Now Who Is a Fiduciary?
Art by Tim Bower
Regulation Best Interest or “Reg BI” will become effective on June 30, 2020. In the preamble to its final rulemaking, the Securities and Exchange Commission (SEC) made clear that Reg BI applies in some circumstances, but not others, to securities recommendations made regarding plans covered by the Employee Retirement Income Security Act (ERISA). Reg BI also applies to recommendations involving individual retirement accounts (IRAs). Thus, firms and their representatives that act as broker/dealers (B/Ds) under the Exchange Act of 1934 must determine whether they are acting as fiduciaries under ERISA even if not acting as advisers under the Investment Advisers Act of 1940.
If they are acting as advisers, the firms and their representatives must navigate how they will apply both ERISA’s and Reg BI’s requirements. Importantly, there is a question as to whether the Department of Labor (DOL) will now change its views about whether a person is, or is not, acting as a fiduciary when providing “investment advice” as the term is defined under ERISA Section 3(21)(A)(ii) and Section 4975(e)(3) of the Internal Revenue Code (IRC).
Reg BI applies when a firm or its representative recommends any securities transaction or investment strategy that involves securities to a retail customer. As is relevant here, a retail customer includes a participant in an ERISA-covered plan as well as an IRA owner. However, a retail customer does not include persons who act as a named fiduciary to the plan as a whole, but only in that capacity to a plan participant.
Additionally, these types of recommendations include any regarding trading securities within a plan account or IRA, or selecting account types, which, the SEC states, include advice to take a distribution from a plan and roll the money into an IRA.
The 5th Circuit Court of Appeals in Chamber of Commerce of the U.S. v. U.S. Department of Labor, a year ago March, vacated the DOL’s regulation intended to change its definition of investment advice. Therefore, in Field Assistance Bulletin (FAB) No. 2018-02, the DOL states that firms and their representatives should treat the regulation as if it never existed. This means the longstanding regulation promulgated under ERISA Section 3(21)(A)(ii) and IRC Section 4975(e)(3), which includes the five-part test for determining whether a person provides investment advice, applies.
The DOL has not explicitly stated whether its views in Advisory Opinion 2005-23A, commonly known as the Deseret opinion, have changed. In the Deseret opinion, the department said a recommendation to take a distribution and roll over the proceeds to an IRA was investment advice under the five-part test only if the person making the recommendation was already a fiduciary to the plan. In that case, such a recommendation would be an exercise of discretionary management over the plan, and thus the adviser would be acting as a fiduciary.
Historically, many broker/dealers concluded that they and their representatives do not provide investment advice to ERISA plans and IRAs under the five-part test. They concluded that, while they make recommendations as to the advisability of buying, investing in, or selling securities or other property, they do not meet one or more of the test’s other requirements: that their advice is on a “regular basis,” by “mutual agreement,” is the “primary basis” for a decision, and is “individualized.”
Additionally, they looked to the Deseret opinion to conclude that they do not provide investment advice when making rollover recommendations.
Notably, after they reviewed the nature of their customer relationships in order to comply with the now vacated DOL investment advice regulation, some B/Ds realized they might not have been passing the five-part test. Those firms are now relying on the transition relief found in FAB No. 2018-02 or considering whether other strategies are available to address prohibited transactions that arise under ERISA Section 406 and IRC Section 4975.
In reaction to the promulgation of a final Reg BI, firms should consider whether complying with the rule will give them fiduciary status under the five-part test. At least arguably, if a firm and its representatives make recommendations covered by Reg BI, and subsequently comply with the rule’s disclosure obligation, care obligation, conflict of interest obligation and compliance obligation, this could result in those advisers moving closer to fiduciary status under the test.
Further, the DOL states in its 2019 regulatory agenda that the Employee Benefits Security Administration (EBSA) will issue a proposed regulation concerning the definition of “investment advice” under ERISA Section 3(21)(A)(ii). Departed DOL Secretary Acosta also publicly stated that the agency will synchronize its own regulations with the SEC’s rulemaking. Exactly what this means remains to be seen.
David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers. He served on the Department of Labor’s ERISA Advisory Council from 2012 through 2014.