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For Advisers: DOL Confirms Investment Advice Exemption

Everything advisers need to know about the Labor Department’s “best interest” standard of care, from the 5-part rule to documentation.

Advisers must now provide retirement account rollover advice in the investor’s best interest, as the Labor Department’s “best interest” standard of care for fiduciary recommendations of rollovers from ERISA-protected retirement accounts has just gone into effect.

What do investment advice fiduciaries need to know about the “Improving Investment Advice for Worker & Retirees” exemption?

An Overview of the Rule

A five-part test determines if you are an ERISA fiduciary. For advice to constitute “investment advice,”’ a financial institution or investment professional who is not a fiduciary under another provision of the statute must:

  1. Render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property,
  2. On a regular basis, 
  3. Pursuant to a mutual agreement, arrangement, or understanding with the Plan, Plan fiduciary or IRA owner, that, 
  4. The advice will serve as a primary basis for investment decisions with respect to Plan or IRA assets, and, 
  5. That the advice will be individualized based on the particular needs of the Plan or IRA.

A financial institution or investment professional that meets this five-part test, and receives a fee or other compensation, direct or indirect, is an investment advice fiduciary, according to Prohibited Transaction Exemption 2020–02, Improving Investment Advice for Workers & Retirees.

And if you are an ERISA fiduciary, that means that first, you must avoid prohibited transactions and second, you must meet the duties of prudence and loyalty as it relates to ERISA assets, according to Bonnie Treichel, the chief operating and compliance officer at Zuna, an RIA and business consulting firm.

Treichel also noted that the best interest standard, with respect to rollover advice, applies where the five-part part test has been met. “Then, the exemption can be used,” she said. “So, if it isn’t an ERISA fiduciary as based on the five-part test, then this doesn’t apply.”

Time to Scramble

Investment advisers -- who were just getting their arms around the new investment adviser marketing rule that is likely to go into effect in the coming months -- now must deal with this unexpected surprise from the Labor Department, said GJ King, president of RIA in a Box.

“On one hand advisers will generally be able to choose if they want to use new forms of marketing which may be available to them such as endorsements or testimonials,” said King. “And on the other hand, it appears with this new Labor Department exemption that most advisers will have no choice but to immediately comply.”

Given that the vast majority of investment advisers provide rollover investment advice, things just got a lot busier for almost every investment adviser who will be scrambling to figure out how to comply, said King.

Of note, the new Labor Department rule typically applies to investment adviser fiduciaries, and excludes most salespersons under a complicated definition of an ERISA fiduciary.

The Silver Lining

The good news is that the Labor Department did reaffirm that advisers may be able to rely upon the Field Assistance Bulletin 2018-02 during a transition period that will end Dec. 20, 2021. According to the Labor Department, this transition period will allow investment advice providers to implement important system changes.

But even though some of the rule's compliance requirements may not take full effect for another 10 months, King said many advisers will have to scurry to quickly familiarize themselves with the impartial conduct standards. Those standards require an adviser to provide advice in the best interest of the investor along with ensuring compensation is reasonable and that no misleading statements are made.

For her part, Treichel noted that the Labor Department’s impartial conduct standard is now aligned with that of the Securities and Exchange Commission.

The Labor Department also published related guidance for retirement investors, employee benefit plans and investment advice providers. So, that should help too.

What do advisers need to know? With respect to rollovers, Treichel noted the following distinction. In the past, advisers who weren’t plan fiduciaries were able to take the position that their rollover recommendations to participants in the plan weren’t fiduciary advice because the recommendation to the participant to roll to the IRA was just “one-time” and thus wasn’t on a regular basis.

This new Labor Department interpretation, she said, changes the game for advisers who didn’t want to be subject to ERISA fiduciary status for rollovers.

The Labor Department now looks at ongoing and regular basis more holistically -- from the perspective of the individual, said Treichel.

“However, advice to roll over plan assets can also occur as part of an ongoing relationship or an intended ongoing relationship that an individual enjoys with his or her investment advice provider,” she said. “In circumstances in which the investment advice provider has been giving advice to the individual about investing in, purchasing, or selling securities or other financial instruments through tax-advantaged retirement vehicles subject to Title I or the Code, the advice to roll assets out of a Title I Plan is part of an ongoing advice relationship that satisfies the regular basis prong.”

Similarly, she said advice to roll assets out of a Title I Plan into an IRA where the investment advice provider has not previously provided advice but will be regularly giving advice regarding the IRA in the course of a more lengthy financial relationship would be the start of an advice relationship that satisfies the regular basis prong.

“It is clear under Title I and the Code that advice to a Title I Plan includes advice to participants and beneficiaries in participant-directed individual account pension plans, so in these scenarios, there is advice to the Title I Plan—meaning the Plan participant or beneficiary—on a regular basis,” said Treichel. Read more from the Federal Register.

Be Ready to Document

For rollovers, be ready to document to show the prudent process, said Treichel.

She recommends developing a rollover documentation process that is flexible and functional. “Something that helps to show the prudent process without showing too much,” she said. “Thinking from the perspective of a litigator, firms will want to show their work without showing too much to create a lawsuit’s exhibit.”

The compliance date starts Tuesday. Firms likely already have some procedures in place, which are fine until December 2021 under the transition guidance, but advisers should be prepared for guidance from the home office to get ready to comply, said Treichel.

According to Treichel, many firms had policies and procedures crafted around the Desert Letter (2005-23A) for rollovers and that no longer applies. “If that’s still the case, the firm will want to see counsel or compliance consulting support to revise procedures,” she said.

For his part, King noted that this step by the Labor Department will probably place the most operational burden on smaller investment adviser firms that often do not have the internal expertise or resources to easily meet the rule's new extensive requirements which will take full effect later this year.

“In order to provide rollover advice, RIA firms are likely now going to need to establish a separate, parallel compliance program in order to comply with this new exemption which will be subject to review by the Labor Department in addition to the firm's more traditional compliance program designed to meet state or federal securities requirements.”

Traps to Avoid

According to Treichel, the five-part test is functional. “Those advisers who are specialists are used to this. But for those stepping into the arena as a part of this rule making by virtue of rollovers, it may be a new concept to get used to the idea that you can’t ‘contract your way out of fiduciary status,’” she said. “It is functional in nature based on what you do.”

Treichel also recommends that you take inventory. “Are you an investment manager or an investment adviser?” she asked. In other words, the prohibited transaction exemption only applies to 3(21) investment advisers and not to discretionary investment managers under 3(38). “This small fact may easily be forgotten by advisers -- particularly those that act in both capacities depending on the relationship,” she said.

One of Many Steps

Worth noting too is that the Labor Department views this exemption as just one of what could be many steps in its effort to improve investment advice for workers and retirees.

“We will continue our stakeholder outreach to determine how we might improve this exemption, the rule defining who is an investment advice fiduciary, and related exemptions to build on this approach,” Ali Khawar, Deputy Assistant Secretary of Labor for the Employee Benefits Security Administration, said in a statement.

The Crystal Ball

Experts also predict, now that the Biden administration is in place, many potential regulatory changes coming not only from the Labor Department but the SEC for those federally registered as an adviser.

For instance, the SEC is likely to tweak in the coming months its just-updated rules that govern investment adviser marketing. Even the rules such as the Prohibited Transaction Exemption 2020-02, approved by the Trump administration and granted a “stay” by the Biden administration, will see changes, experts predict.

The Labor Department is also likely to review and perhaps revise its recent ESG rule, and the SEC might require more disclosures by publicly traded companies.

So, what else should advisers do in the meanwhile? Advisers should pay attention to FINRA’s examination priorities for registered representatives, as well the SEC’s Office of Compliance Inspections and Examinations’ priorities for investment advisers.

And registered representatives, and especially dual registrants, should be on their best behavior. “There will be no more Mr./Ms. Nice Guy from the SEC and FINRA after ‘educational’ warnings last year,” said one expert. “They will be looking for egregious violations of Reg BI and publicize enforcement settlements as an example for others.”