Interesting Angles on the DOL’s Fiduciary Rule #69


Posted on November 7, 2017, by Fred Reish in BICE, Broker-Dealers, DOL Activity, Registered Investment Advisers, RIA. Comments Off on Interesting Angles on the DOL’s Fiduciary Rule #69

Compensation Risks for Broker-Dealers and RIAs

This is my 69th 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.

While the Best Interest Contract Exemption (BICE) is greatly simplified during the transition period, there is more than meets the eye, and broker-dealers and RIAs need to consider whether their practices for compensating advisors encourage advice to retirement investors that may not be in the best interest of those investors. Certain compensation practices are more risky than others. This article discuss some of the arrangements that pose the greatest risks.

As background, transition BICE requires that broker-dealers and RIAs adhere to the Impartial Conduct Standards when making investment recommendations to plans, participants, and IRA owners . . . where there is a conflict of interest. For this purpose, a prohibited conflict of interest exists where the firm or the individual advisor receives compensation from a third party (e.g., 12b-1 fees or insurance commissions) or where the compensation is received as a result of the recommendation (e.g., commissions on securities transactions). Transition BICE first applied on June 9, 2017, and based on recent DOL activity, it appears that it will continue to be the rule until June 30, 2019.

The Impartial Conduct Standards are: the best interest standard of care (basically ERISA’s prudent man rule and duty of loyalty); no more than reasonable compensation; and no materially misleading statements. However, the DOL has imposed one more requirement. In the notice of the extension of the transition rules (and, previously, in a set of FAQs), the DOL made clear that firms need to have policies, procedures and practices that ensure that advisors do not succumb to the allure of incentive compensation and give advice that is not in the best interest of the retirement investor in order to receive that compensation. (However, if the compensation is reasonable for the services rendered, it would be difficult, but not impossible, to argue that a violation had been committed.)

On a related matter, the DOL has said that, for advisors and their supervisory firms to receive the benefit of the DOL and IRS non-enforcement policies, the firms must make diligent and good faith efforts to comply with BICE. I worry that the failure to have policies, procedures and practices in place will cause the loss of protection under the non-enforcement policy.

Based on prior DOL statements and guidance, there are several types of compensation that appear to create greater risks. In those areas, firms are well-advised to have robust policies, procedures and supervision. Some of those are:

  • Recruitment compensation. The DOL has identified recruitment compensation practices that it believes create substantial incentive for advisors to make recommendations that are not in the best interest of retirement investors. Firms should familiarize themselves with that DOL guidance and design their programs accordingly.
  • Bonus arrangements. This is another area where firms should consider re-designing their compensation practices to avoid concerns identified by the DOL. For example, the DOL favors narrower increments to qualify for bonuses (or increased bonuses) and then favors that the bonuses for each of those narrower “steps” be correspondingly smaller so not to be an inappropriate incentive to give advice that favors the advisor over the retirement investors. Similarly, “waterfall” bonus arrangements are disfavored. (A waterfall arrangement is one where the increased bonus percent “waterfalls” back to cover all of the commissions for the year.)
  • Recommendations of plan distributions and rollovers. In the typical situation, the advisor will not earn anything if the participant doesn’t accept the recommendation, but the advisor will receive compensation (and, for a large rollover, perhaps significant compensation) if the retirement investor accepts the recommendation. The DOL has issued detailed guidance about what information it expects broker-dealers and RIAs to collect and examine before making recommendations to participants to take distributions and make rollovers. A firm’s policies and procedures–including supervision–should literally reflect (or even re-state) those requirements. This is not an area to take risk.

Those are just some examples . . . but now that the full exemptions are being delayed until 2019, broker-dealers and RIAs should revisit the DOL’s guidance and focus on developing compliant practices, particularly in the high risk areas.

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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