Best Interest Standard of Care for Advisors #84: Compliance with PTE 2020-02: Special Issues: Monitoring

Key Takeaways

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

    • The DOL’s expanded definition of fiduciary advice was described in the preamble to PTE 2020-02.
    • The PTE then provides conditional relief for conflicted non-discretionary recommendations, if its conditions are satisfied.
    • This article discusses whether the DOL’s position is that the fiduciary definition and the best interest standard in the PTE require “monitoring” of recommended investments. The answer is, possibly, in some cases.


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.

In the preamble to the PTE, the DOL described its expanded definition of fiduciary advice. The fiduciary regulations in ERISA and the Internal Revenue Code have two definitions of fiduciary advice. The first is the obvious—where the investment professional and financial institution have discretion over retirement accounts (ERISA or tax qualified plans, participant accounts in those plans, and IRAs). In effect, that is a one-part test—“discretion”. In addition, there is a 5-part test for non-discretionary fiduciary advice. The DOL did not amend the regulation to modify any of the “parts,” but instead reinterpreted some of the regulatory provisions, and particularly the “regular basis” part, to significantly increase the number of investment professionals and financial institutions who are fiduciaries. This article is not about the expanded definition, but instead about a circumstance in which a fiduciary could have more responsibility than anticipated.

In the preamble, the DOL discussed whether there is a duty to monitor investments that are made because of fiduciary recommendations to retirement investors. Here’s what it said:

As was stated in the proposal, the Department confirms that nothing in the final exemption requires Financial Institutions or Investment Professionals to provide ongoing monitoring services. Of course, the exemption’s general prohibition against misleading statements applies, and Financial Institutions and Investment Professionals should be clear and candid with Retirement Investors about the existence, scope, and duration of any monitoring services

However, as part of making a best interest recommendation, the Department expects that Financial Institutions and Investment Professionals will consider whether the investment can be prudently recommended without some mechanism or plan for ongoing monitoring. To the extent that prudence requires ongoing monitoring, the final exemption does not require that such monitoring be done by the Financial Institution or Investment Professional; such monitoring could be performed by a third party, but the advice fiduciary should clearly explain the need for monitoring to the investor when making the recommendation.

In response to requests for guidance identifying specific products that will require monitoring, or what constitutes a product of unusual complexity and risk, the Department notes that Financial Institutions and Investment Professionals will need to make these decisions on a case-by-case basis. The Department expects that Financial Institutions and Investment Professionals have the expertise necessary to evaluate the need for monitoring based on all the facts and circumstances.

So, from the DOL’s perspective, monitoring is not generally required. But, if a complex or risky investment is recommended to a retirement investor, and the retirement investor lacks the ability to monitor the investment without help, “the advice fiduciary should clearly explain the need for monitoring to the investor when making the recommendation.”

However, the investment professional and financial institution do not need to provide those monitoring services. Practically, that doesn’t seem realistic, because it assumes that an investment professional will put a retirement investor into an investment that the investor lacks the ability to monitor and, in connection with the recommendation, the investment professional will tell the retirement investor to find someone else to do the monitoring. But, if an investment professional doesn’t want to be in that position, the investment professional shouldn’t recommend complex or risky investments to retirement investors who lack the skill to monitor the investment. That appears to be the only alternative.

Fortunately, this requirement only seems to apply to products of unusual complexity and risk. But, unfortunately, the DOL didn’t define those terms or provide examples. It may be, though, that in most cases, the investments will clearly not be of unusual complexity and risk, e.g., mutual funds, or will clearly will be risky or of unusual complexity. In my view, most highly complex or risky investments would likely be investments that are not liquid, not transparent, and volatile. However, the DOL has recently issued guidance suggesting that crypto currencies could fall in that category. I suspect, though, that we will only learn which investments fall in the latter category after large losses are sustained and claims are filed.

Concluding Thoughts

The legal lesson of this story is “forewarned is forearmed”. Where retirement money is invested in products of unusual complexity and risk—and large losses occur, there is a potential for litigation even without the language in the DOL’s preamble to PTE 2020-02. Beyond the general risk, though, these new rules, right or wrong, are designed to protect the financial security of retirement accounts, including IRAs. As a result, investment professionals and financial institutions should consider whether some investment recommendations could require monitoring and whether those recommendations should be made (and, if so, how they will be monitored).

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