The US 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.

This article discusses the DOL’s proposed definition of nondiscretionary advice and the comments in the preamble about relationships of trust and confidence.

First, here is what the definition is. A person is a fiduciary under ERISA and the Internal Revenue Code if:

The person either directly or indirectly (e.g., through or together with any affiliate) makes investment recommendations to investors on a regular basis as part of their business and the recommendation is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest;…

I think that the DOL is relying on:

• The advisor needs to be in the business of providing investment recommendations to investors on a “regular basis;”
• The investment recommendation reasonably appears to be individualized to the needs and circumstances of the particular retirement investor; and
• The circumstances indicate that the recommendation could be relied upon for investment decisions that are in the best interest of the retirement investor.

Ultimately, the courts will decide if those three criteria properly define a relationship of trust and confidence.

The DOL clearly contemplates that the financial services industry will push back and challenge the regulation in court. That is evident from these comments in the preamble to the proposed regulation:

• On March 15, 2018, however, the U.S. Court of Appeals for the Fifth Circuit (Fifth Circuit) overturned a district court’s decision upholding the validity of the 2016 Final Rule and vacated the 2016 Rulemaking in toto, in Chamber of Commerce v. United States Department of Labor (Chamber). The Fifth Circuit held that the 2016 Final Rule conflicted with ERISA section 3(21)(A)(ii) and Code section 4975(e)(3)(B). Specifically, the Fifth Circuit found that the 2016 Final Rule swept too broadly and extended to relationships that lacked ‘‘trust and confidence,’’ which the court stated were hallmarks of the common law fiduciary relationship that Congress intended to incorporate into the statutory definitions. The court concluded that ‘‘all relevant sources indicate that Congress codified the touchstone of common law fiduciary status—the parties’ underlying relationship of trust and confidence—and nothing in the statute ‘requires’ departing from the touchstone.’’
• [Referring to the five-part test in the current regulation:] These components of the five-part test are not found in the statute’s text, and in today’s marketplace, undermine legitimate investor understandings of a professional relationship centered around the investor’s best interest. In other words, there are currently many situations where the retirement investor reasonably expects that their relationship with the advice provider is one in which the investor can (and should) place trust and confidence in the recommendation, yet which are not covered by the current regulation. This proposal attempts to reconcile the regulatory text with the both the reasonable expectations of the retirement investor along with the statutory text and purpose.
• The Department’s proposal is also intended to be responsive to the Fifth Circuit’s emphasis on relationships of trust and confidence. The current proposal is much more narrowly tailored than the 2016 Final Rule, which treated as fiduciary advice, any compensated investment recommendation as long as it was directed to a specific retirement investor regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA. In contrast, the proposal provides that fiduciary status would attach only if compensated recommendations are made in certain specified contexts, each of which describes circumstances in which the retirement investor can reasonably place their trust and confidence in the advice provider. The Department believes the approach in this proposal is consistent with the statutory definition that applies fiduciary status on a functional (and therefore, transactional) basis.
• The current proposal bases investment advice fiduciary status on circumstances that indicate the retirement investor may place trust and confidence in the recommendation as a professional recommendation based upon the particular needs of the investor. The proposal reflects the Department’s interpretation of the text of the statute, as informed by the Fifth Circuit’s emphasis on relationships of trust and confidence. Accordingly, the proposed definition, unlike the 2016 Final Rule, does not automatically treat as fiduciary advice all compensated recommendations directed to a specific retirement investor regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

While each reader can decide if the DOL’s thinking and position is consistent with a relationship of trust and confidence, the courts will be the ultimate arbiters. In reading this, though, keep in mind that these quotes represent the thinking of one side to the upcoming dispute. In due course, we will also see the detailed legal analysis by those opposing this proposed interpretation.

While the new regulation is only proposed at this time, it is likely that the final regulation, which can be expected in the summer of 2024, will likely be similar. At that point, one or more lawsuits will likely be filed by the securities and insurance industries. It is entirely possible that this will go all the way to the Supreme Court. In that case, advisor and agents; insurance companies, broker-dealers and investment advisers will have been covered by, and in compliance with the new rules for several years. Such is the way of the legal world.

Concluding thoughts

The purpose of this article is not to agree or disagree with the DOL’s arguments. Instead, it is to inform readers that the DOL has anticipated a legal challenge to its regulatory positions and has set the stage for its arguments to the courts. In a sense, the battle lines are drawn and it is likely that we are in for years of litigation and appeals on the validity of the regulation, once finalized.