Best Interests Standard of Care for Advisors # 55 | Faegre Drinker Biddle & Reath LLP
The “fiduciary rule” of the Ministry of Labor, PTE 2020-02: the FAQ
This series focuses on the new DOL fiduciary “rule”, which came into effect on February 16. This article, and the following ones, examine the Frequently Asked Questions (FAQ) issued by the DOL to explain the fiduciary definition and conflict of interest exemption.
Key points to remember
- The new fiduciary “rule” — Prohibited Transactions Exemption 2020-02 — has two parts.
- The first part is the expanded definition of the board of trustees (in the preamble to the PTE).
- The second part is the prohibited transaction exemption.
- However, changes are being considered for both the definition and the exemption (as well as other exemptions for non-discretionary board trustees). This article discusses the likely changes and the DOL regulatory agenda.
- The change in the definition of trustee will likely cause even more advisers and agents (and their businesses) to be trustees for plans, members and IRA owners.
- The changes to the exemptions will impose additional compliance burdens on investment advisers, brokers, banks and insurance companies.
DOL’s Prohibited Transaction Exemption (PTE) 2020-02 (Improving investment advice for workers and retirees) allows investment advisers, brokers, banks and insurance companies (“financial institutions”) and their representatives (“investment professionals”) to receive conflicting compensation resulting from non-trust investment advice. discretionary pension plans, members and IRA owners (“retirement investors”).
In addition, the DOL announced, in the preamble to the PTE, an expanded definition of the board of trustees, which means that many other financial institutions and investment professionals will be trustees of their recommendations to retirement investors and, therefore, will need the protections offered by the exemption. The relief provided by the exemption is conditional, i.e. the “conditions” of the exemption must be met in order to obtain relief from the rules on prohibited transactions in ERISA and Internal Revenue Code. For the period February 16 to December 20, a DOL and IRS Non-Enforcement Policy based on the Standards of Impartial Conduct will be available.
In April, the DOL published Faq which explain the reasons for the publication of the guidance. The FAQ also details the fiduciary definition and the conditions of the exemption.
Fiduciary Questions and Answers:
This article discusses FAQ 5, which addresses whether there will be further guidance on the definition of trustee and whether there will be any changes to the exemptions, or exceptions, to the rules on prohibited transactions. The FAQ begins with the question:
Q5. Will the Department take more action on the regulation of trust investment advice?
The Department reviews factual, legal and policy issues related to PTE 2020-02, and more generally, its regulation of fiduciary investment advice. The Department plans to take other regulatory and sub-regulatory actions, as appropriate, including amending the Trust Rules on Investment Advice, amending PTE 2020-02, and amending or revoking some of the other exemptions from existing category available to trustees in investment advice. The regulatory measures will be preceded by a notice and an opportunity for public comments. In addition, while future measures are being considered to improve the exemption, the Department believes that the essential elements of PTE 2020-02, including the standards of impartial conduct and the requirement for strong policies and procedures, are fundamental investor protections that should not be delayed while the Ministry considers additional protections or clarifications. [The bolding is mine.]
Comment: There are at least three things to note in this statement. But, first, the answer is yes, there will be future developments on the fiduciary definition and exemptions from the prohibited transactions rules. Things to note are:
- The planned change to the Investment Advisory Trust Rules will almost certainly increase the number of trustees. Most likely, the proposal will eliminate the “regular basis” requirement of the fiduciary “test”, so that one-off recommendations will be treated as fiduciary recommendations. In addition, there could be provisions that would extend the scope of DOL or private investors to advice and disputes regarding IRAs.
- Changes will be made to the exemptions for prohibited transactions. For example, it is likely that the PTE 84-24 will be modified. One possibility would be to take the Obama-era approach and limit 84-24 to sales of fixed rate annuities, meaning that sales of variable and fixed indexed annuities would have to use the 2020-02 PTE (assuming that the insurance agent is a trustee… but see (1) above). Another more extreme idea that is circulating is that 84-24 would be revoked in its entirety, meaning that when agents make fiduciary recommendations for annuities of any kind, the sale would have to comply with conditions in 2020-02. But these are just “street” rumors. It’s unclear where 84-24 will end up, but it’s unlikely to end up where it is now.
- All exemptions for non-discretionary trust and insurance investment recommendations will include standards of impartial conduct, i.e. the standard of care in the best interests (prudence and loyalty); no more than reasonable compensation; and no materially misleading statement.
If that’s the goal, what’s the plan?
The “plan” is on the DOL agency’s list of rules for spring 2021. EBSA is working on a new fiduciary project and the proposals are expected to be released in December. See See the rule (reginfo.gov)
Here is the summary of the regulatory project:
This regulation would change the regulatory definition of the term fiduciary set out in 29 CFR 2510.3-21 (c) define more appropriately when people who provide fee-based investment advice to employee benefit plans and IRAs are trustees within the meaning of Section 3 (21) of ERISA and Section 4975 (e) (3) of the Internal Revenue Code. The amendment would take into account the practices of investment advisers, the expectations of plan managers and participants, and IRA owners who receive investment advice, as well as developments in the investment market, including changes in the investment market. remuneration arrangements for advisers which may expose advisers to conflicts of interest. Along with this regulation, EBSA will also assess the exemptions available for the prohibited transaction categories and consider proposing changes or new exemptions. to ensure consistent protection of the IRA employee and investor benefit plan. [The bolding is mine.]
Comment: It speaks for itself. But the practical implications are less obvious. First, new regulations and amended exemptions will not arise entirely. It will probably take more than a year for these changes to be final and effective. We could consider an effective date as late as January 1, 2023. But that has implications for today. For example, some of the “solutions” being developed for annuity sales (for example, in relation to rollover recommendations) will be temporary, in the sense that while 84-24 is easy enough to stick to now, it will probably be changed to be more demanding. At a minimum, standards of impartial conduct will be added to clarify that a best interest process should be used for rollover recommendation and IRA (or individual retirement annuity) investment recommendation. And it is possible, if not likely, that the fiduciary definition will extend to a single recommendation for renewal (without the need for “regular” advice). Of course, that’s a guess on my part, but why have a new fiduciary rule and modified exemptions if the renewals are not going to be “captured” by the definition? (The expanded definition in PTE 2020-02 already covers most investment advisor rollover recommendations and some insurance agent rollover recommendations.)
If I’m correct, some of the current efforts to comply with 84-24 (or to avoid fiduciary status) will need to be changed significantly as a result of this DOL regulatory initiative. But, for now, possible changes are just one of the factors to consider in formulating plans to address the compliance issues created by PTE 2020-02 and the expanded DOL definition of fiduciary boards.
It is difficult to make definitive decisions about the future when the future may change. For the time being, the focus should be on meeting the issues created by the expanded fiduciary definition and terms of PTE 2020-02. However, to the extent possible, these solutions should consider the likelihood of significant changes over the next two years. The PTE 84-24 may not be the panacea it appears to be. Therefore, when entities, such as brokers owned by insurance companies, comply with 2020-02 for sales of securities products (including, for example, variable annuities), they may consider include covered sales of fixed rate products and fixed indexed annuities in their 2020-02 efforts. On the other hand, at least for now, the PTE 84-24 may be the preferred course of action for sales through independent agents.