Category Archives: General

Interesting Angles on the DOL’s Fiduciary Rule #11

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.


Interesting Angles on the DOL’s Fiduciary Rule #10

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.



Interesting Angles on the DOL’s Fiduciary Rule #8

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.


Interesting Angles on the DOL’s Fiduciary Rule #6

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).

An Overview of the Fiduciary Rule

The DOL’s fiduciary rule has been published in the Federal Register. Based on our review of the regulation and conversations with our clients, here are some overview thoughts about the regulation and the two “distribution” exemptions (84-24 and BICE).

The Fiduciary Definition

The rule is much as expected. The definition of fiduciary advice continues to be very broad, capturing almost all common sales practices for investments and insurance products. It includes investment recommendations to plans, participants and IRA owners, as well as recommendations about distributions from plans and transfers and withdrawals of IRAs. All of those will be fiduciary activities.

As a result, those recommendations will be subject to the fiduciary standard when made to plans or participants, and subject to the Best Interest standard of care when made to IRA owners (if the adviser needs the prohibited transaction relief provided in BICE or 84-24).

Much of the conversation has been about the requirements of the exemptions. Because of that, we are concerned that the impact of the fiduciary and Best Interest standards of care has not been adequately considered. In our opinion, those standards of care will be more impactful than generally thought.

In both cases (that is, the prudent man rule and the Best Interest standard), the adviser’s recommendations will be measured by what a hypothetical prudent and knowledgeable investor would do. In other words, it is the standard of a hypothetical knowledgeable person, and not the standard of the actual adviser or the investor.

What were the most notable changes in the final regulation from the proposal?

  • The “applicability” date for the regulation was deferred until April 10, 2017. Most people thought that compliance would be required on January 1, 2017, so that gives the financial services sector an additional three months to comply with most of the requirements. (See the additional extension of time for certain BICE requirements below.)
  • Advisers will continue to be able to provide participant education for retirement plans, using asset allocation models (AAMs) that include specific designated investment alternatives. (“Designated investment alternatives” are those investments that are selected by the plan fiduciaries for participant direction in 401(k) or 403(b) plans. As a result, they must be prudently selected and monitored by the plan fiduciaries.)However, populated asset allocation models are not permitted as a part of investment education for IRA owners. In that case, AAMs that include the names of investments would be fiduciary investment advice.
  • Platform providers (that is, recordkeepers) will be allowed to provide additional assistance, within limits, to respond to requests for proposals and similar inquiries from plan sponsors.

When an adviser becomes a fiduciary, the adviser’s conduct is also governed by the fiduciary prohibited transaction rules in ERISA and the Internal Revenue Code. Generally speaking, those rules prohibit advisers (or their affiliates) from receiving payments from third parties (such as 12b-1 fees or insurance commissions) and from making investment recommendations that affect the levels of their compensation. Those transactions are literally prohibited. However, the DOL has issued prohibited transaction exemptions which, if their requirements are satisfied, would allow the receipt of those types of payments. There are two exemptions that could apply to fiduciary advisers to mid-sized plans, participants, and IRAs. Those are 84-24 and BICE, which are discussed below.

Prohibited Transaction Exemption (PTE) 84-24

The current version of 84-24 covers the sale of all insurance products by fiduciary advisers. The proposed amendment to the exemption would have continued to cover those sales to plans and IRAs, but would have transferred the sale of individual variable annuity contracts from the 84-24 exemption to BICE. That was a significant change, because 84-24 is generally viewed as less burdensome than BICE. As a result, many in the insurance industry urged the Department of Labor to return individual variable annuities to 84-24 when the final rules were issued.

But, that didn’t happen. In fact, sales of other types of insurance were moved from 84-24 to BICE.

Before getting into that, though, let’s look at the most important requirements of 84-24. Those are:

  • The adviser must acknowledge in writing that he is a fiduciary and must agree to adhere to the best interest standard of care. (As a practical matter, the best interest standard of care is a combination of ERISA’s prudent man rule and ERISA’s duty of loyalty. In other words, those concepts are being extended from ERISA to IRAs.)Think about the consequences of that. For example, the recommendation of a particular insurance company must be prudent and the recommendation of the particular insurance contract must also be prudent.
  • The adviser’s compensation must be no more than reasonable and the adviser cannot receive any additional financial incentives, for example, trips, awards, or bonuses.
  • The adviser’s statements cannot be materially misleading. The failure to describe a material conflict of interest is deemed to be misleading.
  • The adviser must disclose his compensation.
  • The 84-24 exemption also limits the commissions that can be paid to advisers to “reasonable” amounts. As a result, we believe that advisers who recommend or sell insurance and annuity contracts should obtain benchmarking information about similar sales and the commissions that are reasonable under those circumstances.
  • Before the sale is made, those disclosures must be delivered to the plan fiduciary or IRA owner in writing, and the fiduciary or IRA owner must acknowledge the disclosures and approve of the transaction in writing.

What are the most important changes in the final 84-24 exemption?

  • The types of insurance products covered by 84-24 were further limited. That is because group variable annuity contracts and fixed indexed annuities were transferred from 84-24 to BICE. As a result, 84-24 now covers only fixed rate annuities and insurance policies.
  • The compensation payable to advisers was expended from just commissions to include accruals of health benefits and retirement benefits, but other payments and benefits are prohibited.
  • The applicability date will be April 10, 2017. Many people thought that it would be January 1, 2017, so that allows another three months to develop compliant procedures and practices.

Best Interest Contract Exemption (BICE)

The most significant changes were made to the Best Interest Contract Exemption. The changes were so great that it is not possible to describe them in this short article. So, we will just mention a few. (But, we will be doing a separate article on BICE in the coming weeks.)

BICE provides an exemption for prohibited transactions resulting from recommendations of any investment or insurance products to plans or IRAs. (In that sense, it provides an alternative exemption for the insurance products within the scope of 84-24.)

Generally speaking, it requires a contract or similar writing that is signed by a financial institution and that is given to the investor. (The financial institution is the bank, insurance company, broker-dealer or RIA, who oversees the adviser.) The financial institution contractually agrees that it and the adviser will serve as fiduciaries and will adhere to the best interest standard of care. The financial institutional also must agree to disclose material conflicts of interest and represent that none of its statements are misleading. In addition, a host of other disclosures must be made.

What are the most noteworthy changes in the final BICE?

  • The final version of BICE requires a contract that is signed by the financial institution and an IRA owner. However, for plans, the financial institution can deliver a written disclosure, but it is not required that the plan fiduciaries sign a contract with the financial institution.
  • The contract and disclosures do not have to be delivered or signed at the time of the first conversation. Instead, that requirement can now be satisfied at point of sale.
  • The proposal had demanding disclosure requirements at point of sale and annually thereafter. Those disclosures were liberalized and can now be made with information that is more general, but which has to be clearly and conspicuously provided to the plans or IRA owners. The investor has the right to obtain detailed information on request.
  • The proposal had a website requirement that was difficult, and perhaps impossible, to satisfy. The final has a less burdensome website disclosure requirement.
  • The final version of BICE has simplified compliance procedures for level fee advisers who are (i) capturing distributions and rollovers from plans, (ii) recommending withdrawals or transfers of IRAs, or (iii) recommending transfers from commission-based accounts to fee-based accounts.
  • As finalized, BICE has provided greater relief for investment accounts that are already in existence at the time of the applicability date of the new rules. For example, an adviser can now make a hold recommendation without becoming subject to the prohibited transaction rules.
  • The applicability date has largely been deferred to January 1, 2018. However, some of the requirements become applicable on April 10, 2017. Those include, for example, the best interest standard of care and reasonable compensation limitation.
  • BICE requires that the compensation paid to the adviser, the financial institution, and affiliates be no more than reasonable. We believe that financial institutions (such as broker-dealers and insurance companies) will need to develop or obtain benchmarking information in order to evaluate the reasonableness of the compensation of their advisers. In due course, we suspect that benchmarking services will develop for sales to IRAs, much as they have already developed for advice to plans.
  • While the proposal excluded some assets (e.g., illiquid investments) from its relief, the final BICE is available for all types of investments.


The final rules will require structural changes for some financial services companies. For example, we believe that broker-dealers will be affected the most. Insurance companies will also need to make changes. At the other end of the spectrum, most RIAs will only need to make changes to adjust to the new rules regarding recommendations of distributions and rollovers from plans and withdrawals and transfers of IRAs.

Recordkeepers fall in between those two groups. Recordkeepers who have insurance companies or mutual fund manager affiliates will be impacted more than independent recordkeepers.

While not directly affected by the new rules, mutual fund management firms need to understand their impact, for example, the needs of broker-dealers in this new environment. Some broker-dealers may decide to shift many of their accounts to level fee advisory accounts. In that case, they may not be able to receive 12b-1 fees or other payments. Instead, they will likely want share classes that are specifically designed for advisory accounts. Those share classes could resemble a retail version of institutional shares.

At this point, though, it is impossible to know all of the repercussions. Stay tuned.


Fiduciary Challenges for Evaluating Plan Fees: Investment Expenses and Revenue Sharing

The allocation of revenue sharing in 401(k) plans is a fiduciary decision. We explored that issue in detail in a recent white paper. We also looked at the concept of lowest “net” expense ratios. We concluded that there were fiduciary risk management benefits to “equalizing” revenue sharing (that is, returning it to the participants whose investments generated it) and for using the lowest net expense ratio for investments (i.e., the lowest net expense ratio after offsetting revenue sharing). A copy of that white paper is here.


Did you know…?

Little has been written about how a plan fiduciary should prudently select insurance companies and guaranteed retirement income for participants. There’s a DOL “safe harbor” regulation, but it doesn’t give fiduciaries a checklist for compliance. To address this, Lincoln Financial hired us to work with an insurance consultant to develop a set of criteria that fiduciaries or their advisors can use to make those decisions. Bruce Ashton and I have written an article about the checklist that can be found here:  Did you know…About the Fiduciary Requirements for Selecting a Lifetime Income Provider?  The article has links to the white paper and the checklist.


Selection and Monitoring of Target Date Funds

As I review investment policy statements for participant-directed plans, I see a number of common deficiencies. This email is about one of those—the selection and monitoring of target date funds (“TDFs”).

In my experience, most IPS’ say little or nothing about the criteria to be applied to TDFs. For example, an IPS might be completely silent on the issue or may simply say that they will be selected and monitored. But, in neither case is there a robust set of criteria. That is problematic.

One reason is that TDFs are capturing an increasingly large percentage of 401(k) assets. As more plans automatically enroll, that percentage will continue to grow. I can imagine a day, in the not-so-distant future, where over half of the assets in 401(k) plans will be in TDFs. That leads to the unfortunate conclusion that, based on the current practices of many advisers and committees, over one-half of the assets in the plan will be in a suite of investments that has not been subjected to close scrutiny, while the other investments – that hold less than half of the assets — will be subject to a rigorous evaluation process. That just doesn’t make sense. And, where a situation doesn’t make sense, it can lead to problems.

With that in mind, I recommend that you take a look at the evaluation criteria in DOL comments filed by the Investment Company Institute and the American Benefits Council. It is the most robust set of TDF criteria that I have seen. The ABC/ICI comments can be found at:

The criteria in those comments set a much higher standard than the common practices of advisers and plan committees. However, I think those comments may suggest the future — rather than reflecting the past.

For example, the comments suggest considering, among other things:

  • The performance of each of the mutual funds inside the TDF,
  • Appropriate benchmarks to evaluate TDF performance,
  • Participant demographics, and
  • Whether the plan sponsor also offers a pension plan.

In next month’s post, I will discuss the recent DOL guidance on the selection and monitoring of TDFs.


Limiting the 401(k) Finder’s Fee

Fred Reish was quoted in a New York Times article on June 21. The article, titled, “Limiting the 401(k) Finder’s Fee” takes a look into the fees behind employee’s 401(k)’s as they begin to replace pensions.

A series of lawsuits are making their way through the courts, which have raised questions about whether employees are being overcharged for their accounts. The lawsuits and new federal rules have helped bring fees down to a more reasonable level. While some employers have begun to adopt arrangements with less fees that more clearly separates what they are paying for, fees that workers pay can still vary widely and be hard to recognize or understand.

“It’s unfortunate that it took litigation to focus attention on costs, but it has,” said Fred.

The link to the article can be found on the Drinker Biddle website, here.