Search

The Department of Labor’s 2024 “Investment Advice” Fiduciary Regulations and Their Anticipated Effects on Plan Sponsors and Named Fiduciaries

The Department of Labor has issued new regulations addressing when a person offering investment advice to an employee benefit plan is considered a “fiduciary” of the plan.

Background

Section 3(21) of the Employee Retirement Income Security Act (“ERISA”) says that a person is a fiduciary of an ERISA-governed benefit plan “to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, (ii) he 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, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan.” A person who is named in the plan as a fiduciary or otherwise expressly granted the requisite discretion or authority is a fiduciary, but a person can also become a fiduciary by contract, or by functioning as a fiduciary even in the absence of any written commitment.

A plan fiduciary must carry out the fiduciary’s duties to a plan for the exclusive purpose of providing benefits to plan participants and beneficiaries and defraying reasonable plan expenses. In particular, under ERISA, a fiduciary is required to act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man 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.” A fiduciary must also avoid causing the plan to engage in a transaction which is included in the list of “prohibited transactions” under ERISA and the similar provisions of the Internal Revenue Code (the “Code”). The “prohibited transaction” rules bar plans from engaging in most transactions with the sponsoring employer, fiduciaries, vendors and various other “parties in interest,” unless the transaction qualifies for an exemption from the prohibitions. Some exemptions are established by ERISA and the Code, and others are issued by the Department of Labor.

Efforts at Regulatory Change

During the Obama Administration, the Department of Labor issued new regulations that would have made significant changes to the regulatory standard established in 1975 for determining when a person who provides investment advice for a fee is considered a “fiduciary” of an ERISA-governed plan. Among the changes, the Department’s regulation would have removed the regulatory requirement that investment advice be offered to the plan on a “regular basis.” While that requirement had been in the regulation since 1975, it does not appear in the statute, and the Department felt that it led to a gap between the expectations of a typical investor engaging in a one-off but very important plan-related transaction and the legal standard to which financial professionals were held. The Obama regulations and accompanying prohibited transaction exemptions also would have required financial professionals to adhere to various standards of disclosures and contractual protections depending on the services to be offered and the professional’s willingness to accept a fiduciary role. 

Following the Fifth Circuit’s invalidation of those regulations, the Trump Administration’s Department of Labor largely reinstated the 1975 regulatory provisions regarding the scope of fiduciary status. However, the Trump Administration’s Department attempted to reverse previous sub-regulatory guidance that had held that a financial professional providing advice with respect to a plan distribution or rollover is not a “fiduciary” by reason of offering that advice if the financial professional does not already have or anticipate an ongoing relationship with the plan, since the advice in that circumstance would not be offered on a “regular basis.” The Department’s new view, as reflected in the preamble to a prohibited transaction exemption allowing such advice to be given under specified circumstances and an accompanying online FAQ, was that if the financial professional anticipated a relationship with the plan participant after the payment was received from the plan, that was sufficient to bring the distribution advice within the regulatory requirement that investment advice be offered on a “regular basis” even though the plan in such a scenario would have no further involvement. A Florida court agreed that the interpretation reflected in the FAQ exceeded the Department’s authority and was contrary to the reinstated regulatory definition. A magistrate judge recommended that a Texas judge overseeing a similar lawsuit reject the Department’s new interpretation of its regulatory language in this regard as well, a point to which the Department conceded in a later filing. 

While these challenges to its sub-regulatory guidance were proceeding through the courts, the Department proposed a new set of regulations that would once again remove the “regular basis” requirement from the standard for determining whether someone is an “investment advice” fiduciary, along with making other changes to the regulatory regime for “investment advice” fiduciaries. The final versions of the new regulations (dubbed the “Retirement Security Rule”) and accompanying prohibited transaction exemptions were published on April 25, 2024, and the first lawsuit challenging the validity of the regulations was filed May 2, 2024.

Overview of the New Fiduciary Definition

Under revised Section 2510.3-21 of the Labor Regulations, “a person renders ‘investment advice’ with respect to moneys or other property of a plan or IRA if the person makes a recommendation of any securities transaction or other investment transaction or any investment strategy involving securities or other investment property…to a retirement investor…and either…(i) The person either directly or indirectly (e.g., through or together with any affiliate) makes professional investment recommendations to investors on a regular basis as part of their business and the recommendation is made under circumstances that would indicate to a reasonable investor in like circumstances that the recommendation is based on review of the retirement investor’s particular needs or individual circumstances, reflects the application of professional or expert judgment to the retirement investor’s particular needs or individual circumstances, and may be relied upon by the retirement investor as intended to advance the retirement investor’s best interest; or (ii) The person represents or acknowledges that they are acting as a fiduciary under Title I of ERISA, Title II of ERISA, or both, with respect to the recommendation.” The regulatory preamble explains that this standard will be interpreted in a manner consistent with the SEC’s Regulation Best Interest, and that the key question with respect to whether a communication constitutes a “recommendation” will be whether there is a “call to action.”

The regulation itself goes on to note that “a salesperson’s recommendation to purchase a particular investment or pursue a particular investment strategy is not investment advice if the person does not represent or acknowledge that they are acting as a fiduciary under ERISA Title I or Title II with respect to the recommendation and if the circumstances would not indicate to a reasonable investor in like circumstances that the recommendation is based on review of the retirement investor’s particular needs or individual circumstances, reflects the application of professional or expert judgment to the retirement investor’s particular needs or individual circumstances, and may be relied upon by the retirement investor as intended to advance the retirement investor’s best interest. Similarly, the mere provision of investment information or education, without an investment recommendation, is not advice within the meaning of this rule.” The Department also noted in the preamble that the regulation is not intended to cover ordinary communications by a plan sponsor’s employees to plan participants about their benefits. Furthermore, the Department left intact existing guidance regarding the difference between “investment advice” that can constitute a “recommendation” triggering fiduciary status and “investment education” that is provided on a non-fiduciary basis.

Despite those reassurances, however, the regulation also warns that disclaimers of fiduciary status will not exempt the person making a recommendation from fiduciary status if those disclaimers “are inconsistent with the person’s oral or other written communications, marketing materials, applicable State or Federal law, or other interactions with the retirement investor.” In this regard, it is worth noting that the Department’s prior regulations had required that the investment advice be rendered pursuant to a “mutual agreement, arrangement or understanding, written or otherwise, between such person and the plan or a fiduciary with respect to the plan, that such services will serve as a primary basis for investment decisions with respect to plan assets,” while the new regulations remove the requirement for a “mutual” agreement that the advice will be relied upon by a plan fiduciary.  Instead, the new regulations link fiduciary status to whether a “reasonable investor in like circumstances” would expect the advice to be provided in the investor’s best interest. The Department explained in the regulatory preamble that this change is intended to address situations in which financial institutions and professionals sought to rely on fine-print disclaimers of fiduciary status while presenting “themselves to investors as making a recommendation that considered an individual’s personal circumstances and was in their best interest.”

Furthermore, the Department designed the regulation to ensure that recommendations regarding a participant’s decision to take or defer payment from a plan or IRA or roll assets into an IRA, even if offered on a one-time basis, can qualify as fiduciary advice if the usual conditions are met. Thus, a financial professional who receives a direct or indirect fee for advising an individual as to whether, in that individual’s circumstances, it would be prudent to withdraw money from a retirement plan and roll it to an IRA, and who is reasonably perceived by the participant as acting in the participant’s best interest, would be an ERISA fiduciary. As an ERISA fiduciary, the financial professional would need to act prudently and in the participant’s best interests, and adhere to the terms of a prohibited transaction exemption in order to receive a commission or other type of compensation for the transaction.

With respect to the statutory requirement that a putative fiduciary receive a “fee” for the investment advice in order to become a fiduciary, the regulation takes a broad view. The regulation explains that:

“[A] person provides investment advice ‘for a fee or other compensation, direct or indirect,’ if the person (or any affiliate) receives any explicit fee or compensation, from any source, for the investment advice or the person (or any affiliate) receives any other fee or other compensation, from any source, in connection with or as a result of the recommended purchase, sale, or holding of a security or other investment property or the provision of investment advice, including, though not limited to, commissions, loads, finder’s fees, revenue sharing payments, shareholder servicing fees, marketing or distribution fees, mark ups or mark downs, underwriting compensation, payments to brokerage firms in return for shelf space, recruitment compensation paid in connection with transfers of accounts to a registered representative’s new broker-dealer firm, expense reimbursements, gifts and gratuities, or other non-cash compensation. A fee or compensation is paid ‘in connection with or as a result of’ such transaction or service if the fee or compensation would not have been paid but for the recommended transaction or the provision of investment advice, including if eligibility for or the amount of the fee or compensation is based in whole or in part on the recommended transaction or the provision of investment advice.”

Challenges to the Regulations

Legal experts debate the likelihood that trade groups challenging the regulations in court will succeed in arguments that the new regulatory standard is contrary to ERISA or otherwise beyond the Department’s authority.  

In terms of the possibility for legislative intervention, the regulations have drawn an opposition resolution supported by sixteen members of the Senate (most of them Republicans), but have received strong support from the Biden Administration. Various interest groups and politicians have offered a number of policy arguments for or against the new rules, and have debated the necessity for an expansion of ERISA’s protections to distribution advice in the wake of regulatory action taken by the SEC in this area. In light of these policy disputes, Congress’ other priorities and anticipated continued political gridlock, along with the White House’s support for the regulations, it is not anticipated that the regulations will be overturned legislatively under the current administration. 

Next Steps for Plan Sponsors and Named Fiduciaries

Financial firms that offer advice or products to individuals that may involve those individuals’ IRAs or employee benefit plans, and benefit plan vendors that regularly interact with plan participants, will no doubt be reviewing their protocols and offerings in light of the new regulations, assessing ways in which they may need or want to change their activities or update their documentation. In some cases, this may involve accepting a new level of fiduciary responsibility, and in others, it may involve altering the scope of services or revising disclosures to avoid fiduciary status. The plan fiduciaries who are responsible for selecting and overseeing vendors will need to review any updates provided by their vendors. Fiduciaries need to determine whether they remain comfortable with the services and products offered to their participants (and associated pricing) in the wake of any changes, and whether they are aligned with their vendors’ views as to whether the vendors are or are not fiduciaries with respect to any particular products or services. As always, plan fiduciaries will need to monitor the quality and cost-effectiveness of vendors’ products and services offered to plan participants, and take action to address any concerns by renegotiating prices, changing vendors, adding or dropping services, or otherwise remediating issues. The regulations did not change the obligations of individuals whose fiduciary status does not depend on the altered aspects of the “investment advice fiduciary” definition. Those fiduciaries always had and continue to have an obligation to act with prudence and in the best interests of plan participants. 

Plan sponsors that offer more generalized “financial wellness,” life-coaching and other benefits not tied to specific ERISA-governed plans but which may involve counseling employees about their employee benefit programs and/or IRAs may also need to react to changes made by vendors in response to the new rules, and should follow up with their vendors as necessary to ensure that the vendors have taken the new rules into account. The Department of Labor specifically declined to provide a categorical exemption from fiduciary status for vendors offering programs of these types.

As noted above, a challenge to the validity of the regulations has already been filed. Since the regulations do not take effect until the end of September 2024 and a number of provisions are subject to a delayed effective date pushing into 2025, financial firms may attempt to delay major changes to their operations to give the legal challenges a chance to play out. Plan fiduciaries with concerns about vendor activities in the meantime should discuss their questions with their vendors and legal counsel. Plan fiduciaries or sponsors with questions about what plan sponsor employees can or should do to assist participants with questions about their benefit programs should contact their legal counsel for assistance in understanding the parameters within which participant assistance can be provided without crossing the line into fiduciary advice.

As always, please feel free to contact a member of the Employee Benefits & Executive Compensation group at 585.232.6500 or 716.853.1316 for more information about the items discussed in this newsletter, or for assistance in other matters.

Attorney Advertising. Prior results do not guarantee a similar outcome. This publication is provided as a service to clients and friends of Harter Secrest & Emery LLP. It is intended for general information purposes only and should not be considered as legal advice. The contents are neither an exhaustive discussion nor do they purport to cover all developments in the area. The reader should consult with legal counsel to determine how applicable laws relate to specific situations. ©2024 Harter Secrest & Emery LLP