DOL Finalizes Less-Restrictive Fiduciary Standard for Investment Advice

Professionals who advise 401(k) participants can receive third-party payments

Stephen Miller, CEBS By Stephen Miller, CEBS December 18, 2020
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DOL Finalizes Less-Restrictive Fiduciary Standard for Investment Advice

New Department of Labor (DOL) guidance eases fiduciary requirements for professionals who recommend investments to 401(k) plan participants, allowing advisors to receive compensation from the mutual funds they recommend. Plan sponsors that provide access to advice should understand how and by whom advisors are being paid and whether those payments result in conflicts of interest.

The guidance, Prohibited Transaction Exemption 2020-02—Improving Investment Advice for Workers & Retirees, published in the Federal Register on Dec. 18, updates requirements for advisors who recommend investments to 401(k) and similar defined contribution plan participants and to individual retirement account (IRA) owners. It allows investment-advice fiduciaries to receive compensation from investment funds, which would otherwise violate the prohibited-transaction provisions of the Employee Retirement Income Security Act (ERISA).

The DOL also posted a fact sheet summarizing the key provisions of the prohibited transaction exemption. Only minor changes were made to the original proposal published in July, such as eased record-keeping and disclosure requirements for advisors.

Allowing fiduciary advisors to receive compensation directly from mutual fund companies, albeit with certain restrictions, means participants don't pay out of their own pocket for advice, which might otherwise be unaffordable for them, supporters of the new guidance say. Critics contend that allowing third-party payments to advisors raises concerns about participants receiving conflicted advice that is not in their best interest.

The Public Investors Advocate Bar Association, for instance, called the guidance "a gift to Wall Street" that "represents a dramatic and unprecedented reversal of the intent of Congress in enacting ERISA. Workers and retirees … deserve to have their retirement savings protected, and they should be able to rely on those they have gone to for investment advice."

Jeanne Klinefelter Wilson, acting assistant secretary of labor for the DOL's Employee Benefits Security Administration, responded to those concerns when she said, "Under the exemption, investment professionals must plainly tell retirement investors that they are acting as fiduciaries, and they must act in the retirement investors' best interest. In this way, the exemption protects retirement investors by requiring investment professionals to lay down clear markers about their relationship and their conduct with retirement investors."

The new exemption on prohibited transactions, she argued, "preserves access to investment advice and promotes choice for retirement investors."

Plan Sponsor Oversight

The guidance does not directly place new compliance requirements on employers that sponsor retirement plans. However, plan sponsors, as fiduciaries, have a duty to ensure that if their retirement plan service providers counsel participants, that the advisors act in the participants' best interest under ERISA and related DOL regulations. Plan sponsors' fiduciary oversight includes understanding how and by whom investment advisors are being paid and whether those payments result in conflicts of interest.

Former Rule Struck Down

The final class exemption is less restrictive than a 2016 regulation by the Obama administration, which was struck down in 2018 by the 5th U.S. Circuit Court of Appeals when it ruled that the regulations exceeded the DOL's rulemaking authority and failed to meet reasonableness requirements by prohibiting third-party payments to advisors, among other issues.

The plaintiffs in that case—business groups such as the U.S. Chamber of Commerce, the Financial Services Institute and the Financial Services Roundtable—argued that the Obama-era rule would make investment advice prohibitively expensive for those with modest portfolios, who would have to bear the cost of paying an advisor.

In July, the DOL issued a final rule implementing the court order vacating the 2016 fiduciary rule and reinstating earlier guidance, including a 1975 five-part test for determining fiduciary status and 1996 investment education guidance.

The new guidance maintains the five-part test and interprets it to require that advice be "a" rather than "the" primary basis of investment decisions.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

Impartial Conduct Required

Under the new guidance, investment advisors would be required to abide by "impartial conduct standards" with three key components:

  • Investment advice must be in the best interest of the investor and must not place any other interests ahead of that interest.
  • Compensation paid for such advice must be reasonable.
  • Statements made with respect to the transaction must not be materially misleading.

Third-Party Payment for Advice

The new exemption is based on a temporary policy adopted after the 5th Circuit's 2018 decision, which vacated the Obama administration's 2016 fiduciary rule.

To receive the exemption, an investment professional or financial institution, among other requirements, must abide by the impartial conduct standards. Investment-advice fiduciaries who meet those standards could receive "a wide variety of payments [from mutual fund companies and investment firms] that would otherwise violate the prohibited transaction rules," according to the guidance.

Those payments include "commissions, 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs, and revenue-sharing payments from investment providers or third parties," and would extend to advice on rolling over 401(k) funds to an IRA.

Since the 5th Circuit's ruling in 2018, the Securities and Exchange Commission (SEC) has issued a package of advice standards, including Regulation Best Interest (Reg BI), which took effect June 30. The standards in the DOL's proposed rule align with Reg BI.

"In tandem with action taken last year by the Securities and Exchange Commission, [the final DOL exemption] gives Americans a greater opportunity to invest in the American economy with the assistance of professionals acting in their best interest," U.S. Secretary of Labor Eugene Scalia said.

Advice on Rollovers

"Advice to take a distribution from a workplace retirement plan and roll over the assets to an IRA may be an isolated and independent transaction" that is generally insufficient to meet the fiduciary-status requirement for rendering advice on a regular basis, the DOL fact sheet explains. In that case, advisors should "make clear in their communications that they do not intend to enter into an ongoing relationship to provide investment advice," and can avoid fiduciary status if they act in conformity with that communication.

On the other hand, "advice to roll over retirement plan assets can occur as part of an ongoing relationship or an intended ongoing relationship that an individual enjoys with his or her advice provider," the fact sheet notes. The DOL’s interpretation "recognizes that the rollover recommendation can be the beginning of an ongoing advice relationship, and that it is important that fiduciary status extend to the entire advisory relationship."

Call Center Oversight

The prohibited transaction exemption (PTE) guidance, via its reinterpretation of the 1975 fiduciary advice regulation, would generally make "call center operators affiliated with financial institutions 'advice fiduciaries,' " according to Mike Barry, a senior consultant at retirement plan advisory firm October Three. "This will likely require plan fiduciaries to monitor those advice fiduciaries' compliance with the PTE. Sponsors will want to review the extent and scope of that monitoring obligation with their counsel and discuss with their providers how they intend to comply with the reinterpreted five-part test and the PTE," he advised.

[Need help with legal questions? Check out the new SHRM LegalNetwork.]

What's Ahead

The exemption is effective as of Feb. 16, 2021. For ERISA plans, fiduciary breaches under the reinterpreted five-part test would be enforceable under ERISA’s fiduciary remedies provisions.

The Biden administration, however, may move to replace the new guidance with a broader interpretation of fiduciary responsibilities and stricter limits on payments that fiduciary advisors can receive from mutual fund companies. In reference to the proposed exemption, last summer the Democratic Party platform said Democrats would "take immediate action to reverse the Trump administration's regulations allowing financial advisers to prioritize their self-interest over their clients' financial well-being."

Barry believes it's "likely that a Biden DOL will seek to reimplement the policy pursued vigorously by the Obama DOL—a broad redefinition of fiduciary advice and fiduciary regulation of advice to [retirement plan account] holders. Conceivably, it could accomplish this even by simply reissuing the Obama fiduciary rule" and hoping for more-favorable court rulings that would uphold the guidance, he said.

[update: 2/18/2021]

The DOL's Employee Benefits Security Administration allowed the Trump administration final rule on providing investment advice to retirement plan participants to take effect as scheduled on Feb. 16, surprising those who believed the Biden administration was likely to block the new regulation, which allows advisors to receive payments from mutual funds they recommend.


Related SHRM Articles:

Biden DOL Allows Investment Advice Rule to Take Effect, SHRM Online, February 2021

DOL Final Rule Limits Proxy Voting by Retirement Plan Fiduciaries, SHRM Online, December 2020

Final Rule Limits 401(k)s from Picking Funds Based on Nonfinancial Factors, SHRM Online, November 2020

New SEC Best-Interest Regulation Affects Retirement Plan Rollovers, SHRM Online, June 2019


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