The Presidential Election: Now What?


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

One of the consequences of the presidential election is that the future of the fiduciary rule (and the exemptions) is uncertain. What does that mean to advisers . . . regardless of whether they are representatives of RIAs or broker-dealers, or for that matter, if they are independent insurance agents?

The answer is that nobody knows. However, this article outlines the most likely alternatives. Those are:

  1. The rule will be killed by regulation or legislation.
  2. The rule will be implemented “as is.”
  3. The rule and the exemptions will be modified.

Only the second alternative (the “as is” option) could realistically be implemented by the current deadline of April 10. But, that’s the alternative that is, in my opinion, the least likely to happen. While it is low probability, it is high risk in the sense that broker-dealers and RIAs must be in compliance by April 10 if it happens. As a result, broker-dealers, RIA firms and IMOs need to continue working on complying with the new rules until they hear otherwise.

For either of the other two alternatives to play out in a thoughtful way, the applicability date of the rule will need to be delayed. That would be the first step of the process. If I had to guess, the delay would be until either December 31, 2017 or April 10, 2018.

Assuming there is a delay, I think that it would be a close call as to whether the rule would be killed or re-written. My gut feeling is that the fiduciary rule will be retained, but modified.

I say that for a few reasons. First, the fiduciary rule wasn’t the source of the greatest objections to the DOL’s guidance. Instead, that was the Best Interest Contract Exemption (BICE). Secondly, there is an argument that a rule that requires that retirement money be invested in the best interest of the investor is not, in and of itself, objectionable. In fact, many people may like that approach. Third, because of the ongoing retirement of baby boomers, many of whom are unsophisticated investors, and the rollover of their money to IRAs, there may be a perceived need to protect retirees.

On the other hand, the contrary arguments are that (1) the current system is working well and doesn’t need to be changed (and that therefore additional regulation would increase costs, without a corresponding benefit); and (2) the regulation of securities transactions should be in the hands of the Securities and Exchange Commission (SEC), and not the DOL. (One weakness with that latter argument is that insurance products, such as fixed rate annuities and fixed indexed annuities, are also sold to plans and IRAs, and the SEC doesn’t have the jurisdiction to regulate those products.)

If the SEC were to take the leadership in defining the fiduciary duty of care, there would be a uniform fiduciary definition that would apply to plans, IRAs and “non-qualified” accounts. While the conflict of interest rules for fiduciary advice to non-qualified accounts could be handled largely through disclosure, that is not the case for retirement plans and IRAs, because of the prohibited transaction rules in ERISA and the Internal Revenue Code.

To contemplate a worst case scenario, the SEC could develop a uniform fiduciary standard of care, but fiduciary advice and recommendations that involve conflicts of interest will still be prohibited by ERISA and the Internal Revenue Code. In that case, the Best Interest Contract Exemption would be revoked, and there would not be any generally available exemption for commissions, 12b-1 fees, etc. Obviously, that won’t work. As a result, BICE can’t just be withdrawn. It needs to be improved. (Of course, Congress could pass a bill that would create an exemption based on disclosures alone, but that would take time. Also, the regulatory process, with input from comments and meetings between the private sector and the regulators, is better at producing detailed guidance.)

So, while the outcome is not predictable, my “best guess” is that we will end up with a rule similar to the DOL’s fiduciary standard of care and that there will be modified exemptions that are based more on disclosures and less on prohibitions.

Stay tuned.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Share

Interesting Angles on the DOL’s Fiduciary Rule #28


BICE, DOL, fiduciary, prudent

What About Rollovers that Aren’t Recommended?

This is my twenty-eighth 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.

Under the DOL’s fiduciary regulation, the recommendation of a plan distribution and IRA rollover will be fiduciary advice, subject to the best interest standard of care and the prohibited transaction rules. But, what if a participant takes a distribution and rolls over into an IRA with an adviser . . . without a recommendation by the adviser?

As background, there are three ways that a participant can make a decision to take a distribution and roll over into an IRA. The first is “unsolicited.” In other words, the participant made the decision without any input from an adviser or recordkeeper. The second is “educated.” Distribution education involves providing a participant with information about the participant’s alternatives and the important considerations for selecting among the alternatives. The information must be unbiased and substantially complete. It cannot provide guidance to a participant to make a particular decision. The third way is “recommendation.” In the case of a recommendation, the adviser must engage in a prudent process to evaluate the relevant factors and to reach a reasoned recommendation in the best interest of the participant.

Without much fanfare, the DOL explained the “unsolicited” alternative in Q4 of the FAQs. The question posed by the DOL was: “Is compliance with the BIC exemption required as a condition of executing a transaction, such as a rollover, at the direction of a client in the absence of an investment recommendation?”

The DOL answered: “No. In the absence of an investment recommendation, the rule does not treat individuals or firms as investment advice fiduciaries merely because they execute transactions at the customer’s direction.”

But, the DOL goes on to admonish: “If, however, the firm or adviser does make a recommendation concerning a rollover or investment transaction and receives compensation in connection with or as a result of that recommendation, it would be a fiduciary and would need to rely on an exemption.”

In other words, fiduciary status is tied to a recommendation by an adviser. Absent an adviser recommendation, a decision made by a participant is not regulated by the fiduciary and prohibited transaction rules.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

 

Share

Interesting Angles on the DOL’s Fiduciary Rule #27


408(b)(2), BICE, DOL, registered investment advisers

The Definition of Compensation

This is my twenty-seventh article about interesting observations concerning the fiduciary rule and exemptions.

As the readers of these articles know, one impact of the new fiduciary rule is that compensation paid to Financial Institutions and advisers must be reasonable. Reasonable, in turn, is a function of a transparent and competitive marketplace. However, where the competitive market does not work (for example, where compensation is not transparent), customary compensation may not be reasonable.

But, this article is not about reasonable compensation. Instead, the question is, what is “compensation?”

The Department of Labor partially answered that question in the fiduciary regulation:

“The term ‘fee or other compensation, direct or indirect’ means . . . any explicit fee or compensation for the advice received by the person (or by an affiliate) from any source, and any other fee or compensation received from any source in connection with or as a result of the purchase or sale of a security or the provision of investment advice services, including, though not limited to, commissions, loads, finder’s fees, revenue sharing payments, shareholder servicing fees, marketing or distribution fees, underwriting compensation, payments to brokerage firms in return for shelf space, recruitment compensation paid in connection with transfers of accounts to a registered representative’s new broker-dealer firm, gifts and gratuities, and expense reimbursements.

A fee or compensation is paid ‘in connection with or as a result of’ such transaction or service if the fee or compensation would not have been paid but for the transaction or service or if eligibility for or the amount of the fee or compensation is based in whole or in part on the transaction or service.”

Without getting into the details of that definition, suffice it to say that, if an adviser makes a recommendation and receives money (or credits toward compensation, e.g., a bonus or a grid), that would be considered to be compensation. This concept is referred to as the “but for” test. That is, “but for” the recommendation, would the adviser have received the compensation or have been entitled to greater compensation? The “but for” method is a long-standing approach used by the Department of Labor in evaluating whether a payment is compensatory.

But, what if the payment is not monetary? What if it is non-cash, for example, gifts or trips or conference sponsorships or services? In addition to the quoted language above, the question was clearly answered in the 408(b)(2) regulation. That regulation defined compensation as:

“Compensation is anything of monetary value (for example, money, gifts, awards, and trips), . . .”

In addition, the Best Interest Contract Exemption defines third party payments as including “fees for seminars and educational programs; and any other compensation, consideration or financial benefit.”

In other words, the definition of “compensation” is not limited to cash or similar payments. Instead, it includes any item of monetary value that directly or indirectly, partially or entirely, results from recommendations of investments or insurance or that is payment for advice.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Share

Interesting Angles on the DOL’s Fiduciary Rule #26


BICE, broker-dealers, DOL, fiduciary, prohibited transaction, service providers

Reasonable Compensation for IRAs: When and How Long?

This is my twenty-sixth article about interesting observations concerning the fiduciary rule and exemptions.

This article is a little different than most of my previous posts. However, it is equally as important. To get to the point, I am writing this article about reasonable compensation for advice to IRAs because of a common misunderstanding about the requirement.

In the last month or two, I have seen a number of articles and heard several comments to the effect that it will be difficult to determine reasonable compensation for IRAs because the rule is so new. Stated a little differently, the point is that the reasonable compensation requirement for IRAs will first become effective on April 10, 2017. That is not correct.

Section 4975(c)(1)(C) provides that the “furnishing of . . . services . . . between a plan and a disqualified person” is a prohibited transaction. However, section 4975(d)(2) permits, as an exception to that general prohibition, “any contract, or reasonable arrangement, made with a disqualified person for . . . services necessary for the establishment or operation of a plan, if no more than reasonable compensation is paid therefor.” (Section 4975(e)(2) defines a “disqualified” person as “a person providing services to the plan.” Then, 4975(e)(1)(B) defines a “plan” as “an individual retirement account.” And, (C) includes “an individual retirement annuity.”)

In other words, the reasonable compensation limitation is not new. It’s been with us for decades.

But, if that’s the case, why hasn’t there been more discussion and, in the bigger picture, more enforcement of the rule? There are two reasons. The first is that, by and large, the rule has been ignored. How is that possible? That’s because only the Internal Revenue Service can enforce the rule, but it hasn’t. In this case, the 15% excise tax under section 4975 would be enforced against the service provider, that is, the adviser. But, if the rule has been in effect for years without much publicity, why is there so much discussion now?

The answer is that the Department of Labor has, in conjunction with the fiduciary rule, issued two exemptions—84-24 for life insurance policies and fixed rate annuities, and the Best Interest Contract Exemption (BICE) for any and all investments that can be sold to plans and IRAs. Both of those exemptions—which are needed where prohibited compensation results from the investment or insurance recommendation—limit the adviser’s compensation for recommended investments and insurance products to be no more than a reasonable amount. In the case of BICE, for example, the Financial Institution (e.g., the broker-dealer) must agree that its compensation and the adviser’s compensation for their services will not exceed a reasonable amount. IRA and plan investors will be able to pursue breach of contract claims for excess compensation.

So, while the law limiting the compensation of advisers (and Financial Institutions) is not new, the enforcement mechanism will be.

While the new rules seem burdensome, I believe that a variety of services will be developed to assist Financial Institutions in determining reasonable compensation for different levels of services related to different types of products.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Share

Interesting Angles on the DOL’s Fiduciary Rule #25


BICE, DOL, fiduciary, prudent

Reasonable Compensation Versus Neutral Factors

This is my twenty-fifth article covering interesting observations about the fiduciary rule and exemptions.

In my last post, I wrote about the Best Interest Contract Exemption (BICE) and the requirements for “neutral factors” and “differential compensation” between “reasonably designed investment categories.” As I pointed out, the purpose of neutral factors is to determine the relationship of compensation between different categories of investments and services. In other words, neutral factors don’t establish a dollar amount of compensation, but instead they are used for determining the relative compensation between different reasonably designed investment categories. Think of it as evaluating degree of difficulty in terms of work, complexity, value, etc.

But that begs the question, if neutral factors are used to establish the ratio of compensation, how is the compensation determined?

The best way to approach that question is to look at a single reasonably designed investment category. Within an investment category, the compensation of an adviser must be both reasonable and level. Stated slightly differently, the compensation of the adviser cannot exceed a reasonable amount (based on the services rendered) and the adviser’s compensation must be level regardless of which products are recommended . . . and regardless of the payments made to the adviser’s supervisory entity (e.g., broker-dealer or any affiliate or related party). For example, if the compensation paid to the individual adviser is 1% per year for providing non-discretionary investment advice on a portfolio of mutual funds, that compensation needs to be tested for reasonableness and needs to be level regardless of which mutual funds are recommended and regardless of the payments, if any, to the adviser’s broker-dealer (or any affiliated or related party).

“Level” is fairly easy to grasp. In my example, a level fee is 1% regardless of which mutual funds are recommended. “Reasonable” is a bit more difficult. As explained in prior posts, the DOL says that reasonable compensation is based on market data—in an open, transparent and competitive market. The easiest way to obtain that information is through a benchmarking service. It is important, though, to review the reasonableness of compensation at least every two or three years. The experience of advisers in the 401(k) world is that, as the marketplace has matured, the level of reasonable compensation has become lower and lower.

Also, advisers should be aware that, when a prohibited transaction exemption—such as BICE—is being used, the burden of proof is on the person claiming the exemption, that is, the adviser. So, you need to have information in your file that supports the reasonableness of your compensation.

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.

 

Share

Interesting Angles on the DOL’s Fiduciary Rule #24


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

The Meaning of Differential Compensation Based on Neutral Factors

This is my twenty-fourth article covering interesting observations about the fiduciary rule and exemptions.

The DOL’s fiduciary “package” consists of a regulation that expands the definition of advice and exemptions, or exceptions, from the prohibited transaction (PT) rules. If a recommendation by a fiduciary adviser does not constitute a PT (e.g., does not affect the adviser’s compensation, or that of an affiliate, and does not cause a payment from a third party), no exemption is needed. However, if the fiduciary recommendation causes a PT, an exemption must be used – and most often that will be BICE – the Best Interest Contract Exemption. Therein lies the rub . . . the compensation of the financial institution (e.g., the broker-dealer) and the adviser are regulated by BICE.

Under BICE, the compensation of broker-dealers can be “variable,” but must be “reasonable.” In other words, a broker-dealer can receive different payments from different product providers (e.g., mutual funds), so long as the total compensation received by the broker-dealer is reasonable relative to the services provided to the particular plan, participant or IRA owner.

The rules for compensating advisers are similar because the compensation of the adviser also must be reasonable (relative to the services that the adviser is providing to the plan, participant or IRA owner in the first year and in succeeding years). But, from that point on, the rules are different.

The starting point for understanding the other rules for adviser compensation is to determine “reasonably designed investment categories.” A reasonably designed investment category is an investment product or service that, when properly analyzed, should produce a certain level of compensation for the adviser’s services. For example, non-discretionary investment advice about mutual funds probably involves a different set of services and complexity than investment advice about individual variable annuities. In that sense, each could be called a reasonably designed investment category.

The next step is to understand that, within a particular investment category, the adviser’s compensation must be level. For example, where an adviser is providing non-discretionary advisory services concerning mutual funds, the adviser’s compensation must be level regardless of which mutual funds are recommended or how much those mutual funds pay the broker-dealer. In that way, the adviser will be “financially agnostic” as to which funds are recommended and will, at least in theory, only be interested in recommending the funds that are the best for the qualified investor (e.g., reasonable priced and of good quality). Similarly, if another investment category covers individual variable annuities, the adviser will be paid the same regardless of the particular annuity contract, insurance company, or imbedded mutual funds. That is, the adviser’s compensation will be the same across all variable annuity contracts, regardless of which one is recommended.

But, what if some categories require more work or services than other categories? For example, what if it takes more work to recommend and service an individual variable annuity than to provide non-discretionary investment advice about mutual funds? In that case, the Department of Labor says that it is permissible to pay differential compensation among reasonably designed investment categories, so long as the differences are based on neutral factors. So, for example, if the amount of work, the complexity of the product, and so on, means that the services for a variable annuity are twice as valuable, the adviser could earn twice as much for recommending an individual variable annuity and assisting with the selection of the embedded investments. On the other hand, if the services for the variable annuity were only 50% more difficult each year thereafter, then the adviser could be compensated 50% more than the annual fee that could be paid for a qualified account with mutual funds.

The key to understanding these concepts is to realize that the “neutral factors” differential compensation is not a dollar amount. Instead, it is a ratio established, for both the first and each subsequent year, between the different categories of investments. Where the relative compensation to the adviser for different reasonably designed investment categories could vary according to those ratios, compensation must still be reasonable.

So, as described in this article, an individual adviser’s compensation must be “reasonable,” “level” within an investment category, and “neutral” in differences between investment categories.

It is going to be difficult and time-consuming for the financial services community to adjust to these changes. And, the deadline is April 10 (with an extension for some purposes until January 1, 2018).

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Share

Interesting Angles on the DOL’s Fiduciary Rule #23


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

This is my twenty-third article about interesting observations concerning the fiduciary rule and exemptions.

When the definition of fiduciary advice is expanded on April 10, 2017, the investment and insurance recommendations of a much larger group of advisers will be classified as fiduciary advice and will, as a result, increase the focus on financial conflicts of interest (which ERISA and the Internal Revenue Code refer to as “prohibited transactions,” or PTs). My suspicion is that, for most ERISA retirement plans, there will not be a great impact on advisers—because, to a large degree, advisers to retirement plans already are acknowledged fiduciaries. (To be fair, though, there will be some impact . . . particularly on smaller plans, where some insurance companies and broker-dealers have, in the past, taken the position that their advisers are not fiduciaries. Nonetheless, based on my recent experience in working with broker-dealers, the adjustments are being made without a great deal of difficulty.)

On the other hand, the impact on advisers’ practices with IRAs will be significant. That is particularly true of investment and insurance services provided by broker-dealers. But, it is also true, to a lesser degree, of the services provided by RIAs. (Note: This article does not discuss recommendations to participants to take distributions and roll over to IRAs or recommendations to IRA owners to transfer their IRAs. Significant changes will be required for both RIAs and broker-dealers for those recommendations.)

One of the biggest changes—because of the fiduciary prohibited transaction rules—is that advisers will no longer be able to make recommendations that can affect the level of their compensation. An obvious example is that an adviser could not recommend a proprietary mutual fund (managed by an affiliate) without committing a prohibited transaction. That’s because a recommendation cannot increase the compensation of the adviser, his supervisory entity (e.g., a broker-dealer), or any affiliated or related party. Another example is that a financial adviser with a broker-dealer could not recommend that an IRA invest in mutual funds which pay different levels of 12b-1 fees to the broker-dealer and, indirectly, to the adviser. In effect, the adviser would be setting his own compensation (as well as the compensation of the supervisory entity). Similar issues exist for referral fees, revenue sharing, and so on. In all of those cases, the broker-dealer will need to either move to a level fee environment or to satisfy one of the prohibited transaction exemptions (most likely BICE—the Best Interest Contract Exemption).

Similar issues exist for RIAs. For example, we have seen cases where RIAs recommend proprietary products (e.g., affiliated mutual funds). That is a prohibited transaction. Another example of an RIA prohibited transaction is where the adviser recommends an allocation to fixed income and an allocation to equities, but then charges a higher fee for managing the equities. By virtue of recommending the allocations, the adviser has determined the level of its compensation . . . and, therefore, has committed a prohibited transaction.

The moral of this story is that broker-dealers and RIAs need to closely review their investment practices for qualified money. (“Qualified” money is the new terminology for money in IRAs or plans. It is an easy reference to the types of accounts that are subject to the new rules.) Since virtually all investment and insurance advice to IRAs and plans (including recommendations about distributions, withdrawals and transfers) will become fiduciary advice on April 10, 2017, two steps should be taken. First, if they don’t already exist, processes need to be put in place so that any advice satisfies the prudent person requirement. Generally speaking, that process should result in portfolio investing. Second, all payments for the advice (including indirect and non-cash compensation, whether to the adviser, the supervisory entity or any affiliates or related parties) needs to be examined. Once these rules are applicable, the compensation arrangements will need to satisfy the prohibited transaction rules in section 406(b)(1) and (3) of ERISA and the corresponding provisions in section 4975 of the Internal Revenue Code. Or, in the alternative, the condition of a prohibited transaction exemption must be satisfied.

And, all of that needs to be done by April 10, 2017.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Share

Interesting Angles on the DOL’s Fiduciary Rule #22


BICE, DOL, fiduciary, prohibited transaction

This is my twenty-second article about interesting observations concerning the fiduciary rule and exemptions.

While the application of the new fiduciary rule and prohibited transaction exemptions to broker dealers and investment advisers is fairly obvious — if not fully understood, there has been little in the way of discussion about its application to banks. This post highlights some of those issues.

In a prior Angles article, I talked about how the fiduciary rule applies to referrals of advisers and how the prohibited transaction rules impact solicitors’ fees (see Angles No. 12). There is a similar issue for banks. For example, it appears to be a fairly common practice for employees at bank branches to recommend that customers set up IRAs and put the money into certificates of deposit, and for the bank employees to receive bonuses for the IRAs investments in the CDs (or, alternatively, to receive credits towards bonuses based on a variety of factors, including the IRA investments). Based on the wording of the new fiduciary rule, if a bank employee recommends that an IRA invest in a certificate of deposit, and is compensated directly or indirectly for that recommendation, it is a fiduciary act for compensation. (The bonus, or bonus credit, is the compensation.) Since the bank employee is being paid compensation that is not stated and level, the payment is a prohibited transaction. That means that an exemption is needed. (There are differing opinions within the banking community about whether a bank deposit exemption is available. The specific issue is whether the bank deposit exemption covers the payment to the employee.)

To complicate matters, what if the bank customer is retiring and asks about rolling over his 401(k) account? If the bank employee recommends a rollover, that would be fiduciary advice under ERISA. As such, the bank and its employee would need to develop the recommendation through a prudent process, considering at the least the investments, services and expenses in the plan and the proposed IRA. In addition, the recommendation could be a prohibited transaction, and an exemption would be needed.

The story doesn’t end there. Similar referral and compensation arrangements also exist for referrals to a bank’s trust department, affiliated investment adviser and affiliated broker-dealer. While the Best Interest Contract Exemption is generally available for compensation for these types of referrals, it may be difficult for banks to comply, since the cost and effort of BICE compliance can be significant, but the amounts paid under these referral arrangements are, at least for each individual referral, relatively small.

As we continue working with clients on compliance issues for the new rules, it is becoming increasingly clear that there are a significant number of unanticipated consequences.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Share

Interesting Angles on the DOL’s Fiduciary Rule #21


BICE, DOL, fiduciary, prudent

This is my twenty-first article covering interesting observations about the fiduciary rule and exemptions.

While most of the requirements in the new fiduciary rule and exemptions are “old news” for retirement plan advisers, they may require significant changes for advisers to IRAs. For example, ERISA’s prudent man rule and the new best interest standard of care both require that fiduciary advisers (which will include virtually all advisers to plans, participants and IRA owners when the rules are applicable on April 10, 2017) engage in a prudent process to develop recommendations. Using variable annuities as an example, here are some of the important steps in a prudent process: evaluating whether the insurance company will be able to satisfy its commitments in the future (based on today’s information); a determination of whether the expenses for the variable annuity contract, including expenses of the underlying mutual funds, are reasonable; and determining what portion of an investor’s financial assets should be allocated to the annuity. To do that job, fiduciary advisers will need to gather the information necessary to make an appropriate recommendation and then prudently evaluate that information. Stated slightly differently, there is a duty to investigate. The DOL described that responsibility in the preamble to the best interest contract exemption (BICE):

This is not to suggest that the ERISA section 404 prudence standard or Best Interest standard, are solely procedural standards. Thus, the prudence standard, as incorporated in the Best Interest standard, is an objective standard of care that requires investment advice fiduciaries to investigate and evaluate investments, make recommendations, and exercise sound judgment in the same way that knowledgeable and impartial professionals would.

Here are two more thoughts on that. First, the DOL has historically taken the position that a prudent process for advice to retirement plans must be documented. That could easily be extended to advice to IRAs as well. In fact, there is a specific documentation retention requirement under BICE. Second, there is an argument that, if a fiduciary adviser cannot obtain – through the investigation – enough information to formulate a prudent recommendation, the adviser needs to abstain from making a recommendation. One obvious example is where an adviser is developing a recommendation to a participant to take a distribution and roll it over into an IRA. In that situation, BICE specifically requires that the adviser consider the investments, expenses and services in the plan, and then compare them to the investments, expenses and services in the proposed IRA. The best interest analysis must be documented by the adviser. If the adviser cannot obtain adequate information about the investments, expenses and/or services in the plan, it would be difficult, if not impossible, to make and document that analysis.

As I said earlier in this article, for a retirement plan perspective, this is not a new requirement. Instead, these are long standing rules. However, for IRAs the fiduciary guidance will, in many cases, require changes in processes and practices. Since IRAs are smaller than plans, and therefore can’t afford to pay as much money for services, advisers and their supervisory entities need to develop efficient processes for gathering information and performing the analysis. I suspect this will lead to new programs and computer-based systems.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Share

Interesting Angles on the DOL’s Fiduciary Rule #20


DOL, fiduciary, prudent

As I discussed in an earlier post (Angles #7), the Best Interest Standard of Care has three parts: The prudent man rule; a requirement for individualization; and a duty of loyalty. Notice that none of the three parts requires that the “best” investment be recommended

Because of concerns that the fiduciary rule might be interpreted to require that a “best” investment requirement would apply, the Department of Labor explained in the preamble to the fiduciary regulation that:

In response to commenter concerns, the Department also confirms that the Best Interest standard does not impose an unattainable obligation on Advisers and Financial Institutions to somehow identify the single ‘‘best’’ investment for the Retirement Investor out of all the investments in the national or international marketplace, assuming such advice were even possible. 

So, if you ever had any doubts, it should be clear now that the “Best” Interest Standard of Care is just a label (but a label which, at some level, resonates politically).

If the requirement isn’t that the best investment be recommended, what is it? The answer is that it’s the same standard that advisers have used for about 40 years in recommending investments to ERISA-governed, tax-qualified retirement plans. In other words, it’s been around for a long time and many advisers have survived and thrived under that standard. As the DOL explained in the guidance:

The Best Interest standard . . . is intended to effectively incorporate the objective standards of care and undivided loyalty that have been applied under ERISA for more than 40 years.

But, the duty of prudence should not be confused with the suitability standard. While unsuitable recommendations will not be prudent, it does not necessarily mean that suitable recommendations will be prudent. As the DOL explained:

The Department has not specifically incorporated the suitability obligation as an element of the Best Interest standard, as suggested by FINRA but many aspects of suitability are also elements of the Best Interest standard. An investment recommendation that is not suitable under the securities laws would not meet the Best Interest standard.

As a result, advisers who have not worked with retirement plans under ERISA’s prudent man rule should consider education about the processes required for compliance with the fiduciary standard.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

Share