Interesting Angles on the DOL’s Fiduciary Rule #43


Posted on April 19, 2017, by Fred Reish in BICE, Broker-Dealers, DOL Activity, fiduciary, prohibited transaction, Registered Investment Advisers, RIA, SEC. Comments Off on Interesting Angles on the DOL’s Fiduciary Rule #43

BICE Transition: More Than the Eye Can See

This is my 43rd article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

As we all know by now, the new, and greatly expanded, definition of fiduciary advice becomes applicable on June 9. That means that almost any investment or insurance recommendation to a plan, participant, or IRA will be a fiduciary act. (The definition of investment recommendations is also very broad, including referrals to investment managers, recommendations to take distributions from plans, and recommendations to transfer IRAs.)

As a result, investment and insurance recommendations to participants and plans must be prudently developed and must be loyal to the plan or participant. But, recommendations to IRAs will not be subject to the prudent man standard of care. Instead, they would be subject to the SEC fiduciary duty for RIAs, FINRA’s suitability and know-your-customer standards for broker-dealers, and state law standards of care for both RIAs and broker-dealers.

However, this story does not end there. When investment recommendations cause a third party to pay compensation to the adviser (for example, commissions or 12b-1 fees), that is a prohibited transaction. Also, when the adviser makes a recommendation that causes the adviser to receive additional compensation (for example, a commission on a securities transaction), that is a prohibited transaction. Because of those prohibited transactions (for recommendations to plans, participants and IRAs), an adviser must satisfy the conditions of an exemption.

During the period from June 9 to December 31, the likely exemption will be “transition” BICE, that is, the transition rule under the Best Interest Contract Exemption. Fortunately, those conditions should be fairly easy to satisfy. In fact, there is only one condition, but it has three parts. The condition is that the adviser (and the adviser’s Financial Institution) comply with the Impartial Conduct Standards (ICS). The three parts of ICS are: (1) The best interest standard of care; (2) no more than reasonable compensation; and (3) no materially misleading statements.

Focusing on the best interest standard of care, that means that the adviser and the Financial Institution must engage in a prudent process to develop investment recommendations and must act with a duty of loyalty to the plan, participant or IRA owner.

However, the purpose of this article is to discuss requirements that aren’t obvious on the face of the ICS. In other words, there is more to the rule than meets the eye. That’s because, in the DOL’s final regulation extending the applicability date of the fiduciary rule, the Department said:

Also note that even though the applicability date of the exemption conditions have been delayed during the transition period, it is nevertheless anticipated that firms that are fiduciaries will implement procedures to ensure that they are meeting their fiduciary obligations, such as changing their compensation structures and monitoring the sales practices of their advisers to ensure that conflicts in interest do not cause violations of the Impartial Conduct Standards, and maintaining sufficient records to corroborate that they are adhering to Impartial Conduct Standards.

In other words, while the explicit compensation requirement of the ICS is that advisers and Financial Institutions cannot receive more than reasonable compensation, the DOL is saying that a Financial Institution’s compensation structures cannot promote investment recommendations that are not in the best interest of the investor. Think about that. One possible interpretation is that, even though the compensation of the adviser can vary, both for similar products (e.g., mutual funds) and among product categories (e.g., mutual funds vs. variable annuities), the variation cannot be so great as to unreasonably promote advice that is inconsistent with the best interest standard of care.

That raises the obvious question, how much is too much?

It’s difficult, if not impossible, to answer that question. Having said that though, I think that the answer will be somewhat like the famous Supreme Court position . . . “You know it when you see it.”

In any event, broker-dealers, RIA firms, and other Financial Institutions should evaluate their compensation practices and consider whether they align with the quoted language.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.







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