DOL Expands Investment Advice Subject to Fiduciary Liability

The U.S. Department of Labor (DOL) has adopted new regulations under the Employee Retirement Income Security Act of 1974 (ERISA) that broaden the scope of investor recommendations that are subject to fiduciary duty rules. The original regulations, published in 1974, were adopted at a time when 401(k) plans and individual retirement accounts (IRAs) were far less common. The DOL has frequently raised concerns that the original regulations do not adequately protect plan participants making investment decisions on their own. The DOL's most recent attempt to address the perceived gap in employee protections, in regulations adopted in 2016, was struck down by the courts. New regulations finalized on April 23, 2024, are narrower than the 2016 regulations, but would still extend fiduciary duty rules to investment communications that would reasonably be considered to create a relationship of trust and confidence between the employee and the advisor, including rollover recommendations and investment of plan assets in IRAs. The regulations will become effective as of September 23, 2024.

Original Regulations

The original regulations defining the term "fiduciary" would include retirement investment communications only if they met a five-prong test, which was intended to limit the scope of the regulations to those investment advisers who had established a formal, longstanding relationship with the plan fiduciaries (in particular, advisors to defined benefit pension plans). The five prongs are: (1) making investment recommendations or providing valuation advice, (2) which is individualized to the particular needs of the plan, and (3) serves as a primary basis of an investment decision. The test also required that the advice be provided: (4) on a regular basis and (5) subject to a mutual agreement.

2016 Amended Regulations

In 2016, the DOL, in an effort to expand protections to employees who may be persuaded to roll over or reinvest their retirement plan assets, would have struck down the last two prongs of the test: "regular basis" and "mutual agreement." Following heavy objection, the regulations were vacated by the U.S. Court of Appeals for the Fifth Circuit in 2018 for exceeding the authorized scope of the DOL's regulatory authority.

2023 Re-Proposed Regulations

In 2023, the DOL proposed new regulations that dropped the same two prongs of the original test, but only covered investment advice that would reasonably be likely to create a relationship of trust and confidence. This standard was modeled after the SEC's best interest rule, adopted in 2019, which enhanced the broker-dealer standard of conduct beyond "suitability" to a duty to act in the "best interest" of the customer at the time the recommendation is made, including full and fair disclosure of any conflicts of interest.

2024 Final Regulations

Following several weeks of hearings and a 60-day comment period (more than 30,000 comments were submitted), the DOL finalized these regulations on April 23, 2024, with carve-outs for sales pitches and educational recommendations. The DOL also dropped language that would have treated any adviser with "discretionary authority or control" with respect to plan investments as an investment advice fiduciary, in response to comments that the language was vague and overly broad.

The new regulations apply to investment advice given, for a fee or other direct or indirect compensation, to any "retirement investor," which includes a plan, plan participant or beneficiary, IRA, IRA owner or beneficiary, or a fiduciary to a plan or IRA. An advisor to a retirement investor will be treated as a "fiduciary" subject to the new regulations if the following conditions are met:

• The advisor makes a recommendation to the retirement investor of an investment transaction or investment strategy;
• The advisor or its affiliates could receive direct or indirect compensation if the recommendation is followed by the retirement investor; and either
• The advisor makes professional investment recommendations on a regular basis as part of its business, and this particular recommendation is made under circumstances that would reasonably indicate a relationship of trust and confidence (specifically, a reasonable investor in like circumstances could conclude that the recommendation reflects the advisor's professional judgment based on a review of the retirement investor's particular needs or individual circumstances, and may be relied upon by the retirement investor to advance its best interests), or
• The advisor acknowledges fiduciary status.

Most of the commentary involves what constitutes a recommendation of an investment transaction or investment strategy. Unlike the 1974 regulations, the new rule does not require a mutual agreement between the advisor and retirement investor to create fiduciary status. The new rule would apply to any recommendations as to:

• the advisability of acquiring or selling certain securities or other assets;
• the management of securities and other assets, including recommendations on investment policies or strategies, selection of other investment advisors or managers and voting proxies; and
• advice on rolling over plan assets. (The DOL noted that employees moved $770 billion from 401(k)-type plans into IRAs in 2022 alone.)

Echoing the SEC best interest standard, the communication must effectively be a "call to action" to be treated as a "recommendation" for this purpose.

However, the SEC best interest standard is limited to brokers and investment advisers. Insurance agents who sell annuity products to plans or plan participants are subject to state laws that do not necessarily impose a best interest standard. The new DOL rule is expected to curb some types of sales incentives, such as free trips, for agents selling annuities as a part of a plan investment. The new regulations also apply to "other investment property," such as digital assets, precious metals and banking products such as certificates of deposit (CDs), which are not currently governed by SEC or state insurance laws.

The final regulations add language that clarifies that a salesperson's recommendations do not automatically rise to the level of "investment advice" covered by the rule if they are not given under circumstances that would reasonably be expected to advance the retirement investor's best interests. The final regulations also leave in place a 1996 exemption for investment education, such as plan information, general financial and investment concepts, asset allocation models and certain interactive investment models. Disclaimers, while effective in clarifying the intent of the parties, are not controlling to the extent they are inconsistent with other written or oral communications.

If an advisor is a "fiduciary," then its recommendations are subject to ERISA's duty of care and duty of loyalty, and it generally must comply with a prohibited transaction exemption to avoid penalties and excise taxes. These exemptions require the fiduciary to disclose any conflicts of interest and limit investment advice to take into account the best interests of the investor. If a fiduciary duty is breached, then the plan administrator, or a participant on behalf of the plan, may sue to enforce the fiduciary duty rules and restore any losses or disgorge any ill-gotten gains. In addition, the DOL may pursue restitution to the plan of the perceived loss or profits and may impose a 20% penalty. If an advisor is a fiduciary and fails to comply with the prohibited transaction rules, then an excise tax equal to 15% of the amount involved will be imposed.

Effective Date

The new regulations are scheduled to become effective on September 23, 2024. To align with the new regulations, amendments to Prohibited Transaction Exemptions 84-24, for the sale of annuity products and other insurance, and 2020-02, for eligible investment advice fiduciaries, will be phased in over the following 12 months. It is expected, however, that industry groups representing retirement plan service providers and life insurance companies will challenge the regulations in court, which may delay the new fiduciary rule's implementation. In addition, several Republicans have said that they will be introducing a Senate resolution under the Congressional Review Act that is aimed at overturning the rule. Common criticisms include the relatively short comment period, the similarities between the new regulations and the regulations that were vacated by the Fifth Circuit in 2018, and the anticipated reduction in services being offered to retirement plan investors.

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