Conflict of Interest in Investment Advice Within Retirement Plans: An Overview
September 15, 2023
Conflict of Interest in Investment Advice Within Retirement
Plans: An Overview
Introduction
standards of conduct that depend on the individuals’ roles
A pension is a voluntary benefit offered by employers to
and the actions they are taking.
assist employees in preparing for retirement. Pension plans
can be classified along several dimensions, such as whether
Federal Pensions Law
the plan is a defined benefit (DB) plan (sometimes called a
To protect the interests of private sector pension plan
traditional pension) or a defined contribution (DC) plan
participants and beneficiaries, Congress enacted the
(like a 401(k) plan), whether the plan sponsor is a private
Employee Retirement Income Security Act of 1974
sector or public sector employer, and whether the plan is
(ERISA; P.L. 93-406). ERISA is included in the U.S. Code
sponsored by one employer or more than one employer.
in both Title 26 (the Internal Revenue Code) and in Title 29
(often called the Labor Code). ERISA contains fiduciary
Federal pensions laws and regulations govern many aspects
standards, which require that individuals who make
of pension plans, such as setting standards for individuals
decisions for private sector pension plans and their
who provide recommendations to private sector plans and
participants (referred to as fiduciaries) adhere to specified
plan participants. The Department of Labor (DOL) issued
standards of conduct.
regulations in 1975 that defined investment advice using a
five-part test, and in 2016, DOL expanded the definition of
Prohibited Transaction Exemptions (PTEs)
investment advice so that more such individuals were
ERISA also prohibits fiduciaries from engaging in
subject to a higher standard of conduct. A U.S. court of
transactions deemed likely to injure pension plans, referred
appeals vacated the rule in 2018, meaning that the five-part
to as prohibited transactions. ERISA bars certain
test was reinstated. DOL guidance and regulations apply
transactions between a plan and persons connected to a plan
only to private sector plans and do not apply to public
(referred to as a party in interest) and between a plan and a
sector plans.
plan fiduciary. To facilitate transactions between pension
plans and service providers that would otherwise be
In September 2023, DOL submitted a proposed rule for
prohibited by ERISA, a number of Prohibited Transaction
review to the Office of Management and Budget (OMB)
Exemptions (PTEs) exist, either in statute or as issued by
that DOL said would more appropriately define when
DOL.
recommendations constituted investment advice.
Current Investment Advice Regulations
Recommendations Within Pension Plans
Following the enactment of ERISA, DOL issued
Retirement plans are complex, and individuals often rely on
regulations in 1975 that created a five-part test to determine
financial-services professionals to assist with
whether an individual provided investment advice and thus
decisionmaking. For example, an employer might seek out
was subject to the fiduciary standard (see 29 C.F.R.
assistance in determining what investments to offer in a
§2510.3-21). In addition, DOL issued a PTE to ensure that
401(k) plan it has established, participants in 401(k) plans
fiduciaries could continue to engage in practices that would
might seek assistance in choosing their investments from
otherwise be prohibited (such as brokers receiving
among the options offered by the plans, or workers who
commissions for products they recommend).
participate in employer-sponsored 401(k) plans might seek
assistance on whether to leave their 401(k) account balance
To be held to the 1975 fiduciary standard with respect to his
in the plan or roll it over into an Individual Retirement
or her recommendations, an individual must (1) make
Account (IRA) or into another employer’s DC plan either
recommendations on investing in, purchasing, or selling
upon job change or at retirement.
securities or other property or give advice as to the value
(2) on a regular basis, (3) pursuant to a mutual
The compensation structure of some financial-services
understanding that the advice (4) would serve as a primary
professionals may give rise to conflicts of interest,
basis for investment decisions and (5) would be
particularly if these professionals’ recommendations result
individualized to the particular needs of the plan regarding
in larger commissions or otherwise benefit them. These
such matters as, among other things, investment policies or
potential conflicts could lead to recommendations that are
strategy, overall portfolio composition, or diversification of
not in the interests of their clients. By contrast, some
plan investments. An individual is not treated as a fiduciary
financial-services professionals have compensation
unless each of the five elements of the test is satisfied.
structures that do not vary based on which products clients
choose. This type of compensation structure could mitigate
Individuals who provide investment services to retirement
some conflicts of interest. Individuals who provide
investors or plans may also be subject to other regulatory
recommendations to pension plans are required to meet
structures. For example, broker-dealers who provide
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Conflict of Interest in Investment Advice Within Retirement Plans: An Overview
investment recommendations but whose actions do not
In October 2020, DOL issued PTE 2020-02 which, as with
meet ERISA’s five-part test are subject to Securities and
previous PTEs, allows fiduciaries to conduct transactions
Exchange Commission’s (SEC’s) Regulation Best Interest
which are otherwise prohibited. Investment advice
(Reg BI), which requires that brokers and dealers act in the
fiduciaries who rely on PTE 2020-02 must comply with
best interest of their clients. For more information, see CRS
Impartial Conduct Standards, which require them to
Report R47431, Capital Markets: Overview and Selected
provide advice that is in the best interest of the retirement
Policy Issues in the 118th Congress.
investor, charge no more than reasonable compensation,
and make no misleading statements about investment
Recent Regulatory Actions
transactions.
In October 2010, DOL proposed, and subsequently
withdrew in September 2011, an expansion of the definition
In addition, PTE 2020-02 noted that rollover
of fiduciary advice that would have made more individuals
recommendations from an employer plan to an IRA could
and their actions subject to the fiduciary advice regulation.
be considered investment advice if specified conditions are
In April 2015, DOL issued a revised proposal to broaden
met—for example, if the investment recommendation were
the definition of investment advice and, in April 2016,
expected to be part of an ongoing relationship. On February
issued a final rule and new and amended PTEs.
13, 2023, a federal district court struck down the portion of
PTE 2020-02 related to the rollover recommendations, and
Under the 2016 rule, the types of activities that would
on June 30, 2023, a different federal district court
constitute investment advice, if they are done for a fee or
recommended that the guidance related to rollover advice
other compensation, are recommendations pertaining to the
be vacated.
advisability of buying, selling, holding, or exchanging
investments; how investments should be invested after
Actions Under the Biden Administration
being rolled over, transferred, or distributed from an IRA;
Since spring 2021, DOL has indicated its intent to release a
the management of investments; or IRAs, including
proposed rule that it said would more appropriately define
whether, in what form, in what amount, and to what
when a person providing investment advice would be a
destination rollovers, distributions from IRAs, and transfers
fiduciary. In September 2023, DOL submitted a proposed
from IRAs should be made. The rule also described certain
rule for review to OMB that DOL said would more
activities that did not constitute investment advice (e.g.,
appropriately define when recommendations constituted
marketing by platform providers, providing general
investment advice.
investment education, and executing securities
transactions).
Proponents of a new rule cite the changing retirement
landscape since 1975, when most individuals in retirement
Among the new and amended PTEs accompanying the final
plans had DB plans compared to the DC plans that are
rule were the Best Interest Contract Exemption, Principal
common today. In DC plans, participants have more
Transactions Exemption, and an amended PTE 84-24,
responsibilities regarding plan contributions, investments,
which affects the sale of annuity products. For more
and withdrawals and may need more assistance from
information on the 2016 proposed and final rule and PTEs,
financial services professional regarding their choices.
see CRS Report R44884, Department of Labor’s 2016
Fiduciary Rule: Background and Issues.
Responses to Notice of Proposed Rule in the 118th
Congress
Actions Under the Trump Administration
In an August 2023 letter to DOL, Senator Bill Cassidy and
In March 2017, DOL issued a Temporary Enforcement
Representative Virginia Foxx wrote that they opposed a
Policy that indicated it would not initiate enforcement
rule that would revise the definition of fiduciary under
actions against financial advisers or financial institutions
ERISA, noting that shifting interpretations “created
that failed to satisfy the conditions of the 2016 regulation or
confusion in the marketplace and unwarranted compliance
PTE (see Field Assistance Bulletin 2017-01). In March
expenses.”
2018, a U.S. District Court ruled that the 2016 rule was
improperly promulgated and in March 2018, a U.S. court of
John J. Topoleski, Specialist in Income Security
appeals vacated the 2016 rule. This meant that the five-part
Elizabeth A. Myers, Analyst in Income Security
test was reinstated (see 85 Federal Register 40589-40594,
July 20, 2020).
IF12492
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Conflict of Interest in Investment Advice Within Retirement Plans: An Overview
Disclaimer
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