DOL Fiduciary Rule: The Odyssey Continues | Lord Abbett
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Retirement Perspectives

Biden’s Department of Labor surprisingly allowed the Trump-era rule to go into effect, but more guidance is likely coming down the road.

Read time: 6 minutes
 

There have been several years of uncertainty regarding when an investment advisor is deemed a fiduciary under Employee Retirement Income Security Act (ERISA). In 2016 the Department of Labor (DOL) issued a new fiduciary rule intended to replace the Five-Part Test in effect since 1975. The 2016 Rule generally broadened the definition of when a person is acting as a fiduciary. But the Obama-era regulation was later vacated by the Fifth Circuit Court of Appeals in 2018.

Where does the rule stand now?

 

The quest to define an investment fiduciary under ERISA continues. While the Biden administration let a Trump-era rule take effect, new regulations may be coming.

 

A new DOL rule took effect in February, but the DOL and the Internal Revenue Service (IRS) are both deferring compliance until December 20, 2021, as long as the "impartial conduct standards" are met. Essentially this means that a recommendation must adhere to a best interest standard, with no materially misleading statements and reasonable compensation.

Let’s focus on three main areas of impact for plan advisors, sponsors and retirement investors for the rule as it stands at the moment: the Five-Part Test, the prohibited transaction exemption and the current guidance on IRA rollovers.

1. The Five-Part Test Is Back

In a case of “what is old is new again,” the DOL issued a regulation that reinstated the 1975 Five-Part Test for determining when recommendations count as investment advice. Under this 1975 regulation, the person making the recommendation must meet the Five-Part Test. For advice to constitute “investment advice,” a financial institution or investment professional must:

  1. Render advice to the plan or IRA as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property,
  2. on a regular basis (under the Five-Part Test, for advice to be considered fiduciary investment advice under ERISA, it must be provided on a regular basis. The DOL has noted that one-time advice or sporadic advice generally would not satisfy the regular basis requirement.)
  3. pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary or IRA owner, that
  4. the advice will serve as a primary basis for investment decisions with respect to plan or IRA assets, and that
  5. the advice will be individualized based on the particular needs of the plan or IRA.

In a helpful fact sheet, the DOL noted that “All prongs of the 5-part test must be satisfied for a financial institution or investment professional to be an investment advice fiduciary when making a rollover recommendation,” with status as an investment advice fiduciary to be “informed by all the surrounding facts and circumstances.”

2.  The “Prohibited Transaction Exemption”

On December 18, 2020, the Department released PTE 2020-02, Improving Investment Advice for Workers & Retirees, a new prohibited transaction exemption (PTE) under ERISA and the Code for investment advice fiduciaries with respect to employee benefit plans and individual retirement accounts (IRAs). The exemption became effective February 16, 2021.

PTE 2020-02 offers broad relief allowing Registered Investment Advisers, broker-dealers, insurance companies, banks, and individual investment professionals who are their employees, permitting them to receive compensation as a result of providing fiduciary investment advice. Investment advice fiduciaries who rely on the PTE must render advice that is in the retirement investor’s best interest in order to receive compensation that would otherwise be prohibited in the absence of an exemption. Notably, PTE 2020-02 expressly covers otherwise prohibited transactions resulting from both IRA rollover advice and advice on how to invest the funds within an IRA.

PTE 2020-02 also requires investment professionals and the supervisory financial institution to provide a written acknowledgment they are fiduciaries under ERISA, with respect to fiduciary investment advice provided to retirement investor.

According to the DOL “Investment advice fiduciaries who rely on the exemption must render advice that is in their plan and IRA customers’ best interest in order to receive compensation that would otherwise be prohibited in the absence of an exemption, including commissions, 12b-1 fees, revenue sharing, and mark-ups and mark-downs in certain principal transactions.” 1

The DOL shared a helpful Q&A that can be found here.

How Will It Be Enforced?

In the Q&A the DOL stated that it intends to investigate and enforce compliance with PTE 2020-02 in connection with advice provided to ERISA plans. 

  • The DOL explained that it has investigative and interpretive authority with respect to ERISA plans, but, in contrast, only “interpretive authority” with respect to IRAs and other accounts subject to section 4975 of the Code, such as health savings accounts. Nevertheless, the DOL stated that its interpretive authority extends to determining whether the conditions of PTE 2020-02 have been met with respect to advice given to IRAs and other such accounts, and referring any violations to the Internal Revenue Service for enforcement. 1
  • To ensure that financial institutions provide reasonable oversight of investment professionals and adopt a culture of compliance, they will be ineligible to rely on the exemption if, within the previous 10 years, an investment professional was convicted of certain crimes arising out of the provision of investment advice to retirement investors. They will also be ineligible if they engaged in systematic or intentional violation of the exemption’s conditions or provided materially misleading information to the DOL in relation to their conduct under the exemption. 1
     

3.  Fiduciary Duty Toward Rollovers

The DOL rule expands the fiduciary duty for advisors handling retirement plan rollovers, a transaction historically treated as a one-time, nonfiduciary service. Why? The DOL views a recommendation to roll assets out of a 401(k) as the beginning of an advice relationship, one that would require advisors to act in a client’s' best interest. According to the Investment Company Institute households transferred $463 billion from employer-sponsored defined benefit or defined contribution plans (or both) plans to traditional IRAs in 2017. 2

As the DOL states: “Rollover recommendations are a primary DOL concern, as financial services providers often have a strong economic incentive to recommend that retirement investors roll assets out of ERISA-protected plans into one of their institution’s IRAs. The decision to roll over assets from a plan to an IRA is often the single most important financial decision a plan participant makes, involving a lifetime of retirement savings.” 1

According to the DOL fact sheet, advice pertaining to IRA rollovers will not necessarily trigger fiduciary status under the new paradigm, which states, in part: “Advice to take a distribution from an employee benefit plan and roll over assets to an IRA may be an isolated and independent transaction that would fail to meet the regular-basis prong of the Five-Part Test. On the other hand, advice to roll over employee benefit plan assets can occur as part of an ongoing relationship or an anticipated ongoing relationship that an individual enjoys with his/her advice provider.” 1

The DOL (FAQ-15) outlines factor’s financial institutions and investment professionals should “consider and document” in their disclosure of reasons a rollover recommendation is in a retirement investor’s best interest, including (but not limited to):

  • Alternatives to a rollover, including leaving money in the investor’s Employer’s plan, if permitted;
  • Fees and expenses associated with both the plan and IRA;
  • Whether the employer pays for some or all the plan’s administrative expenses; and
  • Different levels of services and investments available under the workplace retirement plan and the IRA.


Rollovers Are Still A Tricky Area

The DOL, in the PTE, specifically confirms that advice to take a distribution of assets from a retirement plan is, in fact, “advice to sell, withdraw, or transfer investment assets currently held in the plan, and therefore may be covered by the five-part test.” However, the DOL also noted that advice to take a distribution from a retirement plan and rollover assets to an IRA “may be an isolated and independent transaction that would fail to meet the regular-basis prong of 5-part test,” but that, on the other hand, “advice to roll over employee benefit plan assets can occur as part of an ongoing relationship or an anticipated ongoing relationship that an individual enjoys with his advice provider.” 1

Brad Campbell, a partner with Faegre Drinker, says advising on rollovers will continue to be a tricky area -- at least until the DOL clarifies it further. For example, will an advisor meet with the client again in the future to follow up on the rollover advice or transaction? Maybe. Or maybe not.

"If the answer is yes,” Campbell says, “We both intend to meet in the future, the DOL views it as an anticipated ongoing relationship.” He says "In other words, the beginning of an advice relationship that is fiduciary from the initial advice." 3

His colleague at Faegre Drinker, ERISA attorney Fred Reish says: “It will be more difficult than folks think to avoid fiduciary status for rollover recommendations.” 4   

What can we expect going forward?

So where are we on our quest to define an ERISA fiduciary? The answer is: We will wait and see. We will likely see more guidance from this administration once the DOL’s team is fully staffed under the new Secretary of Labor who took office in March.

Brad Campbell opines: "My guess is that things will probably sit as they lie for a while, while the new administration decides how to proceed," Campbell said. "Whether to do a new rule changing the 1975 regulation for what defines fiduciary advice or changing or eliminating the five steps. So, there's still other shoes to drop down the road potentially, but we probably are entering a period where there's some stability in the position the government's taking." 5

For their part, the DOL said it “anticipates taking further regulatory and sub-regulatory actions, as appropriate, including amending the investment advice fiduciary regulation,” among other steps. 6

Key Takeaways

  • The Fiduciary Rule in its current iteration primarily reinstated the Five-Part Test and introduced a prohibited transaction exemption, enabling advisors to be compensated by mutual funds they recommend, provided they render advice that is in their plan and IRA customers’ best interest. 
  • The rollover area is still somewhat of a grey area, but generally the DOL views a rollover recommendation as the beginning of an advice relationship.
  • Stay tuned for more guidance from the DOL, perhaps by the end of the year.

 

1 New Fiduciary Advice Exemption: PTE 2020-02 Improving Investment Advice for Workers & Retirees Frequently Asked Questions, U.S. Department of Labor, Employee Benefits Security Administration, April 2021

2 The Role of IRAs in US Households’ Saving for Retirement, 2020, ICI Research Perspective, January 2021

3 Hilton, John, “DOL Advice Rule Compliance Will Be ‘Heavy Lift’,  insurancenesnet, February 19, 2021)

4 Best Interest Standard of Care for Advisors #40, FredReish.com, March 9, 2021

5 Hilton, John, “DOL Advice Rule Compliance Will Be ‘Heavy Lift’,  insurancenesnet, February 19, 2021)

6 Schoeff, Mark, “DOL releases guidance on Trump-era fiduciary rule,” Investment News, April 13, 2021

 

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