What’s New?

Both the current and new definitions only apply to recommendations to “retirement investors”—private sector retirement plans, participants in those plans, and IRA owners.

The new regulation says that a financial professional (and the firm) will be fiduciaries when a 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 in like circumstances that the recommendation:

In other words, to be a fiduciary a financial professional must make an investment recommendation to a retirement investor for which the financial professional will receive some form of compensation and:

Is in the business of making investment recommendations (which includes insurance and annuities), and

The circumstances surrounding the recommendation could reasonably be viewed as indicating that the recommendation:

The new definition replaces the five-part test in the current regulation.

That definition replaces the five-part test in the current regulation. The most significant change is that the current regulation includes, as one of the five parts, a requirement that advice be given on a “regular basis” to the particular retirement investor, while the new regulation treats one-time recommendations as fiduciary advice.

For example, under the current regulation, a financial professional—whose only relationship to a participant in a 401(k) plan is a rollover recommendation … to be followed by advice for the rollover IRA—wouldn’t be a fiduciary for the rollover recommendation. However, under the new regulatory definition, the financial professional would be a fiduciary, implicating ERISA’s prudent person requirement.

To fully understand the significance of that change, the DOL’s position is that a prudent rollover recommendation requires a comparative analysis of the investments, services, and expenses with the same factors in the proposed IRA, in light of the needs and circumstances of the participant. Then the rule requires that the recommendation be in the best interest of the participant.

In addition to the fiduciary standard, a rollover recommendation typically involves a conflict of interest—the compensation that the financial professional and his or her firm will earn from the rollover IRA. Under ERISA and the Internal Revenue Code, that conflict is a prohibited transaction—which literally means that it’s prohibited for the professional or the firm to earn any compensation from the IRA. How can that be?

Under ERISA and the Code there are exceptions, or exemptions, from the prohibited transaction rules. As a result, the compensation can be retained if the conditions of a prohibited transaction exemption (PTE) are satisfied.

As a part of the new fiduciary regulatory package, the DOL has amended a number of PTEs. For financial professionals, the relevant PTE is 2020-02. That PTE has four sets of conditions that must be satisfied:

The Impartial Conduct Standards:

Written Disclosures:

Policies and Procedures: The firms must have and enforce policies and procedures for:

Annual Retrospective Review and Report: The firm must, after the end of each year, conduct a review of the covered transactions in the prior year, to determine if the firm’s practices, policies and procedures are effectively complying with the conditions of the PTE.

Beginning on September 23, 2024, financial professionals and their firms must comply with the Impartial Conduct Standards and provide the fiduciary acknowledgement disclosure. The remaining conditions will be effective a year later, on September 23, 2025.

The new rules will have much broader impact than just on rollovers.

To this point, this article has used rollovers as examples of how the new regulation and PTE will apply. However, the rules will have a much broader impact than that. For example, they will also apply to recommendations to transfer an IRA from another firm. That will be a fiduciary act subject to the PTE, including the Care and Loyalty Obligations. The new rules will also apply to recommendations to IRA owners that involve conflicts of interest, for example, commissions, revenue sharing, 12b-1 fees, proprietary products, and changes of account types (e.g., from a brokerage account to an advised account).

There will be legal challenges to the new rules—the first lawsuit has already been filed. However, considering the short time before the first effective date, financial professionals and their firms should be working on the steps necessary to comply with these new rules because of the risk that the lawsuits won’t move quickly enough to stop the rules from taking effect.

Concluding Thoughts

The first step is to become familiar with the new rules. The second is to understand what the Care and Loyalty Obligations require for different types of recommendations—rollovers, IRA transfers, transaction-based compensation, and so on. Then compliance steps should be developed for each type of recommendation in order to satisfy the Care and Loyalty Obligations. These steps are an important part of the story, but there is even more … with only a few months before the rules are effective.