In November 2023, the U.S. Department of Labor (DOL) released a new proposed regulation changing the definition of fiduciary “investment advice” under Title I of ERISA and Section 4975 of the Code. Like the DOL’s last unsuccessful attempt in 2016, the proposal seeks to broaden the circumstances under which advice or a recommendation to a plan investor will be deemed subject to ERISA’s fiduciary duties and the prohibited transaction rules under ERISA and/or Section 4975 of the Code. The DOL asserts that its current definition, which it put in place nearly fifty years ago and reinstated in 2020 following the Fifth Circuit’s 2018 vacatur of its 2016 definition, misinterpreted the law and leaves plan investors unprotected, especially as investment options have multiplied and grown more complex and as the responsibility for investment decisions has shifted from professionals to individual participants, beneficiaries and IRA owners.
While the DOL’s proposal is largely reflective of its desire to protect unsophisticated individual investors, particularly in the context of ERISA plan account rollovers to IRAs, the proposal does not confine its changes to such investors or context. Indeed, if adopted in its current form, the proposal will impact not only brokers, agents and others currently providing investment-related information to individual plan investors without assuming fiduciary responsibility, but also banks, broker-dealers, insurers, model providers, fund sponsors and others providing investment products and financial services to sophisticated plan investors or intermediaries on a presumed non-fiduciary basis.
The DOL is providing relatively little time for comments and has rejected industry requests for an extension. Comments are due on January 2, 2024. A public hearing on the proposal was held from December 12-13, 2023.
The Proposal’s Major Highlights
- Expands the types of information deemed to constitute fiduciary investment advice, focusing on the content and certain contextual characteristics of the information provided rather than the actual sophistication of the recipient, the expectations of the provider of information as to its fiduciary status (and related disclaimers), or the regularity of the relationship between the investor and the provider.
- Eliminates the “regular basis” relationship requirement of the current rule, replacing it with a requirement that the provider of the information regularly provide advice or recommendations as a general matter, even if just to other, unrelated customers.
- Treats most rollover-related information as fiduciary investment advice and effectively provides DOL oversight of assets rolled to an IRA and a private right of action to IRA owners vis-à-vis rolled assets.
- Corrals providers into complying with a revised version of Prohibited Transaction Exemption 2020-02 containing much tougher conditions, including by limiting the utility of other exemptions (PTE 75-1, 77-4, 80-83, 83-1, 86-128 and, largely, 84-24) to discretionary fiduciaries.
- Provides for an effective date of 60 days following the DOL’s publication of a final rule, which will almost certainly be insufficient for affected providers to develop and implement necessary policies, procedures, training and practices, as well as conform an enormous volume of disclosures and agreements to the new requirements.
Select Issues with the Proposal
Proposal Will Likely Result in Continued Regulatory Uncertainty
As proposed, the rule will almost certainly be challenged. But the case (or cases) will take time to work their way through the courts, leaving the market to deal with the regulation in the interim, even if the courts ultimately strike it down or curtail it.
The proposal seems particularly ripe for challenge. First, as with the DOL’s last attempt, this proposal throws out a definition promulgated immediately after ERISA was enacted, when presumably the DOL had a better understanding of what Congress actually intended. That definition has stood the test of time for nearly fifty years (and almost forty years before the DOL formally considered changing it). Next, while the proposal acknowledges the Fifth Circuit’s finding that ERISA was intended to regulate only advisory relationships of trust and confidence, the proposal seeks to identify such relationships in a manner that tends to presume their existence and undermines the ability of the parties to define their relationships. Among other things, the proposal (a) requires no expectation on the part of the provider that it is acting in a fiduciary capacity, (b) heavily discounts disclaimers and other contractual provisions seeking to define the relationship and (c) deems a lack of regular interactions between the provider and investor to be irrelevant. Lastly, despite the Fifth Circuit’s stated concern with the DOL extending regulatory authority over IRAs and creating a private right of action for IRA owners, the proposal appears to effectively provide the DOL with oversight over IRA assets rolled from an ERISA plan and provide IRA owners with a private right of action with respect to such assets, potentially up to six years after the rollover.
No Carve-Out for Transactions with Sophisticated Institutional Investors
The DOL’s express justification for changing the definition is that “participants and other retirement investors may be unable to assess the quality of the advice they receive or be aware of and guard against the investment advice provider's conflicts of interest.” Yet, unlike its 2016 attempt to redefine fiduciary advice, its current proposal contains no exception for transactions with plan investors who should be able to assess such quality and guard against such risk. Additionally, the proposal removes the current “mutual understanding” and “primary basis” requirements — the main safeguards relied upon by broker-dealers and other counterparties to avoid fiduciary status when dealing with institutional investors. The proposal thus raises significantly the risk that traditional sales efforts and consulting (e.g., on swaps and other structured products) by investment banks, broker-dealers, swap counterparties and other financial counterparties could be deemed fiduciary investment advice, even where the client is a large institutional investor shopping for investment options with the assistance of its own independent, expert fiduciary advisors. Of course, if broker-dealers and others cannot avoid fiduciary status, they will simply be unable to provide services to or engage in transactions with plan investors due to ERISA’s prohibited transaction rules (absent relief under PTE 2020-02, which, of course, provides no relief for many principal transactions).
Fiduciary Adviser Status May Result from Others’ Discretion Over Unrelated Assets
The proposal independently tests for a relationship of trust and confidence by asking whether the advice provider or an affiliate has discretion over any investment decisions for any assets for the retirement investor. The term “affiliate” has been expanded to include a “representative” of a person, but without defining that term (e.g., without any requirement that a “representative” have any ownership, control or even a contractual relationship with the person). The combination of these provisions would seem to result in a test that will find a relationship of trust and confidence between an advice provider and the retirement investor based on wholly unconnected activities of other persons of which the provider may be unaware. For example, it would test a provider’s fiduciary status to a 401(k) plan participant by reference to unrelated discretionary activities by a remote affiliate or unaffiliated “representative” (whatever that term means) of the provider over the retirement investor’s taxable assets, even if the provider is completely unaware of such activities.
Fiduciary Adviser Status May Result from One Time Advice
As noted above, the proposal eliminates the current rule’s “regular basis” requirement, which helps test for relationships of trust and confidence between the advice provider and the plan investor by looking at qualitative characteristics of their particular relationship – i.e., by looking at whether advice is provided on a regular basis to the plan investor itself. In its place, the proposal requires only that the provider, affiliate or an unaffiliated “representative” offer investment recommendations on a regular basis to third parties. As a practical matter, this requirement would seem to say nothing about the actual relationship between the provider and the plan in question. Further, given that such third-party recommendations need not be individualized or otherwise fiduciary in nature, the new generalized “regular basis” requirement would seem to be satisfied by an affiliation with, or formal or informal representation by, virtually any financial institution in the market, including not only buy-side entities, like advisers, but also sell-side entities, like investment banks, broker-dealers, placement agents and other financial counterparties.
Fund Sponsors and Other Investment Product Providers May Be Deemed Fiduciaries by Virtue of Selling Activities or Even Recommendations by Third Parties
By lowering the bar for recommendations to be deemed fiduciary advice, the proposal raises significantly the risk that common sales efforts by fund sponsors and other product providers may be deemed fiduciary advice, which would then preclude any investment in the fund or product, absent compliance with PTE 2020-02 and its proposed tougher conditions. Further, even if they avoid fiduciary advice in their own sales activities, by extending the term “affiliate” to include “representatives,” the proposal may nevertheless convert fund sponsors and other product providers into fiduciaries based on recommendations by third parties. As discussed above, the proposal includes no definition of “representative,”and, thus, nothing in it limits that term to persons with formally authority to provide fiduciary advice to investors on behalf of the fund or product provider.
Lawyers, Accountants, and Consultants May Be Deemed Fiduciaries Based on Regular Provision of Investment-Related Legal, Tax and Other Advice Traditionally Viewed as Non-Fiduciary
In Interpretive Bulletin 75-2, the DOL stated, under then-current law, that “attorneys, accountants, actuaries and consultants performing their usual professional functions will ordinarily not be considered fiduciaries…” But the DOL cautioned that, “if the factual situation in a particular case falls within [the fiduciary definition], such persons would be considered to be fiduciaries within the meaning of section 3(21) of the Act.” By dramatically expanding the fiduciary advice definition, including eliminating the “mutual understanding” and “primary basis” requirements, discounting fiduciary disclaimers that are inconsistent with other laws (e.g., fiduciary status under State bar rules) and indicating that recommendations as to formal aspects of an investment (e.g., account type or structure) are fiduciary in nature, there is at least a question as to whether the proposal extends (almost certainly unwittingly) fiduciary status to individualized legal, tax and other advice related to the components of an investment (e.g., whether, when or how to structure or restructure an investment to minimize taxes or other costs) on which the investor will reasonably expect to rely. The proposal’s requirement that investment advice be provided on a “regular basis” in the provider’s business generally would not seem to help, at least not where, as is frequently the case, the lawyer, accountant or other consultant regularly provides similar advice on investment structuring to other investors.
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