Category Archives: DOL

Interesting Angles on the DOL’s Fiduciary Rule #13


DOL, fiduciary, General

This is my thirteenth article about interesting observations “hidden” in the fiduciary regulation and the exemptions.

It is not clear under current rules whether “suggesting” investment policies is a fiduciary act. In that vein, it’s also not clear if providing a sample investment policy statement (IPS) is a fiduciary act. However, that is about to change.

When the new fiduciary regulation applies—on April 10, 2017, the recommendation of investment policies, strategies or portfolio composition will be fiduciary activities. As the DOL says in the preamble to the fiduciary regulation:

Specifically, the final rule includes text that describes management of securities or other investment property, as including, among other things, recommendations on investment policies or strategies, portfolio composition, or recommendations on distributions, including rollovers, from a plan or IRA.

And, a mere suggestion to use certain investment policies can result in fiduciary status. The DOL defines a fiduciary recommendation as:

For purposes of this section, ‘‘recommendation’’ means a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.

So, what does this mean? First, if you don’t want to be a fiduciary for that purpose, the safest bet is to avoid suggestions of investment policies or providing a sample IPS. A reasonable question is . . . if you didn’t mean for your comments or the sample document to suggest the use of the policies or IPS, why did you bring it up?

On the other hand, if you are willing to be a fiduciary for this purpose, make sure that you are a fiduciary (that is, that the recommendations/IPS are prudent under the circumstances). Keep in mind that ERISA’s prudent process rule is based on generally accepted investment theories and prevailing investment industry standards. Your policy recommendations should be based on those concepts (absent an explicit instruction from the investor to the contrary).

If you have read to this point, you are probably thinking about these issues in the context of retirement plans. That’s valid, but only partially so. Beginning April 10, these rules also apply to IRAs. Do you suggest investment policies to IRA owners or supply an IPS? If so, the same concepts will apply.

Forewarned is forearmed.

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Interesting Angles on the DOL’s Fiduciary Rule #12


DOL, fiduciary, prohibited transaction

This is my twelfth article about interesting observations “hidden” in the fiduciary regulation and the exemptions.

The DOL has long taken the position that the recommendation of a discretionary investment manager is a fiduciary act. (At least one court has adopted that position – in a case involving investments with Madoff.)

While I am not aware of any guidance or litigation about potential prohibited transactions because of payments to persons who recommend investment managers (e.g., solicitor’s fees), from a legal perspective, if the person making the referral is a fiduciary and that person receives a fee, it may be a prohibited transaction under ERISA and the Internal Revenue Code.

To further complicate matters, when the new fiduciary rule becomes applicable on April 10, 2017, the definition of “fiduciary” will cover someone who makes referrals to both discretionary investment managers and non-discretionary investment advisers for plans, participants and IRAs. More specifically, the fiduciary definition includes:

“A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services . . .” [Emphasis added.]

In other words, a person who recommends a fiduciary adviser (which could include financial advisers, insurance agents and investment advisers under the new definition) will be a fiduciary for that purpose, if a fee is paid for the referral; and the payment of that fee could be (or, perhaps, probably will be) a prohibited transaction.

This is a significant change. Advisers who pay fees for referrals should consider its impact.

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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 #10


DOL, fiduciary, General, prohibited transaction

This is my tenth article about interesting observations “hidden” in the fiduciary regulation and the exemptions.

When the new fiduciary advice regulation is applicable on April 10, 2017, a recommendation to a participant to take a distribution and rollover to an IRA will be a fiduciary act. It doesn’t matter if the adviser has a pre-existing relationship with the plan or the participant, or not.

Some RIA firms and broker-dealers focused on a similar issue when FINRA issued its Regulatory Notice 13-45 in late 2013. As that notice explained, distribution recommendations are investment recommendations (and thus, in the case of FINRA, are subject to the suitability standard), but distribution education is not an investment recommendation. To avoid the additional compliance work (and possibly prohibited transactions), many RIA firms and broker-dealers adopted a distributions education approach using 13-45 as the model. While the DOL agrees that distribution education is not a fiduciary recommendation, it does not agree that 13-45 is a safe harbor:

“In response to the comments suggesting that the Department adopt FINRA Notice 13-45 as a safe harbor for communications on benefits distributions, the FINRA notice did not purport to define a line between education and advice. The final rule [i.e., the fiduciary advice regulation] seeks to ensure that all investment advice to retirement investors adheres to fiduciary norms, particularly including advice as critically important as recommendations on how to manage a lifetime of savings held in a retirement plan and on whether to roll over plan accounts. Following FINRA and SEC guidance on best practices is a good way for advisers to look at for the interests of their customers, but it does not give them a pass from ERISA fiduciary status.”

As a word to the wise, RIAs and broker-dealers should revisit their 13-45 distribution education materials, and revise them to be consistent with the DOL’s approach.

 

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Interesting Angles on the DOL’s Fiduciary Rule #9


DOL, fiduciary, prudent

This is my ninth article about interesting observations “hidden” in the fiduciary regulation and the exemptions.

As I explained in an earlier post, there are three parts to the best interest standard . . .

  • Prudence: “. . . the fiduciary acts with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, . . .”
  • Individualization: “. . . based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor, . . .”
  • Loyalty: “. . . without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.”

The question for this “angles” article is, what is the difference between the prudence part of the Best Interest standard and the prudent man rule in ERISA?

Easy . . . one word. “Man” in ERISA was changed to “person” in the Best Interest standard. So, the prudent man rule has become the prudent person rule. It’s more modern and politically correct.

But, other than that, it is verbatim the same. That means that we have over 40 years of history of DOL guidance and fiduciary litigation to consider in applying the prudent person rule to IRA and rollover recommendations. Think in terms of generally accepted investment theories, (e.g., modern portfolio theory); reasonable costs; compensation that is consistent with services, not products. In terms of its impact, think of transparency, fee and expense compression, and competition.

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Interesting Angles on the DOL’s Fiduciary Rule #8


DOL, fiduciary, General, plan sponsors

This is my eighth article about interesting observations “hidden” in the fiduciary regulation and the exemptions.

The final regulation on fiduciary advice continues, as education, the current practice of providing participants with asset allocation models that are populated with a plan’s designated investment alternatives (DIAs).

However, the rule imposes a burden on plan sponsors to monitor those models and which DIAs are used for the models. The fiduciary focus should be on the costs and payments from investments to providers and advisers. The preamble says:

 “In this connection, it is important to emphasize that a responsible plan fiduciary would also have, as part of the ERISA obligation to monitor plan service providers, an obligation to evaluate and periodically monitor the asset allocation model and interactive materials being made available to the plan participants and beneficiaries as part of any education program.

That evaluation should include an evaluation of whether the models and materials are in fact unbiased and not designed to influence investment decisions towards particular investments that result in higher fees or compensation being paid to parties that provide investments or investment-related services to the plan.”

Who will help plan sponsors satisfy that fiduciary duty?

Most plan sponsors won’t know about this duty. Even if they become aware of the responsibility, they probably won’t know how to evaluate if the “education” models are disguised vehicles for generating management fees for proprietary products or more revenues for advisers or their financial institutions.

This looks like an opportunity for high quality advisers to provide a valuable service to plan sponsors.

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Interesting Angles on the DOL’s Fiduciary Rule #7


DOL, fiduciary, prudent

This is my seventh article about interesting observations “hidden” in the fiduciary regulation and the exemptions.

There are three parts to the best interest standard . . .

  • The prudent person rule.
  • Individualization to the retirement investor’s circumstances.
  • The duty of loyalty.

See the three parts below. Interestingly, none of the parts uses the word “best.” In other words, “best interest” is just a label; the real requirements are prudence and loyalty.

  • Prudence: “. . . the fiduciary acts with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, . . .”
  • Individualization: “. . . based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor, . . .”
  • Loyalty: “. . . without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.”

Moral of the story: Don’t let the label confuse you. There isn’t any requirement to pick the best investment . . . if such a thing exists. It’s just old-fashioned prudence and loyalty. The result is that investment advice to IRAs will often look like investment advice to 401(k) participants: good quality investments, appropriate asset allocation and diversification, and reasonable costs.

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Interesting Angles on the DOL’s Fiduciary Rule #6


DOL, fiduciary, General, prohibited transaction, prudent

This is my sixth article about interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.

In some cases, the concerns about the scope of the fiduciary rule are overblown. For example, there have been some statements that advice about minimum required distributions for IRAs would be fiduciary advice. That is not the case.

In the preamble to the fiduciary regulation, the DOL explained:

“With respect to the tax code provisions regarding required minimum distributions, the Department agrees with commenters that merely advising a participant or IRA owner that certain distributions are required by tax law would not constitute investment advice. Whether such “tax” advice is accompanied by a recommendation that constitutes “investment advice” would depend on the particular facts and circumstances involved.”

So, basic advice about tax requirements and consequences is not fiduciary advice. However, if the adviser recommends which investments the IRA owner should sell to fund the distribution, that is fiduciary investment advice which must be:

  • prudent and in the best interest of the IRA owner, and
  • free from financial conflicts of interest (or in compliance with a prohibited transaction exemption).
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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 #4


DOL, fiduciary, prudent

This is my fourth article about interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.

During a recent webinar for TD Ameritrade, one of the attendees asked if Jim Cramer’s TV stock tips would be considered fiduciary advice. I said that they would not be, since they were not directed to a specific investor.

In hindsight, I wish that I had told him that the preamble to the fiduciary regulation specifically addressed that issue . . . more specifically than you might think. Here’s what the DOL said:

“Many commenters, as the Department noted above, expressed concern about the phrase ‘‘specifically directed’’ in the proposal under paragraph (a)(2)(ii) and asked that the Department clarify the application of the final rule to certain communications including casual conversations with clients about an investment, distribution, or rollovers; responding to participant inquiries about their investment options; ordinary sales activities; providing research reports; sample fund menus; and other similar support activities. For example, they were concerned about communications made in newsletters, media commentary, or remarks directed to no one in particular. Commenters specifically raised the issue of whether on-air personalities like Dave Ramsey, Jim Cramer, or Suze Orman would be treated as fiduciary investment advisers based on their broadcast communications. The concern is unfounded. With respect to media personalities, the rule is focused on ensuring that paid investment professionals make recommendations that are in the best interest of retirement investors, not on regulating journalism or the entertainment industry.”

 

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