Interesting Angles on the DOL’s Fiduciary Rule #75

The Fiduciary Rule: Mistaken Beliefs

This is my 75th article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

The fiduciary regulation has been in effect since June of last year — a period of over six months. As you might expect, we are seeing mistakes and misunderstandings about activities that can result in fiduciary status for advisors. This article covers one of those.

In the past, there was a common belief among advisors that fiduciary status could be avoided by presenting a list of investments to plan sponsors. For example, an advisor might provide a list of three alternatives in each investment category (e.g., three alternatives for a large cap blend fund, three alternatives for a small cap fund, and so on). The belief was that, since the list did not “recommend” any particular investments, it could not be a fiduciary recommendation.

While that may (or may not) have been correct before June 9, it is not correct today. The presentation of a selective list will result in fiduciary status, implicating the prudent man rule, the duty of loyalty, and the fiduciary prohibited transactions.

To quote from the new fiduciary regulation:

“Providing a selective list of securities to a particular advice recipient as appropriate for that investor would be a recommendation as to the advisability of acquiring securities even if no recommendation is made with respect to any one security.”

While the practice of presenting selective lists was, at least in my experience, primarily for participant-directed plans, e.g., 401(k) plans, under the new definition, the presentation of selective lists of investments would also be fiduciary advice to individual retirement accounts and individual retirement annuities.

The “moral of the story” is that advisors and their supervisory entities (for example, broker-dealers and RIAs) need to realize that when they provide these types of lists, they will be making fiduciary recommendations. For recommendations to retirement plans, that means that the advisor must engage in a prudent process to evaluate the investments based on factors such as the expenses of the investments, the quality of investment management, the reasonableness of the compensation paid to the advisor from the investments (e.g., 12b-1 fees), and so on. From a risk management perspective, that process should be documented and retained in a retrievable form.

For recommendations to IRAs, if the advice is given by a “pure” level fee fiduciary, the advisor is not committing a prohibited transaction (that is, doesn’t have a financial conflict of interest), and the best interest standard of care does not apply to the advisor. A “pure” level fee advisor would typically be an RIA that charges a level advisory fee, does not receive any payments from the investments, and does not recommend any proprietary products.

However, where an advisor to an IRA receives payments from the investments or where the advisor can affect the level of his compensation based on the investments that are recommended, that would be a financial conflict of interest, which is a prohibited transaction under the Internal Revenue Code.

As a result, if an advisor presents a selective list of investments to the IRA owner, those would be viewed as fiduciary recommendations and any payments from the investments (such as 12b-1 fees) would be prohibited transactions. To avoid a violation, the advisor and the financial institution would need to satisfy the requirements of transition BICE. The most significant of those requirements is the best interest standard of care, which is a combination of ERISA’s prudent man rule and duty of loyalty. That standard of care is somewhat more demanding than the suitability and know-your-customer standards. Advisors and financial institutions need to understand these rules, so that they do not inadvertently fail to comply with them. Also, the burden of proof of compliance is on the financial institution; as a result, the best interest process should be documented.

The second “moral of the story” is that advisors should be familiar with the new rules, so that they don’t inadvertently fall into a compliance trap.

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