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 ERISA retirement plans, participants and IRA owners (“retirement investors”). In addition, in the preamble to the PTE the DOL announced 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 PTE 2020-02, the DOL defined “rollover” recommendation as:

…any recommendation to roll over assets from a Plan to another Plan or an IRA…, from an IRA…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)….

The PTE requires that, for all “rollover” recommendations, the Financial Institution must provide the participant or IRA owner with the “specific reasons” why the rollover is in the investor’s best interest. Here’s how that was explained in the preamble:

The Financial Institution also must provide documentation of the specific reasons that any recommendation to roll over assets from one Plan or IRA to another Plan or IRA, or from one type of account to another, is in the Retirement Investor’s best interest

My last post, Best Interest #69, discussed the requirement and the documentation to be considered in order to make a best interest recommendation to transfer an IRA. This article augments that discussion.

In the preamble to PTE 2020-02, the DOL explained:

For rollovers from another IRA…, a prudent recommendation would include consideration and documentation of the services that would be provided under the new arrangement.

As a result, the processes used by broker-dealers and investment advisers to recommend transfers of IRAs from other firms should include a consideration of the services provided by the broker-dealer or investment adviser, as compared to the services that the IRA investor was receiving from the other firm. In some cases, it will be fairly easy to do the comparison, for example, where the individual investment professional has moved from the prior firm-where the IRA was held-to the new firm. In other cases, it will require a discussion with the IRA investor about the services being received from the other firm, and an objective determination of the services that the IRA investor needs (and the broker-dealer or investment adviser can provide).

Since a recommendation of an IRA transfer is considered to be a rollover recommendation, PTE 2020-02 requires that the IRA investor be given a written statement of the “specific reasons” why the IRA transfer is in the investor’s best interest. In light of the language in the preamble, it would be advisable to include services in the analysis and the reasons why the rollover is in the best interest of the IRA investor. For additional considerations for the analysis and reasons, see my last post, Best Interest #69.

The language in the preamble continued as follows:

The Department agrees with commenters that the long-term impact of any increased costs and the reason(s) why the added benefits justify those added costs, as well as the impact of features such as surrender schedules and index annuity cap and participation rates, should be considered as part of any rollover recommendation, as relevant.

This statement is consistent with one of the points in my last article—that costs are a part of any best interest analysis. The issue is not that the lower cost product or service is inherently better, but instead that, if the costs in the recommended course of action are higher, the difference should be justifiable based on the needs, investment objectives, risk tolerance and financial circumstances of the IRA investor (or in the words of the PTE, the “retirement investor”).

By the way, I didn’t make up that standard. Here is the PTE’s definition of best interest:

Advice is in a Retirement Investor’s ‘‘Best Interest’’ if such advice reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, and does not place the financial or other interests of the Investment Professional, Financial Institution or any Affiliate, Related Entity, or other party ahead of the interests of the Retirement Investor, or subordinate the Retirement Investor’s interests to their own.

As a result, it would be, at the least, a good practice to specifically information about the IRA investor’s: (i) investment objectives, (ii) risk tolerance, (iii) financial circumstances, and (iv) needs. Without that information, how can a determination be made about which course of action meets those criteria?

Concluding Thoughts

Recommendations to transfer IRAs may be the most common of the rollover recommendations covered by the PTE. As a result, financial institutions (including broker-dealers and investment advisers) should thoughtfully develop processes that comply with the conditions of the PTE. Well-considered processes will support the requirement to provide the specific reasons to the IRA investor, and will also be part of satisfying the mitigation requirement under the PTE.

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.