In a new client alert, “DOL Interprets Five-Part Investment Advice Test and Issues Final investment Advice Prohibited Transaction Exemption,” attorneys with Groom Law Group explain how the Department of Labor (DOL) has extended the reach of its “five-part test” for determining fiduciary status under the Employee Retirement Income Security Act (ERISA).

The attorneys published the alert after the DOL recently put forward the finalized version of a new prohibited transaction exemption. As part of this regulatory effort, the DOL has also reinterpreted the traditional five-part test for determining fiduciary status.

“The DOL retains an expansive interpretation of certain prongs of the five-part test, which could result in a broadening of the universe of those considered to be fiduciaries,” the Groom attorneys explain. “This broadening could, in turn, increase the need for prohibited transaction relief under ERISA and the Internal Revenue Code.

As originally formulated, the DOL’s five-part test regulation states that a person provides fiduciary investment advice if he or she 1) renders advice to a plan 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 understanding; 4) that such advice will be the primary basis for investment decisions; and that 5) the advice will be individualized to the plan. Groom notes that all five of these prongs must be met in order for a person to be considered a fiduciary under ERISA and the Code.

“Historically, the DOL has issued very little guidance on how to interpret each of the prongs,” the attorneys say. Largely as a result of this, “financial services firms have often been able to interpret the five-part in a manner that allows the firm and their employees, representatives and agents to not be fiduciaries. Additionally, DOL guidance issued in 2005 established that recommendations to take a distribution from a plan and roll over to an IRS was not investment advice for purposes of ERISA and the Code.”

In its new interpretation, the DOL again says a truly one-time interaction on a rollover does not necessarily constitute a person becoming a fiduciary. However, even if a financial services firm communicates that this is their intention, if, in practice, they are later in contact on a regular basis, fiduciary status could arise from their actual conduct.

With regards to the mutual agreement prong, the DOL says it will examine marketing materials of financial institutions and investment professionals to see if they hold themselves out as trusted advisers. In its own words, the DOL says a “financial services provider should not expect to avoid fiduciary status through a boilerplate disclaimer buried in the fine print, while in all other communications holding itself out as rendering best interest advice than can be relied upon by the customer in making investment decisions.”

With respect to the primary basis prong, the DOL says the advice from the financial services firm or adviser does not have to be the single most determinative factor for the investor’s decision—only that is was a factor. Furthermore, the DOL says the primary factor could be met even if the investor met with multiple financial professionals.

Along with issuing the updated five-part test, the DOL says it no longer will rely on the “Deseret Opinion,” also known as Advisory Opinion No. 2005-23A, regarding the determination of fiduciary status in the context of rollover recommendations. That means that the DOL now says guidance to take a distribution from an ERISA plan is advice and needs to be evaluated in the context of the five-part test. Any decision made between the DOL’s issuance of the Desert Opinion and February 16, 2021, the effective date of the final exemption, are exempt from breach of fiduciary duty.

According to the Groom attorneys, to take advantage of the new prohibited transaction exemption, a financial professional must meet a “best interest” standard. In the DOL’s eyes and words, this means the financial professional must embody 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, risk tolerance, financial circumstances and needs of the retirement investor—and not place the financial or other interests 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 interests to their own.”

The DOL says this language is intended to harmonize its new exemption with the Securities and Exchange Commission (SEC)’s Regulation Best Interest and the fiduciary duties of prudence and loyalty under ERISA.

The attorneys note that, while the DOL describes the exemption as final, the incoming Biden administration will appoint new leadership at the DOL that could reassess and/or alter all these developments.