The ‘Labor’-ed Story to Redefine ‘Fiduciary’

Prologue: Fiduciary responsibility is one of the primary tenets of ERISA. Recognizing the significance for those considered a fiduciary, the US Department of Labor (the “Department”) adopted a regulation in 1975, shortly after ERISA’s enactment, to bring clarity and certainty to determining who would be considered a fiduciary for purposes of the fiduciary standards and related prohibited transactions. Fiduciary status under the 1975 rule was contingent on a party meeting a five-part test: 1) rendering advice as to the value of securities or other property, or making recommendations as to the advisability of investing in, purchasing, or selling securities or other property, 2) on a regular basis, and 3) pursuant to a mutual agreement, arrangement, or understanding that 4) the advice would be the primary basis for investment decisions with respect to plan assets and 5) the advice would be individualized based on the needs of the plan.

Chapters 2010–2016: Although the five-part test appeared to work well in determining fiduciary status for 35 years, the Obama administration determined that, given the shift from defined benefit to defined contribution plans and an increased emphasis on participant-driven investment responsibility, the 1975 definition was not sufficiently broad enough to capture all the parties considered by the Department to be acting in a fiduciary capacity and so the effort to redefine who qualifies as a fiduciary began in 2010.

Since 2010, the Department’s efforts have taken the industry through multiple proposed definitions and related prohibited transaction exemptions, final rules, and litigation vacating the Department’s regulatory initiatives, followed by a final prohibited transaction exemption (PTE 2020-02) intended to fill a number of operational gaps for those assuming fiduciary status.

Chapter 2023: On October 31, the Department treated the retirement community to its most comprehensive effort to date to redefine who is a fiduciary and expand the requirements for prohibited transaction relief applicable to those determined to be investment advice fiduciaries.

The proposed regulation eliminates the primary basis and mutual understanding prongs of the five-part test. It also makes a significant change to the regular basis prong. Instead of the five-part test, an advisor will be deemed to provide investment advice if the following three conditions are met:

1. The advisor makes a recommendation of any securities or other investment transactions or any investment strategy involving securities or other investment property to the plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary, or IRA fiduciary (retirement investor).
2. The advisor “makes investment recommendations to investors on a regular basis as part of their business.”
3. The recommendation is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and “may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest.”

In addition to changes to the fiduciary definition, the Department issued extensive proposed changes to PTE 2020-02, as well as other PTEs relied on by the financial services industry, such as 84-24, 77-4, and 86-128. The changes to the other PTEs are generally designed to drive those entities relying on those exemptions to comply with the conditions of PTE 2020-02. The significant changes to PTE 2020-02 include the following:

1. The person relying on the exemption must acknowledge in writing that they are a fiduciary to the retirement investor.
2. Detailed disclosures of the compensation or other benefits that will be received by the person making the recommendation and business associates in connection with the proposed course of action.
3. Disclosure of the services that such persons will be providing, as well as disclosure of any conflicts of interest they may have that may “consciously or unconsciously” influence the recommendation being made.
4. If the recommendation being made is to effect a rollover from a qualified plan or IRA, a statement explaining the reasons for such recommendation to roll money from the plan to an IRA.

The next chapter: The Labor Department has scheduled a public hearing on the proposals for December 12-13, in advance of the close of the comment period, which ends January 2, 2024. The early public hearing may be reflective of the Department’s desire to adopt a final definition and related prohibited transaction exemptions on an expedited basis in an effort to prevent congressional review and reversal as well as to complicate the adoption of changes by a new administration. In the absence of significant changes to the proposals, which appear unlikely at this juncture, litigation challenging the rules would not be a surprise.