Special Edition: Fiduciary Rule

President Biden and his administration are focused on retirement security, as they announced on Tuesday, October 31 the Retirement Security Rule to repropose the definition of investment advice and make changes to prohibited transaction exemptions. Paired with multiple releases from the White House, a Fact Sheet from the Department of Labor (DOL), the proposed text of the new rule, and a press conference, this new rule is surrounded by attention to cut “junk fees” and target annuity sales practices.

Let’s Dive In…

Legislative Background

All plans must have at least one fiduciary and most plans have several fiduciaries. The determination of who is a fiduciary is part of the definitions section (that’s section 3) in ERISA. The 21st definition is for a fiduciary and applies to both employers and financial professionals/service providers — as anyone can become a fiduciary to a retirement plan if certain elements are met. A year after ERISA was passed, in 1975, the DOL came out with a five-part test to help determine if advice was being provided for a fee — giving rise to fiduciary status.

One of the five parts of the test that has become controversial is the “regular basis” requirement, grounded in an ongoing relationship between the parties. Over the years there have been multiple updates and rule proposals (including 2010, 2016, and 2018) related to this test and the definition of investment advice. The most recent 2018 proposal was not a change to the regulation but instead was the addition of a prohibited transaction exemption, PTE 2020-02, and an interpretation of the prior 1975 guidance through the DOL’s FAQs.

Just this year, the DOL’s interpretation of the preamble and certain FAQs were challenged in two lawsuits. In one court, an opinion was issued vacating the policy referenced in FAQ 7 (titled “When is advice to roll over assets from an employee benefit plan to an IRA considered to be on a ‘regular basis’?”) and remanded it back to the DOL. In a second court, a magistrate judge recommended portions of PTE 2020-02 should be vacated.

Retirement Security Rule

With this litigious history, where does that leave plan sponsors and participants to understand who is a fiduciary and who is acting in their best interest? The Retirement Security Proposed Rule and Proposed Amendments to Class Prohibited Transaction Exemptions for Investment Advice Fiduciaries seeks to clarify and simply the regulatory ping pong. As the Fact Sheet states, financial professionals will only be considered fiduciaries when “recommendations are made in certain specified contexts, each of which describes circumstances in which the retirement investor can reasonably place their trust and confidence in the advice provider.” There are a few major parts to the proposal, including the following:

• Updates to the five-part test. Under the proposal, there will no longer be a five-part test. Instead, advice can be provided in any one of the following contexts:
  1. The person either directly or indirectly (e.g., through or together with any affiliate) has discretionary authority or control, whether or not pursuant to an agreement, arrangement, or understanding, with respect to purchasing or selling securities or other investment property for the retirement investor; or
  2. The person either directly or indirectly (e.g., through or together with any affiliate) makes investment recommendations to investors on a regular basis as part of their business and the recommendation is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest; or
  3. The person making the recommendation represents or acknowledges that they are acting as a fiduciary when making investment recommendations.
• Updates to administrative exemptions. As you may recall, one reason to understand if you or someone else is a fiduciary is that there are certain things you cannot do if you are a fiduciary. These “things” are usually conflicts of interest that are known as prohibited transactions. For prohibited transactions, a prohibited transaction exemption (PTE) is required. The Retirement Security Rule makes updates to several PTEs including two noteworthy PTEs: PTE 84-24 and PTE 2020-02. Many financial professionals are already using these PTEs, and they will make small tweaks to their procedures given the changes under the Retirement Security Rule. However, more traditional insurance-focused professionals may need to make substantial changes under the proposed rules.

Rulemaking Process: Make Your Voice Heard

There is a lot of excitement under what is just a proposed rule, though the rulemaking process may be a long and winding road. The Retirement Security Rule was announced on October 31, 2023. It is published in the Federal Register shortly thereafter. Once published, there is a period in which comments may be submitted to the DOL — and even you can submit your comments. Although the comment period is slated for 60 days, sometimes that period is extended.

Once the comments are received, the DOL will review and consider all the comments and prepare the final rule, which will go back to the Office of Management and Budget before the final rule is released. Once released, there is generally a short period of time before the rule is effective. In the interim, your financial professionals likely will continue under the existing regulatory scheme.