The Department of Labor has issued final regulations broadening who qualifies as a fiduciary under ERISA. Retirement Security Rule: Definition of an Investment Advice Fiduciary, §2510.3-21, 29 CFR Part 2510, RIN 1210-AC02, April 25, 2024.
Already Being Challenged
The regulations are already being challenged by an advocacy group for independent insurance professionals claiming that the final rule creates heavy compliance burdens and hurts their ability to make commissions by unlawfully turning insurance agents into ERISA fiduciaries. Fed’n of Americans for Consumer Choice Inc. v. DOL, E.D. Tex., No. 6:24-cv-00163, 5/2/24.
The DOL responded to these and other numerous comments during the regulatory process and made certain changes and clarifications discussed below that narrow the contexts in which a covered recommendation will constitute ERISA fiduciary investment advice. The DOL believes the final rule, with these revisions, appropriately defines an investment advice fiduciary to comport with reasonable investor expectations of trust and confidence. It will be interesting to see how courts will respond to litigation efforts to enjoin and vacate the final fiduciary rule in view of the thoughtful and considered examination of public comments and testimony at public hearings conducted by DOL who is the governmental agency responsible for the enforcement of ERISA.
2024 Rule Made Significant Changes to the Definition of Fiduciary
The final regulation makes significant changes to the step-by-step process used to determine when advice is considered subject to ERISA’s fiduciary duties. The DOL had to revert to using a five-part test dating back to 1975 to determine fiduciary status after the Fifth Circuit struck down the agency’s first attempt to modernize the definition in 2018.
The DOL final rule which redefines the meaning of “investment advice fiduciary” expands the circumstances under which a person is treated as providing “investment advice” that is subject to ERISA’s fiduciary standards.
The final rule replaces the five-part test’s requirements that advice be provided (1) on a “regular basis” pursuant to (2) “a mutual agreement, arrangement or understanding” that (3) it would serve as “a primary basis for investment decisions” with a broader test that is based on the retirement investor’s reasonable expectations and context.
Details of the Final Rule - When is a person providing “Investment Advice”?
Under the final rule, a person provides “investment advice” if it provides a “recommendation” of “any securities transaction or other investment transaction or any investment strategy involving securities or other investment property” to a “retirement investor” (i.e., an ERISA plan, plan fiduciary, plan participant or beneficiary, or an IRA, IRA fiduciary or IRA owner or beneficiary) and
[i] The person either directly or indirectly (e.g. through or together with any affiliate) makes professional investment recommendations to investors on a regular basis as part of their business and the recommendation is made under circumstances that would indicate to a reasonable investor that the recommendation is based on review of the retirement investor’s particular needs or circumstances, reflects the application of professional or expert judgment, and may be relied upon by the retirement investor as intended to advance the retirement investor’s best interest; or
[ii] The person represents or acknowledges that they are acting as a fiduciary under ERISA.
According to DOL, a person does not provide “investment advice” if they make a recommendation but neither paragraph [i] nor [ii] above are satisfied.
Investment Information/Education Not Considered Advice
The final rule states that the mere provision of investment information or education, without an investment recommendation, is not advice within the meaning of the rule. This is an important change from the proposed rule. The final rule makes it clear that offering investment information or education to retirement savers is not considered investment advice, leaving room for human resources employees of plan sponsors to provide participants with plan-related materials without being considered a fiduciary.
The final rule emphasizes that written statements by a person disclaiming status as a fiduciary under ERISA, or disclaiming the conditions set forth in paragraph [i] above, will not control to the extent they are inconsistent with the person’s oral or other written communications, marketing materials, applicable State or Federal law, or other interactions with the retirement investor.
Discretionary Authority or Control Required
The final rule provides that a person who is a fiduciary with respect to a plan or IRA by reason of rendering investment advice (as defined above) for a fee or other compensation, direct or indirect, shall not be deemed to be a fiduciary of the plan or IRA with respect to which such person does not have any discretionary authority or control.
According to the final rule, a person provides investment advice “for a fee or other compensation, direct or indirect,” if the person (or any affiliate) receives any fee or compensation, from any source, for the investment advice, including, but not limited to, commissions, loads, finder’s fees, revenue sharing payments, shareholder servicing fees, marketing or distribution fees, mark ups or mark downs, underwriting compensation, payments to brokerage firms in return for shelf space, recruitment compensation paid in connection with transfers of accounts to a registered representative’s new broker-dealer firm, expense reimbursements, gifts and gratuities, or other non-cash compensation.
Implications of New Test
[i] Elimination of “regular basis” requirement
Under the five-part test, an isolated one-time interaction generally was not treated as fiduciary investment advice because the advice was required to be provided on a “regular basis” to the advice recipient. The final rule expands the fiduciary net by allowing the “regular basis” requirement to be satisfied for anyone who makes (or has an affiliate that makes) investment recommendations to any investors on a “regular basis” as part of its business. This means that one-time advice can be subject to the fiduciary standard.
This is the most significant change in the final rule. Now one-time advice, including advice relating to rollover transactions, can make you an investment advice fiduciary. For example, someone recommending a rollover out of a 401(k) plan into an IRA should now be concerned that their recommendation may be a fiduciary interaction that needs to be documented as to why the rollover is in the best interest of the participant.
[ii] Elimination of “mutual agreement, arrangement or understanding” and “primary basis” requirement
Under the five-part test, an adviser could avoid fiduciary status by making clear (including via contract disclaimers) that there is no “mutual agreement, arrangement or understanding” that anything the adviser says will serve as “a primary basis” for an investment decision. The final rule looks instead to whether the objective circumstances surrounding the recommendation make it reasonable for the retirement investor to believe that it could rely upon the advice as “a basis” for an investment decision that is in the retirement investor’s best interest.
[iii] Acknowledgement of fiduciary status
Under the final rule, there is no requirement that an adviser that represents or acknowledges that it is acting as a fiduciary when making investment recommendations be an adviser that provides investment recommendations on a regular basis as part of its business or on a regular basis to the retirement investor. If the adviser says it will be acting as an ERISA fiduciary when providing advice, it will be held to that standard with respect to the provision of such advice.
[iv] No disclaimers
The final rule states that disclaimers regarding fiduciary status will not control to the extent they are inconsistent with the adviser’s verbal communications, marketing materials, State or Federal law or other interactions with the retirement investor. Accordingly, common provisions set forth in private investment fund documentation purporting to make clear that the manager is not providing investment advice to invest in the fund would not be dispositive if inconsistent with the manager’s marketing activities or investment advice related to retirement investors.
Impact On Fiduciary Status
Under the final rule, service providers to ERISA plans or IRAs (who are in the business of providing investment advice on a regular basis) who do not currently hold themselves to fiduciary standards or have not contractually agreed to comply with ERISA and do not represent themselves as fiduciaries, could be deemed to be investment advice fiduciaries providing covered investment advice.
Accordingly, service providers to ERISA plans or IRAs (or vehicles holding “plan assets”) should review their existing arrangements to assess the potential impact of the final rule.
Prohibited Transaction Exemptions
Prohibited transaction exemptions have been revised under the final rule as well. For example, amendments to Prohibited Transaction Exemption (PTE) 2020-02, which contains impartial conduct standards that require financial institutions and investment professionals to provide advice that is in the best interest of the retirement investor, require that compensation, direct or indirect, be reasonable and explicitly prohibit statements (written or oral) about the recommended transaction that are materially misleading at the time the statements are made. (Such statements are also prohibited under the Investment Advisers Act of 1940.)
Effective Date
The final rule is due to go into effect 150 days after its April 25 publication in the Federal Register, with a staggered full compliance date set for a year after that on September 25.