Our recent blog post compared the SEC’s standard of conduct for broker-dealers under Regulation Best Interest (Reg BI) with the standard of conduct for registered investment advisers (RIAs) under the SEC’s Interpretation Regarding Standard of Conduct for Investment Advisers (the RIA Interpretation). Here, we add a comparison of the Department of Labor’s (DOL’s) proposed prohibited transaction exemption, which includes in the preamble an expanded interpretation of who qualifies as an investment advice fiduciary under ERISA and the Internal Revenue Code (the DOL Proposal).
|Terms Used in this Article
For purposes of this Article, the terms identified below have the following meanings:
Code – the Internal Revenue Code of 1986, as amended.
Code Fiduciary – an investment advice fiduciary for a Code Plan.
Code Plan – a non-ERISA tax-qualified plan (other than a governmental plan or non-electing church plan), IRA or other account subject to the prohibited transaction rules of Code Section 4975.
ERISA – the Employee Retirement Income Security Act of 1974, as amended.
ERISA Fiduciary – an investment advice fiduciary for an ERISA Plan.
ERISA Plan – a plan subject to the fiduciary and prohibited transaction rules of ERISA.
The DOL Proposal – A Proposed Prohibited Transaction Exemption
Implications of the New DOL Interpretation of Regular Basis
The DOL Proposal is a proposed prohibited transaction exemption (the Proposed PTE) to the ERISA and Code prohibited transaction rules. It would be available to a fiduciary who provides nondiscretionary investment advice that results in additional compensation to the fiduciary or an affiliate – i.e., a self-dealing transaction. In other words, it would be needed only if the broker-dealer, RIA or other Financial Institution (1) is a fiduciary under ERISA and/or the Code and (2) provides non-discretionary investment advice that results in a self-dealing transaction. As detailed in the chart below, the requirements of the Proposed PTE are modeled generally after Reg BI, but there are some differences.
Like the RIA Interpretation, the preamble to the DOL Proposal includes an interpretation component – namely, the DOL’s interpretation of investment advice fiduciary under the current 5-part test. Under the 5-part test, an investment advice fiduciary under ERISA and the Code is one who (1) provides advice about investments for a fee or other compensation (2) on a regular basis, (3) under a mutual understanding (4) that the advice will form a primary basis for the investment decision, and (5) that the advice is individualized based upon the investor’s particular needs. In its interpretation, the DOL greatly expands the scope of the 5-part test by providing a new interpretation of what constitutes a “regular basis.” The “regular basis” requirement is the part of the 5-part test that firms have commonly used to avoid fiduciary status. Under the DOL’s new interpretation, the “regular basis” requirement under the 5-part test exists if either:
- The adviser had a preexisting advice relationship with the investor, regardless of whether the prior advice was given in connection with retirement assets subject to ERISA and/or the Code or to other assets; in other words, the preexisting relationship would exist for both a preexisting ERISA Fiduciary adviser relationship and a preexisting non-ERISA financial advisory relationship OR
- The adviser establishes a new relationship that is the first step or is anticipated to be the first step in an ongoing advice relationship. (The DOL does acknowledge that merely executing a sales transaction at the customer’s request does not by itself confer fiduciary status unless an ongoing relationship is being established or is contemplated, e.g., an agent who receives trailing commissions for ongoing services with respect to an annuity.)
As a result, a firm that previously avoided status as a fiduciary under the regular basis requirement could now be considered an ERISA or Code Fiduciary with the attendant rules that flow from that status (i.e., standard of care for ERISA Fiduciaries and application of the prohibited transaction rules for both ERISA and Code Fiduciaries). Also, under this new interpretation, plan rollover recommendations to plan participants would, in most cases, result in fiduciary status under ERISA for the firm subject to ERISA’s standard of care and prohibited transaction rules. This is because the fiduciary receives additional compensation (e.g., the IRA advisory fee, commissions) that the fiduciary would not have received absent the investor accepting the recommendation. In that case, the conditions of the Proposed PTE would need to be met.
Current Impact of DOL Proposal
This new interpretation of “regular basis” in the preamble to the DOL Proposal is not a proposal of a new rule. Instead, it is the DOL’s interpretation of the 5-part test and is operative now.
On the other hand, the Proposed PTE is just that – a proposal. We do not know whether it will be adopted in its present form or significantly modified. The DOL is conducting hearings and one of our partners, Bradford Campbell, had the opportunity to testify at those hearings. During this interim period before the exemption is finalized, the DOL and the IRS currently have a Non-Enforcement Policy ( ) in effect for nondiscretionary investment advice that results in a self-dealing transaction, providing the investment advice fiduciary satisfies the Impartial Conduct Standards (i.e., a standard of care virtually identical to the ERISA standard of care, reasonable fee, no materially misleading statements). While this Policy is binding on the DOL and the IRS, it does not protect against private rights of actions that can be brought against plan fiduciaries under ERISA. As an alternative to the Non-Enforcement Policy, an investment advice fiduciary may rely on other available prohibited transaction exemptions, to the extent applicable, and those exemptions will continue to be available even if the DOL Proposal is adopted.
|DOL Proposal||Reg BI||RIA Interpretation|
|Who is subject to the standard?||Under the Proposed PTE, the standard would apply to investment advice fiduciaries (as determined under the DOL’s 5-part test applying the new interpretation of “regular basis”) who are Financial Institutions (an RIA, broker-dealer, bank, insurance company) and their representatives (an employee, independent contractor, agent or representative registered with the Financial Institution).
The Proposed PTE would not apply to others who give fiduciary investment advice, such as independent non-securities licensed insurance agents unless an insurance company undertakes to serve as the Financial Institution with respect to those agents.
|Broker-dealers and natural persons who are associated persons of a broker-dealer (together referred to here as a “broker-dealer”).||Both SEC- and state-registered investment advisers, as well as other investment advisers that are exempt from registration or subject to a prohibition on registration under the Investment Advisers Act, and their supervised persons.
Note that case law, statutes (such as ERISA) and state law may impose obligations on investment advisers as well.
As the chart indicates, the standards that apply to broker-dealers, RIAs and Code/ERISA Fiduciaries are harmonized under these rules. Yet, there are distinctions as to the scope of the standard, to whom it applies and the implications of noncompliance. Financial Institutions that have relied in the past on other prohibited transaction exemptions – such as PTE 84-24 (for annuity, insurance and certain mutual fund transactions), PTE 77-4 (for open-end affiliated mutual funds), PTE 86-128 (for brokerage commissions) – will need to evaluate whether the Proposed PTE, if finalized in its current form, is a more appealing option. These other prohibited transaction exemptions will continue to be available and will not be replaced by the Proposed PTE. Once the Proposed PTE is finalized, Financial Institutions will need to update policies and procedures to address these distinctions and develop training programs to promote compliance.
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