Compliance December 30, 2020

Key DOL Prohibited Transaction Exemption Considerations

Everyone is initially eligible for the DOL’s new prohibited transaction exemption, though the regulator reserves the right to suspend eligibility for up to 10 years after certain violations.

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During a recent webinar hosted by Fi360, Jason Roberts, CEO of Pension Resource Institute, and Steve Niehoff, chief operating officer (COO) at Pension Resource Institute, emphasized a few important points about the new prohibited transaction exemption (PTE) recently finalized by the Department of Labor (DOL).

For the most part, the final fiduciary framework being embraced by the DOL closely resembles the proposed version put forward this summer. This is to say the DOL has confirmed and formalized the return to the old “five-part test” used for determining who is an investment advice fiduciary, while it has also finalized the new PTE, which is directly tied to the Regulation Best Interest (Reg BI) standard implemented this year by the Securities and Exchange Commission (SEC).

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As Niehoff and Roberts explained, all advisers and brokers start out being eligible for the PTE. However, the DOL reserves the right to make an investment professional or financial institution ineligible to use the exemption for a period of up to 10 years, should certain failures or violations occur. These include, first and foremost, being convicted of any crime under Section 411 of the Employee Retirement Income Security Act (ERISA).

“This is a long list of crimes, but they are serious matters, so they should be relatively easily avoidable by prudent and loyal advisers and brokers,” Niehoff said.

The second pathway to becoming ineligible for the new PTE is to receive a written ineligibility notice from the DOL, which can occur for a number of less severe reasons. These include engaging in a systematic pattern or practice of violating the conditions of the exemption, intentionally violating the conditions of the exemption, or providing materially misleading information to the DOL pertaining to the exemption.

“Again, all of these are unlikely to be triggered by prudent and dedicated advisers, but the risk is there, and it must be considered,” Niehoff said. “To that end, you must educate your advisers and staffers on the importance of compliance.”

Roberts encouraged advisers and brokers to closely study the DOL’s stated interpretation of how the five-part fiduciary status test comes into play during rollover recommendations. It seems that the DOL expects rollovers to frequently trigger prohibited transactions and, thus, that the PTE will be used heavily by advisers and brokers working on such matters with their clients and prospects. 

“If you are a fiduciary adviser to a plan and to participants in giving them personalized advice, a rollover recommendation will likely cause either yourself or a partner to collect additional revenues, which means you will have to rely on the DOL’s temporary enforcement policy and document the specific reasons why you believe this rollover is determined to be in the client’s best interest,” Roberts said. “If you are in compliance with the Regulation Best Interest and you are carefully documenting all your decisions, you should ultimately be in compliance with the DOL’s expectations for satisfying the conditions of the PTE.”

One interesting question that Niehoff and Roberts said they have heard a lot asks whether a registered investment adviser (RIA) can simply state to clients that it does not make rollover recommendations—that the financial professional instead can merely provide education on the topic.

“It’s a great question, and the answer is a qualified yes,” Roberts said. “The possibility of a prohibited transaction is not triggered by mere education. Be aware, though, that regulators are going to presume that high balance rollovers didn’t just jump into your boat by chance. The regulators will presume that some type of recommendation was made somewhere along the line, and it will be up to you to show that this wasn’t the case. This is why we are endorsing that, if a recommendation in fact was not made, the financial professional should get the client to positively attest to the fact in written records.”

Along the same lines, the speakers warned that regulators aren’t just going to look at the isolated five minutes when a rollover decision was made.

“They will look at the communications and relationship in aggregate,” Roberts explained. “They will take a holistic view of the entirety of the relationship, including even marketing materials or other things like that.”

Looking ahead to 2021, Roberts and Niehoff agreed that it is likely that the incoming Democratic administration of President-elect Joe Biden will take action in this area. However, they said, they expect the DOL to build on this new PTE as a floor—rather than to go back and rescind the PTE.

“The Biden-led DOL will likely change the definition of fiduciary investment advice, in my view, to cover more parties,” Roberts said. “However, I don’t think it will go so far as to create the same kind of private right of action that derailed the Obama administration’s attempt to expand the fiduciary definition. That private right of action was the crux of the DOL’s impermissible overreach, according to the 5th United States Circuit Court of Appeals.”

Roberts and Niehoff said it will likely take at least a year, and possibly two, for a Biden-led DOL to take action in this area.

Compliance December 30, 2020

SEC Deregulations Diminish Investor Protections, Office of the Investor Advocate Says

The office is also calling on the SEC to establish an ESG framework.

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In its “Report on Activities: Fiscal Year 2020,” the Office of the Investor Advocate at the Securities and Exchange Commission (SEC) outlines several areas in which it believes the SEC fell flat this year.

The office’s first objection concerns the change to the Exchange Act that makes it easier for public companies to exclude shareholder proposals from corporate proxy statements. Specifically, the office says it is now harder for shareholders with smaller investments—which it says often have fruitful ideas with respect to governance reforms—to submit proposals.

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According to the office, the SEC also amended the proxy rules in a way that requires proxy advisory firms to act as a conduit for company management to rebut the advice given. The office says the SEC made this change based on “the claims of select market participants that proxy voting advice historically had not been transparent, accurate and complete. The commission did not evaluate the substance of these claims or distinguish biased opinion from fact, and these claims remain unsupported by empirical evidence. … We believe investors should be free to seek the services of a third party to provide independent, objective advice about voting their shares—and investors should not be forced to pay for feedback mechanisms that subject them to further lobbying by corporate management.”

The SEC also adopted amendments to several Securities Act registration exemptions.

“A central underpinning of the Securities Act of 1933 is the idea that a company must register its shares with the commission and provide robust disclosures if it wishes to sell its securities to the general public. … However, over the past several decades, the central tenet of securities regulation has eroded as Congress and the commission created ever-expanding exemptions that allow companies to raise increasing amounts of capital with less and less public disclosure,” the office says. It says the new rules make “registration entirely voluntary.”

With respect to amendments to Investment Company Act rules concerning the use of derivatives, the office says “critical investor protection provisions contained in the proposed version of the rule were stripped away prior to adoption.” It would have also required broker/dealers (B/Ds) and investment advisers to exercise due diligence before approving retail investor accounts to invest in such products. The office is recommending that the SEC rescind the rule and reconsider the rule as it was originally written.

The Office of the Investor Advocate also detailed new priorities it would like to see the SEC champion, including environmental, social and governance (ESG) disclosure standards. The office notes that, for many years, investors of all sizes have called on the SEC to require public companies to disclose more ESG data, as is already being done in the European Union and elsewhere. “The information provided by companies tends to vary in quality, and it is not presented in a standard format that enables comparisons between companies,” the office says.

The office is also calling for minimum listing standards on corporate governance standards for exchanges. “The primary listing exchanges are now for-profit entities that, unlike their prior mutual ownership structure, have an inherent conflict of interest between protecting investors and generating business revenue from listed issuer fees,” the report says. Some exchanges, according to the office, have lowered their qualitative corporate governance standards in an effort to attract issuers. The office is calling on Congress to “set, by statute, certain minimum standards to guarantee investor protections.”

The office also says it is time for machine-readable disclosures, through a uniform legal entity identifier, as a way to modernize financial services firms. This, the office says, “would help investors utilize publicly available data from multiple sources.”

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