Final Fiduciary Rule advances DOL’s goal of expanding scope of ERISA fiduciary

On April 25, 2024, the Department of Labor (DOL) published its final Retirement Security Rule (Final Rule), the latest effort in its longstanding determination to expand the scope of a person who renders “investment advice for a fee or other compensation” for purposes of becoming a “fiduciary” under the Employee Retirement Income Security Act of 1974 (ERISA). In connection with the Final Rule, the DOL released final amendments to the class prohibited transaction exemptions (PTEs) available to investment advice fiduciaries to ERISA plans and individual retirement accounts (IRAs).  

The Final Rule, which generally becomes effective September 23, 2024,[1] will impose fiduciary status on many previously excluded persons, advancing the DOL’s view that participants need greater protections for the investment advice they receive regarding their retirement savings, including rollovers to IRAs.  

Background and summary of the Final Rule

Over the past several years, the DOL has continuously worked to revamp fiduciary regulations first released in 1975, when defined benefit plans were prevalent and 401(k) plans were uncommon.  In the wake of the Fifth Circuit’s 2018 decision in Chamber of Commerce v. U.S. Dep’t of Labor, which vacated the DOL’s 2016 final fiduciary rule, the DOL published a new proposed investment advice rule on November 3, 2023. The DOL reports it received and reviewed nearly 20,000 public comments to its proposed investment advice rule. 

According to a fact sheet released with the Final Rule, the DOL believes the “rule and amended PTEs will protect retirement investors by requiring trusted advice providers to follow high standards of care and loyalty when they make investment recommendations” and that “[r]etirement investors should expect no less from trusted investment professionals.”  Moreover, the DOL stated that “[t]he rule and exemptions are carefully designed to honor retirement investors’ legitimate expectation of advice that is in their best interest.”

A historical view of fiduciary guidance

Under ERISA’s original statutory definition of a fiduciary, an individual becomes a fiduciary to the extent that they render investment advice (or have the authority to do so) for a fee or other direct or indirect compensation with respect to any moneys or other property of a benefit plan.  A fiduciary has various core duties including, among others, the duty of care, loyalty to plan participants and beneficiaries, prudence in exercising responsibly, and avoiding prohibited transactions and conflicts of interest.  

ERISA fiduciary status has historically held a significant designation that comes with obligations to participants and beneficiaries that are, as one court famously described, “the highest known to the law”[2] and personal liability for violating those obligations.  Many investment advisors have successfully claimed that, although they provide investment advice for a fee, they are not ERISA fiduciaries.

The original DL regulations provided a five-part test to interpret when a person would be considered a fiduciary based on the rendering of “investment advice for a fee.”[3]

The Final Rule

The Final Rule replaces that five-part test with a two-part test, such that a person now will be a fiduciary if the person:

• Makes an investment recommendation to a retirement investor (eg, a benefit plan participant, an IRA owner, a benefit plan fiduciary) for a fee or other compensation, and
  
  
• Makes professional investment recommendations, directly or indirectly, to investors on a regular basis as part of their business and the recommendation is provided under circumstances in which it can be reasonably inferred that:

1. The recommendation 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. The retirement investor may rely upon the recommendation for investment decisions to advance the retirement investor’s best interest.

A person will also be a fiduciary under the Final Rule if the person represents or acknowledges that they are acting as an ERISA fiduciary.  Notably, the Final Rule provides that a person cannot effectively disclaim fiduciary status in written statements, and that status as an ERISA fiduciary will be controlled by the person’s oral or other written communications, marketing materials, appliable state or federal law, or other interactions with the retirement investor. 

The Final Rule, like the proposed rule, eliminates a gap created by the “regular basis” standard in the 1975 rule, so that one-time recommendations, such as those relating to rollovers of plan assets from an employer-sponsored retirement plan to an IRA or annuities, will now be considered “investment advice” if other parts of the test are met.  Notably, the Final Rule eliminated a provision in the proposed rule that would have made a person a fiduciary if the person had discretionary authority or control for purchasing or selling investments for the retirement investor.  The Final Rule also specifies that providing investment information or education without a recommendation is not investment advice that would trigger fiduciary status.

The timing of the release of the Final Rule and its effective date is intended to place this Final Rule outside the reach of the Congressional Review Act following the November 2024 elections.  That Act would allow the new Congress to review, and possibly overturn, rules finalized within the preceding 60 days.

Amendments to prohibited transaction exemptions

In connection with implementing the Final Rule, the DOL issued amendments to PTE 2020-02, PTE 84-24 (and PTEs 75-1 (underwriting and market maker transactions), PTE 77-4 (mutual fund investments), PTE 80-83 (reduction of indebtedness), PTE 83-1 (mortgage pool certificates), and PTE 86-128 (agency transactions) (collectively, the PTE Amendments).  These amendments eliminate relief under all exemptions other than PTE 2020-02 and PTE 84-24 for the receipt of compensation resulting from fiduciary investment advice within the meaning of the Final Rule.  As a result of the PTE Amendments, fiduciaries who act as advisors to an investor, including an ERISA-covered plan or an individual participating in such a plan, will generally need to rely on PTE 2020-02 and PTE 84-24 to receive compensation to avoid engaging in a prohibited transaction.

In 2020, the DOL adopted PTE 2020-02 as a new prohibited transaction class exemption under ERISA and the parallel prohibited transaction provisions contained in the Internal Revenue Code (Code) for investment advice fiduciaries with respect to employee benefit plans and individual retirement accounts.  The exemption expressly covers prohibited transactions resulting from both rollover advice on how to invest assets within a plan or IRA and includes specific conditions that must be met to satisfy the exemption.  PTE 2020-02, as amended, requires that financial institutions and covered investment professionals must:

• Acknowledge their fiduciary status in writing to the retirement investor
  
  
• Disclose their services and material conflicts to the retirement investor
  
  
• Adhere to impartial conduct standards
  
  
• Adopt firm-level policies and procedures prudently designed to ensure compliance with impartial conduct standards and mitigate conflicts of interest
  
  
• Document and disclose the specific reasons for any rollover recommendations, and 
  
  
• Conduct an annual retrospective compliance review.

The PTE Amendments in particular build on these requirements by broadening the scope of the exemption to include within the definition of financial institution both principals and agents – in response to concerns around insurance and annuity product recommendations and availability of the exemption – and non-bank health savings account trustees and custodians.

Prior to amendment, PTE 84-24 provided an exemption for insurance agents, insurance brokers, and pension consultants to receive a sales commission from an insurance company for the purchase of insurance or an annuity contract with plan or IRA assets as well as underwriters in connection with providing fiduciary investment advice.  Subject to minor changes, PTE 84-24 remains available for transactions that do not involve investment advice.  As a result of the amendments to PTE 84-24, those entities will no longer benefit from exemptive relief as they instead now will need to rely on PTE 2020-02 to provide investment recommendations.  Independent insurance agents, however, may rely on PTE 84-24 in connection with providing investment advice but will be subject to additional requirements similar to those applicable under PTE 2020-02 in requiring that the impartial conduct standards be observed and requiring an acknowledgement of fiduciary status when providing investment advice.  In addition, insurance companies will need to supervise the independent insurance agent in connection with the recommendation of the insurance company’s annuities and insurance products. 

Impact on investment professionals and insurance industry

In establishing a new regulatory framework for the Final Rule, the DOL focused particularly on the nature of the protections that should be afforded to plan participants’ rollover decisions, and decisions individuals make with respect to their IRA accounts.  From the DOL’s perspective, IRA owners operate in an environment where the level of protection does not match an individual’s perception of the relationship.  In the Final Rule’s preamble, the DOL expressed concerns over marketing and sales pitches used in the insurance industry that designate professionals as “wealth managers” and “trusted advisors” in situations where the insurance professional is not subject to heightened fiduciary standards and may have financial conflicts that could impact the ability to provide impartial advice. 

In an effort to remedy the DOL’s perceived mismatch of expectations, the Final Rule also added a definition of IRA in order to clarify that the investment advice rules will apply to the wider variety of individual investment accounts that are subject to the prohibited transaction rules within Code Section 4975 including individual retirement accounts, individual retirement annuities, health savings accounts, and certain other tax-advantaged trusts and plans.

As a result, many investment professionals previously who were not covered may now be required to comply with ERISA’s fiduciary requirements or meet all the requirements of an exemption. 

The Final Rule will create additional regulatory obligations for transaction-based investment professionals, driving potential disruption across industries.  The impact on the insurance industry may be particularly significant.  In the Final Rule’s preamble, the DOL expressed particular concerns with both the current state of insurance industry regulations and insurance industry strategies.  The concerns focus on industry practices that perpetuate relationships that obscure whether a professional is acting as a salesperson rather than as an advisor, or whether the circumstances potentially create a financial conflict of interest for the professional.

In discussing the insurance regulatory framework on investment advice, the DOL specifically noted that the National Association of Insurance Commissioners model regulations did not sufficiently protect against financial conflicts of interest because the rules eliminate a wide variety of cash and non-cash compensation arrangements received by insurance professionals from the model regulations’ definition of a “material conflict of interest.” The DOL specifically noted that the model regulations fail to create fiduciary standards beyond mere disclosure of conflicts, and do not require that the customer’s interests be placed above the producer’s or insurer’s interests.  In addition, the DOL noted that the model regulations do not cover contracts used for funding pension and welfare plans covered by ERISA.  From the DOL’s perspective, these gaps created a need for the ERISA-based regulatory structure to protect retirement savers.

While commission arrangements and the potential conflicts associated with commission arrangements were discussed critically and at length in the preamble, the DOL believed that such arrangements could be conducted consistent with a professional’s obligations as an investment advice fiduciary.  However, according to the DOL, compliance would require that the professional be able to place the interests of the customer first, the professional’s compensation is reasonable and disclosed, and procedures are in place to mitigate and control conflicts of interest. 

In addition to the transaction-based approach under the Final Rule, the PTE Amendments now require that insurance and investment companies that intend to provide structures that include fiduciary advice through professionals to comply with the requirements of PTE 2020-02.  The new structures will mean additional reporting and compliance obligations and will require an ongoing compliance regime be established to make certain that the advising enterprise can continue to rely on this fiduciary investment advice exemption.[4]

From a practical perspective, the new transaction-based approach will create a facts-and-circumstances test where investment professionals will need to be noticeably clear as to the nature of the customer interactions to avoid claims for breach of fiduciary duty or claims that the professional engaged in a prohibited transaction.  Investment professionals are encouraged to clearly determine whether they are seeking to be hired or whether they are providing investment advice.  Institutions are additionally encouraged to formulate a path for compliance for investment advice professionals and create processes for continued monitoring and reporting of activities to maintain the ability to rely on the relief provided by PTE 2020-02.  Sale activity will likely need to be more readily distinguishable from investment advice to avoid ERISA-related claims arising under the Final Rule. 

Key takeaways

The Final Rule is already the subject of one lawsuit and may be challenged by a variety of stakeholders seeking to have it invalidated, which could create significant disruption in 2024 and beyond as investment professionals chart a path forward.  Courts will ultimately decide whether the Final Rule is materially different from the 2016 fiduciary rule, or if the Final Rule suffers from the same legal flaws that led to its precursor’s demise.  

Given the scope of the new rule, the DOL has created a structure that provides it with significant and primary oversight with respect to an extremely large block of the investment and insurance industry, and entities may question whether this is the intended and best regulatory structure for the insurance industry and the financial markets as a whole. 

For more information, please contact the authors or any members of our Employee Benefits and Executive Compensation group.

 

[1] The amended PTEs are also effective on September 23, 2024.  Certain conditions in the amended PTEs are subject to a one-year transition period beginning on the effective date.

[2] Donovan v Bierwirth, 680 F.2d 263, 272 n. 8 (2d Cir. 1982).

[3] Under the five-part test, a person will be an “investment advice fiduciary” if such person (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 agreement, arrangement, or understanding with the plan or plan fiduciary that (4) the advice serves as a primary basis for investment decisions with respect to plan assets and (5) the advice will be individualized based on the particular needs of the plan.  29 C.F.R. § 2510.3-21. 

[4] Upon the PTE Amendments described above becoming effective, independent insurance agents will be required to comply with PTE 84-24 when providing investment advice with respect to ERISA-covered assets.