Pursuant to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), those that provide fiduciary investment advice to plan sponsors, plan participants, and IRA owners may not receive payments creating conflicts of interest unless they comply with protective conditions in a “prohibited transaction exemption” (or “PTE”). What constitutes a prohibited transaction, as well as what exemption requirements can overcome a prohibited transaction, are determined by the Department of Labor (“DOL”). DOL PTE 2020-02 (“Improving Investment Advice for Workers & Retirees”) is one such exemption to the otherwise prohibited transaction of receiving compensation in connection with advice regarding retirement plan or IRA rollovers.
Thus, if you are an investment adviser that renders investment advice to clients regarding retirement plan or IRA rollovers, PTE 2020-02 should be on your radar if it isn’t already.
Because of the impending end to the various compliance deadline extensions and enforcement stays applicable to PTE 2020-02, the below frequently asked questions have been compiled to address some of the key tenets of the rule and its practical implications as advisers get ready to comply in full.
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Q1: What constitutes a “rollover” that potentially triggers the need to comply with PTE 2020-02?
A1: (1) Retirement plan to IRA; (2) IRA to IRA; (3) IRA to retirement plan; (4) retirement plan to retirement plan; (5) account type changes (from a commission-based account to a fee-based account).
Q2: What retirement plan account types are subject to potential prohibited transactions, such that PTE 2020-02 may be required?
A2: Most private sector (i.e., non-government) retirement plans sponsored by an employer, as well as IRAs. This includes, e.g., defined benefit pension plans and defined contribution plans, individual participant accounts of such defined benefit pension plans and defined contribution plans, Keogh plans, solo 401(k)s, Archer MSAs, HSAs, Coverdells, SEPs, SIMPLEs, and SARSEPs.
Q3: If I solely educate a client regarding a rollover decision, but do not make any recommendations in this regard, do I need to comply with PTE 2020-02?
A3: Generally speaking, no. But don’t get too cute here. Be sure to comply with DOL Interpretive Bulletin 96-1, which strictly limits what is considered educational information that may be provided to a retirement investor in the context of a rollover decision. Consider documenting the adviser’s “educator-only” role in such situations.
Q4: If I already include a client’s retirement plan assets in my asset-based fee, such that my fee will not increase as a result of the client effecting a rollover of retirement plan assets, do I need to comply with PTE 2020-02?
A4: Generally speaking, no. If a client’s assets included for asset-based fee-billing purposes do not increase as a result of a rollover (all else being equal), the adviser’s financial incentive to recommend a rollover does not exist and therefore no prohibited transaction has occurred. Therefore, no exemption is required.
Q5: If I charge a flat/fixed/retainer fee to a client, and such fee will not increase as a result of the client effecting a rollover of retirement plan assets, do I need to comply with PTE 2020-02?
A5: Generally speaking, no. See A3, above.
Q6: If a client unilaterally directs me to facilitate a rollover without seeking or receiving my advice regarding the rollover decision (i.e., the client’s decision to effect the rollover is a fait accompli), do I need to comply with PTE 2020-02?
A6: Generally speaking, no. If the adviser has not satisfied the “five-part test” of rendering fiduciary investment advice, the associated “investment advice fiduciary” status does not apply. Consider documenting the adviser’s “order taker” role in such situations.
Q7: Do the DOL’s rollover advice requirements and PTE 2020-02 apply to both SEC-registered and state-registered advisers?
A7: Yes. ERISA and its associated PTEs are not regulatory promulgations of the SEC or any state securities authority, and are instead promulgated by the DOL (and more specifically, the Employee Benefits Security Administration, which is an agency of the DOL).
Q8: Assuming I must comply with PTE 2020-02, what am I required to do?
A8:
- Adhere to the “impartial conduct standards” with respect to rollover recommendations, which require that the adviser (1) provide advice that is in the retirement investor’s best interest, (2) charge only reasonable compensation, (3) make no materially misleading statements, and (4) seek best execution of the associated investment transaction.
- Because advisers have long been held to a fiduciary standard of care and loyalty, advisers should not find the above requirements controversial or difficult to satisfy.
- Because advisers have long been held to a fiduciary standard of care and loyalty, advisers should not find the above requirements controversial or difficult to satisfy.
- Acknowledge in writing to the retirement investor, prior to effecting a rollover transaction, that the firm and its investment professionals are fiduciaries under Title I of ERISA and the Internal Revenue Code, as applicable. PTE 2020-02 itself contains model language that can be utilized in this regard, which could also be included in a combination of the adviser’s Form ADV Part 2A, Form CRS (if SEC-registered), advisory agreement, and/or separate rollover disclosure:
When we provide investment advice to you regarding your retirement plan account or individual retirement account, we are fiduciaries within the meaning of Title I of the Employee Retirement Income Security Act and/or the Internal Revenue Code, as applicable, which are laws governing retirement accounts. The way we make money creates some conflicts with your interests, so we operate under a special rule that requires us to act in your best interest and not put our interest ahead of yours.
Additional optional language is also referenced below:
- Under this special rule’s provisions, we must:
- Meet a professional standard of care when making investment recommendations (give prudent advice);
- Never put our financial interests ahead of yours when making recommendations (give loyal advice);
- Avoid misleading statements about conflicts of interest, fees, and investments;
- Follow policies and procedures designed to ensure that we give advice that is in your best interest;
- Charge no more than is reasonable for our services; and
- Give you basic information about conflicts of interest.
- Describe in writing to the retirement investor the adviser’s services and material conflicts of interest.
- A combination of the adviser’s advisory agreement, Form ADV Part 2, and Form CRS (if SEC-registered) should already satisfy this requirement.
- A combination of the adviser’s advisory agreement, Form ADV Part 2, and Form CRS (if SEC-registered) should already satisfy this requirement.
- Document the specific reasons why the rollover recommendation is in the retirement investor’s best interest prior to effecting the rollover transaction, and provide such documentation to the retirement investor.
- This is arguably the most onerous requirement of PTE 2020-02, as it necessitates a documented analysis that requires advisers to “show your work” and provide it in a digestible format to the retirement investor each time a rollover recommendation is made. To evidence delivery to the retirement investor (and the retirement investor’s reading and understanding of the adviser’s rationale), consider utilizing a form signed by the retirement investor that includes the applicable factors impacting the adviser’s recommendation.
With respect to plan-to-IRA rollovers, the DOL’s associated FAQs call for the following factors to be included:- The alternatives to a rollover, including leaving the money in the investor’s employer’s plan, if permitted;
- the fees and expenses associated with both the plan and the IRA;
- whether the employer pays for some or all of the plan’s administrative expenses; and
- the different levels of services and investments available under the plan and the IRA.
- The same FAQ goes on to state the following with respect to the factors to be considered as part of the documented analysis:
- When considering the alternatives to a rollover, you should not focus solely on the retirement investor’s existing investment allocation, without any consideration of other investment options in the plan. For rollovers from another IRA or from a commission-based account to a fee-based arrangement, a prudent recommendation would include consideration and documentation of the services under the new arrangement. As relevant, the analysis should include consideration of factors such as the long-term impact of any increased costs; why the rollover is appropriate notwithstanding any additional costs; and the impact of economically significant investment features such as surrender schedules and index annuity cap and participation rates.
- When considering the alternatives to a rollover, you should not focus solely on the retirement investor’s existing investment allocation, without any consideration of other investment options in the plan. For rollovers from another IRA or from a commission-based account to a fee-based arrangement, a prudent recommendation would include consideration and documentation of the services under the new arrangement. As relevant, the analysis should include consideration of factors such as the long-term impact of any increased costs; why the rollover is appropriate notwithstanding any additional costs; and the impact of economically significant investment features such as surrender schedules and index annuity cap and participation rates.
- In other words, advisers are required to compare and contrast the pre- v. post-rollover state of affairs. In order to meet DOL expectations in this regard, the adviser should make “diligent and prudent efforts” to obtain information about the retirement investor’s existing employee benefit plan and the retirement investor’s interests in it (e.g., participant disclosure information required by rule 404a-5).
If the retirement investor won’t provide the information, even after a full explanation of its significance, and the information is not otherwise readily available, the adviser should make a reasonable estimation of expenses, asset values, risk, and returns based on publicly available information, and document and explain the assumptions used and their limitations. If available, consider utilizing Form 5500 or “reliable benchmarks on typical fees and expenses for the type and size of plan at issue.” - Via cross-reference, the DOL cites FINRA Regulatory Notice 13-45 as a potential source of further factors to consider in connection with a rollover recommendation.
- This is arguably the most onerous requirement of PTE 2020-02, as it necessitates a documented analysis that requires advisers to “show your work” and provide it in a digestible format to the retirement investor each time a rollover recommendation is made. To evidence delivery to the retirement investor (and the retirement investor’s reading and understanding of the adviser’s rationale), consider utilizing a form signed by the retirement investor that includes the applicable factors impacting the adviser’s recommendation.
- Establish policies and procedures designed to comply with the impartial conduct standards, mitigate conflicts of interest, and otherwise comply with PTE 2020-02.
- Undertake an annual retrospective review designed to detect and prevent violations of, and achieve compliance with, the impartial conduct standards and PTE 2020-02.
- The methodology/results of the retrospective review must be documented in a written report that is presented to a “Senior Executive Officer,” which must in-turn annually certify that:
- The officer has reviewed the report of the retrospective review;
- The firm has in place policies and procedures prudently designed to achieve compliance with the conditions of PTE 2020-02; and
- The firm has in place a prudent process to modify such policies and procedures as business, regulatory, and legislative changes and events dictate, and to test the effectiveness of such policies and procedures on a periodic basis, the timing and extent of which is reasonably designed to ensure continuing compliance with the conditions of this exemption.
- The officer has reviewed the report of the retrospective review;
- A “Senior Executive Officer” includes any of the following: the chief compliance officer, the chief executive officer, president, chief financial officer, or one of the three most senior officers of the firm.
- The first annual retrospective review and report should be completed by no later than June 30, 2023.
- The methodology/results of the retrospective review must be documented in a written report that is presented to a “Senior Executive Officer,” which must in-turn annually certify that:
Q9: Where can I review further information and detail about all of these requirements?
A9: