Three Kinds of Level Fee Fiduciaries . . . and What’s A “Level Fee?”

This is my 30^th 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.

The DOL’s use of the phrase “Level Fee Fiduciary” is creating a lot of confusion about the application of the new fiduciary regulation and the Best Interest Contract Exemption (BICE). This article, and the next one, will try to dispel some of that confusion.

The label “Level Fee Fiduciary” has been used for many years for one meaning, but BICE has used it for a different purpose and, depending on your reading, a different definition.

Historically, Level Fee Fiduciary referred to a fiduciary adviser whose compensation was level or, at least, levelized. What’s the different between level and levelized? “Level” refers to an adviser who has a stated fee, for example, 1% per year, and does not receive any other payments. “Levelized” refers to a fiduciary adviser who has a stated fee (e.g., 1%), but who receives payments from third parties as a result of the recommendations — and then levelizes those payments by offsetting them dollar-for-dollar against the 1% fee. In both of those cases, the advisers receive no more, nor any less, than the 1%. Based on two DOL advisory opinions, the offset method works to, in effect, create a level fee. (An alternative method of levelizing is to pay the third party amounts into the plan or IRA; to be safe, that should be mandated in the agreement with the retirement investor.)

The advisers are not committing a prohibited transaction in either of these cases. As a result, the advisers do not need an exemption, or exception, from a prohibited transaction.

BICE then used “Level Fee Fiduciary” in a different setting. In BICE — a prohibited transaction exemption, the rule only applies to three scenarios. Those are: (1) a recommendation to take a distribution from a plan and roll over to an IRA with the adviser; (2) a recommendation to transfer an IRA to the adviser; and (3) a recommendation to switch “qualified money” from a commission-based account to a fee-based account. Each of those three recommendations will result in a prohibited transaction if the adviser receives more compensation if the retirement investor accepts the recommendation. Needless to say, an adviser will almost always make more money (with the possible exception of the case where the adviser is charging the same fee in the IRA as the adviser charged for services to the plan).

For the BICE provisions on these three scenarios (which is sometimes referred to as BICE-lite), the definition of “Level Fee Fiduciary” is:

“A Financial Institution and Adviser are ‘Level Fee Fiduciaries’ if the only fee received by the Financial Institution, the Adviser and any Affiliate in connection with advisory or investment management services to the Plan or IRA assets is a Level Fee that is disclosed in advance to the Retirement Investor. A ‘Level Fee’ is a fee or compensation that is provided on the basis of a fixed percentage of the value of the assets or a set fee that does not vary with the particular investment recommended, rather than a commission or other transaction-based fee.”

In and of itself, that definition could either mean (1) that no other payments can be received by the adviser, or (2) that the adviser could receive other payments so long as they were not on top of, or in addition to, the stated fee (that is, it would be permissible if the additional payments were offset dollar-for-dollar, such that they did not increase the fee). Unfortunately, at least one senior DOL official has said that the Department intended for the language to mean that no additional payments could be received regardless of whether they were offset or not. Keep in mind, though, that the statement of individual DOL employees are not considered to be legal authority.

The third use of the concept of Level Fee Fiduciary is in the Pension Protection Act “level fee” exemption. That involves an entirely different situation. In that case, if the conditions of the exemption are satisfied, an organization can commit a prohibited transaction, so long as the advice is provided by a separate unit that receives only level fee compensation for providing the advice. For example, that separate unit could recommend proprietary funds to IRAs and participants, without violating the law.

So, those are the three scenarios in which an adviser could be labeled as a Level Fee Fiduciary. But, the definitions, the requirements for compliance and the compensation considerations are different for each of the scenarios.

Hopefully, that clarifies the meaning. In my next post, I will talk about the forms of compensation that would cause an adviser’s level fee to become “un-levelized.”

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.