31 changes to prohibited transaction exemptions under DOL proposal

November 22, 2023 1:49 PM

The Labor Department's new potential "retirement security rule" carries significant changes to existing guidelines known as prohibited transaction exemptions for fiduciary investment advice.

While the main part of the rulemaking package would alter the definition of "fiduciary" under the Employee Retirement Income Security Act, three other potential amendments included in the proposal would enforce new requirements for disclosures and apply "best interest" standards to more types of transactions. The exemptions enable advisors to retirement plans to provide investment advice to participants, so long as they comply with "impartial conduct standards" that require the services to be in the investors' best interests without any materially misleading statements but allow for the payment of a reasonable amount of compensation.

The proposed amendments to the guidelines begin with substantial changes to the department's last update to prohibited transaction exemptions under President Donald Trump's administration in December 2020. That prior rule came in response to a 2018 appeals court decision that vacated the "fiduciary rule" issued by President Barack Obama's administration in 2016. President Joe Biden's team is seeking an overhaul of the exemptions as part of its rulemaking.

To read 31 important sections of the potential amendments to the Labor Department's guidelines for prohibited transaction exemptions under the retirement security rule proposal, scroll down the slideshow. And find other coverage of the possible new regulation here:

An overview of potential changes to the 2020 rule

"The Department is proposing to amend PTE 2020–02, which was designed to promote investment advice that is in the best interest of retirement investors (for example, Plan participants and beneficiaries, and IRA owners) by permitting advisers to receive compensation for the advice that is otherwise barred by statute so long as advisers comply with the terms of the exemption. The current exemption conditions emphasize mitigating conflicts of interest and ensuring that retirement investors receive advice that is prudent and loyal. An important objective of the existing exemption is to require fiduciary investment advice providers to adhere to stringent standards that are designed to ensure that their investment recommendations reflect the best interest of Plan and IRA investors."

Effort to provide certainty for clients, firms and professionals

"This proposed amendment would build on these existing conditions to provide more certainty for retirement investors receiving advice and financial institutions and investment professionals complying with the exemption's conditions. In this regard, the Department is proposing additional disclosures to ensure that retirement investors have sufficient information to make informed decisions about the costs of the investment advice transaction and about the significance and severity of the investment advice fiduciary's conflicts of interest. The proposed amendment also would provide more guidance for financial institutions and investment professionals complying with the impartial conduct standards and implementing their policies and procedures."

Agency’s view of differences with 2016 fiduciary rule

"Importantly, the Department is not proposing to require a contract for investment advice to IRAs, as it did in 2016. Neither the existing PTE 2020–02 nor the proposed amendment creates any new causes of action or requires financial institutions to provide enforceable warranties to retirement investors. The primary penalty for an IRA fiduciary that engages in a non-exempt prohibited transaction by failing to satisfy the exemption conditions of amended PTE 2020–02 would be the prohibited transaction excise tax imposed under Code section 4975 and enforced by the Department of the Treasury and the Internal Revenue Service (IRS). This proposal would require financial institutions, as part of their retrospective review, to report any non-exempt prohibited transactions in connection with fiduciary investment advice by filing IRS Form 5330, correcting those transactions, and paying any resulting excise taxes. The proposed amendment would add failure to correct prohibited transactions, report those transactions to the IRS on Form 5330, and pay the resulting excise tax imposed under code section 4975 to the list of behaviors that could make a financial institution ineligible to rely on PTE 2020–02 for ten years. The Department believes these proposed conditions would provide important protections to retirement investors by enhancing the existing protections of PTE 2020–02."

Extending the exemption to computer models

"The Department is now proposing to amend PTE 2020–02 to allow financial institutions providing investment advice through computer models to rely on the exemption. The Department understands that financial institutions may use a combination of computer models and individual investment professionals to provide investment advice and may wish to have a single set of policies and procedures that can govern all recommendations, regardless of whether a retirement investor speaks with an investment professional. Including computer-generated advice in this exemption would simplify financial institutions' compliance, so that a retirement investor could request an investment professional's assistance with a particular transaction, or an investment professional could review the computer model's recommendations, without separate analysis as to whether an investment professional has provided fiduciary investment advice."

Links to SEC’s Regulation Best Interest

"The proposed amendment would retain the best interest standard from PTE 2020–02. To provide additional clarity, the Department is proposing to add an example to the operative text from the 2020–02 preamble specifying that it is impermissible for the investment professional to recommend a product that is worse for the retirement investor because it is better for the investment professional's or the financial institution's bottom line. In other words, the requirement for investment professionals not to subordinate the retirement investor's interests to their own is not satisfied if the investment professional merely considers the retirement investor's interests along with its own and the financial institution's in choosing which product to recommend to a retirement investor. The Department notes this standard is consistent with the SEC's standards for both registered investment advisers and broker-dealers."

Allowances for ‘reasonable compensation’

"For example, in choosing between two investments offered and available to the investor from the financial institution, it is not permissible for the investment professional to advise investing in the one that is worse for the retirement investor but better for the investment professional's or the financial institution's bottom line. It bears emphasis, however, that this standard should not be read as somehow foreclosing the investment professional and financial institution from being paid on a transactional basis, nor does it foreclose investment advice on proprietary products or investments that generate third-party payments, or advice based on investment menus that are limited to such products, in part or whole. Financial institutions and investment professionals are entitled to receive reasonable compensation fairly disclosed for their work, as long as they do not subordinate the retirement investor's interests to their own and have appropriate policies and procedures to safeguard against imprudent or disloyal advice."

When commissions are better for retirement investors

"Certainly, in many cases, it is in the retirement investor's best interest to receive advice from investment professionals that are compensated through commissions incurred on a transactional basis, rather than as part of an ongoing fee-based relationship (for example, pursuant to an advisory relationship subject to a recurring charge based on assets under management). In such cases, the fact that the investment professional received a commission for their services is not inconsistent with the principles set forth herein. Conversely, a recommendation to enter into a fee-based arrangement may, in certain cases, be inconsistent with the best interest standard. For example, 'reverse churning,' or recommending that a retirement investor continue to receive advice and hold assets subject to an ongoing advisory fee, in circumstances where the investor has low trading activity and little need for ongoing advice, would constitute a violation of the impartial conduct standards and ERISA section 406(b)(1) that is not covered by this exemption."

Written fiduciary acknowledgment

"The proposed amendment would clarify the fiduciary acknowledgment requirement so that the financial institution must provide a written acknowledgment that the financial institution and its investment professionals are providing fiduciary investment advice to the retirement investor and are fiduciaries under Title I, the code, or both when making an investment recommendation. If financial institutions and investment professionals are unwilling to meet this exemption condition, they must restructure their operations to avoid prohibited transactions."

New disclosures

"The Department is also proposing a new Section II(b)(4) which would require financial institutions to inform retirement investors of their right to obtain specific information regarding costs, fees, and compensation that is described in dollar amounts, percentages, formulas or other means reasonably designed to present materially accurate disclosure of their scope, magnitude and nature. The financial institution must provide the information in sufficient detail for the retirement investor to make an informed judgment about the costs of the transaction and the significance and severity of conflicts of interest. This includes the total compensation that the financial institution and investment professional receive, not just the costs directly paid by the retirement investor. This disclosure also must describe how the retirement investor can receive the information free of charge. The Department is not proposing to require financial institutions to maintain records of every transaction or be able to quickly provide specific information regarding costs or fees generated by specific transactions. However, the Department is proposing to require financial institutions to maintain sufficient records to allow them to meaningfully respond to retirement investors' requests to demonstrate how the financial institution and its investment professionals are compensated in connection with their recommendations."

Rollover disclosures

"Before engaging in a rollover or making a recommendation to a plan participant as to the post-rollover investment of assets currently held in a plan, the financial institution and investment professional must consider and document their conclusions as to whether a rollover is in the retirement investor's best interest and provide that documentation to the retirement investor. Relevant factors to consider must include but are not limited to: (i) the alternatives to a rollover, including leaving the money in the plan or account type, as applicable; (ii) the comparative fees and expenses; (iii) whether an employer or other party pays for some or all administrative expenses; and (iv) the different levels of fiduciary protection, services and investments available."

Potential rollover analysis fee

"The Department notes it would be permissible under this exemption for a financial institution to charge a discrete fee for the rollover analysis and charge separately for advice following the rollover. Like all other service providers and investment advice fiduciaries, the financial institution may only charge reasonable compensation for the rollover analysis and must satisfy all other conditions of the exemption."

Seeking comment on $20.5M disclosure

"The Department also seeks comment on whether financial institutions should be required to provide additional disclosures to retirement investors and the investing public. In particular, the Department is interested in receiving comments regarding whether it should require financial institutions to maintain a public website containing the pre-transaction disclosure, a description of the financial institution's business model, associated conflicts of interest (including arrangements that provide third-party payments), and a schedule of typical fees. The website could be formatted as a separate website, a web page on an existing website, or in some other way that is publicly accessible. If the Department were to add a web disclosure requirement, the Department would also require financial institutions to provide retirement investors with a link to the web disclosure (or a printed web address) as part of the pre-transaction disclosures currently required by Section II(b)(1)–(4). The Department is interested in receiving data and other information regarding the benefits of such a disclosure. The Department estimates that, if such a disclosure were required, it would require eight hours of labor annually from a computer programmer, on average, resulting in an annual cost of approximately $20.5 million."

What would be on new disclosures

"The Department contemplates that, to the extent applicable, the website would list all product manufacturers and other parties with whom the financial institution maintains arrangements that provide third-party payments to the investment professional, the financial institution or affiliates with respect to specific investment products or classes of investments recommended to retirement investors; a description of the arrangements, including a statement on whether and how these arrangements impact investment professionals' compensation and a statement on any benefits the financial institution provides to the product manufacturers or other parties in exchange for the third-party payments."

Requirement of ‘sufficient detail’ for new disclosures

"The website may describe the above arrangements with product manufacturers, investment professionals, and others by reference to dollar amounts, percentages, formulas or other means reasonably calculated to present a materially accurate description of the arrangements. Similarly, the financial institution may group disclosures on the website based on reasonably defined categories of investment products or classes, product manufacturers, investment professionals and arrangements, and it may disclose reasonable ranges of values, rather than specific values as appropriate. Regardless of how it is constructed, the website should fairly disclose the scope, magnitude, and nature of the financial institution's compensation arrangements and conflicts of interest in sufficient detail to permit visitors to the website to make an informed judgment about the significance of the compensation practices and conflicts of interest with respect to transactions recommended by the financial institution and its investment professionals."

Cutting down on contests, quotas and ‘incentive vacations’

"The financial institution's policies and procedures must mitigate conflicts of interest to such an extent that a reasonable person reviewing the financial institution's policies and procedures and its incentive practices as a whole would conclude that they do not create an incentive for the financial institution or investment professional to place its interests ahead of the retirement investor's interest. The policies and procedures must be prudently designed to protect retirement investors from recommendations to make excessive trades; to buy investment products, annuities, or riders that are not in the retirement investor's best interest; or to allocate excessive amounts to illiquid or risky investments. To satisfy Section II(c), financial institutions may not use quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation, or other similar actions or incentives that are intended, or that a reasonable person would conclude are likely, to encourage investment professionals to make recommendations that are not in retirement investors' best interest. A financial institution should not offer incentive vacations, or even paid trips to educational conferences, if the desirability of the destination is based on sales volume and satisfaction of sales quotas."

Proprietary products

"The financial institution must pay close attention to any conflicts of interest that may exist within the financial institution itself. For example, it is not enough merely to pay investment professionals the same percentage of the financial institution's compensation for a recommended investment product, as for other products, if the financial institution receives more compensation from recommending that product rather than other products. In such cases, the 'level' compensation percentage effectively directly transmits the financial institution's conflict of interest to the investment professional, as the investment professional's compensation is increased in direct proportion to the profitability of the investment to the firm. Thus, Section II(c) requires the financial institution to look carefully at its own incentives and ensure that all recommendations are focused on the retirement investor's best interest rather than the financial institution's interests."

Proprietary products allowed under certain conditions

"This is not to say the exemption is limited to certain types of financial institutions or investment products. Financial institutions that offer a restricted menu of proprietary products or products that generate third-party payments can establish, maintain and enforce written policies and procedures that satisfy these requirements."

More than 19,000 wealth management and other financial firms

"The Department expects the same 19,290 entities that are affected by the existing PTE 2020–02 would be affected by the proposed amendments to the PTE."

The extent of direct contribution plan to IRA rollovers

"In 2022, 49 percent of DC plan-to-IRA rollovers, accounting for 63 percent of DC plan rollover assets, were intermediated by an adviser. For purposes of this analysis, the Department assumes that advisers intermediating rollovers are ERISA fiduciaries, which means the estimate is an upper bound. The Department applies the estimate made for DC plan-to-IRA rollovers to all types of rollovers. Accordingly, the Department estimates that 3.1 million rollovers and $431 billion in rollover assets would be affected by the proposed amendments to PTE 2020–02. The Department requests comments on these assumptions."

$193 million rollover recommendation documentation requirement

"The Department estimates that documenting each rollover recommendation will require 30 minutes for a personal financial advisor whose firms currently do not require rollover documentations and five minutes for financial advisors whose firms already require them to do so. The Department estimates that this will result in an hour burden of 883,953 hours with an equivalent cost of approximately $193.8 million. The Department requests comment on the time it would take to document the rollover recommendation. The burden is estimated as follows: (3,119,833 rollovers × 48% × 30 minutes) + (3,119,833 rollovers × 52% × 5 minutes) = 883,953 hours. A labor rate of $219.23 is used for a personal financial adviser. The labor rate is applied in the following calculation: {[(3,119,833 rollovers × 48% × 30 minutes) + (3,119,833 rollovers × 52% × 5 minutes)] ÷ 60 minutes} × $219.23 = $193,788,961."

Independent producers covered by other amendments

"The Department is proposing to amend PTE 84–24 to address specific issues that insurers confront in complying with the current conditions of PTE 2020–02 when distributing annuities through independent agents. The ERISA and Code provisions at issue generally prohibit employee benefit plan and IRA fiduciaries from engaging in self-dealing in connection with transactions involving these plans and IRAs. Currently, PTE 84–24 allows these fiduciaries to receive compensation when plans and IRAs enter into certain insurance and mutual fund transactions that the fiduciaries recommend, as well as certain related transactions. The proposed amendment would provide exemptive relief to fiduciaries who are independent producers that recommend annuities from an unaffiliated insurer to retirement investors on a commission or fee basis if certain protective conditions are met."

Clarification on fiduciary acknowledgement guidelines

"As amended, PTE 84–24 would not require the insurance company to provide a fiduciary acknowledgement, and the insurance company would not be treated as a fiduciary merely because it exercised oversight responsibilities over independent insurance agents under the exemption. Instead, the proposed amendment would require the independent agent that recommends the annuity to make the fiduciary acknowledgement, and the insurance company selling its product through the independent agent only would be required to exercise supervisory authority over the independent agent's recommendation of its own products. The proposed amended exemption would be limited to commissions or fees as defined in the amendment, which would have to be fully disclosed to the retirement investor."

A ‘level playing field’ for independent insurance agents

"The Department is proposing to amend PTE 84–24 so that investment advice fiduciaries would rely on a new section of PTE 84–24 for independent insurance agents (called independent producers) selling non-securities annuities or other insurance products not regulated by the Securities and Exchange Commission to retirement investors. The proposed amendment would exclude investment advice fiduciaries from the current relief in PTE 84–24 while proposing relief under a new section of the exemption with specific conditions for independent insurance agents providing investment advice. The Department's objective in proposing this amendment is to provide a level playing field for all investment advice fiduciaries."

The agency’s take on fiduciary status

"Although the Department is proposing a pathway for insurance companies to oversee the conduct of independent producers under the proposed amendment to PTE 84–24 without assuming fiduciary status, the Department remains concerned that, without fiduciary status, insurance companies may not take their supervisory obligations as seriously as they should."

Applying best interest standards to independent agents

"Section VII(a) of the proposed amendment would condition relief for investment advice transactions described in proposed Section III(g) on the independent producer that is providing investment advice to retirement investors complying with the impartial conduct standards that are the same as those in PTE 2020–02 — i.e., acting in the retirement investor's best interest, receiving no more than reasonable compensation, and making no misleading statements — with some modifications to reflect the specifics of the independent agent channel."

Pre-sale requirements for annuity purchases with independent agents

"Under proposed Section II(b)(6), before the sale of a recommended non-security annuity, the independent producer would consider and document its conclusions as to whether the recommended non-security annuity is in the best interest of the retirement investor. The independent producer must provide this documentation to both the retirement investor and to the insurer whose products are being sold. The Department requests comment on whether this proposed condition should be expanded to other insurance products not regulated by the SEC."

New rollover disclosures for independent agents

"Proposed Section VII(b)(7) would further require independent producers to provide a rollover disclosure that is similar to the disclosure required in the proposed amendment to PTE 2020–02 Section II(b)(5). Before engaging in a rollover or making a recommendation to a plan participant as to the post-rollover investment of assets currently held in a plan, the independent producer must consider and document its conclusions as to whether a rollover is in the retirement investor's best interest and provide that documentation to the retirement investor. Relevant factors to consider must include but are not limited to:

the alternatives to a rollover, including leaving the money in the plan, if applicable,
the comparative fees and expenses,
whether an employer or other party pays for some or all administrative expenses, and
the different levels of fiduciary protection, services, and investments available.

"To assist the insurer in satisfying its supervisory obligations, the independent producer must also provide the documentation to the insurer."

Restricting sales quotas and incentive trips

"Under proposed Section VII(c)(2), an insurer could not offer incentive vacations, trips or even educational conferences, if qualification for the vacation, trip or conference is based on sales volume or satisfaction of sales quotas. The best interest standard discussed above and defined in proposed Section X(b) clearly prohibits these types of incentives on the grounds they create undue conflicts of interest. Moreover, the Department believes that educational opportunities should be offered equally to all agents and not connected to sales volume, because training is a necessary component of providing best interest advice. This emphasis on independent producer training is consistent with NAIC Model Regulation section 6.C.(2)(c), which requires insurers to provide its producers with product-specific training and training materials that explain all material features of its annuity products."

Nearly 3,000 independent agents and insurance firms

"Insurance agents and brokers, pension consultants, insurance companies, and investment company principal underwriters are expected to continue to take advantage of the exemption for transactions described in Section III(a)–(f). The Department estimates that 2,986 insurance agents and brokers, pension consultants and insurance companies will continue to take advantage of the exemption for transactions described in Section III(a)–(f)."

$8 million documentation requirement

"The Department assumes that, for each of these retirement investors, an independent producer would spend one hour of a financial manager's time drafting the documentation. This results in an estimated hour burden of 52,449 hours with an equivalent cost of $8.3 million annually."

Seeking to unify all fiduciary investment advice under one standard

"Providing for a single standard of care (which is currently found in PTE 2020–02) that would apply universally to all fiduciary investment advice, regardless of the specific type of product or advice provider, will provide greater protection for retirement investors and create a level playing field among investment advice providers. Therefore, to ensure a universal standard of care for the provision of investment advice that is based on the conditions of PTE 2020–02, the Department is proposing to amend PTEs 75–1 Parts III & IV, 77–4, 80–83, 83–1, and 86–128 to include the following statement: 'Exception. No relief from the restrictions of ERISA section 406(b) and the taxes imposed by Code section 4975(a) and (b) by reason of Code sections 4975(c)(1)(E) and (F) is available for fiduciaries providing investment advice within the meaning of ERISA section 3(21)(A)(ii) or Code section 4975(e)(3)(B) and regulations thereunder.' As a result of this amendment, investment advice fiduciaries would instead rely on the amended PTE 2020–02 for exemptive relief for covered investment advice transactions. By providing exemptive relief for fiduciary investment advice transactions under one exemption, PTE 2020–02, retirement investors would receive consistent protections when receiving investment advice from investment professionals such that a level playing regulatory playing field would apply regardless of the investment product the advisor recommends. The Department requests comment on this proposed change."