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

This article continues a discussion of the consequences of limited menus on the availability of the exemptions and the relief they provide for compensation resulting from the recommended transactions.

My last article The New Fiduciary Rule (12) focused on the DOL’s discussion in the preamble to PTE 2020-02 about restricted investment menus. As background, PTE 2020-02 provides relief for conflicts that are prohibited transactions resulting from investment and insurance recommendations to retirement investors (that is, to private sector retirement plans, participants in those plans, and IRA owners).

PTE 2020-02 provides relief to investment advisers, broker-dealers, banks and trust companies, and insurance agents and companies. Sales of insurance products though agents that are employees or statutory employees of insurance companies and sales of insurance products that are securities (e.g., variable annuities) are under PTE 2020-02. However, sales of non-securities annuities by “independent producers” and the insurance companies issuing those insurance products can elect to use PTE 84-24 instead of 2020-02. Why would they do that? Because under PTE 2020-02 the insurance company must be a co-fiduciary with the agent, but under 84-24 the insurance company is not a co-fiduciary. Under the proposed amendments to 84-24, though, the insurer has heightened oversight responsibilities. Future articles will go into more detail about these requirements.

This article continues the discussion in my last article about restricted menus and whether best interest recommendations can be made from restricted menus of options available to advisors or agents.

PTE 2020-02 specifically explains when restricted menus can be used and what must be done if they are used. However, there is a hole in PTE 84-24. That hole is that 84-24 doesn’t mention restricted, or limited, menus of available options. In other words, we are left to guess about the DOL’s thinking on a limited menu of, e.g., fixed rate and fixed indexed annuities for retirement investors.

Unfortunately, the more general language in the 84-24 proposal is susceptible of conflicting interpretations.

First, the preamble says:

For example, in choosing between annuity products offered by Insurers whose products the Independent Producer is authorized to sell, the Independent Producer may not recommend a product that is worse for the Retirement Investor but better or more profitable for the Independent Producer or Insurer.

While not explicit, that suggests that an independent producer only needs to look at the annuities that the producer has available to sell.

On the other hand, an independent producer is required to give a written disclosure to retirement investors similar to this model language:

When we make investment recommendations to you regarding your retirement plan account or individual retirement account, we are fiduciaries within the meaning of Title I of the Employee Retirement Income Security Act and/or the Internal Revenue Code, as applicable, which are laws governing retirement accounts. The way we make money creates some conflicts with your interests, so we operate under a special rule that requires us to act in your best interest and not put our interest ahead of yours. Under this special rule’s provisions, we must:

• Meet a professional standard of care when making investment recommendations (give prudent advice);
• Never put our financial interests ahead of yours when making recommendations (give loyal advice);
• Avoid misleading statements about conflicts of interest, fees, and investments;
• Follow policies and procedures designed to ensure that we give advice that is in your best interest;
• Charge no more than is reasonable for our services; and
• Give you basic information about conflicts of interest.

You can ask us for more information explaining costs, fees, and compensation, so that you may make an informed judgment about the costs of the transaction and about the significance and severity of the Conflicts of Interest. We will provide you with this information at no cost to you.

While not clear, that language (and particularly the bolded provisions) at least suggests that an independent agent cannot recommend an annuity product that is not competitive with other products in the marketplace. In other words, if a retirement investor’s profile supports the need for an annuity and if an agent has a limited menu of annuity options, the language could be read to suggest that, unless that limited menu included a product that a prudent process would support, an agent acting as a fiduciary and in the best interest of the investor could not sell a lesser product to the investor.

Also, it seems illogical that a statutory employee agent selling a fixed indexed annuity under PTE 2020-02 would be subject to the limited menu rules, while an independent producer selling under PTE 84-24 would not.

The purpose of this discussion is not to say what the “right” answer is. Instead, it is to point out the lack of clarity in the requirements. That lack of clarity makes it difficult to advise clients about compliance with the requirements in the exemptions.

To compound matters, there is little helpful guidance on what a prudent process should look like for the evaluation of annuity contracts. Most of the guidance and industry experience is tailored to securities-based products such as mutual funds. For example, a common factor in a prudent process is the consideration of the costs of competing products or services. However, costs are embedded in products such as fixed rate and fixed indexed annuities. How should the costs be identified and quantified? What should the costs be compared to? Costs are more obvious in products such as mutual funds, and they are databases and other sources of information that can be used for the analysis. As a practical matter, it seems likely that there will be similar services in the future for evaluating annuities—both qualitatively and quantitatively.

Concluding Thoughts

If the fiduciary regulation and PTE 84-24 become final rules, independent producers will become fiduciaries for annuity sales in connection with transfers of IRAs and rollovers from ERISA and tax-qualified retirement plans. In that case, those producers will need to engage in prudent processes to determine whether a retirement investor should purchase an annuity and, if so, which type of annuity is appropriate for the particular investor and which annuity product is in the best interest of the investor.

There is a need for guidance on the processes to be used by those producers and the conditions, if any, attached to limited menus of annuity options.