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1 [1] (September 15, 2023)

handle is hein.crs/govemvs0001 and id is 1 raw text is: Congressional Research Service Informing the legislative debate since 1914 0 September 15, 2023 Conflict of Interest in Investment Advice Within Retirement Plans: An Overview Introduction A pension is a voluntary benefit offered by employers to assist employees in preparing for retirement. Pension plans can be classified along several dimensions, such as whether the plan is a defined benefit (DB) plan (sometimes called a traditional pension) or a defined contribution (DC) plan (like a 401(k) plan), whether the plan sponsor is a private sector or public sector employer, and whether the plan is sponsored by one employer or more than one employer. Federal pensions laws and regulations govern many aspects of pension plans, such as setting standards for individuals who provide recommendations to private sector plans and plan participants. The Department of Labor (DOL) issued regulations in 1975 that defined investment advice using a five-part test, and in 2016, DOL expanded the definition of investment advice so that more such individuals were subject to a higher standard of conduct. A U.S. court of appeals vacated the rule in 2018, meaning that the five-part test was reinstated. DOL guidance and regulations apply only to private sector plans and do not apply to public sector plans. In September 2023, DOL submitted a proposed rule for review to the Office of Management and Budget (OMB) that DOL said would more appropriately define when recommendations constituted investment advice. Recommrendations Within Pension Plans Retirement plans are complex, and individuals often rely on financial-services professionals to assist with decisionmaking. For example, an employer might seek out assistance in determining what investments to offer in a 401(k) plan it has established, participants in 401(k) plans might seek assistance in choosing their investments from among the options offered by the plans, or workers who participate in employer-sponsored 401(k) plans might seek assistance on whether to leave their 401(k) account balance in the plan or roll it over into an Individual Retirement Account (IRA) or into another employer's DC plan either upon job change or at retirement. The compensation structure of some financial-services professionals may give rise to conflicts of interest, particularly if these professionals' recommendations result in larger commissions or otherwise benefit them. These potential conflicts could lead to recommendations that are not in the interests of their clients. By contrast, some financial-services professionals have compensation structures that do not vary based on which products clients choose. This type of compensation structure could mitigate some conflicts of interest. Individuals who provide recommendations to pension plans are required to meet standards of conduct that depend on the individuals' roles and the actions they are taking. Federal Pensions Law To protect the interests of private sector pension plan participants and beneficiaries, Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA; P.L. 93-406). ERISA is included in the U.S. Code in both Title 26 (the Internal Revenue Code) and in Title 29 (often called the Labor Code). ERISA contains fiduciary standards, which require that individuals who make decisions for private sector pension plans and their participants (referred to as fiduciaries) adhere to specified standards of conduct. Prohibited Transaction Exemptions (PTEs) ERISA also prohibits fiduciaries from engaging in transactions deemed likely to injure pension plans, referred to as prohibited transactions. ERISA bars certain transactions between a plan and persons connected to a plan (referred to as a party in interest) and between a plan and a plan fiduciary. To facilitate transactions between pension plans and service providers that would otherwise be prohibited by ERISA, a number of Prohibited Transaction Exemptions (PTEs) exist, either in statute or as issued by DOL. Current Investrment Advice Regulations Following the enactment of ERISA, DOL issued regulations in 1975 that created a five-part test to determine whether an individual provided investment advice and thus was subject to the fiduciary standard (see 29 C.F.R. §2510.3-21). In addition, DOL issued a PTE to ensure that fiduciaries could continue to engage in practices that would otherwise be prohibited (such as brokers receiving commissions for products they recommend). To be held to the 1975 fiduciary standard with respect to his or her recommendations, an individual must (1) make recommendations on investing in, purchasing, or selling securities or other property or give advice as to the value (2) on a regular basis, (3) pursuant to a mutual understanding that the advice (4) would serve as a primary basis for investment decisions and (5) would be individualized to the particular needs of the plan regarding such matters as, among other things, investment policies or strategy, overall portfolio composition, or diversification of plan investments. An individual is not treated as a fiduciary unless each of the five elements of the test is satisfied. Individuals who provide investment services to retirement investors or plans may also be subject to other regulatory structures. For example, broker-dealers who provide

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