The Department of Labor’s Prohibited Transaction Exemption and Its Impact on Recommendations to Plans, Participants and IRAs (Part 8)

On February 16, 2021, the DOL’s prohibited transaction exemption (PTE) 2020-02 became effective. The PTE is titled “Improving Investment Advice for Workers & Retirees.” It allows investment advisers, broker-dealers, banks, and insurance companies (“financial institutions”), and their representatives (“investment professionals”), to receive conflicted compensation resulting from non-discretionary fiduciary investment advice to retirement plans, participants and IRA owners (“retirement investors”).

In the preamble to the PTE, the DOL also announced an expanded definition of fiduciary advice, meaning that many more financial institutions and investment professionals will be fiduciaries and therefore will need the protections afforded by the exemption. In addition, they will need prudent, or best practice, processes to satisfy the fiduciary and best interest standards of care.

In order to obtain the benefit of the exemption, financial institutions and investment professionals will need to satisfy the “conditions” in the exemption. For the period from the effective date (February 16) until December 20 of this year, a DOL and IRS non-enforcement policy for prohibited transactions will be available in lieu of the exemption. That is, neither the IRS nor the DOL will enforce the rules against transactions with plans, participants or IRA owners that result from nondiscretionary fiduciary advice and that are prohibited in the Code or ERISA, so long as the Impartial Conduct Standards are satisfied. The Impartial Conduct Standards are: the best interest standard of care, a limit on compensation to reasonable amounts, and a prohibition of materially misleading statements. Note, though, that this only binds the DOL and IRS. That is, the non-enforcement policy does not limit private claims that otherwise exist in the law (e.g., ERISA).

This article builds on the earlier posts, Parts 1-7, Best Interest #36, #37, #38, #39 , #40, #41 and #42. My most recent articles, and the next few, discuss interesting, and lesser known, issues related to the expanded fiduciary definition and the exemption.

This article is about the regulatory definition of fiduciary advisor status, which is commonly called the 5-part test. The regulation has a functional definition of fiduciary status and each of the 5 parts of the regulation must be satisfied for an investment professional and a financial institution to be fiduciaries.

Two of the five parts of the test are: (1) a “mutual agreement, arrangement or understanding” between the advisor and client (2) that the recommendations will be “a primary basis” for investment decisions. In the preamble to the PTE, the DOL said that it will be interpreting those two prongs in a more expansive manner.

For example, with regard to the primary basis prong, the DOL says:

“The Department does not interpret the ‘‘primary basis’’ requirement as requiring proof that the advice was the single most important determinative factor in the Retirement Investor’s investment decision. This is consistent with the regulation’s reference to the advice as ‘‘a’’ primary basis rather than ‘‘the’’ primary basis. Similarly, the fact that a Retirement Investor may consult multiple financial professionals about a particular investment does not indicate that the Department’s analysis is incorrect. If, in each instance, the parties reasonably understand that the advice is important to the Retirement Investor and could determine the outcome of the investor’s decision, that is enough to satisfy the ‘‘primary basis’’ requirement.”

With regard to the mutual understanding prong, the DOL takes the position that a disclaimer of the existence of a “mutual understanding” will not preclude a broker from being deemed a fiduciary. The DOL says:

“In the context of the rendering of investment advice by a financial services professional, written statements disclaiming a mutual understanding or forbidding reliance on the advice as a primary basis for investment decisions will not be determinative, although such statements will be appropriately considered in determining whether a mutual understanding exists. Similarly, after consideration of the comments, the Department also intends to consider marketing materials in which Financial Institutions and Investment Professionals hold themselves out as trusted advisers, in evaluating the parties’ reasonable understandings with respect to the relationship.”

“…A financial services provider should not, for example, expect to avoid fiduciary status through a boilerplate disclaimer buried in the fine print, while in all other communications holding itself out as rendering best interest advice that can be relied upon by the customer in making investment decisions.”

Reading between the lines, the DOL may be taking the position that the SEC’s “best interest” requirements for broker-dealers and investment advisers, and materials given to investors that discuss those requirements can, or will, lead investors (including participants) to believe that recommendations will be in the best interest of the investor and therefore bootstrap a finding of fiduciary status under ERISA and the Code. In that case, it seems likely that the SEC’s best interest standard, coupled with the requirement to obtain appropriate information for the retail customer/client investment profile, could be used by the DOL and the IRS to find a “mutual understanding” that a recommendation would be “a primary basis” for an investment decision (and therefore that two prongs of the 5-part test would be satisfied). See Best Interest #38 for a list of the 5 prongs, including the 3 not discussed in this article.

Concluding thoughts

Where no fiduciary relationship is intended, and despite the DOL’s statements, it would be advisable to have a written disclaimer. And a prominent disclaimer will likely be more persuasive than one included in a lengthy document. But practically speaking, written disclaimers will typically not be dispositive, and a broader set of “facts and circumstances” will be considered when determining whether a financial institution and an investment professional are fiduciaries to a particular IRA owner, participant or retirement plan.