DOL Fiduciary Rule Rises Again, Regulatory Freeze Continues, FINRA Releases Exam Piorities: Regulatory Update for March 2021

For Investment Advisers

Not Quite Dead Yet - DOL’s Fiduciary Rule Rises Again! On December 18, 2020, the Department of Labor (DOL) adopted Prohibited Transaction Exemption 2020-02 (“PTE 2020-02”), subjecting 401(k) rollover subject to ERISA’s fiduciary rules (sometimes). The exemption, called Improving Investment Advice for Workers and Retirees, expands the definition of fiduciary advice under ERISA to recommendations about rollovers and IRA investments. So now, in addition to best interest, fiduciary and disclosure standards imposed by the SEC and FINRA, investment advisers, broker-dealers, banks, and insurance companies (“Financial Institutions”) now have to prove compliance with the DOL’s “Impartial Conduct Standards.” Failure to comply can result in substantial penalties.

The exemption went into effect on February 16, 2021, dashing any hopes that President Biden’s administration might revisit or postpone it. But don’t panic if you are not ready. The DOL and the IRS have agreed to extend their non-enforcement policy until December 20, 2021.

For Financial Institutions and their employees, agents, and representatives (“Investment Professionals”) serving retirement investors, this means more disclosure and documentation.

  1. Who Needs the Exemption

Financial Institutions and Investment Professionals who (a) recommend rollovers to retirement plan participants, and (b) provide advice to IRA owners about how to invest their IRAs.

  1. Why do we need the exemption?

PTE 2020-02 has a significant impact. It expands the definition of investment advice under ERISA to include a recommendation to a plan participant to roll over his or her assets from the plan to an IRA.

This is HUGE because ERISA fiduciaries are prohibited from engaging in transactions where they receive increased compensation as a result of their advice. Simply put, an adviser cannot receive compensation for advising a plan participant to roll over his or her 401(k) assets into an IRA managed by that adviser, assuming that advice is considered ERISA investment advice (more on that later). Receiving an advisory fee for managing the IRA assets could be a prohibited transaction. Additionally, broker-dealers can be prohibited from advising on 401(k) rollovers if they receive additional compensation such as 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs, and revenue sharing payments from mutual funds or third parties.

There are two ways to avoid engaging in a prohibited transaction when giving rollover advice. The first is to avoid being an ERISA fiduciary in the first place. The second is to qualify for a prohibited transaction exemption.

  1. Are all rollover recommendations considered ERISA fiduciary advice?

No. At the core of this exemption is the DOL’s discussion of how to determine whether you are providing investment advice as an ERISA fiduciary. In prior guidance, the DOL had stated the recommendation to a 401(k) plan participant to roll over assets to an IRA was considered a one-time recommendation, and therefore did not satisfy one of the five hallmarks of an ERISA fiduciary, providing advice on a regular basis. The five-part test defines an ERISA fiduciary as someone who, for a fee, (i) provides investment advice to an ERISA plan, plan fiduciary, plan participant, or IRA owner (ii) on a regular basis (iii) pursuant to a mutual agreement. The advice must (iv) serve as the primary basis for an investment decision, and (v) be individualized based on the particular needs of the plan, plan participant, or IRA owner. In the DOL’s prior guidance, the DOL held that advice to roll assets from a plan to an IRA was not “investment advice” because it was not advice with respect to assets of a plan. Broker-dealers also took the position that advice about 401(k) rollovers was not provided on a “regular basis” and was not provided pursuant to a mutual agreement.

This exemption changes this position. The DOL now holds that advice on whether to take a distribution from a retirement plan and roll it over to an IRA (or to roll over from one plan to another plan, or one IRA to another IRA) may be ERISA investment advice if the advice is either part of an ongoing relationship or the start of an ongoing relationship. For example, if a broker-dealer will be providing advice with respect to the IRA after the rollover, this advice would satisfy the “regular basis” requirement. Moreover, the DOL now interprets “mutual” agreement, arrangement, or understanding about the investment advice as being based on the reasonable understanding of each of the parties. A written agreement is not necessarily required.

  1. What does the Exemption Require?

The key conditions of the exemption require Financial Institutions and Investment Professionals to:

  • Acknowledge that they are fiduciaries under ERISA;
  • Disclose, in writing, to the client the scope of the relationship and all material conflicts of interest (similar to Regulation Best Interest’s requirement for broker-dealers);
  • Comply with the Impartial Conduct Standards
    • Exercise reasonable diligence, care, skill and prudence in making a recommendation, meaning that the firm and its representatives have a reasonable basis to believe that the recommendation being made is in the best interest of the client, based on that client’s investment profile and the potential risks and rewards associated with the recommendation;
    • Receive only reasonable compensation (as compared to the marketplace) and seek best execution of the transaction;
    • Establish, maintain and enforce written policies and procedures reasonably designed to identify, disclose and mitigate, or eliminate material conflicts of interest arising from financial incentives associated with such recommendations;
  • Provide written disclosures to retirement investors of the reasons the rollover recommendation is in their best interest;
  • Conduct an annual compliance review and document the results in a written report to a “Senior Executive Officer” of the Financial Institution; and
  • Maintain written documentation of the specific reasons that any recommendation to roll over assets from an ERISA plan to an IRA, from one IRA to another IRA, or from one type account to another (such as commission-based account to a fee-based account) is in the best interest of the retirement investor.

This exemption and its requirements are complicated and require more thorough analysis than can be provided here. Check out the articles included in our “Worth Reading, Watching and Hearing” section, and stay tuned for additional blog posts on this topic. Contributed by Jaqueline M. Hummel, Partner and Managing Director.

Regulatory Limbo – Freeze Impacts on RIAs and Investment Companies. The Biden administration issued a memorandum on January 20, 2021 to freeze the proposal and issuance of new rules pending their review and approval by appropriate heads within the Biden team. It also directs department heads to take certain actions to review rules adopted before the memorandum was issued but have not yet taken effect. Technically, the memorandum does not apply to independent agencies, such as the SEC; however, these agencies have the option to adhere voluntarily. Below is a summary of key investment adviser and investment company rules currently caught in the crosshairs of this freeze:

  • Advisers Act Marketing Rule – At the time of this newsletter’s publication, the Marketing Rule has not yet been published in the Federal Register. There is a possibility that either the acting or newly appointed SEC Chair may subject the rule to further review before letting it proceed.
  • Regarding rules published in the Federal Register that haven’t yet taken effect, the memorandum instructs department heads to consider postponing effective dates for 60 days from the memorandum’s publication. During this time, departments must consider opening a new 30-day comment period and may delay effectiveness further if they identify “substantial questions of fact, law or policy”. Rules impacting Advisers and Investment Companies in this category include:
    • SEC Derivatives Rule (Investment Company Act): Scheduled Effective Date February 19, 2021, and Compliance Date August 19, 2022.
    • CFTC Speculative Position Limits: Scheduled Effective Date March 15, 2021, and Compliance Dates ranging from January 1, 2022, to January 1, 2023.
  • The status of the Department of Labor’s ESG Rule is also unclear. While this rule became effective on January 12, 2021, President Biden could issue an executive order requesting the DOL review this new rule.

Firms affected by these rules should sit tight for now but be aware that some of the same people who dissented to their adoption are now in positions of greater power to influence their trajectory. As a result, there is a possibility for further delays as well as changes. In particular, advisers eager to implement the new Marketing Rule should remember that even after the rule becomes effective, a decision to comply with the rule ahead of the compliance date will require full compliance with all aspects of the rule. Contributed by Cari A. Hopfensperger, Managing Director.

For Broker-Dealers

FINRA Publishes 2021 Enforcement Priorities and Exam Findings Report. On February 1, FINRA published the 2021 Report on FINRA’s Examination and Risk Monitoring Program (“Report”). This Report is a change in FINRA’s normal approach as this publication replaces two of their typical annual publications: (1) the Report on Examination Findings and Observations and (2) the Risk Monitoring and Examination Program Priorities Letter. You will find a lot of the same priorities on this year’s Report as we have seen in previous years (i.e., Anti-Money Laundering, Best Execution, Cybersecurity, Private Placements, etc.). Some priorities that we haven’t seen in the last couple of years include: Books & Records; Business Continuity Planning; Consolidated Audit Trail (CAT); Large Trader Reporting; Net Capital; Regulatory Events Reporting; and Variable Annuities.

Not surprisingly, the COVID-19 Pandemic and Regulation Best Interest/Form CRS are playing a significant role in FINRA’s priorities for 2021. Although Communications with the Public is a common priority for FINRA, this year, they will likely be focusing on member firm’s digital communications to determine if they have reasonably designed programs to monitor, supervise, and retain those communications. Members should keep in mind that digital communications may include the use of video conferencing services/platforms like Microsoft Teams and Zoom. Looking for more information on this topic? Check out “The Rise of Slack, Teams, Hangouts, Stride and Other Instant Messaging Apps for the Remote Workforce – Are your Books and Records Practices up for the Challenge?” by Hardin consultant, Theresa Sekely. Contributed by Doug MacKinnon, Senior Compliance Consultant

FINRA Warns of Risks when Engaging in Low-Priced Securities Business. FINRA released Notice 21-03 reminding Members of certain risks associated with transactions in low-priced securities. The Notice provides information on how Members can enhance their controls for detecting, monitoring, and reporting fraudulent activities. Read-up on potential red flags and indicators of fraud involving low-priced securities based on FINRA’s recent observations, including schemes involving COVID-19 claims. Did you know the extent of a Member’s involvement in low-priced securities transactions (including soliciting customers, conducting offerings, and executing transactions in low-priced securities) could place the firm in a higher risk category and encourage FINRA to visit more often? That being said, it might be time for your firm to review its policies and procedures related to low-priced securities. Notice 21-03 and its predecessor, Notice 19-18, are good launching points. Contributed by Rochelle A. Truzzi, Managing Director.

For Commodity Pool Operators

CFTC Amends Form CPO-PQR. In October 2020, the CFTC adopted amendments to CFTC Regulation 4.27 which resulted in changes to its quarterly CPO filing, the CPO-PQR. Namely, the updated form will drop certain schedules and questions; will include a request for filers to provide Legal Entity Identifiers (LEIs) for CPOs and their pools; and will include a uniform reporting schedule which was previously for filers of different AUMs. The CFTC does not require a December 31, 2020 filing; however, the NFA Form PQR is still due on March 31 and will reflect the changes implemented on the CFTC’s parallel form. The NFA added a template for the new form, which can be reviewed on its website: NFA Form PQR. Contributed by Mark L. Silvester, Compliance Associate.

Photo Credit: Photo by Yan Ming on Unsplash.

Written by:

Hardin Compliance Consulting LLC

Hardin Compliance Consulting LLC on:

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