On December 18, 2020, the U.S. Department of Labor (DOL) published the final version of its new prohibited transaction class exemption for investment professionals: Prohibited Transaction Exemption 2020-02, Improving Investment Advice for Workers and Retirees.
The new class exemption is based on the DOL’s temporary policy adopted after a 2018 ruling by the Fifth Circuit Court of Appeals in Chamber of Commerce of the United States v. United States Department of Labor vacated the DOL’s 2016 Fiduciary Rule. It codifies the reinstatement of the 1975 regulation establishing a “five-part test” to determine who is an investment advice fiduciary under ERISA and IRC Section 4975.
Five-Part Test for Investment Advice Fiduciary Status
The DOL amended the Code of Federal Regulations to execute the Fifth Circuit’s order, which effectively reinstated the Department’s “five-part test” as set forth in its 1975 regulation defining investment advice fiduciaries under the Code and ERISA.
For advice to constitute “investment advice,” a financial institution or investment professional that is not a fiduciary under ERISA must:
- Render advice to the plan as to the value of securities or other property, or make 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 plan, plan fiduciary, or IRA owner, that
- The advice will serve as a primary basis for investment decisions with respect to plan or IRA assets, and that
- The advice will be individualized based on the particular needs of the plan or IRA.
Under the new exemption, a financial institution or investment professional that meets the five-part test, and receives a fee or other compensation, direct or indirect, is an investment advice fiduciary under ERISA and under the Code.
The five-part test also applies to IRA rollovers by including advice related to such rollovers as within the scope of “investment advice” in the class of transactions covered by the exemption. DOL has eschewed prior guidance and states that providing advice regarding the rollover of assets from a plan to an IRA constitutes “advice to sell, withdraw, or transfer investment assets currently held in the plan,” and therefore falls under the definition of fiduciary advice if the five-part test is satisfied.
At the same time, DOL recognized that advice regarding such rollovers “may be an isolated and independent transaction that would fail to meet the ‘regular basis’ prong of the five-part test.” Additionally, DOL stated that advisers providing rollover advice might avoid fiduciary status if they make it clear in their communications that they do not intend to enter into an ongoing relationship to provide advice and then act accordingly.
The New Class Exemption
The new class exemption allows certain investment advice fiduciaries — registered investment advisers, broker-dealers, insurance companies, banks, and individual investment professionals that are their employees or agents — to receive compensation as a result of providing fiduciary investment advice if that advice meets the DOL’s “Impartial Conduct Standards,” which include (1) a best interest standard, (2) a reasonable compensation standard, and (3) a requirement to make no materially misleading statements about recommended investment transactions and other relevant matters.
These standards align with those in the Securities and Exchange Commission’s (SEC) Regulation Best Interest (“Reg BI”), which went into effect on June 30, 2020. Reg BI – also known as Rule 151-1 of the Securities Exchange Act of 1934 – applies to the code of conduct for broker-dealers and their staff when making recommendations to retail customers regarding securities transactions, investment strategies, asset rollovers, and other related business. Reg BI requires that these recommendations be based on a customer’s best interest.
The new exemption also includes the following requirements:
- Financial institutions must provide written disclosures to the investor prior to the transaction that acknowledge fiduciary status, describe the services being provided, and disclose any material conflicts of interest;
- To ensure compliance with the impartial conduct standards, financial institutions must establish, maintain, and enforce written procedures;
- When executing a rollover, financial institutions must document why the rollover is in the best interest of the investor;
- Annual reviews must be conducted to determine a financial institution’s compliance with the impartial conduct standards and include an annual certification from the institution’s CEO or equivalent officer.
The new exemption goes into effect on February 16, 2021, although prior guidance under FAB 2018-02 will remain in effect for one year after official publication to provide a transition period for compliance with the provisions of the new exemption.
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