In November 2023, the U.S. Department of Labor 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). On March 8, 2024, the DOL sent the final rule to the Office of Management and Budget in the White House.

The first, and current, version of Prohibited Transaction Exemption (PTE) 2020-02 was effective in December 2020. In November of 2023, the DOL proposed amendments to PTE 2020-02 in connection with its proposed regulation expanding the definition of fiduciary advice to retirement investors—private sector retirement plans, participants in those plans, and IRA owners.

The proposed regulation will cause many more people and firms to be fiduciaries when they make “investment” recommendations to retirement investors. (I put the apostrophes around investment because the term, as used in the regulation, includes a range of services and types of products.)

When an investment recommendation is conflicted (that is, if the recommendation is accepted and implemented, it will financially benefit the advisor or the firm), the financial benefit is prohibited—literally prohibited. However, if there is an available exemption, and if the conditions of the exemption are satisfied, the transaction can proceed and the financial benefit can be retained.

PTE 2020-02, in both its current form and in the proposed amended version, provides relief to broker-dealers, investment advisers, insurance companies, and banks, and to the individuals who act on their behalf. While those individuals could be advisors or agents of any of those types of firms, this article uses “advisors” for ease of reading.

The proposed 2020-02 has changes from the current version. Some primarily affect the individual advisors (called “investment professionals” by the DOL) while others primarily affect the firms (called “financial institutions”). Both the investment professionals and the financial institutions are fiduciaries for purposes of satisfying the requirements of the exemption.

This article discusses the most significant changes that primarily affect financial institutions. My last post, Fiduciary Rule 26, covered the changes that will affect investment professionals.

For context, PTE 2020-02 imposes four sets of requirements—or, more technically, “conditions” — on investment professionals and financial institutions. However, the burdens of satisfying the different requirements of the PTE fall more heavily on one or the other. The conditions that must be satisfied are:

• The Impartial Conduct Standards: The most demanding of the Standards is the best interest standard of care, which is essentially a combination of ERISA’s duty of care (the prudent person rule) and duty of loyalty. This will fall primarily on the investment professional—to obtain the needed information and to evaluate it in order to make a best interest recommendation, but must be supervised by the firm.
• Written Disclosures: The disclosures will be written by the firm, but will likely be delivered by the investment professional when a fiduciary recommendation is made to a retirement investor.
• Policies and Procedures: The firm will develop the policies and procedures and will enforce them.
• Annual Retrospective Review and Report: The firm will conduct and document the review.

With that in mind, here are changes from the current version of the PTE to the proposed amended version:

• • Pure Robo Advice: The proposed PTE will extend its relief to pure robo advice services—where an individual advisor is not involved. Since there isn’t a person involved in providing the advice, the firm will be both the advisor and the financial institution and will need to satisfy all of the conditions.
  • Disclosures: The proposal added disclosure requirements. Firms will need to draft the disclosures for advisors to provide to retirement investors. Perhaps the most problematic is one that informs retirement investors of their right to request and obtain specific additional information about costs, fees and compensation associated with covered recommendations. Drafting the disclosure will be simple enough, but providing the additional information, if requested, will be more difficult. I imagine the burden to provide the information will, as a practical matter, fall on the firms.
  • Policies and Procedures: These requirements are similar to those in the current PTE. One new requirement is that the policies prohibit incentives—such as bonuses and contests—that “a reasonable person would conclude are likely to result in recommendations that are not in Retirement Investors’ Best Interest.” While not entirely clear, that suggests a two-step process. First, can the particular incentive be mitigated, or is it so great that it cannot? If it can be mitigated, the second step is to determine the proper mitigation technique. In prior guidance, the DOL has described some mitigation techniques. The SEC has also suggested similar mitigation techniques.
  • Annual Retrospective Review and Report: If the firm discovers a compliance failure when reviewing the prior year’s covered transactions, the PTE requires self-correction of the failure. (Self-correction is a complex subject for a future article.) If the failure is corrected on a timely basis (and otherwise done in a matter compliant with the PTE’s provisions, the relief provided by the PTE will, in effect, be reinstated. However, if the correction procedures are not timely or compliant, the failure will be a “non-exempt transaction,” meaning that it is a prohibited transaction. As a part of the certification of the review and report, a senior executive officer will need to certify that the firm has filed a Form 5330 with the IRS and paid the excises that are due. Note that the prohibited transaction still must be unwound and excise taxes and filing requirements will continue until it is corrected.
  • Eligibility: The proposed PTE greatly expands the “ineligibility” provisions. In effect, the DOL has the right to revoke the availability of the PTE to any financial institution or investment professional for enumerated violations of law or systematic failure to comply with the conditions in the PTE. This ineligibility provision extends to acts by affiliates, including oversees affiliates. If the DOL determines that a firm or an advisor is ineligible to use the exemption, that would, as a practical matter, mean that the firm or the advisor could not, for the period of ineligibility, make any covered recommendations, e.g., recommendations of rollovers from qualified plans. That would have serious financial consequences. For that reason, the eligibility provision in the proposal is sometimes referred to as a “death penalty.”

Concluding Thoughts

The proposed changes to PTE 2020-02 are limited, but at least two of them should be concerning to the broker-dealers, investment advisory firms, banks, and insurance companies who will need to rely on the PTE.

The first of those is the requirement to file the Form 5330 for failures that are not corrected promptly. While the DOL requirement is consistent with the filing requirements under the Internal Revenue Code, the penalty for failure to file will, if the PTE is finalized as proposed, make it clear that self-correction under the PTE has limits…in time, reporting and correction methods. In effect, it puts the spotlight on self-correction.

The changes to the eligibility provisions are concerning to many financial institutions. For example, there is concern that, if a foreign affiliate committed a felony under the law of another country, the US financial institution could lose its ability to make recommendations covered by PTE 2020-02. It remains to be seen if the final version of the PTE will have changes in response to industry comments.