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On April 23, 2024, the U.S. Department of Labor (DOL) released its much-anticipated Retirement Security Rule for retirement plans. The rule redefines the term “investment advice fiduciary” under ERISA by expanding the circumstances in which a financial professional must give impartial investment advice that puts the interests of retirement investors first. It closes loopholes in the old rule that allow some financial professionals to give “conflicted” advice that puts profit first in certain circumstances.
Investment advice is considered “conflicted” when the provider’s recommendations can benefit the provider at the expense of their client. A recent study suggests that conflicted advice could cost retirement investors up to $5 billion per year in avoidable losses. When these losses affect 401(k) plan participants, their employer could be liable for restoring their amount as a plan fiduciary. The new rule aims to mitigate these consequences.
In my view, the new rule is a big win for retirement investors – a definition that includes employers who select investments for their 401(k) plan. Here’s what you need to know.
Background
The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that governs retirement plans, including 401(k) plans and individual retirement accounts (IRAs). The law imposes important requirements on "fiduciaries" of these plans. In 1975, the DOL released a “fiduciary rule” that defined the circumstances under which a person rendering investment advice to an employee benefit plan would be an “investment advice fiduciary” under ERISA.
This definition is important because an investment advice fiduciary must meet rigorous conduct standards under ERISA, including:
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- Prudence - They must act with the care, skill, prudence, and diligence that a prudent person familiar with such matters would exercise.
- Loyalty - Fiduciaries must act solely in the interest of plan participants and beneficiaries.
- Conflict Mitigation - Fiduciaries must disclose or mitigate any potential conflicts of interest to prevent them from influencing their advice.
Changes in the retirement plan landscape over the last 50 years have created two major loopholes in the 1975 rule that could make retirement investors vulnerable to conflicted advice in certain circumstances:
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- Brokers and Insurance Agents Excluded – In general, investment advisers meet the 1975 definition of “investment advice fiduciary”, while many brokers and insurance agents - who receive commissions for product recommendations - don’t. Brokers and insurance agents that don't meet the definition are subject to lesser conduct standards that do not prohibit them from giving "conflicted" advice that puts profit first.
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- One-Time Advice Excluded – Only advice provided on a regular basis is covered by the 1975 rule. It does not cover "one-time" advice like a recommendation to roll over 401(k) assets into an IRA or to purchase an annuity.
The new rule aims to close these loopholes by expanding the ERISA definition of “investment advice fiduciary” to include any individual or entity that makes an investment “recommendation” to a “retirement investor” for a fee. It is scheduled to take effect on September 23, 2024.
Definition of an “Investment Advice Fiduciary”
Under the new rule, an individual or entity is an investment advice fiduciary if:
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- They make an investment “recommendation” to a “retirement investor”;
- The recommendation is provided for a fee or other compensation, such as commissions; and
- The financial services provider holds itself out as a trusted adviser by
- Specifically stating that it is acting as a fiduciary under Title I or II of ERISA; or
- Making the recommendation in a way that would indicate to a reasonable investor that it is acting as a trusted adviser making individualized recommendations based on the investor's best interest.
Definition of “Recommendation”
Under the new rule, a "recommendation" encompasses a wide range of investment advice, including:
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- Decisions about buying, holding, or selling securities and other investment properties.
- Strategies on investment management, including advice on portfolio composition and the selection of other financial advisors.
- Guidance on rolling over, transferring, or distributing assets from a plan or IRA.
Definition of a “Retirement Investor”
A "retirement investor" under the new rule is not just an individual but can also be an entity such as:
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- Plans, plan participants, or beneficiaries.
- IRA owners or beneficiaries.
- Employers who select investments for their 401(k) plan.
Buckle Up!
The DOL has been trying to replace the 1975 fiduciary rule for decades now. The agency finalized a replacement in 2016, but that rule was challenged by the US Chamber of Commerce and ultimately vacated by the Fifth Circuit Court of Appeals in 2018. I think it’s safe to assume the Retirement Security Rule will also face lawsuits. Multiple trade groups that represent the financial service industry oppose the rule – especially groups in the insurance and annuity industries.
I hope the rule stands. When financial professionals do not put their clients' interests first, avoidable investment losses are usually the result. These losses can force a saver to work years longer than necessary to afford retirement, while exposing employers to fiduciary liability. The Retirement Security Rule should blunt these losses by subjecting all retirement advice to ERISA’s rigorous fiduciary standards.
