The DOL’s Latest Proposed PTE

Art by Tim Bower

ADVISER QUESTION: I’m an RIA [registered investment adviser], and a significant portion of my business results from 401(k) plan rollover advice where I provide no advice or any other services to the plan. I understand that, because the Department of Labor [DOL] has expanded its interpretation of who qualifies as a fiduciary investment adviser, this rollover advice could result in a prohibited transaction. What steps would I need to take to comply with the DOL’s recent proposed exemption so I can avoid a prohibited transaction?

ANSWER: The proposed exemption requires satisfaction of a number of conditions, some of which mirror the conditions of the best interest contract (BIC) exemption that was part of the vacated fiduciary rule. However, there are some new requirements that will necessitate changes to your policies and procedures if the proposed exemption is finalized as currently written.

In our previous column, we explained that, under the DOL’s new interpretation of “regular basis” under the fiduciary advice five-part test, rollover advice will typically result in a prohibited transaction, even if you have no pre-existing financial advice relationship with the participant. You could then rely on the proposed exemption, if it is finalized, to receive the otherwise prohibited compensation—i.e., the individual retirement account (IRA) advisory fee.

The proposed exemption consists of three principal conditions: a standard of care—i.e., the “impartial conduct standards”; policies and procedures to ensure compliance and an annual review obligation; and a disclosure obligation.

The impartial conduct standards would require: 1) satisfying a best interest standard of care, which mirrors the Employee Retirement Security Act (ERISA) prudence standard and duty of loyalty; 2) receiving no more than reasonable compensation; 3) making no materially misleading statements; and 4) seeking best execution. If you are currently an ERISA fiduciary to clients, you are already subject to these standards. However, this standard will be new if you become an ERISA fiduciary as a result of the DOL’s expanded interpretation of regular basis.

For rollover advice, in order to satisfy this standard, you would need to consider all relevant factors, including the plan investments and the investments available in the proposed IRA; the different levels of services; and the fees and expenses associated with both the existing plan and the IRA, such as whether the employer pays for some of the plan’s expenses. You would then need to evaluate those factors to determine whether recommending a rollover is appropriate based on the participant’s investment objectives, financial circumstances and needs. We note that the Securities and Exchange Commission (SEC)’s best interest standard would require a similar process. (See “SEC’s Position on Rollovers,” PLANADVISER, November–December 2018).

Under the proposed exemption, you would also need to document the specific reasons why the rollover recommendation is in the participant’s best interest.

Further, your policies and procedures would need to be designed to ensure compliance with these standards and to address mitigation of conflicts of interest. The proposed exemption specifically requires that the firm mitigate conflicts of interests by prudently designing policies and procedures and incentive practices to avoid misalignment of the firm’s and its advisers’ interests with those of the plan participant. In addition, the firm would need to conduct a retrospective review at least annually of its compliance with these standards and to detect and prevent violations. This review would need to be documented in a written report and certified by the CEO or equivalent officer.

A written disclosure would need to be provided to the participant prior to engaging in the IRA rollover. The disclosure would need to affirm your fiduciary status and provide a description of your services and of any conflicts of interest. The proposed exemption also affords relief to advisers who serve as fiduciaries.

At this point, we don’t know whether the proposed exemption will be adopted in its present form. Until the finalization, an adviser can use a DOL and IRS nonenforcement policy (Field Assistance Bulletin 2018-02) if the impartial conduct standards are satisfied. Note that this policy does not protect against private rights of actions under ERISA. That said, for risk management purposes, advisers should consider complying with the impartial conduct standards when giving rollover advice, and they should review and update, as needed, their policies and procedures to promote compliance.

Fred Reish is chairman of the financial services ERISA practice at law firm Faegre Drinker Biddle & Reath LLP. Joan Neri, a nationally recognized expert in employee benefits law, is counsel in the firm’s financial services ERISA practice, where she focuses on all aspects of ERISA compliance affecting registered investment advisers and other plan service providers.