The Department of Labor’s (the “DOL”) attempts to regulate the conduct of fiduciaries under ERISA and the Code has been mired in controversy. In 2010, the Obama administration’s DOL proposed a fiduciary regulation that was met with so much criticism that it was subsequently withdrawn in 2011. In 2015, the DOL re-proposed a fiduciary regulation that imposed a fiduciary standard on financial advisors giving clients advice about their retirement plan investments. The DOL issued final regulations and the final rule was being implemented when it was struck down by a federal appeals court in June 2018.
In June 2020, the DOL proposed a new fiduciary rule which significantly revises the Obama administration fiduciary rule. With a new administration set to take office in 2021, it is difficult to predict what, if anything, will become of the latest version of the fiduciary rule.
Until further guidance is issued, the reinstatement of the “five-part test,” which was part of the 2020 DOL proposal, is effective. The 2020 DOL proposal, entitled “Improving Investment Advice for Workers and Retirees,” formally revives the five-part test from 1975 and proposes a new class exemption from certain prohibited transactions under ERISA and the Internal Revenue Code (the “Code”).
Reinstatement of the Five-Part Test
The proposal formally revives the five-part test for determining if a financial institution or investment professional is a fiduciary rendering “investment advice,” which many practitioners presumed to be the rule since 2018.
Under ERISA and the Code, a fiduciary is someone who, with respect to a retirement plan or an IRA:
- exercises discretionary authority or control with respect to the management of the plan or IRA or with respect to the management or disposition of its assets;
- renders “investment advice” for a fee or other compensation, direct or indirect; or
- has any discretionary authority or responsibility in the administration of the plan or IRA.
The five-part test applies only to the provision of investment advice for a fee, the second prong described above. Under the five-part test, a person is considered to be providing investment advice only if the person:
- Renders advice as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property;
- On a regular basis;
- Pursuant to a mutual agreement, arrangement, or understanding with the employee benefit plan, plan fiduciary, or IRA owner;
- The advice will serve as a primary basis for investment decisions with respect to the employee benefit plan or IRA assets; and
- The advice will be individualized based on the particular needs of the employee benefit plan or IRA.
In determining whether someone is an investment advice fiduciary, the DOL has indicated that it will consider all of the facts and circumstances.
Proposed Class Exemption for Investment Advice Fiduciaries
In addition to reinstating the five-part test, the DOL also proposed an exemption that allows investment advice fiduciaries under both ERISA and the Code to receive compensation, including as a result of advice to roll over assets from a plan to an IRA. The proposed exemption also provides relief for certain principal transactions in which a financial institution sells or purchases securities and investments from its own inventory to or from plans and IRAs.
In order to comply with this exemption, the investment advice is required to be provided in accordance with the “impartial conduct standards,” which includes (1) a best interest standard, (2) a reasonable compensation standard, and (3) a requirement not to make materially misleading statements. The DOL states that whether this standard is met will be based on a reasonable analysis of facts. In addition to the impartial conduct standards, an investment advice fiduciary also must comply with the three requirements set forth below.
Prior to engaging in a transaction pursuant to this exemption, a financial institution must disclose its status as an investment advice fiduciary under ERISA and the Code and provide an accurate written description of its services and material conflicts of interest.
Written Policies and Procedures
The financial institution must establish, maintain and enforce written policies and procedures prudently designed to ensure that the financial institution and its investment professionals comply with the impartial conduct standards in connection with covered fiduciary advice and transactions. These policies and procedures should be designed to mitigate conflicts of interests, meaning that the policies and procedures and the financial institution’s incentive practices, taken together, should be designed to avoid the misalignment of the interests of the financial institution and investment professional with the interests of the retirement plan investor.
A financial institution must conduct a retrospective review, at least annually, that is reasonably designed to assist the financial institution in detecting and preventing violations of the impartial conduct standards and the policies and procedures governing compliance with the exemption.
At this juncture, it is difficult to determine whether a new administration will attempt to revive the Obama era fiduciary rule, which seems unlikely without Congressional action. In the meantime, the new proposal continues to be a reinstatement of the old standards. Only time will tell what the future holds for this controversial rule.