PLANADVISER - September/October 2022 - 38

compliance consult
David Kaleda
Principal Trading
PTE 20-02 complicates the meaning of investment advice
AS I WROTE in this column four years ago,
advisers, when engaging in principal transactions
with their clients have specific
compliance obligations under securities
laws, the Employee Retirement Income
Security Act and the Internal Revenue
Code. In the case of such transactions
involving
ERISA-covered accounts
and
The DOL
provides no
more information
about when
accounts subject to the prohibited transaction
provisions of IRC Section 4975-
e.g., individual retirement accounts-the
adviser must rely on a prohibited transaction
exemption. Doing so has become
more complicated, with the Department
of Labor's issuance of Prohibited Transaction Exemption
2020-02 and its interpretation of " investment advice. "
Advisers, particularly broker/dealers that maintain nona
transaction
is a " riskless
principal " one.
advisory brokerage accounts, have always sold securities on
a principal basis to ERISA-covered accounts and IRAs. PTE
75-1 provides exemptive relief in the event the adviser does
not act as a fiduciary. However, many advisers that provide
recommendations to buy or sell securities in brokerage
accounts that are non-advisory for purposes of the Investment
Advisers Act or comparable state law are of the view
that they provide investment advice for purposes of ERISA
or the IRC. Thus, they must comply with PTE 20-02; however,
this applies with transactions involving only certain situations
and certain securities.
The DOL states that a principal transaction is " a purchase
from, or sale to, a Plan or an IRA, of an investment, on behalf
of the financial institution's own account or the account of a
person directly or indirectly, through one or more intermediaries,
controlling, controlled by, or under common control
with the Financial Institution. " However, a principal transaction
does not include the sale of mutual funds or insurance
products such as annuities.
So long as the adviser meets the conditions of PTE 20-02,
he may recommend that a client engage in a " riskless principal "
transaction. There's no limit as to the type of security
that may be recommended. The DOL states that a riskless
principal transaction is " a transaction in which a financial
institution, after having received an order from a retirement
investor to buy or sell an investment product, purchases or
sells the same product for the financial institution's own
account to offset the contemporaneous transaction with the
retirement investor. " The DOL provides no more information
about when a transaction is a " riskless
principal " one. How it is booked under
federal security laws may carry weight.
If the transaction is not riskless, PTE
20-02 requires that it fall within the definition
of a " covered principal transaction. " If
the adviser is buying the security from the
ERISA-covered account or IRA, a covered
principal transaction includes both equity
and debt securities. In the case of a sale,
though, the transaction may involve only
certain securities: U.S. dollar denominated
corporate debt securities offered
pursuant to a registration statement
under the Securities Act of 1933; U.S. Treasury securities;
debt securities issued or guaranteed by a U.S. federal government
agency other than the Department of Treasury; debt
securities issued or guaranteed by a government-sponsored
enterprise; municipal securities; certificates of deposit; and
interests in certain unit investment trusts.
This is a relatively narrow group of securities. The exemption
does not allow for the sale of equity, foreign debt and
myriad other securities that firms traditionally sell on a principal
basis. Certain hybrid securities such as equity-linked
notes or asset-backed securities that have substantial debt
and equity features may not neatly fit within the definition.
Also, PTE 20-02 requires that, with respect to debt securities,
the adviser must have written policies and procedures that
are reasonably designed to ensure that the security, at the
time of the recommendation, has no greater than moderate
credit risk and sufficient liquidity that it could be sold at or
near carrying value within a reasonably short period of time.
Advisers who sell securities on a principal basis to ERISAcovered
accounts and IRAs, and also provide advice, need to
comply with PTE 20-02. Unless the transaction is conducted
on a riskless principal basis, there could be substantial
restrictions on the type of security sold. Compliance with
PTE 20-02 requires the application of other conditions such
as the recommendation being in the best interest of the
investor despite conflicts of interest, which, in the DOL view,
are substantial. If the security involves an extension of credit,
compliance with another exemption may be necessary.
David Kaleda is a principal in the fiduciary responsibility practice
group at Groom Law Group, Chartered, in Washington, D.C.
38 | planadviser.com September-October 2022
Art by Tim Bower
http://www.planadviser.com
PLANADVISER - September/October 2022

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