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 the recommendation is about the investment of “qualified” or retirement accounts (as that is defined in the proposed regulation). Some of the covered investment recommendations include:  investing in securities, annuities or other property; 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).

One of the conditions in the PTEs is that any compliance failures must be corrected and, if need be, the retirement investor must be made whole. This article is the second in a series that will discuss the correction requirements in the proposed amendments to PTEs 2020-02 and 84-24. This article focuses on the requirement to report failures and corrections to the DOL.

Correction under PTE 2020-02

The correction provision in proposed 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; (The emphasis is mine.)

(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).

Correction under PTE 84-24

The parallel provision in the proposed amendment to PTE 84-24 is similar, but the reporting burden is placed on the “independent producer”—the insurance agent—since under that PTE the insurance company is not a co-fiduciary. That provision reads:

(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;…

If a failure of one of the conditions in PTE 84-24 occurred and was found after-the-fact (probably in the annual retrospective review), it would need to be corrected within 90 days after the independent producer “learned of the violation or reasonably should have learned of the violation.” The report to the DOL would need to be made within 30 days of the correction.

With regard to an insurance agent learning of the violation, one of the requirements imposed on insurance companies in the annual retrospective review is: The Insurer provides to the Independent Producer the methodology and results of the retrospective review. Since the review and report would include any violations, the report would have the effect of informing the agent of any violations found as a part of the annual review.

Reporting Violations and Corrections under both PTEs

Both PTEs are similar in the sense that they require that any identified violations be corrected within 90 days after the financial institution (in the case of PTE 2020-02) or the independent producer (in the case of PTE 84-24) learns or reasonably should have learned of the violations. The violations and their corrections would need to be described writing and disclosed to the DOL within 30 days of the correction.

That raises at least two questions. The first is, what corrections would be acceptable to the DOL, which will be the subject of a future article. The second is, what should the disclosure say to reduce the likelihood of a follow up investigation by the Department. That is the subject of this article.

Neither of the PTEs, nor their preambles, discuss that subject. However, it appears that, at this time, the informal practice of the DOL is that, if the firm (in the case of PTE 2020-020 or the independent producer (in the case of PTE 84-24) have taken the necessary steps to comply with the provisions of the exemption, but through a mistake failed to satisfy one of the conditions, the filing would be accepted without follow up—assuming the correction was acceptable.

On the other hand, if the filing is silent on overall compliance, or the reported violations suggest that the compliance issues go beyond a mistake in an otherwise compliant structure, there is a chance that the DOL could initiate an investigation based on the report. For example, if the “notification” identifies violations of several of the conditions in one of the PTEs, that could be interpreted as a general pattern of noncompliance. If that is the case under PTE 84-24, an investigation could be initiated of both the producer and the insurance company, for example, since if an annuity that was issued by an insurance company in a case where there were several failures, it may suggest that the insurer’s policies and practices are inadequate.

Viewed from this perspective, it makes sense, under PTE 84-24 for insurance companies to work with independent producers to draft the notifications of failures and corrections, so that the compliance efforts of the producers and the insurers are fully explained in the notification.

Similarly, firms that are filing the disclosures under PTE 2020-02 should fully explain their compliance efforts and why, under the circumstances, a mistake occurred, nonetheless.

Fortunately, we have some experience with these filings under similar provisions in the current version of PTE 2020-02.

Concluding Thoughts

While much of the compliance time and effort is now focused on learning the requirements of the proposed rules, once they are in place, issues of corrections and reporting will likely arise. Needless to say, the key is to have compliant procedures and advisor/agent training. If the recommendation and intake processes are well designed and implemented, the number of failures will be greatly reduced. And, if a mistake occurs, the firm and the advisor/agent will be able to plausibly assert that, notwithstanding having compliant practices and policies, a mistake was made.

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.