The Department of Labor's New Fiduciary Proposals

The Department of Labor's New Fiduciary Proposals

| March 20, 2024

The Department of Labor (DOL) has issued new proposed rules making most advisors “fiduciaries” when they make investment recommendations to retirement plans and participants in those plans, and to IRA owners. While the rules won’t be effective until finalized in mid-2024, this article gives you an idea of what to expect.

For investment advisors to plans, the changes will not, in most cases, affect their services or fees. That is because most plan advisors are paid a fully disclosed and level fee. However, where a plan’s advisor is paid through commissions, there is a conflict of interest and there will be changes. Both level fee and commissioned advisors do have some conflicts, though, and the proposed rules will affect those recommendations.

For plan sponsors, these proposals highlight the importance of knowing whether their advisors are fiduciaries and, if so, how they manage their conflicts of interest.

The proposed guidance defines fiduciary advisors—as the DOL refers to representatives of broker-dealers, investment advisors and insurance agents who make investment or insurance recommendations to “retirement investors”, which the DOL defines as retirement plans, participants in those plans (including rollover recommendations), and IRA owners.

When an advisor becomes a fiduciary by virtue of making an investment recommendation to a retirement investor, the advisor and his or her firm must give prudent and loyal advice an, in addition, when there are financial conflicts of interest, must comply with a set of complex rules - called prohibited transaction exemptions. A conflict of interest can generally be defined as an investment or insurance recommendation that generates income, or compensation, for the advisor. In other words, a fiduciary can’t make recommendations that financially benefit the advisor. But, under the rules, if the advisor satisfies a number of requirements that protect the investor, the advisor can receive reasonable compensation for the advisor’s services.

This article discusses the types of recommendations that will cause an advisor (and the advisor’s firm) to be fiduciaries, and then covers the requirements in the proposed prohibited transaction exemptions, or PTEs.

The Proposed Fiduciary Definition

The DOL’s proposed regulation—called the “Retirement Security Rule: Definition of an Investment Advice Fiduciary”—lists three ways that an advisor can become a fiduciary:

  1. If the advisor has discretion to manage the investments. Nothing new there—the current regulation also says that

  2. A new definition—is that an advisor will be a fiduciary advisor if the advisor “represents or acknowledges” that the advisor is a fiduciary when making a recommendation. In other words, if a person says they are a fiduciary, then the regulation will treat them as a fiduciary.

  3. The third and most impactful way is the regulation’s definition of nondiscretionary investment advice. Advice is nondiscretionary when it is just a recommendation, and the investor must decide whether to accept the recommendation.

While the current regulation (that will be replaced by the proposal when it becomes final) also has a definition of nondiscretionary fiduciary advice, it requires that five separate conditions be satisfied before an advisor will be a fiduciary. One of those five conditions is that the advisor make recommendations to the retirement investor on a “regular basis”. As a result, one-time advice is not considered to be fiduciary advice under current rules. The proposal will change that dramatically and a one-time recommendation to a retirement investor would be fiduciary advice.

Under the proposal, an advisor will be a fiduciary if the advisor makes an investment recommendation and will earn compensation if the recommendation is accepted, and:

  • The advisor and the firm are in the business of making investment recommendations; and

  • The circumstances reasonably indicate that the recommendation:

    • is based on the investors' individual needs and circumstances, and

    • may be relied upon as a basis to make decisions that are in the best interest of the retirement investor.

Viewed practically, virtually all investment recommendations to retirement investors will be fiduciary advice under the proposal. Securities advisors and insurance agents are in the business of making investment recommendations and they earn money if the recommendations are accepted by investors. When recommendations are made to investors, they are almost always individualized. And, in most circumstances, where an advisor or agent makes a recommendation to an investor, the investor believes that the recommendation is the investor’s best interest. As a result, the likelihood is that, under the proposed definition, securities advisors and insurance agents will be fiduciaries for their recommendations to retirement investors.

It is also important to note that the definition of an investment recommendation is very broad. For example, under the proposal an investment recommendation includes any and all of the following:

  • Buying, selling or holding investments, including securities, annuities, and other property.

  • The management of investments, including recommendations about:

    • investment strategies,

    • investment policies,

    • portfolio composition,

    • investment managers and advisors, and

    • account types

  • Distributions from plans or IRAs, rollovers from plans or transfers of IRAs, and how the rollovers or transfers should be invested

If any of those recommendations involve financial conflicts of interest (called a prohibited transaction in ERISA and the Internal Revenue Code), the advisor or agent cannot retain their compensation (a fee or commission) unless the conditions of an exemption are satisfied. The DOL’s proposals include amendments to existing exemptions to allow compensation from conflicted recommendations, but only if protective conditions are satisfied.

The first exemption, PTE 2020-02, applies to investment advisors, broker-dealers, and insurance agents who are “statutory employees” of an insurance company (defined below). The second exemption, PTE 84-24, covers “independent producers”, that is, insurance agents who sell for several insurance companies.

For ease of reading, the PTE 2020-02 discussion will refer to “advisors” and the PTE 84-24 discussion will refer to “agents”, even though some insurance agents will need to use 2020-02.

Prohibited Transaction Exemption 2020-02

The current version of PTE 2020-02 has been in effect for a few years and the DOL is not proposing material changes to it. However, there are a few changes.

To provide context for those changes, here is what the PTE says now. These conditions remain in effect under the proposal, but additional conditions are added. In order to receive compensation for conflicted recommendations, the advisor and the firm must satisfy these requirements:

  • Compliance with the Impartial Conduct Standards. These standards are:

    • The best interest standard of care. That is, the recommendations must be made prudently and with loyalty to the retirement investor.

    • The compensation received by the advisor and the firm cannot exceed a reasonable amount.

    • Statements to the retirement investor may not be materially misleading

  • Disclosures. These disclosures must be given to a retirement investor in writing before the recommended transaction is implemented:

    • An acknowledgement that the advisor and the firm are fiduciaries under ERISA and the Internal Revenue Code.

    • A description of the services to be provided to the retirement investor and of any material conflicts of interest.

    • For rollover or IRA transfer recommendations, an explanation of the reasons why the recommendation is in the best interest of the plan participant or IRA owner.

  • Policies and procedures. The firm must adopt and enforce written policies and procedures that:

    • Are prudently designed to ensure compliance with the Impartial Conduct Standards.

    • Mitigate the conflicts of the advisor and the firm so that the compensation does not unduly incent the firm or an advisor to place their interests ahead of the interests of the retirement investor.

  • Retrospective review. The firm must conduct an annual review that is reasonably designed to ensure compliance with the Impartial Conduct Standards and the firm’s policies and procedures. This review must be documented in a written report that is signed by a senior executive officer of the firm

With that in mind, let’s look at the proposed changes. By and large, the Impartial Conduct Standards and the Retrospective Review are unchanged. However, there are some meaningful changes to the Disclosure requirement, where the proposal adds:

  • That the advisor and the firm must disclose in writing that they are governed by the best interest standard of care when making recommendations

  • An explanation of how the retirement investor will pay for the services, for example, through third-party payments, such as 12b-1 fees, trailing commissions, or revenue sharing

  • A statement that the retirement investor has the right to obtain additional information regarding costs, fees, and compensation. The DOL explains that this would enable the retirement investor “to make an informed judgment about the costs of the transaction and about the significance and severity of the Conflicts of Interest”

  • The DOL expands the rollover disclosures to provide: “Before engaging in a rollover, or making a recommendation to a Plan participant as to the post-rollover investment of assets currently held in a Plan, the Financial Institution and Investment Professional must consider and document the basis for their conclusions as to whether a rollover is in the Retirement Investor’s Best Interest, and must provide that documentation to the Retirement Investor. Relevant factors to consider must include but are not limited to:

    • the alternatives to a rollover, including leaving the money in the Plan or account type, as applicable;

    • the fees and expenses associated with the Plan and the recommended investment or account;

    • whether an employer or other party pays for some or all of the Plan’s administrative expenses; and

    • the different levels of services and investments available under the Plan and the recommended investment or account.”

While the DOL had previously explained that a fiduciary advisor would need to follow those steps as a part of a fiduciary process, the disclosure is not required under the current version of PTE 2020-02.

Prohibited Transaction Exemption 84-24

Under the current PTE 84-24, all insurance sales to retirement investors (e.g., rollovers to annuities) could be protected by the exemption. However, the DOL is proposing that career and captive agents, and their insurance companies, can no longer rely on this exemption. (For context, career and captive agents work primarily for one insurance company and, for the most part, sell the products of that company.) Under the proposal, those agents and their insurance companies are treated more like broker-dealers and investment advisors. As a result, they must comply with PTE 2020-02 and will need to satisfy the requirements under that exemption. This change will impose compliance burdens on those agents and their insurance companies that are much greater than the current rules. For example, under PTE 2020-02 the insurance companies will be co-fiduciaries with their agents (which is the same as how broker-dealers and investment advisor firms must be co-fiduciaries with their advisors.)

The proposed PTE 84-24, as amended, will apply to independent insurance agents, called “independent producers” by the DOL. The proposal defines an independent producer as someone who “is licensed under the laws of a state to sell, solicit or negotiate insurance contracts, including annuities, and that sells to Retirement Investors products of multiple unaffiliated insurance companies but is not an employee of an insurance company (including a statutory employee under Code section 3121).”

Many of the requirements of PTE 84-24 are the same those in PTE 2020-02. However, there are some significant differences. With regard to the insurance companies, 84-24 does not require that insurance companies be co-fiduciaries with independent agents. However, the DOL proposal does impose meaningful oversight responsibilities for the sales practices of the independent agents.

The independent agents are subject to requirements similar to the 2020-02 provisions for broker-dealers and investment advisors, but are subject to additional restrictions on their compensation. For example, they must report their sales commissions as dollar amounts and cannot receive any sales compensation above and beyond the commission. That means that, for example, they cannot receive production-based marketing allowances, incentive payments, trips and awards.

These restrictions on independent agents and their insurance companies are the most controversial part of the DOL’s proposals.

Concluding Thoughts

As workers accumulate retirement savings in their retirement plans, there is an increasing focus on the quality of investment advice to plans, participants and IRAs. One area of increased focus is on recommendations to participants to leave their retirement plans, which offer fiduciary protections and often have lower-cost services and investments, and move to IRAs. While the DOL’s policy goal is to protect all retirement investors, there is an emphasis on retirees.

The DOL’s proposals are just that—proposals. The private sector will be making their comments and requesting changes to improve the guidance. After receiving those comments, the DOL will draft the final rules, which likely will be issued in mid-2024.

For the moment, though, the message to plan sponsors is to work with professional advisors to understand their plan fees and costs, and to ensure that any financial conflicts of their providers are identified and are properly managed. For individual investors in IRAs, the message is similar… seek advice from advisors and agents who are familiar with retirement investing and who openly discuss and properly manage their conflicts.

We are happy to help provide additional insight, feel free to reach out to me at joe@printers401k.com or 800.307.0376.

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Disclosure: This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. Investment Advice and 3(38) Investment Fiduciary services offered through Diversified Financial Advisors, LLC, a Registered Investment Advisor. 3(16) Administrative Fiduciary Services provided by PISTL Service Corporation. Discretionary Trustee services provided by Printing Industries 401k Trustees. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material. 

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