On April 23, 2024, the U.S. Department of Labor (the “DOL”) promulgated a final rule, titled the “Retirement Security Rule” (the “Final Rule”), updating the definition of an “investment advice fiduciary” under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). In addition, the DOL issued final amendments to several prohibited transaction class exemptions (“PTEs”) available to investment advice fiduciaries, which together with the Final Rule seek to effectuate the DOL’s goal of requiring honest investment advice from investment advice fiduciaries to retirement investors. The updated fiduciary definition under the Final Rule and the amended PTEs will become effective on September 23, 2024, with a one-year phase-in period for certain conditions of the amended PTEs.
Fiduciary Definition
The framework for determining whether a person is an investment advice fiduciary has historically required that investment advice be provided to a retirement investor on a regular basis and pursuant to a mutual agreement, arrangement, or understanding that such advice will serve as a primary basis for investment decisions.
Under the Final Rule, a person will be an investment advice fiduciary for purposes of ERISA if (1) they make a recommendation of any securities transaction or other investment transaction or any investment strategy to a retirement investor for a fee or other compensation (direct or indirect), and (2) such recommendation arises in either one of the following contexts:
- The person either directly or indirectly (e.g., through or together with any affiliate) makes professional investment recommendations to investors on a regular basis as part of their business, and the recommendation is made under circumstances that would indicate to a reasonable investor in like circumstances that the recommendation:
- is based on review of the retirement investor’s particular needs or individual circumstances,
- reflects the application of professional or expert judgment to the retirement investor’s particular needs or individual circumstances, and
- may be relied on by the retirement investor as intended to advance the retirement investor’s best interest; or
- the person represents or acknowledges that they are acting as a fiduciary under ERISA with respect to the recommendation.
For purposes of the Final Rule, a “retirement investor” is defined as a plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary, or IRA fiduciary. “Recommendations” means recommendations as to:
- the advisability of acquiring, holding, disposing of, or exchanging securities or other investment property, investment strategy, or how securities or other investment property should be invested following a rollover, transfer, or distribution from a plan or IRA;
- the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements, or voting of proxies appurtenant to securities; or
- rollovers, transfers, or distributions of assets from a plan or IRA, including recommendations as to whether to engage in the transaction, the amount, the form and the destination of such a rollover, transfer or distribution.
Significant Changes
The investment advice fiduciary standard in the Final Rule has become narrower than initially anticipated:
- The DOL clarified that with respect to a person who becomes an investment advice fiduciary due to their representing or acknowledging that they are acting as a fiduciary under ERISA with respect to a recommendation, fiduciary status would apply only with respect to that recommendation and not with respect to every future interaction with the same retirement investor regardless of the circumstances.
- The Final Rule includes a paragraph specifically confirming that sales pitches and investment education can be provided without triggering ERISA fiduciary status. A key component of this consideration is whether a sales pitch is individualized to a retirement investor’s particular needs and circumstances.
Amendment to Exemption for Transactions Involving Investment Advice (PTE 2020-02)
PTE 2020-02 generally permits parties providing fiduciary investment advice to retirement investors to receive reasonable compensation in exchange for their services, which would otherwise be prohibited in the absence of an exemption. The final amendment to PTE 2020-02 broadens the exemption to cover additional transactions and revises certain conditions, including conditions relating to disclosure, recordkeeping, and ineligibility.
The amended PTE 2020-02 applies to covered transactions on or after September 23, 2024; however, there is a one-year phase-in period beginning on September 23, 2024. During this phase-in period, investment professionals may receive reasonable compensation if they comply with the Impartial Conduct Standards and the fiduciary acknowledgement requirement.
Required Disclosure and Fiduciary Acknowledgement
The amended PTE 2020-02 requires investment advisers to provide a written acknowledgement that the institution and the investment professional are providing fiduciary advice and are fiduciaries under ERISA. Furthermore, the amended PTE 2020-02 requires investment advisers to make certain additional disclosures regarding fees, scope of services, and conflicts of interest.
Impartial Conduct Standard
The amended PTE 2020-02 replaces the “best interest standard” for determining impartial conduct with the “Care Obligation” and the “Loyalty Obligation,” which, according to the DOL, are more consistent with the Securities and Exchange Commission’s Regulation Best Interest. Under the Care Obligation, 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 in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor. Under the Loyalty Obligation, the investment professional must not place the financial or other interests of the professional, their affiliate or related entity, or other party ahead of the interests of the retirement investor or subordinate the retirement investor’s interests to those of the professional, their affiliate, or related entity.
Policies and Procedures
Each investment adviser must establish, maintain, and enforce written policies and procedures prudently designed to ensure that the investment adviser and its investment professionals comply with the Impartial Conduct Standards and other exemption conditions. The policies must mitigate conflict of interests.
Specifically, investment advisers may not use quotas, appraisals, bonuses, special awards, differential compensation, or other similar actions in a manner that is intended, or that a reasonable person would conclude are likely, to result in recommendations that do not meet the Care Obligation or Loyalty Obligation. The investment adviser must provide their complete policies and procedures to the DOL within 30 days of a request.
Additionally, the investment adviser must continue to conduct a retrospective review at least annually that is reasonably designed to detect and prevent violations of and achieve compliance with the conditions of this exemption. The investment adviser must maintain records demonstrating compliance with PTE 2020-02 for a period of six years after the covered transaction.
Penalties
The amended PTE 2020-02 broadens the disqualification provisions to include convictions of certain affiliated entities and foreign convictions. Previously, an investment adviser or an investment professional was ineligible only upon a conviction for “crimes arising out of such person’s provision of investment advice” to retirement investors. Under the amended PTE 2020-02, however, a relevant conviction or final judgment that occurs on or after September 23, 2024, with respect to an entity in the same controlled group as an investment adviser would result in such investment adviser’s becoming ineligible to rely on PTE 2020-02 for a 10-year period.
The DOL’s Retirement Security Rule has broad implications for financial institutions, including investment advisers.
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