U.S. Department of Labor Proposes New Fiduciary Rule

On October 31, 2023, the U.S. Department of Labor (the “DOL”) issued proposed changes to the definition of “investment advice” fiduciary under the Employee Retirement Income Security Act of 1974 (“ERISA”). With this proposal, the DOL revisits its efforts to re-make the fiduciary rule after the 2016 fiduciary rule was vacated by the U.S. Court of Appeals for the Fifth Circuit in 2018.

In conjunction with the amended fiduciary definition, the DOL has also proposed amendments to several prohibited transaction class exemptions (“PTEs”). These changes include eliminating the ability to rely on certain widely-used PTEs for investment advice transactions, curtailing the availability of PTE 84-24 (Transactions Involving Insurance Agents and Brokers, Pension Consultants, Insurance Companies and Investment Company Principal Underwriters) and adding additional conditions to, and considerations for the use of, PTE 2020-02 (Improving Investment Advice). 

In light of the fraught history of the DOL’s proposals on the fiduciary rule and the similarities to the vacated 2016 fiduciary rule, we expect that there will be extensive and voluminous commentary on this latest proposal. Comments are due on or before January 2, 2024 (which is 60 days from the Federal Register publication date of November 3, 2023), and the DOL anticipates holding a public hearing on or around December 18, 2023 (approximately 45 days following the Federal Register publication date). 

This client alert provides high-level, preliminary observations about the proposal. We expect to provide a more detailed review as we complete our analysis of the regulatory package and monitor developments in connection with the comment period. 

Investment Advice Fiduciary Definition

KEY IMPACTS: The proposed changes to the definition of investment advice fiduciary meaningfully broaden the instances in which fiduciary status will apply. Service providers will need to identify and satisfy the conditions of an applicable exemption in connection with the provision of the expanded view of what constitutes fiduciary investment advice. In particular, financial services firms, including broker-dealers, banks, insurance companies, and firms who serve retail investors, may find it challenging to avoid accepting fiduciary status.

Current Definition

Under the current definition of “investment advice” fiduciary that has been in place since 1975, a person is a fiduciary only if all the elements of the following five-part test are satisfied: (1) the person renders advice as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property, (2) on a regular basis to the plan (3) pursuant to a mutual agreement, arrangement, or understanding with the plan or plan fiduciary that (4) the advice will serve as a primary basis for the plan’s investment decisions with respect to plan assets, and that (5) the advice will be individualized based on the particular needs of the plan.

Proposed Definition

KEY IMPACTS: The DOL proposal lowers the bar for investment advice fiduciary status by removing the “mutual agreement, arrangement or understanding,” “primary basis,” and “regular basis to the plan” components of the definition and replacing those prongs with “making investment recommendations to investors on a regular basis as part of their business.” In addition, by specifically referencing rollover transactions in the definition of recommendation, the proposal codifies the DOL’s view that interactions related only to rollover transactions can result in fiduciary status. Firms that currently do not currently consider themselves fiduciaries in connection with recommendations for investment products and services, as well as transactions related to rollovers, may find it more difficult to not accept fiduciary status.

Under the proposal, a person is an investment advice fiduciary when making a recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property to a plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary, or IRA fiduciary (collectively, a “retirement investor”) in one of the following the contexts: 

1. the person either directly or indirectly has discretionary authority or control, whether or not pursuant to an agreement, arrangement, or understanding, with respect to purchasing or selling securities or other investment property for the retirement investor;
2. the person either directly or indirectly makes investment recommendations to investors on a regular basis as part of their business and the recommendation is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest; or
3. the person making the recommendation represents or acknowledges that they are acting as a fiduciary when making investment recommendations.

The phrase ‘‘recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property’’ means recommendations: 

1. as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, as to investment strategy, or as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA;
2. as to 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 (e.g., account types such as brokerage versus advisory) or voting of proxies appurtenant to securities; and
3. as to rolling over, transferring, or distributing 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.

Finally, the DOL proposal specifically states that written disclaimers will not control to the extent inconsistent with other communications, marketing materials, applicable law or other interactions. In addition, the DOL specifically declined to include an exception for sophisticated investors, e.g., the “sophisticated plan fiduciary” exception that was included in the 2016 rule. 

Proposed Amendments to Prohibited Transaction Exemptions

Concurrently with its expansion of what constitutes fiduciary investment advice, the DOL proposes to eliminate the availability of certain PTEs that currently apply to investment advice transactions, while also amending PTE 2020-02 (the exemption that the DOL wants investment advice fiduciaries to utilize) with conditions and requirements that make PTE 2020-02 more challenging to satisfy.

Relief Removed for Investment Advice Transactions from Certain Exemptions

KEY IMPACTS: Firms providing financial services and products will need to consider utilizing PTE 2020-02 in connection with their investment advice transactions following the elimination of relief under current exemptions. 

In its release, the DOL states that the standard of care in PTE 2020-02 should apply “universally to all fiduciary investment advice, regardless of the specific type of product or advice provider.” As a result, the DOL proposes removing relief for investment advice fiduciaries under the following exemptions so that exemptive relief for fiduciary investment advice transactions must be sought under PTE 2020-02:

• PTE 75–1 (Securities Transactions Involving Broker-Dealers, Reporting Dealers and Banks) Parts III & IV
• PTE 77–4 (Purchase of Shares of Open-End Investment Companies)
• PTE 80–83 (Use of Proceeds from Sale of Securities to Reduce or Retire Indebtedness)
• PTE 83–1 (Mortgage Pool Investment Trusts)
• PTE 86–128 Executing Securities Transactions and Recapture of Commissions.

PTE 84-24 Relief Limited to Independent Insurance Agents 

KEY IMPACTS: Service providers (other than independent insurance agents) currently availing themselves of the broad relief provided by PTE 84-24 in connection with the receipt of commissions for the sale of annuities/insurance products will need to seek relief instead under PTE 2020-02 if they are relying on the exemption to receive commissions in connection with the provision of investment advice.

Currently, PTE 84–24 provides broad relief for commission compensation received by insurance agents or brokers, pension consultants, and principal underwriters as result of the purchase by plans and IRAs of insurance or annuity contracts or investment company securities. The DOL is proposing narrowing PTE 84–24 to limit relief to the receipt by independent insurance agents (who sell the products of at least two insurance companies) of fully-disclosed commissions and fees from insurance companies with respect to annuity recommendations or other products not regulated by the U.S. Securities and Exchange Commission. The conditions of the proposed amendments to PTE 84-24 are similar to the conditions contained in PTE 2020–02 and also include conditions specific to what the DOL considers applicable in the context of independent insurance agents.

PTE 2020-02 Additional Conditions and Requirements 

KEY IMPACTS: In light of the DOL’s proposed changes, commentary, and clarifications on top of existing difficult and burdensome exemption conditions, firms that currently rely on PTE 2020-02 may find the revised exemption even more challenging to satisfy, and firms that have not previously relied on PTE 2020-02 may face implementation and compliance challenges.

PTE 2020-02 provides relief for the receipt of compensation in connection with investment advice. As a result of the proposed changes to the PTEs discussed above, more service providers may seek to avail themselves of the relief provided by PTE 2020-02, and the proposal extends relief to robo-advice programs that had previously been excluded from relief under the exemption. 

The DOL, however, has also proposed a number of changes and clarifications to PTE 2020-02 that will make the conditions of an already burdensome exemption more difficult to meet. For example, the DOL’s proposal includes the following changes and clarifications to the existing exemption’s conditions with respect to disclosure, policies and procedures, and retrospective review:

• Additional Disclosure Conditions and Considerations:
  • Requirement of an affirmative fiduciary acknowledgement. Service providers may currently employ flexible phrasing. The DOL has expressed concern about this approach and will require a definitive written acknowledgement of fiduciary status.
  • Requirement of a statement of the “best interest” standard of care.
  • Requirement of a statement as to whether the retirement investor will pay for services directly or indirectly, including through third party payments. For example, if the retirement investor will pay through commissions or transaction-based payments, this must be clearly disclosed.
  • Requirement of a statement that retirement investors have the right obtain specific cost, fee and compensation information in a manner “reasonably designed to present full and fair disclosure that is materially accurate” with sufficient detail to permit the retirement investor to make an informed judgement about the costs of the transaction and the significance and severity of the conflicts of interest.
• Additional Disclosure Conditions and Considerations for Rollover Transactions:
  • Certain factors must be considered in the documentation of the basis for the rollover recommendation. The minimum relevant factors include: (i) alternatives to a rollover, (ii) fees and expenses associated with the plan and the recommended investment or account, (iii) whether an employer or other party pays for some or all of the plan’s administrative expenses, and (iv) different levels of services and investments available under the plan and the recommended investment or account.
• Additional Policies and Procedures Conditions and Considerations:
  • Prohibition on the use of quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation, or other similar actions or incentives that are intended, or that a reasonable person would conclude are likely, to result in, recommendations that are not in the retirement investor’s “best interest.”
• Additional Retrospective Review Conditions and Considerations:
  • Requirement that the “Senior Executive Officer” certification must include a certification related to the timely filing of Form 5330s reporting for any non-exempt prohibited transactions, the correction of those transactions, and payment of any related excise taxes.

Finally, while the broadened definition of investment advice fiduciary and the narrowing of certain exemptions may cause more service providers to seek exemptive relief under PTE 2020-02, the DOL has expanded ineligibility and disqualification criteria for the exemption. For example, the DOL has broadened the crimes that could cause ineligibility by enumerating specific crimes (including foreign crimes) that could cause ineligibility. While current PTE 2020-02 provides for different amounts of time before ineligibility as well as a one-year winding down period, the DOL is proposing that all entities become ineligible six months after the conviction date, the date of the DOL’s written determination regarding a foreign conviction, or the date of the Department’s written ineligibility notice regarding other misconduct.