Caution Needed Regarding Rollovers
Art by Tim Bower
This past December 18, the Department of Labor (DOL) published Prohibited Transaction Exemption (PTE) 2020-02, Improving Investment Advice for Workers and Retirees. In the exemption’s preamble, the DOL changed its interpretation of the term “investment advice” for purposes of the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (IRC). As a result, more recommendations to roll over or transfer assets from plans to individual retirement accounts (IRAs) can be subject to ERISA’s fiduciary provisions and the prohibited transaction provisions of the act and the IRC. Financial professionals and their supervising institutions should begin reviewing their interactions with current and prospective clients to determine whether they provide investment advice.
The preamble presents the DOL’s final interpretation as to when giving investment advice is a fiduciary act. The DOL then published, this April, Fiduciary Advice Exemption: PTE 2020-02 Improving Investment Advice for Workers and Retirees Frequently Asked Questions (FAQ) in which it affirmed and further explained its views. Notably, the guidance applies to both rollover and custodian-to-custodian transfers.
Since at least 2005, as expressed in Advisory Opinion 2005-23A—aka the Deseret letter—the DOL had been of the view that a recommendation to take a distribution from an ERISA-covered plan and roll over that distribution to an IRA was not a recommendation as to the advisability of investing in, purchasing or selling securities or other property. Therefore, such a recommendation was not investment advice as defined in a regulation it promulgated in 1975. However, in the preamble, the DOL announced that its analysis in the Desert letter was incorrect and reversed its position.
The DOL also explained in the preamble its interpretation of other facets of the 1975 regulation. In so doing, it aims to make sure more rollover and transfer recommendations are investment advice under ERISA and the IRC. The 1975 regulation sets forth a five-part test for purposes of determining whether a person provides investment advice. One part, or prong, of that test is that recommendations to invest in, buy or sell securities be made on a regular basis. In the preamble and the FAQ, the DOL states that a rollover or transfer recommendation can be the first step in the creation of an ongoing investment advice relationship and thus the regular basis prong could be met, even with respect to a prospective client.
Moreover, the preamble and FAQ provide additional guidance on how to interpret the other prongs of the test. As a result, the department has made it more difficult for financial advisers and their supervising financial institutions—e.g., broker/dealers(B/Ds), registered investment advisers (RIAs), banks, trust companies, insurance companies, insurance sales and marketing intermediaries—to take the position that they do not provide investment advice. This is the case concerning the rollover or transfer recommendation as well as recommendations provided with regard to ongoing investment of plan and IRA assets. For example, holding oneself out in marketing materials as a trusted adviser, in the eyes of the DOL, is evidence of a mutual understanding that the financial professional provides advice as a fiduciary notwithstanding a contractual disclaimer to the contrary.
At bottom, financial professionals and their firms should be looking at their interactions with clients and prospective clients to determine if conversations they have regarding rollovers and transfers from an ERISA-covered plan to an IRA are investment advice. Furthermore, per the preamble and the FAQ, they should also review recommendations made in connection with rollovers and transfers from an ERISA-covered plan to another ERISA-covered plan or from one IRA to another. Importantly, not every rollover or transfer recommendation is investment advice. Also, the provision of investment education pursuant to DOL guidance is not investment advice. However, in the event they provide investment advice, the financial professional and financial institution will likely need to comply with the conditions of the exemption or, possibly, another exemption, in order to address certain conflicts of interest. In other words, we have some work to do in the coming weeks and months.
David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers.