Introduction

The Department of Labor (“DOL”) on October 31, 2023—Halloween—issued a release (the “Release”) proposing to make changes to the 1975 rule (the “1975 Rule”) defining when institutions and individuals are providing fiduciary “investment advice” to employee benefit plans that are subject to the Employee Retirement Income Security Act of 1974 (“ERISA”) or Section 4975 of the Internal Revenue Code of 1986 (the “Code”) such as private sector retirement plans and individual retirement accounts (“Plans”). The 1975 Rule sets forth a five-part test (the “Five-Part Test”) to determine when one is considered a fiduciary to a Plan through the provision of investment advice (“Investment Advice”).

Rebranded as a “retirement security” rule, as opposed to a “fiduciary” or “conflict of interest” rule, the Release represents the latest chapter in a 13-year effort to change the 1975 Rule. The Release also proposes important changes to several widely used prohibited transaction class exemptions (“PTCEs”). Thus, persons already operating as Investment Advice fiduciaries may face additional compliance requirements that should not be overlooked.

Déjà Vu (or Boo)? As Mark Twain said, history doesn’t repeat itself, but it does tend to rhyme. Those familiar with the DOL’s 2016 fiduciary rule (and accompanying exemptions)—vacated in 2018 by the Fifth Circuit (the “2016 Fiduciary Rule”)—may feel like they are experiencing a bit of déjà vu when reading the Release. This is because many of the concepts embedded in the Release’s proposed new definition, as well as changes to several existing PTCEs may seem eerily reminiscent of the 2016 Fiduciary Rule.

Principal Potential Commercial Impacts of the Release. The Release is voluminous and initial impressions are subject to revision after appropriate study. Nevertheless, we offer the following initial reactions—subject to revision and clarification—as to what we believe would be the principal commercial impacts of the Release.

• Broker-Dealers, Banks, Insurance Companies and Others.
  • Firms Dealing with the High Net Worth Individual and Retail Plan Market.
    • Firms having rollover interactions without reliance on PTCE 2020-02 may find it harder to continue to do so. Firms that recommend rollovers from retirement Plans to individual retirement accounts (“IRAs”) that do not currently rely on PTCE 2020-02 with respect to such recommendations may now find they need to.
    • Firms not accepting fiduciary status in recommending any investment product or service may now find it harder to continue doing so. Firms that make recommendations to Plans concerning any product or service (not only securities, but also commodities, fixed annuities, investment funds and managed accounts) and do not currently rely on PTCE 2020-02 may find it more difficult to avoid Investment Advice fiduciary status.
      • Persons with titles such as “financial consultant,” “financial planner,” and “wealth manager” will likely find it more difficult to avoid being Investment Advice fiduciaries.
      • Written disclaimers will not control to the extent they are inconsistent with other communications, marketing materials, applicable law and other interactions.
    • Firms currently relying on PTCE 2020-02 may discover new compliance challenges. Firms that currently rely on PTCE 2020-02 (including with respect to rollovers) may need to carefully assess the new proposed changes and additional color provided by the DOL which may raise the bar on compliance.
      • Rollover Disclosure. Increased emphasis on rollover documentation and other challenges may apply under the amended PTCE 2020-02.
      • Changes to Model Fiduciary Acknowledgment. Amended PTCE 2020-02 would require an assertive fiduciary acknowledgment before any transaction (including any rollover) was effected in connection with recommendations offered in reliance on the exemption.
      • New Disclosure Requirements; Further Clarification on Conflicted Payments and Incentive Arrangements. The proposed changes would require additional disclosure such as a written statement of the “best interest” standard and enhanced fee disclosure provisions. In addition, the DOL has offered further color on what it believes may be inappropriate compensatory incentive structures.
      • Additional Requirement for Senior Executive Officer Certification. Amended PTCE 2020-02 provides that the senior executive officer’s annual retroactive review certification must include that the firm has filed (or will timely file) Internal Revenue Service (“IRS”) Form 5330 to report, correct and pay excise taxes relating to any non-exempt prohibited transaction discovered by the firm.
      • Expanded Disqualification Events. Amended PTCE 2020-02 would expand the situations in which a given institution could become disqualified from relying on PTCE 2020-02 if it or its affiliates (including those located abroad) engage in certain crimes. The expansion appears to take into consideration certain disqualifying events contained in controversial proposed amendments to PTCE 84-14, the so-called QPAM Exemption. In addition, engaging in a systemic pattern or practice of failing to correct (any) nonexempt prohibited transactions, failing to report those transactions to the IRS, and failing to pay the necessary excise taxes may also result in disqualification.
    • Robo-Advisors Permitted Under PTCE 2020-02. Robo-advice programs that had been excluded from coverage under PTCE 2020-02 would be covered.
    • One-Time Advice. Firms that offer "one-time advice" and who have historically taken the position that such "one-time advice" does not constitute a "regular basis" under the Five-Part Test may find it more difficult to avoid providing Investment Advice.
  • “Sell Side” Firms Dealing with the Institutional Plan Market. Investment banks, institutional broker-dealers, swaps dealers, futures commission merchants, and commercial banks may be impacted with regard to their interactions with Plan customers (whether directly or through an investment manager) unless they appropriately structure their relationship, inclusive of sales pitches, to avoid the provision of Investment Advice (i.e., clearly disclaim that they are not acting in the Plan’s best interest—and not communicate anything to the contrary). The DOL expressly declined to offer a “sophisticated investor” or “institutional” exception as it did in the 2016 Fiduciary Rule.
• Investment Managers and Advisors.
  • Managers and Advisors Using Affiliated Mutual Funds. (Unless acting as a discretionary manager). Advisors and platforms that offer affiliated open-end mutual funds under Investment Advice relationships (but not discretionary mandates) in reliance on PTCE 77-4 would be unable to do so.
  • Managers and Advisors Using Affiliated Broker-Dealers for Execution and Purchasing New Issues in Affiliated Underwritings. (Unless acting as a discretionary manager). Advisors and platforms that act as Investment Advice fiduciaries and that execute agency transactions in securities through themselves or through their affiliates and also earn commissions in reliance on PTCE 86-128 would no longer be able to do so. The Release would also revoke Parts III and IV of PTCE 75-1 for Investment Advice relationships, which some fiduciaries with broker-dealer affiliates rely on to permit fiduciary Plan accounts to purchase new issues in syndicates in which the affiliate participates or is a market maker.
  • Pitching New Business with Plan Clients; Interactions with Intermediaries. The expanded definition of “investment advice” in the Release may create challenges with respect to offering fiduciary (or other) products and services to Plan clients. In addition, investment manager personnel interacting with brokers and other intermediaries may face new challenges under the Release.

The Proposed Investment Advice Definition

As background, the Five-Part Test currently in effect confers Investment Advice fiduciary status when a person provides (1) individualized advice, (2) for a fee or other compensation, (3) on a regular basis, (4) pursuant to a mutual understanding and (5) where the advice will serve as a primary basis for the investment decision. The definition is by design facts and circumstances dependent.

The Release would eliminate the “regular basis,” “primary basis” and “mutual understanding” prongs and would confer Investment Advice fiduciary status pursuant to a two-prong test. The elements (and sub-elements) are listed below. An Investment Advice fiduciary is:

1. (a) person who makes a recommendation of any securities transaction or other investment transaction or any investment strategy involving any securities or any other investment property:

(i) as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, as to investment strategy, or as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA;

(ii) as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., account types such as brokerage versus advisory) or voting of proxies appurtenant to securities; and

(iii) as to rolling over, transferring, or distributing assets from a plan or IRA, including recommendations as to whether to engage in the transaction, the amount, the form, and the destination of such a rollover, transfer, or distribution.

(b) to a Plan, a Plan fiduciary, Plan participant, IRA, IRA owner or beneficiary, or IRA fiduciary (collectively a “Retirement Investor”)

(c) where the advice was provided “for a fee or other compensation, direct or indirect,”

and

2. The person provides investment advice where:

(a) the person either directly or indirectly (e.g., through or together with any affiliate) has discretionary authority or control, whether or not pursuant to an agreement, arrangement, or understanding, with respect to purchasing or selling securities or other investment property for the Retirement Investor;

(b) the person either directly or indirectly (e.g., through or together with any affiliate) 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

(c) the person making the recommendation represents or acknowledges that they are acting as a fiduciary when making investment recommendations.

There are a number of key observations that arise out of the breadth of this formulation and there also appear to be some (likely) unintended drafting issues. However, given the aims of this OnPoint to provide a brief overview, we will not discuss them here. That being the case, it is potentially instructive that the DOL states in the preamble that it believes there is no “purported dichotomy between a mere ‘sales’ recommendation to a counterparty, on the one hand, and advice, on the other, in the context of the retail market for investment products.” Relying on other regulators and other materials, they say, “sales and advice typically go hand in hand in the retail market.”

Proposed Changes To Prohibited Transaction Exemptions

The Release proposes changes to a number of PTCEs, some more widely used than others. Specifically:

• PTCE 2020-02. The Release would make a number of potentially noteworthy changes to PTCE 2020-02. These include proposed modifications and clarifications to the disclosure requirements, with some applying specifically in connection with rollovers and fee disclosure; new model "fiduciary acknowledgment" language that some may find more assertive than the model provided previously by the DOL; a statement in the operative language that it is not permissible for an investment professional to recommend that a Plan invest in the one of two options that is considered "worse" for the Plan but "better or more profitable" for the professional or the institution; changes to the language of the exemption that highlight certain impermissible incentive compensation structures (where intent, as well as impact, may play a role); additional requirements for the senior officer certification regarding reporting and correcting any non-exempt prohibited transactions discovered; and modifications that require that the recommendation not only involve no misleading statements but also that there be no omission of information that would be needed to prevent the information from being misleading. The DOL also offers additional color concerning its views on the use of sales volume and quota satisfaction as targets for certain rewards and offers a strong reminder that leveling of compensation at the individual professional level may not be sufficient where conflicts also reside at the institutional level. Amendments to PTCE 2020-02 would also expand the situations in which a given institution could become disqualified from relying on PTCE 2020-02 if it or its affiliates engage in certain crimes and adds that a firm could also be disqualified if it is found to have engaged in a “systemic pattern or practice of failing to correct prohibited transactions, report those transactions to the IRS on Form 5330 and pay the resulting excise taxes.” The expansion appears to take into consideration some of those disqualifying events contained in controversial proposed amendments to PTCE 84-14, the so-called QPAM Exemption.
• PTCE 77-4. The Release would propose to eliminate the ability to utilize PTCE 77-4 in Investment Advice relationships (but would be retained for discretionary mandates). PTCE 2020-02 would be the primary exemption that would apply in such cases. PTCE 77-4 currently allows a fiduciary to exercise its discretionary or advisory authority in respect of Plan assets under its charge to invest in affiliated open-end U.S. registered mutual funds. While PTCE 77-4 provides relief for so-called “secondary services” compensation, PTCE 2020-02 would presumably require that the receipt of such compensation be justified under that exemption’s standard of care and reasonable compensation requirements.
• PTCE 86-128. This exemption allows a fiduciary to execute agency transactions in securities for reasonable compensation with itself or through certain affiliates subject to certain conditions. The Release would similarly restrict the use of PTCE 86-128 to discretionary mandates so that PTCE 2020-02 becomes the primary pathway of exemptive relief in such cases.
• PTCE 75-1. The Release would also eliminate the ability of mutual fund purchases between fiduciaries and Plans (including IRAs) under PTCE 75-1, “Part II (2)” – with such transactions being now covered primarily under PTCE 2020-02 for Investment Advice relationships and PTCE 77-4 for discretionary mandates. In addition, the Release would revoke Parts III and IV of PTCE 75-1, which could limit Plan access in Investment Advice (but not investment management) relationships to offerings of new issue securities where the investment manager is related to a participating underwriter or a market maker. The Release would also make changes to Part V of PTCE 75-1. Part V of PTCE 75-1 covers certain extensions of credit in connection with the execution of securities transactions. The Release would permit an Investment Advice fiduciary to receive compensation if it extends credit to Plans to avoid a failed securities transaction. However, relief would only be available where the purchase or sale “could not have been caused” by the fiduciary or its affiliates.
• PTCE 84-24. This exemption offers relief to Plans buying insurance and annuity contracts or U.S. registered investment company securities so that insurance agents or brokers, pension consultants, and principal underwriters may receive compensation as a result of these purchases. The proposed amendments to PTCE 84-24 would appear to eliminate relief for non-independent producers and recommendations of annuities and other insurance products that are regulated as securities by the Securities and Exchange Commission (“SEC”) so that PTCE 2020-02 would become the primary exemption in those cases. PTCE 84-24 would be amended to allow relief only for “independent producers” with respect to recommendations of annuities or other insurance products that are not securities regulated by the SEC. Additional requirements would need to be satisfied in connection with Investment Advice associated with a rollover involving the purchase of an insurance product or annuity under PTCE 84-24 for those independent producers eligible for relief. There are also some additional proposed amendments that are intended to conform with certain requirements of PTCE 2020-02. ¹

Comment Period and Next Steps

Comments on the Release will be due 60 days after publication in the Federal Register, meaning the deadline for submission will fall on or around January 2, 2024. In addition, the DOL will hold a public hearing on the proposal 45 days after publication, which would fall on or around December 18. The DOL has provided at least 90 days for public comments on previous iterations of the fiduciary rule, and so it would appear that a similar time frame should be expected.

We would expect many financial services industry groups and Plan sponsors to participate in providing comments as they had done during the 2016 Fiduciary Rule process. We also provide comparisons of the proposed rule against the Five-Part Test, along with comparisons of PTCE 2020-02, PTCE 75-1, PTCE 77-4, PTCE 84-24 and PTCE 86-128 with their respective proposed changes.

Conclusions

The Release is voluminous, and as with other DOL efforts on the same subject over the past 13 years, potentially broad. The above only highlights a number of initial reactions as to market impacts. If the past is any guide to the present, it would not be surprising that an effort of this magnitude would not have a number of important—but as of yet—unforeseen impacts to financial services providers and Plans alike.

1) Additional changes are made for PTCE 80-83 and PTCE 83-1. These exemptions are less common and are being omitted from the discussion presently.