On June 29, 2020, the U.S. Department of Labor (the Department) formally reinstated its “five-part test” for determining what constitutes “investment advice” under ERISA and Section 4975 of the Internal Revenue Code (the Code).1 Providing “investment advice” in connection with ERISA plan assets is a fiduciary function and subjects the advice provider to ERISA’s fiduciary and prohibited transactions provisions, as well as the prohibited transaction provisions of Section 4975 of the Code if tax-qualified plan assets are involved. The five-part test was in effect from 1975 until the Department adopted a much broader definition of investment advice in 2016 as part of a fiduciary rule package that included (or amended) a number of prohibited transaction exemptions. The Department’s broader definition was challenged in court and ultimately vacated, along with the remainder of the 2016 fiduciary rule package, by the Fifth Circuit in 2018.2 The Department did not appeal.
Along with a formal reinstatement of the five-part test, the Department has proposed a new prohibited transaction class exemption that would provide broad exemptive relief for investment advice fiduciaries to receive additional compensation in connection with their advice and engage in principal transactions with plans and IRAs, if the exemption’s conditions are satisfied.3 The proposed exemption’s conditions require compliance with certain impartial conduct standards (discussed below), which will be familiar to advisers who currently comply with the Department’s temporary enforcement policy (put in place after the Fifth Circuit case), the SEC’s Regulation Best Interest or the SEC’s standards for registered investment advisers. If the exemption is finalized, it would become one of the very few class exemptions allowing a fiduciary adviser to transact with an ERISA plan or IRA on a principal basis.
Similar to the now vacated Best Interest Contract (BIC) Exemption from the 2016 package, the proposed exemption requires IRA advice fiduciaries to comply with duties of prudence and loyalty as a condition for relief, even though IRAs are generally not subject to these duties under ERISA. But unlike the BIC Exemption, the proposed exemption does not create a private right of action for failure to meet the terms of the exemption. Instead, a failure to meet the exemption’s conditions will result in a non-exempt prohibited transaction to which excise taxes will apply under Section 4975 of the Code until corrected.
The Department is accepting public comments on the proposed rule until August 6, 2020. We do not expect the Department to extend, at least substantially, the comment period given the limited time remaining to finalize the rule before a potential change in administration in early 2021.
FIVE-PART TESTThe reinstated five-part test establishes when someone is a “fiduciary” under ERISA and Section 4975 of the Code by reason of providing “investment advice” for a fee.4 A person who meets this five-part test and receives a fee or other compensation, direct or indirect (e.g., 12b-1 fees, sales loads, revenue sharing, mark-ups, and mark-downs) will be an investment advice fiduciary under ERISA and/or the Code, as applicable. Unlike the vacated 2016 rule, the proposal does not contain any safe harbor or other exception from fiduciary status for broker-dealers and other counterparties dealing with sophisticated fiduciaries.5
ROLLOVER ADVICEHistorically, the Department did not consider advice on whether to rollover assets from an ERISA plan to another plan or IRA, or from an IRA to another IRA, as “investment advice” because any recommendation “regarding the proceeds of a distribution” would relate to funds that are no longer plan or IRA assets. In the preamble to the proposed exemption, the Department indicates that it will now take a different view of rollover advice that otherwise meets the five-part test, explaining that it now views a rollover recommendation as advice to sell, withdraw, or transfer assets currently held in the plan or IRA. Whether advice otherwise meets the five-part test...
