Interesting Angles on the DOL’s Fiduciary Rule #9


DOL, fiduciary, prudent

This is my ninth article about interesting observations “hidden” in the fiduciary regulation and the exemptions.

As I explained in an earlier post, there are three parts to the best interest standard . . .

  • Prudence: “. . . the fiduciary acts with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, . . .”
  • Individualization: “. . . based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor, . . .”
  • Loyalty: “. . . without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.”

The question for this “angles” article is, what is the difference between the prudence part of the Best Interest standard and the prudent man rule in ERISA?

Easy . . . one word. “Man” in ERISA was changed to “person” in the Best Interest standard. So, the prudent man rule has become the prudent person rule. It’s more modern and politically correct.

But, other than that, it is verbatim the same. That means that we have over 40 years of history of DOL guidance and fiduciary litigation to consider in applying the prudent person rule to IRA and rollover recommendations. Think in terms of generally accepted investment theories, (e.g., modern portfolio theory); reasonable costs; compensation that is consistent with services, not products. In terms of its impact, think of transparency, fee and expense compression, and competition.

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Interesting Angles on the DOL’s Fiduciary Rule #8


DOL, fiduciary, General, plan sponsors

This is my eighth article about interesting observations “hidden” in the fiduciary regulation and the exemptions.

The final regulation on fiduciary advice continues, as education, the current practice of providing participants with asset allocation models that are populated with a plan’s designated investment alternatives (DIAs).

However, the rule imposes a burden on plan sponsors to monitor those models and which DIAs are used for the models. The fiduciary focus should be on the costs and payments from investments to providers and advisers. The preamble says:

 “In this connection, it is important to emphasize that a responsible plan fiduciary would also have, as part of the ERISA obligation to monitor plan service providers, an obligation to evaluate and periodically monitor the asset allocation model and interactive materials being made available to the plan participants and beneficiaries as part of any education program.

That evaluation should include an evaluation of whether the models and materials are in fact unbiased and not designed to influence investment decisions towards particular investments that result in higher fees or compensation being paid to parties that provide investments or investment-related services to the plan.”

Who will help plan sponsors satisfy that fiduciary duty?

Most plan sponsors won’t know about this duty. Even if they become aware of the responsibility, they probably won’t know how to evaluate if the “education” models are disguised vehicles for generating management fees for proprietary products or more revenues for advisers or their financial institutions.

This looks like an opportunity for high quality advisers to provide a valuable service to plan sponsors.

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Interesting Angles on the DOL’s Fiduciary Rule #7


DOL, fiduciary, prudent

This is my seventh article about interesting observations “hidden” in the fiduciary regulation and the exemptions.

There are three parts to the best interest standard . . .

  • The prudent person rule.
  • Individualization to the retirement investor’s circumstances.
  • The duty of loyalty.

See the three parts below. Interestingly, none of the parts uses the word “best.” In other words, “best interest” is just a label; the real requirements are prudence and loyalty.

  • Prudence: “. . . the fiduciary acts with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, . . .”
  • Individualization: “. . . based on the investment objectives, risk tolerance, financial circumstances, and needs of the retirement investor, . . .”
  • Loyalty: “. . . without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.”

Moral of the story: Don’t let the label confuse you. There isn’t any requirement to pick the best investment . . . if such a thing exists. It’s just old-fashioned prudence and loyalty. The result is that investment advice to IRAs will often look like investment advice to 401(k) participants: good quality investments, appropriate asset allocation and diversification, and reasonable costs.

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Interesting Angles on the DOL’s Fiduciary Rule #6


DOL, fiduciary, General, prohibited transaction, prudent

This is my sixth article about interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.

In some cases, the concerns about the scope of the fiduciary rule are overblown. For example, there have been some statements that advice about minimum required distributions for IRAs would be fiduciary advice. That is not the case.

In the preamble to the fiduciary regulation, the DOL explained:

“With respect to the tax code provisions regarding required minimum distributions, the Department agrees with commenters that merely advising a participant or IRA owner that certain distributions are required by tax law would not constitute investment advice. Whether such “tax” advice is accompanied by a recommendation that constitutes “investment advice” would depend on the particular facts and circumstances involved.”

So, basic advice about tax requirements and consequences is not fiduciary advice. However, if the adviser recommends which investments the IRA owner should sell to fund the distribution, that is fiduciary investment advice which must be:

  • prudent and in the best interest of the IRA owner, and
  • free from financial conflicts of interest (or in compliance with a prohibited transaction exemption).
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Interesting Angles on the DOL’s Fiduciary Rule #5


BICE, DOL, fiduciary

This is my fifth article about interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.

The Best Interest Contract Exemption (BICE) has a special exemption for “level fee fiduciaries” who recommend to plan participants that they take distributions and rollover to an IRA advised by the fiduciary adviser. (A level fee fiduciary is an adviser who receives only an advisory fee. That is, neither the adviser, nor his supervisory entity [nor any affiliate or related party] can receive any additional compensation, e.g., revenue sharing or management fees for affiliate products.)

There are several requirements, but perhaps the most difficult is the “best interest” documentation:

“In the case of a recommendation to roll over from an ERISA Plan to an IRA, the Financial Institution [e.g., the RIA firm] documents the specific reason or reasons why the recommendation was considered to be in the Best Interest of the Retirement Investor. This documentation must include consideration of the Retirement Investor’s alternatives to a rollover, including leaving the money in his or her current employer’s Plan, if permitted, and must take into account the fees and expenses associated with both the Plan and the IRA; whether the employer pays for some or all of the plan’s administrative expenses; and the different levels of services and investments available under each option; . . .”

Where the fiduciary adviser is already working with the plan, this requirement appears to be manageable. However, it will likely be difficult for an adviser who does not have a relationship with the plan.

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Interesting Angles on the DOL’s Fiduciary Rule #4


DOL, fiduciary, prudent

This is my fourth article about interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.

During a recent webinar for TD Ameritrade, one of the attendees asked if Jim Cramer’s TV stock tips would be considered fiduciary advice. I said that they would not be, since they were not directed to a specific investor.

In hindsight, I wish that I had told him that the preamble to the fiduciary regulation specifically addressed that issue . . . more specifically than you might think. Here’s what the DOL said:

“Many commenters, as the Department noted above, expressed concern about the phrase ‘‘specifically directed’’ in the proposal under paragraph (a)(2)(ii) and asked that the Department clarify the application of the final rule to certain communications including casual conversations with clients about an investment, distribution, or rollovers; responding to participant inquiries about their investment options; ordinary sales activities; providing research reports; sample fund menus; and other similar support activities. For example, they were concerned about communications made in newsletters, media commentary, or remarks directed to no one in particular. Commenters specifically raised the issue of whether on-air personalities like Dave Ramsey, Jim Cramer, or Suze Orman would be treated as fiduciary investment advisers based on their broadcast communications. The concern is unfounded. With respect to media personalities, the rule is focused on ensuring that paid investment professionals make recommendations that are in the best interest of retirement investors, not on regulating journalism or the entertainment industry.”

 

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Interesting Angles on the DOL’s Fiduciary Rule #3


BICE, broker-dealers, DOL

This is my third article about the interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.

Under the Best Interest Contract Exemption (BICE), the “financial institution” (e.g., a broker-dealer) cannot pay a fiduciary adviser (e.g., a financial adviser) incentive compensation that would encourage an adviser to make investment or insurance recommendations that are not in the best interest of a retirement investor. Needless to say, that requirement is highly disruptive to broker-dealers and insurance companies, since they often compensate advisers through commission payments (which are, by definition, incentive compensation).

But, the DOL’s concern about the impact of incentive compensation goes beyond payments to advisers. In the preamble to BICE, the DOL says the following about payments to managers and supervisors:

“As noted above, Financial Institutions also must pay attention to the incentives of branch managers and supervisors, and how the incentives potentially impact Adviser recommendations. Certainly, Financial Institutions must not provide incentives to branch managers or other supervisors that are intended to, or would reasonably be expected to cause such entities, in turn, to incentivize Advisers to make recommendations that do not meet the Best Interest standard. Financial Institutions, therefore, should not compensate branch managers and other supervisors, or award bonuses or trips to such entities based on sales of certain investments, if such awards could not be made directly to Advisers under the standards set forth in this exemption.”

As this indicates, the new rules will impact almost every aspect of the sales of investments and insurance products to plans . . . and especially to IRAs.

 

 

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Interesting Angles on the DOL’s Fiduciary Rule #2


BICE, DOL, prudent

This is my second article about the interesting observations “hidden” in the preambles to the fiduciary regulation and the exemptions.

The recommendation of investments and insurance products to plans, participants, and IRAs will be subject to the best interest standard of care. (The best interest standard is a combination of ERISA’s prudent man rule and duty of loyalty.)

The legal requirement that advisers make prudent recommendations and act with a duty of loyalty is well understood in the retirement plan world, but is new to IRAs.

Also, it’s commonly conceded that the prudent man rule is more demanding than the suitability standard. But that begs the question, what is required of the adviser?

The DOL answered that question in the context of fixed indexed annuities, and the answer may be surprising. (For other insurance products and investments, the DOL would likely say that a similarly rigorous approach is required.)

Here’s what the DOL said:

“Assessing the prudence of a particular indexed annuity requires an understanding of surrender terms and charges; interest rate caps; the particular market index or indexes to which the annuity is linked; the scope of any downside risk; associated administrative and other charges; the insurer’s authority to revise terms and charges over the life of the investment; and the specific methodology used to compute the index-linked interest rate and any optional benefits that may be offered, such as living benefits and death benefits. In operation, the index-linked interest rate can be affected by participation rates; spread margin or asset fees; interest rate caps; the particular method for determining the change in the relevant index over the annuity’s period (annual, high water mark, or point-to-point); and the method for calculating interest earned during the annuity’s term (e.g., simple or compounded interest).”

Actually, there’s more than that. For example, based on ERISA precedence, an adviser would also need to evaluate the financial stability of the insurance company and its ability to make the annuity payments (e.g., 20 or 30 years from now).

 

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Interesting Angles on the DOL’s Fiduciary Rule #1


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

While you have probably read articles that summarize the DOL’s final fiduciary rule and exemptions—and perhaps even articles that discuss specific aspects of the rules, there are a number of interesting observations “hidden” in the preambles to the regulation and exemptions.

In many cases, those comments are so focused on limited issues or complex that they are beyond the scope of the initial articles, speeches and webcasts. As a result, I will be writing several articles about those “nuggets.” This is the first of those articles.

In the preamble to the Best Interest Contract Exemption (BICE), the DOL noted that a fiduciary adviser and his or her financial institution (e.g., RIA firm or broker-dealer) could contractually limit the duty to monitor. But then the DOL went on to say:

“Further, when determining the extent of the monitoring to be provided, as disclosed in the contract pursuant to Section II(e) of the exemption, such Financial Institutions should carefully consider whether certain investments can be prudently recommended to the individual Retirement Investor, in the first place, without a mechanism in place for the ongoing monitoring of the investment. This is particularly a concern with respect to investments that possess unusual complexity and risk, and that are likely to require further guidance to protect the investor’s interests. Without an accompanying agreement to monitor certain recommended investments, or at least a recommendation that the Retirement Investor arrange for ongoing monitoring, the Adviser may be unable to satisfy the exemption’s Best Interest obligation with respect to such investments. Similarly, the added cost of monitoring such investments should be considered by the Adviser and Financial Institution in determining whether the recommended investments are in the Retirement Investor’s Best Interest.”

In other words, if an adviser isn’t going to have a duty to monitor the investments, don’t recommend investments that retirement investors lack the capacity to properly monitor.

It’s not clear where that line will ultimately be drawn – for example, does it refer to the particular investor or the average investor? As a result, some caution is warranted.

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Inside the Beltway Audiocast April 28, 2016


BICE, DOL

Please join Brad Campbell and me during the April 28, 2016 presentation of “Inside the Beltway,” at noon eastern/9 am pacific time. Inside the Beltway is a quarterly audiocast in which we discuss developments in Washington that directly impact our industry. During this sixteenth presentation of Inside the Beltway we will be discussing the DOL’s final fiduciary regulation and the 84-24 and BIC exemptions and their impact on advice to plans and IRAs, including recommendations to take distributions from plans or IRAs.

The audiocast is free, and will be recorded. There will be an opportunity to ask questions at the end of the session. Please register here if you’d like to listen live, or receive the recording later.

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