On November 3, 2023, the U.S. Department of Labor (DOL) proposed a collection of regulatory changes in its ongoing quest to update the definition of a “fiduciary” under ERISA and Section 4975 of the Internal Revenue Code (the “Proposal”).  The Proposal seeks to conform the term fiduciary to the realities of retirement plans of the twenty-first century: particularly, the explosion of participant-directed 401(k) plans and individual retirement accounts.  The Proposal would also amend a collection of prohibited transaction exemptions.  The DOL will accept written comments regarding the Proposal until January 2, 2024.  In addition, the DOL will hold a public hearing regarding the Proposal beginning December 12, 2023.

This is the DOL’s third attempt to update the definition of an “advice fiduciary” and we expect that, like the prior attempts before, it will face challenges from Congress and in the courts.

Proposed Change to the Definition of Fiduciary under ERISA and Section 4975 of the Code

The Proposal would replace the existing 1975 regulation, which sets forth the “5-Part Test” to determine if an individual is providing investment advice as an ERISA fiduciary.  Under the 5-Part Test, a person providing non-discretionary investment advice with respect to a plan is a fiduciary under ERISA and Section 4975 of the Code if such advice is: (1) on a regular basis; (2) pursuant to a mutual agreement; (3) the primary basis for an investment decision; (4) for a fee or other compensation; and (5) individualized to the particular investor.

The Proposal would substantially amend the “regular basis”, “mutual agreement” and “primary basis” requirements of the 5-Part Test.  Under the Proposal, a person would be deemed to provide “investment advice” if the person makes a recommendation regarding a securities or other investment transaction, or an investment strategy involving investment property, to a plan, plan fiduciary, plan participant or beneficiary, IRA, IRA owner or beneficiary, or IRA fiduciary (each, a “retirement investor”), and the person: (i) directly or indirectly (e.g., through or together with an affiliate) has discretionary authority or control with respect to plan assets; (ii) acknowledges their fiduciary status (even if generally, and not just as an ERISA fiduciary); or (iii) directly or indirectly (e.g., through or together with an affiliate) makes investment recommendations to investors on a regular basis as part of their business, and the recommendation is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest.

The DOL has made clear they intend recommendations to rollover IRA assets to be fiduciary advice and the DOL rejected the prior suggestion to limit the new rules to “retail” plan fiduciaries and participants.

Potential Impacts to Investment Managers of Private Funds and other Institutional Clients

The Proposal, if finalized as drafted, should not have a material impact on investment managers of private funds that are subject to ERISA or that manage separate accounts for ERISA plans (i.e., discretionary fiduciaries).  However, even if your firm does not have a retail business, the Proposal could nevertheless impact your relationship to ERISA plans and IRAs.  If you utilize non-discretionary sub-advisers, use “finders” for investments, or make co-investments, the Proposal could require that those agreements be reviewed and modified.  If you utilize an affiliated broker-dealer and rely on Prohibited Transaction Exemption (PTE) 86-128, the Proposal would require additional disclosures to IRA investors and 401(k) plan participants.  Finally, if your firm is part of a large organization, your provision of discretionary fiduciary services to an ERISA plan could taint the advice given by a non-discretionary affiliate to any of the fiduciaries of that plan or its participants.

If you would like our assistance in commenting on the Proposal, or if you have any questions on the matter, please contact S. John Ryan at (212) 574-1679, Michael O’Brien at (212) 574-1505, or Bradley Fay at (212) 574-1429.