Category Archives: fiduciary

Interesting Angles on the DOL’s Fiduciary Rule #26


BICE, broker-dealers, DOL, fiduciary, prohibited transaction, service providers

Reasonable Compensation for IRAs: When and How Long?

This is my twenty-sixth article about interesting observations concerning the fiduciary rule and exemptions.

This article is a little different than most of my previous posts. However, it is equally as important. To get to the point, I am writing this article about reasonable compensation for advice to IRAs because of a common misunderstanding about the requirement.

In the last month or two, I have seen a number of articles and heard several comments to the effect that it will be difficult to determine reasonable compensation for IRAs because the rule is so new. Stated a little differently, the point is that the reasonable compensation requirement for IRAs will first become effective on April 10, 2017. That is not correct.

Section 4975(c)(1)(C) provides that the “furnishing of . . . services . . . between a plan and a disqualified person” is a prohibited transaction. However, section 4975(d)(2) permits, as an exception to that general prohibition, “any contract, or reasonable arrangement, made with a disqualified person for . . . services necessary for the establishment or operation of a plan, if no more than reasonable compensation is paid therefor.” (Section 4975(e)(2) defines a “disqualified” person as “a person providing services to the plan.” Then, 4975(e)(1)(B) defines a “plan” as “an individual retirement account.” And, (C) includes “an individual retirement annuity.”)

In other words, the reasonable compensation limitation is not new. It’s been with us for decades.

But, if that’s the case, why hasn’t there been more discussion and, in the bigger picture, more enforcement of the rule? There are two reasons. The first is that, by and large, the rule has been ignored. How is that possible? That’s because only the Internal Revenue Service can enforce the rule, but it hasn’t. In this case, the 15% excise tax under section 4975 would be enforced against the service provider, that is, the adviser. But, if the rule has been in effect for years without much publicity, why is there so much discussion now?

The answer is that the Department of Labor has, in conjunction with the fiduciary rule, issued two exemptions—84-24 for life insurance policies and fixed rate annuities, and the Best Interest Contract Exemption (BICE) for any and all investments that can be sold to plans and IRAs. Both of those exemptions—which are needed where prohibited compensation results from the investment or insurance recommendation—limit the adviser’s compensation for recommended investments and insurance products to be no more than a reasonable amount. In the case of BICE, for example, the Financial Institution (e.g., the broker-dealer) must agree that its compensation and the adviser’s compensation for their services will not exceed a reasonable amount. IRA and plan investors will be able to pursue breach of contract claims for excess compensation.

So, while the law limiting the compensation of advisers (and Financial Institutions) is not new, the enforcement mechanism will be.

While the new rules seem burdensome, I believe that a variety of services will be developed to assist Financial Institutions in determining reasonable compensation for different levels of services related to different types of products.

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 #25


BICE, DOL, fiduciary, prudent

Reasonable Compensation Versus Neutral Factors

This is my twenty-fifth article covering interesting observations about the fiduciary rule and exemptions.

In my last post, I wrote about the Best Interest Contract Exemption (BICE) and the requirements for “neutral factors” and “differential compensation” between “reasonably designed investment categories.” As I pointed out, the purpose of neutral factors is to determine the relationship of compensation between different categories of investments and services. In other words, neutral factors don’t establish a dollar amount of compensation, but instead they are used for determining the relative compensation between different reasonably designed investment categories. Think of it as evaluating degree of difficulty in terms of work, complexity, value, etc.

But that begs the question, if neutral factors are used to establish the ratio of compensation, how is the compensation determined?

The best way to approach that question is to look at a single reasonably designed investment category. Within an investment category, the compensation of an adviser must be both reasonable and level. Stated slightly differently, the compensation of the adviser cannot exceed a reasonable amount (based on the services rendered) and the adviser’s compensation must be level regardless of which products are recommended . . . and regardless of the payments made to the adviser’s supervisory entity (e.g., broker-dealer or any affiliate or related party). For example, if the compensation paid to the individual adviser is 1% per year for providing non-discretionary investment advice on a portfolio of mutual funds, that compensation needs to be tested for reasonableness and needs to be level regardless of which mutual funds are recommended and regardless of the payments, if any, to the adviser’s broker-dealer (or any affiliated or related party).

“Level” is fairly easy to grasp. In my example, a level fee is 1% regardless of which mutual funds are recommended. “Reasonable” is a bit more difficult. As explained in prior posts, the DOL says that reasonable compensation is based on market data—in an open, transparent and competitive market. The easiest way to obtain that information is through a benchmarking service. It is important, though, to review the reasonableness of compensation at least every two or three years. The experience of advisers in the 401(k) world is that, as the marketplace has matured, the level of reasonable compensation has become lower and lower.

Also, advisers should be aware that, when a prohibited transaction exemption—such as BICE—is being used, the burden of proof is on the person claiming the exemption, that is, the adviser. So, you need to have information in your file that supports the reasonableness of your compensation.

Forewarned is forearmed.

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 #24


BICE, broker-dealers, DOL, fiduciary, prohibited transaction, prudent, registered investment advisers

The Meaning of Differential Compensation Based on Neutral Factors

This is my twenty-fourth article covering interesting observations about the fiduciary rule and exemptions.

The DOL’s fiduciary “package” consists of a regulation that expands the definition of advice and exemptions, or exceptions, from the prohibited transaction (PT) rules. If a recommendation by a fiduciary adviser does not constitute a PT (e.g., does not affect the adviser’s compensation, or that of an affiliate, and does not cause a payment from a third party), no exemption is needed. However, if the fiduciary recommendation causes a PT, an exemption must be used – and most often that will be BICE – the Best Interest Contract Exemption. Therein lies the rub . . . the compensation of the financial institution (e.g., the broker-dealer) and the adviser are regulated by BICE.

Under BICE, the compensation of broker-dealers can be “variable,” but must be “reasonable.” In other words, a broker-dealer can receive different payments from different product providers (e.g., mutual funds), so long as the total compensation received by the broker-dealer is reasonable relative to the services provided to the particular plan, participant or IRA owner.

The rules for compensating advisers are similar because the compensation of the adviser also must be reasonable (relative to the services that the adviser is providing to the plan, participant or IRA owner in the first year and in succeeding years). But, from that point on, the rules are different.

The starting point for understanding the other rules for adviser compensation is to determine “reasonably designed investment categories.” A reasonably designed investment category is an investment product or service that, when properly analyzed, should produce a certain level of compensation for the adviser’s services. For example, non-discretionary investment advice about mutual funds probably involves a different set of services and complexity than investment advice about individual variable annuities. In that sense, each could be called a reasonably designed investment category.

The next step is to understand that, within a particular investment category, the adviser’s compensation must be level. For example, where an adviser is providing non-discretionary advisory services concerning mutual funds, the adviser’s compensation must be level regardless of which mutual funds are recommended or how much those mutual funds pay the broker-dealer. In that way, the adviser will be “financially agnostic” as to which funds are recommended and will, at least in theory, only be interested in recommending the funds that are the best for the qualified investor (e.g., reasonable priced and of good quality). Similarly, if another investment category covers individual variable annuities, the adviser will be paid the same regardless of the particular annuity contract, insurance company, or imbedded mutual funds. That is, the adviser’s compensation will be the same across all variable annuity contracts, regardless of which one is recommended.

But, what if some categories require more work or services than other categories? For example, what if it takes more work to recommend and service an individual variable annuity than to provide non-discretionary investment advice about mutual funds? In that case, the Department of Labor says that it is permissible to pay differential compensation among reasonably designed investment categories, so long as the differences are based on neutral factors. So, for example, if the amount of work, the complexity of the product, and so on, means that the services for a variable annuity are twice as valuable, the adviser could earn twice as much for recommending an individual variable annuity and assisting with the selection of the embedded investments. On the other hand, if the services for the variable annuity were only 50% more difficult each year thereafter, then the adviser could be compensated 50% more than the annual fee that could be paid for a qualified account with mutual funds.

The key to understanding these concepts is to realize that the “neutral factors” differential compensation is not a dollar amount. Instead, it is a ratio established, for both the first and each subsequent year, between the different categories of investments. Where the relative compensation to the adviser for different reasonably designed investment categories could vary according to those ratios, compensation must still be reasonable.

So, as described in this article, an individual adviser’s compensation must be “reasonable,” “level” within an investment category, and “neutral” in differences between investment categories.

It is going to be difficult and time-consuming for the financial services community to adjust to these changes. And, the deadline is April 10 (with an extension for some purposes until January 1, 2018).

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 #23


DOL, fiduciary, prohibited transaction, prudent, registered investment advisers

This is my twenty-third article about interesting observations concerning the fiduciary rule and exemptions.

When the definition of fiduciary advice is expanded on April 10, 2017, the investment and insurance recommendations of a much larger group of advisers will be classified as fiduciary advice and will, as a result, increase the focus on financial conflicts of interest (which ERISA and the Internal Revenue Code refer to as “prohibited transactions,” or PTs). My suspicion is that, for most ERISA retirement plans, there will not be a great impact on advisers—because, to a large degree, advisers to retirement plans already are acknowledged fiduciaries. (To be fair, though, there will be some impact . . . particularly on smaller plans, where some insurance companies and broker-dealers have, in the past, taken the position that their advisers are not fiduciaries. Nonetheless, based on my recent experience in working with broker-dealers, the adjustments are being made without a great deal of difficulty.)

On the other hand, the impact on advisers’ practices with IRAs will be significant. That is particularly true of investment and insurance services provided by broker-dealers. But, it is also true, to a lesser degree, of the services provided by RIAs. (Note: This article does not discuss recommendations to participants to take distributions and roll over to IRAs or recommendations to IRA owners to transfer their IRAs. Significant changes will be required for both RIAs and broker-dealers for those recommendations.)

One of the biggest changes—because of the fiduciary prohibited transaction rules—is that advisers will no longer be able to make recommendations that can affect the level of their compensation. An obvious example is that an adviser could not recommend a proprietary mutual fund (managed by an affiliate) without committing a prohibited transaction. That’s because a recommendation cannot increase the compensation of the adviser, his supervisory entity (e.g., a broker-dealer), or any affiliated or related party. Another example is that a financial adviser with a broker-dealer could not recommend that an IRA invest in mutual funds which pay different levels of 12b-1 fees to the broker-dealer and, indirectly, to the adviser. In effect, the adviser would be setting his own compensation (as well as the compensation of the supervisory entity). Similar issues exist for referral fees, revenue sharing, and so on. In all of those cases, the broker-dealer will need to either move to a level fee environment or to satisfy one of the prohibited transaction exemptions (most likely BICE—the Best Interest Contract Exemption).

Similar issues exist for RIAs. For example, we have seen cases where RIAs recommend proprietary products (e.g., affiliated mutual funds). That is a prohibited transaction. Another example of an RIA prohibited transaction is where the adviser recommends an allocation to fixed income and an allocation to equities, but then charges a higher fee for managing the equities. By virtue of recommending the allocations, the adviser has determined the level of its compensation . . . and, therefore, has committed a prohibited transaction.

The moral of this story is that broker-dealers and RIAs need to closely review their investment practices for qualified money. (“Qualified” money is the new terminology for money in IRAs or plans. It is an easy reference to the types of accounts that are subject to the new rules.) Since virtually all investment and insurance advice to IRAs and plans (including recommendations about distributions, withdrawals and transfers) will become fiduciary advice on April 10, 2017, two steps should be taken. First, if they don’t already exist, processes need to be put in place so that any advice satisfies the prudent person requirement. Generally speaking, that process should result in portfolio investing. Second, all payments for the advice (including indirect and non-cash compensation, whether to the adviser, the supervisory entity or any affiliates or related parties) needs to be examined. Once these rules are applicable, the compensation arrangements will need to satisfy the prohibited transaction rules in section 406(b)(1) and (3) of ERISA and the corresponding provisions in section 4975 of the Internal Revenue Code. Or, in the alternative, the condition of a prohibited transaction exemption must be satisfied.

And, all of that needs to be done by April 10, 2017.

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 #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 #20


DOL, fiduciary, prudent

As I discussed in an earlier post (Angles #7), the Best Interest Standard of Care has three parts: The prudent man rule; a requirement for individualization; and a duty of loyalty. Notice that none of the three parts requires that the “best” investment be recommended

Because of concerns that the fiduciary rule might be interpreted to require that a “best” investment requirement would apply, the Department of Labor explained in the preamble to the fiduciary regulation that:

In response to commenter concerns, the Department also confirms that the Best Interest standard does not impose an unattainable obligation on Advisers and Financial Institutions to somehow identify the single ‘‘best’’ investment for the Retirement Investor out of all the investments in the national or international marketplace, assuming such advice were even possible. 

So, if you ever had any doubts, it should be clear now that the “Best” Interest Standard of Care is just a label (but a label which, at some level, resonates politically).

If the requirement isn’t that the best investment be recommended, what is it? The answer is that it’s the same standard that advisers have used for about 40 years in recommending investments to ERISA-governed, tax-qualified retirement plans. In other words, it’s been around for a long time and many advisers have survived and thrived under that standard. As the DOL explained in the guidance:

The Best Interest standard . . . is intended to effectively incorporate the objective standards of care and undivided loyalty that have been applied under ERISA for more than 40 years.

But, the duty of prudence should not be confused with the suitability standard. While unsuitable recommendations will not be prudent, it does not necessarily mean that suitable recommendations will be prudent. As the DOL explained:

The Department has not specifically incorporated the suitability obligation as an element of the Best Interest standard, as suggested by FINRA but many aspects of suitability are also elements of the Best Interest standard. An investment recommendation that is not suitable under the securities laws would not meet the Best Interest standard.

As a result, advisers who have not worked with retirement plans under ERISA’s prudent man rule should consider education about the processes required for compliance with the fiduciary standard.

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 #19


DOL, fiduciary, General, prudent

This is my nineteenth article about interesting observations about the fiduciary regulation and the exemptions.

In an earlier post (Angles #16), I described how advisers could use the “hire me” approach to explain their services and fees without becoming a fiduciary for that purpose. Generally stated, under that approach, an adviser could explain his services and fees, but could not discuss specific products or platforms. In other words, if the adviser “suggested” specific products or platforms, the adviser would become a fiduciary even under “hire me.” The DOL explained that result in the preamble to the fiduciary regulation:

“An adviser can recommend that a retirement investor enter into an advisory relationship with the adviser without acting as a fiduciary. But when the adviser recommends, for example, that the investor pull money out of a plan or invest in a particular fund, that advice is given in a fiduciary capacity even if part of a presentation in which the adviser is also recommending that the person enter into an advisory relationship. The adviser also could not recommend that a plan participant roll money out of a plan into investments that generate a fee for the adviser, but leave the participant in a worse position than if he had left the money in the plan. Thus, when a recommendation to ‘‘hire me’’ effectively includes a recommendation on how to invest or manage plan or IRA assets (e.g., whether to roll assets into an IRA or plan or how to invest assets if rolled over), that recommendation would need to be evaluated separately under the provisions in the final rule”

I mention this because I have recently seen some confusion about the extent and scope of “hire me.” As you might expect, it is because people want to extend “hire me” to all kinds of scenarios, and thereby limit their fiduciary status and legal exposure. For example, I was recently asked if an adviser could tell an IRA owner that the adviser would charge 1% per year to help select, manage, and monitor individual variable annuities. That might work if the IRA owner initially told the adviser that he wanted to hire someone to search for individual variable annuities. However, if the “suggestion” that an individual variable annuity would be appropriate comes from the adviser, that would likely result in fiduciary status for identifying the particular type of investment to be made (and, therefore, cause the loss of the non-fiduciary “hire me” approach).

So, as a word of warning, if you intend to use “hire me” to market your services, keep in mind that it is to describe your services and fees, but without a suggestion that any particular product, investment or platform, be used by the IRA owner.

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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