DOL Completes Trifecta of Questionable Policies

The DOL’s new guidance reinstates prior definition of investment fiduciary and offers new exemption for (otherwise prohibited) forms of compensation for plan fiduciaries.

The Department of Labor’s efforts to define when an investment adviser is a plan fiduciary–and the standards that must be followed by investment fiduciaries– have taken a new turn with the release of new guidance.


Fiduciary status under ERISA represents a significant responsibility: fiduciaries must act for the “exclusive benefit” of participants and beneficiaries–considered the highest standard of responsibility under the law–and fiduciary activity is carefully proscribed and scrutinized. One can achieve fiduciary status many ways–by exercising discretionary control over plan administration, by determining claims, and by providing investment advice for a fee (an “investment fiduciary”).

Rules governing investment fiduciaries have been a legal battleground for a decade. Key phases of this battle include the issuance of proposed regulations in 2010, the issuance of final regulations by the Obama administration in 2016, legal challenges to the final regulations, and abandonment of the 2016 final regulations by the Trump administration. The stakes in this battleground are enormous–the private sector retirement market (including DC plans, DB plans and IRAs) has $20 trillion in assets and the fees associated with providing investment advice to this behemoth is tens of billions of dollars–annually. Accordingly, we can expect that this proposed guidance will not be the last word on this issue.

The battle over investment fiduciaries has two components: identifying who is a fiduciary (and, therefore, who is subject to the fiduciary standards in the first place) and what conduct is permitted–or prohibited–for investment fiduciaries.

Who is a Fiduciary?

Prior to the 2010 proposed regulations the DOL utilized a 5-part test (issued in 1975) to determine whether a person (including a corporation) is providing investment advice for a fee–and is, therefore a fiduciary. Under this 5-part test, a person renders investment advice for a fee (and, therefore, is an investment fiduciary) only if such person

•      Renders advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property;
•      on a regular basis
•      pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary, that
•      the advice will serve as a primary basis for investment decisions with respect to plan assets, and that
•      the advice will be individualized based on the particular needs of the plan.

This 5-part test was replaced in the 2016 final regulations and the first part of the new DOL guidance is to reinstate the 5-part test as the standard for determining whether a person is an investment fiduciary.

The 5-part test was created when DB plans (paying only in the form of annuities) dominated the retirement landscape and DC assets were miniscule in comparison. Moreover, the 5-part test has numerous gaps that allow firms to escape the fiduciary label at will. As stated by the DOL in a 2016 report:

Under the 1975 regulation, an investment adviser does not act as a fiduciary unless each element of the five-part test is satisfied for each instance of advice. Therefore, … if an adviser provides one-time individualized, paid advice to a worker nearing retirement on the purchase of an annuity, the adviser is not acting as a fiduciary, because the advice is not provided on a regular basis. This is the result even though the advice involves the investment of a worker’s entire IRA or 401(k) account balance, or defined benefit plan balance.

The ability to evade fiduciary responsibility was an issue that the DOL sought to address in 2016. With the reinstatement of the 5-part test providers, once again, have the opportunity to avoid designation as a fiduciary and avoid fiduciary responsibility.

What a Fiduciary Can–and Cannot–Do

The second part of the DOL’s guidance is in the form of a proposed “prohibited transaction exemption” (or “PTE”). In considering ERISA’s rules governing fiduciary activities–and the impact of this new proposed guidance–it is important to understand the construct used by ERISA. Rather than prohibiting certain enumerated transactions, ERISA broadly proscribes a broad group of “prohibited transactions” between a fiduciary and a plan unless the transaction meets a specific PTE. The definition of prohibited transactions includes virtually any transaction between a fiduciary and a plan. Under this framework, as explained by the DOL, “a fiduciary may not receive payments from any party dealing with the Plan or IRA in connection with a transaction involving assets of the Plan or IRA.” In effect, without a PTE, fiduciaries cannot receive commissions or similar payments for the sales of investment or insurance products.

Proposed Prohibited Transaction Exemption

The DOL proposal creates a new PTE. The DOL’s new guidance is intended to be “in alignment” with the “best interest” standards issued by the SEC in 2019. Under this new DOL exemption financial advisors can receive (otherwise) prohibited compensation if the advisor meets the PTE’s requirements. Per the DOL:

Professionals could receive a wide variety of payments that would otherwise violate the prohibited transaction rules, including, but not limited to, commissions, 12b–1 fees, trailing commissions, sales loads, markups and mark-downs, and revenue sharing payments from investment providers or third parties.

Under the PTE these forms of compensation are permitted if the following requirements are met:

•      The advice provided must be in the “best interest” of the investor. “Best interest” is defined to mean that the advice is prudent and does not place the financial interest of the advisor ahead of the interests of the plan or the participant. Also, the compensation received for the advice must be not exceed “reasonable” compensation and statements about the transaction are not “materially” misleading.
•      The advisor must provide written disclosure of the services to be provided and any “material” conflicts of interest.
•      The financial institution providing the advice must maintain and enforce policies and procedures designed to comply with the DOL PTE. These policies and procedures should be designed to “avoid misalignment of interests” between investment professionals and participants/plans and “mitigate” conflicts of interest between the institution and the plan/participant. As noted in the preamble to the proposed PTE, the DOL believes that certain practices (“sales contests and similar incentives such as sales quotas, bonuses and noncash compensation that are based on sales of certain investments within a limited period of time”) cannot be designed to adequately mitigate conflicts and, in effect, use of these practices is inconsistent with the policies and practices requirement of the PTE.
•      The financial institution conducts retrospective reviews (at least annually) “reasonably designed” to assist in detecting and preventing violations of the PTE.

There are other components of the proposed PTE, regarding certain firms that are prohibited from using this exemption (if convicted of certain crimes or if found to have systematically violated the prohibited transaction rules).

Some Implications

The standards applicable to investment advice to plans and plan participants is large and complex. This new guidance raises numerous concerns, including:

•      The DOL has given the public 30 days to comment on this proposed PTE. In light of the complexities — and the stakes– this in inadequate. In effect, the DOL is trying to ram this exemption, with limited public input, through before the election. That does not represent sound policy.
•      The preamble to the PTE specifies that the best interest standard can be met by a financial advisor that provides advice only with respect to proprietary products or on a limited menu of products that generate third party payments to the financial firm. This represents a significant gap in the “best interest” standard and means that a financial advisor can limit recommendations to poorly performing, high commission proprietary products–and still be considered as acting in participants’ best interest.
•      As noted by the DOL in a 2016 report underperformance and excessive fees resulting from conflicted advice will cost participants tens — or even hundreds–of billions of dollars. However, in evaluating this new PTE the DOL was silent on the adverse impacts on participants. Rather, the DOL focused on the desirability of aligning the PTE with the SEC’s “best interest” standard and preserving the commission-based sales model. In effect, the agency has transitioned from the Department of Labor to the Department of Brokers.

In some ways the new PTE parallels the “Best Interest Contract” exemption issued under the 2016 final regulations–establishing some standards for permitted transactions and some disclosure obligations. However, the new “best interest” standard as defined by the DOL is riddled with gaps and strips away many of the protections afforded to participants under the 2016 regulations. With tens of thousands of dollars at stake for selling a large rollover into a proprietary, commissioned product–brokers will be highly motivated to capitalize on the new PTE’s gaps.

The Questionable Policy Trifecta

In the past few weeks the DOL has (i) sought to discourage the use of ESG factors in selecting plan investments, (ii) paved the way to include private equity investments in DC plans, and (iii) now opened plan participants up to commission-based (i.e., conflicted) investment advice.Perhaps plan participants would benefit if the DOL chose to take the next few months off.