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.

Discussion

The DOL’s fiduciary interpretation applies to advice to IRAs, when the recommended transactions result in prohibited transactions under the Internal Revenue Code. A prohibited transaction is essentially a financial conflict of interest.) For example, a recommendation of an individual retirement annuity would generate a commission for the insurance agent. A recommendation of a mutual fund might cause a broker-dealer to be paid a front end load and trailing 12b-1 fees. Those are prohibited transactions when the “investment professional” satisfies the 5-part test for fiduciary status. As explained in earlier posts, the DOL’s new interpretation of 5-part test will cause many investment professionals and their firms to be fiduciaries for their advice to retirement accounts, including IRAs.

But, that begs the question, “What is an IRA?” The answer is that an IRA is more than you might expect.

At first blush, “IRA” refers to individual retirement accounts and individual retirement annuities. In the eyes of the DOL, it is more than that, at least for purposes of the new guidance in PTE 2020-02.

In the definition section of the PTE, it says that: ‘‘Individual Retirement Account’’ or ‘‘IRA’’ means any plan that is an account or annuity described in Code section 4975(e)(1)(B) through (F).

Then, Code section 4975(e)(1) says:

(e)   DEFINITIONS

(1)    ….

(A)    ….

(B)    an individual retirement account described in section 408(a),

(C)    an individual retirement annuity described in section 408(b),

(D)    an Archer MSA described in section 220(d),

(E)    a health savings account described in section 223(d),

(F)    a Coverdell education savings account described in section 530,…

As a result, a recommendation to transfer an individual retirement account, individual retirement annuity, an Archer medical savings account, a HSA-health savings account, or a Coverdell education savings account from another firm can be a fiduciary recommendation that invokes the requirements of PTE 2020-02 (including the “specific reasons” disclosure), as well as the best interest standard.

In that regard, the best interest standard requires an analysis of the needs and circumstances of the retirement investor (e.g., the IRA owner); the fees, costs and services of the existing provider; and the fees, costs and services contemplated if the account is transferred….all in the best interest of the retirement investor. Unfortunately, the DOL doesn’t provide guidance on the process to be followed to make a best interest recommendation, it is likely that the steps would be along the lines of:

• Consider the needs and circumstances of the “retirement investor”;
• Obtain and evaluate an account statement from the current firm;
• Consider the services, investments and costs for a similar account at the investment professional’s firm;
• Evaluate the investments, costs and services at both firms in light of the needs of the retirement investor; and
• Provide the retirement investor, in writing, with the specific reasons why the “rollover” recommendation is in the investor’s best interest.

Note that the last step—the disclosure of the specific reasons in writing—was extended by the DOL’s non-enforcement policy until July 1, 2022. It is likely that the first 4 steps are required now, since the non-enforcement policy requires that, to obtain its benefit, a financial institution and an investment professional must be making a good faith effort to comply with the Impartial Conduct Standards, which include a best interest standard of care. That best interest standard is a combination of ERISA’s prudent man rule and duty of loyalty. As a result, compliance based on the Reg BI or RIA Interpretation best interest standards may not necessarily satisfy the DOL’s standard.

Concluding Thoughts

Unfortunately, the DOL uses IRA to mean different types of accounts that would not ordinarily be considered to be IRAs. In this case, forewarned is fore armed, in the sense that, once financial institutions are aware of this, their 2020-02 compliance efforts can be extended to cover this broader range of covered recommendations.

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.