The Department of Labor’s “Fiduciary Rule,” PTE 2020-02:  The FAQs

This series focuses on the DOL’s new fiduciary “rule”, which was effective on February 16. This, and the next several, articles look at the Frequently Asked Questions (FAQs) issued by the DOL to explain the fiduciary definition and the exemption for conflicts of interest.

Background

The DOL’s prohibited transaction exemption (PTE) 2020-02 (Improving Investment Advice for Workers & Retirees) allows investment advisers, broker-dealers, banks, and insurance companies (“financial institutions”), and their representatives (“investment professionals”), to receive conflicted compensation resulting from non-discretionary fiduciary investment advice to retirement plans, participants and IRA owners (“retirement investors”). In addition, the DOL announced, in the preamble to the PTE, an expanded definition of fiduciary advice, meaning that many more financial institutions and investment professionals will be fiduciaries for their recommendations to retirement investors and, therefore, will need the protection provided by the exemption.

In April, the DOL issued FAQs that explain its reasons for issuing the guidance.

Fiduciary Status for Rollovers

This article discusses FAQ 8, which explains the DOL’s interpretations of the “mutual understanding” and “primary basis” prongs of the 5-part test. (The 5 parts were discussed in my blog article, Best Interest #56.)

Simply stated, the third and fourth parts of the 5-part test require that, for recommendations to be fiduciary acts, they must be made:  (i) pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary, or IRA owner (ii) that the advice will serve as a primary basis for investment decisions with respect to plan or IRA assets,…

The DOL discussed its views on those requirements in FAQ 8:

Q8. Can an investment advice provider avoid fiduciary status with a fine print disclaimer, such as that there is no “mutual agreement, arrangement, or understanding” that the advice will serve as “a primary basis for investment decisions,” even if other factors suggest otherwise?

Written statements disclaiming a “mutual” understanding or forbidding reliance on the advice as “a primary basis for investment decisions” may be considered in determining whether a mutual understanding exists, but such statements will not be determinative. Boilerplate disclaimers are insufficient to defeat the test, when the parties have a mutual understanding that the adviser is making an individualized recommendation upon which the investor can be expected to rely in making the investment decision. When firms and investment professionals hold themselves out in their oral communications, marketing materials, or interactions with retirement investors as making individualized recommendations that the investor can rely upon to make an investment decision that is in the best interest of the investor, and the investor, accordingly, relies upon the recommendation to make an investment decision, the 1975 test’s requirement for a “mutual agreement, arrangement, or understanding” is satisfied. In applying the 1975 test, the Department intends to consider the reasonable understandings of the parties based on the totality of the circumstances. Firms and investment professionals cannot use written disclaimers to undermine reasonable investor understandings. Similarly, written statements disclaiming other parts of the 1975 test will not be determinative of fiduciary status.

Comment:  In the past, some financial institutions had taken the position that there could not be a “mutual understanding” if their agreements with retirement investors disclaimed fiduciary status, or parts of the 5-part test. The DOL has effectively said that approach won’t work and the totality of the circumstances will be considered in determining fiduciary status. Obviously, this position will make it more difficult for financial institutions to avoid fiduciary status.

This position is consistent with the DOL’s discussions in the preamble to PTE 2020-02, where the Department said that it would look at a firm’s marketing materials to see if the firm held itself or its financial professionals out as trusted advisors:

With respect to determining whether there is ‘‘a mutual agreement, arrangement, or understanding’’ that the investment advice will serve as ‘‘a primary basis for investment decisions,’’ the Department intends to consider the reasonable understanding of each of the parties, if no mutual agreement or arrangement is demonstrated. Written statements disclaiming a mutual understanding or forbidding reliance on the advice as a primary basis for investment decisions will not be determinative, although such statements will be appropriately considered in determining whether a mutual understanding exists. Similarly, after consideration of the comments, the Department also intends to consider marketing materials in which Financial Institutions and Investment Professionals hold themselves out as trusted advisers, in evaluating the parties’ reasonable understandings with respect to the relationship.

In the preamble the DOL also points out that the “primary basis” test is about “a” primary basis and not “the” primary basis:

The Department does not intend to apply the five-part test to determine whether the advice serves as ‘‘the’’ primary basis of investment decisions, as advocated by some commenters, but whether it serves as ‘‘a’’ primary basis, as the regulatory text provides.

*****

The Department does not interpret the ‘‘primary basis’’ requirement as requiring proof that the advice was the single most important determinative factor in the Retirement Investor’s investment decision. This is consistent with the regulation’s reference to the advice as ‘‘a’’ primary basis rather than ‘‘the’’ primary basis. Similarly, the fact that a Retirement Investor may consult multiple financial professionals about a particular investment does not indicate that the Department’s analysis is incorrect. If, in each instance, the parties reasonably understand that the advice is important to the Retirement Investor and could determine the outcome of the investor’s decision, that is enough to satisfy the ‘‘primary basis’’ requirement.

Comment:  In effect, the DOL is saying that the primary basis prong of the 5-part test would be satisfied if a reasonable person, who observed the communications between a financial professional and a retirement investor would conclude that the professional’s recommendations was one of the primary bases for the investor’s decision. It is very much a facts-and-circumstances test, taking into account the totality of the facts. The effect will be to make it harder for a financial institution to disclaim fiduciary status for recommendations.

Concluding Thoughts

While neither of these “interpretations” are surprising, when taken together with the more aggressive re-interpretation of the “regular basis” prong (See Best Interest #57), the effect will be to cause investment professionals and their firms to more often be fiduciaries to retirement investors (i.e., retirement plans, participants, and IRA owners). As a result, those professionals and their firms will need the protections that PTE 2020-02 affords for conflicts of interest related to those recommendations.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.