Best Interest Standard of Care for Advisors #40

The Department of Labor’s Prohibited Transaction Exemption and Its Impact on Recommendations to Plans, Participants and IRAs (Part 5)


On December 18, 2020, the DOL issued its final prohibited transaction exemption (PTE) that permits investment advisers, broker-dealers, banks and insurance companies, and their representatives, to receive conflicted compensation resulting from nondiscretionary fiduciary investment advice. The PTE is titled “Improving Investment Advice for Workers & Retirees.” The citation is Prohibited Transaction Exemption 2020-02. (https://www.govinfo.gov/content/pkg/FR-2019-07-12/pdf/2019-12208.pdf) The exemption became effective on February 16, 2021.

The exemption imposes certain “conditions” that must be satisfied for financial institutions (that is, broker-dealers, investment advisers, banks or insurance companies) and their individual representatives (called “investment professionals” in the exemption) to receive the relief provided by the exemption. This article builds on the earlier posts Parts 1-4, Best Interest #36, #37, #38, and #39. This article and the ones that follow will address interesting, and perhaps lesser known, issues in the exemption.

It has been well publicized that the exemption and the associated expansion of the definition of fiduciary advice will have a significant impact on recommendations by investment professionals (such as individual investment advisers and representatives of broker-dealers) to retirement plan participants to take rollovers to IRAs. My articles, Best Interest #38 and Best Interest #39, discussed the impact on investment advisers who recommend rollovers from retirement plans to IRAs. But, there is more to the meaning of “rollover” than those articles suggested.

The question, then, is, what does “rollover” mean for purposes of fiduciary advice and prohibited transactions? The DOL answered that question in the exemption. Here is the answer. In discussing the requirement to document the reasons why a rollover recommendation is in the best interest of a “retirement investor” (that is, a plan, participant or IRA owner), the DOL specified that “rollover” includes:

The Financial Institution documents the specific reasons that any recommendation to roll over assets from a Plan to another Plan or an IRA as defined in Code section 4975(e)(1)(B) or (C), from an IRA as defined in Code section 4975(e)(1)(B) or (C) to a Plan, from an IRA to another IRA, or from one type of account to another (e.g., from a commission-based account to a fee-based account) is in the Best Interest of the Retirement Investor. [Emphasis added.]

In other words, the DOL is defining a “rollover” recommendation as including the following:

  • A recommendation to take a distribution and transfer it to another plan (as a direct or indirect rollover).
  • A recommendation to take a distribution and transfer it to an IRA (as a direct or indirect rollover).
  • A recommendation to transfer money from an IRA to a plan (as a direct or indirect rollover).
  • A recommendation to transfer money from an IRA to another IRA (as a direct or indirect rollover).
  • A recommendation to transfer money from one type of account to another (g., from a commission-based account to a fee-based account). The DOL and IRS would only have jurisdiction over those transfers if they are within a tax-qualified or ERISA-governed account (e.g., an IRA, a plan or a participant’s account).

Needless to say, that is a much broader definition of rollover than most people have. As a result of the DOL’s position, all fiduciary recommendations about the listed transactions are subject to the prohibited transaction rules and need the relief provided by the exemption. (In addition, the recommendations to plans and participants need to independently satisfy the prudent man rule and duty of loyalty; however, the best interest condition in the PTE closely parallels the ERISA prudent man rule and duty of loyalty.) That means that the listed “rollover” recommendations need to comply with the conditions in the exemption, including developing and delivering the written explanation of why the recommendation is in the best interest of the “retirement investor” (which is the term that the exemption uses for plans, participants and IRA owners).

I would wager that no one has those procedures in place at this time . . . and that it will take considerable effort-and time-to develop the processes, policies and procedures needed to comply with the terms of the exemption. Fortunately, the DOL and IRS have extended their 2018 non-enforcement policy so that financial institutions and investment professionals can rely on the Impartial Conduct Standards until December 20 of this year. But, all of the conditions in the exemption must be satisfied thereafter

Here are some important thoughts to keep in mind about the discussion in this article:

  • While some who are reading this article may think that the rules don’t apply to them because they aren’t fiduciaries, I encourage you to look back at my prior articles in this series. It will be more difficult than folks think to avoid fiduciary status for rollover recommendations.
  • The DOL and SEC have provided similar guidance about the information needed to make a fiduciary (DOL) or best interest (DOL and SEC) recommendation for a rollover. While the DOL/ERISA fiduciary rule will apply to recommendations to plans and participants, only the SEC rules will apply to recommendations to IRA owners. Interestingly, the SEC requirements (for both broker-dealers and investment advisers) apply to recommendations to participants (as do the DOL rules), the same is not true for advice to plans. For plans, the SEC best interest standard applies to investment advisers, but not broker-dealers. And, of course, the DOL fiduciary standard also applies to advice to plans.

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

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