What plan sponsors should know about DOL’s final fiduciary rule 

June 20, 2024

 

A new Department of Labor (DOL) regulation expands the scope of fiduciary investment advice under ERISA. The rule primarily targets financial services firms, such as financial advisers, insurance agents and brokers, asset managers, and defined contribution (DC) plan recordkeepers. Under the new rule, all of these companies could act as fiduciaries when providing some services that previously weren’t considered fiduciary acts. While the direct effect on plan sponsors appears modest, plan vendors may decide to modify their service models — including associated fees — and sales practices. Amendments to seven prohibited transaction exemptions (PTEs) accompany the final rule. Though the rule is scheduled to take effect Sept. 23, several court challenges seek to invalidate it.

Implications for plan sponsors include the following:

• The rule applies to not just retirement plans, but also individual retirement arrangements (IRAs) and health savings accounts (HSAs). While most health and welfare benefits are excluded, the rule extends to ERISA-covered health and welfare benefit plans with an investment component (e.g., certain permanent life and long-term care insurance policies, as well as voluntary employees’ beneficiary associations (VEBAs)).
• Sponsors and service providers can still give participants nonfiduciary “investment education” under existing DOL guidance.
• Sponsors’ in-house human resources (HR) employees generally won’t be deemed investment advice fiduciaries when interacting with participants.

Sponsors should be aware of potential implications for plan vendors since any of the following could be considered fiduciary advice:

• A one-time recommendation that participants roll over their retirement or HSA balance or take a distribution
• Some participant-facing vendor services currently considered nonfiduciary, such as individualized consultations about participants’ plan distribution options
• Current and prospective vendors’ arm’s-length sales conversations with sponsors that include covered recommendations (for instance, a DC recordkeeper’s provision of a sample investment lineup as appropriate for a plan)

This may disrupt existing service arrangements, change the way sponsors select new vendors and limit plans’ investment opportunities.

The rule is slated to take effect Sept. 23, leaving sponsors and vendors little time for implementation. This article provides background on DOL’s efforts to expand the regulatory definition of fiduciary investment advice, summarizes the new rule’s components and highlights key considerations for plan sponsors.

Under ERISA, anyone who provides investment advice for a fee or compensation is a fiduciary. A fiduciary must act prudently and solely in the interest of the plan and its participants — and can be held personally liable for failing to do so. ERISA also prohibits fiduciaries from using their authority to benefit themselves or receive consideration on account of their fiduciary status, unless they comply with an applicable PTE.

1975 investment advice regulation. DOL’s historical regulatory definition of fiduciary investment advice — which continues to apply until the final rule takes effect — uses a bright-line test to determine status as an investment advice fiduciary. Under that test, individuals and companies act as investment advice fiduciaries if they receive direct or indirect compensation for giving advice about the value of securities or other property of a plan or for making recommendations to the plan about investing in, purchasing, or selling securities or other property, and meet either of these conditions:

• Exercise discretionary authority or control over purchasing or selling securities or other property for a plan
• Render advice on a regular basis under a mutual agreement, arrangement or understanding (whether written or otherwise) that the advice will serve as a primary basis for investment decisions regarding plan assets and be individualized for the plan

DOL originally adopted this definition in 1975. At that time, defined benefit (DB) plans were the dominant workplace retirement arrangements, and the regulation reflects that context. Decisions about investing DB plan assets are typically made by professional asset managers advising plan fiduciaries who generally have some knowledge about plan investments. But the retirement landscape is much different today. Workers now rely more on Section 401(k)-type defined contribution (DC) plans, IRAs and other deferral arrangements to save for retirement. Unlike DB plans, DC plans typically make participants responsible for their account investments. DOL believes the 1975 definition of fiduciary investment advice provides inadequate protection for DC plan participants, who routinely rely on advice received from investment professionals but don’t realize those advisers may have conflicts of interest.

Earlier attempt to expand investment advice definition unsuccessful. Updating the regulatory definition of fiduciary investment advice has been a DOL priority for more than a decade: The agency proposed regulations in 2010 but later withdrew them and released a revised proposal in 2015. In 2016, DOL finalized a new regulatory definition that resulted in more advisers becoming investment advice fiduciaries who had to comply with a new best interest contract PTE. The 2016 rule eliminated the requirement that advice be given on a “regular basis” to the recipient — a change intended to pull rollover recommendations into the definition of fiduciary advice, even if that recommendation was the only one an adviser made while the participant’s account was still part of an ERISA plan. However, a federal appeals court vacated the rule and related PTEs in 2018, reinstating the 1975 rule.

Continued focus on rollover recommendations. Despite the 2018 court decision, DOL maintained its position that one-time rollover recommendations are fiduciary investment advice, even under the 1975 rule. In the preamble to PTE 2020-02 — which DOL issued to promote investment advice in the best interest of retirement investors — and related FAQs, DOL said it believes a rollover recommendation is fiduciary investment advice, even when the recommendation is the first instance of advice in a new relationship that’s expected to continue after the rollover. However, in 2023, a federal court invalidated DOL’s FAQ guidance on one-time rollover recommendations.

2023 proposed rule. On Nov. 3, 2023, DOL again proposed replacing the 1975 rule with a broader definition of fiduciary investment advice. The proposal contained a new four-part framework covering recommendations made to retirement investors by persons occupying certain positions of trust or confidence. Like the 2016 rule, the proposal sought to eliminate the “regular basis” requirement to expand fiduciary advice to rollover recommendations. Amendments to seven PTEs used by investment advice fiduciaries accompanied the proposal. For an in-depth discussion of the proposal and PTE amendments, see What plan sponsors should know about DOL’s new fiduciary proposal (Dec. 6, 2023).

The rule replaces the agency’s long-standing bright-line test for fiduciary investment advice with a new more fact-dependent standard that closely tracks last year’s proposal. Investment advice fiduciaries will only be able to rely on one of two amended PTEs for relief from the applicable prohibited transaction restrictions under ERISA and the Internal Revenue Code (IRC).

An investment advice fiduciary includes anyone who receives direct or indirect compensation for making certain kinds of investment-related recommendations to a retirement investor under circumstances in which the investor can reasonably have an expectation of trust and confidence in the recommendations. The following discussion breaks this rule down into four components, all of which must be present for a person to be an investment advice fiduciary. DOL made slight modifications to several of these components from the proposal.

The scope of retirement investors covered by the rule includes:

• ERISA-covered plans, discretionary plan fiduciaries, participants and beneficiaries. While the rule will mostly affect retirement plans, it also includes some ERISA-covered health and welfare plans that have an investment component (e.g., certain permanent life and long-term care insurance policies, as well as VEBAs). On the other hand, recommendations relating to health insurance policies aren’t affected, since those policies don’t have an investment component.
• IRAs, HSAs, medical savings accounts (MSAs) and educational savings accounts (ESAs) covered under IRC Section 4975. Discretionary fiduciaries, owners and beneficiaries of these accounts also are considered retirement investors. These accounts generally aren’t subject to ERISA, but parallel prohibited transaction rules apply to these accounts under IRC Section 4975.

To be investment advice, a communication must include a recommendation “of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property.”

Broad scope of covered recommendations. The rule covers a broad range of investment-related recommendations, such as recommending a distribution or rollover, a particular investment strategy, or another person to provide investment advice or management services. Providing a retirement investor a selective list of securities — even without specifically recommending any particular security on that list — also might be a covered recommendation. However, merely informing a participant about the need to take required minimum distributions or discussing the merits of a participant loan or hardship distribution generally aren’t covered recommendations. Valuations, appraisals and fairness opinions are also excluded.

What is a recommendation? Like the proposal, the final rule purposefully doesn’t explain when a communication rises to the level of a recommendation but instead includes an expansive discussion of that concept the preamble. DOL explains that determining whether a communication is a recommendation depends on whether there is a call to action, which the agency will construe consistent with the Securities and Exchange Commission’s Regulation Best Interest. DOL also explains that the more a communication is individually tailored to a retirement investor, the more likely it is a recommendation. Determining whether a communication is advice will be highly fact-dependent.

A person making a recommendation is only an investment advice fiduciary if that person occupies one of two positions that DOL believes are reasonably indicative of a position of trust or confidence.

Individuals and firms regularly making professional investment recommendations are included. This category encompasses individuals and companies in the business of regularly making professional investment recommendations — either directly or indirectly through an affiliate — to investors. DOL explains that this standard “is an objective facts and circumstances test” rather than a bright line. The standard is broader than the 1975 rule, which requires providing advice to the particular recipient on a regular basis. As a result, the rule covers one-time recommendations not addressed by the 1975 rule, such as advice about a terminating DB plan’s annuity purchase or a recommendation that a participant roll over a plan distribution.

Besides satisfying this reformulated “regular basis” requirement, the recommendation must be made in a manner likely to indicate to a “reasonable investor in like circumstances” that the recommendation is based on the investor’s particular needs or individual circumstances, reflects the application of professional or expert judgment, and may be relied upon as intended to advance the investor’s best interest. Again, this is broader in scope than the 1975 rule, which requires a mutual agreement, arrangement or understanding that the advice will be the primary basis for the recipient’s investment decisions.

Acknowledged fiduciaries are included. The second category applies to persons who represent or acknowledge (either in writing or orally) that they are acting as fiduciaries under ERISA or the IRC when making covered recommendations. This is narrower than the proposal, which would have included fiduciary representations that didn’t specifically mention ERISA or the IRC. Individuals and companies relying on PTEs 2020-02 and 84-24 (discussed later) will automatically fall into this category because these PTEs generally require a written acknowledgment of fiduciary status.

Discretionary fiduciaries are not specifically included. The 1975 rule included individuals or companies with discretion — either directly or indirectly through an affiliate — over a retirement investor’s assets in the plan. The proposal would have expanded that provision to include individuals with discretion over an investor’s assets outside of the plan. In response to comments, DOL completely struck the language relating to discretion. However, the preamble indicates that discretion is a factor in determining whether a person meets the first category of trust or confidence (described above).

Disclaimers aren’t determinative. The final rule doesn’t prohibit the use of written statements disclaiming fiduciary status. However, these statements won’t control if inconsistent with a person’s other communications to a retirement investor or applicable state or federal laws (e.g., state insurance or federal securities laws).

A person is only an investment advice fiduciary if that individual receives a fee or compensation in connection with or as a result of providing advice. The rule defines this concept broadly to include commissions, loads, revenue-sharing payments, expense reimbursements, gifts and gratuities, and noncash compensation. Compensation qualifies if the person wouldn’t have received it absent the recommendation or provision of advice. Compensation also counts if the person’s eligibility to receive it (or the amount received) is based on the recommendation or provision of advice. The rule doesn’t require the plan to pay the fee or compensation for the recommendation to be investment advice.

Investment advice fiduciaries generally must comply with an applicable PTE to receive compensation for their advice. DOL has reduced the number of available PTEs from seven to two, requiring investment advice fiduciaries to comply with a uniform “best interest” standard, regardless of the types of investment products recommended to retirement investors.

Investment advice fiduciaries may continue to use PTE 2020-02 or 84-24, but DOL made additional changes to both. While the amended PTEs are generally effective Sept. 23, some of the new conditions are subject to a one-year phase-in period.

PTE 2020-02 allows investment advice fiduciaries to receive certain compensation for advice — including advice to roll over ERISA-plan assets — that is in a retirement investor’s best interest. The amended PTE includes new conditions and requires additional disclosures, reflecting the likely increased use of this exemption. However, sponsors won’t be able to rely on this PTE to receive compensation for giving investment advice to their participants: The PTE excludes situations in which the investment advice provider is an employer of employees covered by the plan or is the plan’s named fiduciary or administrator.

Some of the notable changes DOL made to the scope of the exemption are:

• IRS-approved nonbank HSA trustees and custodians will be able to use the exemption.
• Asset managers will have a new streamlined exemption for investment advice provided as part of a response to a request for proposal (RFP) for investment management services (i.e., the asset manager would only have to comply with PTE 2020-02’s impartial conduct standards).
• The PTE now covers robo-advice arrangements (i.e., investment advice generated solely by an interactive website that uses software-based models or applications to make recommendations based on personal information supplied by the user).

PTE 84-24 is a long-standing exemption that allows insurance agents and brokers to receive compensation in connection with a plan’s or IRA’s purchase of certain insurance products and mutual funds. DOL narrowed the PTE’s scope so only independent insurance agents that recommend certain types of annuities to retirement investors on a commission or fee basis could use the PTE for investment advice.

The agency also narrowed five PTEs commonly used by fiduciaries for particular types of investment transactions. These PTEs will no longer provide relief for investment advice transactions. Instead, investment advice fiduciaries who have been relying on these PTEs will have to comply with the more stringent conditions of revised PTE 2020-02 or PTE 84-24, as applicable.

While the changes primarily affect financial services firms, certain aspects of the new rule have particular relevance for sponsors.

Nonfiduciary investment education guidance unchanged. Sponsors and their vendors can continue to provide certain nonfiduciary investment education — including general financial and investment information — to participants under DOL’s existing guidance in Interpretive Bulletin (IB) 96-1 without becoming investment advice fiduciaries. DOL also indicates that furnishing the materials described in the vacated 2016 rule’s investment education provision — which included categories not described in the IB — and information about distribution options from IRS’s model 402(f) notice wouldn’t be considered investment advice. However, the preamble suggests that investment education that includes a call to action could be advice and cautions against “steering retirement investors towards certain courses of action under the guise of investment education.”

HR employee interactions with participants aren’t advice. Some sponsors’ interactions with participants go beyond simple investment education and involve personalized discussions, such as conversations about whether to take a distribution and if so, how much to take and in what form (such as a lump sum, installments or an annuity). DOL explains that a sponsor’s HR employees generally wouldn’t provide advice because they don’t make professional investment recommendations to investors as part of the business. Salaries of the sponsor’s HR employees also wouldn’t be a fee or compensation under the rule.

Determine effect on HSAs and ERISA-covered health and welfare plans. Sponsors may need to consider how the rule affects HSAs offered to employees and ERISA-covered health and welfare plans with an investment component (if any). The final rule doesn’t define “investment component” or provide specific examples in the health and welfare plan context. However, the rule presumably includes ERISA-covered life insurance policies with a cash value (like whole, permanent, or universal coverage) and certain long-term care policies that include investments. Life and long-term care policies are subject to the rule only if they are covered by ERISA, but many are not because they fall under the ERISA exemption for voluntary plans. Even though the plan itself may not have an investment component, recommendations involving the assets of trusts that fund ERISA health and welfare plans, such as voluntary employee beneficiary associations (VEBAs), are covered by the rule. The rule leaves some uncertainty about when account-based arrangements — such as health reimbursement arrangements (HRAs) — include investment components. Presumably, DOL doesn’t consider typical account-based arrangements to have investment components, but confirmation would be helpful.

While the direct effect on sponsors appears minimal, plan vendors will likely need to evaluate their service models and sales activities. This could affect existing services arrangements and change the way sponsors select new vendors.

Sponsors can expect vendors to make changes. The rule’s expanded definition of investment advice may cause vendors who haven’t acted as fiduciaries in the past to take a more cautious approach in their interactions with sponsors and participants. Plan vendors may modify their service models — including associated fees — depending on the vendor’s willingness to accept investment advice fiduciary status (and comply with amended PTE 2020-02) or desire to avoid such fiduciary status altogether. As a result, sponsors may face potential renegotiation of existing vendor contracts and changes to participant-facing communications and support services. However, the rule appears less disruptive for vendors that already provide investment advice to sponsors (i.e., any investment recommendations an adviser currently makes to plan fiduciaries will continue to be investment advice under the final rule).

Platform providers can provide limited nonfiduciary assistance. Platform providers include vendors like DC plan recordkeepers and HSA vendors that offer a menu of preselected investment options. DOL confirmed that merely doing so isn’t investment advice under the rule. However, some smaller DC plan sponsors also rely on their recordkeepers’ assistance when selecting and monitoring funds for the plan’s investment lineup. DOL confirmed that platform providers wouldn’t make a covered recommendation when identifying investment funds using objective third-party criteria provided by the investor. Examples of such criteria include expense ratios, fund size and asset type. However, this is narrower in scope than the kinds of assistance recordkeepers may have provided in the past and may reduce their willingness to continue providing the same level of support.

Sponsors’ monitoring obligations and co-fiduciary liability. In the rule’s preamble, DOL emphasized that sponsors already have a fiduciary duty to monitor vendors on an ongoing basis, even when those vendors aren’t acting as fiduciaries. Under ERISA’s co-fiduciary liability provisions, sponsors may in certain circumstances have fiduciary liability for another fiduciary’s breach. Commenters noted that this may raise a sponsor’s potential risk exposure for service providers that give investment advice to participants — either intentionally or inadvertently — but DOL declined to provide a safe harbor or other special rules to limit sponsor’s co-fiduciary liability. Sponsors should consult with legal counsel to ensure that appropriate vendor-monitoring processes are in place.

Application of the rule to sales activities. The rule may sweep in many common arm’s-length sales conversations between vendors and sponsors. This may complicate the vendor selection for sponsors if vendors decide to curtail the information provided during the sales process. DOL explains that the rule isn’t intended to cover the “normal activity” of persons marketing their services to a sponsor. However, DOL continues to believe “when a recommendation to ‘hire me’ effectively includes a recommendation on how to invest or manage plan or IRA assets,” that recommendation would be investment advice if it meets all four elements of the final rule. DOL declined to include a carve-out for vendors’ interactions with sophisticated sponsors but suggested that a sponsor’s level of financial sophistication may be a factor when determining if a vendor’s recommendation during an arm’s-length sales conversation would be advice under the circumstances.

Stakeholders have already filed two lawsuits asking federal courts in Texas to prevent the rule from taking effect, and more lawsuits may follow. DOL anticipated these legal challenges by characterizing the different components of the rule and related PTE changes as severable, meaning a court decision invalidating a particular provision wouldn’t necessarily vacate the entire rule. Members of Congress have also introduced joint resolutions to vacate the rule, but such measures are unlikely to succeed in the face of an expected presidential veto.

• Final rule (Federal Register, April 25, 2024)
• Final amendment to PTE 2020-02 (Federal Register, April 25, 2024)
• Final amendment to PTE 84-24 (Federal Register, April 25, 2024)
• Final amendment to PTEs 75-1, 77-4, 80-83, 83-1 and 86-128 (Federal Register, April 25, 2024)
• Press release (DOL, April 23, 2024)
• Fact sheet (DOL, April 23, 2024)
• News release: Transcript of virtual public hearing (DOL, Dec. 22, 2023)

• What plan sponsors should know about DOL’s new fiduciary proposal (Dec. 6, 2023)
• Court overturns DOL guidance on rollover advice (Feb. 28, 2023)