On December 18, 2020, the Department of Labor (DOL) published in the Federal Register a final prohibited transaction exemption for investment advice fiduciaries that effectively reinstates the DOL’s “five-part test” as set forth in its 1975 regulation defining investment advice fiduciaries under the Code and ERISA.
For advice to constitute “fiduciary investment advice” under the five-part test, a financial institution or investment professional that is not otherwise a fiduciary under an ERISA plan must:
- provide advice to the plan 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;
- on a regular basis;
- pursuant to a mutual agreement, arrangement, or understanding with the plan, or plan fiduciary;
- for which the advice will serve as a primary basis for investment decisions with respect to plan; and that
- the advice will be individualized based on the particular needs of the plan.
In addition to meeting all five tenets of the test, there must also be receipt of direct or indirect compensation to be considered fiduciary investment advice. The exemption also affirms that advice about rolling a distribution to an IRA or another plan can be considered fiduciary investment advice if the five-part test is met and the rollover is part of an ongoing investment relationship, even if the rollover is the first action of that relationship.
The final class exemption allows investment advice fiduciaries – registered investment advisers, broker-dealers, insurance companies, banks, and individual investment professionals that are their employees or agents – to provide a wider range of retirement options so long as they abide by the DOL’S Impartial Conduct Standards:
- A best interest standard. Investment advice must reflect the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use. Investment advice must be based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor. It must not place the financial or other interests of the investment professional or other party ahead of the interests of the retirement investor.
- A reasonable compensation standard. Any compensation received, directly or indirectly, by the financial institution, the investment professional, or their affiliates for their services, would not be permitted to exceed reasonable compensation within the meaning of section 408(b)(2) of ERISA and section 4975(d)(2) of the Internal Revenue Code.
- A best execution standard. Financial institutions and investment professionals are required to seek out the best execution of the investment transaction reasonably available per federal securities law.
- A requirement to make no materially misleading statements. Statements made to retirement investors by financial institutions or investment professionals concerning any transaction or “relevant matters” – fees and compensation conflicts of interest or other facts that may reasonably affect an investor’s investment decisions – must not be materially misleading at the time such statements are made.
These standards align with those found in the Securities and Exchange Commission’s (SEC) Regulation Best Interest (“Reg BI”), which went into effect on June 30, 2020. Reg BI applies to the code of conduct for broker-dealers and their staff when making recommendations to retail customers regarding securities transactions, investment strategies, asset rollovers, and other related business. Reg BI requires that these recommendations be based on a customer’s best interest.
The final exemption also includes the following requirements:
- Financial institutions must provide written disclosures to the investor prior to the transaction that acknowledge fiduciary status, describe the services being provided, and disclose any material conflicts of interest;
- To ensure compliance with the impartial conduct standards, financial institutions must establish, maintain, and enforce written procedures;
- When executing a rollover, financial institutions must document why the rollover is in the best interest of the investor;
- Annual reviews must be conducted to determine a financial institution’s compliance with the impartial conduct standards and include an annual certification from the institution’s CEO or equivalent officer.
The final exemption includes a corrective cure for violations that do not result in any losses to a retirement plan investor if the following conditions are met:
- The violation is corrected within 90 days of the date a financial institution knew (or reasonably should have known) about the violation.
- The DOL is notified within 30 days of correction.
- The violation and correction are documented in the annual compliance review.
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