Interesting Angles on the DOL’s Fiduciary Rule #44


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

The Basic Structure of the Fiduciary Package (June 9)

This is my 44th 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.

This article focuses on the fiduciary rule; next week I will discuss two of the exemptions, the Best Interest Contract Exemption and 84-24.

As we all know by now, the DOL’s new fiduciary definition applies on June 9. As a result the following recommendations will be fiduciary acts on and after June 9:

  • Recommendations of investments, investment strategies, insurance and annuities, investment managers, other fiduciaries, distributions and rollovers, and IRA transfers;
  • Recommendations to ERISA plans, participants or IRA owners.

Fiduciary recommendations to plans and participants (including rollover recommendations) will be subject to ERISA’s prudent man rule and duty of loyalty and, therefore, any breaches can be enforced as ERISA claims.

The same is not true for recommendations to IRAs, because the law does not establish a prudent man and duty of loyalty standard of care for advice to IRAs.

However, that is not the end of the story.

Where an adviser provides fiduciary services to an IRA for a level fee (for example, 1% per year and no other benefits or compensation is received), the adviser will be subject to the standard of care established by the securities laws.

But, if the adviser (or his supervisory entity, e.g., a broker-dealer) receives compensation that is a prohibited transaction (e.g., commissions, 12b-1 fees, asset-based revenue sharing, etc.), the adviser and entity will need the protection of a prohibited transaction exemption.

For the rest of this year–the “transition period,” most firms will use the Best Interest Contract Exemption. However, it is not the BICE you have been hearing about over the past year. Instead, it is “transition BICE.” Transition BICE requires that the entity and the adviser only comply with the Impartial Conduct Standards (ICS). The ICS has 3 components: the best interest standard of care, only reasonable compensation, and no materially misleading statements.

In effect the best interest standard of care brings the ERISA prudent man rule and duty of loyalty to IRAs. As a result, advisers and their supervisory entities need to educate themselves on the requirements of a prudent process with a duty of loyalty to the IRA owner. The suitability and know-your-customer requirements are a part of that, but only part.

Some other things to consider are:

  • The DOL has historically taken the position that a prudent process must be documented. How will advisers be doing that?
  • It is clear that under ERISA, advisers to plans must consider the costs of the investments. That is likely to be extended to IRAs under the best interest standard. How will advisers to IRAs evaluate the expense ratios of recommended mutual funds and the expenses imbedded in annuities? Will the entities (e.g., broker-dealers) be specifying which software is to be used for that purpose?
  • It is also clear under ERISA that the quality of the mutual funds must be considered, quantitatively and qualitatively. What will that process look like for IRAs? How will it be documented? What software will be used for that purpose? Some broker-dealers are limiting the mutual fund families that can be recommended to “qualified” accounts.

These are just some examples. There are others.

But, for the moment, the message is that, beginning on June 9, advisers and their supervisory entities must understand and apply these concepts.

Since the deadline is right around the corner, these are high priority issues.

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 #43


BICE, broker-dealers, DOL, fiduciary, prohibited transaction, registered investment advisers, SEC

BICE Transition: More Than the Eye Can See

This is my 43rd 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.

As we all know by now, the new, and greatly expanded, definition of fiduciary advice becomes applicable on June 9. That means that almost any investment or insurance recommendation to a plan, participant, or IRA will be a fiduciary act. (The definition of investment recommendations is also very broad, including referrals to investment managers, recommendations to take distributions from plans, and recommendations to transfer IRAs.)

As a result, investment and insurance recommendations to participants and plans must be prudently developed and must be loyal to the plan or participant. But, recommendations to IRAs will not be subject to the prudent man standard of care. Instead, they would be subject to the SEC fiduciary duty for RIAs, FINRA’s suitability and know-your-customer standards for broker-dealers, and state law standards of care for both RIAs and broker-dealers.

However, this story does not end there. When investment recommendations cause a third party to pay compensation to the adviser (for example, commissions or 12b-1 fees), that is a prohibited transaction. Also, when the adviser makes a recommendation that causes the adviser to receive additional compensation (for example, a commission on a securities transaction), that is a prohibited transaction. Because of those prohibited transactions (for recommendations to plans, participants and IRAs), an adviser must satisfy the conditions of an exemption.

During the period from June 9 to December 31, the likely exemption will be “transition” BICE, that is, the transition rule under the Best Interest Contract Exemption. Fortunately, those conditions should be fairly easy to satisfy. In fact, there is only one condition, but it has three parts. The condition is that the adviser (and the adviser’s Financial Institution) comply with the Impartial Conduct Standards (ICS). The three parts of ICS are: (1) The best interest standard of care; (2) no more than reasonable compensation; and (3) no materially misleading statements.

Focusing on the best interest standard of care, that means that the adviser and the Financial Institution must engage in a prudent process to develop investment recommendations and must act with a duty of loyalty to the plan, participant or IRA owner.

However, the purpose of this article is to discuss requirements that aren’t obvious on the face of the ICS. In other words, there is more to the rule than meets the eye. That’s because, in the DOL’s final regulation extending the applicability date of the fiduciary rule, the Department said:

Also note that even though the applicability date of the exemption conditions have been delayed during the transition period, it is nevertheless anticipated that firms that are fiduciaries will implement procedures to ensure that they are meeting their fiduciary obligations, such as changing their compensation structures and monitoring the sales practices of their advisers to ensure that conflicts in interest do not cause violations of the Impartial Conduct Standards, and maintaining sufficient records to corroborate that they are adhering to Impartial Conduct Standards.

In other words, while the explicit compensation requirement of the ICS is that advisers and Financial Institutions cannot receive more than reasonable compensation, the DOL is saying that a Financial Institution’s compensation structures cannot promote investment recommendations that are not in the best interest of the investor. Think about that. One possible interpretation is that, even though the compensation of the adviser can vary, both for similar products (e.g., mutual funds) and among product categories (e.g., mutual funds vs. variable annuities), the variation cannot be so great as to unreasonably promote advice that is inconsistent with the best interest standard of care.

That raises the obvious question, how much is too much?

It’s difficult, if not impossible, to answer that question. Having said that though, I think that the answer will be somewhat like the famous Supreme Court position . . . “You know it when you see it.”

In any event, broker-dealers, RIA firms, and other Financial Institutions should evaluate their compensation practices and consider whether they align with the quoted language.

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 #42


broker-dealers, DOL, fiduciary, General, prudent, registered investment advisers

Rollovers under the DOL’s Final Rule

This is my 42nd 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 April 7, 2017 the DOL issued its final regulation on the extension of the applicability date for the fiduciary definition and the related exemptions. This article discusses the impact of those changes on fiduciary status for recommendations to plan participants to take distributions and roll over to IRAs.

In its guidance, the DOL extended the applicability date of the new fiduciary definition from April 10 to June 9, but did not otherwise modify the definition. Since the fiduciary rule defined a recommendation to take a plan distribution as fiduciary advice, any recommendation to take a distribution and rollover to an IRA on or after June 9 will be a fiduciary act. As a result, an adviser will need to engage in a prudent process to develop and make such a recommendation. (For purposes of this rule, an “adviser” includes a representative of an RIA or a broker-dealer, an insurance agent or broker, or any other person who makes such a recommendation and receives compensation, directly or indirectly, as a result. An advisory fee from the IRA or a commission from an annuity or mutual fund are examples of compensation.)

However, more is involved that just the fiduciary rule. A recommendation to rollover is also a prohibited transaction, since the adviser will typically make more money if the participant rolls over than if the participant leaves the money in that plan. Because of the prohibited transaction, the adviser will need an exemption. Under the latest changes to the rules, advisers will probably use a process called “transition BIC,” which is a reference to a transition rule under the Best Interest Contract Exemption. (This process applies only from June 9 to December 31, unless it is extended. But it is likely that, at the least, these requirements will be part of any future exemption.). Transition BIC requires only that the adviser comply with the “Impartial Conduct Standards” (ICS).

The ICS requires that advisers adhere to the best interest standard of care, receive no more than reasonable compensation, and make no materially misleading statements. For this article, let’s focus on the best interest standard. Generally stated it is a combination of the ERISA prudent man rule and duty of loyalty.

So, an adviser must satisfy both ERISA’s prudent man rule (for the recommendation) and the BIC best interest rule (for the exemption). Since the two standards of care are virtually identical, I have combined them for this discussion.

But, that begs the question of, what is a prudent and best interest process?

Specifically, it is that the adviser must act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man 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; . . .”

So, what would a prudent, knowledgeable and loyal person, who is making a recommendation about retirement investing (the “aims” of the “enterprise”), do? The first step is to gather the information needed to make an informed decision. Then that information needs to be evaluated in light of the participant’s needs and circumstances of the participant . . .with a duty of loyalty to the participant.

The only clear guidance from the DOL about what information needs to be gathered and evaluated is found in Q14 in the DOL’s Conflict of Interest FAQs (Part I-Exemptions).

The first part of the FAQ discusses the information needed if the adviser is a “Level Fee Fiduciary.” Basically, the information includes the investments, expenses and services in the plan and the proposed IRA.

But at the end of the FAQ, the DOL explains that those considerations must be evaluated even if the adviser is using regular BIC (as opposed to the Level Fee Fiduciary provision).

Accordingly, any fiduciary seeking to meet the best interest standard (in order to satisfy transition BIC) would engage in a prudent analysis of this information before recommending that an investor roll over plan assets to an IRA, regardless of whether the fiduciary was a “level fee” fiduciary or a fiduciary complying with BIC.

In other words, any adviser making a distribution and rollover recommendation on or after June 9, 2017 must have a process for gathering and evaluating information about the investments, expenses and services in the participant’s plan and in the proposed IRA, and about the participant’s needs and circumstances.

This subject is more complicated than can be covered adequately in a short article, but this is a start for understanding the new rules for distributions and rollovers.

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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Inside the Beltway — April 25, 2017


Announcement

Please join us for our 20th Inside the Beltway presentation on April 25, 2017. This is the next session in our ongoing series of free audiocasts discussing developments in Washington that directly impact our industry.

During this session of Inside the Beltway Fred Reish and Brad Campbell will discuss:

  • Update on Secretary of Labor and DOL Appointees
  • Update on the fiduciary rule
  • Impact of the Congressional proposals for tax treatment of retirement plans
  • Impact on retirement plans of other Trump administration priorities
  • SEC ReTIRE Initiative

The audiocast will be recorded and available to all registrants within a week of the presentation. An Outlook appointment request will be sent with registration confirmation.

Questions? Please contact liz.jutila@dbr.com.

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Interesting Angles on the DOL’s Fiduciary Rule #41


DOL, fiduciary, prohibited transaction, prudent

While We Wait: The Current Fiduciary Rule and Annuities

This is my 41st 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.

As explained in previous posts, the delay of the new fiduciary rule does not mean that we are “rule-less.” Instead, the “old” rule, and exemptions, which have been place for decades, will continue to apply. Does that mean that we are back in the “good old days” where we won’t need to pay attention to the application of the fiduciary rule to IRAs?  I don’t think so.

Over the past few years, a tremendous amount of attention has been paid to the meaning and consequences of being a fiduciary . . . and I doubt that we can walk back from that. And, with this newfound attention, it is possible that many common practices will, when closely examined, result in fiduciary status under the old rule.

The consequences of unknowingly being a fiduciary are significant. If a fiduciary recommendation results in the payment of a commission to a fiduciary adviser or insurance agent, that payment would be a prohibited transaction and, absent compliance with any exemptions (e.g.., 84-24), the commission would be prohibited.

For example, the most common reason that advisors and insurance agents haven’t considered themselves to be fiduciaries for annuities is that their services haven’t been rendered “on a regular basis”. In other words, the sales have been viewed as one-time events. Let’s see how that stands up against common practices for sales and servicing of annuities in IRAs.

What about fixed rate (or “traditional”) annuities? It’s possible, perhaps even probable, that the sale of the annuity is a one-time event and that recommendations are not provided on an on-going basis. In that case, these sales would not be fiduciary services. However, if the agent periodically recommends additional purchases, that could result in fiduciary status. (Keep in mind that the definition is “functional” and it doesn’t matter what the agreements say. Instead, the conduct of the advisor is examined.)

What about fixed indexed annuities? Similar to their fixed rate cousins, the sale could be a one-time event and, therefore, not a fiduciary recommendation. On the other hand, if there are ongoing services that would be fiduciary activities, it can result in fiduciary status.

What about variable annuities? The recommendation of a variable annuity may contemplate ongoing fiduciary services, for example, recommendations about the mutual funds inside the annuity and the allocations and reallocations among those investments. In that case, the services could result in fiduciary status and the payment of the commission could be a prohibited transaction. As a result, both advisers and agents should consider using PTE 84-24. (Remember that 84-24, in its old form, is still in effect and that, therefore, all three types of annuities are covered by the exemption.)

So, after you heave a sigh of relief for the delay of the fiduciary rule, it’s time to go back to work on fiduciary issues . . . and an important one is the treatment of the recommendation of annuities to IRAs.

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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DOL Issues Temporary Enforcement Relief for Fiduciary Rule Non-Compliance


DOL, fiduciary

The DOL has published Field Assistance Bulletin 2017-1, which provides some limited temporary relief while the industry waits to find out if the Fiduciary Rule will be applicable April 10. The Drinker Biddle Employee Benefits and Executive Compensation Group has written a Client Alert, in which we discuss the two scenarios in which the DOL will not take enforcement action for non-compliance with the Fiduciary Rule during this period of uncertainty. We also provide suggestions on how advisers and financial institutions should proceed while we wait to see what happens with the Fiduciary Rule.

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Interesting Angles on the DOL’s Fiduciary Rule #40


DOL, fiduciary, General, prohibited transaction, registered investment advisers

New Rule, Old Rule: What Should Advisers Do Now?

This is my 40th 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 clear that the applicability date of the new fiduciary regulation will be delayed, many advisers (including broker-dealers and RIA firms) may heave a sigh of relief. However, while some relief is justified, that does not mean that their services are not governed, in many cases, by the “old” fiduciary regulation. (By “old” rule, I refer to the DOL regulation that defines fiduciary advice and that has been in effect for decades.) With all the attention that has been devoted to fiduciary status and prohibited transactions, it is possible, perhaps even probable, that the old rule will be applied more vigorously. As a result, advisers need to understand its provisions and need to review their practices to determine whether they are currently acting as fiduciaries under the old rule. To properly discuss that issue, advisory services need to be divided into four categories: advice to plans; advice to participants; advice to IRAs; and recommendations of plan distributions and rollovers. This article will discuss the first of those categories . . . advice to retirement plans.

Briefly stated, the old—and current–fiduciary rule has a five-part test:

  • A recommendation of an investment, insurance product, investment manager, and/or investment strategy or policy.
  • The advice must be given on a regular basis, that is, on an ongoing basis.
  • There must be a mutual understanding between the adviser and the plan fiduciaries.
  • The understanding is that the advice will be a primary basis for decision-making.
  • The advice is individualized and based on the particular needs of the plan.

With regard to qualified retirement plans (for example, 401(k) plans), those conditions will likely be satisfied in many cases. For example, it is common, perhaps even typical, for an adviser to meet with plan fiduciaries quarterly or annually. As a result, the advice is given on a regular basis. Similarly, when an adviser provides a list of investments, it is difficult to say that they are not individualized to the plan, because of the suitability requirements that apply to broker-dealers, RIAs, and insurance agents. In any event, there is a significant risk that an adviser who provides a list of investments to plan fiduciaries will be considered to have made fiduciary recommendations.

As a result, and with likely heightened scrutiny of advisers’ recommendations and fiduciary status, broker-dealers and insurance agents should consider whether they are willing to run the risk of being a fiduciary. (As this suggests, RIA’s probably are fiduciaries for ERISA plans.) And, if they are willing to be fiduciaries, there should be a formal program in place for that purpose. For example, a broker-dealer might establish a fiduciary advisory program under its corporate RIA and allow its most experienced retirement plan advisers to participate in that program. For those advisers who won’t be allowed to be fiduciaries under the RIA program, those broker-dealers should consider requiring that the advisers only recommend 401(k) providers who have platform fiduciaries. For example, a recordkeeping platform might offer a 3(21) non-discretionary fiduciary investment adviser and/or a 3(38) discretionary fiduciary investment manager. In that case, the platform fiduciary would recommend or select the investments, while the adviser would provide other services to the plan, for example, assistance with plan design, coordination with the recordkeeper, participant education meetings, and so on.

My point is that, now that we are more aware of the fiduciary definitions and the impact of fiduciary status, advisers need to be more attentive to their services and to whether those services result in fiduciary status. Correspondingly, their supervisory entities (for example, broker-dealers) need to make decisions about how those services will be offered, including whether some of the registered representatives can be 401(k) fiduciaries under the corporate RIA.

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 #39


DOL, fiduciary, General

FINRA Regulatory Notice 13-45: Guidance on Distributions and Rollovers

This is my 39th 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.

Even though the DOL fiduciary rule is being delayed, other regulators have indicated their interests in protecting participants from inappropriate recommendations to take plan distributions and roll over to IRAs.

FINRA, which oversees broker-dealers, addressed rollover recommendations to participants in Regulatory Notice 13-45. In describing the purpose of the notice, FINRA said:

“FINRA is issuing this Notice to remind firms of their responsibilities when (1) recommending a rollover or transfer of assets in an employer-sponsored retirement plan to an Individual Retirement Account (IRA) or (2) marketing IRAs and associated services.”

FINRA noted that:

“A broker-dealer’s recommendation that an investor roll over retirement plan assets to an IRA typically involves securities recommendations subject to FINRA rules. . . . Any recommendation to sell, purchase or hold securities must be suitable for the customer and the information that investors receive must be fair, balanced and not misleading.”

FINRA went on to say that:

“A recommendation concerning the type of retirement account in which a customer should hold his retirement investments typically involves a recommended securities transaction, and thus is subject to Rule 2111. For example, a firm may recommend that an investor sell his plan assets and roll over the cash proceeds into an IRA. Recommendations to sell securities in the plan or to purchase securities for a newly opened IRA are subject to Rule 2111.”

In essence, FINRA concludes that a recommendation to take a rollover includes a recommendation to liquidate* the investments in a participant’s 401(k) account. . . and that the liquidation recommendation is a “recommended securities transaction” and “thus is subject to Rule 2111.” The guidance then goes on to say:

“If Rule 2111 is triggered, a registered representative must have a reasonable basis to believe that the recommendation is suitable for the customer, based on information about the options obtained through reasonable diligence, and taking into account factors such as tax implications, legal ramifications, and differences in services, fees and expenses between the retirement savings alternatives.” (Emphasis added.)

Earlier in the Notice FINRA also describes the need for an adviser to compare investments, services and expenses in the plan and the recommended IRA before making a recommendation.

That is strikingly similar to the Best Interest Contract Exemption (BICE) requirement that fiduciary advisers must do a comparative analysis of the investments, services and expenses in the Plan and the proposed IRA before recommending a rollover.

The regulators appear to be harmonizing around the type of analysis and investigation required to make a suitable or prudent recommendation.

*In a footnote, FINRA observes that it is possible that a plan could permit distributions in kind, rather than requiring liquidation of the plan’s designated investment alternatives. As a practical matter, I have not worked with any 401(k) plans that distribute in kind. I assume that my experience is typical and that few, if any, 401(k) plans permit distributions of their mutual fund shares.

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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DOL Proposes Delay of Fiduciary Rule Applicability Date


DOL

The Department of Labor (DOL) published a proposed rule to delay the applicability date of the fiduciary rule from April 10 to June 9. The proposal for the delay will still need to go through a regulatory process, including a 15 day comment period; however we expect that the DOL will make the delay effective immediately upon the final regulation’s publication to the Federal Register. The DOL also announced a 45 day comment period on policy issues raised in the February 3 Presidential Memorandum. There are three possible outcomes at the end of the 45 day comment period. In this Alert, we discuss the regulatory process and when the delay might actually go into effect, as well as the possible outcomes at the end of the 45 day period.

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Interesting Angles on the DOL’s Fiduciary Rule #38


broker-dealers, DOL, registered investment advisers, SEC

SEC Examinations of RIAs and Broker-Dealers under the ReTIRE Initiative

This is my 38th 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.

As explained in my last post (Angles #37), the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a National Exam Program Risk Alert concerning examinations about services offered by RIAs and broker-dealers to investors with retirement accounts. One of the areas specifically identified for those examinations is “Reasonable Basis for Recommendations.” The OCIE described that issue as:

“Registrants have important obligations under the federal securities laws and SRO rules (with respect to broker-dealers) when making recommendations or providing investment advice. To the extent applicable and required, the staff will assess the actions of registrants and their representatives for consistency with these obligations when: (i) selecting the type of account; (ii) performing due diligence on investment options; (iii) making initial investment recommendations; and (iv) providing on-going account management.”

At the end of the language about “selecting the type of account,” the SEC included a footnote that referenced FINRA guidance on rollovers to IRAs. That footnote said:

“See FINRA, Rollovers to Individual Retirement Accounts, Regulatory Notice 13-45 (December 2013) (FINRA Regulatory Notice 13-45) (“A recommendation concerning the type of retirement account in which a customer should hold his retirement investments typically involves a recommended securities transaction, and thus is subject to Rule 2111. For example, a firm may recommend that an investor sell his plan assets and roll over the cash proceeds into an IRA. Recommendations to sell securities in the plan or to purchase securities for a newly-opened IRA are subject to Rule 2111.”)”

Combining the language in the Risk Alert with the language in the footnote, the OCIE is saying that recommendations to participants to take distributions from plans (that is, from one type of account), and rolling over to an IRA (that is, to another type of account) will be scrutinized. It also suggests that the OCIE favorably views FINRA’s analysis in Regulatory Analysis 13-45.

In my next post, I will discuss the rollover discussion in FINRA Regulatory Notice 13-45.

For the moment, though, as a word to the wise, broker-dealers and RIAs should review their procedures and policies, as well as their supervisory programs, to ensure that their advisers are complying with the expectations of the OCIE and with the provisions of Regulatory Notice 13-45.

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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