The Department of Labor (DOL) has issued a new regulation defining fiduciary "investment advice" under the Employee Retirement Income Security Act of 1974 (ERISA), as amended, and Section 4975 of the Internal Revenue Code of 1986 (Code), as amended.1 This is DOL's third serious attempt in the past 15 years to overhaul the definition of investment advice under ERISA and the Code. Unless blocked by the courts or Congress, the new regulation will go into effect on September 23, 2024. The new regulation significantly expands the scope of investment-related information considered to be fiduciary advice and thus regulated under ERISA's strict fiduciary responsibility rules and the prohibited transaction rules in Section 4975 of the Code.
The new regulation deems a recommendation to constitute fiduciary investment advice when the person making the recommendation receives direct or indirect compensation for the recommendation and:
- Represents or acknowledges fiduciary status with respect to the recommendation specifically under ERISA or the Code or both
- Or directly or indirectly (e.g., through or together with any
affiliate or representative) makes professional investment
recommendations to investors on a regular basis as part of its or
their business and the circumstances under which the recommendation
is made would indicate to a reasonable investor in similar
circumstances that the recommendation:
- Is based on review of the retirement investor's particular needs or individual circumstances
- Reflects the application of professional or expert judgment to the retirement investor's particular needs or individual circumstances
- May be relied upon by the retirement investor as intended to advance the retirement investor's best interest
The DOL states that it now believes the current regulation, which the DOL put in place in 1975 shortly after ERISA was enacted, actually conflicts with the text and purpose of ERISA and leaves plan investors unprotected, especially in modern times when investment options are more numerous and complex and individual participants, beneficiaries, and individual retirement account (IRA) owners (and not professional managers) often manage their own investments. While the new regulation is largely aimed at capturing recommendations to individual plan and IRA investors, it is not limited to them. Rather, the new regulation applies broadly to ERISA plan and IRA investors regardless of sophistication.
Issues and Observations
The new regulation does the following:
1. Establishes a Holistic Definition of Fiduciary "Investment Advice"
Like the proposed regulation,2 the final new regulation lowers the bar for investment-related information provided to plan and IRA investors to be considered as fiduciary "investment advice." It employs a new, holistic facts and circumstances definition focusing on the reasonable expectations of the investor in light of the substance of the information and the context in which it is received. The new definition disregards the expectations of the provider of the information, the regularity of the provider's relationship to the investor, and the extent of the recipient's reliance on the information as a recommendation (e.g., as a primary versus ancillary basis for an investment decision). The new definition expressly discounts the weight given to disclaimers and makes no exception for sophisticated recipients, although both disclaimers (especially mutually agreed-upon disclaimers) and the recipient's sophistication should remain relevant to the question of the recipient's reasonable expectations.
2. Raises the Risk of Sales and Marketing Activities Being Deemed Fiduciary Investment Advice
The new definition raises the risk that current sales and marketing practices — whether by fund sponsors, broker-dealers, or other financial service and product providers — could be deemed fiduciary investment advice. If deemed as such, the fund sponsor or other provider would then need an exemption just to sell its product or service. Generally, that exemption would have to be the newly toughened version of Prohibited Transaction Exemption (PTE) 2020-02, with its enhanced requirements related to fiduciary conduct, disclosure , recordkeeping, and others.3
While the new regulation expressly provides that "a salesperson's recommendation to purchase a particular investment or pursue a particular investment strategy is not [necessarily] investment advice," the regulation offers no safe harbor or other special protection for sales and marketing activity. Rather, the regulation simply provides, circularly, that a sales recommendation is not fiduciary investment advice if it does not meet the facts and circumstances criteria prescribed by the regulation (e.g., it is not individualized and/or does not reasonably appear to be reliably in the investor's best interests). Still, even under the new definition, a fund sponsor or other product or service provider should not be deemed a fiduciary adviser merely by providing generic factual information about its products and services, whether through advertising, marketing materials, fund or product disclosures, due diligence responses, or otherwise.
But a fund sponsor or other provider could be viewed as providing fiduciary advice, for example, in recommending a product or service as appropriate for a particular plan investor or group of plan investors or in providing a tailored response to a plan investor's request for investment solutions meeting certain stated needs. This is true even if the fund sponsor or other provider recommends a range of alternatives from which the investor or investors may choose and expressly disclaims fiduciary status in related disclosures or client agreements, two common ways of avoiding fiduciary status under the current regulation. The analysis should be different, however, if (i) the plan sponsor is sophisticated enough to understand the proposed products (directly or with the assistance of its own independent fiduciary adviser); (ii) the provider clearly discloses all relevant conflicts, including its obvious financial interest in the sale but also any financial conflicts inherent in the fund or product alternatives; (iii) the provider expressly cautions that its recommendations should be viewed as conflicted and not necessarily in the investor's best interest; (iv) the plan sponsor, in a subscription or other agreement, makes customary representations as to its sophistication and understanding (including reliance on an independent fiduciary adviser when it alone does not possess the necessary sophistication) and lack of reliance on the provider; and (v) the plan sponsor, in such agreement, also expressly acknowledges the conflicts and that any recommendations received are not necessarily in its best interests.
Action items include the following:
- Fund sponsors and other financial product and services providers should review and update their offerings (including considering who is eligible to buy them), marketing materials, disclosures, client agreements, polices, procedures and internal training materials as needed to account for the new legal standard. Many current fund and advisory product materials (e.g., subscription agreements, investment management agreements, offering documentation, and related materials) may need little or no updating because the representations, acknowledgements, and disclosures they include tend to be broadly protective of the provider. But other documents, including underwriter and issuer disclosures and deemed representations and capital markets trading documentation (e.g., ISDA agreements) may need updating because they tend to rely on the precise definition of fiduciary "investment advice" currently in place (e.g., its "primary basis" requirement).
- Fund sponsors and other providers that cannot or do not wish to avoid fiduciary status with respect to their product recommendations should determine whether they may rely on PTE 2020-02 and what steps they will need to take to do so.
3. Raises the Risk of Model Providers and Others Providing Advice to Third-Party Investment Managers Being Deemed Fiduciaries to the Manager's Clients
The new definition raises the risk that model providers and other wholesale providers of tailored advice (i.e., advice tailored to particular investment strategies or other stated needs of the recipient) to brokers, advisers, or other financial intermediaries with discretion over the investment of plan or IRA assets could be viewed as fiduciary investment advice. This is true notwithstanding the lack of privity between the provider and the underlying plan or IRA. In such cases, the new definition views the financial intermediary (as opposed to the underlying plan or IRA) as the covered "retirement investor."
Model providers and other wholesale providers of tailored advice to nondiscretionary fiduciaries (e.g., other nondiscretionary advisers) generally do not have this risk because the new regulation excludes non-discretionary fiduciaries from the definition of covered retirement investor. This exclusion likely has its limits, potentially applying only where the financial intermediary actually provides substantive advice to the end user. It might not apply, for example, when the intermediary merely rubber-stamps or otherwise passes along the advice without first considering whether or how it should be accepted, rejected, or modified for the end-user plan or IRA.
Action items include the following:
- Model providers and other wholesale providers of tailored advice should review and update their offerings (including considering who is eligible to buy them), marketing materials, disclosures, client agreements, polices, procedures, and internal training materials as needed to account for the new legal standard.
4. Attributes Recommendations Made by Unaffiliated Agents in Determining a Person's Fiduciary Status
The new regulation considers recommendations provided through or together with other persons in determining whether a given provider is providing fiduciary investment advice. Unremarkably, those other persons include affiliates and others under the provider's control. But those other persons also include undefined "representatives" that are neither affiliated with the person nor under the person's control. References in the preamble to the proposed regulation suggest that the term "representatives" was intended to capture registered or licensed representatives of broker-dealers and investment advisers. But the text of the final regulation contains no such limitation. Indeed, other than indicating that neither affiliation nor control matters, the final regulation says nothing about what the term "representative" means, leaving open the possibility of broad interpretations conceivably including any person the investor perceives to be "representing" the interests of the putative provider. For example, the term might be interpreted to include unaffiliated distribution agents independently acting as advisers to their own clients, with the agents' recommendations being attributed to the sponsor of the funds being distributed, in turn precluding the sponsor from selling interests in its funds to those clients (at least absent the agents' compliance with an exemption).
Action items include the following:
- Fund sponsors and other providers should review and update their distribution agreements to account for the new legal standard.
- Fund sponsors and other providers that cannot or do not wish to avoid fiduciary status with respect to product recommendations should determine whether they may rely on PTE 2020-02 and what steps they will need to take to do so.
5. No Longer Requires an Ongoing Relationship for Recommendations to Be Considered Fiduciary Investment Advice
The new regulation modifies the "regular basis" relationship requirement of the current definition (i.e., the requirement that there is an ongoing relationship between the advice provider and the recipient). In its place, the new regulation merely requires that the provider, directly or through/with affiliates (including undefined representatives), makes professional investment recommendations to investors on a regular basis as part of its brokerage, advisory, or other financial business. This relaxed requirement should still help persons providing legal, tax, accounting, and other advice (even in an investment context) from being deemed fiduciary investment advisers. But it offers no help to brokers, advisers, and other investment professionals who wish to give nonfiduciary recommendations in certain contexts (e.g., in selling its products).
6. Extends Fiduciary Regulation to Most Distribution and Rollover Recommendations
Under the new regulation, "investment advice" includes most recommendations relating to distributing assets from a plan or rolling over assets from one plan to another, including from an employee benefit plan, such as a 401(k) plan, to an IRA. This includes recommendations as to (i) whether to distribute or roll over the assets, (ii) how much to distribute or roll over, (iii) in what form to distribute or roll over (i.e., in kind or cash), (iv) the destination of the distribution or rollover (e.g., to what kind of account, including to another plan or IRA), and (iv) how to invest following the distribution or rollover (e.g., in a given fund, other product, or asset). This treatment, particularly in addressing the disposition of assets following a rollover, effectively subjects assets distributed from a plan or rolled into an IRA (which assets are otherwise not subject to ERISA) to regulation under ERISA, at least initially, and gives the owners of the distributed or rolled-over assets (who otherwise have no cause of action under ERISA or the Code in such capacity) a cause of action under ERISA with respect to those assets.4
7. Subjects Nondiscretionary Fiduciary Advisors Receiving Variable Compensation to Enhanced Fiduciary Regulatory Regime Under PTE 2020-02
Many brokers, insurance agents, consultants, and others that will be deemed fiduciary advisers under the new definition receive commissions or other variable compensation in connection with their recommendations. Some of that compensation may be covered currently under DOL class exemptions if applicable conditions are met, including PTEs 75-1, 77-4, 80-83, 83-1, 86-128, and 84-24. But new amendments will largely limit use of those exemptions to discretionary fiduciaries, thus forcing fiduciary advisers to either change their compensation structure so that it does not vary with their recommendations or adhere to the enhanced fiduciary regulatory regime (and other requirements) imposed under PTE 2020-02, to which the DOL has also added new, more stringent conditions.
8. Has Already Been Challenged in Court, on the Hill
An insurance industry trade group, the Federation of Americans for Consumer Choice Inc., has sued the DOL, seeking to vacate the new regulation (and the accompanying prohibited transaction exemption amendments).5 A second lawsuit challenging the new regulation has been filed by the American Council of Life Insurers and other insurance trade groups.6 There has also been movement in Congress to overturn the new regulation. Whether such or similar measures will succeed is uncertain and, in any event, may take months or longer to resolve. In the interim, fund sponsors, broker-dealers, and other financial service and product providers should consider and address the effect of the new regulation on their businesses.
Footnotes
1. Retirement Security Rule: Definition of an Investment Advice Fiduciary, 89 Fed. Reg. 32122 (April 25, 2024).
2. See our client alert for a discussion on the proposal: Goodwin, "Rushing to Chaos: The U.S. Department of Labor's Well-Intentioned, Yet Unworkable Proposal to Redefine Fiduciary Investment Advice"(Dec 29, 2023).
3. Amendment to Prohibited Transaction Exemption 2020-02, 89 Fed. Reg. 32260 (April 25, 2024). The amendments to PTE 2020-02 add several new requirements that make compliance with the exemption more challenging (e.g., new disclosure requirements, policies and procedures, and retrospective review). But the amendments also make the exemption more user-friendly in some respects (e.g., specific rollover disclosures are no longer required).
4. The Fifth Circuit vacated the DOL's 2016 definition of fiduciary "investment advice" in part because it provided IRA owners with a new private right of action. Chamber of Commerce v. U.S. Dept. of Labor, 885 F.3d 360 (5th Cir. 2018).
5. Federation of Americans For Consumer Choice, Inc. v. U.S. Dept. of Labor, No 6:24-cv-00163-JDK (E.D. Tex. May 2, 2024).
6. American Council of Life Insurers v. U.S. Dept. of Labor, No. 4:24-cv-00482-O (N.D. Tex. May 24, 2024).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.