Best Interest Standard of Care for Advisors #3


401(k), 403(b), best interest, DOL, reg BI, registered investment advisers, SEC

SEC Best Interests . . . When? And What About the DOL

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the third of the series about the Best Interest Standard of Care.

The Regulatory Agendas for the SEC and DOL were recently issued. Both have plans for guidance by September of 2019, but the anticipated timing of the guidance has, by and large, been misinterpreted. To understand what I mean, read on.

The SEC’s Agenda said that Final Action on the Regulation Best Interest proposal for broker-dealers and the Interpretation of Standard of Conduct for investment advisers would be “09/00/2019.”

Similarly, the Department of Labor Agenda said that there would be a final rule on the “Fiduciary Rule and Prohibited Transaction Exemptions” with the date of “09/00/2019.”

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Best Practices for Plan Sponsors #4


best practices, fiduciary, plan sponsors, prudent, service providers

What is the Baseline for A Committee to Act in the Best Interest of its Participants? (Part 3)

This is the fourth of the series about Best Practices for Plan Sponsors.

 In my last two posts (Best Practices for Plan Sponsors #2 and Best Practices for Plan Sponsors #3), I discuss the NYU case and the “bad” and “good” behavior of committee members. I concluded my last post with the point that process matters. Of course, it was unspoken that I was referring to a good process. This article discusses the fundamentals of a good process and the lessons learned from the NYU decision.

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Best Practices for Plan Sponsors #3


401(k), 403(b), best practices, plan sponsors, prudent, service providers

What is the Baseline for A Committee to Act in the Best Interest of Its Participants? (Part 2)

This is the third of the series about Best Practices for Plan Sponsors.

This is my second article about the case of Sacerdote v. New York University. As I discussed in my last post, the Court’s opinion pointed out the deficiencies in the understandings and conduct of some committee members. However, the Court ultimately ruled in favor of the plan fiduciaries and against the plaintiffs. Why was that?

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Best Practices for Plan Sponsors #2


401(k), 403(b), best practices, fiduciary

What is the Baseline for A Committee to Act in the Best Interest of Its Participants? (Part 1)

This is the second of the series about Best Practices for Plan Sponsors.

The recent decision in the case of Sacerdote v. New York University is a classic story of the good and bad of plan committees. Let’s start with the bad.

Five current and former committee members testified at the trial. But not all of the testimony was helpful.

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Best Practices for Plan Sponsors #1


401(k), 403(b), best practices, plan sponsors, service providers

Projection of Retirement Income

This is the first of the series about Best Practices for Plan Sponsors.

“Best Practice” is above and beyond the legal requirements. Best Practices are not mandated; they are elected.

While the most obvious Best Practices are automatic enrollment and automatic deferral increases, I want to start with the projection of retirement income for participants. That’s partially because it is in a current legislative proposal—in the Retirement Enhancement and Savings Act (RESA), and also because, in my opinion, it doesn’t receive the attention that it deserves.

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Best Interest Standard of Care for Advisors #2


best interest, DOL, FINRA, prudent, reg BI, SEC

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the second of the series about the Best Interest Standard of Care.

In my last post, I discuss the remarkable similarities among the SEC’s proposed Regulation Best Interest, the SEC’s proposed Interpretation for investment advisors, the DOL’s Best Interest standard of care (which is a combination of ERISA’s prudent man rule and duty of loyalty), and the New York State Best Interest standard for sales of annuities and insurance products. All of those rules require that advisors act with care, skill, prudence and diligence, and that they place the interests of the investor ahead of their own.

In the first post, I conclude that the Best Interest standard requires the following:

  • A careful and skillful professional process measured by the objective standard of a knowledgeable and experienced advisor; and
  • A duty of loyalty to the investor.

This post discusses the type of process that would satisfy the Best Interest standard for all of those rules. However, since the process is not well defined (other than in guidance under ERISA), some of the suggestions in the post may, in fact, be Best Practices. Let me define that term. “Best Practices” means that the advisor is doing more than is required by the law. While Best Interest may be required, Best Practices is not; it is voluntary. As a result, Best Practices are for advisors who desire to excel, while Best Interest is for advisors who want to be compliant.

In my view, a combination of Best Interests and Best Practices suggests that advisors should use the following process:

  • Gather the information that is relevant to providing Best Interest advice. (“Relevant” means the information that is necessary to develop a recommendation that is appropriate for the investor. A synonym in this circumstance would be “material” information. If information about the needs and circumstances of the investor could affect the recommendation, then it is material and relevant).
  • Consider the types of investments (and insurance products) and strategies that are appropriate for the investor based on the analysis of the investor’s profile (that is, based on analysis of the relevant information). In effect, this step is the formulation of a strategy for the investor based on the products and services available to the advisor. While there may be some flexibility if the advisor only has access to limited types of products, that flexibility is limited, in the sense that any recommendation will still be measured by the Best Interest standard of care.
  • Select the particular investments, insurance products and services that will be recommended to the investor, that is, that will populate and implement the investment strategy. As the SEC said in its proposed guidance, while cost and compensation are not the only factors to be considered, their significance is enhanced under the SEC proposals. In other words, they are major considerations. Another obvious important consideration is the quality of the product. That includes the “management” of the product, for example, the investment advisor for a mutual fund, the investment manager for an investment service, and the insurance company issuing an annuity contract or life insurance policy.

I suspect that, if an advisor gets into trouble because of his or her recommendations, it will be the result of an inappropriate (and perhaps unsuitable) strategy, excessive costs and compensation, or inferior quality of the “manager” of the product.

That begs the question of, how does an advisor demonstrate a Best Interest process? Other than for the DOL and ERISA plans, there is not a requirement to maintain documentation of the process. However, it probably goes without saying that a well-documented process is good risk management (and, for that matter, that a well-documented process is likely to be a prudent process).

In the next year or two, the SEC may enhance its guidance to further define the processes that are needed to satisfy its Best Interest standard. More certainly, though, the SEC, FINRA, DOL and New York State regulators will, in due course—perhaps over the next three years or so—begin their enforcement activities. Unfortunately, it’s possible that we may see “regulation by enforcement,” meaning that the holes in the guidance are filled in by the enforcers, rather than the regulators.

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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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Best Interest Standard of Care for Advisors #1


best interest, BICE, prudent, SEC

What is the Best Interest Standard of Care?

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the first of the series about the Best Interest Standard of Care.

For this inaugural article, let’s talk about the meaning of “Best Interest.”

There are at least four Best Interest standards. (While “best interest” can also refer to management of conflicts of interest, this article is about the best interest standard of care.)

  • ERISA’s best interest standard of care for plan sponsors and fiduciary advisors for private sector retirement plans. (While ERISA doesn’t literally have a best interest standard—because the Best Interest Contract Exemption was vacated by the 5th Circuit Court of Appeals, that best interest standard was a combination of ERISA’s prudent man rule and duty of loyalty which, of course, are still in the law. As a result, I will use the term to refer to the combination of ERISA’s prudent man rule and duty of loyalty.)
  • The SEC’s proposed best interest standard for broker-dealers in its Regulation Best Interest.
  • The best interest standard in the SEC’s proposed “Interpretation” for investment advisers.
  • The New York State Best Interest standard for recommendations of life insurance policies and annuity contracts.

Let’s look at how each of those are defined.

  • The ERISA Best Interest Standard for Retirement Plans (copied from the Best Interest Contract Exemption):

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.

  • The SEC’s Proposed Best Interest Standard for Broker-Dealers:

The best interest obligation . . . shall be satisfied if: The broker, dealer, or natural person who is an associated person of a broker or dealer, in making the recommendation exercises reasonable diligence, care, skill, and prudence to:… Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation; . . .

A broker, dealer, or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer.

  • The SEC’s Proposed Best Interest Standard for Investment Advisers:

The SEC proposal did not include a definition of best interest. However, the SEC proposal reaffirms that investment advisers are fiduciaries for their clients and includes the best interest standard as a part of the RIA fiduciary duty. It seems inconceivable that the best interest standard for investment advisers would be lower than that same standard for broker-dealers. And, since the SEC uses the same label—“best interest”—for both investment advisers and broker-dealers, the likelihood is that the standard is the same. (In some ways, though, those best interest rules are different, for example, the RIA best interest standard applies to a much wider range of advice and includes monitoring.)

  • The New York State Best Interest Standard:

The producer, or insurer where no producer is involved, acts in the best interest of the consumer when . . .

the producer’s or insurer’s recommendation to the consumer reflects the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use under the circumstances then prevailing. Only the interests of the consumer shall be considered in making the recommendation. The producer’s receipt of compensation or other incentives permitted by the Insurance Law and the Insurance Regulations is permitted by this requirement provided that the amount of the compensation or the receipt of an incentive does not influence the recommendation; and . . .

I have highlighted language in each of the definitions. My purpose is to emphasize how similar the standards are. All of the Best Interest standards seem to require a process. That is, how can an advisor be careful, skillful, prudent and diligent without engaging in a process? In my view, there are several steps to that process. The first is determining the needs and circumstances of the investor; the second is evaluating the investment or insurance strategies in light of those needs; and the third is a consideration of the costs and quality of the investment and insurance products that are being considered. The gathering and analysis of that relevant information must be done carefully and skillfully based on a hypothetical knowledgeable and experienced advisor. In other words, the standard is not the ability of a particular advisor, but instead the industry expectations of professional advisors. The evaluation and performance of the advisor is based on that objective standard.

In addition, each of the definitions requires that an advisor place the interests of the investor ahead of the interests of the advisor. The Best Interest standard imposes a duty of loyalty on the advisor.

“Best Interest” does not mean that an advisor must pick the best investment or insurance product. However, it does impose a higher duty than suitability in the development of recommendations, and it may prove to be more demanding than many people expect. It does mean that quality and costs are more significant considerations than they are under the suitability standard.

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.wpengine.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

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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Hearing on Retirement Income by the ERISA Advisory Council


DOL

I recently testified before the Department of Labor’s ERISA Advisory Council on the subject of lifetime income. More specifically, it was about lifetime income products and services for retirees provided through defined contribution plans. Here are my opening comments:

Thank you for this opportunity to testify.

I am Fred Reish, a partner in the law firm of Drinker, Biddle and Reath. However, this testimony is not on behalf of the firm, but instead represents the views of my partner, Bruce Ashton, and myself.

As a starting point, it is helpful to have a foundation for development of recommendations. For example, I suggest:

  • The conversation about defined contribution plans needs to increasingly and emphatically include retirement income.
  • Plan sponsors and participants need good quality, reasonably priced retirement income products and services.
  • Plan sponsors need clear, objective and implementable guidance on how to do that.
  • Participants need information, education and advice on how to best use those products and services.
  • Both plan sponsors and participants will benefit from the use of knowledgeable fiduciary retirement income consultants.
  • Any guidance should be agnostic as to retirement income products and services. Participants may need a combination of products and services to properly address their needs.

Here are more detailed thoughts that could inform decisions for going forward:

1.       The safe harbor regulation for annuities in defined contribution plans does not work and will not work. Plan sponsors, by and large, are not in a position to determine if those criteria are satisfied.

2.       If a new safe harbor regulation is developed, it needs to be objective and obvious, in the nature of a checklist of items to obtain, but not to be reviewed at the level of an insurance expert.

3.       Insurance consultants are expensive and they are few-and-far-between. But, if used as independent fiduciaries at a platform level, similar to 3(21) and 3(38) fiduciary investment advisers on 401(k) recordkeeping platforms, the cost can be borne by insurance companies or spread over thousands of plans and millions of participants.

4.       Plan sponsors are more likely to provide services to participants if they can do so in a context of providing information and education, and plan sponsors are more likely to use products and services approved by fiduciary advisors and consultants.

5.       In that vein, plan sponsors are more likely to embrace concepts if the service providers are legally responsible. As a result, plan sponsors should be able to rely on their providers (for example, recordkeepers) for that purpose, so long as they do not have a reason to doubt the competency of the providers. In the real world–and especially for small- and mid-sized plans, that is what is already happening–and the rules should parallel the real world in this case.

6.       Participants need help making decisions about retirement income products and services. They are not, by and large, educated or experienced in the analytical processes for determining which products or services to select for 20 or 30 years into the future or the amounts to be allocated among such products and services. This is analogous to the fiduciary services that participants receive for investing their accounts, for example, target date funds and managed accounts.

7.       It may not be realistic to expect participants to make lifelong decisions in the period of days immediately before they take retirement distributions. If retirement income products or services are accumulated during participation in a plan, they are more likely to be used in retirement. That is true of insured products and securities products and services.

8.       Target date funds are popular with both plan sponsors and participants. They are likely to be a popular way to provide non-guaranteed retirement investment income or to accumulate guaranteed retirement income products. As a result, guidance should be issued to make clear that is permissible. Defaults work and should be considered, particularly where a participant’s account has been invested in a manner that incorporates retirement income services and products during the accumulation phase. The Department should recognize the power of its guidance–even soft guidance, for example, look at the favorable impact Interpretive Bulletin 96-1 had on investment education.

9.       It is not possible to develop perfect answers to these complex problems. However, we should not let the perfect be the enemy of the good. Good answers will do the job.

10.     Products and services will be developed in the future that are not even imagined today. Any guidance should be flexible to allow future developments.

With those thoughts in mind, I recommend the following:

1.       The Department of Labor should discuss 401(k) and other defined contribution plan vehicles for retirement income. Words matter. Retirement income projections are not just projections—they are perspective. I cannot think of a better way to change the perspective and, thereby, change the conversation.

2.       The Department should affirmatively state that insurance and annuity products are, in concept, prudent for defined contribution plans and should simplify its annuity safe harbor regulation. We support the legislative proposals on this matter, but suggest that additional objective safeguards be added. In addition, clarify the QDIA safe harbor to include annuities in each of the three QDIA options, that is, target date funds, balanced funds and managed accounts.

3.       The Department should issue guidance that the concepts in the SunAmerica Advisory Opinion and the Pension Protection Act advice exemptions apply to retirement income products and services–at both the plan sponsor level and the participant level, so that plan sponsors can receive advice on the prudence of retirement income insurance companies and guarantees, and so that participants can receive advice on how to use those guaranteed products and investment products and services. It should be clear that the independent fiduciary is the responsible fiduciary, and not the plan sponsor. For example, DOL Field Assistance Bulletin 2007-01 applies a similar approach to participant investment advice.

4.       The Department should issue guidance that platforms of retirement income products and services are analogous to brokerage windows, and therefore the platform, but not the products and services, needs to be vetted by plan sponsors as fiduciaries.

5.       The Department should issue new guidance focusing on retirement income similar to Interpretive Bulletin 96-1 to the effect that education can be provided about retirement income products and services in the plan, and it would not be considered fiduciary advice.

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.wpengine.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

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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Moving from Angles to Bests


Announcement, broker-dealers, DOL, prudent, registered investment advisers, SEC

Now that I have completed 100 articles about interesting Angles on birth –and death–of the DOL’s Fiduciary Rule, and the birth of an SEC best interest standard for broker-dealers and RIAs, I am going to start on a new series. The new series, rather than being titled “Angles,” will be called “The Bests.”

So, from now on, my articles—maybe the next 100—will focus on two “bests”—the SEC’s best interest standard and best practices for advisors and plan sponsors.

I figure that the SEC’s best interest rules will be developed and implemented over the next year or two, giving me a wealth of materials for new articles. But, I don’t want to be limited to that. I think that it’s important to talk about best practices for retirement plans and retiree investing and withdrawing, with a focus on helping participants to and through retirement—accumulation and decumulation.

With this introduction of the new series, the articles will begin after the Labor Day break.

Enjoy the dog days of summer . . . family vacations, baseball games and barbeques!

Fred Reish

To automatically receive these articles in your in box, you can sign up on my blog at http://fredreish.wpengine.com/insight/. Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

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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