Best Interest Standard of Care for Advisors #81: Compliance with PTE 2020-02: Annual Retrospective Review

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.

Key Takeaways

The DOL has issued FAQs that generally explain PTE 2020-02 and the expanded definition of fiduciary advice.

  • In FAQ 19 the DOL discusses the requirement that “financial institutions” (that is, broker-dealers, investment advisers, insurance companies, and banks and trust companies) that intend to comply with PTE 2020-02 must perform a retrospective review each year.
  • The review must be reduced to a written report and signed by a senior executive officer of the firm.
  • The report is available to the DOL on request.
  • The failure to satisfy that requirement results in the loss of the exemption. That would mean that the conflicted recommendations were prohibited transactions, resulting in penalties and costs. For example, the exemption would be lost for recommendations to participants to roll over their plan benefits to an IRA with the financial institution or recommendations to IRA owners to transfer their IRAs to the financial institution.

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 (including rollover recommendations), 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 are fiduciaries for their recommendations to retirement investors and, therefore, will need the protection provided by the exemption.

The DOL has issued FAQs providing additional guidance about the requirements in PTE 2020-02. In Question 19, the DOL discusses the requirement that financial institutions perform annual retrospective reviews of their covered recommendations:

Q19. What is the exemption’s annual retrospective review requirement, and what is its purpose?

Financial institutions must conduct an annual retrospective review that is reasonably designed to assist them in detecting and preventing violations of, and achieving compliance with, the Impartial Conduct Standards and their policies and procedures. The methodology and results of the retrospective review must be reduced to a written report that is provided to one of the financial institution’s senior executive officers, who must then make certain certifications related to their review of the report. The financial institution must retain the report, certification, and supporting data for six years and provide these documents to the Department within 10 business days of a request.

The Department expects financial institutions to use the results of the review to find more effective ways to help ensure that investment professionals are providing investment advice in accordance with the Impartial Conduct Standards and to correct any deficiencies in existing policies and procedures. Senior executive officers should carefully review the report before making the required certifications, so that they can make the certifications with confidence. Making the certifications without carefully reviewing the report would constitute a violation of the exemption. This ensures that the financial institution, through an appropriate senior executive officer, is fully accountable for the retrospective review. The requirement that financial institutions make their report of their retrospective review available to the Department within 10 business days upon request ensures that the Department retains an appropriate level of oversight over exemption compliance.

Comments:  In the preamble to PTE 2020-02, the DOL explained:  The retrospective review is based on FINRA rules governing how brokerdealers supervise associated persons,131 adapted to focus on the conditions of the exemption. The Department is aware that other Financial Institutions are subject to regulatory requirements to review their policies and procedures;132

Those footnote references are to:

131  See FINRA rules 3110, 3120, and 3130.

132   See, e.g., Rule 206(4)–7(b) under the Investment Advisers Act of 1940.

As a result, the requirements for the review should be familiar to broker-dealers and investment advisers.

The preamble goes on to explain:

Financial Institutions can use the results of the review to find more effective ways to ensure that Investment Professionals are providing investment advice in accordance with the Impartial Conduct Standards and to correct any deficiencies in existing policies and procedures. Requiring a Senior Executive Officer to certify review of the report is a means of creating accountability for the review. This would serve the purpose of ensuring that more than one person determines whether the Financial Institution is complying with the conditions of the exemption and avoiding non-exempt prohibited transactions. If the officer does not have the experience or expertise to determine whether to make the certification, he or she would be expected to consult with a knowledgeable compliance professional to be able to do so.

Concluding Thoughts

While the retrospective review for 2022 covered recommendations is almost a year away, broker-dealers and investment advisers need to have a process in place to identify all covered transactions. In addition, they should, as a risk mitigation practice, be closely supervising covered transactions at this time in order to quickly identify and correct any compliance failures. Since the DOL will likely do survey investigations of the reports, and since we are already in the period covered by the 2022 review, it is important to eliminate as many problems as quickly in order to have a clean review and report.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.

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