The Department of Labor has returned to the Fiduciary Rule once again with its third attempt to provide a regulatory framework that protects retirement investors while not imposing unnecessary burdens on investment advisors and consultants.
Plan sponsors of 401(k) plans should be aware that the DOL will once again apply the historical “five-part-test” in evaluating whether 401(k) advisors are plan fiduciaries. The return of the five-part-test is the result of the Fifth Circuit invalidating the DOL’s 2016 version of the fiduciary rule, which had temporarily replaced the five-part-test. Under the “new-again” five-part-test, an investment advisor to a 401(k) plan or plan participant is deemed to be a plan fiduciary if the advisor makes investment recommendations on a regular basis pursuant to an agreement or understanding with the 401(k) plan or plan participant and the advisor’s recommendations serve as the primary basis for making the decision to invest in specific investment options. A 401(k) plan advisor determined to be a fiduciary under the five-part-test cannot receive variable compensation tied to a 401(k) participant’s investment decision (generally, referred to as conflicted compensation).
The historical problem for 401(k) plan sponsors/401(k) committees in managing investment fiduciaries under the five-part-test is that it was very hard to determine under the five-part-test whether a 401(k) advisor is a fiduciary. There were a couple reasons for this:
- It was very common to see 401(k) advisors disclaim their fiduciary status in their advisor agreement (thereby failing the agreement or understanding prong of the five-part-test).
- Investment advisors often characterized their services to the plan as consulting services, asserting that the plan sponsor/401(k) committee did not rely on their guidance as “the primary basis” for making investment decisions (thereby failing the primary basis prong of the five-part-test).
- Advisors working directly with plan participants regarding rollovers out of a 401(k) plan took the position that a rollover recommendation did not rise to the level of providing “regular” advice (thereby failing the regular basis prong of the five-part-test).
The DOL addressed these common defenses to fiduciary status in its recent guidance and largely debunked these arguments. The DOL observed the following:
- Statements disclaiming fiduciary status will not be determinative in applying the five part test, but will be a consideration in evaluating the understanding of the parties.
- The DOL will look at whether an advisor’s recommendation were “a” primary basis for the 401(k) committee or participant’s investment decision (not “the” primary basis for the investment decision).
- Even if an advisor makes only one recommendation, such advisor could be characterized as regularly providing investment advice if the recommendation is made as an interlude to a longer-term relationship (e.g., a recommendation to make a rollover out of a 401(k) plan and into an IRA at the beginning of an advisory relationship).
These clarifications of the five-part-test by the DOL will likely expand the types of 401(k) plan advisors who are fiduciaries to the plan or to a plan participant. In light of this guidance, plan sponsors/401(k) committees should review their agreements with service providers who participate in the investment decision making process. Plan sponsors should consider the following in reviewing these agreements:
- Does the advisor expressly acknowledge his or her fiduciary status with respect to the plan.
- Does the advisor regularly make recommendations to the 401(k) committee or participants that is “a” primary basis for making investment elections under the plan?
- Does the advisor provide guidance to plan participants regarding rollover decisions?
- Does the advisor agreement accurately reflect the role the advisor plays in the investment selection process.
If based on this review, the advisor acknowledges fiduciary status or under the circumstance may be a fiduciary under the five-part-test, the plan sponsor/401(k) committee should engage in a discussion with the advisor regarding the advisor’s compensation structure to determine if the advisor could be receiving conflicted compensation.