On 31 October 2023, the Department of Labor (DOL) unveiled its proposed “Retirement Security Rule” (Proposed Rule)1 redefining who is an investment advice fiduciary under the Employee Retirement Income Security Act (ERISA). The determination of who is a fiduciary is of central importance because many of the protections, duties, and liabilities of ERISA hinge on fiduciary status. DOL also proposed amendments to several existing prohibited transaction exemptions (PTEs) that currently provide prohibited transaction relief to investment advice fiduciaries, including PTE 2020-02, which is the exemption financial institutions commonly rely upon in connection with rollovers.
The Biden Administration is framing the Proposed Rule as part of its initiative aimed at eliminating “junk” fees in the consumer financial markets, but the potential impact of the Proposed Rule is much broader. Retirement assets total over US$30 trillion2 and ERISA imposes strict requirements on persons deemed to be fiduciaries, and severe consequences for breaches of fiduciary duties, including engaging in non-exempt prohibited transactions.
The Proposed Rule is DOL’s fourth try since 2010 to expand investment advice fiduciary status. The first attempt was abandoned due to industry pressure. The second attempt produced a final rule in 2016, but was vacated by the Fifth Circuit in 2018. The third attempt, a more expansive interpretation of the existing rule released in connection with an exemption for investment advice, PTE 2020-02, was partly overturned by a Florida district court decision.3 We expect the Proposed Rule will also face challenges from the industry and in the courts.
The Proposed Rule would replace an almost 50 year old regulation (known as the “five-part test”) defining when a person is deemed to provide ERISA fiduciary investment advice.4 Under the five-part test, a person is a fiduciary only if they meet the following five elements: (1) they 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.
According to DOL, the five-part test as applied to the current marketplace fails to capture many circumstances in which investors reasonably believe they are receiving advice from a fiduciary. If adopted, the Proposed Rule would replace the five-part test with a new test which DOL believes reflects current realities in light of the text and purpose of ERISA. Under the Proposed Rule, a person making an investment recommendation would be a fiduciary in any one of the following contexts:
- The person either directly or indirectly (e.g., through or together with any affiliate) has discretionary authority or control, whether or not pursuant to an agreement, arrangement, or understanding, 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; or
- The person making the recommendation represents or acknowledges that they are acting as a fiduciary when making investment recommendations.
These contexts, asserts DOL, are those in which a retirement investor can reasonably place their trust and confidence in the advice provider, and thus where a retirement investor should be able to expect it is dealing with a fiduciary.
Notably, the change from the five-part test’s “regular basis” prong to persons providing investment recommendations “on a regular basis as part of their business” (as opposed to regular advice to any particular client) would accomplish DOL’s goal of making one-time advice, such as rollover advice, covered by the fiduciary standard. In addition, the change from the “mutual agreement, arrangement, or understanding” and “primary basis” requirements of the five-part test to “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” would also expand the scope of fiduciary status and reduce the ability of financial professionals to rely on disclaimers of fiduciary status.
While DOL, in the preamble to the Proposed Rule, concedes that “[a]n investment advice provider can recommend that a retirement investor enter into an advisory relationship with the provider without acting as a fiduciary,” if the “hire me” recommendation “effectively includes a recommendation” on how to invest or manage plan or IRA assets, that recommendation may trigger fiduciary status if the other requirements of the Proposed Rule are met. DOL also “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.”
Uncertainty regarding the circumstances under which fiduciary status may apply could cause industry participants to err on the side of caution and comply with an exemption, in most cases PTE 2020-02, for borderline cases. If an entity seeks to rely on PTE 2020-02, however, a condition of that exemption is an acknowledgement of fiduciary status, which would automatically cause the entity to be a fiduciary regardless of any other circumstances.
EXEMPTIONS AND INTERPRETIVE BULLETIN
The proposed amendments to PTEs, issued in conjunction with the Proposed Rule, would, with very limited exceptions, remove their applicability for investment advice and compel investment advice fiduciaries to rely instead on DOL’s preferred PTE for investment advice, PTE 2020-02. Specifically, PTEs 75-1 Parts III and IV, 77-4, 80-83, 83-1, and 86-128 would all be amended to eliminate relief for transactions resulting from fiduciary investment advice, as defined under ERISA.
PTE 86-128 currently allows fiduciaries to receive compensation for effecting or executing securities transactions. In addition to removing the coverage for investment advice, the proposed amendments would also remove Section IV(a) which currently allows reliance on the exemption for IRAs or other plans that cover no employees without any further conditions.
Although mutual funds are not themselves subject to ERISA, an exemption is often needed for a plan or IRA to invest in a mutual fund. The proposed amendments would revoke PTE 75-1, Part II(2), which currently contains a special exemption for mutual fund purchases between fiduciaries and plans or IRAs subject to minimal conditions. As mentioned above, the proposed amendments would also remove non-discretionary investment advice transactions from PTE 77-4, a frequently utilized exemption that provides relief for a plan’s or IRA’s purchase or sale of mutual fund shares where the investment adviser for the mutual fund is also a fiduciary to the plan or IRA.
PTE 84-24, a commonly used exemption for the receipt of sales commissions by insurance agents or brokers, would be amended to limit relief for investment advice to independent insurance producers (i.e., independent insurance agencies) that recommend annuities from an unaffiliated financial institution to retirement investors on a commission or fee basis. Relief under this narrower provision would also require compliance with “impartial conduct standards” that match requirements in PTE 2020-02.
PTE 2020-02 would be expanded to cover certain transactions involving pooled employer plans and transactions involving “pure” robo-advice providers. In addition, the proposed amendment includes changes and clarifications regarding the exemption’s conditions, such as clarifications regarding the fiduciary acknowledgement requirement and a new requirement to provide a written statement of the best interest standard of care owed by the investment professional to the retirement investor. If the proposed amendment is adopted, financial institutions relying on PTE 2020-02 may need to amend their client disclosures and make changes to their policies and procedures. Also, because the Proposed Rule broadens the definition of who is an investment advice fiduciary, more parties may need to rely on PTE 2020-02.
DOL’s Interpretive Bulletin 96-1 on educational information and materials would remain unchanged.
POLICY STATE OF PLAY
The Proposed Rule comes as the Biden Administration attempts to advance regulatory priorities ahead of the end of the President’s first term. In his remarks on the release of the Proposed Rule, President Biden said that the approach is intended to modernize retirement plan advice in the context of developments in the industry and “level the playing field” for workers and retirees. “Most financial advisers give their clients good advice at a fair price and are honest with them, but that’s not always the case,” President Biden said. “Some advisers and brokers steer their clients toward certain investments not because they’re in the best interest of their client, but because it means the best payout for the broker. I get it, I understand it, but I just want to let you know, we’re watching.”
The Proposed Rule was met with criticism by Republicans. House Education & the Workforce Committee Chair Virginia Foxx (R-NC) said in a statement, “This latest proposal is just new lipstick on the same old pig, and it will harm retirement plans, retirees, and savers.” Senate HELP Committee Ranking Member Dr. Bill Cassidy (R-LA) said in a statement, [The Proposed Rule] “imposes burdensome regulations that have already proven to make investing more difficult, especially for those who are lower- and middle-income.” Given the high level of interest in the rule, Congress will likely continue to be engaged with the Biden Administration and DOL as the rulemaking proceeds.
Stakeholders are engaging with the Biden Administration and Congress both in support and opposition to the rule. Additionally, stakeholders are expected to advocate for changes to the Proposed Rule on a range of issues to ensure it is administratively feasible for different business models, products, and services.
COMMENT PERIOD AND PUBLIC HEARING
The comment period on the Proposed Rule and amended PTEs is open until 2 January 2024 (60 days after publication in the Federal Register). DOL indicated that it intends to host public hearings approximately 45 days after publication, which would be mid-December 2023.
Although it is possible timeframes slip, the Biden Administration is likely seeking to finalize the rule during the second quarter of 2024 in order to preempt the rule being overturned through the Congressional Review Act by the 119th Congress in 2025. The Congressional Review Act allows Congress to review and overturn certain rules finalized within 60 legislative days.