A Matter of Trust – DOL Issues Final Amendment Broadly Expanding Definition of Investment Advice Fiduciary

Seyfarth Synopsis: On April 23, 2024, the Department of Labor released its latest attempt to amend its 1975 “fiduciary rule” and seven prohibited transaction class exemptions issued between 1975 and 2020 that investment advice fiduciaries have relied in connection with sales of common investment products like securities, mutual funds and annuities. These amendments have already been challenged in court, and it remains to be seen whether it will be “third time’s a charm,” or “three strikes you’re out” for this latest fiduciary rule guidance package.

Background

On April 23, 2024, the Department of Labor (“DOL”) finalized its new package of amendments to the regulations defining who is a fiduciary by virtue of providing investment advice for a fee (an “investment advice fiduciary”) under the Employee Retirement Income Security Act of 1974 (“ERISA”) and amendments to certain related prohibited transaction exemptions. Specifically, this investment advice package is comprised of: (i) final regulations under Section 3(21) of ERISA titled the “Retirement Security Rule: Definition of an Investment Advice Fiduciary,” which expand the definition of an investment advice fiduciary under ERISA and the Internal Revenue Code (the “Code”); and (ii) amendments to seven existing prohibited transaction class exemptions (i.e., PTEs 2020-02, 84-24, 75-1, 77-4, 80-83, 83-1 and 86-128). This latest iteration of the fiduciary rule was published in the Federal Register on April 25, 2024, and is set to become effective September 23, 2024 (although there is a one-year transition period for PTEs 2020-02 and 84-24).

The definition of an investment advice fiduciary has been hotly contested for almost 15 years.

• In October 2010, the DOL first proposed regulations changing the definition of an investment advice fiduciary, which had been adopted in 1975, shortly after ERISA first became effective. In September 2011, it withdrew the 2010 proposal after a flurry of criticism from the financial service industry, Congress and others.
• In April 2015, the DOL again proposed new regulations defining who is investment advice fiduciary (together with a package of new and amended prohibited transaction exemptions) and finalized that rule in April 2016. The 2016 rule (and its related package of new and amended exemptions) was vacated by the Fifth Circuit in toto in March 2018 in Chamber of Commerce v. United States Dep’t of Labor, 885 F.3d 360 (5th Cir. 2018).
• In November 2023, the DOL again proposed changing the definition of an investment advice fiduciary and amending seven existing prohibited transaction exemptions that investment advice fiduciaries have relied in connection with sales of common investment products including securities, mutual funds and annuities. See our earlier blog post here. It is this proposal that has now been finalized in April 2024.

The New Test for Investment Advice Fiduciary Status

Under the 1975 rule, to become a fiduciary by reason of providing investment advice, a person must: (1) render advice to a plan as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property; (2) on a regular basis; (3) pursuant to a mutual understanding; (4) that such advice will be a primary basis for investment decisions; and that is (5) individualized to the plan. The final 2024 rule eliminates this five-part test in favor of a new, broader two-part test, which the DOL argues “is designed to ensure that retirement investors’ reasonable expectations are honored when they receive advice from financial professionals who hold themselves out as trusted advice providers.”

Under the new two-part test, a person is a fiduciary by reason of giving investment advice if the person:

1. Makes “a recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property to a retirement investor;” and
2. Either:

• the person either directly or indirectly (g., through or together with any affiliate) makes professional investment recommendations to investors on a regular basis as part of their business, and the recommendation is made under circumstances that would indicate to a reasonable investor in like circumstances that the recommendation is based on a review of the retirement investor’s particular needs or individual circumstances, and may be relied on by the retirement investor as intended to advance the retirement investor’s best interest; or
• the person represents or acknowledges that they are acting as a fiduciary under Title I of ERISA, Title II of ERISA (which incorporate certain provisions from the Internal Revenue Code) or both with respect to the recommendation.

The final 2024 rule defines the phrase “recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property” in the first part of its test to include:

• The advisability of acquiring, holding, disposing of, or exchanging securities or other investment property, investment strategy, or how securities or other investment property should be invested after they are rolled over, transferred or distributed from the plan or IRA;
• 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
• 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.

Some Significant Changes from the 2023 Proposed Rule

While the final rule largely is consistent with the proposed rule, the DOL made a number of changes in response to comments it received. In addition, the DOL sought to clarify a number of matters in the preamble to the final rule.

• The DOL clarified that, to be a fiduciary, a person generally must provide “professional investment recommendations to investors on a regular basis as part of their business.” The DOL indicates that it added the word “professional” in response to comments expressing concern that the proposed rule could include HR staff who discuss investment options or plan distributions with a plan participant.
• The DOL removed a test that would have made a person a fiduciary if the person “directly or indirectly (g., through or together with an affiliate) has discretionary authority or control. . . with respect to purchasing or selling securities or other investment property for the retirement investor.” Under this proposed language, any financial services company that had discretion with respect to some plan assets could easily be considered an investment advice fiduciary with respect to recommendations concerning other plan assets.

So, while a role as a discretionary manager could in certain situations “indicate to a reasonable investor that the recommendation [by the manager] is based on a review of the retirement investor’s particular needs or individual circumstances, and may be relied on by the retirement investor as intended to advance the retirement investor’s best interest,” it is not dispositive.

• The DOL added a new paragraph (i.e., paragraph (c)(1)(iv)) designed to clarify that, in many cases, sales conversations and investment education will not constitute “investment advice.” Of course, while this addition is helpful, it does not add much because in all cases a person would be an investment advice fiduciary only if the person meets the tests in the final rule. The final rule and its preamble do not provide the “sales exception” requested by many commentors. In addition, the DOL indicated that its 1996 guidance on investment education (IB 96-1) remains in force, and providing educational information described in IB 96-1 is not fiduciary investment advice absent a recommendation. The DOL, however, cautioned that it will monitor investment education practices and whether that guidance is being used to avoid this new rule. The DOL also advised that may revisit that guidance in the future.
• In the final regulation, the DOL removed “investment advice fiduciaries” from the definition of “retirement investors.” This means that a person will not become an investment advice fiduciary if the person provides a recommendation to an investment advice fiduciary. For example, a broker-dealer that provides trade information and market color to an investment advice fiduciary would not by reason of providing that information or market color become an investment advice fiduciary. The DOL did not provide a similar carve-out for recommendations provided to ERISA discretionary asset managers.
• In a nod toward consistency with other applicable regulations, the DOL indicates in the preamble that the DOL will interpret the definition of “recommendation” consistent with how the SEC interprets that term under its Reg BI.
• The regulations specifically provide that written statements (g., disclaimers, contractual provisions, etc.) will not control whether a person is an investment advice fiduciary. That, however, does not mean that contractual provisions, disclaimers, etc. are not a factor in the analysis, and it is possible, particularly in the context of communications and agreements involving institutional investor ERISA fiduciaries, they may be dispositive.

The Prohibited Transaction Class Exemptions

The DOL’s constant theme for this guidance package is that it wanted to provide a “uniform regulatory structure” to investment advice fiduciaries. As a result, the DOL also finalized amendments to several prohibited transaction administrative class exemptions (i.e., PTEs 84-24, 75-1, 77-4, 80-83, 83-1 and 86-128). As a result of these amendments, an investment advice fiduciary will need to satisfy the requirements of PTE 2020-02 in order to receive any benefit by reason of its provision of investment advice. The DOL also amended PTE 2020-02 to strengthen certain requirements, and to broaden its scope.

PTE 2020-02

PTE 2020-02 provides broad relief from the prohibited transaction provisions in ERISA and the Code for investment advice fiduciaries to receive direct and indirect compensation by reason of their provision of investment advice.

To qualify for the exemption, the investment advice fiduciary and the investment professionals giving the advice must:

• acknowledge their fiduciary status in writing to the retirement investor;
• disclose their services and any material conflicts of interest with the retirement investor;
• adhere to “impartial conduct standards” that are substantially identical to ERISA’s duties of care and loyalty;
• charge no more than reasonable compensation;
• if applicable, comply with Federal securities laws regarding ‘‘best execution;’’ and avoid making misleading statements about investment transactions and other relevant matters;
• adopt firm-level policies and procedures prudently designed to ensure compliance with the impartial conduct standards and mitigate conflicts of interest that could otherwise cause violations of those standards;
• document and disclose the specific reasons for any rollover recommendations; and
• conduct an annual compliance review, that is reviewed by a “senior executive officer” (the chief compliance officer, chief executive officer, president, chief financial officer or one of the three most senior officers) of the financial institution, who must certify that: (i) the officer reviewed the report, (ii) the financial institution filed or will timely file any required excise tax filings in connection with any non-exempt prohibited transactions in connection with its investment advice and corrected those prohibited transactions, and (iii) the institution has policies and procedures that meet the conditions of the exemption and that it has a prudent process to modify those procedures to the extent necessary to comply with the exemption.

The final amendment was adopted substantially as proposed with some notable differences, including:

• The scope of the exemptions was expanded to include: recommendations of any investment product, regardless of whether the product is sold on a principal or agency basis, and non-bank Health Savings Account (“HSA") trustees and custodians to the definition of “Financial Institution” with respect to HSAs.
• New streamlined requirements for the exemption when a financial institution gives investment advice in connection with a request for proposal (or RFP) to provide discretionary investment management services as an ERISA Section 3(38) investment manager.
• The fiduciary is required to acknowledge its fiduciary status before the transaction giving rise to the fiduciary’s compensation is entered into, rather than when the fiduciary recommends that transaction.
• It eliminates the 2023 proposal’s highly criticized disqualification process, which would have given the DOL significant discretion to disqualify financial institutions from using the exemption for 10 years in the event of certain misconduct. Instead, the final rule adopts a process that relies on the final judgment or court-approved settlement involving certain determinations in a Federal or State criminal or civil court proceeding brought by the Department, the Department of the Treasury, the IRS, the SEC, the Department of Justice, the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission, a State insurance or securities regulator, or State attorney general.

PTE 84-24

In general, PTE 84-24 provides an exemption for fiduciaries to receive certain compensation in connection with certain insurance and mutual fund transactions, including an insurance agent, broker or pension consultant receiving a commission from an insurance company in connection with a plan’s purchase of an insurance or annuity contract.

As proposed, PTE 84-24 would no longer be available for investment advice fiduciaries, who would have to instead use PTE 2020-02, except that PTE 84-24 would have remained available for “Independent Producers” (e.g., a licensed insurance salesperson who sells insurance products of two or more unrelated insurers and wPTE 84-24 ho is not an employee of an insurance company) to receive commissions in connection with the sale of annuities or other insurance products not regulated as securities by the SEC, subject to certain conditions.

Amendments to PTE 84-24 were adopted substantially as proposed in 2023 (with changes consistent with the changes in final PTE 2020-02). Some points to note in connection with the final exemption are:

• The final PTE 84-24 expanded the exemption’s scope to cover all types of direct or indirect compensation to independent producers.
• PTE 84-24 includes a number of the same conditions as PTE 2020-02, most of which must be met by the independent producer. However, the insurer is required to maintain policies and procedures and conduct an annual retrospective review. The insurer also is required to provide certain information regarding the retrospective review to the independent producer and instruct the independent producer to correct any prohibited transactions, including paying any applicable prohibited transaction excise taxes.

PTEs 75-1, 77-4, 80-83, 83-1 and 86-128

As amended, these exemptions are no longer available for the receipt of compensation by investment advice fiduciaries.

Conclusions

The final rule is the DOL’s third attempt to significantly overhaul its 1975 rule defining an “investment advice fiduciary”. As with its prior attempts, it significantly broadens both the number of people who will become ERISA investment advice fiduciaries and the types of advice that will be considered investment advice (e.g., distribution and rollover advice). As a result, it is likely that there will be numerous parties who are now ERISA investment advice fiduciaries even though they have not historically viewed their roles as fiduciary in nature. Also, similar to the vacated 2016 rule, it drives the majority of ERISA investment advice fiduciaries to a single prohibited transaction exemption, which includes a condition of complying with ERISA’s standard of care and duty of loyalty.

Still, in finalizing its 2023 proposed rule, the DOL did respond a number of comments it received on its proposal. Notably, the DOL largely addressed concerns by plan sponsors that their HR and benefits staff easily could become unintended fiduciaries. Similarly, by providing broad exemptive relief for principal transactions and for all kinds of fees and transactions, the DOL addressed a significant criticism of the vacated fiduciary rule that it favored some types of investments over others.

The DOL went to great lengths to make a case for why this latest iteration of the fiduciary rule (and the related amendments to the prohibited transaction exemptions) base fiduciary status on an expected relationship of trust and confidence, and so should survive the Fifth Circuit’s analysis that supported its vacating the 2016 package. The rule, however, has already been challenged in court, and it remains to be seen whether the DOL has done enough to survive such a challenge.

We will continue to monitor developments as those challenges wind their way through the court system.