The Meaning of Differential Compensation Based on Neutral Factors
This is my twenty-fourth article covering interesting observations about the fiduciary rule and exemptions.
The DOL’s fiduciary “package” consists of a regulation that expands the definition of advice and exemptions, or exceptions, from the prohibited transaction (PT) rules. If a recommendation by a fiduciary adviser does not constitute a PT (e.g., does not affect the adviser’s compensation, or that of an affiliate, and does not cause a payment from a third party), no exemption is needed. However, if the fiduciary recommendation causes a PT, an exemption must be used – and most often that will be BICE – the Best Interest Contract Exemption. Therein lies the rub . . . the compensation of the financial institution (e.g., the broker-dealer) and the adviser are regulated by BICE.
Under BICE, the compensation of broker-dealers can be … Read More »
This is my twenty-second article about interesting observations concerning the fiduciary rule and exemptions.
While the application of the new fiduciary rule and prohibited transaction exemptions to broker dealers and investment advisers is fairly obvious — if not fully understood, there has been little in the way of discussion about its application to banks. This post highlights some of those issues.
In a prior Angles article, I talked about how the fiduciary rule applies to referrals of advisers and how the prohibited transaction rules impact solicitors’ fees (see Angles No. 12). There is a similar issue for banks. For example, it appears to be a fairly common practice for employees at bank branches to recommend that customers set up IRAs and put the money into certificates of deposit, and for the bank employees to receive bonuses for the IRAs investments in the … Read More »
This is my twenty-first article covering interesting observations about the fiduciary rule and exemptions.
While most of the requirements in the new fiduciary rule and exemptions are “old news” for retirement plan advisers, they may require significant changes for advisers to IRAs. For example, ERISA’s prudent man rule and the new best interest standard of care both require that fiduciary advisers (which will include virtually all advisers to plans, participants and IRA owners when the rules are applicable on April 10, 2017) engage in a prudent process to develop recommendations. Using variable annuities as an example, here are some of the important steps in a prudent process: evaluating whether the insurance company will be able to satisfy its commitments in the future (based on today’s information); a determination of whether the expenses for the variable annuity contract, including expenses of the … Read More »
As advisers who work with ERISA-governed retirement plans already know, an adviser’s compensation cannot be more than a reasonable amount. Because of the new fiduciary advice regulation, and the associated prohibited transaction exemptions (84-24 and the Best Interest Contract Exemption (BICE)), that requirement is being imposed on investment and insurance recommendations to IRAs. Interestingly, under the Internal Revenue Code (section 4975(d)(2)), it is already a prohibited transaction for an adviser to earn more than reasonable compensation from an IRA. However, because of lack of enforcement by the IRS, that requirement is often overlooked. As evidence of the fact that it is overlooked, think about the lack of benchmarking or similar services to help advisers determine if their compensation from an IRA is reasonable. But, that is about to change.
To appreciate the “reasonable compensation” requirement, a person needs to understand that … Read More »
Much attention has been given to the new fiduciary rules (applicable April 10, 2017) for recommending distributions from retirement plans and rollovers to IRAs. Where the adviser making the recommendation is a “Level Fee Fiduciary,” the new requirements are sometimes referred to as “BICE-lite,” because only certain of the requirements of the Best Interest Contract Exemption must be satisfied. However, where the adviser will not be a Level Fee Fiduciary, the adviser and his Financial Institution (e.g., broker-dealer or RIA) must comply with all of the BICE conditions.
However, not much attention has been paid to the other BICE-lite recommendations—a recommendation to transfer an IRA from another adviser and a recommendation to change from a transaction-based account to a fee-based account. This article discusses the first of those two . . . a recommendation to transfer an IRA.
The starting point is … Read More »
This is my fifteenth article about interesting observations “hidden” in the fiduciary regulation and the exemptions.
In my last post (Angles #14), I said that the prudent process requirement would apply to many, but not all, advisers. This article explains that statement.
ERISA does not apply to individual IRAs (but does apply to SEP and SIMPLE IRAs). As a result, ERISA’s prudent man rule does not govern the conduct of advisers when providing investment advice to individual IRAs.
However, when the Best Interest Contract Exemption (BICE) applies to “conflicted” advice on April 10, 2017, those advisers will need to, among other things, satisfy the Best Interest standard of care (which is, in its essence, a combination of ERISA’s prudent man rule and duty of loyalty). In effect, conflicted advisers will be bootstrapped into a prudent process requirement. (As background, a “conflicted” fiduciary adviser … Read More »
This is my eleventh article about interesting observations “hidden” in the fiduciary regulation and the exemptions.
ERISA and the Internal Revenue Code limit compensation for services to plans and IRAs to “reasonable” amounts. Prohibited Transaction Exemption (PTE) 84-24 and the Best Interest Contact Exemption (BICE) also limit compensation to reasonable amounts.
While the concept of reasonable compensation is old-hat for advisers and service providers to ERISA qualified retirement plans, it has not, by and large, been used in the IRA world. As a result, some people are asking . . . what is reasonable compensation? The DOL explained the concept in a preamble:
“The obligation to pay no more than reasonable compensation to service providers is long recognized under ERISA and the Code. ERISA section 408(b)(2) and Code section 4975(d)(2) require that services arrangements involving plans and IRAs result in no … Read More »
This is my fifth article about interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.
The Best Interest Contract Exemption (BICE) has a special exemption for “level fee fiduciaries” who recommend to plan participants that they take distributions and rollover to an IRA advised by the fiduciary adviser. (A level fee fiduciary is an adviser who receives only an advisory fee. That is, neither the adviser, nor his supervisory entity [nor any affiliate or related party] can receive any additional compensation, e.g., revenue sharing or management fees for affiliate products.)
There are several requirements, but perhaps the most difficult is the “best interest” documentation:
“In the case of a recommendation to roll over from an ERISA Plan to an IRA, the Financial Institution [e.g., the RIA firm] documents the specific reason or reasons why the recommendation was considered to … Read More »
This is my third article about the interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.
Under the Best Interest Contract Exemption (BICE), the “financial institution” (e.g., a broker-dealer) cannot pay a fiduciary adviser (e.g., a financial adviser) incentive compensation that would encourage an adviser to make investment or insurance recommendations that are not in the best interest of a retirement investor. Needless to say, that requirement is highly disruptive to broker-dealers and insurance companies, since they often compensate advisers through commission payments (which are, by definition, incentive compensation).
But, the DOL’s concern about the impact of incentive compensation goes beyond payments to advisers. In the preamble to BICE, the DOL says the following about payments to managers and supervisors:
“As noted above, Financial Institutions also must pay attention to the incentives of branch managers and supervisors, and how … Read More »
This is my second article about the interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.
The recommendation of investments and insurance products to plans, participants, and IRAs will be subject to the best interest standard of care. (The best interest standard is a combination of ERISA’s prudent man rule and duty of loyalty.)
The legal requirement that advisers make prudent recommendations and act with a duty of loyalty is well understood in the retirement plan world, but is new to IRAs.
Also, it’s commonly conceded that the prudent man rule is more demanding than the suitability standard. But that begs the question, what is required of the adviser?
The DOL answered that question in the context of fixed indexed annuities, and the answer may be surprising. (For other insurance products and investments, the DOL would likely say that a … Read More »