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 advice to plans, participants (including rollovers), and IRAs (including transfers).

This post discusses the “non-discretionary” definition of fiduciary investment advice in the DOL’s proposed fiduciary regulation. The other two definitions of fiduciary status are covered by my posts The New Fiduciary Rule (5) and The New Fiduciary Rule (6).

This definition is a material change from the current regulation because it eliminates the 5-part test for non-discretionary investment advice (including the requirement that advice be given to the particular retirement investor on a “regular basis”). In other words, one-time advice recommendations can be fiduciary advice under this definition.

The proposed definition of non-discretionary fiduciary investment advice says that a person will be a fiduciary 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.

To dissect the definition, there are 3 parts:

• The financial professional must be in the business of making recommendations to investors on a regular basis. Note that it does not say “recommendations to retirement investors,” but more broadly covers recommendations to any investors. In other words, this definition does not require that recommendations be made to the particular retirement investor on a “regular basis.”
• The circumstances indicate that the recommendation is based on the particular needs or individual circumstances of the retirement investor. That should be easily satisfied for retail investors (g., IRA owners and plan participants) because the SEC’s guidance for broker-dealers and investment advisers requires development of investor profiles and NAIC model regulation #275 has a similar requirement.
• The circumstances indicate that the recommendation may be relied upon by the retirement investor for investment decisions that are in the best interest of the retirement investor. Again, this should be satisfied in most cases for retail investors because the SEC and NAIC have adopted best interest standards for investment advisers, broker-dealers and insurance agents (for recommending annuities).

In the preamble to the proposal, the DOL explains its thinking about this proposed definition:

• Regular basis:

  The proposed provision applies only to advice rendered by a person who makes investment recommendations to investors ‘‘on a regular basis as part of their business.’’ As compared to the ‘‘regular basis’’ prong of the 1975 regulation, which the Department believes can work to undermine the current reasonable expectations of retirement investors, this proposed provision is properly focused on whether the advice provider is in the business of providing investment recommendations. The proposal’s updated regular basis requirement avoids concerns that the rule could sweep so broadly as to cover, for example, the car dealer who suggests that a consumer finance a purchase by tapping into retirement funds. Retirement investors would not typically view such persons as making investment recommendations based on the retirement investors’ individual financial interests, and the rule would not treat them as fiduciaries. Similarly, the human resources employees of a plan sponsor would not be considered investment advice fiduciaries under the proposed regulatory definition, because they do not regularly make investment recommendations to investors as part of their business.

  However, the proposal’s regular basis requirement would not defeat legitimate investor expectations by automatically excluding one-time advice from treatment as fiduciary investment advice. For example, the proposed rule would treat an insurance agent’s recommendation to invest a retiree’s retirement savings in an annuity as fiduciary advice if the agent regularly makes investment recommendations to investors, and the circumstances indicate that the recommendation is based on the retiree’s particular needs and circumstances and may be relied upon for making an investment decision that is in the investor’s best interest.

• Particular needs or individual circumstances and reliance on best interest:

  The preamble explains that the proposed regulation: …provides that, to count as fiduciary advice, the recommendation must be 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.’’

  This provision of the proposal is similar to, but improves upon, the parts of the 1975 regulation that require a ‘‘mutual agreement, arrangement or understanding’’ that the advice will serve as ‘‘a primary basis’’ for the retirement investor’s investment decisions. Instead of the ‘‘mutual agreement, arrangement, or understanding’’ requirement—which over time has encouraged investment professionals to hold themselves out as trusted advisers while disclaiming fiduciary status in the fine print—the proposal would focus on the objective ‘‘circumstances’’ surrounding the recommendation, including how the investment professional held themselves out to the retirement investor and described the services offered. The Department believes that the proposed language will better avoid loopholes and fine print disclaimers, while properly focusing on a reasonable understanding of the nature of their relationship.

Comment: The language about “objective circumstances” of the recommendation means that the standard is not subjective—that is, it is not what an advisor or agent and the retirement investor think—but objective, that is, what would a reasonable third person observing the conversations and communications think? Was the advice individualized or personalized? Did the circumstances indicate that the retirement investor could reasonably believe that the recommendation was being made in the investor’s best interest?

Concluding thoughts

This is the definition that will most impact fiduciary status and therefore require the use of one of the prohibited transaction exemptions–PTE 2020-02 for investment advisers, broker-dealers, and insurance companies with statutory employee agents, and PTE 84-24 for independent insurance agents and the insurance companies issuing the annuities they sell.

This non-discretionary fiduciary advice provision will be the subject of many articles to follow, but this article is an introduction to the definition.