Best Interest Standard of Care for Advisors #82: Compliance with PTE 2020-02: Correction of Violations of PTE 2020-02

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 20, the DOL discussed whether violations of PTE 2020-02 may be corrected and, if so, how they should be corrected.
  • It should come as no surprise, but yes, they can be corrected and, in fact, must be corrected. If a violation is not corrected, it is a violation of the prohibited transaction rules in ERISA and/or the Internal Revenue Code, subject to penalties and interest and, even then, must still be corrected.
  • In effect, by correcting (e.g., by restoring any losses to the retirement account), the protections of PTE 2020-02 will be preserved and the corrected transaction will not be considered to be a prohibited transaction.

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 20, the DOL asks and answers whether violations of the PTE can be corrected and, if so, how.

Q20. Is there any way for financial institutions to correct violations of the exemption?

Yes, PTE 2020-02 contains a correction procedure for financial institutions to correct certain violations. Financial institutions can correct violations of the exemption within 90 days after the financial institution learns, or reasonably should have learned, of the violation. If the violation did not result in investment losses to the retirement investor or the financial institution made the retirement investor whole for any resulting losses, the financial institution can correct the violation and notify the Department within 30 days of correction. The financial institution must notify the persons responsible for conducting the retrospective review described in Q19 of the violation and correction, and the violation and correction must be specifically set forth in the written report of the retrospective review.

Comments:

The Department of Labor expects correction, that is, if a conflicted recommendation was made, and one or more of the conditions of the PTE were not satisfied, and the “retirement account” had “resulting losses”, those losses must be restored in order for the violation to be corrected. That may sound straightforward on paper, but I expect it will be more difficult to apply in many cases. For example, if a plan-to-IRA rollover recommendation is made and implemented, but there wasn’t a disclosure that the recommendation was a conflict of interest, what is the “loss” if the plan’s expenses were 50 basis points but the IRA’s expenses are 150 basis points (potentially for the next 20 or 30 years)? This is an issue for further development, but for the moment (and as self-serving as it sounds) I recommend that an ERISA attorney be involved in any correction discussions.

Next, the DOL says that the violation and correction must be specifically described in the report that documents the annual retrospective review. The DOL has the right to obtain that report and I suspect that, at least initially, the DOL will be doing survey investigations to determine the level of compliance with the PTE. In addition, it wouldn’t surprise me if the SEC were to ask for the report as well. Other than the requirement to provide the retirement investor with the written “specific reasons” why a rollover recommendation is in the investor’s best interest, the SEC roll over requirements in Reg BI are remarkably similar to the DOL’s. (While the SEC’s Interpretation for Investment Advisers didn’t go into the specifics the way that Reg BI did, I can’t imagine the SEC having lower expectations for investment advisers when they recommend rollovers.)

As an aside, the requirement to provide the specific best interest reasons in writing won’t be enforced until recommendations beginning July 1.

I have a number of concerns about this. Here are two. First, I am concerned that not all broker-dealers and investment advisers had their compliance efforts fully implemented by February 1. If that’s the case, then any conflicted recommendations to retirement accounts, including rollover recommendations, are likely to be violations that need to be corrected and documented in the report for the annual retrospective review in the first part of next year. Second, I am worried that some broker-dealers and investment advisers may not know that they are subject to these new rules or how demanding they are. While that may seem hard to imagine, the SEC’s experience with Form CRS compliance suggests that may be the case.

Concluding Thoughts

I believe that these new changes—the fiduciary “re-interpretation” and the PTE 2020-02 conditions are more demanding that many people believe. The correction requirements in this article are examples of that. A failure to satisfy with even one of the many conditions in the PTE will mean that the violation will need to be corrected and reported in the report for the annual review and, if there were resulting “losses”, those losses must be restored to the retirement account. Keep in mind that, for DOL purposes, a loss isn’t just a reduction in value of an investment. It can also be, for example, additional expenses.

Even if a broker-dealer or investment adviser has implemented PTE 2020-02 disclosures and practices, it would be a good idea to review those efforts now that they have been rolled out. Don’t let too much time go by since we are now in the period that will be covered by the annual retrospective review.

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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