The ERISA Edit: DOL Again Seeks to Amend Five-Part "Investment Advice" Fiduciary Definition Under ERISA and the Code
Employee Benefits Alert
On October 31, 2023, the U.S. Department of Labor (DOL) released proposed amendments to the regulatory definition of an "investment advice fiduciary" set forth in 29 C.F.R § 2510.3-21 and to three related class Prohibited Transaction Exemptions (PTE). Collectively, these new proposals are DOL's latest attempt to extend ERISA's fiduciary protections to individual retirement accounts (IRAs). Like the invalidated 2016 rule, the current proposed rule would broaden ERISA to cover advice offered by investment professionals who do not satisfy the agency's current five-part regulatory definition of an "investment advice fiduciary" interpreting ERISA section 3(21)(A)(ii). DOL claims that the five-part test, developed in 1975, has not kept up with changes in the retirement marketplace and is underinclusive and enhanced protections are needed to safeguard the interests of retirement plan participants and IRA owners. For more than a decade, DOL has been troubled by investment losses and excessive fees it says have been the result of conflicted advice rendered to participants in participant-directed account plans and owners of IRAs seeking to rollover a lifetime of retirement savings into alternative investment options, including annuities and IRAs. This week, we'll discuss the key components of the proposed amendments.
- Most significantly, the proposed rule expands DOL's regulatory definition of an "investment advice fiduciary" to both ERISA employee benefit plans and to IRAs. Throughout the proposal, "plan and IRA" has been substituted for "plan" in retained regulatory text from 1975. The proposed rule expressly includes annuities, IRAs, IRA owners and beneficiaries, and IRA fiduciaries, along with the employee benefit plans and their fiduciaries, participants, and beneficiaries that have historically been covered by the existing rule, provided certain conditions are met. The preamble to the proposed rule states:
- For purposes of the proposed rule, the term "IRA" is defined as any account or annuity described in [the Internal Revenue Code (the Code)] section 4975(e)(1)(B) – (F), and includes individual retirement accounts, individual retirement annuities, health savings accounts, and certain other tax-advantaged trusts and plans. However, for purposes of any rollover of assets between a Title I Plan and an IRA described in this preamble, the term "IRA" includes only an account or annuity described in Code section 4975(e)(1)(B) or (C). Additionally, while the Department uses the term "retirement investor" throughout this document to describe advice recipients, that is not intended to suggest that the fiduciary definition would apply only with respect to employee pension benefit plans and IRAs that are retirement savings vehicles. As discussed herein, the rule would apply with respect to plans as defined in Title I and Title II of ERISA that make investments.
- The proposal would extend ERISA's fiduciary reach to one-time investment advice and replace the existing five-part test with a broader three-part standard. It sets forth three scenarios that will render a person an "investment advice fiduciary" under ERISA and the Code and is intended to capture "circumstances in which the retirement investor can reasonably place their trust and confidence in the advice provider." According to the proposed rule, a person renders "investment advice" with respect to moneys or other property of a plan or IRA 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 retirement investor and the person also satisfies one of the following:
- (a) 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
- (b) The person either directly or indirectly (e.g., through or together with any affiliate) 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
- (c) The person making the recommendation represents or acknowledges that they are acting as a fiduciary when making investment recommendations
Part (a) expands the current regulatory text to include purchasing and selling of securities or other investment property for a "retirement investor," not just investments through a plan or IRA. Part (b) is based on the 1975 five-part test with several tweaks. First, it substitutes the retirement of providing advice to the investor "on a regular basis" with a requirement that the advisor be a person who makes investment recommendations to investors "on a regular basis as part of their business." The proposal would also do away with the criterion in the current regulation that there be an agreement or understanding that the investment advice will serve as the "primary basis" for investment decision-making. Instead, the proposal contains what DOL regards as an "objective" test focused on whether the advice recommendation is given in circumstances indicating it is based on the particular needs or circumstances of the investor and may be relied upon as a basis for investment decision-making that is in the investor's best interest. Part (c) is new, but echoes requirements that appeared in DOL's 2016 fiduciary rule that was vacated in court.
- Similar to the 2016 rule, the proposed amendments would cover "investment advice" in the form of recommendations on transactions or investment strategies. Under the proposal, the phrase "recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property" means recommendations:
- (a) As to the advisability of acquiring, holding, disposing of, or exchanging securities or other investment property, as to investment strategy, or 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
- (b) As to the management of securities or other investment property, including, among other things, recommendations on 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
- (c) As to rolling over, transferring, or distributing assets from a plan or IRA, including recommendations as to whether to engage in the transaction, the amount, the form, and the destination of such a rollover, transfer, or distribution
- The proposal to amend the regulatory definition of an "investment advice fiduciary" is accompanied by three proposals to amended related PTEs, reminiscent of the prior 2016 rule.
- (a) PTE-2020-02: Under the current framework of PTE 2020-02, financial institutions and investment professionals relying on the exemption must acknowledge their fiduciary status in writing, disclose their services and material conflicts of interest, adhere to impartial conduct standards delineated in the exemption, adopt policies and procedures prudently designed to ensure compliance with the impartial conduct standards and mitigate conflicts of interest that could otherwise cause violations of those standards, document and disclose the specific reasons that any rollover recommendations are in the retirement investor's best interest, and conduct an annual retrospective compliance review. The proposed amendment adds to these conditions additional disclosures to ensure that retirement investors have sufficient data to make informed decisions about the costs of the investment advice transaction and about the significance and severity of any investment advice fiduciary's conflicts of interest. The proposed amendment would also provide more guidance for complying with the impartial conduct standards and implementing established policies and procedures.
- (b) PTE 84-24: DOL is proposing to amend PTE 84-24 to address specific issues that insurers confront in complying with the current conditions of PTE 2020-02 when distributing annuities through independent agents. The ERISA and Code provisions at issue generally prohibit employee benefit plan and IRA fiduciaries from engaging in self-dealing in connection with transactions involving these plans and IRAs. Currently, PTE 84-24 allows these fiduciaries to receive compensation when plans and IRAs enter into certain insurance and mutual fund transactions that the fiduciaries recommend, as well as certain related transactions. The proposed amendment would provide exemptive relief to fiduciaries who are independent producers that recommend annuities from an unaffiliated insurer to retirement investors on a commission or fee basis if certain protective conditions are met.
- (c) PTEs 75-1, 77-4, 80-83, 83-1, 86-128: DOL is proposing amendments to existing PTEs 75-1, 77-4, 80-83, 83-1, and 86-128 that currently provide relief for investment advice fiduciaries to receive compensation when plans and IRAs enter into certain transactions recommended by the fiduciaries as well as certain related transactions. The ERISA and Code provisions at issue generally prohibit fiduciaries with respect to employee benefit plans and IRAs from engaging in self-dealing in connection with transactions involving these plans and IRAs. The proposed amendments would remove fiduciary investment advice, as defined in the proposed rule, from the covered transactions in each exemption and make certain other administrative changes.
In the preamble, DOL states that "the proposal comports with the broad language and protective purposes of [ERISA], while at the same time limiting the treatment of recommendations as ERISA fiduciary advice to those objective circumstances in which a retirement investor would reasonably believe that they can rely upon the advice as rendered by an investment professional who is acting in the investor's best interest, rather than merely promoting their own competing financial interests at the investor's expense." The agency distinguishes federal securities laws and other regulatory regimes with the statutory prohibited transaction provisions in Title I and Title II of ERISA that it claims "contemplate a more stringent approach for the protection of these tax-advantaged retirement savings." According to DOL, in the context of the latter provisions, "an appropriately constructed regulatory definition of an investment advice fiduciary under Title I and Title II of ERISA is essential."
The proposals have already received praise from investor advocacy groups, while financial industry groups have signaled an intent to fight the amendments as they did the 2016 rule. Comments are due 60 days after publication of the proposals in the Federal Register, which we expect to occur shortly, but several industry groups have expressed an intent to request an extension of the comment period.
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