How would the proposed investment-advice rule affect you?

How would the proposed investment-advice rule affect you?

On October 31, President Biden and Acting Secretary of Labor Julie A. Su announced that she will propose a new rule to interpret whether a person provides investment advice that makes the person an employee-benefit plan’s fiduciary. The same rule would interpret also whether one is a fiduciary regarding an Individual Retirement Account or Annuity (IRA), a health savings account, an Archer Medical Savings Account, or a Coverdell education savings account, even if the account is unconnected to an employment-based plan. (Whether a rule would be or might become contrary to law is beyond this explanation.)

To go with those interpretations about investment advice that makes one a fiduciary, the Secretary will propose changes for five class prohibited-transaction exemptions (PTEs). These matter because both section 406 of the Employee Retirement Income Security Act of 1974 (ERISA) and Internal Revenue Code of 1986 (I.R.C.) § 4975 make it a prohibited transaction for a fiduciary’s advice-giving to affect her compensation, business, or other personal interest.

Under a 1978 government reorganization plan, the Labor department’s rules, exemptions, and interpretations are authority not only for ERISA-governed employee-benefit plans but also for accounts subject to a tax-law consequence under or regarding I.R.C. § 4975.

BenefitsLink’s news pages link to the prepublication texts and some news releases and articles. Eight hyperlinks are posted in the October 31 news.

The proposals are not yet published in the Federal Register.

If published soon, the 60-day comment period would end in early January. And without waiting for a request, the Labor department expects to schedule a hearing in mid-December.

What’s in the proposals?

Here’s a few key points:

Investment advice that makes one a fiduciary includes a recommendation of any investment transaction or any investment strategy. That applies for someone in a business that regularly involves investment-related recommendations, or who “represents or acknowledges that they are acting as a fiduciary when making investment recommendations.”

The proposed rule’s explanation of a recommendation aligns with uses of that word under securities law and insurance law.

A recommendation need not be about securities; it would be about any kind of investment property, including an annuity contract, even a fixed annuity contract, and a life insurance contract, unless it has no investment element.

An investment adviser is a fiduciary only “to the extent” it renders investment advice. For example, a securities broker-dealer or insurance agency that presents a rollover recommendation might be a plan’s or IRA’s fiduciary only when it forms and presents a particular recommendation. One might be a fiduciary only for a day or two. For example, a one-time recommendation to rollover a payout into an IRA could make the recommender a fiduciary, but her responsibility might end when the distributee accepts or rejects the recommendation.

Responsibility for one-time advice also might apply to a suggestion about how another fiduciary selects or monitors designated investment alternatives, or about whether to allow a brokerage window.

That a person is not (or is no longer) a fiduciary under ERISA or the Internal Revenue Code does not excuse the person from duties under banking, commodities, insurance, or securities law.

The revised best-interest exemption (PTE 2020-02) would let a Financial Institution—such as a bank, trust company, insurance company, securities broker-dealer, or registered investment adviser—and its Investment Professionals provide self-dealing advice if they don’t put their interests ahead of the Retirement Investor’s interests and don’t put the Retirement Investor’s interests below the Financial Institution’s or its Investment Professional’s interests.

Some changes would widen which persons can get relief. Some changes would tighten disclosures. Among other changes, a Financial Institution and its Investment Professional must confirm in a written disclosure that they act as fiduciaries.

A change would require a Financial Institution’s yearly compliance reviews to check “that [t]he Financial Institution has filed (or will file timely, including extensions) Form 5330 reporting any non-exempt prohibited transactions discovered by the Financial Institution in connection with investment advice covered under [I.R.C. §] 4975(e)(3)(B), corrected those transactions, and paid any resulting excise taxes owed under [§] 4975[.]”

If the Labor department adopts its proposed change in PTE 84-24, an Independent Producer who recommends an unaffiliated Insurer’s annuity contract could get a fully disclosed commission or fee if the exemption’s protective conditions are met. What’s the big change? The Insurer “would not be treated as a fiduciary merely because it exercised oversight responsibilities over independent insurance agents under the exemption.” And the Insurer “only would be required to exercise supervisory authority over the independent agent’s recommendation of [the Insurer’s] products.”

Another proposal would change PTEs 75-1, 77-4, 80-83, 83-1, and 86-128 so each provides no relief for a self-dealing transaction, including conflicted compensation. Instead, a fiduciary must meet the conditions of the best-interest exemption.

This is only a quick and short look at a few of the many points in the proposals. For more information, read the source texts. Or, post your query in this BenefitsLink discussion.

Here are some questions for our BenefitsLink neighbors.

If the Labor department’s proposed rule becomes a final rule and becomes effective and applicable, what effects would the rule have on your business?

Is there a service you now provide that you would stop when the rule becomes applicable?

Is there a service you don’t now provide that you would develop and offer?

If you’re a recordkeeper or third-party administrator, would the rule change any aspect of your relationships with investment brokers and advisers?

If you provide services as a § 3(16) administrator, are you ready to defend claims that you knew an investment adviser breached and you didn’t do enough to remedy that other fiduciary’s breach?

And how about your own business:

(1) Even as only a third-party administrator, do you sometimes help an employer select a participant-directed plan’s “menu” of investment alternatives? Or do you as a part of your business help an employer select a recordkeeper and that choice means taking on some of the recordkeeper’s or its affiliate’s investments?

(2) Do you get any compensation, however indirectly, you would not get unless the plan made a choice under #1?

If #1 and #2 are yes, are you an investment-advice fiduciary?

If you are, which exemption do you use to cure your compensation conflicts?

These are very thought-provoking questions, and bring out of the shadows and into the light some of the nuances of being a fiduciary versus trying very hard not to be fiduciary.

In our business, we are not a 3(16) administrator.  As you allude to, even being a limited fiduciary will not fully isolate us from the fiduciary mandate that "if you see something, you must say something".

We take every precaution we can to educate and inform the plan fiduciaries about their responsibilities, and to document that it is a plan fiduciary that ultimately is making a fiduciary decision.  If these proposals are adopted, we will have to be able to explain them to plan fiduciaries.

We are compensated for our work strictly based on our fee schedule which has no links to investments.  We offset our fees with any revenue we receive from sources other than the plan sponsor.  When we participate in a vendor selection process, we educate the client on any revenue streams that each vendor and each investment has available.

I expect there will be a lot of resistance to these proposals from investment professionals involved with ERISA plans.  Generally, the structure of compensation within that profession is interwoven with the revenue streams from the assets held in a plan such as commissions, trailing commissions, 12b-1 fees, other forms of revenue sharing, finders fees, expense charges based on AUM and other similar sources.  This puts an investment professional in the untenable position of explaining how being rewarded for doing their job well is simply a by product of not acting in their self-interest and always putting the best interests of the plan ahead of personal reward.  Try as they might, investment professionals are not omniscient about global financial markets, perfect investment performance is elusive, and the near-term performance of investments based on the advice of the most successful investment professional can fluctuate significantly. 

1 hour ago, Paul I said:

When we participate in a vendor selection process, we educate the client on any revenue streams that each vendor and each investment has available.

Just curious: In your experience, does the indirect compensation that would be used as a set-off on your compensation influence the employer's decision-making?

It does, but the influence is not only in one direction.  On one side, we have clients that want to pay admin fees out of pocket, particularly when they realize that the fees often are charged to participants based on account balances and the owners and senior employees have the biggest balances.  On the other side, we have clients take the attitude that they have the plan so employees won't gripe about not having a plan and the plan also helps with recruiting.  They figure the employees should pay for the cost of administration.

BenefitsLink host Lois Baker gives us the hyperlinks to the Office of the Federal Register’s posting of the prepublication texts, showing they are scheduled to be published tomorrow, November 3.

https://benefitslink.com/boards/topic/71280-dol-proposed-investment-advice-package-scheduled-for-publication-in-the-federal-register/#comment-334192

Before third-party administrators too hastily assume this would affect only investment brokers and advisers, read the proposed rule. You don’t need the explanation; just skip to page 272.

And think carefully if your arrangements about indirect compensation are anything less tidy than what Paul I describes.