New guidance from the Department of Labor further clarifies that bolstering oversight of rollover recommendations and mitigating financial institutions' conflicts of interest are top priorities.
The two pieces of guidance issued April 13 relate to the Labor Department's investment-advice exemption that took effect in February. The exemption permits investment-advice fiduciaries to receive compensation for more types of guidance, including advice to roll over assets to an individual retirement account from a retirement plan.
While the first piece of guidance details questions a retirement investor might ask potential investment advice providers, the second piece is directed In one of its FAQs, the Labor Department outlined the types of analysis financial institutions must undertake to determine whether a rollover is in a customer's best interest, including weighing the long-term impact of any increased costs. It also said that a "single, discrete instance of advice to roll over assets from an employee benefit plan to an IRA" would generally not give rise to investment advice, but reiterated a point it made in the exemption's preamble: that rollover advice can be considered fiduciary advice so long as the other conditions of the five-part test are met.
When proposing the exemption in June, the Labor Department also announced a final rule reinstating the five-part test used to determine whether an investment professional or financial institution is a fiduciary. It was in 2016 that the Labor Department under the Obama administration finalized a rule, commonly known as the fiduciary rule, that aimed to replace the five-part test by broadening the definition of when a person or entity is taking on fiduciary responsibilities. The rule was struck down in federal court in 2018 due to regulatory overreach.
Also in June, the Labor Department stated that its previous analysis — a 2005 advisory opinion known as the Deseret Letter, which found that rollover advice did not constitute investment advice — was incorrect.
In the FAQ this month, the Labor Department said it will not delay the application of its interpretation related to rollover advice. Previously, in the exemption's preamble, the Labor Department said it would not pursue claims for breaches of fiduciary duty or prohibited transactions when the Desert Letter was in effect — 2005 to February 2021. But now, "Having disavowed the Deseret Letter both in its 2016 rulemaking and its 2020 exemption, the department does not believe additional extensions are warranted or protective of plan participants' interests in sound advice," it said in the FAQ.
Jennifer Eller, a Washington-based principal at Groom Law Group and co-chairwoman of the firm's retirement services practice group and fiduciary practice, said, "If you were relying on Deseret as the reason why you weren't a fiduciary, now you don't have that ability."
The Labor Department in its FAQs also explained how advisers must mitigate conflicts of interest under the exemption.
"Financial institutions must take special care in developing and monitoring compensation systems to ensure that their investment professionals satisfy the fundamental obligation to provide advice that is in the retirement investor's best interest," the Labor Department stated. To do so, "financial institutions must be careful not to use quotas, bonuses, prizes, or performance standards as incentives that a reasonable person would conclude are likely to encourage investment professionals to make recommendations that are not in retirement investors' best interest. The financial institution should aim to eliminate such conflicts to the extent possible, not create them."
Kent Mason, a partner with law firm Davis & Harman LLP in Washington, said the conflicts of interest portion of the FAQ goes further than the preamble in some respects and presents problems for financial professionals.
Under the FAQ, "arguably any solicitation of a rollover would run afoul of it," Mr. Mason said. "When I solicit a rollover and obtain it my compensation goes up, so that gives me an incentive to solicit rollovers; how do I square that with this language in (the FAQ)?"
Barbara Roper, Pueblo, Colo.-based director of investor protection at the Consumer Federation of America, said in an email that the Labor Department "is sending a very strong message that firms should not create incentives that undermine compliance with the best interest standard. And they make clear that, while strong supervision is necessary to address conflicts, it is not a replacement for steps to reduce or eliminate the harmful incentives."
Another segment of the FAQs indicated that financial institutions should "avoid compensation that is likely to incentivize investment professionals to recommend one investment product over another comparable product based on the greater compensation to them or their financial institutions." Steven W. Rabitz, New York-based partner at Dechert LLP, said that will likely "be taken as a reminder that the exemption's focus is on conflicts at both the franchise and the investment professional level."
In announcing the new guidance, the Labor Department said it is continuing to review issues of fact, law and policy related to the exemption, and more generally, its regulation of fiduciary investment advice.
George Michael Gerstein, co-chairman of the fiduciary governance and ESG groups at Stradley Ronon Stevens & Young LLP in Washington, said if there is more guidance on this issue it will likely "be like these FAQs, which maybe add a little bit more detail, but the bones of the exemption look like it will be with us now for quite a long time."
Mr. Mason said that even minor changes in guidance can present big challenges for firms. "The biggest takeaway here is any short-term efforts to comply with this exemption are going to be aiming at a moving target," he said. "Whatever you were working on is going to have to refined periodically as they give more guidance."
Ms. Eller likened the potential for additional guidance or a new rule-making effort to learning to juggle with the items already in the air. Using a different metaphor, she said, "If I'm starting down the road of compliance and I think that road is a mile long and four months from now or four days from now the department says, 'No, no it's a mile-and-a-half long,' that has a real impact on whether I would've started down that road in the first place."
For Ms. Roper, the guidance is a good first step, but further action will be needed to deliver real protections to retirement investors.
"In particular, DOL still needs to undertake rule-making to close loopholes in the definition of fiduciary investment advice and incorporate the Impartial Conduct Standards" — a best interest standard, a reasonable compensation standard and a requirement to make no materially misleading statements — "into related exemptions. Without that, firms will continue to find ways to work around these rules. I'm confident the folks at DOL are aware of that."