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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Interesting Angles on the DOL’s Fiduciary Rule #52


BICE, DOL, fiduciary, prudent, service providers

The Fiduciary Rule and Exemptions: How Long Will Our Transition Be?

This is my 52nd 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 fiduciary regulation that dramatically expanded the definition of fiduciary investment advice went into effect on June 9. As a result, virtually all advisers to plans, participants and IRAs are now fiduciaries, or will be as soon as they make the next investment recommendation to one of those qualified accounts. At the same time—June 9, the “transition” transaction exemptions were effective.

If viewed out of context, the fiduciary regulation, as currently written, will continue in effect for years to come. However, the transition exemptions will only apply until December 31, when the full exemptions will apply, with their many and demanding requirements. But, that’s out of context.

When viewed in context, the situation looks much different. For example, the Department of Labor will be publishing the Request for Information asking, among other things, about the potential impact of the fiduciary rule and changes that may be needed. Not to be outdone, the SEC has asked a series of questions about a possible fiduciary standard for all investment advice within its purview. The SEC and DOL have indicated that they will be working together to develop their respective fiduciary definitions (and, in the case of the SEC, a fiduciary standard of care) or, perhaps, they will develop an identical definition of fiduciary advice.

In addition, the DOL has asked for input concerning the structure and requirements of the prohibited transaction exemptions, including the two exemptions that impact most advisers . . . the Best Interest Contract Exemption (BICE) and Prohibited Transaction Exemption 84-24. Those exemptions are exceptions from the prohibited transaction rules, but come with strings attached. On the other hand, the SEC does not have a statutory basis for adopting similar prohibited transactions or, for that matter, exemptions from prohibited transactions. Because of those differences, it is likely that, even if the two regulatory bodies adopt a common definition of fiduciary advice (and a common standard of care), their treatment of conflicts of interest will vary.

As mentioned earlier, the transition period for the DOL’s exemptions is only until December 31. And, if I haven’t made clear, there isn’t any transition period for the fiduciary regulation; it is in full force and effect.

What does this mean in terms of timing? My view is that it will be virtually impossible for the DOL and SEC to collaborate on the development of a common, or at least compatible, definition of fiduciary advice and standard of care before December 31. Because of the Administrative Procedures Act, the final regulation would need to be published in early November, which means a proposed regulation would probably need to be published in early to mid-September. To hit those deadlines, the two regulatory bodies would need to develop a proposed regulation within that time frame. That seems almost impossible —partially because of the need for coordination and partially because the SEC hasn’t previously proposed guidance on these issues. In other words, even though the DOL has a basis for revising its regulation and exemptions, the SEC doesn’t.

As a result, my view is that the DOL will extend the transition period, perhaps for as much as a year. That would allow time for the two agencies to work together in a thoughtful manner and at a reasonable pace.

That is both good news and bad news to the regulated community, that is, for financial services companies. It is good news because it allows more time to fully adapt to the new rules and because the compliance requirements for the transition exemptions are not that difficult or burdensome. It is bad news—at least for those firms that strenuously object to the fiduciary rule, because, by a year from now, financial services companies will be in compliance with the fiduciary standard and fiduciary advice will have become the standard course of business. The training will have been done, products will have been developed, solutions will have been implemented, and so on. In other words, the fiduciary standard will have become the norm. As a result, it may be more difficult to change the fiduciary definition and standard of care. On the other hand, there will still be significant changes to the exemptions and, particularly, to the Best Interest Contract Exemption.

One way or another, I expect that we will hear, in August or September, that the transition period is being extended.

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 #51


BICE, broker-dealers, DOL, fiduciary, prudent

Recommendations to Transfer IRAs

This is my 51st 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 new fiduciary regulation includes, among its definitions of fiduciary advice, a recommendation to an IRA owner to transfer the IRA from another firm. As a result, the recommendation, if accepted by the IRA owner, will automatically result in a prohibited transaction. That is because, if the recommendation is accepted and the IRA is transferred, the adviser will obviously make more money than if it were not. That is a financial conflict of interest that is a prohibited transaction under the Internal Revenue Code.

Fortunately, there is an exemption, or exception, called the Best Interest Contract Exemption (BICE). However, BICE comes with conditions . . . the adviser and his or her supervisory entity (typically a broker-dealer or RIA firm) must comply with the Impartial Conduct Standards. There are three Impartial Conduct Standards:

  • The adviser (and the supervisory entity) must adhere to the best interest standard of care (which includes the duties of prudence and loyalty).
  • Neither the adviser nor the supervisory entity can receive more than reasonable compensation.
  • The adviser and the supervisory entity must not make any materially misleading statements.

This article looks at the requirement to engage in a best interest process.

The first step of a best interest, or prudent process, is to determine the information that is “relevant” to making a decision that is “informed.” In other words, what would a person who is knowledgeable about such matters, and who is unbiased and loyal to the IRA owner, want to review in order to develop a recommendation? Unfortunately, there aren’t any specific guidelines in the fiduciary regulation or BICE. However, it seems reasonable to conclude that, at the least, the following would be required in most cases:

  • The investments, services and expenses in the current IRA.
  • The investments, services and expenses available in the IRA that the adviser will recommend.
  • The needs, objectives, risk tolerance and financial circumstances of the IRA owner.

In the typical case, that may be enough. However, in some cases, there may be special circumstances that would require considerations of additional factors.

Once those considerations have been identified, the next step is to gather the information; that documentation should be retained in retrievable fashion in the event of SEC or FINRA examinations, IRS audits, or private claims.

The next step is to analyze the information. For example, if the investments and the expenses are similar for both the current IRA and a new IRA, the key is to consider the services in light of the needs and circumstances of the IRA owner. With that in mind, in this new fiduciary world, advisers and their supervisory entities should focus on the services that they will provide to retirement money, such as Individual Retirement Accounts. Generally speaking, the investment of retirement money (at least, based on guidance from the Department of Labor) involves considerations of generally accepted investment theories—such as modern portfolio theory, and of prevailing investment industry standards. Ordinarily, that would include strategies such as asset allocation, diversification among and within asset classes, portfolio construction, and so on. Those are “services” that are consistent with the best interest standard of care and that could justify a prudent, or best interest, recommendation to transfer an IRA.

The considerations listed in this article are not exclusive. There are many other factors that could reasonably be considered in developing a recommendation to transfer an IRA. The key, though, is that the appropriate documentation be gathered, a thoughtful analysis be made, and the recommendation be prudent and loyal.

The best interest fiduciary process is a new way of looking at everyday transactions and making recommendations about those transactions. It’s important for advisers to realize that it’s not just a compliance issue; instead, it’s a process . . . a thoughtful, documented, best interest process.

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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