In the latest development in a long-running regulatory saga, the U.S. Department of Labor (DOL) on October 31, again proposed major changes (the Proposal) to the fiduciary rules applicable to the offering of financial products to most individual retirement accounts (IRAs) and private sector retirement plans (collectively with IRAs, “plans”). To address DOL’s longstanding concerns over perceived abuses in connection with rollovers from plans to IRAs and with compensation practices associated with retail sales of financial products to plans, DOL has previously made multiple attempts to (1) expand the universe of conduct that is subject to fiduciary standards and (2) permit plan transactions involving conflicts of interest only in narrow circumstances where DOL believes plan participants have strong protections. DOL’s prior attempts to achieve these goals were highly controversial and generally were either withdrawn or dealt fatal setbacks by the courts. For background, see our previous Advisories here, here, here, here, and here.
The approximately 500-page regulatory release accompanying the Proposal is complex and is still being analyzed across the financial services industry. Our initial observations on select key aspects of the Proposal are summarized below.
The Proposal, which was described in a Fact Sheet released by the White House as a “retirement security” rule to crack down on alleged “junk” fees paid by plans, covers much the same ground as DOL’s prior proposals but with a few tweaks intended to navigate the adverse court rulings on prior proposals.
Expanded Conduct Subject to Fiduciary Standards
Since 1975, a person providing “investment advice” to a plan is an “investment advice fiduciary” only if the advice satisfies all prongs of a five-part test (in contrast to a fiduciary with discretionary investment authority who is automatically a fiduciary). Specifically, under the five-part test, the advice must be (1) on a regular basis, (2) pursuant to a mutual agreement, (3) the primary basis for an investment decision, (4) individualized, and (5) for a fee. Under the Proposal, however, a person generally would be an investment advice fiduciary if, in respect of a plan, such person, for a direct or indirect fee, makes a recommendation — interpreted by DOL to mean a “suggestion” to take a particular course of action — regarding any securities transaction or other investment transaction or any investment strategy (expressly including rollover transactions) and the person falls within at least one of the following categories:
- The person, directly or indirectly, already has discretionary investment authority over any assets of the retirement investor (i.e., the IRA owner or plan participant), including non-retirement assets
- The person acknowledges fiduciary status (the Proposal purports to render disclaimers of fiduciary status ineffective)
- The person, directly or indirectly, makes investment recommendations to investors generally on a regular basis as part of its business and the recommendation is based on the individual needs or circumstances of the plan investor and may be relied upon as a basis for the plan investor’s decision.
As a result, the Proposal effectively does away with key elements of the five-part test. The “mutual agreement” prong is gone, and “primary basis” is changed to merely “a basis.” Further, the “regular basis” prong, which was often utilized in the marketplace to avoid investment advice fiduciary status in one-off situations such as a rollover transaction or a one-time annuity purchase, is also gone (although a new and different “regular basis” concept is now found in the third category of potential “investment advice fiduciaries” discussed above).
It is important to note that DOL, consistent with its prior proposals, continues to reject the notion that there is a “dichotomy between a mere ‘sales’ recommendation to a counterparty on one hand, and advice, on the other, in the context of the retail market for investment products.” In fact, DOL believes that “sales and advice typically go hand in hand in the retail market.” Under DOL’s interpretation, financial institutions dealing with plans in the retail marketplace may face difficulty avoiding investment advice fiduciary status.
Changes to Prohibited Transaction Exemptions
By statute, plan fiduciaries are broadly restricted from engaging in conflict of interest transactions (prohibited transactions) unless an exemption applies. Over the decades, DOL has issued a number of prohibited transaction exemptions (PTEs) that permit various conflict of interest transactions and are widely relied upon by the financial services industry. However, the Proposal would eliminate the ability of investment advice fiduciaries to rely on several of these exemptions (for example, aspects of PTEs 75-1 (certain securities transactions), 77-4 (affiliated mutual funds), 86-128 (affiliated brokerage; agency cross transactions), and much of 84-24 (insurance products and mutual funds)). The limitation on utilizing prior PTEs is an express attempt by DOL to funnel most conflict of interest transactions involving investment advice fiduciaries into a beefed-up PTE 2020-02, which generally requires an investment advice fiduciary to act in the best interest of plan participants in order to obtain relief. The Proposal would add new conditions to PTE 2020-02, including enhanced disclosure requirements and a functional obligation to file prohibited transaction excise tax returns and pay associated taxes in the event that the financial institution fails to satisfy all of PTE 2020-02’s conditions for a particular transaction. In addition, the Proposal would expand eligibility for reliance on PTE 2020-02 to investment advice fiduciaries that provide robo-advice.
The Proposal is subject to a tight, 60-day public comment period unless DOL issues an extension (which has already been formally requested by various trade organizations). If the proposed rule is adopted without changes and survives the probable court challenges, financial institutions, particularly those in the retail space and/or involved in rollover transactions, such as broker-dealers, banks, and insurance companies, will likely be required to modify certain of their business practices in order to comply with the new fiduciary rule. The new rule is proposed to be prospectively effective 60 days after publication of the final rule in the Federal Register.
This post comes to us from Arnold & Porter Kaye Scholer LLP. It is based on the firm’s memorandum, “DOL (Again) Proposes Major Changes to the Fiduciary Rules for Plans and IRAs,” dated November 13, 2023, and available here.