Labor Department Finalizes Investment Advice Fiduciary Rule Under ERISA

For the second time in a decade, the Department of Labor (DOL) attempted to expand the reach (and requirements) of the Employee Retirement Income Security Act of 1974 (ERISA). On April 23, 2024, DOL succeeded and announced that it finalized the "Retirement Security Rule: Definition of an Investment Advice Fiduciary" rule package, 29 CFR Part 2510 (the "Final Rule"), which broadens the definition of a fiduciary under ERISA and amends prohibited transaction exemptions (PTEs) applicable to fiduciary advisers.

The Final Rule comes after several failed efforts by DOL to expand the definition of an investment advice fiduciary to encompass more advisers to retirement investors. During its most recent attempt, in 2016, DOL finalized an updated investment advice fiduciary definition, granted new prohibited transaction exemptions including the Best Interest Contract Exemption, and amended some pre-existing exemptions. However, in 2018, the 5th Circuit Court of Appeals struck down the 2016 rule as too broad and as exceeding DOL's authority. The Final Rule's definition is more narrowly tailored than the 2016 rule, which applied to virtually all paid recommendations to retirement investors. While the Final Rule may be narrower than the previous iteration(s), it will still result in more market participants being subject to ERISA's fiduciary responsibilities given its expansion of the investment advice fiduciary definition.

Who Is an Investment Advice Fiduciary?

Under the Final Rule, a person is now considered an investment advice fiduciary if, with respect to the funds of a retirement plan or IRA, they provide a recommendation of any securities/investment transaction or of any investment strategy to a "retirement investor" and:

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:
- 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, and
- may be relied upon by the retirement investor as intended to advance the retirement investor's best interest; OR
The person represents or acknowledges that they are acting as a fiduciary under Title I of ERISA, Title II of ERISA, or both with respect to the recommendation.

In addition, the recommendation must be provided "for a fee or other compensation, direct or indirect," which means the person (or any affiliate):

receives any explicit fee or compensation, from any source, for the investment advice; OR
receives any other fee or compensation, from any source, in connection with or as a result of a recommended purchase, sale, or holding or a security or other investment property or the provision of investment advice (such as commissions, revenue sharing, and gifts or gratuities).

In this context, the term "retirement investor" includes retirement plans, participants and beneficiaries in retirement plans, IRA owners and beneficiaries, and fiduciaries with authority over a plan or IRA.

What Is a Primary Consequence of the Final Rule's Expansion?

Notably, the Final Rule closes the loophole for "one-time advice." Prior to the Final Rule, advice provided on a "one-time" basis, like a recommendation to roll retirement savings out of a workplace retirement plan and into an IRA, was not treated as fiduciary advice because it failed to meet the requirement that such advice be provided on a "regular basis." Under the Final Rule, one-time advice to roll over retirement funds to another account will now be considered fiduciary advice subject to ERISA. This is true even if the person delivering the advice doesn't manage the account where the funds are rolled and/or even if they don't advise on how to invest the rolled funds. Market participants cautioned that this will result in less advice to plan participants facing a rollover decision, but only time will tell if this prediction turns out to be accurate.

What Amendments Were Made to the PTEs?

The Final Rule also amends two prohibited transaction exemptions available to investment advice fiduciaries. PTE 84-24 applies to the oversight of investment recommendations by independent insurance agents who recommend annuities issued by more than one insurance company. The Final Rule amends PTE 84-24 to provide relief for those agents receiving compensation that would otherwise be prohibited for investment advice transactions. PTE 2020-02 allows investment advice fiduciaries to receive compensation that would otherwise be prohibited, if the fiduciaries comply with the exemption's conditions. The Final Rule makes clarifying changes to PTE 2020-02, which build on those conditions.

Both exemptions require that investment recommendations adhere to Impartial Conduct Standards, which require that:

Advice must meet obligations of care and loyalty.
The investment professional and firm must charge no more than reasonable compensation.
Advice must comply with applicable federal securities laws regarding "best execution."
The advice must be free from misleading statements about investment transactions and other relevant matters.

In addition, and among other requirements, fiduciaries who provide investment advice must also avoid misleading statements about conflicts of interest, fees, and investments, follow policies and procedures designed to ensure the advice given is in an investor's best interest, and give investors basic information about conflicts of interest.

What Does the Final Rule Mean for Retirement Plan Sponsors?

While the Final Rule does not directly impact plan sponsors, they should find some comfort in the fact the Final Rule defines an investment advice fiduciary as a person making a "professional" investment recommendation to a retirement investor. In doing so, DOL intends to provide additional certainty that ordinary communications about a company's retirement plan by a company's non-investment professional employee (such as a Human Resources staff member) to plan participants would not be investment advice.

Retirement plan sponsors should also find relief in that the Final Rule clarifies the types of investment education described in DOL's Interpretive Bulletin ("IB") 96-1 remain non-fiduciary in nature, absent a recommendation, regardless of the type of retirement investor to whom it is provided. Under IB 96-1, the types of information and materials considered to be investment education are plan information, general financial and investment information, asset allocation models, and interactive investment materials. The Final Rule notes that the line between an investment recommendation and investment education will depend on whether there is a call to action. So, a general conversation about retirement planning such as providing a company's retirement plan options to a retirement investor should not be swept up into the Final Rule.

Initial Reactions?

The industry quickly expressed concern that the Final Rule lacked an explicit "hire me" exemption for preliminary discussions with retirement investors. DOL sought to address this omission by reiterating that it did not intend the Final Rule to capture normal marketing activities. Unfortunately, after stating its intention, DOL muddied the waters by admonishing market participants in the Final Rule that "when the investment advice provider recommends, for example, that the investor pull money out of a plan or invest in a particular fund, that advice may be given in a fiduciary capacity even if part of a presentation in which the provider is also recommending that the person enter into an advisory relationship." This injects a degree of unpredictability into advisers' discussions with prospective clients, both individuals and plan sponsors.

The failure to articulate clear boundaries surrounding initial marketing activity or communications could cause a chilling effect in the industry. For example, ERISA retirement plan sponsors' requests for proposals (RFPs) typically ask prospective advisers to provide examples of specific plan recommendations in their RFP responses. If advisers are uncertain or unclear about becoming a fiduciary before they are hired, they may decline or limit the information provided in their RFP responses. This would limit the quality and quantity of RFP responses, thereby negatively impacting the advisers' selection process by the plan sponsors and possibly the advice provided to plan participants.

When Does the Final Rule Become Effective?

The Final Rule will generally go into effect on September 23, 2024, although there is a one-year transition period after that date for certain PTE conditions. Given the tumultuous history of the Final Rule, it is likely the Final Rule will face additional legal challenges. On May 2, 2024, the Federation of Americans for Consumer Choice and five insurance industry plaintiffs sued the regulator in Texas federal court over the Final Rule, echoing the arguments made in the 2018 litigation that was resolved in the 5th Circuit.

DWT's ERISA and financial services teams are monitoring the Final Rule's progress and can assist advisers with developing and implementing policies and procedures to ensure compliance with the Final Rule. In addition, we can advise retirement plan sponsors on how to understand the impact of the Final Rule on their relationships and agreements with investment advisers.