Understanding the DOL’s definition of an investment advice fiduciary

If the proposed rule and associated amendments are finalized, they'd significantly expand which parties may be considered investment advice fiduciaries under ERISA and the code. This would impose new and expanded requirements on investment firms and professionals.

Existing fiduciary rule

The proposed rule would replace the DOL’s “five-part test,” which was originally issued in 1975. Under the five-part test, individuals are a fiduciary only if they meet the following five elements:

• Render advice about the value of securities or other property or make recommendations on the advisability of investing in, purchasing, or selling securities or other property
• Provide advice on a regular basis
• Provide advice pursuant to a mutual agreement, arrangement, or understanding with the plan or a plan fiduciary 
• Advice serves as a primary basis for investment decisions on plan assets
• Advice is individualized based on the plan’s needs

According to the DOL, the five-part test as applied to the current marketplace fails to capture many circumstances in which investors reasonably believe they’re receiving advice from a fiduciary. If adopted, the proposed rule would replace the five-part test with a new test that the DOL believes reflects the current marketplace and the intent of ERISA.

It’s important to note that the current regulation was drafted when IRAs were less common and 401(k) plans didn’t exist. Today, 401(k) plan participants and IRA owners are expected to make important, complex financial decisions and are, therefore, more likely to seek the help of investment advisers.

Proposed fiduciary rule

The proposed rule defines investment advice fiduciaries as individuals who perform the following:

• Directly or indirectly (through or together with any affiliate) have discretionary authority or control—that may or may not be pursuant to an agreement, arrangement, or understanding—about purchasing or selling securities or other investment property for the retirement investor
• Directly or indirectly (through or together with any affiliate) make investment recommendations to retirement investors on a regular basis as part of their business, and recommendations are in the retirement investors’ best interest and based on their particular needs or individual circumstances
• Represent or acknowledge that they’re acting as a fiduciary when making investment recommendations

Amendments to prohibited transaction exemptions  

The DOL is also proposing amendments to related existing PTEs that are available to investment advice fiduciaries. These proposed amendments seek to make the exemption conditions more uniform and protective. 

Under ERISA, investment advice fiduciaries must avoid conflicts of interest or comply with the conditions of a PTE. The proposed amendments to the exemptions would uniformly require investment advice fiduciaries to give advice that:

• Meets a professional standard of care or duty of prudence
• Puts the retirement investor first (duty of loyalty)
• Prohibits charging more than reasonable compensation or misleading investors

DOL objectives

According to the DOL, the proposed rule would ensure that when investors entrust their retirement security to investment firms and professionals, their confidence isn’t misplaced, regardless of what investment is recommended. The proposed rule would also assure that investment firms and professionals are able to compete for business on a level playing field, instead of an unbalanced system that holds advisers to different standards based on their recommended products. For example, investment firms and professionals would now be held to the fiduciary standard on rollover IRAs.

Reactions to the proposed rule

The proposed rule has been met with some criticism. Opposers feel this latest proposal imposes burdensome regulations that have already proven to make investing more difficult, especially for those who fall in the lower income levels. They’ll most likely advocate for changes to the proposed rule to ensure it’s administratively feasible for different business models, products, and services.

Conversely, proponents say updated fiduciary rules should better position employees for retirement. Since investment advice associated with 401(k) and other employer-sponsored plans isn’t subject to the SEC’s Regulation Best Interest and, therefore, not currently required to be in the customer’s best interest, the proposed rule will put the right focus on investment recommendations.

Next steps

The proposals include a 60-day period for public comments and instructions on how to submit comments, which is open until January 2, 2024. Additionally, the DOL plans to hold a public hearing on December 12 through December 13. Information on the hearing has been published in the Federal Register.