The Final Rule, along with the amended PTEs, will impact broker-dealers, banks, investment advisers and insurance firms and their agents to the extent they provide advice and recommendations (including rollover recommendations) with respect to their job-based retirement accounts and other retirement-savings plans.
The Final Rule and the amended PTEs are scheduled to be effective September 23, 2024, with a one-year transition period after such date for two of the amended PTEs (PTE 2020-02 and PTE 84-24) during which investment advisers will need to comply with the Impartial Conduct Standards and provide a written acknowledgment of their fiduciary status in order to rely on either exemption. However, the Final Rule and the PTE amendments are already facing legal challenges that may delay their effectiveness.
Five Key takeaways from the Final Rule and the PTE amendments
- A person will be considered to be an investment advice fiduciary if the person makes a “recommendation” of any securities or other investment property, or any investment strategy related to such securities or other investment property, to a “retirement investor” for a fee or compensation and (A) facts and circumstances indicate the person is a fiduciary; OR (B) the person acknowledges fiduciary status.
- Whether a “recommendation” has been made is interpreted in a manner consistent with the framework in Regulation Best Interest promulgated by the U.S. Securities and Exchange Commission (the “SEC”). To that end, the inquiry will focus on whether the communication is a “call to action.”
- The exception for recommendations made to sophisticated investors is eliminated.
- Investment advice fiduciaries are excluded from the definition of “retirement investors.”
- The requirement in the proposed amendments to PTE 2020-02 and 84-24 that would have required financial institutions to disclose their compensation arrangements on a publicly available website is eliminated.
A wide range of fiduciaries will be subject to the Final Rule. Despite the expected delay in implementation, the Final Rule would be a sea of change in the approach to advising retail clients with respect to their retirement assets, and investment advisers should prepare for and ensure their compliance with the Final Rule in anticipation of the current effective date.
Please refer to sections below for further details on how the Final Rule may impact your business and points for your consideration.
History and background
Since 1975, the DOL has used a five-part test (the “Five-Part Test”) to determine whether a person is providing investment advice that would render the person a fiduciary to the advice recipient under ERISA. The Final Rule is a culmination of the DOL’s attempts over the last decade to remove certain conditions that must be met before an advice provider is deemed to be a fiduciary in light of the shifting retirement landscape from defined benefit pension plans to defined contribution plans (such as 401(k) plans).
The DOL made a series of attempts to broaden the definition of investment advice fiduciary. The Obama administration issued its version of a fiduciary rule in 2016 (the “2016 Rule”) which, similar to the Final Rule, sought to replace the definition of investment advice fiduciary in place from 1975. The 2016 Rule was vacated by the Fifth Circuit Court of Appeals in 2018, due to its broad reach to relationships lacking the “trust and confidence” that the court found to be key to a common law fiduciary relationship. In response to the Fifth Circuit’s decision, the DOL reinstated the Five-Part Test in 2020 with an updated interpretation that stated the test could cover certain recommendations to rollover retirement assets to a new account. This interpretation was invalidated by a Florida district court decision in 2023.
In 2019, new “best-interest” rules were issued by the SEC under its Regulation Best Interest and the National Association of Insurance Commissioners under its revised model regulations providing that brokers-dealers and insurance agents, respectively, must act in the consumer’s best interest. The DOL, however, believed that the SEC’s rule did not cover certain types of investment products and retirement savings transactions that were becoming more common (e.g., one-time advice on rolling over 401(k) assets into an individual retirement account (“IRA”) or on selecting 401(k) investment options), and that the SEC’s rule did not apply to commodities or insurance products (e.g., fixed index annuities). Noting these gaps, the DOL expressed its desire to expand covered investment advice made to retirement investors.
The DOL issued the Proposed Rule on October 31, 2023 to replace the Five-Part Test, which sought to address the Fifth Circuit’s emphasis on relationships of “trust and confidence” and establish a narrower definition of fiduciary advice than the 2016 Rule. During the 60-day comment period following the release of the Proposed Rule, the DOL held a public hearing and received more than 19,000 public comment letters and testimony about the Proposed Rule.
The Final Rule and PTE amendments explained
Definition of investment advice fiduciary expanded—now with carveouts
The Final Rule replaces the Five-Part Test by eliminating the requirement that advice be provided to a retirement investor on a “regular basis” and serve as “a primary basis for investment decisions” in order to be investment advice that is fiduciary in nature. Therefore, the Final Rule could impose fiduciary status on a person providing one-time investment advice.
A person would be an investment advice fiduciary under the Final Rule if the person (1) makes a recommendation of any securities or other investment property or any investment strategy related to such securities or other investment property to a retirement investor for a fee or compensation and (2) makes the recommendation in one of the following two contexts:
(A) Facts and circumstances: 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 makes a recommendation to a retirement investor under circumstances that would indicate to a reasonable investor in like circumstances that the recommendation is based on a review of the retirement investor’s particular needs or individual circumstances, reflects the application of professional or expert judgment to the retirement investor’s particular needs or individual circumstances, and may be relied upon by the retirement investor as intended to advance the retirement investor’s best interest, OR
(B) Fiduciary acknowledgement: the person represents or acknowledges that the person is acting as a fiduciary under Title I of ERISA, Title II of ERISA, or both, with respect to the recommendation.
In reaction to comments on the Proposed Rule, the Final Rule excludes situations in which the advice provider has discretionary authority or control with respect to purchasing or selling securities or other property for a benefit plan. Therefore, a person will not be deemed to be providing “investment advice” under the Final Rule merely because the person has discretionary authority or control with respect to purchasing or selling securities or other property for the retirement investor. The Final Rule eliminates any reference to discretionary control, and instead relies on the facts and circumstances surrounding the covered recommendation to determine when a person is acting as an investment advice fiduciary.
The DOL further clarified that a person does not provide investment advice as a fiduciary if the person’s recommendation does not meet one of the two contexts above and that fiduciary status will be determined on a transaction-by-transaction basis. The Final Rule carves out two types of communication that do not constitute fiduciary investment advice, unless the communication meets the facts and circumstances of a recommendation as described above or the person acknowledges their fiduciary status: (1) a salesperson’s pitch for a particular investment or investment strategy and (2) a person providing investment information or education, such as a human resources presentation.
Definition of “recommendation”—consistent with Regulation Best Interest
The Final Rule does not include a definition of “recommendation.” Rather, the DOL explains in the preamble to the Final Rule that whether a recommendation has been made will turn on the facts and circumstances of the particular situation, including whether the communication reasonably could be viewed as a “call to action,” and that whether a recommendation has been made will be construed in a manner consistent with the SEC’s framework in Regulation Best Interest. This appears to be a narrower standard than under the Proposed Rule, where recommendation was defined as a communication that, based on its content and presentation, would reasonably be viewed as a “suggestion” that the retirement investor engage in or refrain from taking a particular course of action.
Further, the DOL noted that communications to a group of retirement investors or communications with respect to “a selective list of [appropriate] securities” may constitute recommendations based on the context. However, the more individually tailored the communication is to a retirement investor, the more likely it is that such communication would be viewed as a recommendation.
Definition of “retirement investor”—now with limitations
The Final Rule defines the term “retirement investor” to include ERISA plans and their participants or beneficiaries, as well as IRAs, their owners or beneficiaries. Therefore, fiduciaries of an ERISA plan or IRA may also be retirement investors under the Final Rule unless their fiduciary status would derive solely from the fact that they provide “investment advice” as fiduciaries to other retirement investors. This change from the Proposed Rule ensures that asset managers do not render “investment advice” in a fiduciary capacity by making recommendations to a financial professional or firm that itself will render investment advice to retirement investors in a fiduciary capacity.
Despite industry comments, the DOL chose not to address the status of independent marketing organizations (“IMOs”), field marketing organizations (“FMOs”) and other insurance intermediaries under the Final Rule. The DOL indicated it would determine the fiduciary status of these entities based on a determination of whether communications by the organization involved “recommendations” and whether insurance producers are considered “retirement investors” under the Final Rule. The DOL also did not eliminate health and welfare plans and health savings accounts (“HSAs”) from the definition of a “retirement investor” in the Final Rule, despite commentors’ requests, noting that such plans are clearly covered by either Title I of ERISA or by the prohibited transaction provisions in Title II of ERISA.
No exception for sophisticated investors—consistent with the Proposed Rule
The 2016 Rule contained an exception for recommendations made to independent fiduciaries managing at least $50 million in assets, which would have been applicable to discussions between large pension plans and their investment managers and principals of investment funds and other investment vehicles. The Final Rule, consistent with the Proposed Rule, does not include any special provision for recommendations made to sophisticated advice recipients. Instead, any communications between sophisticated investors and advice providers would be subject to analysis under the Final Rule’s new standards to determine if the communication is fiduciary investment advice.
Amendments to prohibited transaction exemptions (PTEs)
Certain PTEs under ERISA were amended in connection with the Final Rule. These amendments may be relied upon by financial professionals in various investment advice situations to avoid conflicts of interest: (1) PTE 2020-02 (applicable to investment advice provided to retirement investors); (2) PTE 84-24 (applicable to independent insurance agents); and (3) PTEs 75-1, 77-4, 80-83, 83-1 and 86-128 (applicable to certain securities transactions). The amendments to these PTEs remain largely unchanged from the Proposed Rule, but there are notable differences.
PTE 2020-02. PTE 2020-02 applies to financial professionals who are under the supervision of a financial institution. The proposed amendment makes clarifying changes to PTE 2020-02, including specifying disclosure and notification requirements and expanding the scope of the exemption to certain transactions and parties. Under amended PTE 2020-02, insurance companies selling products through an independent agent would be required to provide a fiduciary acknowledgment and be treated as a fiduciary if they exercise oversight responsibilities over the independent agents. Agents who are more closely affiliated with insurers, broker-dealers or investment companies and operate under PTE 2020-02 would have to provide a notice acknowledging that they would receive commissions or other transaction-based compensation and must offer to provide specific compensation information for free upon request.
PTE 2020-02 was expanded to specifically provide an exemption from the prohibited transaction rules for “pure” robo-advice relationships, a notable difference from the 2016 Rule. The DOL also removed the requirement from the Proposed Rule that would have required financial institutions to disclose their compensation arrangements on a publicly available website in response to criticisms over the potential cost in meeting such requirement and to make PTE 2020-02 more consistent with the requirements under the SEC’s Regulation Best Interest.
PTE 84-24. PTE 84-24 applies to financial professionals who are not under the supervision of a financial institution. A new section was added to PTE 84-24 to provide relief for compensated investment advice by independent insurance producers (“Independent Producers”) that recommend annuities from multiple unaffiliated insurance companies to retirement investors, subject to criteria similar to those relying on PTE 2020-02. PTE 84-24 requires that an independent insurance agent selling products for an insurance company acknowledge its fiduciary status, and that an insurance company exercise supervisory authority over the independent agent with regard to an agent’s recommendation of the insurance company’s own products. Independent agents who operate under PTE 84-24 can continue to earn commissions but have to disclose their initial commissions and renewal commissions, both in terms of dollar amount and as a percentage of premium payments. Unlike the 2016 Rule, PTE 84-24 does not require insurance companies to assume fiduciary status with respect to independent insurance agents.
In a departure from the Proposed Rule, the Final Rule expands the types of compensation covered under the exemption by replacing the narrow allowance for the receipt of insurance sales commission with “reasonable compensation” under ERISA, subject to the Impartial Conduct Standard. In response to comments, the Final Rule scales back the amended recordkeeping conditions in PTE 84-24 and now requires that Independent Producers maintain for six years from the date of a covered transaction sufficient records to demonstrate that the conditions of the exemption have been met. Similar to the PTE 2020-02, financial institutions will not be required to disclose their compensation arrangements with third parties on a public website to rely on PTE 84-24.
As a reminder, under both PTE 2020-02 and PTE 84-24, investment advisers must adhere to “Impartial Conduct Standards,” which require, among other things, that the investment advice be in the “best interest” of the retirement investor, the investment professional and firm must charge no more than reasonable compensation and comply with federal securities laws, and the investment advice be free from misleading statements about investment transactions and other relevant matters. Financial institutions relying on PTE 2020-02 or PTE 84-24 are not required to disclose all of their compensation arrangements with third parties on a publicly available website, as was required by the 2016 Rule.
PTEs 75-1, 77-4, 80-83, 83-1, and 86-128. PTE 75-1 Parts III and IV, PTEs 77-4, 80-83, 83-1, and 86-128 are amended to eliminate relief for transactions resulting from fiduciary investment advice as defined under ERISA. The PTEs currently provide relief for certain transactions in connection with investment advice, and the amendment eliminates fiduciary investment advice transactions from the covered transactions under each exemption and makes certain other administrative changes. As a result of the amendments, investment advice fiduciaries would need to rely on PTE 2020-02 or PTE 84-24 to receive compensation that otherwise would be prohibited in connection with investment advice transactions and would be held to the same conduct standards in administrative exemptions.
In contrast to the Proposed Rule, in which the DOL had proposed to adjust the recordkeeping requirements under PTE 75-1 to shift the burden from plans and IRA owners to financial institutions, the Final Rule keeps the recordkeeping requirement unchanged from the existing exemption.
When will the Final Rule take effect?
The regulation will be effective September 23, 2024, 150 days from the date of its publication in the Federal Register. However, the Final Rule will likely face legal challenges, similar to the 2016 Rule, which may delay its implementation. For PTE 202002 and PTE 84-24, there is an additional one-year transitional period (running through September 23, 2025) during which investment advisers will need to comply with the Impartial Conduct Standards and provide a written acknowledgment of their fiduciary status in order to rely on either exemption.
Who will be impacted by the Final Rule?
A wide range of investment advisers will be subject to the Final Rule, including:
- retirement advisers generally, irrespective of the types of security or insurance products on which they are providing recommendations (including commodities and insurance products, which are currently not covered under the fiduciary rule) or the states in which they are located;
- financial advisors providing one-time recommendations to plans and to participants on 401(k) rollovers into IRAs or investment options;
- investment advisers to plan sponsors providing advice regarding which investments to make available as options in 401(k) plans and other employer-sponsored plans;
- current fiduciaries or those working in a fiduciary capacity due to amendments to exemptions commonly relied upon by such fiduciaries; and
- annuities and employee welfare benefit plans with an investment component (e.g., health savings account programs).
Considerations for investment advisers and investors
Investment advisers and investors should consider the potential impact of the Final Rule on their businesses and may wish to do the following:
- review and prepare for potential changes to current disclosures (such as offering materials) that include fiduciary rule language;
- become familiar with the Final Rule’s requirements and consider compliance planning;
- if relying on PTE 2020-02 and PT 84-24, keep in mind the one-year transition period during which written acknowledgment of fiduciary status is required, along with compliance with the Impartial Conduct Standards;
- plan sponsors and investors seeking assistance from investment advisers should conduct due diligence about prospective investment advisers and confirm their advice will be made in your best interests and in compliance with the Final Rule;
- if applicable, communicate with current investment advisers to understand how the advisor is planning for compliance.
We invite you to reach out to your A&O Shearman contact to discuss how the Final Rule may impact your business.