The U.S. Department of Labor (DOL) this week issued a new proposal aimed at streamlining investment advice protections provided to workers and retirees under the Employee Retirement Income Security Act (ERISA).
The measure includes a best interest standard intended to align with a broader investment advice regulation issued by the U.S. Securities and Exchange Commission (SEC) that takes effect June 30, as well as a complementary model regulation for annuity sales adopted earlier this year by the National Association of Insurance Commissioners (NAIC).
Jason Berkowitz, the Insured Retirement Institute (IRI)’s chief legal and regulatory affairs officer, tells PLANSPONSOR he is studying the DOL proposal, which has three primary components. First and foremost, he explains, the proposal would establish a new prohibited transaction exemption (PTE) for investment advice fiduciaries who, among other requirements, meet a best interest standard and a reasonable compensation standard. Notably, these are also components of the SEC’s Regulation Best Interest (Reg BI).
Second, the DOL is officially reinstating the “five-part test” for fiduciary status and other guidance that had been modified by the prior administration’s 2016 rule, which was vacated by the 5th U.S. Circuit Court of Appeals in 2018. Lastly, Berkowitz says, the proposal clarifies the circumstances under which fiduciary status would be triggered by advice to roll over retirement savings from a 401(k) or other employment-based plan to an individual retirement account (IRA).
“We are reviewing the Department of Labor proposal to determine its full ramifications, but some initial signs are encouraging that it will align with both the SEC’s Regulation Best Interest, which takes effect today, and the enhanced NAIC model regulation,” Berkowitz says. “Close alignment of these important standard of conduct rules for financial professionals will avoid confusion, enhance consumer protections and establish clear regulatory guidance.”
Berkowitz notes that industry stakeholders will have 30 days to file comments from the time the proposed rule appears in the Federal Register, which is expected shortly.
Jasmin Sethi, associate director of policy research at investment research firm Morningstar, is also studying the proposed regulation. Sethi says she believes the proposed rule “appears to be protective of investors, but it may not go far enough” to fully protect them.
“We are pleased to see that the DOL asserted that investment advice provided on rollovers from 401(k) plans to IRA accounts would be subject to Title I of ERISA,” Sethi says. “Further, in order to rely on the proposed exemption, investment advice fiduciaries would have to satisfy standards of impartial conduct, including a best interest standard, reasonable compensation and a requirement to not make materially misleading statements about investment recommendations. However, the devil is in the details.”
Sethi says the rule as proposed will not entirely clarify what constitutes fiduciary-level investment advice under ERISA, even with the emphasis being put back on the five-part test.
“We are concerned because the ‘regular basis’ requirement of this test excludes one-off transaction advice on a distribution or rollover,” she says. “For many individuals, such a transaction could be the beginning of a new investment advice relationship or may be the first time they are receiving investment advice at all.”
Sethi notes that the DOL’s proposal asserts that “advice to take a distribution from a plan and roll over the assets may be an isolated and independent transaction that would fail to meet the regular-basis prong.” Further, the DOL stipulates that “the determination of whether there is a mutual agreement, arrangement or understanding that the investment advice will serve as a primary basis for investment decisions is appropriately based on the reasonable understanding of each of the parties, if no mutual agreement or arrangement is demonstrated.”
Against this backdrop, Sethi suggests advice on the rollover transaction itself may not satisfy the five-part test, adding that firms could potentially use disclaimers to position the advice as not creating a “mutual understanding.”
“The DOL also explicitly says that no private action is created by such a disclosure,” Sethi says. “This means that enforcement will be left up to the DOL. In many ways, the DOL echoes the SEC by requiring the disclosure and mitigation of conflicts. Compensation for advice on rollovers is permitted. However, such compensation must be reasonable and the conflicts must be mitigated. The DOL is also accommodating of higher-cost products, clarifying that ‘recommendations of the lowest cost security or investment strategy, without consideration of other factors, could in fact violate the exemption.’ We are still considering the implications of the DOL’s view on costs and whether further clarity is needed.”
In Sethi’s view, like the SEC’s Reg BI, much of the future of advice under ERISA depends on how the SEC and DOL enforce their rules.
“The DOL is silent on how it plans to enforce these rules,” she says. “Crackdowns on conflicts that drive investors into higher-priced, conflict-ridden products would go a long way to give both rules teeth and protect investors.”
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