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.

View the full bio for Fred Reish at the Faegre Drinker website.

Articles by Fred Reish:


Compensation Requirements under Proposed Amendments to PTE 2020-02

Broker-dealers and their registered representatives (advisors) providing services to private sector tax-qualified and ERISA-governed retirement plans, participants in those plans and IRA owners (collectively, Retirement Investors) are subject to a number of compensation rules.

ERISA’s fiduciary responsibility rules mandate that ERISA plans pay no more than reasonable compensation to service providers (including advisors).

In addition, the prohibited transaction rules that apply to Retirement Investors set limitations on compensation. For example, if a service provider receives compensation in excess of a reasonable amount, the excess is a prohibited transaction for both the plan fiduciary and the service provider. It is also a prohibited transaction if an advisor receives compensation that varies based upon the recommendation made (i.e., variable compensation) or third-party compensation as a result of the recommendation, unless a prohibited transaction exemption applies. Lastly, some prohibited transaction exemptions – like Prohibited Transaction Exemption (PTE) 2020-02 – have other limitations on compensation. This post focuses on the compensation limitations in the DOL’s proposed amendments to PTE 2020-02.

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The Proposed DOL Fiduciary Rule: Significant Changes for Advisers

Benefits and executive compensation partner Fred Reish and counsel Joan Neri coauthored an article for IAA Today on the proposed fiduciary rule issued by the Department of Labor (DOL).

The authors highlight key provisions of the proposal and the amendments to prohibited transaction exemption (PTE) 2020-02 that will potentially impact investment advisers. They also note that the next step is for the DOL to receive comments on the proposed changes and develop a final regulation, and they reasonably expect final rules in mid-year 2024.

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The Best Interest Standard for Recommending Account Types

Under Regulation Best Interest (Reg BI), the SEC imposes a best interest standard on account recommendations by broker-dealers.  This is because recommending an account type is viewed by the SEC as recommending an investment strategy involving securities.  The SEC imposes a similar best interest standard on registered investment advisers under the SEC’s Interpretation Regarding Standard of Conduct for Investment Advisers (the RIA Interpretation).

The DOL also imposes a best interest standard under its prohibited transaction exemption (PTE) 2020-02 (Improving Investment Advice for Workers & Retirees) (the PTE), which allows broker-dealers and their registered representatives to receive conflicted compensation resulting from non-discretionary fiduciary investment advice about a change of account types for a retirement plan or an IRA.

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Florida Court Decision’s Impact on Rollover Advice

Key Takeaways:

The Department of Labor (the DOL) expanded its interpretation of fiduciary advice in its guidance issued in connection with Prohibited Transaction Exemption (PTE) 2020-02. As a result, many more broker-dealers and registered representatives (advisors) became fiduciaries under ERISA and/or the Code for their recommendations to retirement investors, including rollover recommendations. Since fiduciary recommendations that result in transaction-based compensation are generally prohibited transactions, they will need the protection provided by complying with the conditions in PTE 2020-02.

A federal district court in Florida (American Securities Association (ASA) v. U.S. Department of Labor, Case No. 8:22-cv-330 (M.D. Fla. Feb. 13, 2023)) set aside the DOL’s expanded interpretation of fiduciary investment advice for rollover recommendations. At the time of writing this article, we do not know whether the DOL will appeal that decision.

However, the court did not change the regulatory definition of fiduciary advice and its application to advice to retirement plans or IRAs. Even if the expanded interpretation for rollover recommendations does not apply, where broker-dealers and their advisors provide ongoing advice to retirement investors they can still be fiduciaries for recommendations to IRA owners, plan fiduciaries and participants (and, in addition, under the DOL’s previous guidance can, in limited circumstances, still be fiduciaries for rollover recommendations). As a result, broker-dealers and their advisors will still need the relief provided by PTE 2020-02, including the best interest process it requires.

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The DOL’s New Fiduciary Rule: What We Can Expect

Key Takeaways:

The current DOL fiduciary rule says that a broker-dealer and its registered representatives (advisors) are fiduciaries to a plan under ERISA if a functional 5-part test is satisfied. This same 5-part test applies to determining whether an advisor is a fiduciary to an IRA under the Internal Revenue Code (the Code).

The DOL expanded its interpretation of fiduciary advice in the Preamble to PTE 2020-02 by re-interpreting one of the elements of that 5-part test. As a result, many more broker-dealers and their advisors are fiduciaries under ERISA and/or the Code for their recommendations to retirement investors, including rollover recommendations. While a recent decision by a Federal District Court in Florida set aside the DOL’s position on fiduciary status due to rollover recommendations, it did not change the 5-part test and its application to advice to retirement plans or IRAs. (We will discuss the impact of that holding on rollover recommendations in a future article.)

The DOL’s regulatory agenda indicates that in the near future, the DOL will be proposing a new fiduciary definition and proposing amendments to existing prohibited transaction exemptions (PTEs) to align with the proposed regulation. While we don’t know what the new regulation will say, we anticipate that, at the least, it will include the DOL’s expanded interpretation of fiduciary advice for rollovers (and might go beyond that). We also anticipate that many of the conditions in PTE 2020-02 will be included in the proposals for other exemptions, for example, in PTE 84-24.

Background

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Managing IRAs: Charging Different Fees for Different Investments

Key Takeaways:

Registered investment advisers, including dual registrant broker-dealers (collectively “advisers”) who provide discretionary investment management services to individual retirement accounts (IRAs), are fiduciaries under the Internal Revenue Code (the “Code”). While the Code does not have a fiduciary standard of care, it does have a duty of loyalty in the sense that most conflicts of interest are prohibited.

The Code prohibits an investment adviser fiduciary to an IRA from using its authority as a fiduciary to receive additional compensation. This means that an adviser with the authority to make asset allocation decisions in an IRA cannot charge a different fee for different investment categories (e.g., equities vs. fixed income) unless a prohibited transaction exemption is available. Alternatively, there are other compensation structures that can be considered.

 

Advisers who manage IRAs may have discretionary authority to determine the asset allocation among equities and fixed income assets based on the investor’s investment objectives, financial needs and circumstances. The fee charged for this service may be a level fee based on the value of all assets – equity and fixed income; in that case, there would not be a conflict that it was a prohibited transaction. But, let’s suppose the adviser wants to charge one fee for advising on the portion of the investor’s IRA portfolio that is allocated to equities, and a lower fee for the portion allocated to fixed income investments, and the adviser has the discretion to decide how much is allocated to equities and how much is allocated to fixed income. As explained later in this article, the allocation to the higher fees (that is, to equities) is an exercise of discretion that is a conflict and a prohibited transaction because it increases the adviser’s compensation.

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Rollover Recommendations – Do the SEC and DOL Requirements Align?

Key Takeaways

The SEC and the DOL have separately issued guidance on rollover recommendations – however, a close examination indicates that the guidance by both agencies is very similar. The SEC’s guidance for broker-dealers is in Regulation Best Interest and a recent Staff Bulletin on account recommendations. The DOL’s guidance about rollover recommendations came in the form of an expanded interpretation of fiduciary advice found in the Preamble to PTE 2020-02 and a set of Frequently Asked Questions. These pieces of guidance share the following three principles: (1) a best interest standard, (2) a process to support that best interest standard that requires consideration of relevant factors about the investor, the investor’s current retirement account and the recommended rollover account, and (3) documentation supporting the basis for the recommendation.

There are a few differences between the SEC and the DOL guidance that broker-dealers and their registered representatives should know about, including that the SEC rollover guidance is applicable to a much broader array of retirement plans and accounts, and also that the SEC guidance does not require a disclosure about the best interest reasons for the rollover recommendation as does the DOL under PTE 2020-02.

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16 “At One Blow” – The SEC Sanctions for Recordkeeping Failures

On September 27, 2022, the SEC announced that it had sanctioned 15 Broker-Dealers and one affiliated RIA for widespread recordkeeping violations of Section 17(a)(1) of the Exchange Act and Rule 17a-4(b)(4) thereunder resulting from the firms’ failure to maintain and preserve electronic communications. The SEC uncovered the misconduct after commencing a September 2021 sweep – a risk-based initiative to investigate the use of off-channel and unpreserved communications at broker-dealers. These firms agreed to the facts set forth in the SEC’s Order Imposing Remedial Sanctions and a Cease-and-Desist and agreed to pay total penalties of $1.1 BILLION and to implement improvements to their compliance policies and procedures.

The SEC Press Release advised that:

“Finance, ultimately, depends on trust. By failing to honor their recordkeeping and books-and-records obligations, the market participants we have charged today have failed to maintain that trust.”… As technology changes, it’s even more important that registrants appropriately conduct their communications about business matters within only official channels, and they must maintain and preserve those communications.”

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