Action Taken: In December, the Department of Labor (DOL) finalized and published in the Federal Register its Prohibited Transaction Exemption (PTE). The PTE became effective February 16, 2021, and is available to Investment Advice Fiduciaries, including Investment Professionals and Financial Institutions, who receive variable compensation – e.g. commissions – based on their investment advice to ERISA Plans or IRAs.
The DOL defines Investment Advice Fiduciaries as individuals who render advice:
1. As to the value of securities or other property, or makes 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 Retirement Investor that;
4. the advice will serve as a primary basis for investment decisions with respect to Plan or IRA assets; and that
5. the advice will be individualized based on the particular needs of the plan or IRA.
In order for the investment advice fiduciaries (as defined by the above "5-part test") to comply with the PTE they must satisfy the following Impartial Conduct Standards:
1. Act in the best interest of the Retirement Investor;
2. Receive reasonable compensation for the services provided (based on longstanding DOL and IRS “reasonableness” guidance);
3. Seek to obtain the best execution of the transaction reasonably available; and
4. Avoid making any materially misleading statements about the transaction or other relevant matters (e.g., compensation, conflicts of interest).
In order for Investment Professionals to be said to be acting in their clients’ best interests, their investment advice must:
1. Reflect the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives; and
2. Not place the financial or other interest of the Investment Professional, Financial Institution or any affiliate, related entity or other party ahead of the interests of the Retirement Investor, or subordinate the Retirement Investor’s interest to their own.
In interpreting the best interest standard, the DOL states that its intent is to remain consistent with the Securities and Exchange Commission (SEC)’s Regulation Best Interest (Reg BI) standard. The DOL’s standard, like the SEC rule:
1. Does not require “conflict-free” advice (so Investment Professionals may, for instance, recommend proprietary products):
2. Utilizes the benchmark of a prudent professional in like circumstances;
3. Is evaluated at the time the advice is rendered, not in hindsight;
4. Does not require recommendation of “the best” or lowest-cost investment option; and
5. Does not establish an ongoing duty to monitor, unless such a duty is established by agreement or understanding with the Retirement Investor.
Under the PTE, Financial Institutions are required to do the following:
1. Provide certain disclosures regarding:
2. Establish, maintain, and enforce policies and procedures:
3. Conduct retrospective compliance reviews at least annually to detect and prevent violations with the exemption (the results of which would be memorialized in a report);
4. Produce an annual Senior Executive Officer certification that: s/he has reviewed the compliance report, the Financial Institution has sufficient policies and procedures in place to satisfy the exemption, and it has implemented prudent processes to periodically test the efficacy of those policies and procedures and to modify them as law and regulations may require; and
5. Retain records, including compliance reports and certifications, demonstrating compliance with the exemption for six years (to which DOL and the Treasury Department would have access).
Disclosures may be provided as part of any other disclosures already given to clients, so long as the required elements are included – but disclosures must be provided prior to the transaction for which the exemption is needed (or for rollover disclosures, prior to the rollover recommendation).
As under the SEC’s Reg BI, DOL indicates that, under its conditions, financial institutions would be barred from establishing or permitting sales contests or quotas, or bonuses or non-cash compensation tied to the sale of certain investments within a limited time period.
It is advisable for Investment Professionals to work with their Financial Institutions to ensure they are delivering adequate disclosures to their clients, satisfying any new policies and procedures related to the PTE, and adhering to any internal documentation requirements the Financial Institution may impose.
Without an exemption, receipt of variable compensation based on fiduciary investment advice is a prohibited transaction and is subject to certain penalties under ERISA and the Code. The exemption does provide an opportunity for “self-correction” (i.e., the pertinent transaction will be rendered prohibited and subject to penalty) if:
1. The Retirement Investor does not suffer any losses (may be made whole by the Financial Institution if there are investment losses);
2. The Financial Institution corrects the violation within 90 days of learning of it and notifies the DOL; and
3. The violation and correction are included in the annual compliance review report.
If an Investment Professional systemically or intentionally violates the PTE’s conditions, or if s/he provides materially misleading information to the Department in connection with conduct under the exemption, the Investment Professional may be barred from utilizing this particular exemption for 10 years.
Background: Under the Obama administration, the DOL issued a rule that would have imposed restrictive fiduciary duty on financial professionals and hindered access of middle-market investors to retirement services and advice. NAIFA was among the organizations that filed a lawsuit resulting in the U.S. Court of Appeals for the Fifth Circuit vacating the rule in 2018.
In December of 2020, the DOL finalized its new PTE for financial professionals who provide retirement plan advice. The DOL exemption aligns with SEC’s Reg BI, and preserves opportunities and choices for workers and retirees seeking high-quality, personalized advice.
NAIFA believes that the DOL PTE will benefit retirement investors by preserving access to a wide variety of investment advice, professionals, products, and compensation arrangements. We believe that the DOL struck the right balance between crafting a PTE with robust compliance obligations that serve the interests of investors, while avoiding an overly prescriptive approach or penalizing certain market segments or arrangements versus others.
Next Steps: The new PTE is effective Feb. 16, 2021. In addition, FAB 2018-02 will remain in effect for one year to give institutions a transition period to develop procedures to comply with the new PTE. NAIFA members who meet the DOL’s definition of Investment Professionals and who wish to take advantage of this Prohibited Transaction Exemption may now do so in accordance with the DOL’s conditions.
Additionally, it is strongly recommended that NAIFA members follow the guidance and instructions set by their financial institutions when working with retirement savings and other investments, and when taking advantage of the Prohibited Transaction Exemption.