Compliance June 25, 2021

A DOL Fiduciary Rule and PTE Refresher

No matter if an adviser is a flat-fee registered investment adviser or a commission-based broker/dealer, the DOL says the collection of compensation related to rollover guidance is almost always going to be a prohibited transaction, triggering the need for an exemption.

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Even as experts anticipate further regulatory activity will affect the Department of Labor (DOL)’s fiduciary investment advice standards, it is important to get caught up on the current state of affairs, which can best be described as convoluted.

Effective February 16 of this year, the DOL implemented an expanded definition of “fiduciary advice.” Experts say this new definition will cause many registered investment adviser (RIA) services that were previously considered non-fiduciary under the Employee Retirement Income Security Act (ERISA) to be subject to a fiduciary best interest standard of conduct moving forward.

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In a related move in February, the DOL also established a new prohibited transaction exemption (PTE) for fiduciary advice, meant to allow advisers to provide guidance and collect compensation in more situations than they otherwise would have been able to under the expanded advice definition. Formally, this exemption is known as PTE 2020-02.

During a webinar hosted this week by the law firm Faegre Drinker Biddle & Reath LLP, a team of expert ERISA attorneys—including Joan Neri, Fred Reish, Brad Campbell, Joshua Waldbeser and Jeffrey Blumberg—dissected these rule changes and offered their thoughts about what comes next.

The panel of attorneys explained that the newly expanded definition of fiduciary advice is built directly upon the older “five-part fiduciary advice test” that was initially articulated by the DOL way back in 1975. Under the test, an entity such as an adviser or an RIA firm is giving fiduciary investment advice only if it 1) is providing advice about investments for a fee; 2) is giving the advice on a regular basis; 3) is providing the advice subject to a mutual understanding that said advice is fiduciary in nature; 4) is giving advice with the understanding that it will be the primary basis for an investment decision; and 5) is providing individualized advice.

As the Faegre Drinker attorneys explained, the main change the DOL has made to this longstanding test was to reinterpret the second prong, i.e., the regular basis requirement. Put simply, the DOL has directly confirmed that advice causing someone to enact a rollover, for example from a 401(k) plan to an individual retirement account (IRA), does in fact meet the regular basis requirement in itself. Previously, rollover recommendations were not generally treated as fiduciary in nature, because they were construed as a one-time event that may or may not lead to a future ongoing fiduciary relationship.

In the view of the Faegre Drinker attorneys, the DOL’s new position is that essentially all types of guidance and recommendations pertaining to rollovers will be fiduciary advice. Previously, the opposite was true. Part of the rationale for this, the attorneys suggested, is that the DOL sees rollover recommendations as the likely start of an ongoing advisory relationship, and so the advice to enact the rollover should itself be treated as the beginning of the fiduciary relationship—not a precursor.

This state of affairs raises a key question: If rollover advice is fiduciary in nature, and it will result in added compensation going to the adviser or an affiliate, isn’t that a prohibited transaction? According to the Faegre Drinker attorneys, the answer is a clear yes—and hence explains why the DOL concurrently created a new prohibited transaction exemption. Stated another way: Whether one is a flat-fee RIA or a commission-based broker/dealer (B/D), the DOL has set it up so that the rollover recommendation itself is almost always going to be a prohibited transaction that requires formal exemption, all because the adviser is influencing the amount of compensation he or she will receive from a fiduciary client.

Here is where things get even more convoluted. Currently, as of June, the DOL is operating under a non-enforcement policy addressing this entire area of the law. This policy states, essentially, that advisers making good faith efforts to meet an existing federal best interest standard—such as the Regulation Best Interest (Reg BI) package already being enforced by the U.S. Securities and Exchange Commission (SEC)—need not now be in formal compliance with the PTE 2020-02 in order to collect compensation on rollover recommendations. This nonenforcement policy is set to expire on December 20.

The Faegre Drinker attorneys said a key takeaway for advisers is that a pathway for recommending fiduciary rollovers and being compensated for that advice (and the future relationship) certainly exists. However, there is a lot of work that will go into actually complying with all the practical and documentation requirements of PTE 2020-02—far more than many advisers and firms may realize.

The attorneys noted that advisers or other entities that cannot, for whatever reason, meet the requirements of PTE 2020-02, may be able to use other exemptions that already exist. And, adding yet more complexity, the DOL has just this month confirmed that it will be revisiting the underlying fiduciary advice regulation, i.e., the five-part test. It will be doing this as a full regulatory project that will begin this December with an entirely new proposed regulation. At the earliest, this regulatory project would not be finished until 2022, meaning it could become applicable in 2023.

As Campbell put it, “We are still in the thick of this.”

The Markets June 25, 2021

Helping Near-Retirees Stay on Track for Retirement Security

It can be tempting for those nearing retirement to turn to equities in a last ditch effort to improve retirement savings, but certain communications and plan design features can steer them in the right direction.

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The “Late Baby Boomer” generation—which includes those born between 1960 and 1965—was hit hard by the great financial crisis (GFC) and the COVID-19 recession. However, some of that vulnerability could be self-inflicted, Capital Group contends. At the cusp of retirement, a good number of these investors might have over-allocated to equities in a last-ditch attempt to fill the gap in their retirement savings—the exact opposite of what they should have done.

During a session presented by Capital Group, home of American Funds, at the 2021 virtual PLANSPONSOR National Conference (PSNC), Naomi Fink, retirement economist within Capital’s Institutional Analytics Group, noted that Late Boomers had saved less than previous generations at time of the GFC; they had an average defined contribution (DC) account balance of $29,963. “Why they saved less is a great mystery because of concerns about Social Security and the disappearance of DB [defined benefit] plans,” she said.

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However, Fink said, the Center for Retirement Research at Boston College (CRR) found the lower savings came about because during the GFC, Late Boomers experienced job losses or had lower earnings.

“Job losses and lower earnings can affect retirement savings. One way the effect can be shifted is through a boost in earnings or by working longer,” she said. Fink calls job and earning status a person’s “human capital” and says instead of just trying to save as much as possible, Late Boomers can focus on boosting their human capital.

But another problem affecting the retirement savings of this generational group is incorrect investment decisions. “Anecdotally, they weren’t contributing during a job loss. Then they went back to work with lower wages, so to make up for lost time, they invested in equities,” Fink said. She said individuals at this age should be shifting from equities to bonds, and that is true even when a job loss has occurred.

“When there is a job separation, it often leads to lower earnings, and this downward motion of human capital doesn’t change,” Fink said. “They need to use effective strategies to make up for that.”

Enhancing Plan Design and Investments

To help improve plan design and investments not only for participants near retirement but for everyone in the plan, Chris Anast, senior retirement strategist with the Institutional Analytics Group at Capital Group, said automatic plan features, such as auto-enrollment and auto-escalation, are a great step. “Thinking of participants who are in similar situations now and those that might be going forward, it’s important to get people in the plan,” he said.

If plan sponsors use auto-enrollment, they should set it at a healthy default deferral rate, Fink said.

It’s also important to prevent money from coming out of the plan, Anast added.

Christina Elliott, executive director of the Ohio Public Employees Deferred Compensation Plan (Ohio DC), said the plan doesn’t include a loan program. However, in light of the pandemic, Ohio DC considered the Coronavirus Aid, Relief and Economic Security (CARES) Act and what it could adopt to help people through the COVID-19 crisis.

“We saw more unexpected emergency withdrawals than we’ve seen in the plan’s history,” she said. “There were not job losses with our employees, but with their families, and also some employees and their families had health issues due to COVID.”

To avoid having participants take money out of the plan, Fink suggested plan sponsors communicate about the potential consequences of loans and withdrawals and educate about the unexpected. She also suggested that plan sponsors implement a holistic financial wellness program.

“One thing that keeps recurring is those without emergency savings are more likely to take a withdrawal, so encouraging emergency savings, either through an employer or not, will help,” Fink said. “Similarly, education and aid with managing student loan and other types of debt will help participants avoid withdrawals [from retirement plans].”

In addition to the temptation to move assets from fixed income to equity investments, pre-retirees may face other investment temptations, Anast noted, citing as an example the GameStop incident in 2020, when the company’s stock price went through the roof after amateur traders in a Reddit forum invested in the stock to drive up the price. “Plan sponsors should educate participants about how to keep from falling for [these short-term spikes],” he said.

Elliott said Ohio DC thought it was important to communicate about the GameStop incident. “People don’t make the best decisions when in crisis,” she said. “We partnered with a company for AI [artificial intelligence], smart, ethical and specific customized messages about financial wellness. Outside investing and outside investing tools are not bad things, but if participants don’t understand the basics of finance, they can get into trouble.”

Financial wellness programs and communications help participants focus on what’s important, Elliott added.

She also said Ohio DC received some questions from participants about annuitizing part of their balances—an option the pandemic has brought to light as something to explore. But, for public employees in Ohio, she said, having pension plans and helping participants understand the benefits of those plans helps with managing investment risk.

Fink said asset allocation funds, such as target-date funds (TDFs), also help participants with investment decisions. “And sometimes they help people ‘do nothing,’ which is sometimes the best thing,” she said.

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