What Broker-Dealers Need to Know About Correcting PTE 2020-02 Mistakes

Key Takeaways

The DOL expanded its interpretation of fiduciary advice in the Preamble to PTE 2020-02 and as a result, many more broker-dealers and their registered representatives (investment professionals) are fiduciaries for their recommendations to retirement investors, including rollover recommendations. Therefore, they will need the protection provided by PTE 2020-02. The PTE contains a number of conditions and if those conditions are not met, a prohibited transaction will result.

The good news is that the PTE provides a self-correction process. Unfortunately, some conditions of the self-correction process are difficult to interpret and additional DOL guidance is needed.

To avoid these challenges, broker-dealers should implement good processes and documentation to satisfy the PTE conditions and closely supervise their investment professionals to ensure that the processes are followed.

Background

As we have discussed in previous posts, the DOL’s prohibited transaction exemption (PTE) 2020-02 (Improving Investment Advice for Workers & Retirees), (the “PTE”) allows broker-dealers and their registered representatives (investment professionals) to receive conflicted compensation resulting from non-discretionary fiduciary investment advice to private sector tax-qualified and ERISA-governed retirement plans, participants in those plans, and IRA owners (collectively, “retirement investors”). Also, in the Preamble to the PTE, the DOL expanded its interpretation of fiduciary advice. As a result of that expanded interpretation, many more broker-dealers and their investment professionals are fiduciaries for their recommendations to retirement investors – including rollover recommendations – and therefore will need the protection provided by the PTE.

The PTE contains a number of conditions and if those conditions are not satisfied, the compensation that the broker-dealer earns from the recommendation – for example, commissions or 12b-1 fees on IRA investment transactions, in the case of a rollover – is a prohibited transaction.  Most of the PTE’s requirements became effective on February 1, 2022, and some broker-dealers are already discovering compliance issues because of failures to meet all of the PTE’s conditions. For example, we have seen the following kinds of PTE failures:

  • Failing to provide an adequate and/or timely acknowledgement of fiduciary status under ERISA and the Internal Revenue Code.
  • Failing to recognize that the PTE is needed for recommending a transfer from an existing IRA with another firm to an IRA with the broker-dealer.
  • Failing to disclose that plan to IRA rollover recommendations and IRA to IRA transfer recommendations are conflicts of interest.
  • Failing to disclose the specific reasons why the plan to IRA rollover or IRA to IRA transfer is in the investor’s best interest. (This condition went into effect July 1, 2022).

The good news is that the PTE provides a self-correction process.

The PTE Self-Correction Procedures:

Fortunately, if the self-correction process in the PTE is satisfied, the failure will not be treated as a prohibited transaction. The PTE self-correction process has the following four requirements:

  1. The failure did not result in investment losses to the retirement investor or if losses did result, the broker-dealer made the retirement investor whole.

    This condition is challenging because the DOL has not provided guidance about the meaning of “investment loss”.  On the one hand, it is not likely that the DOL expects the firm to cover a loss resulting from normal market fluctuations, as long as the investment professional prudently selected the investments in the rollover IRA and they were reasonably priced.  On the other hand, it’s possible that “investment loss” could refer to the increased fees and costs that may result in the rollover IRA. And, if so, this raises the issue of whether the correction should include the ongoing effect of the higher expenses that will continue year-after-year.

  2. The broker-dealer corrects the violation and notifies the DOL of the violation and correction via email to IIAWR@dol.gov within 30 days of correction.

    This condition requires correcting the violation and the DOL has not provided specific details about how to correct failures to comply with the different conditions in the PTE. Correcting a prohibited transaction typically requires that the retirement investor be restored to the position he or she would have been in had the prohibited transaction not occurred. However, in a rollover context, this would mean unwinding the rollover — and since plans do not accept returns of rollovers from former employees, it is not likely that this is what the DOL had in mind. Also, what if there are systemic failures? For instance, suppose that the firm’s rollover disclosure form was deficient and did not contain a conflict of interest disclosure – –  that a rollover recommendation is a conflict because of the compensation that will be earned from the rollover IRA.  Applying a reasonable interpretation, it is likely that the DOL would expect the correction to consist of providing the conflicts disclosure to all participants and/or IRA owners who implemented the recommended rollovers and would want to be notified of this failure.  That then raises the issue of the consequences of a retirement investor then objecting to the rollover.  The correction in that case is not clear and broker-dealers should work with ERISA counsel to determine the appropriate correction.

  3. The correction is made no later than 90 days after the broker-dealer learns of the violation or reasonably should have learned about it.

    To satisfy this condition, broker-dealers should closely supervise and review the procedures for rollover recommendations and other recommendations requiring PTE relief.  This will enable the broker-dealer to discover the error and remedy it in a timely manner.

  4. The broker-dealer notifies the person responsible for conducting the retrospective review during the relevant review cycle and the violation and correction is specifically set forth in the written report.

    Broker-dealers can satisfy this condition by ensuring that the supervisory procedures identify the person responsible for conducting the retrospective annual review (usually the Chief Compliance Officer) and by training investment professionals and supervisors to report PTE failures and corrections to that person.

Conclusion

With these conditions in mind, broker-dealers should review and modify their supervisory procedures, as needed, to reflect compliant processes and documentation for rollover recommendations and other recommendations requiring relief through the PTE.  This should be coupled with training of their investment professionals and close supervision of covered recommendations to ensure that the processes are  followed, and to timely identify and correct failures under the PTE’s self-correction process.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

About the Author: Fred Reish

Fred Reish represents clients in fiduciary issues, prohibited transactions, tax-qualification and Department of Labor, Securities and Exchange Commission and FINRA examinations of retirement plans and IRA issues.

About the Author: Joan M. Neri

Joan Neri represents plan service providers – including broker-dealers and registered investment advisers – and employer plan sponsors and counsels them on fulfilling their obligations under ERISA and complying with the Internal Revenue Code rules governing retirement plans and accounts. Joan advises on ERISA fiduciary status and responsibilities, avoidance of prohibited transactions, the considerations associated with structuring, developing and offering investment products and services to ERISA plans and day-to-day plan operational compliance issues.

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