On April 25, 2024, the Department of Labor published its final regulation defining fiduciary status for investment advice and the related exemptions—PTE 2020-02 and 84-24. The exemptions provide relief from prohibited conflicts and compensation resulting from fiduciary recommendations to “retirement investors”–private sector retirement plans, participants (including rollovers), and IRAs (including transfers and exchanges). The fiduciary regulation and exemptions will be effective on September 23, 2024, although compliance with some of the conditions in the exemptions will be further delayed.

Let’s look at the final of PTE 2020-02 and its effective dates.

As background, PTE 2020-02 protects financial institutions and investment professionals from the adverse consequences of making conflicted fiduciary recommendations (that is, recommendations that, if accepted, will result in cash or non-cash benefits for the investment professional and/or the financial institution). The protection is that the financial institution will not need to unwind the recommended transaction, restore any losses and costs, contribute any missed earnings, return any compensation, and pay excise taxes.

The reason that the protection of the PTE will be needed, more than ever, beginning September 23 is that the new fiduciary definition includes one-time recommendations that are individualized, made with professional judgment, and in the best interest of the retirement investor. (That is a conversational explanation. For the details, look at my prior blog articles.) In other words, beginning September 23 the number of fiduciary prohibited recommendations will increase dramatically.

And, for context, a “financial institution” is a bank, a broker-dealer, an investment adviser, or an insurance company. An “investment professional” is a representative or employee of a financial institution. A “retirement investor” includes private sector retirement plans, participants in those plans, and IRA owners.

All financial institutions can use PTE 2020-02 for the protection it affords. Broker-dealers, investment advisers, and banks must use the PTE for relief for their conflicted fiduciary recommendations. In addition, relief for insurance products that are treated as securities (e.g., variable and registered annuities) can only be found under 2020-02. Finally, if an insurance product is sold by an employee or statutory employee of an insurance company, PTE 2020-02 must be used for relief.

Life insurance products recommended to retirement investors that require only an insurance license can be sold under another PTE . . . 84-24, which will be the subject of another post.

Under PTE 2020-02, the investment professional and the financial institution are co-fiduciaries, in the sense that they are both fiduciaries for compliance with the terms of the PTE.

A conflicted or prohibited recommendation is one that will cause the financial institution or the investment professional to receive financial benefits that would not otherwise be received. Think of cash compensation, such as commissions, fees, revenue sharing, bonuses. Also, think in terms of non-cash compensation, such as trips, conferences, tickets. (For example, one of  the statutory prohibitions is that a fiduciary advisor or agent cannot “deal with the assets of the plan in his own interest or for his own account”.)

A conflicted recommendation would include a recommendation to roll over from a retirement plan to an IRA with the advisor (“investment professional”) because of the fees or commissions that would be earned for investing the rollover money. Similarly, a recommendation to transfer an IRA or qualified annuity to the investment professional or financial institution would be a conflicted recommendation because of the compensation earned from the transferred money.

To obtain the protection of PTE 2020-02, four categories of “conditions” must be satisfied. Those are:

• The Impartial Conduct Standards.
• Written Disclosures.
• Policies and Procedures
• Annual Retrospective Review and Report

This article will cover the conditions that are effective on September 23 of this year. Those are:

• The Impartial Conduct Standards
  • Care Obligation
  • Loyalty Obligation
  • Reasonable compensation limitation (including best execution, if applicable)
  • No materially misleading statements (including by omission)
• The Fiduciary Acknowledgement Disclosure

Impartial Conduct Standards

Of the four Impartial Conduct Standards, the reasonable compensation and no misleading statements are the easiest to understand and comply with. As a result, this post will focus on the two obligations (although there will be a future article on the provisions related to compensation).

The Care Obligation is defined in the PTE as follows:

Advice meets the ‘‘Care Obligation’’ if, with respect to the Retirement Investor, such advice reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor.

This is very close to the prudent person rule in ERISA. It is a process-driven approach measured by the hypothetical standard of a knowledgeable person—”a prudent person … familiar with such matters”.

In essence, it requires that a fiduciary consider the relevant information about (i) the retirement investor (e.g., the needs and circumstances of the investor), (ii) the investor’s current situation (e.g., the investor’s current investments and strategies, including the investments, services and costs), and (iii) the potential recommendation contemplated by the fiduciary investment professional. The current and potential arrangements would then be evaluated in light of the retirement investor’s profile…in a knowledgeable, careful, skillful, diligent, and prudent manner. That process would result in a recommendation that is in the best interest of the retirement investor.

The Loyalty Obligation is defined in the PTE as follows:

Advice meets the ‘‘Loyalty Obligation’’ if, with respect to the Retirement Investor, such advice does not place the financial or other interests of the Investment Professional, Financial Institution or any Affiliate, Related Entity, or other party ahead of the interests of the Retirement Investor, or subordinate the Retirement Investor’s interests to those of the Investment Professional, Financial Institution or any Affiliate, Related Entity, or other party.

This is similar to the SEC’s approach in Regulation Best Interest for broker-dealers. In practice, it means that an investment professional (and financial institution) cannot place its interest ahead of the retirement investor’s by, e.g., recommending a higher cost and compensating investment or annuity when another course of action would be better for the retirement investor. Another practical example would be that an investment professional cannot recommend a rollover where the better course of action for the participant would be to leave the money in the plan.

The Fiduciary Acknowledgement

PTE 2020-02 describes the disclosure of the fiduciary acknowledgement as follows:

A written acknowledgment that the Financial Institution and its Investment Professionals are providing fiduciary investment advice to the Retirement Investor and are fiduciaries under Title I of ERISA, Title II of ERISA, or both with respect to the recommendation.

Fortunately, the DOL has provided sample language for this disclosure.

Concluding Thoughts

Of the requirements that are effective on September 23, the hardest to satisfy will likely be the Care Obligation. It requires gathering the information that a knowledgeable person would know is relevant to the particular recommendation and then engaging in a thoughtful process to identify which alternatives are in the best interest of the retirement investor. The necessary information can vary depending on the nature of the recommendation—plan rollovers, IRA transfers, investing for growth, investing for withdrawals, guaranteed income, and on and on. Financial institutions can help their representatives by developing guidelines, information, procedures, and documents to support the processes and decision-making.