The U.S. Department of Labor has released its package of proposed changes to the regulation defining nondiscretionary fiduciary advice and to the exemptions for conflicts and compensation for investment recommendations to retirement plans, participants (including rollovers), and IRAs.

The proposed regulation redefines fiduciary status for “investment” recommendations. But what is an investment recommendation? The answer: More than you think.

This article begins a discussion of the definitions of investments and other property that, if recommended to a retirement investor (that is, a private sector qualified plan, participants in those plans, or IRA owners), will require satisfaction of the fiduciary standards and, in most cases, of the conditions of a prohibited transaction exemption.

My last article, The New Fiduciary Rule (9), quoted the three types of covered recommendations and discussed the first category in detail. Here is the first definition:  Recommendations…

1. 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;

In this article, I cover the second category of covered recommendations…The phrase ‘‘recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property’’ means recommendations:

2. 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;

Let’s break subparagraph (ii) down into its component parts: Recommendations about…

• the management of securities or other investment property;
• 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);
• voting of proxies appurtenant to securities.

Let’s look at each of those:

• the management of securities or other investment property;

  As explained in the preamble to the proposed fiduciary regulation, this is intended to cover a very broad range of recommendations to retirement investors about how they should “manage” the assets in the retirement accounts:  Recommendations as to investment management or strategy fall within the most straightforward reading of the statutory text. Accordingly, the proposed regulation makes clear that covered investment advice is not artificially limited solely to recommendations to buy, sell, or hold particular securities or investment property to the exclusion of all the other important categories of investment advice that investment professionals routinely provide.

  In effect, the DOL is saying that advisors, insurance agents, and others making recommendations about how to invest retirement accounts should not take a limited view of the rules applying only to buy, sell and hold recommendations, but instead should more broadly consider the possibility of any recommendations related to strategies or management of investments in retirement accounts as being fiduciary advice.

• investment policies or strategies, portfolio composition;

  Similarly, this provision is intended by the DOL to capture virtually all investment-related recommendations that otherwise satisfy the fiduciary definition. This could include, for example, the development of an investment policy statement, asset allocation strategies, the investments to populate the asset allocation, and recommendations about strategic or tactical allocations or strategies.

• selection of other persons to provide investment advice or investment management services;

  While it has been generally accepted that recommendations of discretionary investment managers (for compensation, e.g., a solicitor’s fee) could be fiduciary advice, the same is not true of recommendations of nondiscretionary investment advisers. The DOL has explicitly stated that recommendations of discretionary investment managers (and at least one court has agreed), I don’t remember any explicit statements by the DOL that recommendations of nondiscretionary advisers would be fiduciary advice. Nonetheless, this provision makes clear that, once these rules are finalized, both types of recommendations will be fiduciary advice, if the referral is compensated and if the other parts of the proposed definition of fiduciary status are satisfied.

• selection of investment account arrangements (e.g., account types such as brokerage versus advisory);

  This is consistent with the DOL’s thinking in the current version of PTE 2020-02 (and for that matter with the SEC’s thinking in Reg BI for broker-dealers and the SEC 2019 Interpretation for investment advisers). As such, it should not be viewed as new or novel.However, it would be helpful if the DOL provided additional guidance on the definition of an “account type” beyond the brokerage versus advisory example. The definition of account type can be quite broad. For example, are variable annuities, fixed indexed annuities, and fixed rate annuities three different account types or just one—annuities?  If I had to bet, I would say that they are three different account types.

  Here is how the SEC explained account types in a footnote to Reg BI: In addition to brokerage versus investment advisory accounts, there are also many options or account types within brokerage accounts. For example, brokerage accounts can include: Education accounts (e.g., 529 Plans and tax-free Coverdell accounts); retirement accounts (e.g., IRA, Roth IRA, or SEP–IRA accounts); and specialty accounts (e.g., cash or margin accounts, and accounts with access to Forex or options trading). Different brokerage accounts can also offer different levels of services, such as access to online trading, or can offer different products, for example, in higher dollar amount accounts (e.g., access to products with break-points).

  Arguably, any securities investment or strategy, insurance product with an investment component, or other property could be a different account type if it had materially different characteristics, different fees or costs, different tax attributes, different leverage, and so on.

I don’t think the provision about recommendations for proxy voting needs additional explanation, so I will end it here for Part 2 of the covered recommendations.

Concluding thoughts

In my opinion, the key point to be derived from the second definition of covered recommendations is that the DOL is taking a very broad approach to the types of recommendations that will be fiduciary in nature. In other words, for those types of recommendations to private sector retirement plans and participants in those plans. As a result, advisers and agents will need to engage in prudent processes to develop recommendations that are informed and in the best interest of the retirement investors.

While fiduciary recommendations to IRA owners are not subject to ERISA’s duties of care and loyalty, they are subject to the standards of the relevant regulator, e.g., the SEC, FINRA or state insurance regulators.

But, in most cases, that is probably not the final word. Since many recommendations can result in compensation to the person making the recommendation (e.g., a commission or a solicitor’s fee), the compensation will cause the recommendation to be a prohibited transaction, which means that the relief provided by PTE 2020-02 or PTE 84-24 will be needed. And both of those will require the use of a best interest process under the DOL’s proposals. In short, the best interest standard in the DOL’s PTE is a combination of ERISA’s prudent man rule and duty of loyalty.