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 the fiduciary interpretation and the conditions of the exemption.

Prohibited Transaction Relief for Rollover Recommendations

This article discusses FAQ #9, which discusses the relief provided by PTE 2020-02 for compensation resulting from rollover recommendations.

Q9. Does PTE 2020-02 provide prohibited transaction relief for rollover recommendations?

Yes, the exemption provides relief for rollover recommendations that result in prohibited transactions, so long as the exemption conditions are satisfied. In addition to the other conditions, financial institutions must document and disclose in writing the specific reasons that a rollover recommendation is in the retirement investor’s best interest. In doing so, financial institutions should consider the retirement investor’s alternatives to a rollover, such as leaving the money in an employer’s plan and taking advantage of the investment options available in that plan, including available options other than those reflected in the retirement investor’s current plan holdings. Financial institutions and investment professionals are expected to make diligent and prudent efforts to obtain information about the existing employee benefit plan and the participant’s interests in it. See Q15 for more information on the factors to consider in connection with rollover recommendations.

Let’s break this down into steps.

1. If a rollover recommendation is given in a manner which satisfies the 5-part fiduciary test (and, because of the DOL’s new interpretation, most rollover recommendations will), the “financial institution” and the “investment professionals” will be giving fiduciary advice. The advice will be nondiscretionary, since the participant must agree with the recommendation before it can be implemented.
2. If the recommendation is fiduciary advice, it will result in a prohibited transaction, since the financial institution (and/or perhaps an affiliate, e.g., an investment manager) and the investment professional will make money from the IRA as a result of the fiduciary recommendation. If it is a prohibited transaction, the “compensation” must be restored to the IRA (as opposed to being retained by the financial institution and investment professional)…unless the terms of an available PTE are satisfied. In ERISA-speak, those terms are called “conditions”.
3. Fortunately, PTE 2020-02 provides that relief (that is, it applies to nondiscretionary fiduciary recommendations to roll over to an IRA), if the exemption’s conditions are satisfied).
4. As the FAQ says, the financial institution must document and disclose in writing the specific reasons that a rollover recommendation is in the retirement investor’s (i.e., participant’s) best interest. I bold “specific reasons” because I have seen some efforts to comply that use a generic list of reasons that might apply to any retirement investor, as opposed to describing why the recommendation is in the particular participant’s best interest.
5. To be able to determine why a rollover might be in a participant’s best interest, the financial institution and investment professional must engage in a “prudent” process (to satisfy ERISA) and a “best interest” process (to comply with the PTE). Fortunately, the requirements for both are the same . . . gather the relevant information about the plan, the IRA and then participant, and then evaluate that information to determine which option is in the participant’s best interest. (These four steps might be labelled (i) plan information, (ii) IRA information, (iii) participant information, and (iv) a best interest process.)
6. Those four steps work until December 20 (because of a DOL and IRS non-enforcement policy in effect till then, which doesn’t require compliance with the 5th step). However, beginning December 21, a fifth step is required, which is a written disclosure of why the recommendation is in the best interest of the participant.
7. Unfortunately, there is a mistaken belief in some quarters that the fiduciary/best interest requirement for rollover recommendations is also deferred until December 21. That is not the case.
8. The FAQ also notes that a financial institution and investment professional must have and consider information about all of the investments in the plan, even those not being used by the participant. That adds an additional element of difficulty in obtaining and evaluating the information.

As the FAQ notes, Question and Answer #15 provides more detail about the information to be gathered and evaluated in the fiduciary/best interest process. In a few weeks, we will get to that FAQ.

Concluding Thoughts

PTE 2020-02 offers relief from prohibited transactions resulting from recommendations to participants to rollover their accounts into IRAs. However, it does not provide relief from the fiduciary/best interest standard of care. In that case, financial institutions and investment professionals must engage in a prudent process to gather and assess the relevant information. That fiduciary requirement already applies and is not delayed until December 21.

On the other hand, many of the requirements of PTE 2020-02 are, in effect, delayed until December 21, due to the DOL and IRS non-enforcement policy. But, even there, financial institutions and investment professionals must currently satisfy the Impartial Conduct Standards, which are: a best interest standard of care, no more than reasonable compensation, and no materially misleading statements.

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.