In November 2023, the U.S. Department of Labor released its package of proposed changes to the regulation defining fiduciary advice and to the exemptions for conflicts and compensation for investment recommendations to retirement plans, participants (including rollovers), and IRAs (including transfers). On March 8, 2024, the DOL sent the final rule to the Office of Management and Budget in the White House.
Key Takeaways
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- The DOL’s proposed fiduciary regulation includes a new and expanded definition of when a representative of a broker-dealer, investment adviser, bank or insurance company will become a fiduciary under ERISA and the Internal Revenue Code.
- The new definition starts with whether a “recommendation” has been made. If a recommendation results in fiduciary status, but does not include a conflict of interest, the only purpose of the definition is to determine whether ERISA’s fiduciary standards apply to advice to ERISA-governed retirement plans (including participants in those plans). It would have no effect under the Code (e.g., IRAs) in that case.
- However, if a fiduciary recommendation is conflicted, it will be a prohibited transaction under ERISA and the Code, which would necessitate compliance with the conditions of a prohibited transaction exemption (PTE).
- This article discusses the definition of “recommendation.”
The preamble to the proposed fiduciary regulation describes the significance of a recommendation as follows:
Whether a person has made a ‘‘recommendation’’ is a threshold element in establishing the existence of fiduciary investment advice.
In other words, unless there is a recommendation, the fiduciary requirements will not and cannot apply. For example, in some cases recordkeepers, advisors and others will use an educational approach about investment principles and factors that participants may want to consider. In fact, there is DOL guidance that goes into some detail on the educational approach–Interpretive Bulletin 96-1. The non-fiduciary approach includes, in addition to education, the provision of information and the use of “hire me”—which is, in effect, the ability to tout one’s services. The key, though, is that there not be a recommendation.
That begs the question of, what is a recommendation? The preamble to the proposal explains:
For purposes of the proposed rule, the Department views a recommendation as a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the retirement investor engage in or refrain from taking a particular course of action.
To help understand that description, the DOL further explains:
The analysis would apply equally to a communication that is made orally or in writing and would include electronic communications. The determination of whether a recommendation has been made would be an objective rather than a subjective inquiry.
In this regard, the more individually tailored the communication is to a specific retirement investor or investors about, for example, a security, investment property, or investment strategy, the more likely the communication will be viewed as a recommendation; however, the Department cautions that the fact that a communication is made to a group rather than an individual would not be dispositive of whether a recommendation exists.
Generally speaking, I believe this means that, if an advisor is saying, explicitly or implicitly, that a particular investment or strategy is appropriate for a retirement investor, it could be viewed as a recommendation, thereby invoking the fiduciary standard and the prohibited transaction rules. Since this an objective standard, it could be described as whether a reasonable person, observing a conversation between an advisor and a retirement investor, would believe that a recommendation had been made to, e.g., purchase a particular investment or pursue a particular strategy.
While in most cases it would be clear whether a recommendation is being made, in others it would not. The safe assumption is that, if specific investments or strategies are discussed, the DOL would likely consider it a recommendation. As an example, the DOL has said that the presentation of a portfolio of investments to a retirement investor, with a representation that it was individualized to the investor, would be viewed as a recommendation, even if the word “recommend” (or similar language) is not used in the presentation.
In the past, some advisors who wanted to avoid fiduciary status have given lists of investments (e.g., three mutual funds) to a participant, plan fiduciary or IRA owner, and taken the position that it was not a recommendation. While that was risky even then, it is clearly an issue now. Here is the DOL’s position on that strategy:
Additionally, providing a selective list of securities to a particular retirement investor as appropriate for the investor would be a recommendation as to the advisability of acquiring securities even if no recommendation is made with respect to any one security.
Also, other approaches to avoiding fiduciary status may be at risk. The DOL is using what is called a step-transaction theory which, in effect, says that a series of steps or separate events or communications will be considered in the aggregate rather as being treat as being unrelated.
Furthermore, a series of actions, taken directly or indirectly (e.g., through or together with any affiliate), that may not constitute a recommendation when each action is viewed individually may amount to a recommendation when considered in the aggregate. Even if an action rises to the level of a recommendation, the advice is only fiduciary investment advice if the rest of the regulatory test is met.
For regulatory efficiency, the DOL made an effort to define “recommendation” consistent with the SEC and FINRA definitions for broker-dealers.
In evaluating whether a recommendation has been made under the proposal, the Department intends to take an approach similar to that taken by the SEC and FINRA in the broker-dealer context. In the SEC’s Regulation Best Interest, the SEC stated that it would apply the term as currently interpreted with respect to broker-dealer regulation for purposes of the suitability obligations, to achieve efficiencies for broker-dealers. The Department likewise believes that efficiencies will apply if it adopts a similar approach.
Comments have been filed with the DOL requesting that it define “recommendation” using language identical to that used by the SEC and FINRA. The final regulation may make that change.
However, both the DOL and the SEC acknowledge that their definitions do not draw a bright line, but instead must be applied based on the fact-and-circumstances of a particular communication.
In the Regulation Best Interest release, the SEC stated, [T]he determination of whether a broker-dealer has made a recommendation that triggers application of Regulation Best Interest should turn on the facts and circumstances of the particular situation and therefore, whether a recommendation has taken place is not susceptible to a bright line definition. Factors considered in determining whether a recommendation has taken place include whether the communication ‘‘reasonably could be viewed as a ‘call to action’’’ and ‘‘reasonably would influence an investor to trade a particular security or group of securities.’’ The more individually tailored the communication to a specific customer or a targeted group of customers about a security or group of securities, the greater the likelihood that the communication may be viewed as a ‘‘recommendation.’’
In the Department’s view, the framework established by the SEC for broker-dealers is consistent with ordinary understandings of ‘‘advice’’ and familiar to the broker-dealers that are regulated by the SEC. Accordingly, the Department would consider a recommendation for purposes of the SEC’s Regulation Best Interest as a recommendation for purposes of this proposed regulation.
In other words, it appears that advisors and insurance agents, and their firms, can rely on SEC and FINRA interpretations of “recommendations”, as well as the DOL guidance. At the least, that should help broker-dealers determine when their advisors will be making fiduciary recommendations.
Concluding thoughts
Realistically, though, this is the stuff of lawyers and regulators. I imagine that in almost all cases it will be clear that a recommendation has or has not been made. The keys are (i) if a recommendation was made (or if it could reasonably be concluded that a recommendation was made) and there is a conflict of interest, the conditions in a PTE should be satisfied—why take any risk, but (ii) if the intent is to provide information and/or education or to rely on the “hire me’ approach, those non-fiduciary options should be properly executed and hopefully documented. Good documentation can be invaluable if the fiduciary status or compliance of an advisor or agent is later questioned.
