Why is this important to me?
Before we even begin to explain what it means to be a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA), you may be asking: “Why do I care?” Your status as an ERISA-fiduciary (or not) is important because the Department of Labor’s (“DOL”) new interpretation of its rules governing ERISA retirement plans and Individual Retirement Accounts (“Rules”), which becomes enforceable on December 20, 2021, will alter when the DOL considers you to be acting (or not acting) as a fiduciary. This affects what and how you can be paid for recommendations you make. If you work with ERISA-governed retirement plans or IRAs, you need to understand how these changes will impact your business.
The Impact of the Rule
When the DOL’s rules apply, people the DOL considers fiduciaries are generally prohibited from receiving:
- Compensation that varies depending upon the advice that is provided; or
- Compensation from a third-party, which is anyone other than a fiduciary’s client.
If such compensation is received, the DOL considers the transaction that generated the compensation to be a “Prohibited Transaction.” So, typically, if an ERISA fiduciary makes a sale that generates a commission, that sale is a Prohibited Transaction. That is because the compensation varies depending upon the advice that is given. For example, if you recommend that a client purchase a mutual fund, you will be paid. Conversely, if you recommend that they do not purchase the mutual fund, or anything else, you will not be paid. This means that the compensation varies based upon the advice that you provide. Additionally, commissions paid on products, like mutual funds and variable annuities, are paid by fund companies and insurance companies who are not your client and are, therefore, considered third parties.
If you are a fiduciary and you make investment recommendations regarding ERISA plans and IRAs – including recommendations to rollover assets to an IRA – you must meet the requirements of a Prohibited Transaction Exemption (PTE) in order to receive compensation that would otherwise be prohibited. Generally, this means complying with the new PTE (PTE 2020-02), or an existing PTE (PTE 84-24, which applies to recommendations of insurance products), to avoid violating DOL regulations when you receive compensation.
Many times, a client only needs information about their options. If you only provide education, allowing the investor to make their own decision, you are not an ERISA fiduciary and the Rules do not apply. So, if you provide only education to a client about their available options, without making a product or account recommendation, then the Rules (and their prohibited transactions) are not triggered.
However, if you feel you need to make a recommendation, you must ensure you understand the requirements that come with it.
So, when am I a fiduciary?
When are you acting as a fiduciary? Under ERISA, you are a fiduciary if you meet each element of a 5-part test:
- You provide advice or recommendations regarding purchasing or selling securities or other property of the plan for a fee;
- You do so on a regular basis;
- Your advice is given pursuant to a mutual agreement or understanding;
- The investment advice serves as a primary basis for the investment decision; and
- The advice is individualized.
If you meet the elements of the five-part test, you’re a fiduciary under ERISA. And under the new DOL interpretation of these rules, you are more likely to satisfy this test if you recommend a rollover from an ERISA governed plan (for example, a 401(k)), especially if you and your client contemplate providing ongoing advice in the IRA after the rollover occurs.
What’s the good news?…
PTE 2020-02 allows you to receive third-party compensation for advice related to ERISA accounts and IRAs, provided you meet certain criteria.
Under PTE 2020-02, if you make recommendations to an ERISA-governed plan or account, you can still receive commissions from the sale of a product related to that recommendation if you:
- Adhere to the Impartial Conduct Standards, which are:
- Advice must be in the best interest of the investor;
- Compensation must be reasonable;
- No material misstatements of facts.
- Additionally, you must:
- Disclose to the client your status as a fiduciary under Title I of ERISA;
- Provide a written description of the services available and conflicts of interest, and
- Prior to a rollover transaction, provide the investor the specific reasons for the recommended transaction.
The elements of the Impartial Conduct Standards are very similar to those of the SEC’s Regulation Best Interest, which went into effect in 2020. So, meeting the standards and requirements of Reg BI will generally satisfy the elements of the Impartial Conduct Standards.
With respect to the disclosure and notification requirements, ESI is in the process of amending its forms and disclosure documents to address the elements that must be provided to the client in conjunction with making a recommendation and prior to engaging in a transaction. For example, if you recommend that an investor roll their retirement assets into an IRA, you will have to provide the client with the rationale for the recommendation prior to the transaction. As such, ESI is working on revising its new account paperwork or, in some instances, creating new forms that will help you address such specific requirements under the Rules. So, stay tuned for additional information on updated forms and documents as we roll them out closer to the enforcement date.
Education may be the preferred path.
As a reminder, if you only provide education, you will not be an ERISA fiduciary, and the prohibited transaction rules do not apply. As you know, for rollovers under Reg BI, the Firm has a process to only educate clients on their rollover options. If you are comfortable using that process today, it will likely continue to serve you well when the DOL rules begin being enforced in December.
Look for our next communication, which will outline the difference between (1) providing education and (2) making a recommendation. And then, effective December 20th, you can decide which path – education or recommendation – best suits your business model.
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