After several false starts and years of work and intense debate, the Department of Labor (DOL) has proposed a rule to update the nearly 50-year-old fiduciary standard. On October 31, 2023, the DOL issued its latest regulation, Retirement Security Rule: Definition of an Investment Advice Fiduciary. The rule seeks to redefine who is an investment advice fiduciary under the Employee Retirement Income Security Act (ERISA) by substantially expanding the circumstances in which an investment recommendation rises to the level of a fiduciary act and amend certain prohibited transaction exemptions.
The new fiduciary initiative would require financial advisors, brokers, and insurance sales personnel to be held to a fiduciary standard when marketing financial products to retirement investors, including individual retirement accounts (IRAs). The proposal, if adopted, would affect those who sell financial products to qualified plans and IRAs and would require them to make significant changes to their sales practices. The impact would be felt primarily in sales of annuities to fund rollovers from plans to IRAs.
The proposal is DOL’s fourth attempt since 2010 to amend the five-part test in its 1975 regulation for determining whether a person is an ERISA fiduciary. The first effort was abandoned due to extreme pressure from Wall Street and other financial services providers. The second attempt produced a final rule in 2016, but the Fifth Circuit vacated the rule two years later. The third effort, PTE 2020-02, was a broader interpretation of the existing rule with an exemption for investment advice. This rule was partly overturned by a Florida district court decision (American Securities Association v. U.S. Department of Labor, Case No. 8:22-cv-330).
According to the DOL, the current regulation that defines when a person is acting as an ERISA fiduciary fails to include many situations in which an investor would reasonably believe they are receiving impartial advice from a fiduciary. Specifically, the legislation would replace the five-part test’s requirements that advice be provided on a “regular basis” in conjunction with a “mutual agreement, arrangement or understanding” that the advice would serve as “a primary basis for investment decisions” with a much broader test with the advice provider delivering investment recommendations “on a regular basis as part of their business.” This language would appear to accomplish the DOL’s goal of having one-time advice, such as plan rollover advice, covered by the fiduciary standard and would also align more closely with an investor’s expectations that advice is conflict-free and provided objectively.
The proposed rule would identify investment advice or investment recommendations to a retirement investor (a qualified plan, participant or beneficiary, IRA, etc.) as a fiduciary act in situations where the investment advice or recommendation is provided for a fee or other compensation, direct or indirect, and the advice provider meets any of the following criteria:
The advice provider has discretionary authority or control with respect to purchasing or selling securities or other investment property for the retirement investor.
The advice provider 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 individual needs or circumstances of the retirement investor and may be relied upon by the retirement investor as a basis for investment decisions that are in the saver’s best interest.
The advice provider’s fiduciary status is acknowledged when making investment recommendations.
The proposed rule would also close the existing loophole in the current regulation. Under the SEC’s Best Interest Regulation, recommendations to purchase securities such as mutual funds must be in the saver’s best interest, but that rule does not cover insurance products such as fixed index annuities, as these insurance products are primarily regulated by state law. The proposed rule, however, would close that loophole and require advisors to provide advice in the saver’s best interest regardless of the investment product they are recommending.
The extension of the fiduciary net to cover advice in plan rollover transactions is a welcome outcome of the proposal. The broadening of the definition is aimed at protecting savers from the rampant practice of self-serving investment recommendations committed during the rollover process. This one- time advice is often the most important advice the retirement investor will ever receive and affects millions of investors every year. In 2022 alone, Americans rolled over approximately $779 billion from defined contribution plans into IRAs. The proposed rule will also close the above-mentioned loophole to ensure the advice given is in the saver’s best interest.
Despite the new regulation’s obvious benefits to savers, the DOL Retirement Security Rule has been met with some criticism from members of Congress and other interested parties. Its detractors have stated that the legislation would impose burdensome regulations that would make investing more cumbersome, especially for lower-income investors.
The stakes are high, and the potential financial impact of the DOL proposal is considerable. US retirement assets total over $30 trillion, and ERISA imposes strict requirements on persons deemed to be fiduciaries. As this rulemaking is still in the proposal stage, North Pier expects that it will face substantial challenges from stakeholders, which may ultimately modify the legislation’s outcome.
Winter 2023/2024 Fiduciary Commentary
After several false starts and years of work and intense debate, the Department of Labor (DOL) has proposed a rule to update the nearly 50-year-old fiduciary standard. On October 31, 2023, the DOL issued its latest regulation, Retirement Security Rule: Definition of an Investment Advice Fiduciary. The rule seeks to redefine who is an investment advice fiduciary under the Employee Retirement Income Security Act (ERISA) by substantially expanding the circumstances in which an investment recommendation rises to the level of a fiduciary act and amend certain prohibited transaction exemptions.
The new fiduciary initiative would require financial advisors, brokers, and insurance sales personnel to be held to a fiduciary standard when marketing financial products to retirement investors, including individual retirement accounts (IRAs). The proposal, if adopted, would affect those who sell financial products to qualified plans and IRAs and would require them to make significant changes to their sales practices. The impact would be felt primarily in sales of annuities to fund rollovers from plans to IRAs.
According to the DOL, the current regulation that defines when a person is acting as an ERISA fiduciary fails to include many situations in which an investor would reasonably believe they are receiving impartial advice from a fiduciary. Specifically, the legislation would replace the five-part test’s requirements that advice be provided on a “regular basis” in conjunction with a “mutual agreement, arrangement or understanding” that the advice would serve as “a primary basis for investment decisions” with a much broader test with the advice provider delivering investment recommendations “on a regular basis as part of their business.” This language would appear to accomplish the DOL’s goal of having one-time advice, such as plan rollover advice, covered by the fiduciary standard and would also align more closely with an investor’s expectations that advice is conflict-free and provided objectively.
The proposed rule would identify investment advice or investment recommendations to a retirement investor (a qualified plan, participant or beneficiary, IRA, etc.) as a fiduciary act in situations where the investment advice or recommendation is provided for a fee or other compensation, direct or indirect, and the advice provider meets any of the following criteria:
The proposed rule would also close the existing loophole in the current regulation. Under the SEC’s Best Interest Regulation, recommendations to purchase securities such as mutual funds must be in the saver’s best interest, but that rule does not cover insurance products such as fixed index annuities, as these insurance products are primarily regulated by state law. The proposed rule, however, would close that loophole and require advisors to provide advice in the saver’s best interest regardless of the investment product they are recommending.
The extension of the fiduciary net to cover advice in plan rollover transactions is a welcome outcome of the proposal. The broadening of the definition is aimed at protecting savers from the rampant practice of self-serving investment recommendations committed during the rollover process. This one- time advice is often the most important advice the retirement investor will ever receive and affects millions of investors every year. In 2022 alone, Americans rolled over approximately $779 billion from defined contribution plans into IRAs. The proposed rule will also close the above-mentioned loophole to ensure the advice given is in the saver’s best interest.
Despite the new regulation’s obvious benefits to savers, the DOL Retirement Security Rule has been met with some criticism from members of Congress and other interested parties. Its detractors have stated that the legislation would impose burdensome regulations that would make investing more cumbersome, especially for lower-income investors.
The stakes are high, and the potential financial impact of the DOL proposal is considerable. US retirement assets total over $30 trillion, and ERISA imposes strict requirements on persons deemed to be fiduciaries. As this rulemaking is still in the proposal stage, North Pier expects that it will face substantial challenges from stakeholders, which may ultimately modify the legislation’s outcome.
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