The Department of Labor’s Prohibited Transaction Exemption (Part 10): Plan Information for Rollover Recommendations

On February 16, 2021, the DOL’s prohibited transaction exemption (PTE) 2020-02 became effective. The PTE is titled “Improving Investment Advice for Workers & Retirees.” It 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 the preamble to the PTE, the DOL also announced an expanded definition of fiduciary advice, meaning that many more financial institutions and investment professionals will be fiduciaries and therefore will need the protections afforded by the exemption. In addition, they will need prudent, or best practice, processes to satisfy the fiduciary and best interest standards of care.

In order to be protected by the exemption, financial institutions and investment professionals will need to satisfy the “conditions” in the exemption. For the period from the effective date (February 16) until December 20 of this year, a DOL and IRS non-enforcement policy for prohibited transactions will be available in lieu of the exemption. That is, neither the IRS nor the DOL will enforce the rules against transactions with plans, participants or IRA owners that result from nondiscretionary fiduciary advice and that are prohibited in the Code or ERISA, so long as the Impartial Conduct Standards are satisfied.

This article builds on the earlier posts, Parts 1-9, which discuss interesting, and little known, provisions about the exemption and the fiduciary definition. As explained in those earlier articles, a financial institution and investment professional must, as a part of a best interest process, consider the investments in the participant’s account as well as the investment lineup of the plan. At one point in the preamble, the DOL said:

“To satisfy this condition for Title I Plan to IRA rollovers, the Department expects that Investment Professionals and Financial Institutions evaluating this type of potential rollover will make diligent and prudent efforts to obtain information about the existing Title I Plan and the participant’s interests in it. In general, such information should be readily available as a result of DOL regulations mandating disclosure of Plan-related information to the Plan’s participants (see 29 CFR 2550.404a–5).” [Emphasis added.]

But what if the participant can’t or won’t provide the information to the investment professional?  The preamble had an answer for that:

“If the Retirement Investor is unwilling to provide the information, even after a full explanation of its significance, and the information is not otherwise readily available, the Financial Institution and Investment Professional should make a reasonable estimation of expenses, asset values, risk, and returns based on publicly available information. The Financial Institution and Investment Professional should document and explain the assumptions used and their limitations. In such cases, the Investment Professional could rely on alternative data sources, such as the most recent Form 5500 or reliable benchmarks on typical fees and expenses for the type and size of Plan at issue.” [Emphasis added.]

So, a financial institution and the investment professional could rely on “alternative data”—such as benchmarking information or Form 5500 data, but only if certain conditions are satisfied:

• The investment professional must make “diligent and prudent efforts” to obtain the plan information, but if those efforts aren’t successful, then
• The participant must be given a full explanation of the significance of using the actual plan information in the best interest analysis, and
• The financial institution and the investment professional should document and explain the assumptions used, and their limitations, for purposes of the best interest analysis regarding the participant’s options.

Keep in mind that the best interest standard is a condition of the exemption, and the burden of proof of compliance with an exemption is on the financial institution and the investment professional. As a result, for risk management purposes, financial institutions should consider developing written materials for the disclosures described in the preamble, and requiring (1) that those written materials be given to the participant (the “retirement investor”) and (2) that the participant acknowledge receipt of those materials.

Based on my discussions with clients, there is tension in this process. On the one hand, their investment professionals have experienced difficulty in obtaining plan information from participants. On the other, the process should not incent investment professionals to avoid making “diligent and prudent” efforts to first obtain plan information. The starting point is not the alternative data; instead, it is the effort to obtain actual plan information. But, recognizing that those efforts may not produce the intended result, the fallback is to use the alternative data approach.

Once the investment professional obtains the required information, the next step is to analyze that information, and other relevant, factors, and to make a recommendation that is in the best interest of the participant. And, while financial institutions and their investment professionals may rely on the DOL/IRS non-enforcement policy (by complying with the Impartial Conduct Standards) until December 21 of this year, thereafter the reasons why the recommendation are in the participant’s best interest must be reduced to writing and that document must be given to the participant. The DOL undoubtedly intends for that requirement to increase the pressure to ensure that the best interest analysis is done thoughtfully and appropriately considers the information that is relevant to that particular participant.

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.