduciary. If the fiduciary advisor and related financial institution comply with the PTE, they may engage in the transaction without penalty, and the plan fiduciary who caused the plan to enter into the transaction will not have committed an ERISA fiduciary breach.

To get this relief from prohibited transaction treatment, the advisor (e.g., the call center operator) and the related financial institution must comply with a detailed set of conditions:

• Compliance with “Impartial Conduct Standards” requiring them to:

  • “[I]nvestigate and evaluate investments, provide advice, and exercise sound judgment in the same way that knowledgeable and impartial professionals would in similar circumstances (the Care Obligation).” This is, essentially, ERISA’s prudence requirement.

  • “[N]ever place their own interests ahead of the Retirement Investor’s interest, or subordinate the Retirement Investor’s interests to their own (the Loyalty Obligation).”

  • Charge only reasonable compensation.

  • Make no materially misleading statements.

• With respect to rollovers, prior to the rollover, providing a description of the bases for their recommendation to engage in the rollover.

• 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.

Why this matters to sponsors

Sponsor fiduciaries will be required to monitor an advice fiduciary’s compliance with these conditions; failure to do so (where the PTE is needed to avoid a prohibited transaction) may result in a fiduciary breach by plan/sponsor fiduciaries. In this regard, see our article on the Ninth Circuit decision in Bugielski v. AT&T, holding that sponsor fiduciaries had, under the terms of the applicable PTE (there, the service provider PTE), a fiduciary obligation to monitor the reasonableness of a service provider’s compensation (which is a condition of the availability of that PTE).

To be clear, at this point, the exact extent of the sponsor’s duty-to-monitor is unclear. In the abstract it means that the plan/sponsor fiduciary must be reasonably satisfied that the advice fiduciaries that it has retained (e.g., call center operators) are complying with, e.g., the impartial conduct standards and rollover disclosures. How that is to be accomplished is unclear.

Final amendments to PTE 2020-02

The 2024 amendment includes the following changes:

• For clarity, the “best interest” requirement was changed to a “Care and Loyalty” standard (noted above).

• The PTE was extended to include recommendations of any investment product/transaction, including principal transactions.

• Non-bank Health Savings Account (HSA) trustees/custodians were added to the definition of Financial Institution.

• The disclosure requirements were revised “to more closely track other regulators’ disclosure requirements with respect to the provision of investment advice.”

• The list of events (e.g., certain crimes) triggering ineligibility was expanded, and the disqualification rules were modified.

• New “streamlined exemption provisions” for Request for Proposals (RFPs) for “3(38) investment management services” were added. Under this rule, the advisor/financial institution is able to take advantage of the PTE for advice given during the RFP process if it has met the Impartial Conduct standards – Care/Loyalty, reasonable compensation, no misleading statements.

Review of PTE 2020-02 as amended

While the revision of the definition of advice fiduciary fundamentally changes/expands who is a fiduciary, the PTE had (in 2020) already largely anticipated this expansion, and the final 2024 changes to it are more in the nature of “tweaks.” In what follows, we provide a more general review of PTE 2020-02, as amended.

Conditions

To take advantage of PTE 2020-02, the Financial Institution/advisor must meet the following conditions.

Impartial Conduct

The Financial Institution/advisor must comply with Impartial Conduct Standards. As noted, these include a Care Obligation, a Loyalty Obligation, a limitation to reasonable compensation, and a duty not to make any misleading statements.

Disclosures

The Financial Institution/advisor must make disclosures with respect to:

Fiduciary status: The financial institution must acknowledge in writing its fiduciary status. The final 2024 amendment makes this requirement more explicit.

Care/Loyalty Obligation: The financial institution must provide the advisee with a written statement of the Care Obligation and the Loyalty Obligation.

Services provided/conflicts: The financial institution/advisor must disclose all “material facts” with respect to the advisor relationship, including:

• Fees and costs.

• Type and scope of services, “including any material limitations on the recommendations that may be made to them,” (e.g., where investments are limited to proprietary products).

• All conflicts of interest “associated with the recommendation.”

Rollovers. Before recommending a rollover from an ERISA-covered plan or making a recommendation as to post-rollover investments “the Financial Institution and Investment Professional must consider and document the bases for their recommendation to engage in the rollover, and must provide that documentation to the Retirement Investor.” In this regard, relevant factors must include:

• Alternatives, including leaving assets in the plan.

• Fees/expenses under the plan vs. under the recommended investment/ account.

• Whether the employer (or other party) pays plan fees/expenses.

• Levels of service/investments available under the plan vs. under the recommended investment/account.

Required policies and procedures

The financial institution must adopt “policies and procedures prudently designed to ensure that the financial institution and its Investment Professionals comply with the Impartial Conduct Standards and other exemption conditions.”

In this regard, the final amendment to the PTE goes into detail as to which sorts of, e.g., broker compensation arrangements may or may not be appropriate, in what circumstances, explicitly targeting certain practices. For instance:

Financial Institutions may not use quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation, or other similar actions or incentives in a manner that is intended, or that a reasonable person would conclude are likely, to result in recommendations that do not meet the Care Obligation or Loyalty Obligation.

Retrospective review

The financial institution must conduct an annual retrospective review “reasonably designed to detect and prevent violations of, and achieve compliance with the conditions of this exemption.” With respect to this review, a ”Senior Executive Officer” must certify that he has reviewed the review/report and that the financial institution has:

• Filed Form 5330 for any non-exempt prohibited transactions, corrected them, and paid any excise taxes owed.

• Written policies and procedures that meet the PTE’s requirements.

• Has a prudent process to modify those policies and procedures.

Enforcement

Breaches of the conditions of the PTE are generally enforceable under ERISA’s and the Internal Revenue Code’s prohibited transaction rules. Prohibited transactions themselves would (as noted) trigger excise taxes (enforceable by IRS). Fiduciary breaches (by, e.g., the plan/sponsor fiduciary who caused the plan to enter into the prohibited transaction) would be enforceable generally, with respect to ERISA plans, under ERISA’s fiduciary remedies provisions.

Other provisions

The final amendment modifies the PTE to cover Pooled Employer Plans (PEPs). And it expands somewhat the current ineligibility provisions, under which a person would “become ineligible to rely on this exemption with respect to any covered transaction” (because of, e.g., certain criminal violations).

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The amendment is “applicable” 150 days after publication in the Federal Register.

We will continue to follow this issue.