Best Interest Standard of Care for Advisors #83: Compliance with PTE 2020-02: Enforcement of the Exemption

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 21, the DOL discussed how it would enforce compliance with the exemption.
  • As a starting point, the DOL has the authority to interpret and enforce the requirements of the PTE as they apply to retirement plans, including recommendations to participants to take their benefits out of a retirement plan and roll to an IRA.
  • In addition, under ERISA there are private rights of actions for breaches of fiduciary duties to plans and participants, including recommendations to rollover.
  • In addition, while the DOL does not have investigative or enforcement authority for violations of the conditions of the exemption for non-ERISA vehicles, such as IRAs, if it finds those violations it will refer them to the IRS.

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 21, the DOL asks and answers how it will enforce compliance with the exemption.

Q21. How will the Department enforce compliance with the exemption?

The Department has investigative and interpretive authority with respect to exemption compliance. For plans covered by ERISA Title I, the Department will investigate for compliance with the exemption and enforce the Title I protections. In addition, participants, beneficiaries, and fiduciaries of these plans have a statutory cause of action under Section 502 of ERISA for fiduciary breaches and prohibited transactions. For IRAs and other non-Title I plans, the Department has interpretive authority to determine whether the exemption conditions have been satisfied and transmits information to the IRS for enforcement of the excise tax. In marked contrast to the 2016 rulemaking, the new exemption does not impose contract or warranty requirements on the financial institutions or investment professionals responsible for compliance. The exemption also does not expand retirement investors’ ability to enforce their rights in court or create any new legal claims beyond those in Title I of ERISA and the Code.

The exemption also includes several provisions intended to support and incentivize compliance. In addition to the annual retrospective review and self-correction discussed in previous FAQs, the exemption also encourages compliance by setting forth circumstances under which financial institutions and investment professionals can become ineligible to rely on the exemption for a period of 10 years. Parties can become ineligible following conviction for specified crimes, or if they have engaged in systematic or intentional violation of the exemption’s conditions or provided materially misleading information to the Department in relation to their conduct under the exemption.

Discussion

The Answer start by pointing out that the DOL has the right to investigate and enforce fiduciary breaches and failures to satisfy the conditions of prohibited transaction exemptions for ERISA-governed plans. DOL investigations are often based on reviews of Forms 5500. The first 5500s for 2022 (when the PTE is first enforceable by the DOL) will be due on July 1, 2023. The investigations usually begin about a year after the Forms are filed. So the first 5500-based investigations will likely be in the summer of 2024.

However, investigations can be initiated for other reasons, as well. For example, a participant or fiduciary complaint filed with the DOL can cause an investigation.

There is at least a chance that the DOL will do “survey” investigations of the reports on the initial retrospective annual reviews. The deadline for the 2022 reviews and reports is June 30, 2023. So it’s possible that the DOL will be requesting those reports from select “financial institutions” in the second half of 2023.

Since ERISA provides private rights of action for plans, participants and the DOL, compliance failures can be also enforced by lawsuits, which should be of concern to broker-dealers, investment advisers, and other financial institutions.

The Answer goes on to explain that the DOL does not have enforcement jurisdiction over IRAs and non-ERISA plans (e.g., solo 401(k)s), but if it finds violations, it will refer those violations to the IRS, which does have enforcement jurisdiction over IRAs and non-ERISA plans. An obvious question is, how would the DOL find violations if it doesn’t investigate financial institutions for IRA conflicts and practices? Most likely, it would be through obtaining copies of the annual retrospective review reports.

There is also some concern that the SEC and FINRA will review their supervised entities for compliance with the policies and procedures that are required by PTE 2020-02.

The Answer concludes by discussing the “nuclear option”. That is that the DOL can revoke access to the PTE if it finds egregious violations of the PTE. If the availability of the PTE’s relief is taken away, the financial institution and its investment professionals could not recommend plan-to-IRA rollovers, IRA-to-IRA transfers, and a host of other conflicted transactions for retirement accounts for a period of 10 years. That might be enough to put a firm out of business, or to cause a loss of key professionals.

Concluding Thoughts

By its very nature, regulatory enforcement tends to begin a few years after a rule is effective. While that may seem to be far in the future, firms shouldn’t take any comfort in the delay. The consequences of failure could be significant. For example, the DOL’s view on correction of a violation is to restore money, plus interest, to the retirement account. If the compliance deficiency is systemic (that is, if it is a failure that cuts across many recommendations, for example, a disclosure failure), the resulting violations could be extensive and the needed corrections could be expensive.

Now that the DOL’s non-enforcement policy has ended, it would be a good idea to re-examine the conditions of the exemption and review the policies and practices put in place to comply. In my experience, in a rush to meet a deadline, good faith “solutions” can be put in place with the knowledge that they need to be improved at a later date. Unfortunately, the good faith period expired on February 1 and literal compliance is now expected.

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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