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The New Retirement Security Rule: Updated Fiduciary Definition Under ERISA

National Law Forum — Thu, 16 May 2024 14:32:00 +0000

On April 23, 2024, the U.S. Department of Labor (the “DOL”) promulgated a final rule, titled the “Retirement Security Rule” (the “Final Rule”), updating the definition of an “investment advice fiduciary” under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). In addition, the DOL issued final amendments to several prohibited transaction class exemptions (“PTEs”) available to investment advice fiduciaries, which together with the Final Rule seek to effectuate the DOL’s goal of requiring honest investment advice from investment advice fiduciaries to retirement investors. The updated fiduciary definition under the Final Rule and the amended PTEs will become effective on September 23, 2024, with a one-year phase-in period for certain conditions of the amended PTEs.

Fiduciary Definition

The framework for determining whether a person is an investment advice fiduciary has historically required that investment advice be provided to a retirement investor on a regular basis and pursuant to a mutual agreement, arrangement, or understanding that such advice will serve as a primary basis for investment decisions.

Under the Final Rule, a person will be an investment advice fiduciary for purposes of ERISA if (1) they make a recommendation of any securities transaction or other investment transaction or any investment strategy to a retirement investor for a fee or other compensation (direct or indirect), and (2) such recommendation arises in either one of the following contexts:

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 on by the retirement investor as intended to advance the retirement investor’s best interest; or
the person represents or acknowledges that they are acting as a fiduciary under ERISA with respect to the recommendation.

For purposes of the Final Rule, a “retirement investor” is defined as a plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary, or IRA fiduciary. “Recommendations” means recommendations as to:

the advisability of acquiring, holding, disposing of, or exchanging securities or other investment property, investment strategy, or how securities or other investment property should be invested following a rollover, transfer, or distribution from a plan or IRA;
the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements, or voting of proxies appurtenant to securities; or
rollovers, transfers, or distributions of assets from a plan or IRA, including recommendations as to whether to engage in the transaction, the amount, the form and the destination of such a rollover, transfer or distribution.

Significant Changes

The investment advice fiduciary standard in the Final Rule has become narrower than initially anticipated:

The DOL clarified that with respect to a person who becomes an investment advice fiduciary due to their representing or acknowledging that they are acting as a fiduciary under ERISA with respect to a recommendation, fiduciary status would apply only with respect to that recommendation and not with respect to every future interaction with the same retirement investor regardless of the circumstances.
The Final Rule includes a paragraph specifically confirming that sales pitches and investment education can be provided without triggering ERISA fiduciary status. A key component of this consideration is whether a sales pitch is individualized to a retirement investor’s particular needs and circumstances.

Amendment to Exemption for Transactions Involving Investment Advice (PTE 2020-02)

PTE 2020-02 generally permits parties providing fiduciary investment advice to retirement investors to receive reasonable compensation in exchange for their services, which would otherwise be prohibited in the absence of an exemption. The final amendment to PTE 2020-02 broadens the exemption to cover additional transactions and revises certain conditions, including conditions relating to disclosure, recordkeeping, and ineligibility.

The amended PTE 2020-02 applies to covered transactions on or after September 23, 2024; however, there is a one-year phase-in period beginning on September 23, 2024. During this phase-in period, investment professionals may receive reasonable compensation if they comply with the Impartial Conduct Standards and the fiduciary acknowledgement requirement.

Required Disclosure and Fiduciary Acknowledgement

The amended PTE 2020-02 requires investment advisers to provide a written acknowledgement that the institution and the investment professional are providing fiduciary advice and are fiduciaries under ERISA. Furthermore, the amended PTE 2020-02 requires investment advisers to make certain additional disclosures regarding fees, scope of services, and conflicts of interest.

Impartial Conduct Standard

The amended PTE 2020-02 replaces the “best interest standard” for determining impartial conduct with the “Care Obligation” and the “Loyalty Obligation,” which, according to the DOL, are more consistent with the Securities and Exchange Commission’s Regulation Best Interest. Under the Care Obligation, advice must reflect the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person 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, based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor. Under the Loyalty Obligation, the investment professional must not place the financial or other interests of the professional, their affiliate or related entity, or other party ahead of the interests of the retirement investor or subordinate the retirement investor’s interests to those of the professional, their affiliate, or related entity.

Policies and Procedures

Each investment adviser must establish, maintain, and enforce written policies and procedures prudently designed to ensure that the investment adviser and its investment professionals comply with the Impartial Conduct Standards and other exemption conditions. The policies must mitigate conflict of interests.

Specifically, investment advisers may not use quotas, appraisals, bonuses, special awards, differential compensation, or other similar actions in a manner that is intended, or that a reasonable person would conclude are likely, to result in recommendations that do not meet the Care Obligation or Loyalty Obligation. The investment adviser must provide their complete policies and procedures to the DOL within 30 days of a request.

Additionally, the investment adviser must continue to conduct a retrospective review at least annually that is reasonably designed to detect and prevent violations of and achieve compliance with the conditions of this exemption. The investment adviser must maintain records demonstrating compliance with PTE 2020-02 for a period of six years after the covered transaction.

Penalties

The amended PTE 2020-02 broadens the disqualification provisions to include convictions of certain affiliated entities and foreign convictions. Previously, an investment adviser or an investment professional was ineligible only upon a conviction for “crimes arising out of such person’s provision of investment advice” to retirement investors. Under the amended PTE 2020-02, however, a relevant conviction or final judgment that occurs on or after September 23, 2024, with respect to an entity in the same controlled group as an investment adviser would result in such investment adviser’s becoming ineligible to rely on PTE 2020-02 for a 10-year period.

The DOL’s Retirement Security Rule has broad implications for financial institutions, including investment advisers.

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Department of Labor Enables Consideration of ESG Factors in ERISA Investments

National Law Forum — Wed, 23 Nov 2022 18:00:37 +0000

Yesterday, the Department of Labor “released a final rule under the Employee Retirement Income Security Act (ERISA) . . . [that] clarif[ied] that fiduciaries may consider climate change and other environmental, social, and governance (ESG) factors when they make investment decisions and when they exercise shareholder rights, including voting on shareholder resolutions and board nominations.” This rule effectively overturned two rules published in the last months of the Trump Administration, which essentially prohibited the consideration of ESG factors when ERISA fiduciaries made investments or exercised their rights. In short, the Biden Administration has now enabled investment managers of ERISA funds to consider “factors [that] may include the economic effects of climate change and other ESG consideration on the particular investment or investment course of action.”

This action by the Department of Labor is one of several steps undertaken by the Biden Administration to enable (and promote) consideration of ESG factors, particularly climate-related risks, in the context of financial decision-making. (The most prominent of these initiatives is the pending SEC proposed rule which would require climate-related disclosures by public companies, and so promote consideration of climate factors by investors due to the availability of this type of information.) Indeed, as part of the Biden Administration’s broader climate agenda, it has consistently focused on financial decisions as a means to combat climate change, and this latest development fits neatly within that broader framework.

It should also be noted that the timing of this action suggests that the Biden Administration has been emboldened by the results of the 2022 midterm elections to proceed with its climate agenda. As a parallel point, shortly after the elections, the Biden Administration issued a rule that will compel federal contractors to disclose GHG emissions–this action by the Department of Labor is encompassed within the same overall architecture of initiatives designed to encourage the incorporation of ESG factors into financial decision-making.

With respect to the Department of Labor rule itself, the key point is that ESG factors may now be considered when making an investment decision, without fear of enforcement action (as suggested by the Trump-era guidance). Specifically, the “regulatory text clarif[ies] that a fiduciary’s duty of prudence must be based on factors that the fiduciary reasonably determine are relevant to a risk and return analysis and that such factors may include the economic effects of climate change and other ESG considerations on the particular investment or investment course of action.” (emphasis added) In other words, the regulation embraced by the Department of Labor expressly contemplates that ESG considerations can be incorporated into financial decision-making because such factors are deemed to have an economic impact.

Notably, the federal government’s embrace of the consideration of ESG factors as part of prudent financial decision-making in the context of investing for retirement, as reflected in this Department of Labor rule concerning ERISA, conflicts directly with initiatives embraced by certain conservative-leaning states, such as Florida, which have prohibited the consideration of ESG factors (albeit with exceptions) in the investment decisions by state pension funds. This move by the Biden Administration reflects and amplifies the partisan divide over ESG, particularly climate risks, that is resulting in conflicting directives to companies across America.

The Department of Labor (Department) is adopting amendments to the Investment Duties regulation under Title I of the Employee Retirement Income Security Act of 1974, as amended (ERISA). The amendments clarify the application of ERISA’s fiduciary duties of prudence and loyalty to selecting investments and investment courses of action, including selecting qualified default investment alternatives, exercising shareholder rights, such as proxy voting, and the use of written proxy voting policies and guidelines. The amendments reverse and modify certain amendments to the Investment Duties regulation adopted in 2020.

https://www.dol.gov/sites/dolgov/files/ebsa/temporary-postings/prudence-and-loyalty-in-selecting-plan-investments-and-exercising-shareholder-rights-final-rule.pdf

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ESG Considerations for Retirement Plans: A Moving Target

National Law Forum — Wed, 02 Nov 2022 22:30:56 +0000

For those with an eye on ERISA and its fiduciary rules, the past few years have caused whiplash when it comes to environmental, social, and corporate governance (“ESG”) investments in retirement plans. With a new rule from the Department of Labor imminent, let’s review where we are, how we got here, and what’s next.

ERISA generally requires those making investment decisions for retirement plans to do so solely in the best interests of plan participants, taking into account pecuniary factors like fees, and risks and returns. Guidance issued during the Obama administration indicated an openness to non-pecuniary factors, such as ESG, as a “tie-breaker”. The tide turned during the Trump administration, with additional guidance and a final rule eventually issued, which required plan fiduciaries to “select investment and investment courses of action based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.”

In an unsurprising twist, the Biden administration soon reversed course, blocking the Trump administration’s final rule and issuing its own proposed rule to “remove barriers to plan fiduciaries’ ability to consider climate change and other environmental, social and governance factors when they select investments and exercise shareholder rights.” A DOL fact sheet seeks to address concerns that the rule fundamentally changes a fiduciary’s duties, by highlighting the fact that the proposed rule “retains the core principle that the duties of prudence and loyalty require ERISA plan fiduciaries to focus on material risk-return factors and not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives unrelated to the provision of benefits under the plan.”

The final rule is now under review with the White House and is expected to be released soon. We will provide an update when that occurs.

Meanwhile, four House Republicans recently introduced the Safeguarding Investment Options for Retirement Act, with the stated purpose of protecting “investors from having politically motivated ‘woke’ environmental, social, and governance (ESG) issues put ahead of hardworking Americans’ investment return.”

What is a plan sponsor or committee to do? Whatever happens in the upcoming midterms, we expect the rules regarding ESG funds in retirement plans to remain a contentious subject, potentially changing with each presidential administration. It is imperative for plan fiduciaries to work closely with the plan’s financial advisors and legal counsel to ensure that all relevant factors—including the latest guidance on ESG—are being considered when making plan investment decisions.

For more ESG Legal News, click here to visit the National Law Review.

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