As the Department of Labor readies its latest rule proposal on fiduciary investment advice, likely concerning rollovers, it must contend with prior court rulings that have gone against it, according to Fred Reish, a partner at Faegre Drinker Biddle & Reath.
The department has signaled that it believes that workers should maintain their fiduciary protections when rolling over assets from a 401(k) plan to and individual retirement account, Reish said.
"From a policy perspective, the DOL believes that not necessarily that money has to stay in plans, but if it comes out of plans and somebody recommends that, then they should be held to an fiduciary standard for making that recommendation, and not be able to make a recommendation in the best interest of the adviser as opposed to the retirement investor," he added.
In its latest regulatory agenda, the department said it was working on a "conflict of interest in investment advice" rule that would take into account "practices of investment advisers, and the expectations of plan officials and participants, and IRA owners who receive investment advice, as well as developments in the investment marketplace, including in the ways advisers are compensated that can subject advisers to harmful conflicts of interest."
Also, it will "evaluate available prohibited transaction class exemptions and propose amendments or new exemptions to ensure consistent protection of employee benefit plan and IRA investors," the department said in its agenda.
The department on Sept. 8 submitted its proposal for review to the Office of Information and Regulatory Affairs within the White House's Office of Management and Budget. The review process could take up to 90 days, but sources expect it to take about 30-60 days.
Fiduciary investment advice has been a focal point for the department under the last three administrations.
Most notably, under the Obama administration in 2016, the department finalized a regulation known as the fiduciary rule that broadened the definition of a person or entity taking on fiduciary responsibilities and replaced a five-part test used to determine whether an investment professional or financial institution serves as a fiduciary.
But in 2018, a three-judge panel at the Fifth U.S. Circuit Court of Appeals in New Orleans vacated the rule in a 2-1 decision, saying the department exceeded its legal authority.
The Trump administration decided not to appeal the decision, but it 2020 it announced a final rule reinstating the five-part test. Then later that year, it finalized a prohibited transaction exemption that permitted investment-advice fiduciaries to receive compensation for more types of guidance, including advice to roll over assets from a retirement plan to an IRA.
The Biden administration in 2021 issued guidance in the form of frequently asked questions that related to the Trump-era exemption. That guidance has faced legal challenges, and in February, a federal judge vacated one of the FAQs that outlined when rollover advice is considered to be on a "regular basis," a component of the five-part test.
With that history in mind, Reish expects the department to propose that "a single rollover recommendation, if the adviser receives compensation directly or indirectly related to that, then it will be a fiduciary recommendation, and it will be a prohibited transaction because you used your fiduciary authority to cause yourself to make more money. Then you'd need an exemption."
To get there, Reish said the department will have to keep prior legal rulings in mind, especially the 2018 Fifth Circuit decision. The judges in that decision ruled against the department in part because they didn't buy that there could be fiduciary status established when there wasn't a relationship of trust and confidence between an adviser and client, Reish explained. The judges thought "that a sales pitch was not a relationship of trust and confidence and that participants would know that," he added.
Reish said the department in its new proposal will have to deal with the "trust and confidence" issue, possibly by defining what a relationship of trust and confidence looks like or establishing some sort of test.
"I don't know how they're going to get around that, but I do think they do have to get around the Fifth Circuit decision," Reish said. "They certainly can't just write something that on the face of it directly conflicts with the Fifth Circuit."
Reish expects the department to include an explanation in its proposal regarding how its new rule-making initiative steers clear of the 2018 ruling.
But regardless of its explanation, industry groups are already signaling heavy opposition to the proposal. Whenever the rule is finalized — it must go through a notice-and-comment period first — Reish expects it to face a legal challenge.
"I can't imagine that it won't be (challenged)," he said. "I don't even see that as one of the options on the table."
