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.

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 protections afforded by the exemption. The relief provided by the exemption is conditional, that is, the “conditions” in the exemption must be satisfied in order to obtain relief from the prohibited transaction rules in ERISA and the Internal Revenue Code. For the period from February 16 until December 20, a DOL and IRS non-enforcement policy based on the Impartial Conduct Standards will be available.

In April, the DOL issued FAQs that explain its reasons for issuing the guidance. The FAQs also go into detail about the fiduciary definition and the conditions of the exemption. This article discusses FAQs 3 and 4, the temporary non-enforcement policy.

As background, the DOL reversed its prior position on rollovers in the preamble to 2020-02. Before that, the DOL position was that, generally speaking, a recommendation to a participant to rollover his or her plan benefits to an IRA was not fiduciary advice. (The only exception was where the investment professional making the recommendation was already a fiduciary advisor to the plan.)  That “old” guidance was in a 2005 advisory opinion, referred to as the Deseret Letter.

Then, after the Obama-era fiduciary rule and exemptions were vacated by the 5th Circuit Court of Appeals, the DOL issued, with the concurrence of the IRS, an enforcement policy (Field Assistance Bulletin 2008-02) that said that the DOL and IRS would not enforce the prohibited transaction rules for nondiscretionary fiduciary recommendations (which includes, e.g., rollover recommendations). But that relief was conditioned on compliance with the “Impartial Conduct Standards” (ICS). There are 3 ICS standards:  a best interest standard of care, no more than reasonable compensation and no materially misleading statements.

In discussing the new PTE 2020-02, the DOL explained in its FAQs:

Q3. Is the Department withdrawing Field Assistance Bulletin 2018-02 at this time?

No. FAB 2018-02 will remain in place until December 20, 2021. This date is unchanged from the period set forth in PTE 2020-02.

Comment:  In other words, the DOL and IRS will not enforce the prohibited transaction rules against financial institutions and investment professionals for non-discretionary advice to retirement investors, so long as they comply with the Impartial Conduct Standards…but only until December 20, 2021. Then, on December 21, financial institutions and investment professionals will be expected to comply with all of the conditions in the exemption. I am concerned that some financial institutions may be treating the December 21 date as the beginning of their compliance efforts…without understanding that they need to comply with the ICS during the interim. Or they may be thinking that compliance with Reg BI may satisfy the ICS. As explained later in the FAQs, “There is no safe harbor based solely on compliance with other regulators’ standards.”

Q4. Is the Department delaying the application of its interpretation related to rollover recommendations? No.

The preamble to PTE 2020-02 stated that, as a matter of enforcement policy, the Department would not pursue claims for breaches of fiduciary duty or prohibited transactions for the period between 2005 (when the Deseret Letter was issued) and February 16, 2021, or treat parties as violating the prohibited transaction rules, based on rollover recommendations that would have been considered non-fiduciary conduct under the reasoning of the Deseret Letter. The Department will respect this enforcement policy, but is not extending it. Rollover recommendations are a primary concern of the Department because of their extraordinary importance to retirement investors. Having disavowed the Deseret Letter both in its 2016 rulemaking and its 2020 exemption, the Department does not believe additional extensions are warranted or protective of plan participants’ interests in sound advice.

Comment:  The DOL will not retroactively enforce its new interpretation of fiduciary status for rollover recommendations. However, the Department uses “retroactive” to refer to periods prior to February 16, 2021. That means that the new interpretation applies for enforcement purposes beginning on February 16. It also means that most rollover recommendations by securities-based professionals after February 15 will, as a practical matter, be fiduciary recommendations. In that case, the rollover recommendations of investment professionals and financial institutions, beginning February 16, needed to be best interest recommendations, including consideration of the investments, services and expenses in the plan (among other things). While most covered recommendations made to plans, participants and IRA owners during that period (that is, from February 16 to December 20) could reasonably have satisfied a best interest process, the same could not be said of rollover recommendations, since DOL guidance explicitly requires that specified factors be taken into account that either were or weren’t considered. Absent consideration of those factors (for example, the investments, services and costs in the plan), the DOL would contend that the investment professional and financial institution failed to engage in a best interest process. The DOL explained its thinking in the preamble to the PTE:

With respect to recommendations to roll assets out of an Title I Plan and into an IRA, the factors that a Financial Institution and Investment Professional should consider and document include the following: The Retirement Investor’s alternatives to a rollover, including leaving the money in his or her current employer’s Plan, if permitted, and selecting different investment options; the fees and expenses associated with both the Plan and the IRA; whether the employer pays for some or all of the Plan’s administrative expenses; and the different levels of services and investments available under the Plan and the IRA.

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In response to commenters who asked whether these factors cited in the proposal’s preamble are required to be documented in all cases, or whether they are suggested considerations, it is the Department’s view that these factors are relevant to a prudent fiduciary’s analysis of a rollover. It would be difficult to justify a rollover recommendation that did not consider these factors. Of course, the discussion of factors identified above is not intended to suggest that Financial Institutions and Investment Professionals may not consider other factors, including those that are important to a particular Retirement Investor, as part of their rollover recommendation.

In saying that “It would be difficult to justify a rollover recommendation that did not consider these factors,” the DOL is signally that any failure to consider all of those factors would be closely scrutinized.

Concluding Thoughts

The new fiduciary “rule” has two parts with two effective dates. The first part-the expanded definition of fiduciary advice-became effective for enforcement purposes on February 16. In other words, it is effective now for determining if a financial institution and its investment professionals are fiduciaries. There is no enforcement relief or delay for that. The second part-the prohibited transaction exemption-also became on February 16, but a non-enforcement policy delayed most, but not all, of its conditions to December 21. The condition now in effect is satisfaction of the Impartial Conduct Standards.

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.