U.S. Department of Labor Publishes its Newest Fiduciary Rule

On April 23, 2024, the U.S. Department of Labor (DOL) released a final rule, titled the “Retirement Security Rule” (the Final Rule), updating the definition of an “investment advice fiduciary” under the Employee Retirement Income Security Act of 1974, as amended (ERISA).  In addition, the DOL issued final amendments to several prohibited transaction class exemptions (PTEs) available to investment advice fiduciaries, which together with the Final Rule seek to effectuate the DOL’s goal of requiring “trusted investment advice providers to give prudent, loyal, honest advice free from overcharges.” The Final Rule and the amended PTEs were published in the Federal Register on April 25, 2024. The updated fiduciary definition under the Final Rule and the amended PTEs will become effective on September 23, 2024, although there is a one-year phase-in period for certain conditions of the amended PTEs.

Redefining Investment Advice Fiduciary

As further described in our recent client alert summarizing the DOL’s initial proposal for the Final Rule (the Proposed Rule), available here, the framework for determining whether a person is an investment advice fiduciary has historically adhered to the longstanding “five-part test.” In the DOL’s view, however, the changing retirement plan landscape since the five-part test was promulgated in 1975 (i.e., a shift from defined benefit plans to defined contribution/401(k) plans and individual retirement accounts (IRAs) as the preeminent retirement saving vehicles) has caused the five-part test to become underinclusive — particularly the requirements that in order to give rise to a fiduciary relationship, investment advice must be provided to a retirement investor on a “regular basis” and pursuant to “a mutual agreement, arrangement, or understanding” that such advice will serve as “a primary basis for investment decisions.”

Under the Final Rule, a person will be an investment advice fiduciary for purposes of ERISA if (1) they make a recommendation of any securities transaction or other investment transaction or any investment strategy to a retirement investor for a fee or other compensation (direct or indirect), and (2) such recommendation arises in either one of the following contexts:

1. The 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
   1. is based on review of the retirement investor’s particular needs or individual circumstances,
   2. reflects the application of professional or expert judgment to the retirement investor’s particular needs or individual circumstances, and
   3. may be relied on by the retirement investor as intended to advance the retirement investor’s best interest; or
2. the person represents or acknowledges that they are acting as a fiduciary under ERISA with respect to the recommendation.

For purposes of the Final Rule, a “retirement investor” is defined as a plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary, or IRA fiduciary. “Recommendations” means recommendations as to

• the advisability of acquiring, holding, disposing of, or exchanging securities or other investment property, investment strategy, or how securities or other investment property should be invested following a rollover, transfer, or distribution from a plan or IRA
• the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements, or voting of proxies appurtenant to securities
• rollovers, transfers, or distributions of assets from a plan or IRA, including recommendations as to whether to engage in the transaction, the amount, the form and the destination of such a rollover, transfer or distribution

Significant Changes From Proposed Rule

Although the investment advice fiduciary standard in the Final Rule is similar to the standard initially proposed in the Proposed Rule, the Final Rule contains some significant differences that, in most cases, attempt to narrow certain provisions that had concerned commenters as being overbroad:

• The DOL removed a component of the proposed fiduciary definition whereby a person who rendered investment advice to a retirement investor would be considered a fiduciary if they directly or indirectly (e.g., through or together with any affiliate) had discretionary authority or control with respect to purchasing or selling securities or other investment property for a retirement investor. This appears to be in response to concerns raised by commenters regarding the ambiguity of the term “discretion” as well as the inclusion of affiliates who have discretion.
• The DOL clarified that with respect to a person who becomes an investment advice fiduciary due to their representing or acknowledging that they are acting as a fiduciary under ERISA with respect to a recommendation, fiduciary status would apply only with respect to that recommendation and not with respect to every future interaction with the same retirement investor regardless of the circumstances.
• The Final Rule includes a new paragraph specifically confirming that sales pitches and investment education can be provided without ERISA fiduciary status necessarily being triggered. According to the DOL, a key component of this consideration is whether a sales pitch is individualized to a retirement investor’s particular needs and circumstances.
• The DOL added a new definition of “retirement investor,” as described above. Notably, the Final Rule clarifies that a person who is a fiduciary to a plan or IRA by reason of rendering investment advice is not considered a “retirement investor” for these purposes, and therefore communications with persons acting solely as investment advice fiduciaries would not give rise to an ERISA fiduciary relationship.

Amendment to Exemption for Transactions Involving Investment Advice From Financial Institutions and Investment Professionals, PTE 2020-02

PTE 2020-02 generally permits parties providing fiduciary investment advice to retirement investors to receive reasonable compensation in exchange for their services, which would otherwise be prohibited in the absence of an exemption. The final amendment to PTE 2020-02 broadens the exemption to cover additional transactions and revises certain conditions, including conditions relating to disclosure, recordkeeping, and ineligibility. 

Like the Final Rule, the amended PTE 2020-02 applies to covered transactions on or after September 23, 2024; however, there is a one-year phase-in period beginning on September 23, 2024. During this phase-in period, investment professionals may receive reasonable compensation if they comply with the “Impartial Conduct Standards” and the fiduciary acknowledgement requirement, both of which are discussed below.

Change in Covered Principal Transactions and Covered Providers

Prior to amendment, in addition to the relief described above, PTE 2020-02 also provided relief for certain principal transactions that were defined as “covered principal transactions” and “riskless principal transactions.” The amended PTE 2020-02 expands this exemptive relief to all transactions pursuant to which a financial institution, investment professional, or its affiliate provides investment advice, regardless of whether they are executed on a principal or agent basis. However, PTE 2020-02 generally does not apply in transactions where the investment professional or financial institution is acting in a capacity other than as an investment advice fiduciary.

Additionally, the amended PTE 2020-02 expands the type of providers who can utilize PTE 2020-02 to include pooled plan providers and robo-advisers.

Required Disclosure and Fiduciary Acknowledgement

The amended PTE 2020-02 requires that financial institutions provide a written acknowledgement that the institution and the investment professional are providing fiduciary advice and are fiduciaries under ERISA. The DOL has included a model disclosure, available here. Furthermore, the amended PTE 2020-02 requires financial institutions to make certain additional disclosures regarding fees, scope of services, and conflicts of interest.

Impartial Conduct Standard

The amended PTE 2020-02 replaces the “best interest standard” for determining impartial conduct with the “Care Obligation” and the “Loyalty Obligation,” which according to the DOL are more consistent with the Securities and Exchange Commission’s Regulation Best Interest. Under the Care Obligation, advice must reflect 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. Under the Loyalty Obligation, the investment professional must not place the financial or other interests of the professional, their affiliate or related entity, or other party ahead of the interests of the retirement investor or subordinate the retirement investor’s interests to those of the professional, their affiliate, or related entity.

Policies and Procedures

Each financial institution must establish, maintain, and enforce written policies and procedures prudently designed to ensure that the financial institution and its investment professionals comply with the Impartial Conduct Standards and other exemption conditions. The policies must mitigate conflict of interests.

Specifically, the financial institutions may not use quotas, appraisals, bonuses, special awards, differential compensation, or other similar actions in a manner that is intended, or that a reasonable person would conclude are likely, to result in recommendations that do not meet the Care Obligation or Loyalty Obligation. The financial institution must provide their complete policies and procedures to the DOL within 30 days of a request.

Additionally, the financial institution must conduct a retrospective review at least annually that is reasonably designed to detect and prevent violations of and achieve compliance with the conditions of this exemption. The financial institution must maintain records demonstrating compliance with PTE 2020-02 for a period of six years after the covered transaction.

Disqualification

Similar to the recent amendment to PTE 84-14 for “qualified professional asset managers” (QPAMs), summarized here, the amended PTE 2020-02 broadens the disqualification provisions to include convictions of certain affiliated entities and foreign convictions. Previously, a financial institution or an investment professional was ineligible only upon a conviction for “crimes arising out of such person’s provision of investment advice” to retirement investors. Under the amended PTE 2020-02, however, a relevant conviction or final judgment that occurs on or after September 23, 2024, with respect to an entity in the same controlled group as a financial institution would result in such financial institution’s becoming ineligible to rely on PTE 2020-02 for a 10-year period.

Amendment to Exemption for Transactions Involving Insurance Products and Investment Company Securities, PTE 84-24

PTE 84-24 provides a prohibited transaction exemption for certain transactions relating to the purchase, with plan assets, of insurance contracts, annuities, and securities issued by an investment company, as well as the payment of related commissions to insurance agents or brokers and certain other parties. The amendment to PTE 84-24 removes the ability of investment advice fiduciaries, other than “Independent Producers” (defined generally as a person or entity that is licensed to sell insurance contracts, including annuities, and that sells products of multiple unaffiliated insurance companies and is not an employee of the insurance company), to use PTE 84-24 for transactions involving insurance contracts, annuities, or securities issued by an investment company; instead, investment advice fiduciaries, other than Independent Producers, must rely on the relief provided by PTE 2020-02 (see discussion above).

Like the Final Rule and PTE 2020-02, the amended PTE 84-24 is effective September 23, 2024, with a one-year phase-in period similar to the one-year phase-in period provided in PTE 2020-02.

The conditions of the amended PTE 84-24, as applied to Independent Producers, are similar to those in PTE 2020-02. Under the amended PTE 84-24, an insurance company selling its product through Independent Producers would not be required to assume fiduciary status but would be required to exercise supervisory authority over the Independent Producers’ recommendation of its own products as a condition for relief. In this regard, among other conditions, an insurance company will be required to

• maintain and enforce written policies for the review of Independent Producers’ recommendations
• conduct a retrospective review at least annually of each Independent Producer that is reasonably designed to detect and prevent violations of the conditions of the exemption

If the applicable conditions of PTE 84-24 are satisfied, an Independent Producer

• may receive, directly or indirectly, “reasonable compensation” (which includes sales commissions and any other type of compensation)
• may sell any “non-security annuity contract” or any other insurance product that does not meet the definition of “security” under federal securities laws

PTE 84-24 does not provide relief for the sale of variable annuities (which constitute securities under federal securities laws) or other types of securities. An Independent Producer selling those products must rely on PTE 2020-02 for exemptive relief.

Like the conditions in PTE 2020-02 and the recent amendment to PTE 84-14 for QPAMs relating to ineligibility to use those exemptions, the amendment to PTE 84-24 adds a new section that specifies the circumstances under which an Independent Producer or an insurance company would be ineligible to rely on PTE 84-24. Previously, PTE 84-14 contained no provisions regarding ineligibility resulting from the conviction of crimes or other misconduct. The disqualification provisions apply to the specified crimes and misconduct that occur on or after September 23, 2024.

The changes to PTE 84-24 are significant as they effectively eliminate the ability of investment advice fiduciaries in the insurance industry, other than Independent Producers, to use that exemption. Those fiduciaries have relied on PTE 84-14 for the sale of insurance products for decades and will have to rely on PTE 2020-02 with its more burdensome conditions than those that existed under PTE 84-24 prior to amendment.

Amendment to Exemption for Certain Transactions Exempt Under PTE 75-1 (Relating to Underwritings, Market-Making, and Extension of Credit in Connection With Securities Transactions)

The amendment to PTE 75-1 removes the ability of investment advice fiduciaries to rely on the relief for underwriting and market-making transactions described in PTE 75-1. Instead, investment advice fiduciaries will have to rely on PTE 2020-02 for exemptive relief for underwriting and market-making transactions described in PTE 75-1.

The amendments also add new provisions to the extension of credit section of PTE 75-1. These new provisions provide an exemption for a fiduciary’s receipt of reasonable compensation for extending credit to avoid a failed purchase or sale of securities if certain conditions apply.

Amendments to PTE 77-4 (Relating to Transactions Involving Registered Investment Companies), PTE 80-83 (Relating to Purchase of Securities Where Issuer May Use Proceeds to Reduce or Retire Indebtedness), PTE 83-1 (Relating to Certain Transactions Involving Mortgage Pool Investment Trusts), and PTE 86-128 (Relating to Securities Transactions Involving Broker-Dealers)

The amendments to these exemptions remove the ability of investment advice fiduciaries to rely on them. Instead, investment advice fiduciaries will have to rely on PTE 2020-02 for exemptive relief for the transactions described in PTE 77-4, PTE 80-83, PTE 83-1, and PTE 86-128.