On October 31, 2023, the U.S. Department of Labor (“DOL”)'s Employee Benefits Security Administration (“EBSA”) proposed a new fiduciary rule (the “Proposal”).

If finalized, the Proposal would (1) expand the definition of “investment advice fiduciary” under the U.S. Employee Retirement Income Security Act of 1974 (“ERISA”) and (2) amend the exemptions that fiduciaries can rely on to avoid violation of prohibited transactions, which may affect the way investment advisors provide and investors receive certain advice on their job-based retirement accounts and other retirement savings plans.

Background

The Proposal follows a series of other changes made to the fiduciary rule in the past decade by the DOL. President Barack Obama proposed a similar rule in 2016 (the “2016 Rule”), which replaced the definition of investment advice fiduciary from a 1975 regulation that set forth a five-part test for determining when someone is providing fiduciary investment advice (the “1975 Rule”). The 2016 Rule was vacated by the Fifth Circuit Court of Appeals (the “Fifth Circuit”) in 2018, who found that the 2016 Rule was too broad and extended to relationships that lacked “trust and confidence” which the Fifth Circuit said were key to a common law fiduciary relationship. Subsequently, the DOL reinstated the 1975 Rule’s five-part test in 2020, along with an updated interpretation of the test.

The DOL believes that its new Proposal addresses the Fifth Circuit’s emphasis on relationships of trust and confidence and has a narrower impact than the 2016 Rule. If the Proposal is finalized, investment advisors that provide advice for a fee and are currently not considered investment advice fiduciaries under ERISA would be subject to fiduciary standards and rules of conduct to avoid conflicts of interest and would therefore need to rely on certain prohibited transaction exemptions (“PTEs”) to avoid a potential violation of ERISA.

Since the 2016 Rule was vacated, new "best-interest" rules were issued by the US Securities and Exchange Commission (the “SEC”) in its Regulation Best Interest. The DOL, however, believes that the SEC’s rule does not cover all types of investment products or retirement savings transactions that have become more common over time (e.g. one-time advice on rolling over 401(k) assets into an IRA or on selecting 401(k) investment options), and the SEC’s rule does apply to commodities or insurance products (e.g. fixed index annuities). The Proposal intends to cover investment advice made to retirement investors in connection with these types of investment and insurance products.

The rules explained

The rules set forth in the DOL’s release are extensive. Below are some of the key aspects of the Proposal:

Expanded definition of investment advice fiduciary

The Proposal would revise the five-part test in the 1975 Rule by eliminating the requirement that in order for advice to be fiduciary in nature, the advice needs to be provided to the investor on a “regular basis” and that the advice serves as “a primary basis for investment decisions.” Instead, the Proposal provides that fiduciary status would apply to a person who makes investment recommendations to investors on a regular basis as part of their business. Relatedly, a recommendation would be fiduciary in nature if it is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and the recommendation may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest. Therefore, the Proposal would apply to any investment advice provided even if it is not provided on a regular basis, such as one-time recommendations to roll over assets from a 401(k) plan into an IRA or annuity, resulting in those who provide any such one-time advice to be considered fiduciaries.

Under the Proposal, a financial services provider would be an investment advice fiduciary under Title I and Title II of ERISA if:

1. the provider provides investment advice or makes an investment recommendation to a retirement investor (such as a plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary or IRA fiduciary);
2. the advice or recommendation is provided for a fee or other compensation, direct or indirect; and
3. the financial services provider makes the recommendation in one of the following contexts:
   1. the provider has discretion over investment decisions for the retirement investor;
   2. the provider makes investment recommendations to investors on a regular basis as part of their business, and the recommendation is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest; or
   3. the provider states that they are acting as a fiduciary when making investment recommendations.

The DOL notes that each component under the Proposal’s definition of investment advice fiduciary would have to be satisfied for a recommendation to constitute investment advice by a fiduciary, and a fiduciary status will be determined on a transactional basis, which means that an investment advisor shall be a fiduciary only to the extent the advisor meets the requirements for the particular transaction at issue involving such advice.

Recommendations

Making a “recommendation” is a key hallmark of providing “investment advice” under the Proposal, and for purposes of the Proposal, the DOL “views a recommendation as a communication that, based on its content, context, and presentation would reasonably be viewed as a suggestion that the retirement investor engage in or refrain from taking a particular course of action.” In this regard, the DOL further notes that the more individually tailored the communication is to a retirement investor, the more likely such communication would be viewed as a recommendation.

No exception for sophisticated investors

The 2016 Rule contained an exception for recommendations made to independent fiduciaries managing at least USD50 million in assets, which was used in situations such as discussions between large pension plans and their investment managers with principals of investment funds and other investment vehicles. The Proposal does not include any special provision for recommendations made to sophisticated advice recipients. Instead, any such communications between sophisticated investors and providers would be subject to the Proposal’s new standards of what constitutes fiduciary investment advice.

Amendments to Prohibited Transaction Exemptions (PTEs)

The DOL also proposed three sets of amendments to certain PTEs under ERISA that may be relied upon by financial professionals in various investment advice situations to avoid conflicts of interest: (1) PTE 2020-02 (applicable to investment advice provided to retirement investors); (2) PTE 84-24 (applicable to independent insurance agents); and (3) PTEs 75-1, 77-4, 80-83, 83-1, and 86-128 (applicable to certain transactions involving investment advice).

PTE 2020-02

PTE 2020-02 applies to financial professionals who are under the supervision of a financial institution, and the proposed amendment makes clarifying changes to PTE 2020-02 building on the existing conditions, such as specifying disclosure and notification requirements thereunder and expanding the scope of the exemption to certain transactions and parties. For instance, under PTE 2020-02, insurance companies selling products through an independent agent would be required to provide a fiduciary acknowledgment and be treated as a fiduciary if they exercise oversight responsibilities over the independent agents. Agents who are more closely affiliated with insurers, broker-dealers or investment companies and operate under PTE 2020-02, would have to provide a notice acknowledging that they would receive commissions or other transaction-based compensation and offering to provide specific compensation information, for free, upon request.

PTE 84-24

PTE 84-24 applies to financial professionals who are not under the supervision of a financial institution. The proposed amendment adds a new section to PTE 84-24 to provide relief for independent insurance agents receiving compensation that would otherwise be prohibited for investment advice transactions, tailored to the special challenges posed for overseeing investment recommendations by independent insurance agents who recommend annuities issued by more than one insurance company. Specifically, PTE 84-24 requires that an independent insurance agent selling products for an insurance company acknowledge its fiduciary status, and that the insurance company exercise supervisory authority over the independent agent with regard to an agent’s recommendation of the insurance company’s own products. Independent agents who operate under PTE 84-24 could continue to earn commissions but would have to disclose their initial commissions and renewal commissions, both in terms of dollar amounts and as a percentage of the premium payments.

Under both exemptions PTE 2020-02 and PTE 84-24, investment advisors must adhere to Impartial Conduct Standards, which require, among other things, that the investment advice be in the “best interest” of the retirement investor, the investment professional and firm must charge no more than reasonable compensation and comply with federal securities laws; and the investment advice be free from misleading statements about investment transactions and other relevant matters.

Amendments to PTEs 75-1, 77-4, 80-83, 83-1, and 86-128

Additionally, PTE 75-1 Parts III and IV, PTEs 77-4, 80-83, 83-1, and 86-128 would be amended to eliminate relief for transactions resulting from fiduciary investment advice as defined under ERISA. The PTEs currently provide relief for certain transactions in connection with investment advice, and the proposed amendments eliminate the fiduciary investment advice transactions from the covered transactions under each exemption and make certain other administrative changes.

As a result of the amendments to the above PTEs, investment advice fiduciaries would need to rely on PTE 2020-02 or PTE 84-24 to receive compensation that otherwise would be prohibited in connection with investment advice transactions and would be held to the same conduct standards in administrative exemptions.

When would the rule take effect?

It will take some time for the Proposal to be finalized. The Proposal includes a 60-day public comment period, and the DOL plans to hold a public hearing approximately 45 days after the Proposal is published in the Federal Register. Given the length and complexity of the Proposal, it is speculated that the comment period may be further extended. If finalized, the Proposal would take effect 60 days after the approval date.

We note that the Proposal is already facing some opposition from the insurance industry and insurance brokers and may face legal challenges similar to the 2016 fiduciary rule, which may delay the approval process.

Who will be Impacted by this rule?

Under the Proposal, a wider range of fiduciaries will be included in and subject to the rules, including:

• retirement advisers generally, irrespective of the types of security or insurance products (e.g., commodities or insurance products, which are currently not covered under the fiduciary rule) on which they are providing recommendations or the states in which they are located;
• financial advisors providing one-time recommendations to plans and to participants on 401(k) rollovers into individual retirement accounts (“IRAs”) or investment options;
• investment advisors to plan sponsors about which investments to make available as options in 401(k) plans and other employer-sponsored plans;
• current fiduciaries or those working in a fiduciary capacity due to amendments to exemptions commonly relied upon by such fiduciaries; and
• annuities and employee welfare benefit plans with an investment component (e.g., health savings account programs).

Considerations for investment advisors and investors

While the Proposal may be subject to changes as a result of forthcoming public comments provided to the DOL, now would be a good time to start thinking about the potential impact of these new rules on your business. In this regard, you may wish to:

• Review and prepare for potential changes to current disclosures (such as offering materials) that include fiduciary rule language and consult legal advisors on how they may be updated to comply with the Proposal;
• If you are an investment advisor, familiarize yourself with the Proposal’s requirements and consult a legal advisor on the applicability of the Proposal to you and, if so, how best to comply with them.
• If you are an asset manager marketing to retail investors, consider potential complications and challenges that may be presented by the Proposal with a legal advisor.
• If you are an investor, communicate with your current investment advisors and familiarize yourself with the Proposal and your rights thereunder.

[View source.]