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 post discusses the “discretionary” definition of fiduciary investment advice in the DOL’s proposed fiduciary regulation.

In that regard, the proposal says:

(c) Investment advice. (1) For purposes of section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974 (the Act), section 4975(e)(3)(B) of the Internal Revenue Code (Code), and this paragraph, a person renders ‘‘investment advice’’ with respect to moneys or other property of a plan or IRA if the person makes a recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property (as defined in paragraph (f)(10) of this section) to the plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary or IRA fiduciary (retirement investor), and the person satisfies paragraphs (c)(1)(i), (ii), or (iii) of this section:

(i) The person either directly or indirectly (e.g., through or together with any affiliate) has discretionary authority or control, whether or not pursuant to an agreement, arrangement, or understanding, with respect to purchasing or selling securities or other investment property for the retirement investor;…

For context, if a fiduciary makes recommendations, but they are not implemented until the retirement investor agrees to the recommendation, that is “nondiscretionary” investment advice. (And is sometimes referred to as 3(21).) On the other hand, if the adviser can implement its investment decisions without approval by the retirement investor, that is “discretionary” investment advice, or management. (This is sometimes referred to as 3(38).)

In both cases, the adviser is a fiduciary subject to the prudent man rule and the duty of loyalty. However, there are significant differences in the treatment of financial conflicts of interest, which are “prohibited transactions” under ERISA and the Internal Revenue Code. As you might imaging, there are a few exceptions (or “exemptions”) to the prohibited transaction rules for discretionary investment management, due to the control exercised by the fiduciary adviser. For example, PTE 2020-02 only provides relief for financial conflicts resulting from nondiscretionary advice.

As I said earlier, this is not a controversial definition of a fiduciary adviser. That is largely due to the fact that it has been one of the definitions of fiduciary advice since 1975. For example, the current regulation has this definition:

(c) Investment advice.

(1) A person shall be deemed to be rendering “investment advice” to an employee benefit plan, within the meaning of section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974 (the Act) and this paragraph, only if:

(i) ….

(ii) Such person either directly or indirectly (e.g., through or together with any affiliate)—

• Has discretionary authority or control, whether or not pursuant to agreement, arrangement or understanding, with respect to purchasing or selling securities or other property for the plan;….

While the concept in the proposal is generally the same as in the current regulation, there are some differences that aren’t immediately obvious. Here is what the DOL said about the similarities and differences in the preamble to the proposal:

This proposed provision is similar to a provision in the 1975 rule that provides for investment advice fiduciary status if a covered recommendation is made and the person making the recommendation either directly or indirectly has ‘‘discretionary authority or control, whether or not pursuant to an agreement, arrangement, or understanding, with respect to purchasing or selling securities or property for the plan.’’ The proposal would broaden this provision by referencing securities or other investment property of the retirement investor, not just an investment through a plan or IRA.

Persons that have discretionary authority or control over the investment of a retirement investor’s assets necessarily are in a relationship of trust and confidence with respect to the retirement investor. Further, like the 1975 provision, the proposal would extend to circumstances in which the person making the recommendation ‘‘indirectly (e.g., through or together with any affiliate)’’ has discretionary authority or control over securities or other investment property; in this context, the use of ‘‘indirectly’’ generally refers to an arrangement in which an affiliate has discretionary authority or control.

In other words, if the adviser or an affiliate of the adviser has discretion over other non-retirement investments of a retirement investor, the DOL’s proposal says that the adviser is already in a relationship of trust and confidence with the retirement investor, and therefore any advice given to the retirement investor about retirement assets would be fiduciary advice. For example, if an adviser managed only personal assets of an investor, that adviser would automatically be a fiduciary for any recommendations made about retirement assets. That is an expansion of the definition in the current regulation. But it isn’t clear how impactful it would be since the proposal already defines one-time advice to a retirement investor as fiduciary advice.

Concluding thoughts

This definition is most likely to affect registered investment advisers since other types of financial professionals are limited in their ability to manage investments with discretion. However, the registered representatives of broker-dealers are permitted limited discretionary authority under the SEC’s Interpretation about solely incidental advisory services. The DOL has a more expansive definition of discretion which means that, on occasions, broker-dealers and their representatives could be discretionary fiduciaries. That could occur when they have limited discretion over investments in a customer’s IRA.

The next step in the regulatory process is for interested parties to file comments. Those must be filed by early January 2024 and will be posted on a DOL public website. At that point, we will be able to see if the modified definition is more controversial than I think.