Unpacking DOL PTE 2020-02

In today’s podcast, DOL PTE 2020-02 experts Fred Reish, David Porteous and Joan Neri from the law firm of Faegre Drinker Biddle & Reath will be discussing the current state of the industry’s implementation, how different firms are approaching the requirements, self-correction, and what they see as the DOL’s approach. 

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Transcript

Bob Mooney:  Welcome to the Oyster Stew Podcast. I'm Bob Mooney, General Counsel for Oyster Consulting. Thanks for joining us for the first of two podcasts, covering the current state of the Department of Labor Prohibited Transaction Exemption 2020-02.  Oyster’s Ed Wegener is joined by DOL experts, Fred Reish, David Porteous, and Joan Neri from the law firm of Faegre Drinker Biddle, and Reath. In today's podcast, our experts will be discussing the current state of the industry's implementation questions and challenges that have come up, how firms are implementing the requirements, including the self-correction obligation, and what they see as the do L's approach. Let's get started, ed.

Ed Wegener:  Well, thank you and hello, everyone. I'm Ed Wegener, and I am the head of Governance Risk and Compliance at Oyster Consulting. I want to welcome you to today's discussion regarding the current state of the DOL PTE 2020-02, and by current, we're recording this podcast in mid-April of 2023. For, for context. So the prohibited transaction exemption allows parties that provide fiduciary investment advice to re retirement investors to be able to receive otherwise prohibited compensation or engage in otherwise prohibited transactions, provided they comply with specific requirements. The enforcement date for most of the exemption began in February of 2022, with enforcement of the remaining requirements related to rollover disclosures beginning in July of 2022. So today we wanted to talk about the current state of the industry's implementation of these requirements, including questions and challenges that have come up in terms of that implementation. We also want to discuss some of the legal challenges to the requirements that have happened and the impact, if any of those if any, on of, of the, the legal challenges that have been made. So I'm very fortunate to have joining me today from the law firm of Faegre Drinker Biddle and Reath, Fred Reish, Joan Neri, and David Porteous.  Each are very much experts in these areas, and I want to welcome you all for joining us today.

Thank you. So why don't we get started and maybe it'd be good to provide a short refresher on the exemption, including when firms need to rely on the exemption and what the requirements they need to meet if they are relying on the exemption. So, Joan, maybe we'll start with you. If you could kick us off there and others please feel free to join in.

Joan Neri:  Thank you, Ed.  As you mentioned this is a PTE prohibited transaction exemption that's available for non-discretionary conflicted advice. So advice that would otherwise be prohibited. And one of the most significant elements of this exemption is that the DOL also reinterpreted when they issued this exemption, the regulatory definition of fiduciary advice. And in particular, one of the elements of that regulatory test, namely the element that the advisor that is regularly providing the advice. And what the Department of Labor interprets that to mean now is that it includes advice that's provided where the advisor anticipates that that will be the first step in an ongoing financial relationship. So the significance of that is rollover advice where an advisor is recommending a rollover in most instances, that is the first step in what the advisor anticipates being an ongoing financial relationship in the IRA that that the advisor manages.

So, it was a big element to causing rollover recommendations to now meet the regulatory definition of fiduciary advice. And for that reason, this PTE is now being used by advisors who make rollover recommendations, so as to avoid a prohibited transaction. So that's sort of the background behind the scope of this. The exemption itself, as you mentioned, has a number of conditions that need to be met in order to avoid a prohibited transaction. These include meeting a standard of conduct, which looks and feels a lot like the ERISA prudence standard and duty of Loyalty. So it's basically requiring that an advisor who needs to use this exemption now needs to meet a fiduciary like standard of conduct and then be able to establish that the advice is in the best interest of the investor.

In addition the fee that's charged can be no more than a reasonable fee, disclosure has to be provided in advance of the implementation of the transaction. So if it's a rollover in advance of the rollover being implemented, and that disclosure needs to acknowledge to the investor that the advisor is a fiduciary under ERISA or the code, and also describe how the recommendation results in a conflict of interest for the advisor, describe the services that are recommended as part of that advice. And also, and this is probably one of the most challenging elements of the exemption, when it's a rollover recommendation, the advisor needs to describe why that, or explain why that recommendation is in the best interest of the investor. So needs to provide the best interest reason or reasons for making that recommendation.

And in what the DOL tells us is that to carry out that analysis, the advisor needs to dig deep and make a comparison and evaluation of the plan that the investor is currently in and the IRA that is recommended as part of the rollover.  And evaluate the services, the fees, the investments, and ultimately determine whether that recommendation is in the best interest. One thing I should do, and back up here, and say is that this definition of fiduciary advice that's in the DOL regulatory rules and this PTE has a wider scope than just ERISA plans. It also does cover individual retirement accounts and other tax qualified plans that are subject to the prohibited transaction rules. And that's because the internal revenue code has prohibited transaction rules that mirror the ERISA prohibited transaction rules.

And the DOL regulatory definition of fiduciary advice applies, applies to both. So, this exemption is not only used for rollovers that involve plan to IRA rollovers, but also IRA to IRA recommendations and plan to plan rollover recommendations, and even a change of account for a plan or an IRA. So, so a very broad definition of rollover advice. So, as I mentioned, there's a disclosure obligation. There's also an obligation that policies and procedures be established to ensure compliance with the PTE. And there is an obligation after the end of the year to undertake, and we'll get into this in more detail in this podcast, a retrospective review of whether there's been compliance, and also to identify and detect any mistakes or errors that were undertaken or that occurred in the course of trying to meet this, this PTE and a senior executive officer has to certify to the results of that retrospective review. So let me just pause there. That's a lot to digest and give the other panelists a chance to weigh in on what I've laid out there.

Fred Reish:

Yeah, let me jump in at this point, Joan, and Ed a couple things. One, I just wanted to add to the last thing that Joan said, that annual retrospective review has to be reduced to a report, and as Joan said, it's got to be signed off on by a senior executive officer by June 30. So it's just around the corner that's coming up fast. Going back to the fact that, as Joan pointed out, this is both who is a fiduciary, and then if you make a fiduciary recommendation that causes you to receive income, what's the consequence of that? So going back to who is a fiduciary, as Joan mentioned, there is this regular basis test, but it's really a five-part test. People listening to this call have probably heard of the five-part test.

Well, the regular basis requirement is one of those five parts. The other four are pretty uniformly satisfied. So that's the big one is particularly with rollovers, is regular basis. So that's for non-discretionary investment advice. And PTE 2020-02 will, if its conditions are satisfied, provide relief.  They will, in other words, the exemption will exempt the broker dealer, or the investment advisor, whoever the advisor is, from the prohibited transaction consequences if all the conditions of the exemption are satisfied. Non-discretionary investment advice is where an advisor satisfies the five-part test. So they're a fiduciary, and then they make a recommendation, juxtapose that to discretion. If an advisor, an investment advisor, for example, is managing an account with discretion, an IRA or a plan, there is no exemption there. I mean, there are very few exemptions and clearly 2020-02 does not apply.

Either you find another exemption, and there are a couple others, for example, prohibited transaction exemption 77-4 for proprietary mutual funds, but there are very few, nothing anywhere near as broad as 2020-02. So that's the fiduciary part of this. On the prohibited transaction side, what is a prohibited transaction? Well, once you're a fiduciary, virtually any transaction-based compensation is conflicted. It's a prohibited transaction 12b-1 fees, insurance commissions, front end loads on mutual funds, but then some of the things that are less obvious, revenue sharing payments from a custodian for assets held by that custodian, payments back to the RIA or the broker dealer, that results. So any additional income like that, any financial benefit that results from a fiduciary recommendation is a prohibited transaction. And where it's non-discretionary investment advice, you then need to satisfy the exemption, or you can't keep the compensation plus penalties can be assessed.

So, and then as Joan said, we'll get to the annual retrospective review later, but that's what you're looking for in the annual retrospective review that you, one of the things is, wow, we had transactions we didn't even properly identify, that should have been subject to the exemption as well as we had transactions that we didn't satisfy all of the conditions for. So that's sort of the lay of the land, and just adding to what Joan already said about what is fiduciary status and what is a private transaction and how does the exemption relate to that.

Ed Wegener:  You know, one of the things that you had mentioned in terms of the five part test, one of the big ticket items is the regular basis portion, and that's been challenged in the courts and I want to get to that court challenge. But before we do, just one of the things that comes up in discussions with our clients, I hear a lot is where firms are either saying that they're not making recommendations in their discussions around rollovers or they're just providing educational information, which there's a limited exemption around that.  Are you seeing that being identified as an exemption that firms are relying on. And if so, what sort of advice would you give those firms in terms of what they should be thinking about if they're going to rely on that exemption? And I'll throw that open to the group.

Fred Reish:

Sure. Well, let me jump in first, because you and I've talked about this a little bit in the past. Yes, there are some firms relying on that.  And in my experience working with clients, that's primarily broker dealers and primarily mid-sized and smaller broker dealers. But if well, now that I think about it also some small investment advisory firms and the issue there is if you're providing education and you're not making a recommendation, then you're not a fiduciary because fiduciary requires that you make recommendations on a regular basis that are individualized and that all five parts of the test are satisfied. But if you're providing education information and education, then you're not making a recommendation. And some firms either because of the burden of complying with PTE 2020-02, are because they're worried about the sophistication of their advisors in this area have decided to go.

The education approach, I've talked to other firms about it, and they've said, Fred, our advisors make recommendations. That's what they do all day every day. We don't, we're not educators, we're brokers, we're advisors. And so they've rejected it entirely in a sense, for fear that their advisors wouldn't follow it anyway. And then that gets to, well, what about the people that are trying to follow it? And I've seen that to, sort of two scenarios firms or three scenarios, RIA firms that are so small, they look at all the requirements and say, there are only two or three advisors here, Fred, how are we going to do an annual retrospective review of each other? And, put in all the time to do that. And it just doesn't make sense to us. We're going to our clients, we generally get rollovers from people whose accounts we're already managing.

We'll just talk to them about it. We'll just educate them. Then on the broker dealers side, you get either all of our brokers, all of our advisors have to just educate, or we're going to let the advisors that do a certain amount of retirement plan work recommend and use PTE 2020-02, and we're going to require that the others educate. There's risk and education as FINRA pointed out in in its regulatory notice 1345, you have to make sure that the advisors are just educating. I mean, there is a responsibility on the broker dealer to make sure that it is education. And you know, people try to walk along the line. The problem is, if you walk along the edge of a cliff, you might fall into the canyon. And the issue there is implied recommendations, even if all the advisors don't use sentences that start with, I recommend you get to, although there's an implied recommendation is something that's sort of one of the stories in the retirement industry about an applied recommendation is, if I were you, I would do such and such.

I mean, we all agree that's an applied recommendation. I mean, that's sort of the chitter chatter in the retirement world. Beyond that, though, the top official at the Department of Labor has come out and said if you make a proposal as to how the IRA would be invested if the participant rolled over, we, the Department of Labor will view that as an implied recommendation subject to PTE 2020-02. Well, if you're treating as education, obviously are not complying with PTE 2020-02 and the multiple conditions that Joan told us about. So that means you've got a non-exempt prohibited transaction, maybe a lot of them. And if you do, then you know that, at that point, there's no way to cure it. You just have a world of hurt. So I think if a firm recognizes the risk they're taking and really manages it well, there's a good chance you could make education work. But I think the risk is that your advisors, by and large, their value proposition is that they make recommendations. And to expect a cat to become a dog is, might be a little much, but anyway, it's a risk. It's a risk, Ed. That's my view.

Joan Neri:

I've also had similar experiences as you Fred, and what I'll say is I have advisors that have started off thinking that that's what they're going to do. They're just going to be educators. And then I have a follow up meeting with them where they're telling me, it's very difficult. We're in there.  Our advisor’s in the room with the investor. And then when the investor is asking, what do you think? What should I do? What are they going to do? Walk away?  They can't do that. So, as you said, it's very easy to step over the line and for those education meetings to morph into investment advice. And so what I'm finding is a lot of firms are training their advisors to be able to deal with both avenues, because as I said, those education meetings can very, very easily slip into an advisory meeting,

Ed Wegener:  You know, following on the analogy that you use Fred with the walking next to the cliff, one way that you can mitigate the risk of walking next to a cliff is staying well clear of the cliff, right? And so that would be somebody who says, we're just going to go ahead and comply and just assume that we're doing recommendations.  But if you're going to walk close to the cliff, building up a wall so that you don't accidentally fall into the cliff. And so what we've been talking to our clients about who want to explore that path or go down that path, is, if you're going to do so, make sure you understand where the cliff is and understand what types of things would cause you to be considered making recommendations or going beyond the limited educational information that you can provide.

So really understanding that, making sure that you bake that into your policies and procedures and that you're very clear about what you can and can't do, and the p policies and procedures, and then making sure that you're providing training to your advisors so that when they're in those rooms, they're very clear on what it is that they can and can't do. And then having some way to document your efforts around all of those things that you have built that wall up around the edge of the cliff. I think those are the types of things that I would want to do in order to mitigate any potential risk. And I would anticipate based on what you had heard from the DOL that there's going to be a level of skepticism if you're saying that you're relying on no recommendations or education. So you really want to be persuasive to the DOL if they come in and start asking this and say, okay, we're taking this approach and here's how we've built that wall. I think that's kind of how I would approach that. And I don't know if anybody has any other thoughts with respect to that.

Fred Reish:   I agree. I was just going to say, I agree that the steps that I just discussed are good steps. So you can document that it wasn't just words written on one page that this is an education, but that you've actually trained the people to do it. You're actually supervising it, you know, that you've got all the steps in place that a reasonable organization would want to have in place to make sure there was compliance. And you can show it, you can show that you've got the steps.

David Porteous:

Yeah, and I think to that point, it's context is everything. If you're saying, we're going to be education only, but our guys go out into the field and they're all doing this in one-on-one meetings, you're stepping into that skepticism.  It doesn't mean that you can't overcome it because you can say, here, look at our marketing materials, look at the training regarding our marketing materials and this is how it's presented. And then also look at the disconnect between the timeframe we have the education only seminar. And, ultimately when a person makes a decision, it's not day of taking a step back from that. You know, when I've seen, particularly with RIAs who do a lot of investment education as a general marketing practice, they have it pretty systematized, right? There's a dinner, 50 people are invited to it, you know, the purpose of the dinner is to talk about market outlook and big picture concepts.

And so to the extent that context is baked into your process, again, you've avoided the one-on-one perception that they don't believe <laugh>, that it's education only.  It's institutionalized, that we have a marketing process. This is kind of the education we do. We talk market outlook. We also talk about the rollover options and how that works as a general matter. You know, I think that those all go into having that your paperwork, meaning your marketing materials, your training materials line up with the practice in the field. So whether it's a one-on-one setting or it's a broader seminar type setting, those are also going to set you up for a greater degree of credibility in the process of adhering to an education only system.

Ed Wegener:  Absolutely.