Compliance for Wealth Managers

Art by Tim Bower

As of July 1, registered investment advisers and their adviser representatives should now be in full compliance with Department of Labor Prohibited Transaction Exemption 2020-02. Unsurprisingly, there has been considerable focus on PTE 20-02, the past few months. However, wealth managers who exercise discretion over the management of certain account assets should consider that they cannot exclusively rely on this PTE to address all conflicts of interest that may arise in conducting their management activities. Thus, they may need to turn to other exemptions and should verify they have appropriate compliance procedures in place.

If acting as a fiduciary to firm accounts covered by the fiduciary provisions of the Employee Retirement Income Security Act and other accounts such as individual retirement accounts subject to the prohibited transaction provisions of Internal Revenue Code Section 4975, the adviser should avoid prohibited transactions specified in ERISA Section 406 and IRC Section 4975. The other alternative is to comply with a prohibited transaction exemption.

PTE 20-02 is the exemption on which most firms recently have focused. This exemption is available to address many prohibited transactions that occur when an adviser provides investment advice for purposes of ERISA and the IRC. However, many wealth managers provide discretionary asset management services. Indeed, in many cases, the provision of such services is a key selling point for a wealth management relationship.

… they may need to turn to other exemptions and should verify they have appropriate compliance procedures in place.

PTE 20-02 is available to address prohibited transactions that arise in connection with an adviser’s recommendation to take a distribution from an ERISA-covered plan and roll that amount into an IRA so the adviser may provide discretionary management services to the money. Additionally, compliance with PTE 20-02 will also address prohibited transactions that arise when the adviser suggests that the investor transfer assets from one IRA to another, particularly if the person is in a brokerage account IRA and the adviser will provide services in an advisory account IRA. In either case, the DOL’s view is that such a recommendation creates a conflict because the adviser receives compensation only when the rollover or transfer occurs. Compliance with the PTE will prevent a nonexempt prohibited transaction.

Still, PTE 20-02 does not exempt prohibited transactions that arise regarding providing the discretionary management services once the rollover or transfer occurs. Therefore, for example, if the RIA can affect the amount or timing of compensation that it, its adviser representatives or its affiliates are paid as a result of the RIA’s exercise of discretion, prohibited transactions under ERISA Sections 406(b)(1) and 406(b)(3) and IRC Sections 4975(c)(1)(E) and 4975(c)(1)(F) will likely occur; to avoid them, the adviser must comply with an exemption or otherwise eliminate the conflict.

Such conflicts can arise in a number of situations, including when: 1) the client invests in a mutual fund to which the adviser or an affiliate is an adviser or underwriter; 2) the client invests in other types of funds, services or products with regard to which the adviser or its affiliate receives compensation or other benefit; 3) the adviser or affiliate receives compensation such as revenue sharing or other payments from unaffiliated investment funds or third parties in connection with exercising discretion; and 4) the adviser or its affiliates receives commissions in connection with the exercise of discretion.

These transactions can be addressed by being sure to—and making sure all affiliates—comply with DOL guidance such as Advisory Opinions 97-15A and 2005-10A—aka the “Frost opinion” and “Country Trust opinion,” respectively. This guidance effectively requires a level fee across the adviser firm and all of its affiliates. Otherwise, the adviser should comply with available exemptions such as PTE 77-4, PTE 86-128 and ERISA Section 408(b)(8).

In summary, PTE 20-02 is an effective exemption for wealth managers in situations where they provide investment advice. But when they exercise investment discretion, they should look to other exemptions or other ways to address any prohibited transaction.

David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C.