By Jenny Kiffmeyer, J.D – The Retirement Learning Center
Five-Part Test and Reasonable Understanding
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in North Carolina is representative of a common question on what constitutes investment advice. The advisor asked: “Can you give me real-world insight into the five-part test the Department of Labor (DOL) will apply for determining whether an advisor or firm is giving fiduciary investment “advice?”
Highlights of the Discussion
To determine whether investment guidance rises to the fiduciary level of investment advice, the DOL and IRS will apply the following five-part test (see PTE 2020-02 and IRS FAQs on PTE 2020-02. If the answer is “yes” to all five of the following test questions, and the advisor receives payment for the advice, he or she is an investment advice fiduciary, and would have to follow a prohibited transaction exemption (PTE) (e.g., PTE 2020-02) to receive payment for the advice.
Five-Part Test Questions
Consideration: Authorities will consider written statements disclaiming any element of the five-part test but the disclaimers will not in and of themselves be determinative of fiduciary status. Firms and investment professionals cannot use written disclaimers to undermine reasonable investor understandings.
|1. Will the advisor render advice to the plan, plan fiduciary, or IRA owner as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing, or selling securities or other property?
Consideration: Advice could include a recommendation to an investor to conduct a rollover. A recommendation to roll assets out of a retirement plan is advice with respect to moneys or other property of the plan and, if provided by a person who satisfies all of the requirements of the five-part test, constitutes fiduciary investment advice.
|2. Will the advice be given on a regular basis?
Considerations: Whether advice to rollover assets from a workplace retirement plan to an IRA constitutes advice “on a regular basis” depends on whether the advice
Occurs at the beginning of an intended future ongoing relationship that an individual has with an investment advice provider.
|3. Is the advice given pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary or IRA owner?
Consideration: When making a determination on this question, the DOL intends to consider the reasonable understandings of the parties based on the totality of the circumstances.
|4. Will the advice serve as a primary basis for investment decisions with respect to plan or IRA assets?
Consideration: The recommendation need only be “a” primary basis for investment decisions—not necessarily “the” primary basis for investment decisions—before it would constitute investment advice. If the parties reasonably understand that the advice is important to the investor and could affect the investor’s decision, that is enough to satisfy the primary basis requirement.
|5. Will the advice be individualized based on the particular needs of the plan or IRA?
Consideration: Put another way, is the advisor making an individualized recommendation to an investor upon which he or she will rely on to make an investment decision? Here again, the DOL will look at the reasonable understandings of the parties based on the totality of the circumstances.
Although the DOL’s five-part test for fiduciary investment advice may seem straightforward, there are important subtleties that come into play. The DOL will consider the reasonable understandings of the parties based on the totality of the circumstances.