DOL Removes Restrictions on Recommendations of Principal Traded Assets from Prohibited Transaction Exemption 2020-02

The US Department of Labor (DOL) amended Prohibited Transaction Exemption 2020-02 (PTE 2020-02) to provide relief for recommendations of all types of principal trades. This change, effective September 23, 2024 and subject to all PTE 2020-02’s conditions, further aligns the retirement rules with securities laws like the US Securities and Exchange Commission’s (SEC’s) Regulation Best Interest (Reg. BI).

The DOL amended PTE 2020-02 to eliminate restrictions on the ability to rely on the exemption for recommendations of assets that are traded on a principal basis (i.e., from the inventory or in an underwriting/syndication allocation of the advice provider).

This change allows financial institutions to recommend that retirement investors (including those investing through IRAs, Keoghs, and employer-sponsored plans) to invest in any principal traded asset, including equity initial public offerings (IPOs), underwritings, syndicates, and debt instruments regardless of issuer, credit quality, or liquidity—so long as the recommendation is in the retirement investor’s best interest, and the other conditions of PTE 2020-02 are satisfied. 

This change helpfully aligns the retirement rules with the securities laws, including the SEC’s Reg. BI. However, it is important to note that the DOL’s year-long transition period does not appear to apply to principal trades. Because of this, firms will need to meet the full conditions of PTE 2020-02 by the September 23 effective date for all fiduciary recommendations of principal traded assets, including those covered under the current, pre-amendment, PTE 2020-02.

What Has Changed

Prior to the amendment, PTE 2020-02 allowed an investment advice fiduciary to recommend that retirement investors invest in any assets traded on an agency or riskless principal basis. However, through its definition of “Covered Principal Transaction,” it limited the types of assets permitted to be sold to retirement accounts on a true principal basis, including the following:

• US dollar denominated corporate debt
• US Department of the Treasury securities
• US debt securities guaranteed by US federal agencies and government-sponsored enterprises
• Municipal securities
• Certificates of deposit
• Unit investment trust interests

Debt securities were allowed to have no greater than a moderate credit risk and were required to have sufficient liquidity to be sold at—or near—carrying value within a reasonably short period of time.

The amendment eliminates the “Covered Principal Transaction” definition, allowing fiduciary recommendations to retirement investors regardless of how the asset is traded.

When Is the Change Effective?

The PTE 2020-02 amendments, including the change to eliminate “Covered Principal Transaction,” are effective as of September 23. Therefore, firms can allow fiduciary advice with respect to any principal traded asset starting on September 23.

What Conditions Must Be Met?

By September 23, all PTE 2020-02 conditions must be satisfied for fiduciary investment advice with respect to any principal traded asset—this includes principal trades that were permitted prior to the amendment.

• The DOL provided a one-year “phase-in” period beginning September 23 to help affected financial institutions come into compliance with the Retirement Security Rule’s expanded definition of “investment advice fiduciary” and amendments to various prohibited transaction exemptions, including PTE 2020-02.
• Under PTE 2020-02 Section VI, during this phase-in period, financial institutions and investment professionals may receive reasonable compensation under Section I of the exemption, so long as they comply with the Impartial Conduct Standards and fiduciary acknowledgment requirements. Note that enhanced ineligibility provisions are also effective as of September 23 and firms may need to develop additional compliance procedures to meet this requirement.
• However, a principal trade, or “The purchase or sale of an investment product to or from a Retirement Investor, and the receipt of a payment, including a mark-up or mark-down,” is a separate transaction under Section I of the exemption that does not appear to be covered by the Section VI phase-in period.

Therefore, it appears that all of the PTE 2020-02 conditions will apply to fiduciary recommendations of principal traded assets as of September 23, including the following:

• Impartial Conduct Standards
• Fiduciary acknowledgment
• Statement of Care and Loyalty Obligations
• Disclosure of material facts regarding services, fees, costs, and conflicts
• Ineligibility provisions
• Policies and procedures
• Retrospective review
• Six-year recordkeeping

Our Observations

Given that principal trades are subject to extensive regulatory requirements under the securities laws, including Reg. BI and various Financial Industry Regulatory Authority rules, we expect firms may be able to leverage their existing compliance framework substantially to meet the PTE 2020-02 conditions, particularly with respect to the care obligation, disclosures, and general policies and procedures requirements. It may also be worth reviewing current practices to ensure there are no gaps that need to be addressed, particularly with respect to the types of securities that may be less appropriate for retirement accounts. Firms may also want to consider adopting policies and procedures tailored to PTE 2020-02 requirements. These can leverage existing policies and procedures through cross-referencing or otherwise.

Pitfalls to Look Out For

PTE 2020-02 does not provide relief for fiduciary extensions of credit. As such, firms will want to consider whether principal trades that include a credit component, such as affiliate issued structured notes, can be sold to retirement accounts in compliance with the prohibited transaction rules. Additionally, firms may want to consider the extent to which prior limitations, including credit quality and liquidity, may still be relevant to the care obligation analysis under PTE 2020-02.