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 (all of whom are referred to as “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.

For example, a rollover recommendation will ordinarily be nondiscretionary fiduciary advice and result in a financial conflict of interest that is a prohibited transaction under both ERISA and the Internal Revenue Code. But, since the recommendation is nondiscretionary, PTE 2020-02 provides relief, but only if all of its conditions are met.

Those conditions are:

• Adherence to the Impartial Conduct Standards.
• Providing the four required disclosures.
• Adopting and implementing the required policies and procedures.
• Conducting an annual retrospective review and recording the findings in a written report.

The first three requirements were effective on February 1 of this year (with the exception of providing retirement investors with written specific reasons why a rollover recommendation is in their best interest. That requirement applies beginning July 1, 2022). The 4^th requirement—the annual retrospective review–begins next year.

Unfortunately, we are already seeing failures that occurred after the February effective date for most of the PTE’s requirements. Clients are asking for help with understanding the consequences and implementing the processes in the PTE to correct and report the failures. This article discussions the PTE’s provisions on dealing with failures to satisfy the conditions of the PTE’s requirements. But, first, here are some of the types of failures that we are seeing:

• Failure to provide retirement investors with the new fiduciary acknowledgement.
• Failure to know that these new rules apply to recommendations to transfer IRAs from other firms to the investment professional’s firm.
• Failure to have policies and procedures to mitigate the conflicts of interest of both the firms and the individuals.
• Failure to disclose that plan-to-IRA rollover recommendations and IRA-to-IRA transfer recommendations are conflicts of interest.

Beyond that, I am concerned that some firms may not realize that, beginning July 1, they need to give retirement investors the specific reasons, in writing, why a plan-to-IRA rollover or IRA-to-IRA transfer is in the best interest of the retirement investor.

With that introduction, here is what the PTE says:

Self-Correction. A non-exempt prohibited transaction will not occur due to a violation of the exemption’s conditions with respect to a transaction, provided:

(1) Either 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;

(2) The Financial Institution corrects the violation and notifies the Department of Labor of the violation and the correction via email to IIAWR@ dol.gov within 30 days of correction;

(3) The correction occurs no later than 90 days after the Financial Institution learned of the violation or reasonably should have learned of the violation; and

(4) The Financial Institution notifies the person(s) responsible for conducting the retrospective review during the applicable review cycle and the violation and correction is specifically set forth in the written report of the retrospective review required under subsection II(d)(2).

Here are comments on each of those points:

• Self-Correction. A non-exempt prohibited transaction will not occur due to a violation of the exemption’s conditions with respect to a transaction, provided:

Comment: In other words, the failure to satisfy the requirements in the PTE will cause the compensation earned by the firm and the investment professional to be a prohibited transaction, resulting in loss of the compensation and penalties. But if the following 4 requirements are satisfied, the failure will not be treated as a prohibited transaction.

• (1) Either 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;

Comment: Unfortunately, neither the PTE nor its preamble adds any detail to the definition of “investment loss” or to the possibility of an ongoing “loss”. For example, the term “investment loss” probably doesn’t refer to normal market fluctuations for well-selected and reasonably priced investments. But it likely does include increased fees and costs, e.g., higher expenses in a rollover IRA than in the retirement plan. But, in that case, the higher expenses continue year-after-year, perhaps for decades. Would the correction include calculating the ongoing effect of the higher expenses? Decisions need to be made in order to correct, but guidance is lacking.

• (2) The Financial Institution corrects the violation and notifies the Department of Labor of the violation and the correction via email to IIAWR@dol.gov within 30 days of correction;

Comment:  Unfortunately, in most cases it appears that the failures (e.g., failure to provide the fiduciary acknowledgement) will be systemic, at least for certain types of recommendations. By “systemic”, I mean that there is a systems failure (or a more global lack of awareness) such that tens, hundreds or even thousands of recommendations will fail to satisfy one or more of the PTE’s conditions, resulting in the need to notify the DOL about a large number of failures, possibly on a continuing basis.

• (3) The correction occurs no later than 90 days after the Financial Institution learned of the violation or reasonably should have learned of the violation; and

Comment: The key to satisfying this condition is close supervision of conflicted recommendations to retirement investors. The best outcome would be if the failures were discovered, through supervision, almost immediately after they occurred. For one thing, that makes the corrections much easier. For another, it would likely be better received by the DOL than a violation that wasn’t discovered until the retrospective review was performed months or even a year later.

• (4) The Financial Institution notifies the person(s) responsible for conducting the retrospective review during the applicable review cycle and the violation and correction is specifically set forth in the written report of the retrospective review required under subsection II(d)(2).

Comment: This is straightforward. In my experience, the financial institution’s Chief Compliance Officer is the one usually charged with the responsibility for performing the annual review. In any event, that designation should be made and the appropriate personnel should be informed of their responsibility to report violations to that person.

Concluding Thoughts

Finding, correcting and reporting failures to comply with the PTE’s conditions is an demanding, but necessary, task.

Because of the unanswered questions about corrections, and the possible lack of awareness of the prescribed procedures, if failures are found, a knowledgeable attorney should be engaged for advice. Until the requirements are clarified, this is a potentially treacherous area.

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.