United States: Department Of Labor Takes Another Look At Investment Advice

Department of Labor Takes Another Look at Investment Advice

On June 29, 2020, the Department of Labor (DOL) proposed a prohibited transaction exemption called Improving Investment Advice for Workers & Retirees (Exemption), which could have a substantial impact on the compliance operations of financial firms and their representatives. Possibly, the most significant development can be found in the preamble to the Exemption. The DOL states that it will now interpret more broadly its long-standing regulation defining investment advice so that more recommendations to investors, particularly rollover distribution recommendations, will result in the provision of "investment advice" for purposes of Section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974, as amended (ERISA) and Section 4975(e)(3)(B) of the Internal Revenue Code of 1986, as amended (Code). Additionally, if finalized in its current form, a fiduciary will be able to receive "conflicted compensation" in connection with providing investment advice to retail investors pursuant to the conditions of the Exemption. The Exemption will also allow a fiduciary to provide investment advice in connection with the recommendation of certain principal transactions despite the inherent conflicts involved in such recommendations.

Background

The DOL in 1975 promulgated a regulation in which it defined the term "investment advice" for purposes of Section 3(21)(A)(ii) of ERISA. The Regulation states that a person provides "investment advice" if he or she: (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 understanding; (4) that such advice will be a primary basis for investment decisions; and (5) that the advice will be individualized to the plan. This is known as the "five-part test." A regulation promulgated by the Department of the Treasury defines "investment advice" in the same manner for purposes of the Section 4075(e)(3)(B) of the Code. Therefore, if a person provides investment advice in connection with an ERISA-governed employee benefit plan (Plan) or a "plan" defined in Section 4975(e)(1) that is not subject to ERISA, such as an individual retirement account (IRA), he or she acts as a fiduciary in connection with the Plan or IRA.In 2005, the DOL issued Advisory Opinion 2005-23A to Deseret Mutual Fund Administrators (Deseret Letter) in which the DOL provided its interpretation of when a person provides investment advice in connection with taking a distribution from

In 2005, the DOL issued Advisory Opinion 2005-23A to Deseret Mutual Fund Administrators (Deseret Letter) in which the DOL provided its interpretation of when a person provides investment advice in connection with taking a distribution from a Plan and rolling over the distribution proceeds to an IRA. The Department stated that an investment adviser who was not otherwise a fiduciary with regard to the Plan would not be deemed a fiduciary with respect to the Plan solely on the basis of making a rollover recommendation to a plan participant, even if the adviser gave specific advice as to how to invest the distributed funds. In reaching this conclusion, the DOL stated that such a recommendation did not meet prong one of the five-part test; that is, the recommendation is not a recommendation as to the advisability of investing in, purchasing, or selling securities. On the other hand, the DOL stated that where a Plan officer who is already a fiduciary to the plan responds to questions regarding a Plan distribution or the investment of amounts withdrawn from the Plan, such fiduciary would be exercising discretionary management over the Plan, thus resulting in fiduciary status.

Preamble to the Proposed Exemption

In the preamble to the Exemption, the DOL concluded that its prior reasoning in the Deseret Letter was incorrect and that a recommendation to liquidate securities held in a Plan account, take a distribution, and roll those assets over to an IRA involves a recommendation described in the first prong of the five-part test. In reaching its conclusion, the DOL stated that "[a] recommendation to roll assets out of a Plan is necessarily a recommendation to liquidate or transfer the Plan's property interest in the affected assets, the participant's associated property interest in the Plan investments, and the fiduciary oversight structure that applies to the assets. Typically, the assets, fees, asset management structure, investment options, and investment service options all change with the decision to roll money out of the Plan." The DOL also pointed to the fact that "...a distribution recommendation commonly involves either advice to change specific investments in the Plan or to change fees and services directly affecting the return on those investments..." Therefore, in its view, the firms and their representatives should apply the above-described five-part test. Notably, the factors to which the DOL pointed are strikingly similar to those which the Securities and Exchange Commission (SEC) pointed out when it concluded that account recommendations, which include recommendations to rollover from a Plan to an IRA, should be subject to the requirements of Regulation Best Interest (Reg BI).

In addition, the DOL in the preamble provides guidance on how it interpreted several parts of the five-part test. Traditionally, based on the language in the regulation, firms and their representatives could often reach the conclusion that one or more of the prongs of the five-part test would not be met. In applying the DOL's guidance, many financial services firms and their representatives concluded that even if they made recommendations to buy or sell securities or other property, they did not do so (1) on a regular basis (for example, the advice was provided on a one-time or sporadic basis), or (2) pursuant to a mutual understanding that the firm and representative provides investment advice (for example, the account agreement specifically states that no investment advice will be provided). Additionally, the firms and their representatives may take the position that any advice they provide is not the "primary basis" for the investment decisions made by the Plan participant or IRA owner. At bottom, the preamble to the Exemption provides language that suggests a firm and its representatives may have more difficulty taking those positions.

With regard to the "regular basis" part of the test, the DOL stated that while a recommendation to take a distribution and rollover to an IRA or another account may be a one-time transaction that does not give rise to recommendations on a "regular basis," such recommendations "...can occur as part of an ongoing relationship or an anticipated ongoing relationship that an individual enjoys with his or her advice provider." Thus, for example, if a person is a fiduciary to the Plan participant with regard to investing Plan account assets and then recommends a rollover distribution, the person likely will provide advice in connection with that rollover recommendation. Furthermore, the DOL went on to state that

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