Category Archives: BICE

Interesting Angles on the DOL’s Fiduciary Rule #22


BICE, DOL, fiduciary, prohibited transaction

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 CDs (or, alternatively, to receive credits towards bonuses based on a variety of factors, including the IRA investments). Based on the wording of the new fiduciary rule, if a bank employee recommends that an IRA invest in a certificate of deposit, and is compensated directly or indirectly for that recommendation, it is a fiduciary act for compensation. (The bonus, or bonus credit, is the compensation.) Since the bank employee is being paid compensation that is not stated and level, the payment is a prohibited transaction. That means that an exemption is needed. (There are differing opinions within the banking community about whether a bank deposit exemption is available. The specific issue is whether the bank deposit exemption covers the payment to the employee.)

To complicate matters, what if the bank customer is retiring and asks about rolling over his 401(k) account? If the bank employee recommends a rollover, that would be fiduciary advice under ERISA. As such, the bank and its employee would need to develop the recommendation through a prudent process, considering at the least the investments, services and expenses in the plan and the proposed IRA. In addition, the recommendation could be a prohibited transaction, and an exemption would be needed.

The story doesn’t end there. Similar referral and compensation arrangements also exist for referrals to a bank’s trust department, affiliated investment adviser and affiliated broker-dealer. While the Best Interest Contract Exemption is generally available for compensation for these types of referrals, it may be difficult for banks to comply, since the cost and effort of BICE compliance can be significant, but the amounts paid under these referral arrangements are, at least for each individual referral, relatively small.

As we continue working with clients on compliance issues for the new rules, it is becoming increasingly clear that there are a significant number of unanticipated consequences.

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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Interesting Angles on the DOL’s Fiduciary Rule #21


BICE, DOL, fiduciary, prudent

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 underlying mutual funds, are reasonable; and determining what portion of an investor’s financial assets should be allocated to the annuity. To do that job, fiduciary advisers will need to gather the information necessary to make an appropriate recommendation and then prudently evaluate that information. Stated slightly differently, there is a duty to investigate. The DOL described that responsibility in the preamble to the best interest contract exemption (BICE):

This is not to suggest that the ERISA section 404 prudence standard or Best Interest standard, are solely procedural standards. Thus, the prudence standard, as incorporated in the Best Interest standard, is an objective standard of care that requires investment advice fiduciaries to investigate and evaluate investments, make recommendations, and exercise sound judgment in the same way that knowledgeable and impartial professionals would.

Here are two more thoughts on that. First, the DOL has historically taken the position that a prudent process for advice to retirement plans must be documented. That could easily be extended to advice to IRAs as well. In fact, there is a specific documentation retention requirement under BICE. Second, there is an argument that, if a fiduciary adviser cannot obtain – through the investigation – enough information to formulate a prudent recommendation, the adviser needs to abstain from making a recommendation. One obvious example is where an adviser is developing a recommendation to a participant to take a distribution and roll it over into an IRA. In that situation, BICE specifically requires that the adviser consider the investments, expenses and services in the plan, and then compare them to the investments, expenses and services in the proposed IRA. The best interest analysis must be documented by the adviser. If the adviser cannot obtain adequate information about the investments, expenses and/or services in the plan, it would be difficult, if not impossible, to make and document that analysis.

As I said earlier in this article, for a retirement plan perspective, this is not a new requirement. Instead, these are long standing rules. However, for IRAs the fiduciary guidance will, in many cases, require changes in processes and practices. Since IRAs are smaller than plans, and therefore can’t afford to pay as much money for services, advisers and their supervisory entities need to develop efficient processes for gathering information and performing the analysis. I suspect this will lead to new programs and computer-based systems.

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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Interesting Angles on the DOL’s Fiduciary Rule #18


BICE, DOL, fiduciary, prohibited transaction, prudent

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 the amount that is reasonable is determined based on the services that are provided. In its guidance, the DOL explains how reasonableness is to be determined:

“The reasonableness of the fees depends on the particular facts and circumstances at the time of the recommendation. Several factors inform whether compensation is reasonable including, inter alia, the market pricing of service(s) provided and the underlying asset(s), the scope of monitoring, and the complexity of the product. No single factor is dispositive in determining whether compensation is reasonable; the essential question is whether the charges are reasonable in relation to what the investor receives.”

However, there is a difference between “market” compensation and “customary” compensation. That difference is primarily whether the market is transparent and competitive:

“Ultimately, the “reasonable compensation” standard is a market based standard. As noted above, the standard incorporates the familiar ERISA section 408(b)(2) and Code section 4975(d)(2) standards. The Department is unwilling to condone all “customary” compensation arrangements and declines to adopt a standard that turns on whether the agreement is “customary.” For example, it may in some instances be “customary” to charge customers fees that are not transparent or that bear little relationship to the value of the services actually rendered, but that does not make the charges reasonable.”

As a hypothetical example . . . if an adviser provides a wide range of services, that might justify compensation of 1% per year of the assets under management. On the other hand, if an adviser provides a more limited range of services, that might be worth one-half of 1% per year (that is, 50 basis points). As a more specific example, BICE requires that advisers state whether or not they will be monitoring the investments on behalf of the IRA owner or plan. Obviously, all other things being equal, an adviser that provides fiduciary monitoring services is entitled to more money than one that does not.

With that understanding, the key question is, how will an adviser determine whether its compensation is reasonable? Most likely, it will be done in the same way that is in the 401(k) world. In other words, the value of services will be determined by the competitive marketplace. Since competitive market data is not generally available for IRAs, RIA firms and broker-dealers will need to work with service providers who have that information. In the 401(k) world, those are called benchmarking services.

The better benchmarking services will consider both the range of services and the compensation of the adviser. As explained above, the calculation of reasonable compensation is based on the services provided, but not just on the size of the account. In that regard, there will need to be a range of benchmarking alternatives, for example, discretionary investment advice for individual securities; discretionary investment advice for mutual funds; non-discretionary advice for both of those scenarios; recommendations for the purchase of individual annuities, including evaluations that take into account the different types of annuities (e.g., fixed rates annuities, fixed indexed annuities, and variable annuities); referrals to discretionary investment managers; and so on. The benchmarking will need to consider services and compensation in the first year and in subsequent years (for example, will the adviser be monitoring the investments).

While the services do not exist today, it is likely that they will in the relatively near future, say, in the next six to 12 months.

Forewarned is forearmed. Advisers need to be attentive to these issues, now that they are front and center.

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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Interesting Angles on the DOL’s Fiduciary Rule #17


BICE, DOL, fiduciary

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 to know that the fiduciary regulation says that a recommendation to transfer an IRA is a fiduciary act. More specifically, it says that fiduciary acts include:

“…recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made.”

The next step is to understand that the recommendation will almost necessarily result in a financial conflict of interest, which the Internal Revenue Code refers to as a prohibited transaction. In other words, a receipt of compensation as a result of the recommendation is prohibited. Fortunately, though, there is an exception, which the Code calls an exemption, that if its conditions are satisfied, allows the adviser to receive compensation on a transferred IRA. The exemption is BICE.

BICE-lite has several requirements, including that the adviser receive only reasonable compensation, that no misleading statements be made, and that the recommendation to transfer the IRA satisfy the best interest standard of care. However, the most demanding requirement is that the adviser document why the recommendation is in the best interest of the investor. (More accurately, BICE-lite requires that the Financial Institution—for example, the broker-dealer or RIA firm—document why the recommendation is in the best interest of the investor.) To quote from the exemption:

“…in the case of a recommendation to rollover from another IRA or to switch from a commission-based account to a level fee arrangement, the Level Fee Fiduciary documents the reasons that the arrangement is considered to be in the Best Interest of the Retirement Investor, including, specifically, the services that will be provided for the fee.”

In doing the analysis to determine whether the recommendation is in the IRA owner’s best interest, BICE specifically requires that the adviser consider the services offered in the existing IRA and the services that the adviser will offer in the new IRA. In that regard, it would be risky to document the “best interest” recommendation without some specific consideration of the services. However, that is not the end of the story. The rule more generally requires that the adviser act in the best interest of the IRA owner, which could involve other considerations. For example, the general rule for a prudent process is that the fiduciary adviser consider the “relevant” factors. (Those are the factors that a hypothetical knowledgeable person would want to review in making the decision.) The best interest standard also requires that the adviser consider the needs, circumstances, objectives and risk tolerance of the IRA owner.

So, what does all of that mean? While there could be a number of ways of satisfying the requirements, I believe that one way—and probably a good way—is to have procedures, forms and services for gathering and evaluating the information and for documenting why the analysis of that information results in a recommendation that the transfer (or not transferring) is in the best interest of the IRA owner.

Also, while BICE does not specifically discuss the analysis that needs to be made if the adviser will not be providing “Level Fee Fiduciary” advice to the IRA, the logical conclusion would be that the requirements are the same (in addition to satisfying the other conditions of BICE that do not apply to Level Fee Fiduciary advice).

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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Interesting Angles on the DOL’s Fiduciary Rule #15


BICE, DOL, fiduciary, prudent

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 is one with a conflict of interest, e.g., the advice can result in higher compensation or payments from third parties – such as 12b-1 fees or where proprietary investments are used.)

However, a pure level fee adviser does not have any financial conflicts and therefore will not need to use BICE. (A “pure level fee adviser” is one who charges a level fee, e.g., one percent per year, and neither the adviser, his supervisory entity nor any affiliated or related party receives any money or financial benefit on top of that fee.) Since a pure level fee, or non-conflicted, adviser won’t commit a prohibited transaction and therefore won’t need an exemption, that adviser will not be bound by the best interest standard for investment advice to individual IRAs. Instead, the adviser will only be subject to the conduct standards in the securities laws.

As a result, pure level fee advisers for IRAs won’t be affected by the new fiduciary rules . . . with a couple of notable exceptions. The biggest of those exceptions is a recommendation to a plan participant to take a distribution and roll over to an IRA with the adviser. But that is a subject for a future article.

For the moment, though, let me leave you with a positive thought. If you are a pure level fee adviser, your existing IRA clients, and your services to those clients, will not be affected by the new rules.

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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Interesting Angles on the DOL’s Fiduciary Rule #11


BICE, DOL, fiduciary, General

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 more than reasonable compensation to the service provider. Accordingly, Advisers and Financial Institutions – as service providers – have long been subject to this requirement, regardless of their fiduciary status. At bottom, the standard simple requires that compensation not be excessive, as measured by the market value of the particular services, rights, and benefits the Adviser and Financial Institution are delivering to the Retirement Investor.

The reasonableness of the fees depends on the particular facts and circumstances at the time of the recommendation. Several factors inform whether compensation is reasonable including, inter alia, the market pricing of service(s) provided and the underlying asset(s), the scope of monitoring, and the complexity of the product. No single factor is dispositive in determining whether compensation is reasonable; the essential question is whether the charges are reasonable in relation to what the investor receives.”

In other words, “reasonableness” is defined by free market practices . . . in a market where the costs and compensation are transparent and, therefore, where the market is truly competitive. As a result, broker-dealers, RIAs, insurance companies and banks will need to use market data to evaluate the compensation they receive for the distribution of their products and services to plans and IRAs.

Benchmarking is on its way to IRAs. Expect compensation to drop – for the more “expensive” advisers.

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Interesting Angles on the DOL’s Fiduciary Rule #5


BICE, DOL, fiduciary

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 be in the Best Interest of the Retirement Investor. This documentation must include consideration of the Retirement Investor’s alternatives to a rollover, including leaving the money in his or her current employer’s Plan, if permitted, and must take into account the fees and expenses associated with both the Plan and the IRA; whether the employer pays for some or all of the plan’s administrative expenses; and the different levels of services and investments available under each option; . . .”

Where the fiduciary adviser is already working with the plan, this requirement appears to be manageable. However, it will likely be difficult for an adviser who does not have a relationship with the plan.

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Interesting Angles on the DOL’s Fiduciary Rule #3


BICE, broker-dealers, DOL

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 the incentives potentially impact Adviser recommendations. Certainly, Financial Institutions must not provide incentives to branch managers or other supervisors that are intended to, or would reasonably be expected to cause such entities, in turn, to incentivize Advisers to make recommendations that do not meet the Best Interest standard. Financial Institutions, therefore, should not compensate branch managers and other supervisors, or award bonuses or trips to such entities based on sales of certain investments, if such awards could not be made directly to Advisers under the standards set forth in this exemption.”

As this indicates, the new rules will impact almost every aspect of the sales of investments and insurance products to plans . . . and especially to IRAs.

 

 

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Interesting Angles on the DOL’s Fiduciary Rule #2


BICE, DOL, prudent

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 similarly rigorous approach is required.)

Here’s what the DOL said:

“Assessing the prudence of a particular indexed annuity requires an understanding of surrender terms and charges; interest rate caps; the particular market index or indexes to which the annuity is linked; the scope of any downside risk; associated administrative and other charges; the insurer’s authority to revise terms and charges over the life of the investment; and the specific methodology used to compute the index-linked interest rate and any optional benefits that may be offered, such as living benefits and death benefits. In operation, the index-linked interest rate can be affected by participation rates; spread margin or asset fees; interest rate caps; the particular method for determining the change in the relevant index over the annuity’s period (annual, high water mark, or point-to-point); and the method for calculating interest earned during the annuity’s term (e.g., simple or compounded interest).”

Actually, there’s more than that. For example, based on ERISA precedence, an adviser would also need to evaluate the financial stability of the insurance company and its ability to make the annuity payments (e.g., 20 or 30 years from now).

 

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Inside the Beltway Audiocast April 28, 2016


BICE, DOL

Please join Brad Campbell and me during the April 28, 2016 presentation of “Inside the Beltway,” at noon eastern/9 am pacific time. Inside the Beltway is a quarterly audiocast in which we discuss developments in Washington that directly impact our industry. During this sixteenth presentation of Inside the Beltway we will be discussing the DOL’s final fiduciary regulation and the 84-24 and BIC exemptions and their impact on advice to plans and IRAs, including recommendations to take distributions from plans or IRAs.

The audiocast is free, and will be recorded. There will be an opportunity to ask questions at the end of the session. Please register here if you’d like to listen live, or receive the recording later.

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