On October 31, 2023, the Department of Labor (the “Department”) released its “Retirement Security Rule (the “Proposed Rule”). If finalized, the Proposed Rule will (once again) broaden the regulatory definition of “investment advice fiduciary” for purpose of Title I and Title II of the Employee Retirement Income Security Act of 1974, as amended (ERISA).
The definition in the Proposed Rule is, however, intended to be narrower than the Department’s 2016 definition, which was ultimately vacated by the Fifth Circuit as being too broad and conflicting with the plain text of ERISA and traditional trust law.[1] The Department also proposed amendments to several prohibited transaction exemptions (PTEs), including PTE 2020-02, which advisors typically rely upon in connection with rollovers of 401(k) accounts.
The Proposed Rule and revised PTEs will have a significant impact on investment advisors, broker-dealers, insurance agents, and other professionals providing investment-related services to retirement investors (which includes retirement plans, plan fiduciaries, plan participants and beneficiaries, IRAs, IRA owners or beneficiaries, and IRA fiduciaries). Under the broader definition, many professionals will find themselves subject to the duties and responsibilities of an ERISA fiduciary – most notably in the context of recommendations for 401(k) rollovers, but it will likely extend to certain other recommendations as described below.
The Proposed Rule
Under the Proposed Rule, a service provider will be an “investment advice fiduciary” if it makes an investment recommendation (for a fee) to a retirement investor in the context of a professional relationship in which the client would reasonably expect to receive sound investment recommendations that are in the client’s best interest. This would include situations in which the service provider:
- has discretion over investment decisions for the retirement investor;
- makes investment recommendations to investors on a regular basis as part of its business, and the recommendation to the retirement investor 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
- states that they are acting as a fiduciary when making investment recommendations.
In addition, the Proposed Rule would disregard any written statements or agreements in which a service provider disclaims fiduciary status under ERISA or the Internal Revenue Code, to the extent the disclaimer is inconsistent with the provider’s oral communications, marketing materials, applicable state or federal laws, or other interactions with the retirement investor.
Differences From the Current Rule
The current regulatory definition of “investment advice fiduciary,” which was adopted in 1975, uses the so-called five-part test, in which a service provider is a fiduciary if it provides to a retirement investor: (1) investment advice or recommendations for a fee, (2) on a regular basis, (3) pursuant to a mutual understanding or agreement, (4) that the investment advice will serve as the primary basis for an investment decision, and (5) the advice is individualized.
Common investment services, such as recommendations for 401(k) rollovers to IRAs, are typically not treated as fiduciary advice under the current rule, because the recommendation is made one time and, therefore, not on a “regular basis.” Under the Proposed Rule, a rollover recommendation would be treated as fiduciary advice if it is provided under one of the situations described above, which notably changes the “regular basis” requirement from the advice the service provider provides to an individual client to advice provided to all clients as part of the service provider’s business. Therefore, the threshold question becomes whether or not the service provider provides investment
recommendations on a regular basis as part of its business.
The Department notes that other one-time recommendations could be covered by the Proposed Rule[2], such as:
- recommendations to terminate a pension plan and purchase a group annuity contract to cover the plan’s liabilities; and
- a plan’s purchase of an illiquid real estate asset.
Accordingly, the Proposed Rule would also extend to services provided at the plan level and not just services directed toward individual participants or beneficiaries.
In addition, service providers often disclaim ERISA fiduciary status in their advisory service agreements with clients. By disclaiming fiduciary status, service providers may argue that their advice was not pursuant to a “mutual understanding or agreement” that the investment advice will serve as the “primary basis” for an investment decision. Under the Proposed Rule, these types of disclaimers will not protect the service provider from fiduciary responsibilities to the extent they are inconsistent with other marketing materials or communications with the client. In fact, as discussed below, advisors will likely need to rely on PTE 2020-02 to avoid any prohibited transactions, and one of
the requirements of PTE 2020-02 is to acknowledge fiduciary status in writing.
Changes to Prohibited Transaction Exemptions
The Department also updated PTEs 2020-02 and 84-24. Advisors generally rely on PTE 2020-02[3] when making recommendations with respect to rollover advice or how to invest assets in a retirement plan or IRA. Under PTE 2020-02, advisors must adhere to certain Impartial Conduct Standards, which include making recommendations that are in the best interest of the plan participant or IRA owner, charging no more than a reasonable fee, and not making any misleading statements. Notably, advisors are also required to acknowledge, in writing, their status as a fiduciaries under ERISA, which will automatically make them a fiduciary under the Department’s new definition.
The Department made changes to several other PTEs[4] to remove their application to investment advice and effectively require any service provider providing investment advice to retirement plans or IRAs to rely on PTE 2020-02. In addition, PTE 84-24, which is widely used by insurance agents and brokers to receive commission payments, would require investment advisors to comply with the Impartial Conduct Standards and limit the exemption to insurance agencies selling annuities from unaffiliated financial institutions.
Comment and Public Hearing
The Department’s new definition and amended PTEs are currently in proposed form and not yet final. The deadline for the Proposed Rule and amended PTEs is January 2, 2024 (60 days after publication in the Federal Register).
The Department’s Employee Benefits Security Administration (EBSA) announced that it will hold virtual public hearings on December 12, 2023, and December 13, 2023 (and December 14, 2023, if necessary) for the public to provide input on the Proposed Rule.
Calfee will continue to monitor the development of the Proposed Rule and amended PTEs given they will likely have a significant impact on advisory firms of all types. In the meantime, please feel free to contact Steven Day in our Employee Benefits and Executive Compensation group or your Calfee attorney.
[1] Chamber of Commerce v. Department of Labor, 885 F.3d 360 (5th Cir. 2018)
[2] Department of Labor Fact Sheet: Retirement Security Proposed Rule and Proposed Amendments to Class Prohibited Transaction Exemptions for Investment Advice Fiduciaries, released October 31, 2023.
[3] PTE 2020-02 was partially overturned as overreaching in American Securities Association v. U.S. Department of Labor, Case No. 8:22-cv-330 (M.D. Fla. Feb. 13, 2023); however, it would likely fit within the Department’s new definition of “investment advice fiduciary.”
[4] Specifically, PTEs 75-1, 77-4, 80-83, 83-1, and 86-128
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