The New Fiduciary Rule (9): What is An Investment? (Part 1)

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

The proposed regulation redefines fiduciary status for “investment” recommendations. But what is an investment recommendation? The answer: More than you think.

Key Takeaways

  • The Department of Labor’s proposed fiduciary “package” includes new definitions of nondiscretionary fiduciary investment advice.
  • Of course, fiduciary status depends on a recommendation to a retirement investor about “investments”. The proposed regulation has an expansive definition of an investment recommendation.
  • Broker-dealers, investment advisers, and insurance companies, and their representatives, need to understand the range of recommendations that are covered by the fiduciary standards.
  • That is particularly true (i) since one-time recommendations can result in fiduciary status and (ii) where the fiduciary investment recommendation involves a conflict of interest (e.g., a new fee or a commission), the firms and their representatives and agents will need to satisfy the conditions of either PTE 84-24 or PTE 2020-02.

This article begins a discussion of the definitions of “investments” that, if recommended to a retirement investor (that is, a private sector qualified plan, participants in those plans, or IRA owners), will require satisfaction of the fiduciary standards and, in many cases, of the conditions of a prohibited transaction exemption.

As a starting point, here is how the proposed regulation defines “investment recommendation”:

The phrase ‘‘recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property’’ means recommendations:

  • As to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, as to investment strategy, or as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA;
  • As to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., account types such as brokerage versus advisory) or voting of proxies appurtenant to securities; and
  • As to rolling over, transferring, or distributing assets from a plan or IRA, including recommendations as to whether to engage in the transaction, the amount, the form, and the destination of such a rollover, transfer, or distribution.

Let’s break subparagraph (i) down into its component parts (and I will discuss the other two in follow up posts).

The definition starts with “recommendations as the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property.” Read narrowly, that could refer to particular investments. Read broadly, it could apply to recommendations to invest in securities (or other types of properties) more generally without a recommendation of a specific investment. It is likely that the DOL intended the broader definition, but keep in mind that, in order to be a fiduciary recommendation, the fiduciary advisor or agent must receive compensation that directly or indirectly results from or is associated with the recommendation.

The second type covered recommendation in subparagraph (i) is a recommendation “as to investment strategy”. Needless to say, that could also cover a broad range of recommendations. However, when an advisor makes an investment strategy recommendation to a retirement investor and is compensated for it, the advisor will likely know that they have recommended a strategy.

In fact, in the preamble to the proposed regulation the DOL explicitly said that it intends to interpret this provision broadly:

Similar to the SEC and FINRA, the Department intends to interpret ‘‘investment strategy’’ broadly, to include ‘‘among others, recommendations generally to use a bond ladder, day trading . . . or margin strategy involving securities, irrespective of whether the recommendations mention particular securities.’’

The preamble goes on to explain:

The reference to ‘‘other investment property’’ is intended to capture other investments made by plans and IRAs that are not securities. This includes, but would not be limited to, non-securities annuities, banking products, and digital assets (regardless of status as a security). The Department does not see any basis for differentiating advice regarding investments in CDs, including investment strategies involving CDs (e.g., laddered CD portfolios), from other investment products, and therefore would interpret paragraph (f)(10) to cover such recommendations.

The third part of the subparagraph (i)’s definition is a recommendation “as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA.” At first blush, a reader might think that says that a rollover recommendation is fiduciary advice. But it’s not. That is in subparagraph (iii). This is different in a number of regards.

First, it says that a recommendation before money is rolled over about how to invest the money after it is rolled over is, in and of itself, is a fiduciary recommendation.

Here’s what the DOL said in the preamble to the proposed regulation:

This proposed provision addresses an important concern of the Department that investment advice providers should not be able to avoid fiduciary responsibility for a rollover recommendation by focusing solely on the investment of assets after they are rolled over from the plan. In many or most cases, a recommendation to a plan participant or beneficiary regarding the investment of securities or other investment property after a rollover, transfer, or distribution involves an implicit recommendation to the participant or beneficiary to engage in the rollover, transfer, or distribution. Certainly, a prudent and loyal fiduciary generally could not make a recommendation on how to invest assets currently held in a plan after a rollover, without even considering the logical alternative of leaving the assets in the plan or evaluating how that option compares with the retirement investor’s likely investment experience post-rollover. A fiduciary would violate ERISA’s 404 obligations if it recommended that a retirement investor roll the money out of the plan without proper consideration of how the money might be invested after the rollover. [Emphasis added by me.]

Second, it refers to a recommendation to roll over or transfer money between any private sector retirement plan or IRA. As a result, it covers recommendations about how to invest for plan-to-IRA rollovers, plan-to-plan rollovers, IRA-to-plan rollovers, and IRA-to-IRA transfers.

Third, it covers recommendations about how to invest if money is withdrawn (“distributed”) from a plan, participant account, or IRA. For example, if an insurance agent were to recommend that money be withdrawn from an IRA and invested in a life insurance strategy, that would be covered because of the insurance illustration would likely be viewed as an investment recommendation (if it were individualized and if it were reasonable for the retirement investor to believe that the recommendation was in the investor’s best interest).

Concluding Thoughts

The moral of this story is that virtually any recommendation to a retirement investor related to securities, insurance or other property can be fiduciary advice…if it is individualized and can reasonably be seen as best interest advice.

The DOL’s expansive interpretation of covered recommendations includes any asset with investment value, any strategies for investing, and any recommendations about how to invest rollovers, transfers or withdrawals from private sector retirement plans, participant accounts and IRAs.

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.