The Department of Labor (DOL) confirmed on February 12 that the Trump-era Prohibited Transaction Exemption (PTE) 2020-02 would go into effect as scheduled on February 16, 2021. The PTE will likely affect the business of broker-dealers that regularly make investment recommendations to IRA owners, as well as retirement plans and their participants (including rollover recommendations). This is due in part to the requirements of the PTE itself, but also because the rulemaking includes new interpretations that will expand the circumstances under which broker-dealers and their associated persons will be deemed to be advice fiduciaries. (The exemption refers to broker-dealers as “financial institutions” and their associated persons as “investment professionals” and this article uses those terms.)

As a result of these changes, broker-dealers need to re-evaluate whether and when they (and their investment professionals) may be fiduciaries, and where they are fiduciaries, they need to develop compliant practices, policies and procedures.

Here are five key points of which brokerage firms should be aware:

1.   Though the new PTE became effective on February 16, the key compliance date is December 21, 2021.

When the Fifth Circuit struck down the Obama-era fiduciary rule in 2018, the Best Interest Contract (BIC) Exemption, which gave prohibited transaction relief for “conflicted compensation,” was vacated at the same time. With no remaining broad-based exemption permitting advice fiduciaries to receive commissions, 12b-1 fees and other “conflicted” compensation, the DOL issued Field Assistance Bulletin (FAB) 2018-02 as a temporary stopgap. In the FAB, the DOL and IRS said it would not enforce penalties for violation of the prohibited transaction restrictions, so long as advice fiduciaries were working diligently and in good faith to comply with the “best interest” and other impartial conduct standards set forth in the vacated BIC Exemption. The DOL says it will keep this “non-enforcement policy” in place through December 20, 2021.

The additional time will provide broker-dealers that are advice fiduciaries to IRAs, plans and participants with a transition period to come into compliance with the new PTE (or a combination of other exemptions, as discussed later).

As a word of caution, the PTE only exempts prohibited conflicts resulting from nondiscretionary investment advice. If a financial institution engages in a prohibited transaction when exercising investment discretion, the exemption will not apply (although in limited circumstances, other exemptions may be available).

2.   The DOL has not changed the text of the “five-part test” that defines fiduciary investment advice, but it is interpreting the “regular basis” requirement more expansively, which will affect rollovers.

The DOL’s five-part test requires, among other things, that, to be fiduciary advice, the advice be given on a “regular basis”. The PTE’s preamble significantly expands the circumstances under which a rollover recommendation will be found to satisfy the “regular basis” requirement. The DOL states that “regular basis” may be met as part of an ongoing relationship or just an anticipated one:

“…(A)dvice to roll over plan assets can also occur as part of an ongoing relationship or an intended ongoing relationship that an individual enjoys with his or her investment advice provider…. (A)dvice to roll assets out of a Title I Plan into an IRA where the investment advice provider has not previously provided advice but will be regularly giving advice regarding the IRA in the course of a more lengthy financial relationship would be the start of an advice relationship that satisfies the regular basis prong.” [Emphasis added]

3.   The five-part test’s requirements of a “mutual agreement, arrangement or understanding” between the advisor and client that the recommendations will be a “primary basis” for investment decisions are being interpreted more expansively.

For example, the DOL explains in the PTE preamble that:

“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.”

The DOL also says that disclaiming the existence of a “mutual understanding” will not preclude a broker from being deemed a fiduciary. The DOL says:

“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…

“…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.”

Where no fiduciary relationship is intended, it is probably still advisable to make written disclaimers. But practically speaking, the written disclaimers will typically not be treated as dispositive, and a broader set of “facts and circumstances” will be considered when determining if a financial institution is a fiduciary to a particular IRA, participant or plan customer.

4.   By design, there is significant commonality between the requirements of Reg BI and those in the PTE, but there are also key differences for which firms need to prepare.

Many of the supervisory policies and procedures, client disclosures, and conflict mitigation steps broker-dealers have implemented for retail customers subject to Reg BI will be applicable for compliance with the PTE, in some cases with limited changes. However, there are a number of key differences, including the fact that the PTE applies to advice given to plan sponsors, who are not retail customers under Reg BI. Also, the disclosures provided to customers under the PTE will need to include an acknowledgement of the firm’s and the individual professional’s fiduciary status. And, the requirement in the PTE to mitigate applies to both the financial institution and the investment professional, while the Reg BI mitigation provision applies only to the investment professional.

The PTE also requires an annual review and compliance certification from a top officer of the firm, and imposes certain additional conditions and limitations (for example, on principal transactions) that Reg BI does not. (This is only a partial list of the differences.)

5.   There are a number of existing exemptions that permit fiduciary advisors to plans and IRAs to receive variable compensation, but they are not broad-based like PTE 2020-02.

Two examples: PTE 86-128 is available where a fiduciary receives brokerage commissions on the basis of its advice; and PTE 84-24 permits a fiduciary to receive commissions when recommending an annuity or insurance policy.

The requirements imposed under existing exemptions are generally less subjective, and in many respects less onerous, than those of the PTE. For example, the 86-128 requirements for IRAs are minimal (though additional disclosure and other requirements apply to ERISA plans). Plus, existing exemptions do not impose the “best interest” or other impartial conduct standards, require an acknowledgment of fiduciary status or an annual review and compliance certification. As a result, broker-dealers may wish to rely on exemptions other than the PTE where it is feasible to do so.

However, existing exemptions are generally specific to particular products and forms of compensation, whereas the PTE is more expansive. As a result, in some cases it may be necessary to rely on the new exemption instead, especially for rollover recommendations.

The new DOL guidance creates compliance challenges for broker-dealers. Firms should be able to leverage much of their Reg BI compliance work when developing policies, procedures, and disclosures under PTE 2020-02. That said, we recommend that brokers perform a “gap analysis” sooner than later, so they will have ample time to prepare before the December 21 compliance date.

We intend to address five key things that broker-dealers need to do prior to December 21 in our next article.