Category Archives: fiduciary

Interesting Angles on the DOL’s Fiduciary Rule #47

The “Real” Requirements of the Fiduciary Rule

This is my 47th 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.

I have seen articles and heard comments about the fiduciary rule and exemptions that are misleading. The purpose of this article is to clarify the requirements of the fiduciary rule and the related exemptions.

In order to discuss the “fiduciary package” of guidance, we need to divide it into two categories. The first is the transition rule, for the period from June 9 to December 31, 2017. The second category is the final set of the regulation and exemptions, which are scheduled to become applicable on January 1, 2018, and which are being reviewed by the DOL for changes.

The Transition Rules

The transition rules require, in essence, that advisers, and their supervisory entities, “adhere to” the following:

  • The Best Interest Standard of Care. The Best Interest standard of care is a combination of ERISA’s prudent man rule and duty of loyalty. The consequence is that advisers and their supervisory entities need to engage in a prudent process to develop their investment and insurance recommendations to plans, participants and IRA owners.
  • Reasonable compensation. “Reasonable compensation” is a market-based standard. In other words, what would a transparent and competitive market pay for the services of the adviser and his or her supervisory entity?
  • Misleading statements. The adviser cannot make materially misleading statements about the investments, fees, material conflicts of interest or other matters that would be material to the investment decision.

I used the phrase “adhere to” (as the guidance does) to emphasize that there is no contract or disclosure requirement. In other words, it is a conduct-based standard.

Think about it. Beginning on June 9, an adviser’s recommendations to plans, participants and IRAs has to be prudent and loyal; the adviser cannot mislead the retirement investor; and the adviser and supervisory entity’s compensation must be reasonable. The question is, are these reasonable requirements?

However, on January 1, 2018, the full Best Interest Contract Exemption (BICE) will apply. As currently written, it is disruptive of existing practices, and would be expensive to comply with. That is obviously a problem. However, it will likely be revised. Unfortunately, we don’t know what the changes will be. Hopefully, though, they will reduce the compliance burden while maintaining investor protections.

Notice, though, that I referenced needed changes to the Best Interest Contract Exemption, but not to the fiduciary rule. That’s not to say that the fiduciary rule cannot be improved . . . because it can. However, most of the objections are to the Best Interest Contract Exemption and not to the rule. Unfortunately, people put a label on the package of guidance and, when objecting to the fiduciary rule, their complaints are usually about the Best Interest Contract Exemption. That adds to the confusion about the fiduciary standard of care and its requirements, as opposed to the concerns about the conditions in the exemptions.

While there are some concerns about the fiduciary rule itself, for example, some broker-dealers argue that the Securities and Exchange Commission should write a single fiduciary rule for all investment accounts, including both qualified and non-qualified accounts. That raises the issue of whether there is, or should be, a distinction between accounts that are designed for producing retirement income and those that are intended for personal investing. If the answer is “yes,” then investment advice will be different for the two types of accounts, regardless of which agency writes the rules.

To further complicate matters, the main issue is the prohibited transaction rules, which are statutory, rather than regulatory. Neither the SEC, nor FINRA nor the DOL, can issue regulations that conflict with a statute. As a result, even if the standard of care is changed, the prohibited transaction exemptions will continue to be written by the Department of Labor. In other words, the SEC does not have the statutory authority to create exemptions from the prohibited transaction rules.

As concluding thoughts, while the fiduciary regulation and the transition rules for the exemptions will require changes in practices (for example, fiduciary training and documentation), those rules should not be overly burdensome or expensive to comply with. However, that changes on January 1, 2018 when the final exemptions will apply. Fortunately, the DOL will be reviewing the requirements of those exemptions and, hopefully, the requirements will be modified to be more reasonable in terms of the cost and burden of compliance.

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 #46

How Does an Adviser Know How to Satisfy the Best Interest Standard?

This is my 46th 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.

Beginning on June 9, the new “transition” exemptions will apply to investment and insurance (e.g., annuities) recommendations for IRAs. If an adviser and his supervisory entity (the “financial institution”) are “pure” level fee fiduciaries, there will not be a prohibited transaction under the Internal Revenue Code (so long as the fees are reasonable). Two consequences flow from that. First, the adviser and entity will not need to use the Best Interest Contract Exemption (BICE), which means that they will not be bound by the best interest standard of care. Second, their services to the IRA will be regulated by the securities laws, and not by these new rules.

But, if there is a financial conflict of interest (that is, a prohibited transaction, or PT), the adviser and entity (e.g., broker dealer) will need to use an exemption in order to be paid. The most likely exemption is BICE, and one of the conditions is that the adviser and entity adhere to the “best interest standard of care.” But, what is the best interest standard of care? In essence, it is a combination of ERISA’s prudent man rule and duty of loyalty. Literally, it is:

Investment advice is in the “Best Interest” of the Retirement Investor when the Adviser and Financial Institution providing the advice act 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, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.

While advisers to retirement plans are familiar with those concepts, many advisers to IRAs are not. That raises the question, how can those advisers know what is required? The answer is that fiduciary training and education are needed . . . and needed immediately in light of the June 9 applicability date.

What is the basis for the training? Answer: The fiduciary requirements in ERISA. The DOL made that clear in the preamble to BICE:

“The Best Interest standard set forth in the final exemption is based on longstanding concepts derived from ERISA and the law of trusts. It is meant to express the concept, set forth in ERISA section 404, that a fiduciary is required to act “solely in the interest of the participants . . . with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man 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.” Similarly, both ERISA section 404(a)(1)(A) and the trust-law duty of loyalty require fiduciaries to put the interests of trust beneficiaries first, without regard to the fiduciaries’ own self-interest.”

As a result, broker-dealers and others should look to training and education materials based on ERISA’s provisions, DOL regulations and guidance, and ERISA litigation. Those materials should cover the broad concepts and principles, but should also provide detailed education about the information to be reviewed and the processes to be followed, on a step-by-step basis.

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 #45

The DOL Fiduciary “Package”: Basics on the Prohibited Transaction Exemptions

This is my 45th 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.

My last post (Angles #44) discussed the requirements of ERISA’s prudent man rule and of the best interest standard of care for IRAs and plans. This article outlines the requirements of the two prohibited transaction exemptions that will apply to recommendations of investment products and services and insurance products to plans, participants and IRAs (“qualified accounts”). Those two exemptions are:

  • Prohibited Transaction Exemption 84-24 (which covers recommendations of insurance products, including annuities and life insurance policies). This “transition” 84-24 has been amended to cover all types of annuities (group and individual, variable, fixed rate and fixed index) and applies to the period from June 9, 2017 through December 31, 2017.
  • The Best Interest Contract Exemption (BICE) which can be used for sales of any investment products and services or any insurance products (including those covered by 84-24) during the transition period.

Before discussing the general requirements of those exemptions, I should point out that not all advisory services require the use of an exemption. For example, if an adviser provides investment services to a plan, participant or IRA for a pure level fee, there is not a conflict of interest, in the sense that the adviser’s compensation remains the same regardless of the investments that are recommended. By “pure level fee,” I mean that neither the adviser, nor any affiliate nor related party (including the adviser’s supervisory entities, e.g., broker-dealer), receives any additional compensation or financial benefit.

If, however, the adviser, or any affiliated or related party, does receive additional compensation, that would be a financial conflict of interest, which is a “prohibited transaction” under ERISA and the Internal Revenue Code. In that case, the adviser would need to take advantage of one of the exemptions: BICE or 84-24. (I should point out that neither 84-24 nor BICE is available where the adviser has discretion over the investments in the plan, participant’s account or IRA. As a result, discretionary investment management must be for a pure level fee or a different exemption must be found.)

Here are some examples of compensation that constitutes a prohibited transaction: commissions; 12b-1 fees; trailing payments; asset-based revenue sharing; solicitor’s fees; proprietary investments; and payments from custodians. If any of those payments, or any other financial benefits (such as trips, gifts, or marketing allowances), are received by the adviser, or any affiliated or related party, partially or entirely as a result of an investment or insurance recommendations, that would be a prohibited transaction.

The most common exemption will be the Best Interest Contract Exemption. During the transition period, that exemption, BICE, requires only that the adviser (and the adviser’s Financial Institution, e.g., the RIA firm or broker-dealer) “adhere” to the Impartial Conduct Standards (ICS). There are three requirements in the ICS. Those are:

  • Best interest standard of care (which, in its essence, consists of the prudent man rule and duty of loyalty).
  • The receipt of only reasonable compensation.
  • The avoidance of any materially misleading statements.

The use of the word “adhere” means only that the adviser and Financial Institution must comply with those requirements. There is not a requirement to notify the plan, participant or IRA owner of those requirements, nor is there a requirement during the transition period to enter into a Best Interest Contract.

On the other hand, 84-24 does impose some written requirements. For example, the insurance agent or broker must disclose his initial and recurring compensation, expressed as a percentage of the commission payments. And, the plan fiduciaries or IRA owners must, in writing, acknowledge receipt of that information and affirm the transaction. On top of that, though, the agent must also “adhere” to the Impartial Conduct Standards.

It is my view that Financial Institutions (such as broker-dealers and IRA firms) should, between now and June 9, focus on the fiduciary processes that will be implemented by the home offices (for example, which mutual fund families and insurance products can be sold to “qualified” accounts such as IRAs plans). In a sense, the Financial Institutions will be co-fiduciaries with the advisers and, therefore, share responsibility for the recommendations that are made to the qualified accounts. As a result, Financial Institutions need to have protective policies, procedures and practices in place.

In addition, the home offices of Financial Institutions need to focus on the training of their advisers to comply with the prudent process requirement imposed by the fiduciary rules, including documentation of those processes. While part of a prudent process will be similar to what is currently required under the suitability and know-your-customer rules, these new fiduciary standards place greater emphasis on certain factors, for example, the costs of investments and the quality of the investment management (as well as the financial stability of an insurance company).

With regard to the reasonable compensation requirement, the burden of proof is on the person claiming that the compensation was reasonable. In other words, the burden of proof will be on the broker-dealer, the RIA firm, and the agent or insurance adviser. As a result, advisers and Financial Institutions should have data in place to support their compensation for each investment category that they recommend to plans, participants and IRA owners.

Finally, with regard to 84-24, the required disclosure and consent forms need to be developed and agents need to be educated on the use of the forms, including the disclosure and consent requirements.

Unfortunately, in a short article like this one, I can only discuss some of the requirements. Obviously, there is more than this, but this is a good starting point for understanding the rules and working on compliance with the new requirements.

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 #44

The Basic Structure of the Fiduciary Package (June 9)

This is my 44th 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.

This article focuses on the fiduciary rule; next week I will discuss two of the exemptions, the Best Interest Contract Exemption and 84-24.

As we all know by now, the DOL’s new fiduciary definition applies on June 9. As a result the following recommendations will be fiduciary acts on and after June 9:

  • Recommendations of investments, investment strategies, insurance and annuities, investment managers, other fiduciaries, distributions and rollovers, and IRA transfers;
  • Recommendations to ERISA plans, participants or IRA owners.

Fiduciary recommendations to plans and participants (including rollover recommendations) will be subject to ERISA’s prudent man rule and duty of loyalty and, therefore, any breaches can be enforced as ERISA claims.

The same is not true for recommendations to IRAs, because the law does not establish a prudent man and duty of loyalty standard of care for advice to IRAs.

However, that is not the end of the story.

Where an adviser provides fiduciary services to an IRA for a level fee (for example, 1% per year and no other benefits or compensation is received), the adviser will be subject to the standard of care established by the securities laws.

But, if the adviser (or his supervisory entity, e.g., a broker-dealer) receives compensation that is a prohibited transaction (e.g., commissions, 12b-1 fees, asset-based revenue sharing, etc.), the adviser and entity will need the protection of a prohibited transaction exemption.

For the rest of this year–the “transition period,” most firms will use the Best Interest Contract Exemption. However, it is not the BICE you have been hearing about over the past year. Instead, it is “transition BICE.” Transition BICE requires that the entity and the adviser only comply with the Impartial Conduct Standards (ICS). The ICS has 3 components: the best interest standard of care, only reasonable compensation, and no materially misleading statements.

In effect the best interest standard of care brings the ERISA prudent man rule and duty of loyalty to IRAs. As a result, advisers and their supervisory entities need to educate themselves on the requirements of a prudent process with a duty of loyalty to the IRA owner. The suitability and know-your-customer requirements are a part of that, but only part.

Some other things to consider are:

  • The DOL has historically taken the position that a prudent process must be documented. How will advisers be doing that?
  • It is clear that under ERISA, advisers to plans must consider the costs of the investments. That is likely to be extended to IRAs under the best interest standard. How will advisers to IRAs evaluate the expense ratios of recommended mutual funds and the expenses imbedded in annuities? Will the entities (e.g., broker-dealers) be specifying which software is to be used for that purpose?
  • It is also clear under ERISA that the quality of the mutual funds must be considered, quantitatively and qualitatively. What will that process look like for IRAs? How will it be documented? What software will be used for that purpose? Some broker-dealers are limiting the mutual fund families that can be recommended to “qualified” accounts.

These are just some examples. There are others.

But, for the moment, the message is that, beginning on June 9, advisers and their supervisory entities must understand and apply these concepts.

Since the deadline is right around the corner, these are high priority issues.

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 #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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Interesting Angles on the DOL’s Fiduciary Rule #42

Rollovers under the DOL’s Final Rule

This is my 42nd 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.

On April 7, 2017 the DOL issued its final regulation on the extension of the applicability date for the fiduciary definition and the related exemptions. This article discusses the impact of those changes on fiduciary status for recommendations to plan participants to take distributions and roll over to IRAs.

In its guidance, the DOL extended the applicability date of the new fiduciary definition from April 10 to June 9, but did not otherwise modify the definition. Since the fiduciary rule defined a recommendation to take a plan distribution as fiduciary advice, any recommendation to take a distribution and rollover to an IRA on or after June 9 will be a fiduciary act. As a result, an adviser will need to engage in a prudent process to develop and make such a recommendation. (For purposes of this rule, an “adviser” includes a representative of an RIA or a broker-dealer, an insurance agent or broker, or any other person who makes such a recommendation and receives compensation, directly or indirectly, as a result. An advisory fee from the IRA or a commission from an annuity or mutual fund are examples of compensation.)

However, more is involved that just the fiduciary rule. A recommendation to rollover is also a prohibited transaction, since the adviser will typically make more money if the participant rolls over than if the participant leaves the money in that plan. Because of the prohibited transaction, the adviser will need an exemption. Under the latest changes to the rules, advisers will probably use a process called “transition BIC,” which is a reference to a transition rule under the Best Interest Contract Exemption. (This process applies only from June 9 to December 31, unless it is extended. But it is likely that, at the least, these requirements will be part of any future exemption.). Transition BIC requires only that the adviser comply with the “Impartial Conduct Standards” (ICS).

The ICS requires that advisers adhere to the best interest standard of care, receive no more than reasonable compensation, and make no materially misleading statements. For this article, let’s focus on the best interest standard. Generally stated it is a combination of the ERISA prudent man rule and duty of loyalty.

So, an adviser must satisfy both ERISA’s prudent man rule (for the recommendation) and the BIC best interest rule (for the exemption). Since the two standards of care are virtually identical, I have combined them for this discussion.

But, that begs the question of, what is a prudent and best interest process?

Specifically, it is that the adviser must act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man 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; . . .”

So, what would a prudent, knowledgeable and loyal person, who is making a recommendation about retirement investing (the “aims” of the “enterprise”), do? The first step is to gather the information needed to make an informed decision. Then that information needs to be evaluated in light of the participant’s needs and circumstances of the participant . . .with a duty of loyalty to the participant.

The only clear guidance from the DOL about what information needs to be gathered and evaluated is found in Q14 in the DOL’s Conflict of Interest FAQs (Part I-Exemptions).

The first part of the FAQ discusses the information needed if the adviser is a “Level Fee Fiduciary.” Basically, the information includes the investments, expenses and services in the plan and the proposed IRA.

But at the end of the FAQ, the DOL explains that those considerations must be evaluated even if the adviser is using regular BIC (as opposed to the Level Fee Fiduciary provision).

Accordingly, any fiduciary seeking to meet the best interest standard (in order to satisfy transition BIC) would engage in a prudent analysis of this information before recommending that an investor roll over plan assets to an IRA, regardless of whether the fiduciary was a “level fee” fiduciary or a fiduciary complying with BIC.

In other words, any adviser making a distribution and rollover recommendation on or after June 9, 2017 must have a process for gathering and evaluating information about the investments, expenses and services in the participant’s plan and in the proposed IRA, and about the participant’s needs and circumstances.

This subject is more complicated than can be covered adequately in a short article, but this is a start for understanding the new rules for distributions and rollovers.

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 #41

While We Wait: The Current Fiduciary Rule and Annuities

This is my 41st 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 explained in previous posts, the delay of the new fiduciary rule does not mean that we are “rule-less.” Instead, the “old” rule, and exemptions, which have been place for decades, will continue to apply. Does that mean that we are back in the “good old days” where we won’t need to pay attention to the application of the fiduciary rule to IRAs?  I don’t think so.

Over the past few years, a tremendous amount of attention has been paid to the meaning and consequences of being a fiduciary . . . and I doubt that we can walk back from that. And, with this newfound attention, it is possible that many common practices will, when closely examined, result in fiduciary status under the old rule.

The consequences of unknowingly being a fiduciary are significant. If a fiduciary recommendation results in the payment of a commission to a fiduciary adviser or insurance agent, that payment would be a prohibited transaction and, absent compliance with any exemptions (e.g.., 84-24), the commission would be prohibited.

For example, the most common reason that advisors and insurance agents haven’t considered themselves to be fiduciaries for annuities is that their services haven’t been rendered “on a regular basis”. In other words, the sales have been viewed as one-time events. Let’s see how that stands up against common practices for sales and servicing of annuities in IRAs.

What about fixed rate (or “traditional”) annuities? It’s possible, perhaps even probable, that the sale of the annuity is a one-time event and that recommendations are not provided on an on-going basis. In that case, these sales would not be fiduciary services. However, if the agent periodically recommends additional purchases, that could result in fiduciary status. (Keep in mind that the definition is “functional” and it doesn’t matter what the agreements say. Instead, the conduct of the advisor is examined.)

What about fixed indexed annuities? Similar to their fixed rate cousins, the sale could be a one-time event and, therefore, not a fiduciary recommendation. On the other hand, if there are ongoing services that would be fiduciary activities, it can result in fiduciary status.

What about variable annuities? The recommendation of a variable annuity may contemplate ongoing fiduciary services, for example, recommendations about the mutual funds inside the annuity and the allocations and reallocations among those investments. In that case, the services could result in fiduciary status and the payment of the commission could be a prohibited transaction. As a result, both advisers and agents should consider using PTE 84-24. (Remember that 84-24, in its old form, is still in effect and that, therefore, all three types of annuities are covered by the exemption.)

So, after you heave a sigh of relief for the delay of the fiduciary rule, it’s time to go back to work on fiduciary issues . . . and an important one is the treatment of the recommendation of annuities to IRAs.

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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DOL Issues Temporary Enforcement Relief for Fiduciary Rule Non-Compliance

The DOL has published Field Assistance Bulletin 2017-1, which provides some limited temporary relief while the industry waits to find out if the Fiduciary Rule will be applicable April 10. The Drinker Biddle Employee Benefits and Executive Compensation Group has written a Client Alert, in which we discuss the two scenarios in which the DOL will not take enforcement action for non-compliance with the Fiduciary Rule during this period of uncertainty. We also provide suggestions on how advisers and financial institutions should proceed while we wait to see what happens with the Fiduciary Rule.

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Interesting Angles on the DOL’s Fiduciary Rule #40

New Rule, Old Rule: What Should Advisers Do Now?

This is my 40th 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.

Now that it seems clear that the applicability date of the new fiduciary regulation will be delayed, many advisers (including broker-dealers and RIA firms) may heave a sigh of relief. However, while some relief is justified, that does not mean that their services are not governed, in many cases, by the “old” fiduciary regulation. (By “old” rule, I refer to the DOL regulation that defines fiduciary advice and that has been in effect for decades.) With all the attention that has been devoted to fiduciary status and prohibited transactions, it is possible, perhaps even probable, that the old rule will be applied more vigorously. As a result, advisers need to understand its provisions and need to review their practices to determine whether they are currently acting as fiduciaries under the old rule. To properly discuss that issue, advisory services need to be divided into four categories: advice to plans; advice to participants; advice to IRAs; and recommendations of plan distributions and rollovers. This article will discuss the first of those categories . . . advice to retirement plans.

Briefly stated, the old—and current–fiduciary rule has a five-part test:

  • A recommendation of an investment, insurance product, investment manager, and/or investment strategy or policy.
  • The advice must be given on a regular basis, that is, on an ongoing basis.
  • There must be a mutual understanding between the adviser and the plan fiduciaries.
  • The understanding is that the advice will be a primary basis for decision-making.
  • The advice is individualized and based on the particular needs of the plan.

With regard to qualified retirement plans (for example, 401(k) plans), those conditions will likely be satisfied in many cases. For example, it is common, perhaps even typical, for an adviser to meet with plan fiduciaries quarterly or annually. As a result, the advice is given on a regular basis. Similarly, when an adviser provides a list of investments, it is difficult to say that they are not individualized to the plan, because of the suitability requirements that apply to broker-dealers, RIAs, and insurance agents. In any event, there is a significant risk that an adviser who provides a list of investments to plan fiduciaries will be considered to have made fiduciary recommendations.

As a result, and with likely heightened scrutiny of advisers’ recommendations and fiduciary status, broker-dealers and insurance agents should consider whether they are willing to run the risk of being a fiduciary. (As this suggests, RIA’s probably are fiduciaries for ERISA plans.) And, if they are willing to be fiduciaries, there should be a formal program in place for that purpose. For example, a broker-dealer might establish a fiduciary advisory program under its corporate RIA and allow its most experienced retirement plan advisers to participate in that program. For those advisers who won’t be allowed to be fiduciaries under the RIA program, those broker-dealers should consider requiring that the advisers only recommend 401(k) providers who have platform fiduciaries. For example, a recordkeeping platform might offer a 3(21) non-discretionary fiduciary investment adviser and/or a 3(38) discretionary fiduciary investment manager. In that case, the platform fiduciary would recommend or select the investments, while the adviser would provide other services to the plan, for example, assistance with plan design, coordination with the recordkeeper, participant education meetings, and so on.

My point is that, now that we are more aware of the fiduciary definitions and the impact of fiduciary status, advisers need to be more attentive to their services and to whether those services result in fiduciary status. Correspondingly, their supervisory entities (for example, broker-dealers) need to make decisions about how those services will be offered, including whether some of the registered representatives can be 401(k) fiduciaries under the corporate RIA.

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 #39

FINRA Regulatory Notice 13-45: Guidance on Distributions and Rollovers

This is my 39th 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.

Even though the DOL fiduciary rule is being delayed, other regulators have indicated their interests in protecting participants from inappropriate recommendations to take plan distributions and roll over to IRAs.

FINRA, which oversees broker-dealers, addressed rollover recommendations to participants in Regulatory Notice 13-45. In describing the purpose of the notice, FINRA said:

“FINRA is issuing this Notice to remind firms of their responsibilities when (1) recommending a rollover or transfer of assets in an employer-sponsored retirement plan to an Individual Retirement Account (IRA) or (2) marketing IRAs and associated services.”

FINRA noted that:

A broker-dealer’s recommendation that an investor roll over retirement plan assets to an IRA typically involves securities recommendations subject to FINRA rules. . . . Any recommendation to sell, purchase or hold securities must be suitable for the customer and the information that investors receive must be fair, balanced and not misleading.”

FINRA went on to say that:

“A recommendation concerning the type of retirement account in which a customer should hold his retirement investments typically involves a recommended securities transaction, and thus is subject to Rule 2111. For example, a firm may recommend that an investor sell his plan assets and roll over the cash proceeds into an IRA. Recommendations to sell securities in the plan or to purchase securities for a newly opened IRA are subject to Rule 2111.”

In essence, FINRA concludes that a recommendation to take a rollover includes a recommendation to liquidate* the investments in a participant’s 401(k) account. . . and that the liquidation recommendation is a “recommended securities transaction” and “thus is subject to Rule 2111.” The guidance then goes on to say:

“If Rule 2111 is triggered, a registered representative must have a reasonable basis to believe that the recommendation is suitable for the customer, based on information about the options obtained through reasonable diligence, and taking into account factors such as tax implications, legal ramifications, and differences in services, fees and expenses between the retirement savings alternatives.” (Emphasis added.)

Earlier in the Notice FINRA also describes the need for an adviser to compare investments, services and expenses in the plan and the recommended IRA before making a recommendation.

That is strikingly similar to the Best Interest Contract Exemption (BICE) requirement that fiduciary advisers must do a comparative analysis of the investments, services and expenses in the Plan and the proposed IRA before recommending a rollover.

The regulators appear to be harmonizing around the type of analysis and investigation required to make a suitable or prudent recommendation.

*In a footnote, FINRA observes that it is possible that a plan could permit distributions in kind, rather than requiring liquidation of the plan’s designated investment alternatives. As a practical matter, I have not worked with any 401(k) plans that distribute in kind. I assume that my experience is typical and that few, if any, 401(k) plans permit distributions of their mutual fund shares.

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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