In 2020, the Department of Labor (DOL) issued its Prohibited Transaction Exemption (PTE) 2020-02 to provide an exemption to most prohibited transactions resulting from nondiscretionary fiduciary advice to retirement plans governed by either ERISA or the Internal Revenue Code, or both, as well as nondiscretionary fiduciary advice to IRAs.
The DOL’s Fiduciary Interpretation and Prohibited Transaction Exemption
In the preamble to the PTE, the DOL expanded its view of the nature of the advice that would result in fiduciary status. One of those expanded interpretations was that, in a rollover context, IRAs and plans should be viewed as having a continuous connection because they are retirement assets on a continuum. More specifically, the DOL said that, if an advisor has been providing investment advice on a regular basis to an IRA and then recommends that the IRA owner make a rollover to the IRA, the plan-to-IRA rollover recommendation would be connected to the advice to the IRA that had been provided on a regular basis and, as a result, the advisor would be a fiduciary for the rollover recommendation. Similarly, if an advisor made a plan-to-IRA rollover recommendation and then provided investment advice to the rollover IRA on a regular basis, the advisor would be a fiduciary for the rollover recommendation because the rollover recommendation and the advice to the rollover IRA would be on a continuum. (For the purposes of this article, “advisor” includes broker-dealers and investment advisers, and their representatives, and insurance agents.)
The consequence of fiduciary status for the rollover recommendation is that the advisor would have engaged in a prohibited transaction because of the compensation resulting from the fiduciary rollover recommendation, that is, the money that will be earned as, e.g., commissions or fees, from the rollover IRA. As a result, the advisor would need the protection of an exemption…and the applicable exemption is PTE 2020-02.
The PTE requires that the advisor engage in a prudent, or best interest, process, which in turn requires that the advisor obtain and evaluate information about the plan and the potential rollover IRA and evaluate that information in the best interest of the participant. The relevant information, at the least, includes the investments, expenses, and services in the plan and the IRA. In addition, the advisor would need to acknowledge the advisor’s fiduciary status in writing and would need to provide the participant, in writing, with the specific reasons why the rollover recommendation was in the best interest of the participant. (The PTE has other conditions, but we don’t need to go into those for the purposes of this article.)
Lawsuits Challenging the Interpretation and PTE
Needless to say, the DOL’s fiduciary interpretation and PTE conditions were opposed by some in the financial services industry. As a result, two lawsuits were filed in Federal Courts—one in Florida and one in Texas. The Florida court has reached its conclusion; the Texas lawsuit is still pending.
In essence, the Florida court handed down two decisions..
The first is that the rollover recommendation and the previous or subsequent investment advice to an IRA cannot be connected. In other words, the “regular basis” requirement in the current regulation that defines fiduciary status for nondiscretionary advice to a plan (that is, the rollover recommendation) cannot be satisfied by connecting it to the investment advice given to an IRA. As a result, and absent other factors, a rollover recommendation standing alone, will not result in an advisor being a fiduciary for the rollover recommendation.
The Court’s second conclusion was that the conditions in PTE 2020-02 were within the authority of the DOL to establish exemptions from prohibited transactions. As a result, where a prohibited transaction occurs from nondiscretionary fiduciary advice to a plan or an IRA, the PTE will be available for protection, but only if its conditions are satisfied.
The DOL initially indicated that it would appeal the decision. However, the appeal has since been voluntarily withdrawn.
So, where does that leave us?
The Current Status of Fiduciary Status and Compliance
The DOL’s decision to not appeal the Court’s opinion likely indicates that the DOL will be issuing a new proposed regulation on the definition of fiduciary advice, probably before the end of summer. And, in my view at least, that proposal will, one way or another, say that a rollover recommendation is a fiduciary recommendation.
But we will need to wait and see if there is a proposal and, if so, what it says. What should be done for now?
The withdrawal of the appeal suggests that the DOL has conceded that its fiduciary interpretation about fiduciary status resulting from the connection of plans and IRAs will likely not withstand scrutiny from the courts. As a result, some advisors may decide to make rollover recommendations without complying with the conditions in the PTE.
However, the considerations are complex. First, the SEC staff has issued bulletins for broker-dealers and investment advisers that explain that the best interest standard applies to rollover recommendations and that seemingly require the same kind of comparative analysis of plan and IRA investments, expenses, and services.
Second, while it seems that the DOL has backed away from its rollover interpretation, that is based on its decision to not appeal the Florida Court’s decision. The DOL has not said that it will no longer enforce its interpretation.
Third, keep in mind that the DOL has historically said that, if an advisor is a fiduciary to a plan, and then recommends that a participant rollover to an IRA with the advisor, the advisor will be a fiduciary for purposes of the rollover recommendation. (Keep in mind that this refers to both the individual advisor and the firm.) In other words, the DOL’s position has been that the advisor’s fiduciary status with the plan extends to rollover recommendations. While the written guidance to that effect was withdrawn as a part of the reinterpretation in the PTE’s preamble, it could still be the DOL’s position.
As a result, the conservative answer is to continue to comply with the PTE’s conditions for rollover recommendations until we have further clarity.
Beyond that, the Florida court’s opinion is limited. It only applies to rollover recommendations. As a result, the DOL’s interpretation of the fiduciary rule continues to apply to investment advice to IRAs. If an advisor provides regular basis (that in, ongoing) advice to an IRA (and the other 4 prongs of the 5-part definition are satisfied—as they likely would be), and the advice is conflicted (e.g., transaction-based compensation, such as commissions, front end loads, revenue sharing), then the protection of the PTE would be needed. Similarly, if ongoing investment advice is provided to a qualified and/or ERISA governed retirement plan, and the advice is conflicted, the PTE would be needed.
A more difficult issue is whether the PTE would be needed for recommendations to a retirement investor that the investor transfer an IRA from another firm to the advisor’s firm. The Florida court decision did not address that issue. It could be argued that the recommendation to transfer the IRA should not be connected to investment advice to the IRA at the new firm. But that is not squarely within the ruling by the Florida court and therefor such a recommendation without satisfying the conditions of the PTE is the legal equivalent of walking on thin ice. The conservative (and perhaps moderate) position is to continue to treat those recommendations as fiduciary advice and to comply with the conditions in the PTE.
Annual Retrospective Review and Report
Most firms are now working on their annual retrospective reviews and reports which, for calendar year 2022 must be completed and signed by June 30. In my experience, most firms are completing those reports as if the DOL’s rollover interpretation were still valid. One exception is where minor violations are the PTE’s conditions are found, for example, a failure to give one of the required acknowledgements or explanations, where the recommendation otherwise satisfies the process and best interest requirements. The issue is whether to report the failure to the DOL as required by the PTE. In at least some cases, where the failure related to a rollover recommendation has been corrected, there is, at the least, an argument that the Florida decision supports a determination that the rollover recommendation was not a fiduciary act and therefor the PTE’s protections were not needed.
All things considered, the conservative, or “safe,” position is to continue to operate as if the DOL’s fiduciary interpretation for rollovers was valid, for both 2022 and 2023. By the end of this year, there should be clarity about the significance of the DOL’s withdrawal of the appeal and we will know if the DOL is issuing a new proposal (and, if so, what it says).
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