Department Of Labor: Prohibited Transactions Exemption For Fiduciary Advice

In 1974, the Employee Retirement Income Security Act (ERISA) was enacted to address public concern over private pension funds being mismanaged or abused, with the goal of protecting the interests of participants and their beneficiaries in employee benefit plans. Strict guidelines were enacted regarding information availability, standards of conduct, disclosures, protections and favored tax treatment.

 In 2016, the Department of Labor (DOL) proposed a Fiduciary Rule. That rule amended the regulatory definition of a fiduciary of an employee benefit plan to replace the restrictive five-part test (to determine fiduciary status) with a definition more in accordance with the statutory language in ERISA. That legislation was ultimately struck down by the court in 2018.

In 2019, the Securities and Exchange Commission (SEC) proposed the Regulation Best Interest (Regulation BI) rule, and ultimately adopted it in 2020. The Best Interest standard raised the bar when it came to client protections for non-fiduciary investment advice. The rule established clear guidelines between a fiduciary and non-fiduciary and included disclosure of conflicts, transparency around services and recommendations.

As a second act to the now-scrapped DOL Fiduciary Rule, the DOL proposed a rule (The Proposal) in June 2020 affecting ERISA and the Internal Revenue Code (IRC) of 1986, as amended (the Code), which would allow Investment Professionals managing ERISA retirement plans to engage in “exemptions” to  the strict set of guidelines.

For advisors acting as fiduciaries, the guidance will allow those managing ERISA accounts to charge a fee for services rendered as long as they pass the five-part test. The DOL proposed to reinstate a previous rule from 1975 that reestablishes this five-part test for determining the advisor’s fiduciary status, and all five parts need to be met to qualify for the “prohibited transactions exemption”.

The Proposal is intended to align its enforcement and oversight with the SEC’s current Regulation BI rule and it borrows significant terminology and definitions from that rule.

The DOL view is that recommendations from an advisor to take a distribution or to transfer assets out of an ERISA plan constitutes a decision to sell which would (if all other requirements are met) allow the advisor to collect a fee for the recommendation. Additionally, full rollover transactions are also covered as long as there is a reasonable belief that those assets will continue to be serviced by the advisor on an ongoing basis. The Proposal would also apply to standard buy/sell recommendations within an existing relationship.

Additionally, The Proposal will not prohibit investment firms from collecting revenue on principal transactions. Principal transactions in all forms will be allowed as long as they also comply with the exemption criteria.

Those who comply with the rule in order to gain ERISA exemptions will need to comply with “impartial conduct standards” consisting of a Best Interest standard, reasonable compensation standard, as well as a requirement that no materially misleading statements about the transaction were made.

On December 18th, 2020 the DOL published the final version of the rule impacting fiduciary compensation while managing ERISA accounts. Included below are the key changes from the final rule. The DOL also announced the effective date of the new rule to be February 16th, 2021 which will occur under a new administration that may take action to amend, delay, or scrap the rule entirely.

1. IRA Rollovers – The advice is generally unchanged; In the final rule the DOL confirms that advice to rollover assets from an employee benefit plan to an IRA may be covered if all prongs of the five-part test are fulfilled. Although, where rollover advice is conflicted fiduciary advice that requires an exemption the DOL added a condition to provide written disclosure to Retirement Investors of the reasons that a rollover recommendation is in their best interest

2. As part of the prohibited transactions exemption (PTE), other occurrences of conflicted advice including certain principal transactions with a compensatory element, DOL:
   1. Narrowed the recordkeeping requirement to limit access to regulators, and not to plan fiduciaries and participants
   2. Permitted the certification of the retroactive compliance review to be made by any Senior Executive Officer, as opposed to only by the CEO
   3. Added a self-correction provision

In order to qualify for the exemption, the advisor will be required to comply with all parts of a five-part test. The test reinstates a guidance from a rule from 1975 and consists of the following parts:

• Giving Advice or a Recommendation

  The advisor must provide advice as to the value of securities or other property 

• Ongoing Relationship

  There needs to be the reasonable assumption or explicit knowledge of an ongoing relationship with recommendations occurring on a regular basis

• Primary Basis

  The advice rendered needs to be considered the primary basis for the actions taken by the advisor 

• Individualized Advice

  The advice needs to be tailored to the needs of the individual

• Mutual Agreement

  The advisor and client must have a mutual agreement with regard to the scope of services rendered

The proposed exemption gives advisors new opportunity to service retirement accounts and extends to both advisors and insurance providers as well as financial institutions and affiliates. The range of reasonable payments includes but is not limited to commissions, 12b-1 fees, trailing commissions, sales loads, mark-ups, mark-downs, and revenue sharing payments from investors or third parties. 

As in Regulation Best Interest, there is no private right of action for the investor, but advisors will need to adopt policies and procedures that prove that they are compliant with the standard when taking an exemption. The advisor must also be considered a fiduciary to be eligible for the exemption and conflicts of interest must be mitigated.

Non-fiduciary brokers will continue to be held to the previously passed Regulation Best Interest standards when conducting their business. The above rule will only impact compensation for those acting in a fiduciary capacity and is intended to align with the previously passed Regulation Best Interest Standard.

The DOL also announced the effective date of the new rule to be February 16th, 2021. Due to the fact the rule will go into effect under a new administration, there remains a high likelihood that it will either be amended, delayed, or scrapped entirely. It is expected that there will be additional developments in the coming weeks.