On October 31, 2023, the Department of Labor released a “Proposed Retirement Security Rule: Definition of an Investment Advice Fiduciary,” revisions to its Prohibited Transaction Exemption PTE 2020-02 (the advice fiduciary PTE), and revisions to certain other prohibited transaction exemptions.

In this article we review the proposed regulation redefining “advice fiduciary,” which fundamentally changes current rules. In a follow-on article, we will discuss the changes to PTE 2020-02, which are for the most part “clarifying” amendments.

Why This Matters to Plan Sponsors

The rule/guidance package is primarily targeted at financial institutions. But it will, if adopted, turn many persons—critically, call center operators affiliated with financial institutions—who currently understand 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.

The New Definition of “Advice Fiduciary”

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

[The] 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.

For a fee or other compensation, direct or indirect.

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

  • The person either directly or indirectly … has discretionary authority or control … with respect to purchasing or selling securities or other investment property for the retirement investor.
  • The person either directly or indirectly … makes investment recommendations to investors on a regular basis as part of their business and the recommendation is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest.
  • The person making the recommendation represents or acknowledges that they are acting as a fiduciary when making investment recommendations.

Just to be clear, if you are not in one of these three contexts, you are not an advice fiduciary.

Some More Detail

DOL concerns about the (current) five-part test: We are going to discuss some key elements of this definition in more detail below. But first, it may be useful to discuss how this definition is different from the current rule, the “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 proposal, 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 advice on regular basis (to its clients/customers). Thus, someone in the “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 is one of fact (the advice need only be “provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor”). And providing that disclaimers by the adviser “will not control to the extent they are inconsistent with the person’s oral communications, marketing materials, applicable State or Federal law, or other interactions with the retirement investor.”
  • Changing “a primary basis” (the meaning of which is disputed) to, simply, “a basis for investment decisions that are in the retirement investor’s best interest.”

Highlighted Issues

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

Advice vs. sales recommendations

DOL interprets “investment advice” broadly, and in this regard it “rejects the purported dichotomy between a mere ‘sales’ recommendation to a counterparty, on the one hand, and advice, on the other, in the context of the retail market for investment products. As reflected in recent regulatory developments from both the SEC and NAIC, financial service industry marketing materials, and the industry’s comment letters reciting the guidance they provide to investors, sales and advice typically go hand in hand in the retail market.”

Some persons/transactions that would not be covered by the rule: DOL does, however, provide carve-outs for certain specific circumstances:

As noted below, recommending to, e.g., a plan committee that it hire a particular investment adviser would be investment advice under the rule. But a “hire me” recommendation would not.

“Platform providers” 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 in selecting and monitoring investment alternatives, without additional screening or recommendations based on the interests of plan or IRA investors, would not be considered under the proposal to be making a recommendation.”

Valuation services generally would not be investment recommendations.

“Wholesaling” activity is generally not covered – “communications by product manufacturers or other financial service providers to financial intermediaries who then directly advise plans, participants, beneficiaries, and IRA owners and beneficiaries, the Department believes that communications to financial intermediaries would typically fall outside the scope of [the rule] because they would not involve recommendations based on the particular needs or individual circumstances of the plan or IRA serviced by the intermediary.”

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.

In the business of making investment recommendations

As noted, the “regular basis” element of the proposal now only requires that the adviser be “in the investment advice business.” DOL believes that because of this requirement, e.g., sponsor HR officials “would not be considered investment … because they do not regularly make investment recommendations to investors as part of their business.”

Discretionary authority or control … with respect to purchasing or selling securities or other investment property for the retirement investor

Note that this discretionary authority or control does not have to be with respect to the retirement investor’s plan or IRA assets; it could be with respect to a participant’s personal assets.

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 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 proposed changes to PTE 2020-02 released in connection with the newly proposed rule. Here, we are just going to sketch it out briefly, as it is an integral part of DOL’s proposed advice fiduciary regime.

Why is a prohibited transaction exemption necessary? The proposed redefinition of advice fiduciary will turn a lot of persons into fiduciaries who are not fiduciaries under the (current) 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.

Comments on the proposal are due 60 days after its publication date. DOL expects to hold a public hearing on its proposal within 45 days.

We will continue to follow this issue.