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 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.

Fiduciary Issues and Answers:

This article discusses FAQ 5, which addresses the question of whether there will be further guidance on the definition of fiduciary and whether there will be changes to the exemptions, or exceptions, to the prohibited transaction rules. The FAQ starts with the question:

Q5. Will the Department take more actions relating to the regulation of fiduciary investment advice?

The Department is reviewing issues of fact, law, and policy related to PTE 2020-02, and more generally, its regulation of fiduciary investment advice. The Department anticipates taking further regulatory and sub-regulatory actions, as appropriate, including amending the investment advice fiduciary regulation, amending PTE 2020-02, and amending or revoking some of the other existing class exemptions available to investment advice fiduciaries. Regulatory actions will be preceded by notice and an opportunity for public comment. Additionally, although future actions are under consideration to improve the exemption, the Department believes that core components of PTE 2020-02, including the Impartial Conduct Standards and the requirement for strong policies and procedures, are fundamental investor protections which should not be delayed while the Department considers additional protections or clarifications. [The bolding is mine.]

Comment:  There are at least three items of note in that statement. But, first, the answer is, yes, there will be future developments on the fiduciary definition and the exemptions from the prohibited transaction rules. The items of note are:

1. The anticipated amendment of the investment advice fiduciary regulation will almost certainly expand who is considered a fiduciary. Most likely the proposal will eliminate the “regular basis” requirement from the fiduciary “test”, so that one-time recommendations will be treated as fiduciary recommendations. Also, there could be provisions that would expand the reach of either the DOL or private investors to advice to, and conflicts regarding, IRAs.
2. There will be changes to the prohibited transaction exemptions. For example, it is likely that PTE 84-24 will be amended. One possibility would be to take the Obama-era approach and limit 84-24 to sales of fixed rate annuities, meaning that variable and fixed indexed annuity sales would need to use PTE 2020-02 (assuming that the insurance agent is a fiduciary…but see (1) above). Another more extreme idea floating around is that 84-24 would be revoked in its entirety, meaning that, where the agents are making fiduciary recommendations of annuities of any kind, the sale would need to comply with the conditions in 2020-02. But these are just rumors “on the street”. It’s not clear where 84-24 will end up, but it’s not likely to end up where it is now.
3. All exemptions for nondiscretionary fiduciary investment and insurance recommendations will include the Impartial Conduct Standards, that is, the best interest standard of care (prudence and loyalty); no more than reasonable compensation; and no materially misleading statements.

If that’s the goal, what is the plan?

The “plan” is in the DOL’s Agency Rule List for Spring 2021. The EBSA is working on a new fiduciary project and the proposals are expected to be issued in December. See View Rule (reginfo.gov)

Here is the abstract for the regulatory project:

This rulemaking would amend the regulatory definition of the term fiduciary set forth at 29 CFR 2510.3-21(c) to more appropriately define when persons who render investment advice for a fee to employee benefit plans and IRAs are fiduciaries within the meaning of section 3(21) of ERISA and section 4975(e)(3) of the Internal Revenue Code. The amendment would take into account practices of investment advisers, and the expectations of plan officials and participants, and IRA owners who receive investment advice, as well as developments in the investment marketplace, including in the ways advisers are compensated that can subject advisers to harmful conflicts of interest. In conjunction with this rulemaking, EBSA also will evaluate available prohibited transaction class exemptions and consider proposing amendments or new exemptions to ensure consistent protection of employee benefit plan and IRA investors. [The bolding is mine.]

Comment: This speaks for itself. But the practical implications are less obvious. First, a new regulation and modified exemptions will not spring forth full born. It will probably take over a year for these changes to be final and effective. We could be looking at an effective date as late as January 1, 2023. But, it has implications for today. For example, some of the “solutions” being developed for sales of annuities (for example, in connection with rollover recommendations) will be temporary, in the sense that, while 84-24 is fairly easy to comply with now, it will probably be changed to be more demanding. At the least, the Impartial Conduct Standards will be added to clarify that a best interest process must be used for the rollover recommendation and the IRA (or individual retirement annuity) investment recommendation. And it’s possible, or perhaps even probable, that the fiduciary definition will be expanded to a single recommendation of a rollover (without the need for “regular basis” advice). Of course, this is conjecture on my part, but why have a new fiduciary regulation and modified exemptions if rollovers aren’t going to be “captured” by the definition? (The expanded definition in PTE 2020-02 already covers most rollover recommendations by securities-based advisors and some rollover recommendations by insurance agents.)

If I am correct, some of the current efforts to comply with 84-24 (or to avoid fiduciary status) will need to be materially changed because of this regulatory initiative by the DOL. But, for the moment, the possible changes are just one of the factors to be considered in formulating plans for dealing with the compliance issues created by PTE 2020-02 and the DOL’s expanded definition of fiduciary advice.

Concluding Thoughts:

It’s hard to make definitive decisions about the future when the future may change. The focus for the moment should be on compliance with the issues created by the expanded fiduciary definition and the conditions in PTE 2020-02. However, where possible, those solutions should contemplate the likelihood of significant changes in the next year or two. PTE 84-24 may not be the panacea that it appears to be. As a result, where entities, such as insurance company-owned broker-dealers, will be complying with 2020-02 for sales of securities products (including, eg., variable annuities), they may want to consider including covered sales of fixed rate and fixed indexed annuities in their 2020-02 efforts. On the other hand, at least for the moment, PTE 84-24 may be the preferred course of action for sales through independent agents.

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.