The U.S. Department of Labor has released its package of proposed changes to the regulation defining fiduciary advice and to the exemptions for conflicts and compensation for investment recommendations to retirement plans, participants (including rollovers), and IRAs (including transfers).

When a person makes a “covered” recommendation to a “retirement investor” and the recommendation, when implemented, results in the person (or his or her firm or an affiliate) receiving additional compensation, a prohibited transaction (under the Code and/or ERISA) will occur.

A “covered” recommendation is one in which the person is a fiduciary (as defined in the proposed fiduciary recommendation) and which falls into one of the three defined categories in the proposed regulation. Those categories include, for example, recommendations about investing in securities or annuities, rollovers, IRA transfers, withdrawals from retirement accounts, and investment strategies, policies and allocations.

The proposed regulation defines a “retirement investor” as a: …plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary or IRA fiduciary (retirement investor). (In a future article, I will discuss the definition of “IRA fiduciary” and “plan fiduciary” as it applies to wholesalers and others who may unknowingly become fiduciaries by making recommendations to an IRA fiduciary or a plan fiduciary.)

One of the conditions in the PTEs is that any compliance failures be corrected and, if need be, the retirement investor be made whole. This article is the first in a series that will discuss the correction requirements in PTEs 2020-02 and 84-24.

The correction provision in PTE 2020-02—where the financial institution is a co-fiduciary—is:

(e) 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).

Note that the financial institution must correct and report the conflicted recommendation (that is, the prohibited transaction) in its capacity as a co-fiduciary. Since the financial institution is a co-fiduciary it shares the fiduciary responsible with the advisor or agent who made the recommendation.

The correction provision in PTE 84-24—where the insurance company is not a co-fiduciary—is:

(e) 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 Independent Producer has refunded any charge to the Retirement Investor or the Insurer has rescinded a mis-sold annuity, cancelling the contract and waiving the surrender charges;

(2) The Independent Producer notifies the Department of Labor of the violation and the refund or rescission via email to PTE_84-24@dol.gov within 30 days of correction;

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

(4) The Independent Producer notifies the person(s) at the Insurer 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 Section VII(d)(2).

Note that the insurance agent–the “independent producer”—must correct the violation and report to the DOL on a timely basis. Since the insurance company is not a co-fiduciary, it does not have joint fiduciary responsibility for the recommendation to the retirement investor.

However, in many, if not most, cases, it will be the insurance company that discovers the failure. In addition, the insurance company may need to be involved in the correction—at least in some cases, for example, if the annuity is rescinded. As a result, and as a practical matter, the discovery and correction of failures  will require communication and coordination by the insurance company and the independent producer.

To further explain, if the insurance company, in fulfilling its heightened oversight responsibilities, identifies a defect (e.g., lack of a best interest process or failure to provide required disclosures) in the process of reviewing the application, the annuity contract or insurance policy would not have been issued and a failure would not have yet occurred. In that case, the insurer would communicate with the insurance agent about the nature of the defect and the agent can likely correct the matter  by going back to the retirement investor and curing the defect.

However, if the defect in the agent’s compliance with the PTE’s conditions was not discovered in the application process and the annuity contract or insurance policy is issued, the failure could later be identified in the annual retrospective review. The insurance company would need to let the agent know so that the correction can be made and the failure and correction can be reported to the DOL.

With regard to the correction, it is possible that the appropriate correction would be to rescind the annuity and restore the premium (together with interest for the intervening period). In that case, the insurance company would need to be an integral part of the correction.

As I pointed out in my last article Fiduciary Rule 18, if the correction and report is not timely done, the transaction will be considered to be “non-exempt”, meaning that the insurance company will be required to file a Form 5330 with the IRS and excise taxes will need to be paid. In addition, if there is a pattern of noncompliance in failing to satisfy the requirements to correct, file and pay, an insurance company can lose its eligibility to use the PTE and, in effect, to issue annuities where the premiums are sourced in qualified money.

The next several articles will go into more detail about the correction issues.

Concluding Thoughts

It is likely that mistakes will be made, notwithstanding the supervisory and oversight efforts of financial institutions. And it is likely that some of those failures will be discovered in the retrospective review process. In that case, the failures should be properly corrected and reported in order to avoid additional problems with excise taxes and possibly eligibility.

There is “tension” built into the system in the sense that a Senior Executive Officer, probably the Chief Compliance Officer, must certify the report about the annual retrospective review.

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.