# Improving Investment Advice for Workers & Retirees > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2020-14261 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** July 7, 2020 - **Citation:** 85 FR 40834 ## Text DEPARTMENT OF LABOR Employee Benefits Security Administration 29 CFR Part 2550 [Application No. D-12011] ZRIN 1210-ZA29 Improving Investment Advice for Workers & Retirees AGENCY: Employee Benefits Security Administration, U.S. Department of Labor. ACTION: Notification of Proposed Class Exemption. SUMMARY: This document gives notice of a proposed class exemption from certain prohibited transaction restrictions of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code of 1986, as amended (the Code). The prohibited transaction provisions of ERISA and the Code generally prohibit fiduciaries with respect to employee benefit plans (Plans) and individual retirement accounts and annuities (IRAs) from engaging in self-dealing and receiving compensation from third parties in connection with transactions involving the Plans and IRAs. The provisions also prohibit purchasing and selling investments with the Plans and IRAs when the fiduciaries are acting on behalf of their own accounts (principal transactions). This proposed exemption would allow investment advice fiduciaries under both ERISA and the Code to receive compensation, including as a result of advice to roll over assets from a Plan to an IRA, and to engage in principal transactions, that would otherwise violate the prohibited transaction provisions of ERISA and the Code. The exemption would apply to registered investment advisers, broker-dealers, banks, insurance companies, and their employees, agents, and representatives that are investment advice fiduciaries. The exemption would include protective conditions designed to safeguard the interests of Plans, participants and beneficiaries, and IRA owners. The new class exemption would affect participants and beneficiaries of Plans, IRA owners, and fiduciaries with respect to such Plans and IRAs. DATES: Written comments and requests for a public hearing on the proposed class exemption must be submitted to the Department within August 6, 2020. The Department proposes that the exemption, if granted, will be available 60 days after the date of publication of the final exemption in the Federal Register . ADDRESSES: All written comments and requests for a hearing concerning the proposed class exemption should be sent to the Office of Exemption Determinations through the Federal eRulemaking Portal and identified by Application No. D-12011: Federal eRulemaking Portal: www.regulations.gov at Docket ID number: EBSA-2020-0003. Follow the instructions for submitting comments. See SUPPLEMENTARY INFORMATION below for additional information regarding comments. FOR FURTHER INFORMATION CONTACT: Susan Wilker, telephone (202) 693-8557, or Erin Hesse, telephone (202) 693-8546, Office of Exemption Determinations, Employee Benefits Security Administration, U.S. Department of Labor (these are not toll-free numbers). SUPPLEMENTARY INFORMATION: Comment Instructions All comments and requests for a hearing must be received by the end of the comment period. Requests for a hearing must state the issues to be addressed and include a general description of the evidence to be presented at the hearing. In light of the current circumstances surrounding the COVID-19 pandemic caused by the novel coronavirus which may result in disruption to the receipt of comments by U.S. Mail or hand delivery/courier, persons are encouraged to submit all comments electronically and not to follow with paper copies. The comments and hearing requests will be available for public inspection in the Public Disclosure Room of the Employee Benefits Security Administration, U.S. Department of Labor, Room N-1513, 200 Constitution Avenue NW, Washington, DC 20210; however, the Public Disclosure Room may be closed for all or a portion of the comment period due to circumstances surrounding the COVID-19 pandemic caused by the novel coronavirus. Comments and hearing requests will also be available online at www.regulations.gov, at Docket ID number: EBSA-2020-0003 and www.dol.gov/ebsa, at no charge. Warning: All comments received will be included in the public record without change and will be made available online at www.regulations.gov, including any personal information provided, unless the comment includes information claimed to be confidential or other information whose disclosure is restricted by statute. If you submit a comment, EBSA recommends that you include your name and other contact information, but DO NOT submit information that you consider to be confidential, or otherwise protected (such as Social Security number or an unlisted phone number), or confidential business information that you do not want publicly disclosed. However, if EBSA cannot read your comment due to technical difficulties and cannot contact you for clarification, EBSA might not be able to consider your comment. Additionally, the www.regulations.gov website is an “anonymous access” system, which means EBSA will not know your identity or contact information unless you provide it. If you send an email directly to EBSA without going through www.regulations.gov, your email address will be automatically captured and included as part of the comment that is placed in the public record and made available on the internet. Background The Employee Retirement Income Security Act of 1974 (ERISA) section 3(21)(A)(ii) provides, in relevant part, that a person is a fiduciary with respect to a Plan to the extent he or she renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such Plan, or has any authority or responsibility to do so. Internal Revenue Code (Code) section 4975(e)(3)(B) includes a parallel provision that defines a fiduciary of a Plan and an IRA. In 1975, the Department issued a regulation establishing a five-part test for fiduciary status under this provision of ERISA. 1 The Department's 1975 regulation also applies to the definition of fiduciary in the Code, which is identical in its wording. 2 1 29 CFR 2510.3-21(c)(1), 40 FR 50842 (October 31, 1975). 2 26 CFR 54.4975-9(c), 40 FR 50840 (October 31, 1975). Under the 1975 regulation, for advice to constitute “investment advice,” a financial institution or investment professional who is not a fiduciary under another provision of the statute must—(1) render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property (2) on a regular basis (3) pursuant to a mutual agreement, arrangement, or understanding with the Plan, Plan fiduciary or IRA owner that (4) the advice will serve as a primary basis for investment decisions with respect to Plan or IRA assets, and that (5) the advice will be individualized based on the particular needs of the Plan or IRA. A financial institution or investment professional that meets this five-part test, and receives a fee or other compensation, direct or indirect, is an investment advice fiduciary under ERISA and under the Code. Investment advice fiduciaries, like other fiduciaries to Plans and IRAs, are subject to duties and liabilities established in Title I of ERISA (ERISA) and Title II of ERISA (the Internal Revenue Code or the Code). Under Title I of ERISA, plan fiduciaries must act prudently and with undivided loyalty to employee benefit plans and their participants and beneficiaries. Although these statutory fiduciary duties are not in the Code, both ERISA and the Code contain provisions forbidding fiduciaries from engaging in certain specified “prohibited transactions,” involving Plans and IRAs, including conflict of interest transactions. 3 Under these prohibited transaction provisions, a fiduciary may not deal with the income or assets of a Plan or IRA in his or her own interest or for his or her own account, and a fiduciary may not receive payments from any party dealing with the Plan or IRA in connection with a transaction involving assets of the Plan or IRA. The Department has authority to grant administrative exemptions from the prohibited transaction provisions in ERISA and the Code. 4 3 ERISA section 406 and Code section 4975. 4 ERISA section 408(a) and Code section 4975(c)(2). Reorganization Plan No. 4 of 1978 (5 U.S.C. App. (2018)) generally transferred the authority of the Secretary of the Treasury to grant administrative exemptions under Code section 4975 to the Secretary of Labor. These provisions require the Secretary to make the following findings before granting an administrative exemption: (i) The exemption is administratively feasible; (ii) the exemption is in the interests of the Plans and IRAs and their participants and beneficiaries, and (iii) the exemption is protective of the rights of participants and beneficiaries of the Plans and IRAs. The Department is proposing this new class exemption on its own motion pursuant to ERISA section 408(a) and Code section 4975(c)(2), and in accordance with procedures set forth in 29 CFR part 2570, subpart B (76 FR 66637 (October 27, 2011)). In 2016, the Department finalized a new regulation that would have replaced the 1975 regulation and it granted new associated prohibited transaction exemptions. After that rulemaking was vacated by the U.S. Court of Appeals for the Fifth Circuit in 2018, 5 the Department issued Field Assistance Bulletin (FAB) 2018-02, a temporary enforcement policy providing prohibited transaction relief to investment advice fiduciaries. 6 In the FAB, the Department stated it would not pursue prohibited transactions claims against investment advice fiduciaries who worked diligently and in good faith to comply with “Impartial Conduct Standards” for transactions that would have been exempted in the new exemptions, or treat the fiduciaries as violating the applicable prohibited transaction rules. The Impartial Conduct Standards have three components: A best interest standard; a reasonable compensation standard; and a requirement to make no misleading statements about investment transactions and other relevant matters. 5 Chamber of Commerce of the United States v. U.S. Department of Labor, 885 F.3d 360 (5th Cir. 2018). Elsewhere in this issue of the Federal Register , the Department is publishing a technical amendment related to the decision. 6 Available at www.dol.gov/agencies/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2018-02. The Impartial Conduct Standards incorporated in the FAB were conditions of the new exemptions granted in 2016. See Best Interest Contract Exemption, 81 FR 21002 (Apr. 8, 2016), as corrected at 81 FR 44773 (July 11, 2016). This proposal takes into consideration the public correspondence and comments received by the Department since February 2017 and responds to informal industry feedback seeking an administrative class exemption based on FAB 2018-02. As noted in the FAB, following the 2016 rulemaking many financial institutions created and implemented compliance structures designed to ensure satisfaction of the Impartial Conduct Standards. These parties were permitted to continue to rely on those structures pending further guidance. Under the exemption, financial institutions could continue relying on those compliance structures on a permanent basis, subject to the additional conditions of the exemption, rather than changing course to begin complying with the Department's other existing exemptions for investment advice fiduciaries. In addition, the exemption would provide a defense to private litigation as well as enforcement action by the Department, while the FAB is limited to the latter. This new proposed exemption would provide relief that is broader and more flexible than the Department's existing prohibited transaction exemptions for investment advice fiduciaries. The Department's existing exemptions generally provide relief for discrete, specifically identified transactions, and they were not amended to clearly provide relief for the compensation arrangements that developed over time. 7 The exemption would provide additional certainty regarding covered compensation arrangements and would avoid the complexity associated with a financial institution relying on multiple exemptions when providing investment advice. 7 See e.g. , PTE 86-128, Class Exemption for Securities Transactions involving Employee Benefit Plans and Broker-Dealers, 51 FR 41686 (Nov. 18, 1986), as amended, 67 FR 64137 (Oct. 17, 2002)(providing relief for a fiduciary's use of its authority to cause a Plan or IRA to pay a fee for effecting or executing securities transactions to the fiduciary, as agent for the Plan or IRA, and for a fiduciary to act as an agent in an agency cross transaction for a Plan or IRA and another party to the transaction and receive reasonable compensation for effecting or executing the transaction from the other party to the tranaction); PTE 84-24 Class Exemption for Certain Transactions Involving Insurance Agents and Brokers, Pension Consultants, Insurance Companies, Investment Companies and Investment Company Principal Underwriters, 49 FR 13208 (Apr. 3, 1984) , as corrected, 49 FR 24819 (June 15, 1984), as amended, 71 FR 5887 (Feb. 3, 2006) (providing relief for the receipt of a sales commission by an insurance agent or broker from an insurance company in connection with the purchase, with plan assets, of an insurance or annuity contract). The proposed exemption's principles-based approach is rooted in the Impartial Conduct Standards for fiduciaries providing investment advice. The proposed exemption includes additional conditions designed to support the provision of investment advice that meets the Impartial Conduct Standards. This notice also sets forth the Department's interpretation of the five-part test of investment advice fiduciary status and provides the Department's views on when advice to roll over Plan assets to an IRA 8 could be considered fiduciary investment advice under ERISA and the Code. 8 For purposes of any rollover of assets between a Plan and an IRA described in this preamble, the term “IRA” only includes an account or annuity described in Code section 4975(e)(1)(B) or (C). Since 2018, other regulators have considered enhanced standards of conduct for investment professionals as a method of addressing conflicts of interest. At the federal level, on June 5, 2019, the Securities and Exchange Commission (SEC) finalized a regulatory package relating to conduct standards for broker-dealers and investment advisers. The package included Regulation Best Interest, which establishes a best interest standard applicable to broker-dealers when making a recommendation of any securities transaction or investment strategy involving securities to retail customers. 9 The SEC also issued an interpretation of the conduct standards applicable to registered investment advisers. 10 As part of the package, the SEC adopted new Form CRS, which requires broker-dealers and registered investment advisers to provide retail investors with a short relationship summary with specified information (SEC Form CRS). 11 9 Regulation Best Interest: The Broker-Dealer Standard of Conduct, 84 FR 33318 (July 12, 2019) (Regulation Best Interest Release). 10 Commission Interpretation Regarding Standard of Conduct for Investment Advisers, 84 FR 33669 (July 12, 2019) (SEC Fiduciary Interpretation). 11 Form CRS Relationship Summary; Amendments to Form ADV, 84 FR 33492 (July 12, 2019)(Form CRS Relationship Summary Release). State regulators and standards-setting bodies also have focused on conduct standards. The New York State Department of Financial Services has amended its insurance regulations to establish a best interest standard in connection with life insurance and annuity transactions. 12 The Massachusetts Securities Division has amended its regulations for broker-dealers to apply a fiduciary conduct standard, under which broker-dealers and their agents must “[m]ake recommendations and provide investment advice without regard to the financial or any other interest of any party other than the customer.” 13 The National Association of Insurance Commissioners has revised its Suitability In Annuity Transactions Model Regulation to clarify that all recommendations by agents and insurers must be in the best interest of the consumer and that agents and carriers may not place their financial interest ahead of in the consumer's interest in making the recommendation. 14 12 New York State Department of Financial Services Insurance Regulation 187, 11 NYCRR 224, First Amendment, effective August 1, 2019. 13 950 Mass. Code Regs. 12.204 & 12.207 as amended effective March 6, 2020. 14 NAIC Takes Action to Protect Annuity Consumers; available at https://content.naic.org/article/news_release_naic_takes_action_protect_annuity_consumers.htm. The approach in this proposal includes Impartial Conduct Standards that are, in the Department's view, aligned with those of the other regulators. In this way, the proposal is designed to promote regulatory efficiencies that might not otherwise exist under the Department's existing administrative exemptions for investment advice fiduciaries. This proposed exemption is expected to be an Executive Order (E.O.) 13771 deregulatory action because it would allow investment advice fiduciaries with respect to Plans and IRAs to receive compensation and engage in certain principal transactions that would otherwise be prohibited under ERISA and the Code. The temporary enforcement policy stated in FAB 2018-02 remains in place. The Department is proposing this class exemption on its own motion, pursuant to ERISA section 408(a) and Code section 4975(c)(2), and in accordance with the procedures set forth in 29 CFR part 2570 (76 FR 66637 (October 27, 2011)). Description of the Proposed Exemption As discussed in greater detail below, the exemption proposed in this notice would be available to registered investment advisers, broker-dealers, banks, and insurance companies (Financial Institutions) and their individual employees, agents, and representatives (Investment Professionals) that provide fiduciary investment advice to Retirement Investors. The proposal defines Retirement Investors as Plan participants and beneficiaries, IRA owners, and Plan and IRA fiduciaries. 15 Under the exemption, Financial Institutions and Investment Professionals could receive a wide variety of payments that would otherwise violate the prohibited transaction rules, including, but not limited to, commissions, 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs, and revenue sharing payments from investment providers or third parties. The exemption's relief would extend to prohibited transactions arising as a result of investment advice to roll over assets from a Plan to an IRA, as detailed later in this proposed exemption. The exemption also would allow Financial Institutions to engage in principal transactions with Plans and IRAs in which the Financial Institution purchases or sells certain investments from its own account. 15 The term “Plan” is defined for purposes of the exemption as any employee benefit plan described in ERISA section 3(3) and any plan described in Code section 4975(e)(1)(A). The term “Individual Retirement Account” or “IRA” is defined as any account or annuity described in Code section 4975(e)(1)(B) through (F), including an Archer medical savings account, a health savings account, and a Coverdell education savings account. As noted above, ERISA and the Code include broad prohibitions on self-dealing. Absent an exemption, a fiduciary may not deal with the income or assets of a Plan or IRA in his or her own interest or for his or her own account, and a fiduciary may not receive payments from any party dealing with the Plan or IRA in connection with a transaction involving assets of the Plan or IRA. As a result, fiduciaries who use their authority to cause themselves or their affiliates 16 or related entities 17 to receive additional compensation violate the prohibited transaction provisions unless an exemption applies. 18 16 For purposes of the exemption, an affiliate would include: (1) Any person directly or indirectly through one or more intermediaries, controlling, controlled by, or under common control with the Investment Professional or Financial Institution. (For this purpose, “control” would mean the power to exercise a controlling influence over the management or policies of a person other than an individual) (2) Any officer, director, partner, employee, or relative (as defined in ERISA section 3(15)), of the Investment Professional or Financial Institution; and (3) Any corporation or partnership of which the Investment Professional or Financial Institution is an officer, director, or partner. 17 For purposes of the exemption, related entities would include entities that are not affiliates, but in which the Investment Professional or Financial Institution has an interest that may affect the exercise of its best judgment as a fiduciary. 18 As articulated in the Department's regulations, “a fiduciary may not use the authority, control, or responsibility which makes such a person a fiduciary to cause a plan to pay an additional fee to such fiduciary (or to a person in which such fiduciary has an interest which may affect the exercise of such fiduciary's best judgment as a fiduciary) to provide a service.” 29 CFR 2550.408b-2(e)(1). The proposed exemption would condition relief on the Investment Professional and Financial Institution providing advice in accordance with the Impartial Conduct Standards. In addition, the exemption would require Financial Institutions to acknowledge in writing their and their Investment Professionals' fiduciary status under ERISA and the Code, as applicable, when providing investment advice to the Retirement Investor, and to describe in writing the services to be provided and the Financial Institutions' and Investment Professionals' material conflicts of interest. Finally, Financial Institutions would be required to adopt policies and procedures prudently designed to ensure compliance with the Impartial Conduct Standards and conduct a retrospective review of compliance. The exemption would also provide, subject to additional safeguards, relief for Financial Institutions to enter into principal transactions with Retirement Investors, in which they purchase or sell certain investments from their own accounts. The exemption requires Financial Institutions to provide reasonable oversight of Investment Professionals and to adopt a culture of compliance. The proposal further provides that Financial Institutions and Investment Professionals would be ineligible to rely on the exemption if, within the previous 10 years, they were convicted of certain crimes arising out of their provision of investment advice to Retirement Investors; they would also be ineligible if they engaged in systematic or intentional violation of the exemption's conditions or provided materially misleading information to the Department in relation to their conduct under the exemption. Ineligible parties could rely on an otherwise available statutory exemption or apply for an individual prohibited transaction exemption from the Department. This targeted approach of allowing the Department to give special attention to parties with certain criminal convictions or with a history of egregious conduct with respect to compliance with the exemption should provide significant protections for Retirement Investors while preserving wide availability of investment advice arrangements and products. The proposed exemption would not expand Retirement Investors' ability to enforce their rights in court or create any new legal claims above and beyond those expressly authorized in ERISA, such as by requiring contracts and/or warranty provisions. 19 19 ERISA section 502(a) provides the Secretary of Labor and plan participants and beneficiaries with a cause of action for fiduciary breaches and prohibited transactions with respect to ERISA-covered Plans (but not IRAs). Code section 4975 imposes a tax on disqualified persons participating in a prohibited transaction involving Plans and IRAs (other than a fiduciary acting only as such). Scope of Relief Financial Institutions The exemption would be available to entities that satisfy the exemption's definition of a “Financial Institution.” The proposal limits the types of entities that qualify as a Financial Institution to SEC- and state-registered investment advisers, broker-dealers, insurance companies and banks. 20 The proposed definition is based on the entities identified in the statutory exemption for investment advice under ERISA section 408(b)(14) and Code section 4975(d)(17), which are subject to well-established regulatory conditions and oversight. 21 Congress determined that this group of entities could prudently mitigate certain conflicts of interest in their investment advice through adherence to tailored principles under the statutory exemption. The Department takes a similar approach here, and therefore is proposing to include the same group of entities. To fit within the definition of Financial Institution, the firm must not have been disqualified or barred from making investment recommendations by any insurance, banking, or securities law or regulatory authority (including any self-regulatory organization). 20 The proposal includes “a bank or similar financial institution supervised by the United States or a state, or a savings association (as defined in section 3(b)(1) of the Federal Deposit Insurance Act (12 U.S.C. 1813(b)(1)).” The Department would interpret this definition to extend to credit unions. 21 ERISA section 408(g)(11)(A) and Code section 4975(f)(8)(J)(i). The Department recognizes that different types of Financial Institutions have different business models, and the proposal is drafted to apply flexibly to these institutions. 22 Broker-dealers, for example, provide a range of services to Retirement Investors, ranging from executing one-time transactions to providing personalized investment recommendations, and they may be compensated on a transactional basis such as through commissions. 23 If broker-dealers that are investment advice fiduciaries with respect to Retirement Investors provide investment advice that affects the amount of their compensation, they must rely on an exemption. 22 Some of the Department's existing prohibited transaction exemptions would also apply to the transactions described in the next few paragraphs. 23 Regulation Best Interest Release, 84 FR at 33319. Registered investment advisers, by contrast, generally provide ongoing investment advice and services and are commonly paid either an assets under management fee or a fixed fee. 24 If a registered investment adviser is an investment advice fiduciary that charges only a level fee that does not vary on the basis of the investment advice provided, the registered investment adviser may not violate the prohibited transaction rules. 25 However, if the registered investment adviser provides investment advice that causes itself to receive the level fee, such as through advice to roll over Plan assets to an IRA, the fee (including an ongoing management fee paid with respect to the IRA) is prohibited under ERISA and the Code. 26 Additionally, if a registered investment adviser that is an investment advice fiduciary is dually-registered as a broker-dealer, the registered investment adviser may engage in a prohibited transaction if it recommends a transaction that increases the broker-dealer's compensation, such as for execution of securities transactions. As noted above, it is a prohibited transaction for a fiduciary to use its authority to cause an affiliate or related entity to receive additional compensation. 27 24 Id. 25 As noted above, fiduciaries who use their authority to cause themselves or their affiliates or related entities to receive additional compensation violate the prohibited transaction provisions unless an exemption applies. 29 CFR 2550.408b-2(e)(1). 26 The Department has long interpreted the requirement of a fee to broadly cover “all fees or other compensation incident to the transaction in which the investment advice to the plan has been rendered or will be rendered.” Preamble to the Department's 1975 Regulation, 40 FR 50842 (October 31, 1975). The Department's analysis of the five-part test's application to rollovers is discussed below. 27 29 CFR 2550.408b-2(e)(1). Insurance companies commonly compensate insurance agents on a commission basis, which generally creates prohibited transactions when insurance agents are investment advice fiduciaries that provide investment advice to Retirement Investors in connection with the sales. However, the Department is aware that insurance companies often sell insurance products and fixed (including indexed) annuities through different distribution channels than broker-dealers and registered investment advisers. While some insurance agents are employees of an insurance company, other insurance agents are independent, and work with multiple insurance companies. The proposed exemption would apply to either of these business models. Insurance companies can supervise independent insurance agents and they can also create oversight and compliance systems through contracts with intermediaries such as independent marketing organizations (IMOs), field marketing organizations (FMOs) or brokerage general agencies (BGAs). 28 Eligible parties can also continue to use relief under the existing exemption for insurance transactions, PTE 84-24, as an alternative. 29 The Department requests comment on these suggestions, and whether there are alternatives for oversight of investment advice fiduciaries who also serve as insurance agents. 28 Although the proposal's definition of Financial Institution does not include insurance intermediaries, the Department seeks comments on whether the exemption should include insurance intermediaries as Financial Institutions for the recommendation of fixed (including indexed) annuity contracts. If so, the Department asks parties to provide a definition of the type of intermediary that should be permitted to operate as a Financial Institution and whether any additional protective conditions might be necessary with respect to the intermediary. 29 Class Exemption for Certain Transactions Involving Insurance Agents and Brokers, Pension Consultants, Insurance Companies, Investment Companies and Investment Company Principal Underwriters, 49 FR 13208 (Apr. 3, 1984), as corrected, 49 FR 24819 (June 15, 1984), as amended, 71 FR 5887 (Feb. 3, 2006). Finally, banks and similar institutions would be permitted to act as Financial Institutions under the exemption if they or their employees are investment advice fiduciaries with respect to Retirement Investors. The Department seeks comment on whether banks and their employees provide investment advice to Retirement Investors, and if so, whether the proposal needs adjustment to address any unique aspects of their business models. The Department seeks comment on other business models not listed here, and invites commenters to explain whether other business models would be appropriate to include in this framework. The proposal also allows the definition of Financial Institution to expand after the exemption is finalized based upon subsequent grants of individual exemptions to additional entities that are investment advice fiduciaries that meet the five-part test seeking to be treated as covered Financial Institutions. Additional types of entities, such as IMOs, FMOs, or BGAs, that are investment advice fiduciaries may separately apply for relief for the receipt of compensation in connection with the provision of investment advice on the same conditions as apply to the Financial Institutions covered by the proposed exemption. 30 If the Department grants an individual exemption under ERISA section 408(a) and Code section 4975(c) after the date this exemption is granted, the expanded definition of Financial Institution in the individual exemption would be added to this class exemption so other entities that satisfy the definition could similarly use the class exemption. The Department requests comment on the procedural aspects, e.g., ensuring sufficient notice to Retirement Investors, of this permitted expansion of the definition. 30 Exemption relief for an insurance intermediary would only be required if the intermediary is an investment advice fiduciary under the applicable regulations. An exemption is not necessary for an insurance intermediary or its insurance agents who conduct sales transactions and are not fiduciaries under ERISA or the Code. The Department seeks comment on the definition of Financial Institution in general and whether any other type of entity should be included. The Department also seeks comment as to whether the definition is overly broad, or whether Retirement Investors would benefit from a narrowed list of Financial Institutions. In addition, the Department requests comment on whether the definition of Financial Institution is sufficiently broad to cover firms that render advice with respect to investments in Health Savings Accounts (HSA), and about the extent to which Plan participants receive investment advice in connection with such accounts. Investment Professionals As defined in the proposal, an Investment Professional is an individual who is a fiduciary of a Plan or IRA by reason of the provision of investment advice, who is an employee, independent contractor, agent or representative of a Financial Institution, and who satisfies the federal and state regulatory and licensing requirements of insurance, banking, and securities laws (including self-regulatory organizations) with respect to the covered transaction, as applicable. Similar to the definition of Financial Institution, this definition also includes a requirement that the Investment Professional has not been disqualified from making investment recommendations by any insurance, banking, or securities law or regulatory authority (including any self-regulatory organization). Covered Transactions The proposal would permit Financial Institutions and Investment Professionals, and their affiliates and related entities, to receive reasonable compensation as a result of providing fiduciary investment advice. The exemption specifically covers compensation received as a result of investment advice to roll over assets from a Plan to an IRA. The exemption also would provide relief for a Financial Institution to engage in the purchase or sale of an asset in a riskless principal transaction or a Covered Principal Transaction, and receive a mark-up, mark-down, or other payment. The exemption would provide relief from ERISA section 406(a)(1)(A) and (D) and 406(b) and Code section 4975(c)(1)(A), (D), (E), and (F). 31 31 The proposal does not include relief from ERISA section 406(a)(1)(C) and Code section 4975(c)(1)(C). The statutory exemptions, ERISA section 408(b)(2) and Code section 4975(d)(2) provide this necessary relief for Plan or IRA service providers, subject the applicable conditions. Subsection (1) of the exemption would provide broad relief for Financial Institutions and Investment Professionals that are investment advice fiduciaries to receive all forms of reasonable compensation as a result of their investment advice to Retirement Investors. For example, it would cover compensation received as a result of investment advice to acquire, hold, dispose of, or exchange securities and other investments. It would also cover compensation received as a result of investment advice to take a distribution from a Plan or to roll over the assets to an IRA, or from investment advice regarding other similar transactions including (but not limited to) rollovers from one Plan to another Plan, one IRA to another IRA, or from one type of account to another account ( e.g., from a commission-based account to a fee-based account). The exemption would cover compensation received as a result of investment advice as to persons the Retirement Investor may hire to serve as an investment advice provider or asset manager. Subsection (2) of the exemption would address the circumstance in which the Financial Institution may, in addition to providing investment advice, engage in a purchase or sale of an investment with a Retirement Investor and receive a mark-up or a mark-down or similar payment on the transaction. The exemption would extend to both riskless principal transactions and Covered Principal Transactions. A riskless principal transaction is a transaction in which a Financial Institution, after having received an order from a Retirement Investor to buy or sell an investment product, purchases or sells the same investment product for the Financial Institution's own account to offset the contemporaneous transaction with the Retirement Investor. Covered Principal Transactions are defined in the exemption as principal transactions involving certain specified types of investments, discussed in more detail below. Principal transactions that are not riskless and that do not fall within the definition of Covered Principal Transaction would not be covered by the exemption. The following sections provide additional information on the proposal as it would apply to investment advice to roll over ERISA-covered Plan assets to an IRA, and as it would apply to Covered Principal Transactions. Rollovers Amounts accrued in an ERISA-covered Plan can represent a lifetime of savings, and often comprise the largest sum of money a worker has at retirement. Therefore, the decision to roll over ERISA-covered Plan assets to an IRA is potentially a very consequential financial decision for a Retirement Investor. For example, Retirement Investors may incur transaction costs associated with moving the assets into new investments and accounts, and, because of the loss of economies of scale, the cost of investing through an IRA may be higher than through a Plan. 32 Retirement Investors who roll out of ERISA-covered Plans also lose important ERISA protections, including the benefit of a Plan fiduciary representing their interests in selecting a menu of investment options or structuring investment advice relationships, and the statutory causes of action to protect their interests. Retirement Investors who are retirees may not have the ability to earn additional amounts to offset any costs or losses. 32 See, e.g., “IRA Investors Are Concentrated in Lower-Cost Mutual Funds” (Aug. 8, 2018), available at https://www.ici.org/viewpoints/view_18_ira_expenses_fees (“The data show that 401(k) investors incur lower expense ratios in their mutual fund holdings than IRA mutual fund investors. One reason for this is economies of scale, as many employer plans aggregate the savings of hundreds or thousands of workers, and often carry large average account balances, which are more cost-effective to service. In addition, employers that sponsor 401(k) plans may defray some of the costs of running the plan, enabling the sponsor to select lower-cost funds (or fund share classes) for the plan.”) Rollovers from ERISA-covered Plans to IRAs were expected to approach $2.4 trillion cumulatively from 2016 through 2020. 33 These large sums of money eligible for rollover represent a significant revenue source for investment advice providers. A firm that recommends a rollover to a Retirement Investor can generally expect to earn transaction-based compensation such as commissions, or an ongoing advisory fee, from the IRA, but may or may not earn compensation if the assets remain in the Plan. 33 Cerulli Associates, “U.S. Retirement Markets 2019.” In light of potential conflicts of interest related to rollovers from Plans to IRAs, ERISA and the Code prohibit an investment advice fiduciary from receiving fees resulting from investment advice to Plan participants to roll over assets from a Plan to an IRA, unless an exemption applies. The proposed exemption would provide relief, as needed, for this prohibited transaction, if the Financial Institution and Investment Professional provide investment advice that satisfies the Impartial Conduct Standards and they comply with the other applicable conditions discussed below. 34 In particular, the Financial Institution would be required to document the reasons that the advice to roll over was in the Retirement Investor's best interest. In addition, investment advice fiduciaries under Title I of ERISA would remain subject to the fiduciary duties imposed by section 404 of that statute. 34 The exemption would also provide relief for investment advice fiduciaries under either ERISA or the Code to receive compensation for advice to roll Plan assets to another Plan, to roll IRA assets to another IRA or to a Plan, and to transfer assets from one type of account to another, all limited to the extent such rollovers are permitted under law. The analysis set forth in this section will apply as relevant to those transactions as well. In determining the fiduciary status of an investment advice provider in this context, the Department does not intend to apply the analysis in Advisory Opinion 2005-23A (the Deseret Letter), which suggested that advice to roll assets out of a Plan did not generally constitute investment advice. The Department believes that the analysis in the Deseret Letter was incorrect and that advice to take a distribution of assets from an ERISA-covered Plan is actually advice to sell, withdraw, or transfer investment assets currently held in the Plan. A recommendation to roll assets out of a Plan is necessarily a recommendation to liquidate or transfer the Plan's property interest in the affected assets, the participant's associated property interest in the Plan investments, and the fiduciary oversight structure that applies to the assets. Typically the assets, fees, asset management structure, investment options, and investment service options all change with the decision to roll money out of the Plan. Accordingly, the better view is that a recommendation to roll assets out of a Plan is advice with respect to moneys or other property of the Plan. Moreover, a distribution recommendation commonly involves either advice to change specific investments in the Plan or to change fees and services directly affecting the return on those investments. 35 35 The SEC and FINRA have each recognized that recommendations to roll over Plan assets to an IRA will almost always involve a securities transaction. See Regulation Best Interest Release, 84 FR at 33339; FINRA Regulatory Notice 13-45 Rollovers to Individual Retirement Accounts (December 2013), available at https://www.finra.org/sites/default/files/NoticeDocument/p418695.pdf. All prongs of the five-part test must be satisfied for the investment advice provider to be a fiduciary within the meaning of the regulatory definition, including the “regular basis” prong and the prongs requiring the advice to be provided pursuant to a “mutual” agreement, arrangement, or understanding that the advice will serve as “a primary basis” for investment decisions. As discussed below, these inquiries will be informed by all the surrounding facts and circumstances. The Department acknowledges that advice to take a distribution from a Plan and roll over the assets may be an isolated and independent transaction that would fail to meet the regular basis prong. 36 However, the Department believes that whether advice to roll over Plan assets to an IRA satisfies the regular-basis prong of the five-part test depends on the surrounding facts and circumstances. The Department has long interpreted advice to a Plan to include advice to participants and beneficiaries in participant-directed individual account pension plans. 37 The Department also recognizes that advice to roll over Plan assets can occur as part of an ongoing relationship or an anticipated ongoing relationship that an individual enjoys with his or her advice provider. For example, in circumstances in which the advice provider has been giving financial advice to the individual about investing in, purchasing, or selling securities or other financial instruments, the advice to roll assets out of a Plan is part of an ongoing advice relationship that satisfies the “regular basis” requirement. Similarly, advice to roll assets out of the Plan into an IRA where the advice provider will be regularly giving financial advice regarding the IRA in the course of a more lengthy financial relationship would be the start of an advice relationship that satisfies the “regular basis” requirement. In these scenarios, there is advice to the Plan—meaning the Plan participant or beneficiary—on a regular basis. The Department is disinclined to propose an exemption that would artificially exclude rollover advice from investment advice when that would be contrary to the parties' course of dealing and expectations. And it is more than reasonable, as discussed below, that the advice provider would anticipate that advice about rolling over Plan assets would be “a primary basis for [those] investment decisions.” 36 Merely executing a sales transaction at the customer's request also does not confer fiduciary status. 37 Interpretive Bulletin 96-1, 29 CFR 2509.96-1. This interpretation would both align the Department's approach with other regulators and protect Plan participants and beneficiaries under today's market practices, including the increasing prevalence of 401(k) plans and self-directed accounts. Numerous sources acknowledge that a common purpose of advice to roll over Plan assets is to establish an ongoing relationship in which advice is provided on a regular basis outside of the Plan, in return for a fee or other compensation. For example, in a 2013 notice reminding firms of their responsibilities regarding IRA rollovers, the Financial Industry Regulatory Authority (FINRA) stated that “a financial adviser has an economic incentive to encourage an investor to roll Plan assets into an IRA that he will represent as either a broker-dealer or an investment adviser representative.” 38 Similarly, in 2011, the U.S. Government Accountability Office (GAO) discussed the practice of cross-selling, in which 401(k) service providers sell Plan participants products and services outside of their Plans, including IRA rollovers. GAO reported that industry professionals said “cross-selling IRA rollovers to participants, in particular, is an important source of income for service providers.” 39 38 FINRA Regulatory Notice 13-45. 39 U.S. General Accountability Office, 401(k) Plans: Improved Regulation Could Better Protect Participants from Conflicts of Interest, GAO 11-119 (Washington, DC 2011), available at https://www.gao.gov/assets/320/315363.pdf. Therefore, the regular basis prong of the five-part test would be satisfied when an entity with a pre-existing advice relationship with the Retirement Investor advises the Retirement Investor to roll over assets from a Plan to an IRA. Similarly, for an investment advice provider who establishes a new relationship with a Plan participant and advises a rollover of assets from the Plan to an IRA, the rollover recommendation may be seen as the first step in an ongoing advice relationship that could satisfy the regular basis prong of the five-part test depending on the facts and circumstances. 40 40 The Department is aware that some Financial Institutions pay unrelated parties to solicit clients for them. See Rule 206(4)-3 under the Investment Advisers Act of 1940; see also Investment Advisers Advertisements; Compensation for Solicitations, Proposed Rule, 84 FR 67518 (December 10, 2019). The Department notes that advice by a paid solicitor to take a distribution from a Plan and to roll over assets to an IRA could be part of ongoing advice to a Retirement Investor, if the Financial Institution that pays the solicitor provides ongoing fiduciary advice to the IRA owner. Further, the determination of whether there is a mutual agreement, arrangement, or understanding that the investment advice will serve as a primary basis for investment decisions is appropriately based on the reasonable understanding of each of the parties, if no mutual agreement or arrangement is demonstrated. Written statements disclaiming a mutual understanding or forbidding reliance on the advice as a primary basis for investment decisions are not determinative, although such statements are appropriately considered in determining whether a mutual understanding exists. More generally, the Department emphasizes that the five-part test does not look at whether the advice serves as “the” primary basis of investment decisions, but whether it serves as “a” primary basis. When financial service professionals make recommendations to a Retirement Investor, particularly pursuant to a best interest standard such as the one in the SEC's Regulation Best Interest, or another requirement to provide advice based on the individualized needs of the Retirement Investor, the parties typically should reasonably understand that the advice will serve as at least a primary basis for the investment decision. By contrast, a one-time sales transaction, such as the one-time sale of an insurance product, does not by itself confer fiduciary status under ERISA or the Code, even if accompanied by a recommendation that the product is well-suited to the investor and would be a valuable purchase. 41 41 Like other Investment Professionals, however, insurance agents may have or contemplate an ongoing advice relationship with a customer. For example, agents who receive trailing commissions on annuity transactions may continue to provide ongoing recommendations or service with respect to the annuity. In addition to satisfying the five-part test, a person must receive a fee or other compensation to be an investment advice fiduciary. The Department has long interpreted this requirement broadly to cover “all fees or other compensation incident to the transaction in which the investment advice to the plan has been rendered or will be rendered.” 42 The Department previously noted that “this may include, for example, brokerage commissions, mutual fund sales commissions, and insurance sales commissions.” 43 In the rollover context, fees and compensation received from transactions involving rollover assets would be incident to the advice to take a distribution from the Plan and to roll over the assets to an IRA. If, under the above analysis, advice to roll over Plan assets to an IRA is fiduciary investment advice under ERISA, the fiduciary duties of prudence and loyalty would apply to the initial instance of advice to take the distribution and to roll over the assets. Fiduciary investment advice concerning investment of the rollover assets and ongoing management of the assets, once distributed from the Plan into the IRA, would be subject to obligations in the Code. For example, a broker-dealer who satisfies the five-part test with respect to a Retirement Investor, advises that Retirement Investor to move his or her assets from a Plan to an IRA, and receives any fees or compensation incident to distributing those assets, will be a fiduciary subject to ERISA, including section 404, with respect to the advice regarding the rollover. 42 Preamble to the Department's 1975 Regulation, 40 FR 50842 (October 31, 1975). 43 Id. The Department requests comment on all aspects of this part of its proposal. For instance: Are there other rollover scenarios that are not clear and which the Department should address? Does the discussion above reflect real-world experiences and concerns? Does it provide enough clarity to financial entities interested in the proposed exemption? Principal Transactions Principal transactions involve the purchase from, or sale to, a Plan or IRA, of an investment, on behalf of the Financial Institution's own account or the account of a person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the Financial Institution. Because an investment advice fiduciary engaging in a principal transaction is on both sides of the transaction, the firm has a clear conflict. In addition, the securities typically traded in principal transactions often lack pre-trade price transparency and Retirement Investors may, therefore, have difficulty evaluating the fairness of a particular principal transaction. These investments also can be associated with low liquidity, low transparency, and the possible incentive to sell unwanted investments held by the Financial Institution. Consistent with the Department's historical approach to prohibited transaction exemptions for fiduciaries, this proposal includes relief for principal transactions that is limited in scope and subject to additional conditions, as set forth in the definition of Covered Principal Transactions, described below. Importantly, certain transactions would not be considered principal transactions for purposes of the exemption, and so could occur under the more general conditions. This includes the sale of an insurance or annuity contract, or a mutual fund transaction. Principal transactions that are “riskless principal transactions” would be covered under the exemption as well, subject to the general conditions. A riskless principal transaction is a transaction in which a Financial Institution, after having received an order from a Retirement Investor to buy or sell an investment product, purchases or sells the same investment product in a contemporaneous transaction for the Financial Institution's own account to offset the transaction with the Retirement Investor. The Department requests comment on whether the exemption text should include a definition of the terms “principal transaction” and “riskless principal transaction.” The proposal uses the defined term “Covered Principal Transaction” to describe the types of non-riskless principal transactions that would be covered under the exemption. For purchases from a Plan or IRA, the term is broadly defined to include any securities or other investment property. This is to reflect the possibility that a principal transaction will be needed to provide liquidity to a Retirement Investor. However, for sales to a Plan or IRA, the proposed exemption would provide more limited relief. For those sales, the definition of Covered Principal Transaction would be limited to transactions involving: corporate debt securities offered pursuant to a registration statement under the Securities Act of 1933; U.S. Treasury securities; debt securities issued or guaranteed by a U.S. federal government agency other than the U.S. Department of Treasury; debt securities issued or guaranteed by a government-sponsored enterprise (GSE); municipal bonds; certificates of deposit; and interests in Unit Investment Trusts. The Department seeks comment on whether any of these investments should be further defined for clarity. The Department intends for this exemption to accommodate new and additional investments, as appropriate. Accordingly, the definition of Covered Principal Transaction is designed to expand to include additional investments if the Department grants an individual exemption that provides relief for investment advice fiduciaries to sell the investment to a Retirement Investor in a principal transaction, under the same conditions as this class exemption. For sales of a debt security to a Plan or IRA, the definition of Covered Principal Transaction would require the Financial Institution to adopt written policies and procedures related to credit quality and liquidity. Specifically, the policies and procedures must be reasonably designed to ensure that the debt security, at the time of the recommendation, has no greater than moderate credit risk and has sufficient liquidity that it could be sold at or near its carrying value within a reasonably short period of time. This standard is intended to identify investment grade securities, and is included to prevent the exemption from being available to Financial Institutions that recommend speculative debt securities from their own accounts. The proposal is broader than the scope of FAB 2018-02, which did not include principal transactions involving municipal bonds. The Department cautions, however, that Financial Institutions and Investment Professionals should pay special care to the reasons for advising Retirement Investors to invest in municipal bonds. Tax-exempt municipal bonds are often a poor choice for investors in ERISA plans and IRAs because the plans and IRAs are already tax advantaged and, therefore, do not benefit from paying for the bond's tax-favored status. 44 Financial Institutions and Investment Professionals may wish to document the reasons for any recommendation of a tax-exempt municipal bond and why the recommendation, despite the tax consequences, was in the Retirement Investor's best interest. 44 See e.g., Seven Questions to Ask When Investing in Municipal Bonds, available at http://www.msrb.org/~/media/pdfs/msrb1/pdfs/seven-questions-when-investing.ashx. (“[T]ax-exempt bonds may not be an efficient investment for certain tax advantaged accounts, such as an IRA or 401k, as the tax-advantages of such accounts render the tax-exempt features of municipal bonds redundant. Furthermore, since withdrawals from most of those accounts are subject to tax, placing a tax exempt bond in such an account has the effect of converting tax-exempt income into taxable income. Finally, if an investor purchases bonds in the secondary market at a discount, part of the gain received upon sale may be subject to regular income tax rates rather than capital gains rates.”) The Department seeks public comment on all aspects of the proposal's treatment of principal transactions, including the proposal to provide relief in this exemption for principal transactions involving municipal bonds. Do commenters believe that the exemption should extend to principal transactions involving municipal bonds? Do commenters believe the definition of municipal bonds should be limited to taxable municipal bonds? Should the exemption include any additional safeguards for these transactions? Are there any other transactions that would benefit from special care before making a recommendation in addition to municipal bonds? The Department requests comments on whether its proposed mechanism for including new and additional investments through later, individual exemptions provides sufficient flexibility. Exclusions Section I(c) provides that certain specific transactions would be excluded from the exemption. Under Section I(c)(1), the exemption would not extend to transactions involving ERISA-covered Plans if the Investment Professional, Financial Institution, or an affiliate is either (1) the employer of employees covered by the Plan, or (2) is a named fiduciary or plan administrator, or an affiliate thereof, who was selected to provide advice to the Plan by a fiduciary who is not independent of the Financial Institution, Investment Professional, and their affiliates. The Department is of the view that, to protect employees from abuse, employers generally should not be in a position to use their employees' retirement benefits as potential revenue or profit sources, without additional safeguards. Employers can always render advice and recover their direct expenses in transactions involving their employees without need of an exemption. 45 Further, the Department does not intend for the exemption to be used by a Financial Institution or Investment Professional that is the named fiduciary or plan administrator of a Plan or an affiliate thereof, unless the Financial Institution or Investment Professional is selected as an advice provider by a party that is independent of them. 46 Named fiduciaries and plan administrators have significant authority over Plan operations and accordingly, the Department believes that any selection of these parties to also provide investment advice to the Plan or its participants and beneficiaries should be made by an independent party who will also monitor the performance of the investment advice services. 45 ERISA section 408(b)(5) provides a statutory exemption for the purchase of life insurance, health insurance, or annuities, from an employer with respect to a Plan or a wholly-owned subsidiary of the employer. 46 For purposes of this exemption, the Department would view a party as independent of the Financial Institution and Investment Professional if: (i) The person was not the Financial Institution, Investment Professional or an affiliate, (ii) the person did not have a relationship to or an interest in the Financial Institution, Investment Professional or any affiliate that might affect the exercise of the person's best judgment in connection with transactions covered by the exemption, and (iii) the party does not receive and is not projected to receive within the current federal income tax year, compensation or other consideration for his or her own account from the Financial Institution, Investment Professional or an affiliate, in excess of 2% of the person's annual revenues based upon its prior income tax year. As reflected in Section I(c)(2), the exemption also would not extend to transactions that result from robo-advice arrangements that do not involve interaction with an Investment Professional. Congress previously granted statutory relief for investment advice programs using computer models in ERISA sections 408(b)(14) and 408(g) and Code sections 4975(d)(17) and 4975(f)(8) and the Department has promulgated applicable regulations thereunder. 47 Thus, while “hybrid” robo-advice arrangements 48 would be permitted under the exemption, arrangements in which the only investment advice provided is generated by a computer model would not be eligible for relief under the exemption. The Department requests comment on whether additional relief is needed for robo-advice arrangements which do not involve interaction with an Investment Professional. 47 29 CFR 2550.408g-1. 48 Hybrid robo-advice arrangements involve both computer software-based models and personal investment advice from an Investment Professional. Finally, under Section I(c)(3), the exemption would not extend to transactions in which the Investment Professional is acting in a fiduciary capacity other than as an investment advice fiduciary. This is consistent with FAB 2018-02, which applied to investment advice fiduciaries. For clarity, Section I(c)(3) cites to the Department's five-part test as the governing authority for status as an investment advice fiduciary. Exemption Conditions Section II of the proposal sets forth the general conditions that would be included in the exemption. Section III establishes the eligibility requirements. Section IV would require parties to maintain records to demonstrate compliance with the exemption. Section V includes the defined terms used in the exemption. These sections are discussed below. In order to avoid a prohibited transaction, the Financial Institution and Investment Professional would have to comply with all of the conditions of the exemption, and could not waive or disclaim compliance with any of the conditions. Similarly, a Retirement Investor could not agree to waive any of the conditions. Investment Advice Arrangement (Section II) Section II sets forth conditions that would govern the Financial Institution's and Investment Professionals' provision of investment advice. As discussed in greater detail below, Section II(a) would require Financial Institutions and Investment Professionals to comply with the Impartial Conduct Standards by providing advice that is in Retirement Investors' best interest, charging only reasonable compensation, and making no materially misleading statements about the investment transaction and other relevant matters. The Impartial Conduct Standards would further require the Financial Institution and Investment Professional to seek to obtain the best execution of the investment transaction reasonably available under the circumstances, as required by the federal securities laws. Section II(b) would require Financial Institutions, prior to engaging in a transaction pursuant to the exemption, to provide a written disclosure to the Retirement Investor acknowledging that the Financial Institution and its Investment Professionals are fiduciaries under ERISA and the Code, as applicable. 49 The disclosure also would be required to provide a written description, accurate in all material respects regarding the services to be provided and the Financial Institution's and Investment Professional's material conflicts of interest. Under Section II(c), the Financial Institution would be required to establish, maintain and enforce written policies and procedures prudently designed to ensure that the Financial Institution and its Investment Professionals comply with the Impartial Conduct Standards. Section II(d) would require Financial Institutions to conduct an annual retrospective review. 49 As noted above, the Department does not intend the exemption to expand Retirement Investors' ability, such as by requiring contracts and/or warranty provisions, to enforce their rights in court or create any new legal claims above and beyond those expressly authorized in ERISA. Neither does the Department believe the exemption would create any such expansion. Best Interest Standard As defined in Section V(a), the proposed best interest standard would be satisfied if investment advice “reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, and does not place the financial or other interest of the Investment Professional, Financial Institution or any affiliate, related entity or other party ahead of the interests of the Retirement Investor, or subordinate the Retirement Investor's interests to their own.” This proposed best interest standard is based on longstanding concepts derived from ERISA and the high fiduciary standards developed under the common law of trusts, and is intended to comprise objective standards of care and undivided loyalty, consistent with the requirements of ERISA section 404. 50 These longstanding concepts of law and equity were developed in significant part to deal with the issues that arise when agents and persons in a position of trust have conflicting interests, and accordingly are well-suited to the problems posed by conflicted investment advice. 50 Cf. also Code section 4975(f)(5), which defines “correction” with respect to prohibited transactions as placing a Plan or IRA in a financial position not worse that it would have been in if the person had acted “under the highest fiduciary standards.” While the Code does not expressly impose a duty of loyalty on fiduciaries, the best interest standard proposed here is intended to ensure adherence to the “highest fiduciary standards” when a fiduciary advises a Plan or IRA owner under the Code. The proposal's standard of care is an objective standard that would require the Financial Institution and Investment Professional to investigate and evaluate investments, provide advice, and exercise sound judgment in the same way that knowledgeable and impartial professionals would. 51 Thus, an Investment Professional's and Financial Institution's advice would be measured against that of a prudent Investment Professional. As indicated in the text, the standard of care is measured at the time the advice is provided, and not in hindsight. 52 The standard would not measure compliance by reference to how investments subsequently performed or turn Financial Institutions and Investment Professionals into guarantors of investment performance; rather, the appropriate measure is whether the Investment Professional gave advice that was prudent and in the best interest of the Retirement Investor at the time the advice is provided. 51 See Regulation Best Interest Care Obligation, 17 CFR 240.15l-1(a)(2)(ii); Regulation Best Interest Release, 84 FR at 33321 (Under the Care Obligation, “[t]he broker-dealer must understand potential risks, rewards, and costs associated with the recommendation.”); id., at 33326 (“We are adopting the Care Obligation largely as proposed; however, we are expressly requiring that a broker-dealer understand and consider the potential costs associated with its recommendation, and have a reasonable basis to believe that the recommendation does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer.”); id. at 33376 & n. 598 (discussing the Care Obligation in the context of complex or risky securities and investment strategies; citing FINRA Regulatory Notice 17-32 as explaining that “[t]he level of reasonable diligence that is required will rise with the complexity and risks associated with the security or strategy. With regard to a complex product such as a volatility-linked [Exchange Traded Product], an associated person should be capable of explaining, at a minimum, the product's main features and associated risks.”). 52 See Donovan v. Mazzola, 716 F.2d 1226, 1232 (9th Cir. 1983). The proposal articulates the best interest standard as the Financial Institutions' and Investment Professionals' duty to “not place the financial or other interest of the Investment Professional, Financial Institution or any affiliate, related entity or other party ahead of the interests of the Retirement Investor, or subordinate the Retirement Investor's interests to their own.” The standard is to be interpreted and applied consistent with the standard set forth in the SEC's Regulation Best Interest 53 and the SEC's interpretation regarding the conduct standard for registered investment advisers. 54 55 53 Regulation Best Interest's best interest obligation provides that a “broker, dealer, or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer.” 17 CFR 240.15l-1(a)(1). 54 “An investment adviser's fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. This fiduciary duty requires an adviser `to adopt the principal's goals, objectives, or ends.' This means the adviser must, at all times, serve the best interest of its client and not subordinate its client's interest to its own. In other words, the investment adviser cannot place its own interests ahead of the interests of its client.” SEC Fiduciary Interpretation, 84 FR at 33671(citations omitted). 55 The NAIC's updated Suitability in Annuity Transactions Model Regulation includes a safe harbor for recommendations made by financial professionals that are ERISA and Code fiduciaries in compliance with the duties, obligations, prohibitions and all other requirements attendant to such status under ERISA and the Code. NAIC Suitability in Annuity Transactions Model Regulation, Spring 2020, Section 6.E.(5)(c), available at https://www.naic.org/store/free/MDL-275.pdf. This best interest standard would allow Investment Professionals and Financial Institutions to provide investment advice despite having a financial or other interest in the transaction, so long as they do not place the interests ahead of the interests of the Retirement Investor, or subordinate the Retirement Investor's interests to their own. For example, in choosing between two investments equally available to the investor, it would not be permissible for the Investment Professional to advise investing in the one that is worse for the Retirement Investor because it is better for the Investment Professional's or the Financial Institution's bottom line. Because the standard does not forbid the Financial Institution or Investment Professional from having an interest in the transaction this standard would not foreclose the Investment Professional and Financial Institution from being paid, nor would it foreclose investment advice on proprietary products or investments that generate third party payments. The best interest standard in this proposal would not impose an unattainable obligation on Investment Professionals and Financial Institutions to somehow identify the single “best” investment for the Retirement Investor out of all the investments in the national or international marketplace, assuming such advice were even possible at the time of the transaction. The obligation under the best interest standard would be to give advice that adheres to professional standards of prudence, and that does not place the interests of the Investment Professional, Financial Institution, or other party ahead of the Retirement Investor's financial interests, or subordinate the Retirement Investor's interests to those of the Investment Professional or Financial Institution. Neither the best interest standard nor any other condition of the exemption would establish a monitoring requirement for Financial Institutions or Investment Professionals; the parties can, of course, establish a monitoring obligation by agreement, arrangement, or understanding. Under Section II(b), discussed below, Financial Institutions would, however, be required to disclose which services they will provide. Moreover, Financial Institutions should carefully consider whether certain investments can be prudently recommended to the individual Retirement Investor in the first place without ongoing monitoring of the investment. Investments that possess unusual complexity and risk, for example, may require ongoing monitoring to protect the investor's interests. An Investment Professional may be unable to satisfy the exemption's best interest standard with respect to such investments without a mechanism in place for monitoring. The added cost of monitoring such investments should also be considered by the Financial Institution and Investment Professional in determining whether the recommended investments are in the Retirement Investor's best interest. The Department requests comments on this best interest standard and whether additional examples would be useful. Reasonable Compensation General Section II(a)(2) of the exemption would establish a reasonable compensation standard. Compensation received, directly or indirectly, by the Financial Institution, Investment Professional, and their affiliates and related entities for their services would not be permitted to exceed reasonable compensation within the meaning of ERISA section 408(b)(2) and Code section 4975(d)(2). The obligation to pay no more than reasonable compensation to service providers has been long recognized under ERISA and the Code. ERISA section 408(b)(2) and Code section 4975(d)(2) expressly require all types of services arrangements involving Plans and IRAs to result in no more than reasonable compensation to the service provider. Investment Professionals and Financial Institutions—as service providers—have long been subject to this requirement, regardless of their fiduciary status. The reasonable compensation standard requires that compensation not be excessive, as measured by the market value of the particular services, rights, and benefits the Investment Professional and Financial Institution are delivering to the Retirement Investor. Given the conflicts of interest associated with the commissions and other payments that would be covered by the exemption, and the potential for self-dealing, it is particularly important that Investment Professionals and Financial Institutions adhere to these statutory standards, which are rooted in common law principles. In general, the reasonableness of fees will depend on the particular facts and circumstances at the time of the recommendation. Several factors inform whether compensation is reasonable, including the market price of service(s) provided and/or the underlying asset(s), the scope of monitoring, and the complexity of the product. No single factor is dispositive in determining whether compensation is reasonable; the essential question is whether the charges are reasonable in relation to what the investor receives. Under the exemption, the Financial Institution and Investment Professional would not have to recommend the transaction that is the lowest cost or that generates the lowest fees without regard to other relevant factors. Recommendations of the “lowest cost” security or investment strategy, without consideration of other factors, could in fact violate the exemption. The reasonable compensation standard would apply to all transactions under the exemption, including investment products that bundle together services and investment guarantees or other benefits, such as annuities. In assessing the reasonableness of compensation in connection with these products, it is appropriate to consider the value of the guarantees and benefits as well as the value of the services. When assessing the reasonableness of a charge, one generally needs to consider the value of all the services and benefits provided for the charge, not just some. If parties need additional guidance in this respect, they should refer to the Department's interpretations under ERISA section 408(b)(2) and Code section 4975(d)(2). The Department will provide additional guidance if necessary. Best Execution Section II(a)(2)(B) of the exemption would require that, as required by the federal securities laws, the Financial Institution and Investment Professional seek to obtain the best execution of the investment transaction reasonably available under the circumstances. Financial Institutions and Investment Professionals subject to federal securities laws such as the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940, and rules adopted by FINRA and the Municipal Securities Rulemaking Board (MSRB), are obligated to a longstanding duty of best execution. As described recently by the SEC, “[a] broker-dealer's duty of best execution requires a broker-dealer to seek to execute customers' trades at the most favorable terms reasonably available under the circumstances.” 56 This condition complements the reasonable compensation standard set forth in ERISA and the Code. 56 Regulation Best Interest Release, 84 FR at 33373, note 565. The Department would apply the best execution requirement consistent with the federal securities laws. Financial Institutions that are FINRA members would satisfy this subsection if they comply with the standards in FINRA rules 2121 (Fair Prices and Commissions) and 5310 (Best Execution and Interpositioning), or any successor rules in effect at the time of the transaction, as interpreted by FINRA. Financial Institutions engaging in a purchase or sale of a municipal bond would satisfy this subsection if they comply with the standards in MSRB rules G-30 (Prices and Commissions) and G-18 (Best Execution), or any successor rules in effect at the time of the transaction, as interpreted by MSRB. Financial Institutions that are subject to and comply with the fiduciary duty under section 206 of the Investment Advisers Act, which as described by the SEC encompasses a duty to seek best execution, would satisfy this subsection. 57 57 SEC Fiduciary Interpretation, 84 FR at 33674-75 (Section II.B.2 “Duty to Seek Best Execution”). Misleading Statements Section II(a)(3) would require that statements by the Financial Institution and its Investment Professionals to the Retirement Investor about the recommended transaction and other relevant matters are not materially misleading at the time they are made. Other relevant matters would include fees and compensation, material conflicts of interest, and any other fact that could reasonably be expected to affect the Retirement Investor's investment decisions. For example, the Department would consider it materially misleading for the Financial Institution or Investment Professional to include any exculpatory clauses or indemnification provisions in an arrangement with a Retirement Investor that are prohibited by applicable law. 58 Retirement Investors are clearly best served by statements and representations free from material misstatements and omissions. Financial Institutions and Investment Professionals best avoid liability—and best promote the interests of Retirement Investors—by ensuring that accurate communications are a consistent standard in all their interactions with their customers. 58 See, e.g., ERISA section 410 and see also ERISA Interpretive Bulletin 75-4—Indemnification of fiduciaries under ERISA § 410(a). (“The Department of Labor interprets section 410(a) as rendering void any arrangement for indemnification of a fiduciary of an employee benefit plan by the plan. Such an arrangement would have the same result as an exculpatory clause, in that it would, in effect, relieve the fiduciary of responsibility and liability to the plan by abrogating the plan's right to recovery from the fiduciary for breaches of fiduciary obligations.”) Disclosure—Section II(b) Section II(b) of the exemption would require the Financial Institution to provide certain written disclosures to the Retirement Investor, prior to engaging in any transactions pursuant to the exemption. The Financial Institution must acknowledge, in writing, that the Financial Institution and its Investment Professionals are fiduciaries under ERISA and the Code, as applicable, with respect to any fiduciary investment advice provided by the Financial Institution or Investment Professional to the Retirement Investor. The Financial Institution must provide a written description of the services to be provided and material conflicts of interest arising out of the services and any recommended investment transaction. The description must be accurate in all material respects. The disclosure obligations in this proposal are designed to protect Retirement Investors by enhancing the quality of information they receive in connection with fiduciary investment advice. The disclosures should be in plain English, taking into consideration Retirement Investors' level of financial experience. The requirement can be satisfied through any disclosure, or combination of disclosures, required to be provided by other regulators so long as the disclosure required by Section II(b) is included. The proposed disclosures are designed to ensure that the fiduciary nature of the relationship is clear to the Financial Institution and Investment Professional, as well as the Retirement Investor, at the time of the investment transaction. The Department does not intend the fiduciary acknowledgment or any of the disclosure obligations to create a private right of action as between a Financial Institution or Investment Professional and a Retirement Investor and it does not believe the exemption would do so. 59 As noted above, ERISA section 502(a) provides a cause of action for fiduciary breaches and prohibited transactions with respect to ERISA-covered Plans (but not IRAs). Code section 4975 imposes a tax on disqualified persons participating in a prohibited transaction involving Plans and IRAs (other than a fiduciary acting only as such). These are the sole remedies for engaging in non-exempt prohibited transactions. 59 In Chamber of Commerce of the United States v. U.S. Department of Labor, supra note 5, the U.S. Court of Appeals for the 5th Circuit found that the Department did not have authority to include certain contract requirements in the new exemptions granted as part of the 2016 fiduciary rulemaking. The Department is mindful of this holding and has not included any contract requirement in this proposal. The description of the services to be provided and material conflicts of interest is necessary to ensure Retirement Investors receive information to assess the conflicts and compensation structures. The approach taken in the proposal is principles-based and meant to provide the flexibility necessary to apply to a wide variety of business models and practices. The proposal does not require specific disclosures to be tailored for each Retirement Investor or each transaction as long as a compliant disclosure is provided before engaging in the particular transaction for which the exemption is sought. The Department requests comments on the disclosure requirements. In particular, the Department seeks comment on whether the written acknowledgment of fiduciary status should be accompanied by a disclosure of the fiduciary's obligations under the exemption to provide advice in accordance with the Impartial Conduct Standard. The Department also requests comment on whether the Department should instead require this disclosure of Financial Institutions' and Investment Professionals' obligations under the Impartial Conduct Standards as an alternative to requiring written disclosure of their fiduciary status. Policies and Procedures—Section II(c) General Section II(c)(1) of the proposal would establish an overarching requirement that Financial Institutions establish, maintain and enforce written policies and procedures prudently designed to ensure that the Financial Institution and its Investment Professionals comply with the Impartial Conduct Standards. Under Section II(c)(2), Financial Institutions' policies and procedures would be required to mitigate conflicts of interest to the extent that the policies and procedures, and the Financial Institution's incentive practices, when viewed as a whole, are prudently designed to avoid misalignment of the interests of the Financial Institution and Investment Professionals and the interests of Retirement Investors. In accordance with this standard, a reasonable person reviewing the Financial Institution's incentive practices, policies, and procedures would conclude that the policies do not give Investment Professionals an incentive to violate the Impartial Conduct Standards, but rather are reasonably designed to promote compliance with the standards. As defined in the proposal, a conflict of interest is “an interest that might incline a Financial Institution or Investment Professional—consciously or unconsciously—to make a recommendation that is not in the Best Interest of the Retirement Investor” 60 Conflict mitigation is a critical condition of the exemption, and is an important factor for the Department to make the findings under ERISA section 408(a) and Code section 4975(d)(2), that the exemption is in the interests of, and protective of, Retirement Investors. The requirement to avoid misalignment means, for example, that Financial Institutions' policies and procedures would be required to be prudently designed to protect Retirement Investors from recommendations to make excessive trades, or to buy investment products, annuities, or riders that are not in the investor's best interest or that allocate excessive amounts to illiquid or risky investments. 60 This definition is consistent with the concept of a conflict of interest in the SEC's rulemaking. Regulation Best Interest definition of Conflict of Interest, 17 CFR 240.15l-1(b)(3); SEC Fiduciary Interpretation, 84 FR at 33671. Section II(c)(3) of the exemption would establish specific documentation requirements for recommendations to roll over Plan or IRA assets to another Plan or IRA and to change from one type of account to another ( e.g., from a commission-based account to a fee-based account). Financial Institutions making these recommendations would be required to document the specific reason or reasons why the recommendation was considered to be in the best interest of the Retirement Investor. The Department requests comments on whether additional specific documentation requirements would be appropriate. To comply with the conditions in Section II(c), Financial Institutions would identify and carefully focus on the particular aspects of their business model that may create incentives that are misaligned with the interests of Retirement Investors. If, for example, a Financial Institution anticipates that conflicts of interest in its business model will center on advice to roll over Plan assets, and after the rollover, the Financial Institution and Investment Professional will be compensated on a level-fee basis, the Financial Institution's policies and procedures should focus on the rollover or distribution recommendation. The proposed requirement in Section II(c)(3) to document the reason for rollover and account recommendations supports compliance with the Impartial Conduct Standards in this context. 61 61 In general, after the rollover, the ongoing receipt of compensation based on a fixed percentage of the value of assets under management does not require a prohibited transaction exemption. However, the Department cautions that certain practices such as “reverse churning” ( i.e. recommending a fee-based account to an investor with low trading activity and no need for ongoing monitoring or advice) or recommending holding an asset solely to generate more fees may be prohibited transactions that would not satisfy the Impartial Conduct Standards. On the other hand, if a Financial Institution intends to receive transaction-based third party compensation, and compensate Investment Professionals based on transactions that occur in a Retirement Investor's accounts, such as through commissions, the Financial Institution's policies and procedures would also address the incentives created by these compensation arrangements. Financial Institutions that provide advice regarding proprietary products or from limited menus of products would consider the conflicts of interest these arrangements create. Approaches to these conflicts of interest are discussed in more detail below. Advice To Roll Over Plan or IRA Assets Rollover recommendations are a primary concern of the Department, as Financial Institutions and Investment Professionals may have a strong economic incentive to recommend that investors roll over assets into one of their Institution's IRAs, whether from a Plan or from an IRA account at another Financial Institution, or even between different account types. The decision to roll over assets from an ERISA-covered Plan to an IRA may be one of the most important financial decisions that Retirement Investors make, as it may have a long-term impact on their retirement security. The Department believes the requirement in Section II(c)(3) to document the reasons that advice to take a distribution or to roll over Plan or IRA assets were in the Retirement Investor's best interest will serve an important role in protecting Retirement Investors during this significant decision. The requirement is designed to ensure that Investment Professionals take the time to form a prudent recommendation, and that a record is available for later review. For purposes of compliance with the exemption, a prudent recommendation to roll over from an ERISA-covered Plan to an IRA would necessarily include consideration and documentation of the following: The Retirement Investor's alternatives to a rollover, including leaving the money in his or her current employer's Plan, if permitted, and selecting different investment options; 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. For rollovers from another IRA or changes from a commission-based account to a fee-based arrangement, a prudent recommendation would include consideration and documentation of the services that would be provided under the new arrangement. In evaluating a potential rollover from an ERISA-covered Plan, the Investment Professional and Financial Institution should make diligent and prudent efforts to obtain information about the existing Plan and the participant's interests in it. If the Retirement Investor is unwilling to provide the information, even after a full explanation of its significance, and the information is not otherwise readily available, the Investment Professional should make a reasonable estimation of expenses, asset values, risk, and returns based on publicly available information and explain the assumptions used and their limitations to the Retirement Investor. The Department requests comment on whether there are any other actions the Department should or could take with respect to disclosure or reporting that would promote prudent rollover advice without overlapping existing regulatory requirements. Commission-Based Compensation Arrangements Financial Institutions that compensate Investment Professionals through transaction-based payments and incentives would need to consider how to minimize the impact of these compensation incentives on fiduciary investment advice to Retirement Investors, so that the Financial Institution would be able to meet the exemption's standard of conflict mitigation set forth in proposed Section II(c)(2). As noted above, this standard would require the policies and procedures, and the Financial Institution's incentive practices, when viewed as a whole, to be prudently designed to avoid misalignment of the interests of the Financial Institution and Investment Professionals and the interests of Retirement Investors. For commission-based compensation arrangements, Financial Institutions would be encouraged to focus on both financial incentives to Investment Professionals and supervisory oversight of investment advice. These two aspects of the Financial Institution's policies and procedures would complement each other, and Financial Institutions would retain the flexibility, based on the characteristics of their businesses, to adjust the stringency of each component provided that the exemption's overall standards would be satisfied. Financial Institutions that significantly mitigate commission-based compensation incentives would have less need to rigorously oversee Investment Professionals. Conversely, Financial Institutions that have significant variation in compensation across different investment products would need to implement more stringent supervisory oversight. In developing compliance structures, the Department envisions that Financial Institutions would implement conflict mitigation strategies identified by the Financial Institutions' other regulators. The following non-exhaustive examples of practices identified as options by the SEC could be implemented by Financial Institutions in compensating Investment Professionals: (i) Avoiding compensation thresholds that disproportionately increase compensation through incremental increases in sales; (ii) Minimizing compensation incentives for employees to favor one type of account over another; or to favor one type of product over another, proprietary or preferred provider products, or comparable products sold on a principal basis, for example, by establishing differential compensation based on neutral factors; (iii) Eliminating compensation incentives within comparable product lines by, for example, capping the credit that an associated person may receive across mutual funds or other comparable products across providers; (iv) Implementing supervisory procedures to monitor recommendations that are: near compensation thresholds; near thresholds for firm recognition; involve higher compensating products, proprietary products or transactions in a principal capacity; or, involve the rollover or transfer of assets from one type of account to another (such as recommendations to roll over or transfer assets in an ERISA account to an IRA) or from one product class to another; (v) Adjusting compensation for associated persons who fail to adequately manage conflicts of interest; and (vi) Limiting the types of retail customer to whom a product, transaction or strategy may be recommended. 62 62 Regulation Best Interest Release, 84 FR at 33392. Financial Institutions also should consider minimizing incentives at the Financial Institution level. Firms could establish or enhance the review process for investment products that may be recommended to Retirement Investors. This process could include procedures for identifying and mitigating conflicts of interest associated with the product and declining to recommend a product if the Financial Institution cannot effectively mitigate associated conflicts of interest. Insurance companies and insurance agents that are investment advice fiduciaries relying on the exemption would be encouraged to adopt strategies similar to those identified above to address conflicts of interest. Insurance companies could also supervise independent insurance agents who provide investment advice on their products through the mechanisms noted above. To comply with the exemption, the insurer could adopt and implement supervisory and review mechanisms and avoid improper incentives that preferentially push the products, riders, and annuity features that might incentivize Investment Professionals to provide investment advice to Retirement Investors that does not meet the Impartial Conduct Standards. Insurance companies could implement procedures to review annuity sales to Retirement Investors to ensure that they were made in satisfaction of the Impartial Conduct Standards, much as they may already be required to review annuity sales to ensure compliance with state-law suitability requirements. 63 63 Cf. NAIC Suitability in Annuity Transactions Model Regulation, Spring 2020, Section 6.C.(2)(d) (“The insurer shall establish and maintain procedures for the review of each recommendation prior to issuance of an annuity that are designed to ensure that there is a reasonable basis to determine that the recommended annuity would effectively address the particular consumer's financial situation, insurance needs and financial objectives. Such review procedures may apply a screening system for the purpose of identifying selected transactions for additional review and may be accomplished electronically or through other means including, but not limited to, physical review. Such an electronic or other system may be designed to require additional review only of those transactions identified for additional review by the selection criteria”); and (e) (“The insurer shall establish and maintain reasonable procedures to detect recommendations that are not in compliance with subsections A, B, D and E. This may include, but is not limited to, confirmation of the consumer's consumer profile information, systematic customer surveys, producer and consumer interviews, confirmation letters, producer statements or attestations and programs of internal monitoring. Nothing in this subparagraph prevents an insurer from complying with this subparagraph by applying sampling procedures, or by confirming the consumer profile information or other required information under this section after issuance or delivery of the annuity”), available at https://www.naic.org/store/free/MDL-275.pdf. The prior version of the model regulation, which was adopted in some form by a number of states, also included similar provisions requiring systems to supervise recommendations. See Annuity Suitability (A) Working Group Exposure Draft, Adopted by the Committee Dec. 30, 2019, available at https://www.naic.org/documents/committees_mo275.pdf. (comparing 2020 version with prior version). In this regard, insurance company Financial Institutions would be responsible only for an Investment Professional's recommendation and sale of products offered to Retirement Investors by the insurance company in conjunction with fiduciary investment advice, and not unrelated and unaffiliated insurers. 64 Insurance companies could implement the policies and procedures by monitoring market prices and benchmarks for their products and services, and remaining attentive to any financial inducements they offer to independent agents that could result in a misalignment of the interests of the agent and his or her Retirement Investor customer. Insurers could also create a system of oversight and compliance by contracting with an IMO to implement policies and procedures designed to ensure that all of the agents associated with the intermediary adhere to the conditions of this exemption. Thus, for example, as one possible approach, the intermediary could eliminate compensation incentives across all the insurance companies that work with the intermediary, assisting each of the insurance companies with their independent obligations under the exemption. This might involve the intermediary's review of documentation prepared by insurance agents to comply with the exemption, as may be required by the insurance company, or the use of third-party industry comparisons available in the marketplace to help independent insurance agents recommend products that are prudent for the Retirement Investors they advise. 65 64 Cf. Id., Section 6.C.(4) (“An insurer is not required to include in its system of supervision: (a) A producer's recommendations to consumers of products other than the annuities offered by the insurer”), available at https://www.naic.org/store/free/MDL-275.pdf. 65 None of the conditions of this proposal are intended to categorically bar the provision of employee benefits to insurance company statutory employees, despite the practice of basing eligibility for such benefits on sales of proprietary products of the insurance company. See Internal Revenue Code section 3121. The Department notes that regulators in the securities and insurance industry have adopted provisions requiring elimination of sales contests and similar incentives such as sales quotas, bonuses, and non-cash compensation that are based on sales of certain investments within a limited period of time. 66 The Department agrees that these practices create incentives to recommend products that are not in a Retirement Investor's best interest that cannot be effectively mitigated. Therefore, Financial Institutions' policies and procedures would not be prudently designed to avoid a misalignment of interests between Investment Professionals and Retirement Investors if they establish or permit these practices. To satisfy the exemption's standard of mitigation, Financial Institutions would be required to carefully consider performance and personnel actions and practices that could encourage violation of the Impartial Conduct Standards. 66 Regulation Best Interest Release, 84 FR at 33394-97; NAIC Suitability in Annuity Transactions Model Regulation, Spring 2020, Section 6.C.(2)(h), available at https://www.naic.org/store/free/MDL-275.pdf. The Department notes Financial Institutions complying with the exemption would need to review their policies and procedures periodically and reasonably revise them as necessary to ensure that the policies and procedures continue to satisfy the conditions of this exemption. In particular, the exemption would require ongoing vigilance as to the impact of conflicts of interest on the provision of fiduciary investment advice to Retirement Investors. As a matter of prudence, Financial Institutions should address any deficiencies in their policies and procedures if, in fact, the policies and procedures are not achieving their intended goal of ensuring compliance with the exemption and the provision of advice that satisfies the Impartial Conduct Standards. The Department seeks comment on the proposed policy and procedure requirements, including whether this principle-based method is sufficiently protective of participants and beneficiaries. Proprietary Products and Limited Menus of Investment Products It is important to note that the Department believes that the best interest standard can be satisfied by Financial Institutions and Investment Professionals that provide investment advice on proprietary products or on a limited menu, including limitations to proprietary products 67 and products that generate third party payments. 68 Product limitations can serve a beneficial purpose by allowing broker-dealers and associated persons to develop increased familiarity with the products they recommend. At the same time, limited menus, particularly if they focus on proprietary products and products that generate third party payments, can result in heightened conflicts of interest. Financial Institutions and their affiliates may receive more compensation than they would for recommending other products, and, as a result, Investment Professionals' and Financial Institutions' interests may be misaligned with the interests of Retirement Investors. 67 Proprietary products include products that are managed, issued or sponsored by the Financial Institution or any of its affiliates. 68 Third party payments include sales charges when not paid directly by the Plan or IRA; gross dealer concessions; revenue sharing payments; 12b-1 fees; distribution, solicitation or referral fees; volume-based fees; fees for seminars and educational programs; and any other compensation, consideration or financial benefit provided to the Financial Institution or an affiliate or related entity by a third party as a result of a transaction involving a Plan or IRA. Financial Institutions and Investment Professionals providing investment advice on proprietary products or on a limited menu would satisfy the standard provided they give complete and accurate disclosure of their material conflicts of interest in connection with such products or limitations and adopt policies and procedures that are prudently designed to prevent any conflicts of interest from causing a misalignment of the interests of the Financial Institution and Investment Professional with the interests of the Retirement Investor. This would include policies applicable to circumstances where the Financial Institution or Investment Professional prudently determines that its proprietary products or limited menu do not offer Retirement Investors an investment option in their best interest when compared with other investment alternatives available in the marketplace. The Department envisions that Financial Institutions complying with the Impartial Conduct Standards would carefully consider their product offerings and form a reasonable conclusion about whether the menu of investment options would permit Investment Professionals to provide fiduciary investment advice to Retirement Investors in accordance with the Impartial Conduct Standards. The exemption would be available if the Financial Institution prudently concludes that its offering of proprietary products, or its limitations on investment product offerings, in conjunction with the policies and procedures, would not cause a misalignment of interests. Financial Institutions and Investment Professionals cannot use a limited menu to justify making a recommendation that does not meet the Impartial Conduct Standards. The Department seeks comment on this analysis. Is this preamble guidance sufficient or do commenters believe that it is important for the exemption text to specifically address proprietary products and limited menus of investment products? Should the Department more specifically incorporate provisions of Regulation Best Interest in this respect? 69 Should this exemption specify documentation requirements reflecting the Financial Institution's analysis or conclusions with respect to its adoption of a limited menu or its recommendation of proprietary products, and its ability to comply with the conditions of this exemption with respect to such products or menus? 69 See 17 CFR 240.15l-1(a)(2)(iii)(C) describing policies and procedures addressing material limitations placed on securities or investment strategies. Retrospective Review—Section II(d) Section II(d) of the proposal relates to the Financial Institution's oversight of its compliance, and its Investment Professionals' compliance, with the Impartial Conduct Standards and the policies and procedures. While mitigation of Financial Institutions' and Investment Professionals' conflicts of interest is critical, Financial Institutions must also monitor Investment Professionals' conduct to detect advice that does not adhere to the Impartial Conduct Standards or the Financial Institution's policies and procedures. Under the proposal, Financial Institutions would be required to conduct a retrospective review, at least annually, that is reasonably designed to assist the Financial Institution in detecting and preventing violations of, and achieving compliance with, the Impartial Conduct Standards and the policies and procedures governing compliance with the exemption. The Department envisions that the review would involve testing a sample of transactions to determine compliance. The methodology and results of the retrospective review would be reduced to a written report that is provided to the Financial Institution's chief executive officer (or equivalent officer). That officer would be required to certify annually that: (A) The officer has reviewed the report of the retrospective review; (B) The Financial Institution has in place policies and procedures prudently designed to achieve compliance with the conditions of this exemption; and (C) The Financial Institution 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. This retrospective review, report and certification would be required to be completed no later than six months following the end of the period covered by the review. The Financial Institution would be required to retain the report and supporting data for a period of six years. If the Department, any other federal or state regulator of the Financial Institution, or any applicable self-regulatory organization, requests the written report and supporting data within those six years, the Financial Institution would make the requested documents available within 10 business days of the request. The Department believes that the requirement to provide the written report within 10 business days will ensure that Financial Institutions diligently prepare their reports each year, resulting in meaningful protection of Retirement Investors. The Department requests comments about this process, including regarding the timing and certified information. Financial Institutions can use the results of the review to find more effective ways to ensure that Investment Professionals are providing investment advice in accordance with the Impartial Conduct Standards, and to correct any deficiencies in existing policies and procedures. Requiring the chief executive officer (or equivalent, i.e., the most senior officer or executive in charge of managing the Financial Institution) to certify review of the report is a means of creating accountability for the review. This would serve the purpose of ensuring that more than one person determines whether the Financial Institution is complying with the conditions of the exemption and avoiding non-exempt prohibited transactions. If the chief executive officer does not have the experience or expertise to determine whether to make the certification, he or she would be expected to consult with a knowledgeable compliance professional to be able to do so. The proposed retrospective review is based on FINRA rules governing how broker-dealers supervise associated persons, 70 adapted to focus on the conditions of the exemption. The Department is aware that other Financial Institutions are subject to regulatory requirements to review their policies and procedures; 71 however, for the reasons stated above, the Department believes that the specific certification requirement in the proposal will serve to protect Retirement Investors in the context of conflicted investment advice transactions. 70 See FINRA rules 3110, 3120, and 3130. 71 See e.g., Rule 206(4)-7 under the Investment Advisers Act of 1940. Eligibility (Section III) Section III of the proposal identifies circumstances under which an Investment Professional or Financial Institution would not be eligible to rely on the exemption. The grounds for ineligibility would involve certain criminal convictions or certain egregious conduct with respect to compliance with the exemption. The proposed period of ineligibility would be 10 years. Criminal Convictions An Investment Professional or Financial Institution would become ineligible upon the conviction of any crime described in ERISA section 411 arising out of provision of advice to Retirement Investors, except as described below. The Department includes crimes described in ERISA section 411 for the proposal because they are likely to directly contravene the Investment Professional's or Financial Institution's ability to maintain the high standard of integrity, care, and undivided loyalty demanded by a fiduciary's position of trust and confidence. Ineligibility after a criminal conviction described in the exemption would be automatic for an Investment Professional. However, Financial Institutions with a criminal conviction described in the exemption would be permitted to submit a petition to the Department and seek a determination that continued reliance on the exemption would not be contrary to the purposes of the exemption. Petitions would be required to be submitted within 10 business days of the conviction to the Director of the Office of Exemption Determinations by email at e-OED@dol.gov, or by certified mail at Office of Exemption Determinations, Employee Benefits Security Administration, U.S. Department of Labor, 200 Constitution Avenue NW, Suite 400, Washington, DC 20210. Following receipt of the petition, the Department would provide the Financial Institution with the opportunity to be heard, in person or in writing or both. Because of the 10-business day timeframe for submitting a petition, the Department would not expect the Financial Institution to set forth its entire position or argument in its initial petition. The opportunity to be heard in person would be limited to one in-person conference unless the Department determines in its sole discretion to allow additional conferences. The Department's determination as to whether to grant the petition would be based solely on its discretion. In determining whether to grant the petition, the Department will consider the gravity of the offense; the relationship between the conduct underlying the conviction and the Financial Institution's system and practices in its retirement investment business as a whole; the degree to which the underlying conduct concerned individual misconduct, or, alternately, corporate managers or policy; how recent was the underlying lawsuit; remedial measures taken by the Financial Institution upon learning of the underlying conduct; and such other factors as the Department determines in its discretion are reasonable in light of the nature and purposes of the exemption. The Department would consider whether any extenuating circumstances would indicate that the Financial Institution should be able to continue to rely on the exemption despite the conviction. The standard for the determination, as stated above, would be that continued reliance on the exemption would not be contrary to the purposes of the exemption. Accordingly, the Department will focus on the Financial Institution's ability to fulfil its obligations under the exemption prudently and loyally, for the protection of Retirement Investors. The Department will provide a written determination to the Financial Institution that articulates the basis for the determination. The Department notes that the denial of a Financial Institution's petition will not necessarily indicate that the Department will not entertain a separate individual exemption request submitted by the same Financial Institution subject to additional protective conditions. Conduct With Respect to Compliance With the Exemption An Investment Professional or Financial Institution would become ineligible upon the date of a written ineligibility notice from the Director of the Office of Exemption Determinations that they (i) engaged in a systematic pattern or practice of violating the conditions of the exemption; (ii) intentionally violated the conditions of this exemption; or (iii) provided materially misleading information to the Department in connection with the Investment Professional's or Financial Institution's conduct under the exemption. This type of conduct in connection with exemption compliance would indicate that the entity should not be permitted to continue to rely on the broad prohibited transaction relief in the class exemption. The proposal sets forth a process governing the issuance of the written ineligibility notice, as follows. Prior to issuing a written ineligibility notice, the Director of the Office of Exemption Determinations would be required to issue a written warning to the Investment Professional or Financial Institution, as applicable, identifying specific conduct that could lead to ineligibility, and providing a six-month opportunity to cure. At the end of the six-month period, if the Department determined that the conduct persisted, it would provide the Investment Professional or Financial Institution with the opportunity to be heard, in person or in writing, before the Director of the Office of Exemption Determinations issued the written ineligibility notice. The written ineligibility notice would articulate the basis for the determination that the Investment Professional or Financial Institution engaged in conduct warranting ineligibility. Period and Scope of Ineligibility The proposed period of ineligibility would be 10 years; however, the ineligibility provisions would apply differently to Investment Professionals and Financial Institutions. An Investment Professional convicted of a crime would become ineligible immediately upon the date the Investment Professional is convicted by a trial court, regardless of whether that judgment remains under appeal, or upon the date of the written ineligibility notice from the Office of Exemption Determinations. A Financial Institution's ineligibility would be triggered by its own conviction or receipt of a written ineligibility notice, or that of another Financial Institution in the same Control Group. A Financial Institution is in a Control Group with another Financial Institution if, directly or indirectly, the Financial Institution owns at least 80 percent of, is at least 80 percent owned by, or shares an 80 pe [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2020-14261. Public record. Not legal advice.