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 (including transfers).

When a person makes a “covered” recommendation to a “retirement investor” and the recommendation, when implemented, results in the person (or his or her firm or an affiliate) receiving additional compensation, a prohibited transaction (under the Code and/or ERISA) will occur.

A “covered” recommendation is one in which the person is a fiduciary (as defined in the proposed fiduciary recommendation) and the recommendation is about the investment of “qualified” or retirement accounts (as that is defined in the proposed regulation). Some of the covered investment recommendations include: Investing in securities, annuities or other property; rollovers; IRA transfers; withdrawals from retirement accounts; and investment strategies, policies and allocations.

The proposed regulation defines a “retirement investor” as a: …plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary or IRA fiduciary (retirement investor).

One of the conditions in the PTEs is that any compliance failures must be corrected and, if need be, the retirement investor must be made whole. This article is the third  in a series that discusses the correction requirements in the proposed amendments to PTEs 2020-02 and 84-24. This article focuses on the requirement to correct failures to comply with the conditions in the exemptions.

Corrections of violations of exemption conditions

Unfortunately, neither PTE (84-24 nor 2020-02) nor their preambles give us any examples of acceptable corrections. As a result, we are left to making educated guesses about how to correct failures. To compound matters, different failures could need significantly different corrections (and no correction may be available for some violations).

Here are some examples of failures and possible corrections:

Impartial Conduct Standards failures

• Receipt of excessive compensation.

  One of the requirements in the Impartial Conduct Standards is that the fiduciary (that is, the individual agent or advisor and the “financial institution” cannot receive more than reasonable compensation). But what if the compensation is excessive for the value of the services?

  This may be one of the easiest to correct….just put the excess amount (plus interest)  over the reasonable amount back into the plan, the participant’s account, or the IRA.

  Keep in mind, though, the DOL hasn’t said that works. That is just me trying to anticipate what the DOL will expect.

• Failure to engage in a best interest process to develop a recommendation.

  This one is more difficult. I think a good first step would be to gather the information needed for a best interest process and then prudently and loyally evaluate it. If it turns out that a best interest process would have supported the recommendation, perhaps no further correction is needed. However, the DOL could easily require that notification to, and consent from, the retirement investor was required.

  But what if the new best interest process concludes that the recommendation could not be supported? As a general premise, the participant (perhaps now an owner of a rollover IRA) basically needs to be put in the same position he or she would have been if the recommendation hadn’t been made and accepted. That is easy to say, but hard to do. For example, if the recommendation was a rollover recommendation, it is highly unlikely that the money can be rolled back into the plan. One example—and you, the reader, need to decide if this is realistic—would be to put the participant/IRA owner in a better position than he or she would have been in the plan. That could be accomplished, for example, by waiving advisory fees, reducing other costs, and adding services without additional cost.

  The DOL hasn’t said anything that supports this approach. But think about it. What else could be done?

  In PTE 84-24 the DOL does describe two corrections, but does not say which failures would need the corrections:

  Either the Independent Producer has refunded any charge to the Retirement Investor or the Insurer has rescinded a mis-sold annuity, canceling the contract and waiving the surrender charges;… (Emphasis added.)

  But how does an independent agent refund a commission…by making it an additional premium payment to the annuity?  Any payment directly to an IRA owner would be taxable and perhaps subject to an excise tax.

  A decision to rescind an annuity would probably be a joint decision by the insurer and the producer, which introduces some complexity. For example, the insurer would probably require that the commission be repaid to the insurance company. Another complexity is that the payment to the retirement investor would need to be deposited into an IRA to avoid taxation and possibly penalties.

Disclosure failures

• Failure to acknowledge fiduciary status and to describe best interest duties

  Assuming that the advisor/agent and the firm are in overall compliance, but made a mistake in this case, the obvious answer is to now provide the disclosures.

  But is that enough?

  The DOL may accept that as a correction or may require that the retirement investor acknowledge receipt of the disclosures and agree in writing that the recommended transaction is approved after receipt of the missing disclosures. The latter is the more likely to be a “safe” answer.

Policies and procedures failures

• Failure to implement and enforce the required policies and procedures

  The answer probably depends on the nature of the failure. For example, if the required policies and procedures are in place and generally satisfy the rules, but for a minor deficiency, or if they are implemented well except in a few cases, they violations can probably be corrected.

  In that case, the starting point for a correction would be to “re-do” the evaluation of the covered recommendations to ensure that they satisfied the conditions covered by the particular policies and procedures. If they did, then the violation may, in effect, be corrected.

  If not, then the particular covered transaction will need to be corrected.

  On the other hand, if the status of the implementation or enforcement of the policies and procedures is so far afield from the requirements, it is possible that the DOL will not allow self-correction and all compensation to the firm and the advisors/agents will be prohibited. In that case, that compensation will need to be restored (with missed earnings) to the affected retirement investors. In addition, a Form 5330 may need to be filed with the IRS and excise taxes may need to be paid.

Retrospective Annual Review and Report

• Failure to perform the review and report.

  While it almost defies imagination that some “financial institutions” would completely miss doing the review and report, it is possible that, at some point, it will happen. I don’t see a viable correction short of going back and doing it. But I don’t know if the DOL would accept that as a correction.

  On the other hand, if the review were, as a general matter, done well, but had some relatively minor deficiencies (e.g., not enough covered recommendations of a certain type were reviewed), the correction might be to do a more comprehensive review of the recommendations of that type for that year. If no failures were found in the more comprehensive review, that may be the end of the story.

Concluding Thoughts

As this article explains, there is little guidance about corrections. There are at least three morals to this story. The first is make sure that financial institutions are  fully in compliance with the requirements for policies and procedures and retrospective reviews. The second is to train advisors and agents on compliance with these rules and to monitor their performance. The third is, when it comes to corrections, make sure to get professional advice. We are in unchartered waters.