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 continues a discussion of the definitions of investment and other property transactions 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 two articles, The New Fiduciary Rule (9) and The New Fiduciary Rule (10), discussed the first two definitions of covered recommendations in detail. Here are the first two definitions:  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;
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;

 In this article, I cover the third definition of covered recommendations…

3. 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.

This is obviously intended to require that rollover recommendations be subject to ERISA’s duty of care (the “prudent man rule”) and duty of loyalty. That is accomplished, for ERISA governed retirement plans and participants in those plans, through the ERISA duties and through the requirements in PTE 2020-02 (including its best interest standard of care) for investment advisers, broker-dealers, banks and trust companies, and insurance companies selling through their employees and statutory employees.

Under PTE 2020-02, the individual making the recommendation and the financial institution are co-fiduciaries.

For independent insurance agents, the same ERISA fiduciary standards apply to recommendations of plan-to-IRA rollovers. The independent agents are also subject to the best interest standard of care in PTE 84-24—because of the conflict of interest arising from the commission related to the rollover annuity. However, while the insurance agent is a fiduciary under 84-24, the insurance company will not be required to act as a co-fiduciary for the independent insurance agent.

In all cases, the individual making the recommendation will need the protection afforded by a prohibited transaction exemption because of the fees or commissions that will be earned from the rollover IRA–individual retirement account or individual retirement annuity.

To this point, this article has only discussed plan-to-IRA rollovers. But the DOL definition of a rollover is much broader than that. As the preamble to the proposed amended PTE 2020-02 explains:

This requirement extends to recommended rollovers from a Plan to another Plan or IRA as defined in Code section 4975(e)(1)(B) or (C), from an IRA as defined in Code section 4975(e)(1)(B) or (C) to a Plan, from an IRA to another IRA, or from one type of account to another (e.g., from a commission-based account to a fee-based account).

In other words, there are 5 definitions of “rollover”…plan-to-IRA, IRA-to-IRA, IRA-to-plan, plan-to-plan, and change of account type. The change of account type is interesting. For example, it could mean a change of account type within an IRA—brokerage to advised.

I will get into more details on “rollovers” in future articles, but for the moment I want to discuss the reference in the transaction definition to “distribution”.

A plan-to-IRA rollover necessarily involves a distribution, as the money must come out of the plan in order to be rolled over. But transactions based on distributions are not limited to rollovers. Covered transactions also include recommendations to take money out of a plan or an IRA to purchase securities, insurance products or other property outside of a plan or IRA. For those kinds of recommendations, the new proposals would impose a fiduciary standard on the recommendation to take a distribution (and the prudence of the distribution recommendation would likely be evaluated, at least partially, in light of the recommended investment for the withdraws money and the prudence of the recommended investment). That approach is suggested by the language in the definition:  as to whether to engage in the transaction, the amount, the form, and the destination of such a rollover, transfer, or distribution.

The DOL has stated its view on the “destination” even more emphatically in a preamble discussion of rollovers from plans to IRAs:

A fiduciary would violate ERISA’s 404 obligations if it recommended that a retirement investor roll the money out of the plan without proper consideration of how the money might be invested after the rollover.

Concluding Thoughts

While the Department of Labor has a number of reasons for issuing the proposed regulation and exemptions, it seems clear that an important reason, and perhaps the most important, is to provide protections for retirement investors when rollover recommendations are made. By and large, retirement savings are accumulated in a fiduciary “bubble-wrapped” environment inside ERISA governed retirement plans. However, when participants retire they typically go from those fiduciary protections (and perhaps institutional pricing) to the retail market in IRAs—where the pricing is typically higher and conflicts are more prevalent. This is an attempt by the DOL to extend as much of the fiduciary bubble-wrap to the decision to take money out of plans and to invest in IRAs. As the DOL explains in the preamble to the fiduciary proposal:

The treatment of rollover recommendations or advice under the 1975 rule has been a central concern in the Department’s regulation of fiduciary investment advice. The decision to roll over assets from a plan to an IRA is often the single most important financial decision a plan participant makes, involving a lifetime of retirement savings.

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The decision to roll over one’s retirement savings from an ERISA-covered employer-based plan into an IRA or other plan has significant consequences, and for many investors is the single most consequential advice they will receive and affects a lifetime of savings.