Interesting Angles on the DOL’s Fiduciary Rule #62


408(b)(2), broker-dealers, DOL, fiduciary, recordkeeper

Is It Possible To Be An Advisor Without Being A Fiduciary?

This is my 62nd 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 and related developments in the securities laws.

Under the new fiduciary definition (that applied on June 9), an investment “suggestion” is fiduciary advice. That includes suggestions about a range of issues, including investments, insurance products, investment strategies, other investment advisors and managers, IRA transfers, and plan distributions.

Because of the breadth of the definition, it is almost impossible to be an advisor to a plan without becoming a fiduciary. Under the old rules advisors would provide investment information that, at least arguably, was not fiduciary investment advice. However, under the new definition, where an advisor provides information about investments, it’s possible, perhaps even probable, that the advisor would reasonably be viewed as having suggested that the plan sponsor, participant or IRA owner choose the investments. Otherwise, why provide information about those specific investments . . . unless it was a suggestion that the retirement investor select one or more of them?

Let’s delve into that a little more deeply . . . in the context of a 401(k) plan. It is possible that for a new plan or for a plan changing recordkeepers, the recordkeeper would provide a list of investments in response to an RFI or RFP. If properly done, the list will not be fiduciary advice—because of a fiduciary exception for recordkeepers. In turn, if the advisor does not comment on the list, either favorably or unfavorably, the advisor would not be viewed as having provided fiduciary advice.

Then, at future meetings with the plan sponsor, the advisor or the recordkeeper could simply provide information about the existing investments. However, is it feasible that an advisor would not make comments about poorly performing investments which could be viewed as “suggestions” that they be removed? If those suggestions are made by an advisor, it could be fiduciary advice. Similarly, if an investment is removed, a plan sponsor needs to select a replacement investment. Who will provide the potential replacement investments to the plan sponsor? If the advisor does, that could be a suggestion, or fiduciary advice, that one of those replacement investments be used.

Alternatively, some broker-dealers may decide that their advisors can only use recordkeepers that include fiduciary advisers on their platforms. Those platform advisers would then recommend or select a plan’s investment line-up (and, in the future, would remove and replace investments, as appropriate). That might work. However, the recommendation of a third party fiduciary investment adviser or manager is also a fiduciary act. So, while the advisor would not be a fiduciary for the recommendation of investments, the advisor could be a fiduciary for “suggesting” that the plan sponsor use a fiduciary on the recordkeeper platform.

Unfortunately, these issues have not been tested in the courts or in FINRA arbitrations . . . so, it’s almost impossible to tell where the line will be drawn. As a result, broker-dealers and RIAs need to decide whether they will take the position that they are not fiduciaries—and be subject to risk, or whether they will take a conservative position and clearly be compliant.

While these rules apply to both ERISA retirement plans and IRAs, the issue is particularly acute for plans. That is because a service provider to plans must state, in its 408(b)(2) disclosures, whether it is serving as an ERISA fiduciary. If it is not, then it can remain silent on the issue. However, if the firm and its advisors will be acting as ERISA fiduciaries, that must be affirmatively stated in the 408(b)(2) disclosures. (Note that, during the transition period, recent DOL guidance permits the firm to describe its fiduciary services in the 408(b)(2) disclosures, but does not require that the firm specifically state that it is an ERISA fiduciary . . . with one exception. If a firm has previously said in its 408(b)(2) disclosures, that it was not acting as a fiduciary, that must be corrected by affirmatively saying that it is now acting as a fiduciary.)

The new rules have a number of unforeseen applications. With the likely delay of the applicability dates of the exemptions, including of the full and final Best Interest Contract Exemption, this is a good time to think about how these rules apply and what changes need to be made.

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 #61


DOL, fiduciary, prudent, service providers

The Fiduciary Rule, Distributions and Rollovers

This is my 61st 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 and related developments in the securities laws.

Now that it seems likely that the fiduciary rule and the transition exemptions will continue “as is” until at least July 1, 2019, it’s time to re-visit the fiduciary rule and the requirements of the transition exemptions. This article focuses on the requirements for recommending that a participant take a distribution and roll it over to an IRA with a financial institution and its advisor. (Practically speaking, the financial institutions will likely be broker-dealers, RIA firms, and banks and trust departments). For ease of reading, this article uses “advisor” to refer to both the entity and the individual.

In order to recommend that a participant take a distribution, the financial institution and advisor must satisfy ERISA’s prudent man rule and duty of loyalty. That is because a recommendation to a participant is considered to be advice to a plan. Among other things, that means that, if the advisor violates the rules, there is a cause of action under ERISA for breach of fiduciary duty (as opposed to the Best Interest Contract Exemption, where a private right of action is less certain).

If the advisor will earn more money if a participant’s benefits are moved to an IRA, that will be a prohibited transaction. As a result, the advisor will also need to comply with the condition of an exemption, most likely the Best Interest Contract Exemption (BICE). The transition version of BICE requires that an advisor adhere to the Impartial Conduct Standards. Of those standards, the most significant for this purpose is the best interest standard of care. Since the best interest standard of care and ERISA’s duties of prudence and loyalty are substantially similar, this article just refers to the best interest standard (even though both apply). The best interest standard requires that an advisor obtain the information that is relevant to making a prudent and loyal recommendation about a distribution. The Department of Labor has said that, at the least, that includes the services, investments, and fees and expenses in both the plan and the IRA. In addition, the best interest standard requires that the plan and IRA information be evaluated in light of the needs and circumstances of the participant.

The information about the services, investments, and fees and expenses in the plan is the most difficult to obtain. Fortunately, that information can be found in the participant’s plan disclosure statements. Additional important information is in the participant’s quarterly statements.

But, what if the participant can’t locate the information? Realistically, that should be a rare case, since plan sponsors are required to distribute the disclosures at the time of initial participation and annually thereafter.

But, what if the participant can’t find those disclosure materials? In a set of Frequently Asked Questions, the DOL responded that an advisor must make “diligent and prudent efforts” to obtain the plan information. If the participant can’t find those materials, then it seems likely that, at the least, a diligent and prudent effort would require that the advisor inform the participant that:

  1. The information is usually available on the plan’s website and they could obtain it from that source.
  2. The information is available from the plan sponsor upon request to the benefits personnel.

If neither of those options is successful, or if the participant is unwilling to take those steps, the advisor can use information from the Form 5500 or from industry averages. (Interestingly, 5500 data is not considered primary data for this purpose. It can only be used after a diligent and prudent effort has been made to obtain current plan data from the participant.)

Even where 5500 data or average plan data is used, there are additional considerations:

  • The advisor must provide “fair disclosure” of the significance of using the primary plan data, that is, current information about the plan from, e.g., the participant disclosure forms.
  • Plan averages must be based on “the type and size of plan at issue.” As a result, the advisor will need to know the type and size of the plan.
  • The advisor must explain the alternative data’s limitations.
  • The advisor must explain “how the financial institution determined that the benchmark or other data were reasonable.”

However, it would likely be a rare case that alternative data could be used. If a financial institution finds that its advisors are consistently using alternative data, that suggests that the advisors are not making “diligent and prudent efforts” to obtain actual plan data. The consequence of non-compliance is that the compensation paid from the rollover IRA is prohibited and cannot be retained by the financial institution or the adviser. There could also be an ERISA claim for breach of fiduciary duty.

An additional issue is that the “alternative data” may only include information about fees and expenses. In order to perform a best interest analysis, the advisor must also have information about a plan’s services and investments. For example, does the plan offer a brokerage account where, if the participant desired, the participant could have access to a wider range of investments? Another example is whether the plan offers discretionary investment management for participants’ accounts. If it does not, that may be a valuable service offered by the IRA; but, if it does, the expenses and the quality of those services in the plan and IRA should be compared.

As this article suggests, there are more issues than appear at first blush.

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 # #60


DOL, fiduciary

What the Tibble Decision Means to Advisers

This is my 60th 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 and related developments in the securities laws.

On June 9th, almost all advisers to retirement plans became fiduciaries—or, more accurately, those that were not already serving as fiduciary advisers became fiduciaries. While most of my Angles posts have been about the fiduciary rule and prohibited transaction exemptions, this article is about the impact of the latest Tibble decision (Tibble v. Edison Int’l, No. CV 07-5359 SVW (AGRx), 2017 WL 3523737 (C.D. Cal. Aug. 16, 2017)) on the development and delivery of fiduciary investment advice to 401(k) plans and ERISA-governed 403(b) plans.

As background, the Tibble case, through a series of decisions, held that it was a breach of fiduciary duty for a plan committee to select overly-expensive share classes of mutual funds. More specifically, the issue was whether the Tibble committee should have selected institutional share classes rather than retail share classes.

Viewed superficially, the decision could be interpreted to mean that plan fiduciaries must always select the cheapest share class. However, that is not correct. As a part of the decision, the attorneys for the plan committee argued that the retail share classes were justified since the revenue sharing paid by the mutual funds (and their affiliates) was used to pay for appropriate plan expenses (and, presumably, were enough to offset the additional cost of the retail share classes). The attorneys were justified in taking that position because other courts have held that, where mutual funds pay amounts to cover reasonable costs for operating a plan, the additional expense is reasonable. The Tibble court responded that the attorneys should have raised the argument at trial (which was years ago) and that the argument would not be considered at this point in the proceedings. As a result, the Tibble fiduciaries were left without a legal basis for justifying the increased expenses of the retail share classes.

With that background, plan committees, and their fiduciary advisers, have two alternatives when evaluating share classes. The first is to select the lowest-cost available share class, for example, an institutional share class. (I say “available share class” because not all share classes are generally available to smaller plans. Obviously, fiduciaries do not need to consider share classes that they can’t invest in. However, there is a fiduciary “duty to ask” about the available share classes.) The second is to select a higher-cost share class (for example, retail shares) where the increased expense can be justified by revenue sharing for operating the plan, for example, for compensation to the recordkeeper and adviser. Both alternatives are legally permissible.

However, there are several issues. Some of those are:

  • Who should decide whether to use higher cost share classes that pay revenue sharing for plan expenses?

Unfortunately, there isn’t any specific guidance on that question. However, in my experience, most advisers believe that plan fiduciaries should decide whether expenses are paid by revenue sharing, by the plan sponsor, or by charges to the participants. Accordingly, the first step for an adviser is to consult with the plan fiduciaries to determine whether the adviser should recommend the lowest-cost available share classes or whether the adviser should recommend share classes that pay reasonable amounts of revenue sharing to offset plan expenses. (Where the mutual funds pay more revenue sharing than is needed for reasonable plan expenses, the excess should be restored to the plan and the participants. For example, that might be done through an expense recapture account.)

  • What is the adviser’s responsibility?

When a fiduciary adviser recommends mutual funds to the plan fiduciaries (e.g., the plan committee), the adviser should recommend the appropriate share class for that plan. In other words, the adviser should evaluate the mutual fund share classes in light of the revenue sharing decisions made by the plan fiduciaries.

  • What are the adviser’s subsequent responsibilities?

The Tibble decision also held that the plan fiduciaries have an ongoing duty to monitor for these purposes. As a result, if a fiduciary adviser is providing monitoring advice, the share class issue needs to be re-visited at reasonable intervals. There’s no specific guidance on the appropriate timing of those reviews, but advisers need to consider the issue when developing and communicating their monitoring recommendations.

While both of the alternatives—that is, no revenue sharing and revenue sharing share classes—are available, the easier course of action would be to use the lowest-cost share class (and, if possible, non-revenue paying shares). Where some of the investments pay revenue sharing, the plan can be immunized by returning that revenue sharing to the participants who hold shares of those mutual funds (which is sometimes called “levelization” or “equalization”). In this case, the scope of monitoring is reduced and the plan is more transparent.

My point in writing this article is that Tibble impacts advisers as much as it impacts responsible plan fiduciaries. As a secondary, but important risk management matter, fiduciary advisers need to consider whether their discussions with plan committees about revenue sharing are adequate to enable the plan fiduciaries to fully understand the issues and to make informed decisions. The Tibble decision is an important reminder that, when mutual funds are recommended, an adviser needs to focus on the appropriate share class and needs direction about the use of funds that pay revenue sharing.

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 #59


DOL

What Plans and Arrangements Are Covered by the Fiduciary Rule

This is my 59th 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 and related developments in the securities laws.

I continue to be asked about which “plans” are covered by the new DOL fiduciary rules, and which are not. It’s more complicated than you might think, in the sense that some of the covered plans may surprise you. Fortunately, three of our attorneys, Bruce Ashton, Elise Norcini and Josh Waldbeser have written an article that explains “what’s in and what’s out” in terms of the plans and other investment accounts that are covered by the fiduciary rule (and therefore by the prohibited transaction exemptions). A full reprint of their June 7, 2017 article follows:

“With the June 9 applicability date of the DOL Fiduciary Rule (Rule) just a few days away, there may still be confusion about exactly which plans and other arrangements are subject to the Rule. Some plans are not subject to the Rule, and some arrangements that are not actually IRAs are treated as if they were IRAs and therefore subject to the Rule. So, how are “plans” and “IRAs” defined?

The purpose of this Alert is simple – to describe which plans and arrangements are covered, and which are not. Below is a summary, followed by a brief discussion for those who want more explanation.

SUBJECT to the Rule – Treated as Plans

  • 401(k) plans – all types
  • Individual (“solo”) 401(k)s
  • 403(b) plans (other than governmental and non-electing church plans, and payroll deduction only 403(b)s)
  • Profit-sharing plans
  • ESOPs, including KSOPs
  • Money purchase plans (other than governmental and non-electing church plans)
  • Defined benefit plans (other than governmental and non-electing church plans)
  • SEPs, including SARSEPs
  • SIMPLEs
  • Keogh plans

SUBJECT to the Rule – Treated as IRAs

  • IRAs – all types
  • Payroll deduction only IRAs
  • Individual retirement annuities
  • Health savings accounts (HSAs)
  • Archer medical savings accounts (MSAs)
  • Coverdell education savings accounts (ESAs)

NOT SUBJECT to the Rule

  • Governmental plans – all types
  • Payroll deduction only 403(b)s
  • 457 plans – both 457(b) and 457(f)
  • Non-qualified equity compensation, such as stock options and restricted stock units
  • Non-electing church plans – all types
  • Non-qualified deferred compensation plans
  • Rabbi trusts
  • 529 plans
  • Uniform Gifts/Transfers to Minors Accounts

Covered Plans

Under the Rule, covered plans include (1) all “plans” as ERISA defines the term, and (2) all plans that are tax-qualified under Section 401(a) of the Internal Revenue Code (Code). Many plans fall under both categories, but only one is required. To illustrate:

  • 401(k) plans (benefiting employees of an employer) are both ERISA plans and qualified plans. The same is true of profit-sharing plans, ESOPs, and most money purchase and defined benefit plans, unless they fall into one of the excluded categories from our chart (more on excluded categories later).
  • Individual 401(k) plans (benefiting a self-employed individual) are not ERISA plans, but are qualified.
  • SEPs and SIMPLEs are ERISA plans, even though they are IRA-based, and thus are not qualified plans. This is because both SEPs and SIMPLEs require employer contributions. 403(b) plans that are subject to ERISA are also covered – this includes 403(b) plans sponsored by private tax-exempt entities that are not churches.

Covered IRAs

Covered IRAs include all arrangements that are not “plans” under the above definition, but are treated as plans under the Code’s excise tax rules – this includes both “actual” IRAs and other similar arrangements like HSAs (an HSA may also be part of an ERISA plan, although this is the exception).

Also, under ERISA, employers are permitted to take payroll deductions from employees and remit them to IRAs, without being deemed to sponsor a plan. In these cases, the employer can have only limited involvement and cannot make employer contributions. These “payroll deduction only” IRAs are subject to the Rule as IRAs, but are not plans.

Excluded Plans and Arrangements

The Rule does not affect arrangements that are neither plans nor IRAs, as defined above.  Here are some specifics:

  • Governmental Plans. Governmental plans may be qualified under the Code but are not subject to the Code’s excise tax provisions, and are entirely excluded from ERISA. This means the Rule does not apply to investment advice given to governmental plans, though similar state laws may apply.
  • Non-Electing Church Plans. Churches and certain affiliated tax-exempt employers may sponsor “church plans.” Church plans are not subject to ERISA unless the plan sponsor affirmatively elects ERISA coverage. And, even though “non-electing” (non-ERISA) church plans may be qualified, like governmental plans they are not subject to the Code’s excise tax provisions. Thus, the Rule likewise has no application to non-electing church plans. (Though beyond the scope of this Alert, one way advisers can check on a plan’s “ERISA status” is to see whether the plan has filed Forms 5500 with the DOL. If so, it is subject to ERISA.)
  • Payroll Deduction Only 403(b)s. Tax-exempt employers that take payroll deductions from employees and remit them to 403(b) tax-deferred annuities, but otherwise have limited involvement and do not make employer contributions, are not treated as sponsoring a plan subject to ERISA. Also, 403(b) plans are not subject to the Code’s prohibited transaction excise taxes. Thus, payroll deduction only 403(b)s are not subject to the Rule at all.
  • Non-Qualified Deferred Compensation Plans. “Top hat” deferred compensation plans that cover only a select group of management or highly compensated employees are not treated as plans so long as they are “unfunded” (i.e., to the extent assets are set aside, they are in a “rabbi trust” or similar vehicle where the assets are subject to the employer’s creditors). These plans are not subject to ERISA or to the Code’s excise tax provisions, and the Rule does not affect them. The same is true for non-qualified equity-based compensation arrangements.
  • 457 Plans. 457(b) and 457(f) plans are non-qualified deferred compensation plans that can be sponsored by governmental and private tax-exempt employers. 457 plans of tax-exempt entities are excluded from ERISA as either “top hat” or non-electing church plans and are not subject to the Rule. “Non-top hat” 457 plans of a private sector employer could be subject to ERISA and the Rule, though this is rare.
  • Other Arrangements. Other arrangements such as 529 plans and UGMA/UTMA accounts are neither plans nor IRAs. They may, however, be similar to certain arrangements that are subject to the Rule. For example, 529 plans (excluded) and Coverdell ESAs (covered) are both used for college savings. Thus, advisors and financial institutions will need to be careful to differentiate between them.

Given this complexity, we understand why confusion may persist about what plans and arrangements are subject to the Rule. If you have any questions or concerns, do not hesitate to contact your Drinker Biddle attorney.”

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 #58


408(b)(2), DOL, fiduciary, General

Recommendations to Contribute to a Plan or IRA

This is my 58th 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 and related developments in the securities laws.

In Angles article #56, I discussed the DOL’s position that recommendations of contributions to plans and IRAs were fiduciary advice. However, a week after that article was posted on my blog, the DOL reversed its position. The new guidance is found in the DOL’s “Conflict of Interest FAQs (408b-2 Disclosure Transition Period, Recommendations to Increase Contributions and Plan Participation).”

In the newly issued FAQs, the DOL posed the following question:

Q2. Plans and their service providers often encourage plan participants to make contributions to the plan at levels that maximize the value of employer matching contributions or to otherwise increase participants’ contributions or savings to meet objective financial retirement milestones, goals, or parameters based upon the participant’s age, time to retirement or other similar measures, without recommending any particular investment or investment strategy. Would it be fiduciary investment advice under the Fiduciary Rule to encourage additional savings or contributions to a plan or IRA in this manner?

The DOL then reversed its prior position by responding that those recommendations would not be fiduciary advice.

So, recordkeepers and advisers can unconditionally recommend contributions to plans and IRAs, right? Not so fast. A close reading of the guidance suggests otherwise. In other words, there may be traps for the unwary.

First, the recommended increase must be “objective.” For example, a non-fiduciary recommendation could be made to increase contributions to obtain the full benefit of an employer’s matching contributions. Also, a non-fiduciary recommendation for increased contributions could be “to meet objective financial retirement milestones, goals, or parameters based upon the participant’s age, time to retirement or other similar measures.” For example, a recommendation to increase contributions could be made based on calculations of the amounts needed for adequate retirement (for example, a 75% income replacement ratio in retirement). Another example is that, as a general rule of thumb, the combined employee-employer contributions should be 15% of pay in order to reasonably accumulate enough for a secure retirement.

Second, a recommendation to increase contributions is non-fiduciary advice where it is made “without recommending any particular investment or investment strategy.” So, for example, if the recommendation to increase contributions to a plan or IRA is made during a conversation that also includes a discussion of the investments, that could cause the recommendation to be fiduciary advice.

As a result, the “rules of the road” for recommending increased contributions to plans or IRAs, while avoiding fiduciary status, is to (1) make the recommendation based on an objective measurement, and (2) avoid a concurrent discussion of investments or investment strategies for the plan or IRA.

Even though there are traps in this guidance, the DOL’s position is a significant improvement.

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 #57


408(b)(2), BICE, broker-dealers, DOL, fiduciary, General

DOL FAQs on 408(b)(2) Fiduciary Disclosures

This is my 57th 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 and related developments in the securities laws.

The Department of Labor has issued a new set of “Conflict of Interest FAQs (408(b)(2) Disclosure Transition Period, Recommendations to Increase Contributions and Plan Participation).”

This article discusses the DOL’s relief from the 408(b)(2) requirement that a “change” notice be given for advisers who became fiduciaries to ERISA-governed retirement plans because of the June 9th expansion of the definition of fiduciary advice.

Before getting into the details of the relief, let’s look at what the DOL’s FAQs did not do. If an adviser (or his or her supervisory entity) was a fiduciary, functional or acknowledged, before June 9th, but did not give a 408(b)(2) notice of fiduciary status, that is not covered. In other words, it is a violation that is not remedied by the Department of Labor’s guidance. If the adviser’s prior 408(b)(2) disclosures, or agreement, stated that the adviser (and his or her supervisory entity) is not a fiduciary, then relief is not provided and a disclosure must be given.

So, what does that leave?

The DOL’s relief applies where an adviser became a fiduciary solely because of the change of definition. But, the relief from disclosing the new fiduciary status only applies if “the covered service provider furnishes an accurate and complete description of the services that will be performed under the contract or arrangement with the plan, including the services that would make the covered service provider an investment fiduciary under the currently applicable Fiduciary Rule.”

In other words, the covered service provider (for example, a broker-dealer) must provide an accurate and complete description of its fiduciary services. For example, those services could be recommendations about the selection and monitoring of the investments in a 401(k) plan. My experience is that, few—if any—broker-dealers made that representation in their previous 408(b)(2) disclosures (since it would have resulted in fiduciary status under the old rules). As a result, it is likely that advisers, and their supervisory entities, will need, at the least, to give more detailed descriptions of their services in order to take advantage of the 408(b)(2) relief. Needless to say, that should be done as soon as possible. (Technically, the DOL FAQs say that these disclosures should be made “as soon as practicable after June 9, 2017, even if more than 60 days after June 9, 2017.”)

Even if those conditions are satisfied and, therefore, the relief is available, the requirement for the 408(b)(2) fiduciary notice is only delayed until the applicability date of the final exemptions (that is, the Best Interest Contract Exemption (BICE) and the Principal Transactions Exemption). If the fiduciary definition remains the same, or substantially similar, the pre-June 9th 408(b)(2) disclosures will need to be updated at that time to declare fiduciary status. However, there is at least an outside chance that the regulation will be modified to define some sales practices as non-fiduciary. Obviously, if that change is made, there would not be a need to disclose fiduciary status for those non-fiduciary sales practices.

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 #56


DOL, fiduciary, prohibited transaction

The Department of Labor has reversed its position on the issues discussed in the article below. Angles article #58 explains the changes.

Recommendations of Contributions as Fiduciary Advice

This is my 56th 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 and related developments in the securities laws.

The Department of Labor’s Request for Information on the fiduciary rules and exemptions focuses on a number of issues that became apparent as financial institutions and advisers work to comply with the new requirements. One of these, which is addressed in the RFI, but which has not been generally discussed, is that a recommendation of a contribution, or of increased contributions, to plans and IRAs is a fiduciary act. As a result, if the recommended contribution causes higher compensation to be paid to the adviser (or the adviser’s financial institution), the recommendation would result in a prohibited transaction.

The problems are obvious. Even though there is a potential conflict of interest where an adviser could make a little more money because of the increased contributions, the benefits to participants of increasing their retirement savings in plans and IRAs are meaningful. In that regard, it seems that public policy would favor increased contributions to IRAs and plans, even though there may be some minor benefit to the person making the recommendation.

With that in mind, the Department of Labor’s RFI asked:

Contributions to Plans or IRAs

Should recommendations to make or increase contributions to a plan or IRA be expressly excluded from the definition of investment advice? Should there be an amendment to the Rule or streamlined exemption devoted to communications regarding contributions? If so, what conditions should apply to such an amendment or exemption?

The first question is whether a recommendation to make those contributions should be viewed as a fiduciary act. My view is that it should not. The benefits of increased contributions are so obvious, and the potential conflict is so small, that the easiest, and most direct, solution would be for the DOL to conclude that a recommendation to make or increase contributions is not fiduciary advice.

However, if the DOL doesn’t do that, it should follow through with a favorable response to the second question. In its essence, the DOL’s second question is whether there should be a streamlined exemption for contribution recommendations. A truly streamlined exemption might work. However, usually exemptions have conditions. If those requirements are more than di minimus, the rules would likely create a trap for the unwary. In saying that, I mean that many advisers might not be aware of those additional requirements when recommending that a retirement investor save more in his or her IRA or plan.

Hopefully, the DOL will conclude that recommendations to a participant or IRA owner to increase their retirement contributions is not a fiduciary act. If they conclude otherwise, a recommendation to make or increase contributions would result in a prohibited transaction . . . and an exemption will be necessary. Unless it is an exemption without conditions (which is rare, but possible), there will undoubtedly be inadvertent violations.

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 #55


BICE, broker-dealers, DOL, fiduciary, registered investment advisers

The DOL’s RFI and the Recommendation of Annuities

This is my 55th 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 and related developments in the securities laws.

The Department of Labor’s Request for Information (RFI) on the fiduciary rule and exemptions does a good job of focusing on the key issues for advisers and their financial institutions (e.g., broker-dealers and RIA firms). That is, the questions in the RFI cover most of the issues that prove to be compliance problems for our clients, in the sense that the requirements were difficult to satisfy or expensive to implement.

In addition, the RFI also highlights an issue for independent insurance agents, which is that, in the exemptions scheduled to apply on January 1, 2018, the sale of fixed indexed annuities to qualified accounts (e.g., plans and IRAs) is transferred from Prohibited Transaction Exemption 84-24 to the Best Interest Contract Exemption (BICE). That creates a difficult situation, because independent insurance agents will not be able to sell fixed indexed annuities under BICE, because BICE requires that a financial institution supervise the sale. I believe the DOL thought that insurance companies would serve as the supervisory entities (and, in a manner of speaking, as co-fiduciaries) for independent insurance agents who were appointed as agents for the insurance companies. However, insurance companies were not willing to do that. As a result, independent insurance agents will effectively be precluded from selling fixed indexed annuities. (Note that a number of insurance intermediaries have applied to the DOL for “financial institution” status under BICE. However, the DOL has not issued final guidance for the applicants.)

Fortunately for those agents, the 84-24 exemption was amended for the transition period to put fixed indexed annuities, along with variable annuities and fixed rate annuities, under the exemptive relief of 84-24. However, the final 84-24 exemption continues to say that fixed indexed annuities are not included in 84-24, but instead must be sold under BICE.

Because of those issues, the Department of Labor asked, in Question 17 of the RFI:

If the Department provided an exemption for insurance intermediaries to serve as Financial Institutions under the BIC Exemption, would this facilitate advice regarding all types of annuities? Would it facilitate advice to expand the scope of PTE 84–24 to cover all types of annuities after the end of the transition period on January 1, 2018? What are the relative advantages and disadvantages of these two exemption approaches (i.e., expanding the definition of Financial Institution or expanding the types of annuities covered under PTE 84–24)? To what extent would the ongoing availability of PTE 84–24 for specified annuity products, such as fixed indexed annuities, give these products a competitive advantage vis-a`-vis other products covered only by the BIC Exemption, such as mutual fund shares?

In effect, the DOL is asking questions about two alternatives. The first is whether “insurance intermediaries,” such as IMOs, should be allowed to serve as “financial institutions,” which would allow independent insurance agents to use the Best Interest Contract Exemption. Based on our representation of a number of IMOs and BGAs, many of those types of organizations would be willing to serve in the financial institution role, if that was available. If properly done, that solution would work.

The second question is whether to continue to include fixed indexed annuities, along with fixed rate and variable annuities, under the 84-24 exemption. In that case, independent insurance agents would not need a financial institution to supervise their activities. At the present time, the 84-24 rules are more restrictive on compensation and require greater disclosure of compensation than BICE. So, while that alternative is less burdensome in terms of the need for a financial institution, it is more demanding in terms of compensation disclosures.

It is likely that one or both of those solutions will be permitted when the rules are revised by the current leadership at the DOL. While the financial institution alternative is more burdensome and involves greater regulation, it could be favored by the DOL because of the financial institutions’ supervision of the independent insurance agents. On the other hand, if the DOL favors less regulation and burden, the 84-24 exemption will be expanded to include all forms of annuities. Only time will tell.

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 #54


BICE, DOL, fiduciary, prudent

The DOL’s RFI and Possible Changes to BICE

This is my 54th 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 and related developments in the securities laws.

The Department of Labor issued a Request for Information (RFI) about the fiduciary regulation and the prohibited transition exemptions. The questions in the RFI indicate the issues of greatest interest to the DOL and, in some cases, are suggestive of possible outcomes. This article looks at two issues concerning BICE–the Best Interest Contract Exemption.

The first question is about a possible extension of the transition rules, now scheduled to expire on December 31 of this year. The DOL asks:

“Would a delay in the January 1, 2018, applicability date of the provisions in the BIC Exemption, Principal Transactions Exemption and amendments to PTE 84-24 reduce burdens on financial services providers and benefit retirement investors by allowing for more efficient implementation responsive to recent market developments? Would such a delay carry any risk? Would a delay otherwise be advantageous to advisers or investors? What costs and benefits would be associated with such a delay?”

While it is always risky to make predictions, I think that the transition period will be extended, perhaps through the end of 2018.

As background, “transition” BICE requires only that the “financial institution”—e.g., the broker dealer or RIA firm—and the adviser “adhere to” the Impartial Conduct Standards (ICS). The ICS has three conditions: the best interest standard of care, no more than reasonable compensation, and no materially misleading statements. It is a conduct-based standard, and there aren’t requirements for written agreements or disclosure statements.

I believe that the DOL will find that those protections are adequate for the intervening period, as financial institutions transition to the new fiduciary regime, and that delaying compliance with additional requirements for contracts, disclosures, etc., will not negatively impact qualified investors in a material way.

Another set of BICE questions deals with the written contract and warranty requirements in the version of the exemption scheduled to apply on January 1 of 2018 (but likely to be delayed). The two requests for information are:

“5. What is the likely impact on Advisers’ and firms’ compliance incentives if the Department eliminated or substantially altered the contract requirement for IRAs? What should be changed? Does compliance with the Impartial Conduct Standards need to be otherwise incentivized in the absence of the contract requirement and, if so, how?

6. What is the likely impact on Advisers’ and firms’ compliance incentives if the Department eliminated or substantially altered the warranty requirements? What should be changed? Does compliance with the Impartial Conduct Standards need to be otherwise incentivized in the absence of the warranty requirement and, if so, how?”

The outcome on these issues is less clear. The DOL needs to balance the burdens of compliance with protection of retirement investors. For example, the cost, complexity and possible litigation implicit in those requirements could cause financial institutions to limit the range of investments and/or to increase their charges to investors. On the other hand, how will IRA retirement investors obtain relief if there was a breach of the best interest standard of care? While plans and participants can file claims under ERISA, retirement investors in IRAs don’t have a similar statutory right.

Those are complicated issues and there will certainly be comments by both pro-industry groups and pro-investor organizations. While I can’t predict the outcome, I believe that the DOL will try to balance those considerations, with the objective of providing retirement investors with access to a wide range of investments without increasing their costs, but at the same time providing an opportunity for enforcement of the best interest standard of care.

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 #53


BICE, broker-dealers, DOL, fiduciary, prohibited transaction, prudent

The Fiduciary Rule and Discretionary Investment Management

This is my 53rd 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 and related developments in the securities laws.

In recent conversations I have learned that many broker-dealers and RIAs do not understand how the prohibited transaction rules and exemptions (and, particularly, the Best Interest Contract Exemption) apply differently to discretionary accounts and non-discretionary accounts. This article discusses some of those differences.

One similarity, though, is that ERISA’s prudent man rule and duty of loyalty apply for both discretionary and non-discretionary advice to retirement plans and participants.

However, ERISA does not generally govern investment advice to IRAs. As a result, absent the need for a prohibited transaction exemption, advisers to IRAs will not be governed by fiduciary/best interest standard of care. For example, where an adviser (and his or her supervisory entity) provides discretionary or non-discretionary investment advice to an IRA on a “pure” level fee basis, the adviser and the entity are subject to the fiduciary standards under the securities laws, but are not covered by the new fiduciary rule. That is because, where an adviser is providing advice for a reasonable level fee, it is not a prohibited transaction. As a result, an exemption is not needed. (By the way, a “pure” level fee is compensation that does not vary based on the advisory decisions or recommendations and that is not paid by third parties, e.g., 12b-1 fees, insurance commissions, etc. Also, the fee must be level across all related and affiliated parties.)

However, where there is a financial conflict of interest for non-discretionary or discretionary investment advice to an IRA, a prohibited transaction results. That includes, for example, where the adviser or supervisory entity (or any affiliated or related party) receives compensation in addition to the level fee. Examples of those additional, and conflicted, payments are: 12b-1 fees; insurance commissions and trails; proprietary products; asset-based revenue sharing; and payments from custodians.

Where conflicted payments are received, and a prohibited transaction occurs, the adviser and the supervisory entity will need an exemption. If the adviser provides non-discretionary investment advice, the Best Interest Contract Exemption (BICE) is available, if its conditions are satisfied. BICE requires only that the adviser and the supervisory entity comply with the Impartial Conduct Standards during the transition period (the transition period is from June 9 to December 31, 2017, but will likely be extended). The Impartial Conduct Standards are that the adviser and entity adhere to the best interest standard of care, receive no more than reasonable compensation for their services, and make no materially misleading statements. The entity–-the broker-dealer or RIA firm-–also needs to have procedures and practices to ensure that the conflicts do not result in advice that is not in the best interest of the retirement investor.

However, BICE cannot be used for prohibited transactions that result from discretionary investment management. In fact, there are only a few exemptions for discretionary investment management, and none as broad as BICE. For example, there is an exemption for the use of proprietary mutual funds.

As a result, many—and perhaps most—financial conflicts (that is, prohibited transactions) that result from discretionary investment management decisions are absolutely prohibited, because there are not exemptions for the conflicted payments.

The moral of this story is that RIA firms and broker-dealers need to distinguish between discretionary investment management and non-discretionary investment advice. For the time being, at least, most conflicts of interest for nondiscretionary advisers are permissible, if the Impartial Conduct Standards are satisfied. However, for discretionary investment management, there are few exemptions and most financial conflicts will be prohibited without any available exemptions. To the extent that the prohibited transaction rules are being inadvertently violated for managed IRAs, now is the time to correct the errors.

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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