Best Interest Standard #60: Compliance with PTE 2020-02

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The DOL “Fiduciary Rule,” FAQ 10: The PTE Conditions

This series focuses on the DOL’s new fiduciary “rule”, which was effective on February 16. This, and the next several, articles look at the Frequently Asked Questions (FAQs) issued by the DOL to explain the fiduciary definition and the exemption for conflicts of interest.

Key Takeaways

  • The DOL FAQs generally explain PTE 2020-02 and the expanded definition of fiduciary advice. FAQ 10 discusses the requirements imposed by the PTE.
  • Prohibited Transaction Exemption 2020-02–has two parts. One part is the expanded interpretation of the definition of fiduciary advice (in the preamble to the PTE) which will cause many more rollover recommendations to be considered fiduciary advice. This article looks at DOL FAQ #9 that explains that Prohibited Transaction Exemption (PTE) 2020-02 provides relief from the prohibition on compensation from a rollover IRA due to a fiduciary recommendation to roll over.
  • The second part is an exemption that creates an exception to the prohibited transaction rules for fiduciary advice that results in compensation for a financial institution (e.g., broker-dealer or investment adviser) and its investment professionals. The exemption includes relief for compensation earned from a rollover IRA and its investments (including annuities). FAQ 10 covers the requirements of the exemption.

Background

The DOL’s prohibited transaction exemption (PTE) 2020-02 (Improving Investment Advice for Workers & Retirees) 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 addition, in the preamble to the PTE the DOL announced an expanded definition of fiduciary advice, meaning that many more financial institutions and investment professionals will be fiduciaries for their recommendations to retirement investors and, therefore, will need the protection provided by the exemption.

In April, the DOL issued FAQs that explain the fiduciary interpretation and the conditions of the exemption.

This article discusses FAQ 10—the exemption’s conditions.

Q10. What is required to comply with PTE 2020-02?

PTE 2020-02 conditions prohibited transaction relief on financial institutions (SEC- and state-registered investment advisers, broker-dealers, banks, and insurance companies) and their investment professionals (employees, agents, and representatives) providing advice in accordance with the Impartial Conduct Standards. Financial institutions must also acknowledge in writing their and their investment professionals’ fiduciary status under Title I of ERISA and the Internal Revenue Code, as applicable, when providing investment advice to the retirement investor, and they must describe in writing the services to be provided and the financial institutions’ and investment professionals’ material conflicts of interest. Financial institutions must document the reasons that a rollover recommendation is in the best interest of the retirement investor and provide that documentation to the retirement investor. Financial institutions must adopt policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and that mitigate conflicts of interest, and must conduct an annual retrospective review of compliance.

Comment: While the conditions listed in this paragraph apply now (and have since February 16, 2021), most of them will not be enforced by the DOL and the IRS until December 21st because of a non-enforcement policy issued by the DOL (and concurred in by the IRS). Instead, the non-enforcement policy requires only that the financial institution and the investment professionals adhere to the Impartial Conduct Standards until the non-enforcement policy ends on December 20, 2021.

Thereafter, financial institutions and investment professionals will be required to comply with all of the conditions in the exemption, including those mentioned above: disclosure of fiduciary status, other disclosures and the policies and procedures. Compliance with the Impartial Conduct Standards (the “ICS”) will continue to be required, as well. The ICS require that recommendations be in the best interest of retirement investors, that any compensation is no more than a reasonable amount (relative to the services provided to the retirement investor), and that there not be any materially misleading statements. (My next post, about FAQ 11, will further discuss the ICS.)

Stated as bullet points, the conditions of the exemption are:

  • The Impartial Conduct Standards.
  • Acknowledgement in writing of the firm’s and the investment professional’s fiduciary status under Title I of ERISA and the Internal Revenue Code when providing covered recommendations to a retirement investor.
  • Describe in writing the services to be provided to the retirement investor, and the financial institution and investment professional’s material conflicts of interest.
  • Document the reasons that a rollover recommendation is in the best interest of the retirement investor and provide that documentation to the retirement investor.
  • Adopt policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and that mitigate conflicts of interest.
  • Conduct an annual retrospective review of compliance with the PTE’s conditions.

These conditions are a heavy lift for both small and large firms. Because of that, some of the small firms that I am working with have opted for an educational (that is, no recommendations) approach to rollovers (because of the cost and effort to build compliant systems). Larger firms are adopting compliance approaches that can be automated. In addition, they will need to train hundreds or thousands of investment professionals on the new requirements by December 21.

FAQ 10 continues:

To ensure that financial institutions provide reasonable oversight of investment professionals and adopt a culture of compliance, financial institutions and investment professionals will be ineligible to rely on the exemption if, within the previous 10 years, they were convicted of certain crimes arising out of their provision of investment advice to retirement investors. They will also be ineligible if they engaged in systematic or intentional violation of the exemption’s conditions or provided materially misleading information to the Department in relation to their conduct under the exemption.

Comment:  If a financial institution has a pattern of noncompliance, and therefore this is invoked, it could the equivalent of corporate death for the firm. If access to the protective provisions of the exemption are taken away, it would be impossible to recommend rollovers, to provide commission-based advice to IRAs, and to provide ongoing financial services to plans, participants and IRAs where prohibited transactions are involved.

Concluding Thoughts

Hopefully, the compliance efforts by investment advisers, broker-dealers, and other financial institutions are well under way. December 21 is just around the corner and it will take months to develop the processes, policies, and procedures needed to comply. It’s not too late. But it soon will be.

My next post will discuss FAQ 11, “What are the Impartial Conduct Standards?”

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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