DOL Proposes Revised Prohibited Transaction Exemption
On June 29, 2020, the U. S. Department of Labor (“DOL”) issued a proposed prohibited transaction exemption (“PTE”) – along with a related fact sheet – that would permit “investment advice fiduciaries” to receive compensation in exchange for providing investment advice to retirement plans and their participants and beneficiaries. Among other things, the proposal generally would reinstate the “five-part test” for determining who is a fiduciary within this context. The revised proposal represents the latest in a soap opera-like series of events involving initial proposed and final DOL regulations, explosive reaction, and their eventual overturning by a federal court of appeals.
COMMENT: This has been a “hot button” issue for 401(k) plans for many years, amid growing charges that investment professionals often charge excessive fees or otherwise fail to act in participants’ and beneficiaries’ best interests. On the other hand, investment advisors have largely resisted imposition of ERISA’s fiduciary duty – and its attendant threat of litigation, fines and other sanctions — upon providing investment advice and similar services. In particular, the question of whether proffering investment advice for a fee may constitute a “prohibited transaction” under ERISA has long been a largely unresolved issue.
Background. ERISA’s strict fiduciary standards require retirement plan fiduciaries to act at all times in the best interests of plan participants and beneficiaries. (See our articles entitled “401(k) ERISA’s Duty of Care and Liability” and “401(k) Fiduciary and Non-Fiduciary Functions” for a general discussion.) Generally stated, the fiduciary rules apply to those persons who exercise control or discretion over retirement plan assets, as opposed to those who merely perform administrative functions.
But nothing is that simple. In the case of retirement plan investment advisors, the picture has been murky. In particular, whether providing investment advice in connection with a 401(k) plan’s menu of investments rises to the level of a fiduciary act – and whether charging fees for such advice might constitute a “prohibited transaction” — has been hotly debated, with answers uneven and in a continual state of flux.
In 2015, in response to the Obama administration’s urging and related pressure from participant activists, the DOL proposed regulations that would significantly expand the scope of investment advice with respect to retirement plan financial advisors (“investment advice fiduciaries”). Following four days of heated public hearings, the regulations were finalized in 2016. However, following proposed legislation to delay implementation of the regulations — along with over 178,000 public comments, review by the federal Office of Management and Budget, and a change in DOL administration — the DOL delayed applicability of the rule, first by 60 days, then by 18 months.
But in February 2017, the newly elected Trump Administration issued a memorandum that attempted to delay implementation of the regulations by another 180 days. The DOL itself further delayed implementation of the final regulations until July 2019. However, the Fifth Circuit Court of Appeals, in March 2019, vacated the regulations in a 2-to-1 decision, calling them “an arbitrary and capricious exercise of administrative power.” On June 21, 2018, the Fifth Circuit Court of Appeals confirmed its decision, thereby assuring that the final regulations, as initially conceived, would never take effect.
Who Is an “Investment Advice Fiduciary?” The Five-Part Test. The Fifth Circuit’s vacating of the DOL’s regulations essentially brought the matter back to where it stood prior to 2015, when persons generally relied on a five-part test dating back to 1975 to determine whether a person is a “fiduciary” by reason of providing “investment advice” for a fee:
- The individual renders advice as to the value of securities or other property, or makes recommendations as to investing in, purchasing or selling securities or other property;
- He or she does so on a regular basis;
- The advice is rendered pursuant to a mutual agreement, arrangement, or understanding with the plan or plan fiduciary that —
- The advice will serve as a primary basis for investment decisions with respect to the plan or plan assets; and
- The advice will be individualized based on the particular needs of the plan.
An individual who meets all five prongs of the tests, and receives compensation in exchange for the advice, is generally considered to be an “investment advice fiduciary” under the 1975 rule. Whether or not the prongs of the test are satisfied is generally a “facts and circumstances” determination.
Highlights of Proposed Exemption.
NOTE: The text of the proposed PTE is lengthy and highly technical. The following is meant as a high-level, general overview of some of the major provisions applicable to 401(k) plans, and is not intended as an exhaustive analysis of all the provisions included in the proposed PTE.
The new proposed PTE, if finalized in its present form, would generally provide the following:
- The proposed PTE would give relief for certain “investment advice fiduciaries” (but not for parties having discretion) that is broader and more flexible than existing exemptions, provided that the fiduciary complies with “impartial conduct standards” (see below).
- The proposed PTE would permit investment advice fiduciaries to receive compensation in exchange for providing what might, absent the PTE, be considered “conflicted” fiduciary investment advice.
- For this to apply, the “investment advice fiduciary” must be a registered investment adviser, broker-dealer, bank, or insurance company, or an employee or representative of one of these entities.
- The proposed PTE would also permit certain investment advice fiduciaries to enter into and receive compensation for “riskless” and certain other “principal transactions” with retirement investors.
- Typically, this occurs when a fiduciary either purchases certain investments from a retirement investor for its own account, or sells investments to the retirement investor.
- Fiduciaries could become barred from relying on the PTE for ten years if they:
- Are convicted of certain crimes relating to providing investment advice to retirement investors;
- Engage in systemic or intentional violation of the PTE’s conditions; or
- Provide materially misleading information to the DOL about their conduct under the PTE.
- The proposed PTE would not cover advice arrangements that rely solely on “robo-advice” without interaction with an actual investment professional.
Impartial Conduct Standards. The impartial conduct standards generally align with the standards of conduct for investment advice professionals established by other U.S. Federal and state regulators (for example, the U.S. Securities and Exchange Commission). In a nutshell, the impartial conduct standards require investment advice fiduciaries to provide advice in the best interest of retirement investors, charge only reasonable compensation, and make no materially misleading statements.
Specifically, the proposed PTE requires investment advice fiduciaries to:
- Disclose both the financial institution’s and the investment professional’s status as an investment advice fiduciary, along with any material conflicts of interest;
- Establish, maintain and enforce policies and procedures designed to ensure compliance with the impartial conduct standards; and
- Conduct an annual review to ensure compliance with the conditions of the proposed PTE.
Comment Period. As is customary in the case of proposed regulations or similar guidance, the DOL solicits and often is responsive to comments from interested parties, including professionals in the field (including both investment professionals and plan sponsors). Comments on the proposed PTE are due by August 6, 2020 and may be submitted at www.regulations.gov at Docket ID number: EBSA-2020-0003.
Effective Date. If finalized in its present form, the proposed PTE would become effective 60 days after the date of its publication in the Federal Register.
The information and content contained in this blog post are for general informational purposes only, and does not, and is not intended to, constitute legal advice. As always, for specific questions concerning your 401(k) retirement plan, or for help in operating your plan during the current COVID-19 crisis, please consult your own ERISA attorney or professional advisor.