Ice Miller LLP: Insights

DOL Proposes New "Fiduciary Rule" and Provides Guidance for IRA Rollovers

Summary

Proposed Prohibited Transaction Class Exemption: On June 29, 2020, the U.S. Department of Labor (DOL) proposed a new class exemption that permits investment advice fiduciaries to engage in otherwise prohibited transactions and receive compensation (including commissions, trailing fees, 12b-1 fees and revenue sharing) as long as certain conditions, including “Impartial Conduct Standards,” are satisfied. Additionally, the impacted financial institutions and investment professionals must acknowledge their fiduciary status and describe (in writing) the services they offer and any material conflicts of interest. Affected financial institutions must also “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.” The proposed rule does not attempt to expand the definition of “fiduciary,” but rather reaffirms that the definition of what it means to be a “fiduciary” is tied to the historic “five-part test,” as explained below.

Guidance Overview

The Proposed Class Exemption

A financial institution or investment professionals who are “fiduciaries” under the Employee Retirement Income Security Act of 1974, as amended (ERISA), because they provide investment advice (“investment advice fiduciaries”), are at risk of engaging in a prohibited transaction if they use their fiduciary authority to generate additional fees that may affect their best judgment as a fiduciary, unless an exemption applies. The proposed exemption would require an investment advice fiduciary to follow “impartial conduct standards” that include: (i) a best interest standard, (ii) a reasonable compensation standard, (iii) a best execution duty, and (iv) a requirement not to make materially misleading statements about recommended investment transactions. The new proposed class exemption:

Applies to registered investment advisers, broker-dealers, insurance companies, banks, and individual investment professionals who are their employees or agents.
Permits investment advice fiduciaries to:
- receive compensation as a result of providing fiduciary investment advice, including fiduciary investment advice to roll over a participant's account in an employee benefit plan to an IRA (e.g., the advice included a recommendation to roll over into a product managed by the investment advice fiduciary—such rollover advice may be prohibited in the absence of an exemption.); and
- enter into "principal transactions" in which they could sell or purchase certain securities and other investments from their own inventories to or from plans and IRAs.

Any violations of these rules would be enforced under ERISA’s and the Internal Revenue Code’s fiduciary and prohibited transaction provisions.

Rendering of Investment Advice (Five-Part Test)

Along with the proposed exemption, the DOL adopted a technical amendment (as a final rule) to reinstate the DOL’s five-part test for determining whether a person renders investment advice. Under the five-part test, a financial institution or investment professional is deemed to provide investment advice if that person:

renders advice to a plan as to the value of securities or other property or makes recommendations as to the advisability of investing in, purchasing or selling securities or other property;
on a regular basis;
pursuant to a mutual agreement, arrangement or understanding with the plan or plan fiduciary;
the advice serves as a primary basis for investment decisions with respect to such plan assets; and
the advice will be individualized based on the particular needs of the plan.

The new proposed class exemption would require financial institutions to disclose to retirement investors their status as investment advice fiduciaries under ERISA and the Internal Revenue Code, as applicable, and provide an accurate written description of their services and material conflicts of interest.

Regulation Best Interest

It is anticipated that financial institutions that adhere to Regulation Best Interest ("Reg BI"), which the Securities and Exchange Commission’s (“SEC”) adopted in June 2019, will most likely be deemed in compliance with the DOL’s proposed class exemption or will only require minimal changes to their policies and procedures to achieve compliance. The Reg BI applies to broker-dealers, investment advisers, and associated persons of those entities when they make a recommendation to a retail customer of any securities transaction. Any recommendation made to retail customers must be in the "best interests" of that customer at the time of the actual recommendation.

IRA Rollovers

The proposed exemption would provide broader relief than the existing statutory exemption for investment advice fiduciaries. However, the DOL’s guidance as described in the Preamble to the proposed exemption would make it more difficult to avoid fiduciary status when an advisor provides rollover advice. Under the proposed exemption, whether one is an investment advice fiduciary will depend upon whether the “five-part test” is satisfied. The DOL believes that if rollover advice is provided as part of an ongoing advice relationship to an individual, it is much more likely to meet the “regular basis” prong as compared to advice provided on a single occasion. However, if the advice was part of the advisor’s first step toward an ongoing advice relationship with a client, then it could satisfy the “regular basis” prong of the five-part test depending on the particular facts and circumstances of the relationship.

According to the DOL, a client’s written acknowledgement that any advice from the advisor or broker will not constitute fiduciary advice or is not being used as the primary basis for the client’s investment decisions will not automatically avoid the third (“mutual agreement”) and fourth (“primary basis”) prongs of the “five-part test.” However, the DOL indicated that such client acknowledgements may be considered in determining whether a mutual understanding exists.

If an investment advisor either encourages a rollover to an IRA product where the investment advisor has a financial interest or, the compensation for the advisor is now higher than what the advisor was earning on the same assets as before the rollover, this rollover advice would be prohibited without an exemption. To receive compensation, advisers and brokers historically relied on the statutory exemption in Internal Revenue Code 4975(d)(2), which only requires that the contract and any related fees must be reasonable. The DOL’s position is that the IRC 4975 exemption is not applicable when advisers receive compensation and there is fiduciary self-dealing. In these situations, a careful analysis of the “five-part test” is now required based on the facts and circumstances to ensure the new proposed exemption is applicable.

Takeaways

In rollover situations, plan sponsors can take several steps to help participants be aware of and protect themselves against conflicts of interest. For instance, plan sponsors should carefully review investment advisory agreements and be sure to include protective clauses that prevent advisors from selling their own products or that result in the advisors realizing significant profit to the disadvantage of plan participants. Additionally, plan sponsors should review and approve any financial disclosures provided by investment advisors to participants and ensure that the language describing any potential conflicts of interest is clear and understandable to the average plan participant. Further, plan sponsors should consider providing additional education to plan participants about the importance of rollovers and how to identify and avoid the financial conflicts of interest that could arise from these transactions.

If you would like to discuss the impact of the DOL’s new proposed rule, please contact Erik Hansen, Gary Blachman, Ian Minkin or any attorney in our Investment Management Group or Employee Benefits Group for whom you work.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.