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Department of Labor’s rules on rollover advice now in effect

Financial, Executive and Professional Risks (FINEX)
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By Lawrence Fine | July 19, 2022

Expanding liability for financial service entities who give advice concerning pension rollovers.

Overview

Financial service entities which provide advice in connection with rollovers from pension plans into IRAs have hopefully taken note and made all necessary preparations: the Department of Labor's Prohibited Transaction Exemption 2020-02 began to be fully enforced effective July 1. While aspects of the rule were already in effect, now advisors must also provide the mandated written explanation to rollover clients of the specific reasons as to why the investment professional and/or financial institution believe that the rollover is in the client’s best interest, or else face substantial potential liability. This exposure is likely to trigger coverage under professional liability (E&O) policies, as opposed to fiduciary liability policies which protect plan sponsors.

The requirements which retirement investment advisors must meet in order to warrant the safe harbor of a Department of Labor (DOL) Prohibited Transaction Exemption have just increased. As of July 1, 2022, the final requirements of DOL PTE 2020-02 kicked into effect.

The DOL explained the background in its April 2021 release (“New Fiduciary Advice Exemption: PTE 2020-02 Improving Investment Advice for Workers & Retirees Frequently Asked Questions”): “Under Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code of 1986, as amended (the Code), parties providing fiduciary investment advice to plan sponsors, plan participants, and IRA owners may not receive payments creating conflicts of interest, unless they comply with protective conditions in a prohibited transaction exemption.”

However, “[o]n December 18, 2020, the Department adopted PTE 2020-02, Improving Investment Advice for Workers & Retirees, a new prohibited transaction exemption under ERISA and the Code for investment advice fiduciaries with respect to employee benefit plans and individual retirement accounts (IRAs). Investment advice fiduciaries who rely on the exemption must render advice that is in their plan and IRA customers’ best interest in order to receive compensation that would otherwise be prohibited in the absence of an exemption, including commissions, 12b-1 fees, revenue sharing, and mark-ups and mark-downs in certain principal transactions.1 The exemption expressly covers prohibited transactions resulting from both rollover advice and advice on how to invest assets within a plan or IRA.”

According to the DOL’s recently reinstated 1975 regulations, there is a “five-part test for determining when recommendations count as [fiduciary] investment advice. Under this 1975 regulation, the person making the recommendation must:

  1. Render advice to the plan, plan fiduciary, or IRA owner 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,
  2. On a regular basis,
  3. Pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary, or IRA owner, that
  4. The advice will serve as a primary basis for investment decisions with respect to plan or IRA assets, and that
  5. The advice will be individualized based on the particular needs of the plan or IRA.

All parts of the 1975 test must be satisfied for a firm or investment professional to be an investment advice fiduciary when making a recommendation.”

The “regular basis” prong is not met from a relationship which literally begins and ends with a recommendation concerning pension rollovers, but is met if the person or institution had or is about to have an ongoing relationship with the investing individual before and/or after such rollover.

PTE 2020-02 offers relief from the presumption that transactions between plans and their fiduciaries are prohibited if certain conditions are met, including that financial institutions (SEC- and state-registered investment advisers, broker-dealers, banks, and insurance companies) and their investment professionals (employees, agents, and representatives) provide advice in accordance with the Impartial Conduct Standards, of which the 3 components are:

  1. Give advice that is in the best interests of the retirement investor (prudent and putting the interests of the investor first);
  2. Charge no more than reasonable compensation and comply with federal securities laws regarding “best execution”; and
  3. Make no misleading statements.

Retirement investment fiduciaries must also acknowledge in writing their and their investment professionals’ fiduciary status under Title I of ERISA and the Internal Revenue Code, as applicable, when providing investment advice to the retirement investor, and they must describe in writing the services to be provided and the financial institutions’ and investment professionals’ material conflicts of interest.

While most of the requirements of PTE 2020-02 went into effect on February 1, 2022, the final requirement (which just went into effect on July 1, 2022) is that “financial institutions must document the reasons that a rollover recommendation is in the best interest of the retirement investor and provide that documentation to the retirement investor. Financial institutions must adopt policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and that mitigate conflicts of interest, and must conduct an annual retrospective review of compliance.”

As stipulated in FAQ 15 of the DOL publication, investment professionals and financial institutions in evaluating and comparing investment options should make "diligent and prudent efforts to obtain information about the existing employee benefit plan and the participant's interests in it". Generic reasons, such as access to more investment options in a managed IRA account, won't be sufficient to meet this standard.

Key takeaways

Financial institutions and their employees/agents who advise clients concerning pension rollover decisions need to be fully aware of the many requirements of the DOL’s Prohibited Transaction Exemption 2020-02 in order to prevent potentially substantial liability exposures. In addition to exposure to investors and the DOL from violations of the prohibited transaction rules, retirement investment advisors can also face exposure in connection with alleged excessive fees and/or underperformance which could follow from such rollover decisions. Consequently, it is vital that such investment advisors have their processes, procedures and disclosures firmly in place, bearing in mind the need to evaluate and compare the investments, services and expenses of each specific relevant retirement plan, consulting experienced attorneys and ERISA benefits experts as necessary.

The liability which advisors could face pursuant to these rules would not implicate fiduciary liability policies, which only cover plan sponsors, plans and their employees in relation to fiduciary breaches. Coverage for these exposures ought to be available under relevant professional liability (E&O) policies, as long as they don’t have overly broad ERISA/fiduciary liability exclusions (any such exclusions should be limited to work performed for the client’s own plans).

Footnote

1 https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/faqs/new-fiduciary-advice-exemption#footnotes

Disclaimer

Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).

Author

Management Liability Coverage Leader
FINEX North America
WTW

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