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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An Overview of the Fiduciary Rule


BICE, DOL, fiduciary, General, prohibited transaction

The DOL’s fiduciary rule has been published in the Federal Register. Based on our review of the regulation and conversations with our clients, here are some overview thoughts about the regulation and the two “distribution” exemptions (84-24 and BICE).

The Fiduciary Definition

The rule is much as expected. The definition of fiduciary advice continues to be very broad, capturing almost all common sales practices for investments and insurance products. It includes investment recommendations to plans, participants and IRA owners, as well as recommendations about distributions from plans and transfers and withdrawals of IRAs. All of those will be fiduciary activities.

As a result, those recommendations will be subject to the fiduciary standard when made to plans or participants, and subject to the Best Interest standard of care when made to IRA owners (if the adviser needs the prohibited transaction relief provided in BICE or 84-24).

Much of the conversation has been about the requirements of the exemptions. Because of that, we are concerned that the impact of the fiduciary and Best Interest standards of care has not been adequately considered. In our opinion, those standards of care will be more impactful than generally thought.

In both cases (that is, the prudent man rule and the Best Interest standard), the adviser’s recommendations will be measured by what a hypothetical prudent and knowledgeable investor would do. In other words, it is the standard of a hypothetical knowledgeable person, and not the standard of the actual adviser or the investor.

What were the most notable changes in the final regulation from the proposal?

  • The “applicability” date for the regulation was deferred until April 10, 2017. Most people thought that compliance would be required on January 1, 2017, so that gives the financial services sector an additional three months to comply with most of the requirements. (See the additional extension of time for certain BICE requirements below.)
  • Advisers will continue to be able to provide participant education for retirement plans, using asset allocation models (AAMs) that include specific designated investment alternatives. (“Designated investment alternatives” are those investments that are selected by the plan fiduciaries for participant direction in 401(k) or 403(b) plans. As a result, they must be prudently selected and monitored by the plan fiduciaries.)However, populated asset allocation models are not permitted as a part of investment education for IRA owners. In that case, AAMs that include the names of investments would be fiduciary investment advice.
  • Platform providers (that is, recordkeepers) will be allowed to provide additional assistance, within limits, to respond to requests for proposals and similar inquiries from plan sponsors.

When an adviser becomes a fiduciary, the adviser’s conduct is also governed by the fiduciary prohibited transaction rules in ERISA and the Internal Revenue Code. Generally speaking, those rules prohibit advisers (or their affiliates) from receiving payments from third parties (such as 12b-1 fees or insurance commissions) and from making investment recommendations that affect the levels of their compensation. Those transactions are literally prohibited. However, the DOL has issued prohibited transaction exemptions which, if their requirements are satisfied, would allow the receipt of those types of payments. There are two exemptions that could apply to fiduciary advisers to mid-sized plans, participants, and IRAs. Those are 84-24 and BICE, which are discussed below.

Prohibited Transaction Exemption (PTE) 84-24

The current version of 84-24 covers the sale of all insurance products by fiduciary advisers. The proposed amendment to the exemption would have continued to cover those sales to plans and IRAs, but would have transferred the sale of individual variable annuity contracts from the 84-24 exemption to BICE. That was a significant change, because 84-24 is generally viewed as less burdensome than BICE. As a result, many in the insurance industry urged the Department of Labor to return individual variable annuities to 84-24 when the final rules were issued.

But, that didn’t happen. In fact, sales of other types of insurance were moved from 84-24 to BICE.

Before getting into that, though, let’s look at the most important requirements of 84-24. Those are:

  • The adviser must acknowledge in writing that he is a fiduciary and must agree to adhere to the best interest standard of care. (As a practical matter, the best interest standard of care is a combination of ERISA’s prudent man rule and ERISA’s duty of loyalty. In other words, those concepts are being extended from ERISA to IRAs.)Think about the consequences of that. For example, the recommendation of a particular insurance company must be prudent and the recommendation of the particular insurance contract must also be prudent.
  • The adviser’s compensation must be no more than reasonable and the adviser cannot receive any additional financial incentives, for example, trips, awards, or bonuses.
  • The adviser’s statements cannot be materially misleading. The failure to describe a material conflict of interest is deemed to be misleading.
  • The adviser must disclose his compensation.
  • The 84-24 exemption also limits the commissions that can be paid to advisers to “reasonable” amounts. As a result, we believe that advisers who recommend or sell insurance and annuity contracts should obtain benchmarking information about similar sales and the commissions that are reasonable under those circumstances.
  • Before the sale is made, those disclosures must be delivered to the plan fiduciary or IRA owner in writing, and the fiduciary or IRA owner must acknowledge the disclosures and approve of the transaction in writing.

What are the most important changes in the final 84-24 exemption?

  • The types of insurance products covered by 84-24 were further limited. That is because group variable annuity contracts and fixed indexed annuities were transferred from 84-24 to BICE. As a result, 84-24 now covers only fixed rate annuities and insurance policies.
  • The compensation payable to advisers was expended from just commissions to include accruals of health benefits and retirement benefits, but other payments and benefits are prohibited.
  • The applicability date will be April 10, 2017. Many people thought that it would be January 1, 2017, so that allows another three months to develop compliant procedures and practices.

Best Interest Contract Exemption (BICE)

The most significant changes were made to the Best Interest Contract Exemption. The changes were so great that it is not possible to describe them in this short article. So, we will just mention a few. (But, we will be doing a separate article on BICE in the coming weeks.)

BICE provides an exemption for prohibited transactions resulting from recommendations of any investment or insurance products to plans or IRAs. (In that sense, it provides an alternative exemption for the insurance products within the scope of 84-24.)

Generally speaking, it requires a contract or similar writing that is signed by a financial institution and that is given to the investor. (The financial institution is the bank, insurance company, broker-dealer or RIA, who oversees the adviser.) The financial institution contractually agrees that it and the adviser will serve as fiduciaries and will adhere to the best interest standard of care. The financial institutional also must agree to disclose material conflicts of interest and represent that none of its statements are misleading. In addition, a host of other disclosures must be made.

What are the most noteworthy changes in the final BICE?

  • The final version of BICE requires a contract that is signed by the financial institution and an IRA owner. However, for plans, the financial institution can deliver a written disclosure, but it is not required that the plan fiduciaries sign a contract with the financial institution.
  • The contract and disclosures do not have to be delivered or signed at the time of the first conversation. Instead, that requirement can now be satisfied at point of sale.
  • The proposal had demanding disclosure requirements at point of sale and annually thereafter. Those disclosures were liberalized and can now be made with information that is more general, but which has to be clearly and conspicuously provided to the plans or IRA owners. The investor has the right to obtain detailed information on request.
  • The proposal had a website requirement that was difficult, and perhaps impossible, to satisfy. The final has a less burdensome website disclosure requirement.
  • The final version of BICE has simplified compliance procedures for level fee advisers who are (i) capturing distributions and rollovers from plans, (ii) recommending withdrawals or transfers of IRAs, or (iii) recommending transfers from commission-based accounts to fee-based accounts.
  • As finalized, BICE has provided greater relief for investment accounts that are already in existence at the time of the applicability date of the new rules. For example, an adviser can now make a hold recommendation without becoming subject to the prohibited transaction rules.
  • The applicability date has largely been deferred to January 1, 2018. However, some of the requirements become applicable on April 10, 2017. Those include, for example, the best interest standard of care and reasonable compensation limitation.
  • BICE requires that the compensation paid to the adviser, the financial institution, and affiliates be no more than reasonable. We believe that financial institutions (such as broker-dealers and insurance companies) will need to develop or obtain benchmarking information in order to evaluate the reasonableness of the compensation of their advisers. In due course, we suspect that benchmarking services will develop for sales to IRAs, much as they have already developed for advice to plans.
  • While the proposal excluded some assets (e.g., illiquid investments) from its relief, the final BICE is available for all types of investments.

Conclusion

The final rules will require structural changes for some financial services companies. For example, we believe that broker-dealers will be affected the most. Insurance companies will also need to make changes. At the other end of the spectrum, most RIAs will only need to make changes to adjust to the new rules regarding recommendations of distributions and rollovers from plans and withdrawals and transfers of IRAs.

Recordkeepers fall in between those two groups. Recordkeepers who have insurance companies or mutual fund manager affiliates will be impacted more than independent recordkeepers.

While not directly affected by the new rules, mutual fund management firms need to understand their impact, for example, the needs of broker-dealers in this new environment. Some broker-dealers may decide to shift many of their accounts to level fee advisory accounts. In that case, they may not be able to receive 12b-1 fees or other payments. Instead, they will likely want share classes that are specifically designed for advisory accounts. Those share classes could resemble a retail version of institutional shares.

At this point, though, it is impossible to know all of the repercussions. Stay tuned.

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Investment Advice to Plans Under the DOL’s Fiduciary Rules


broker-dealers, DOL, registered investment advisers

As I work with broker-dealers and RIA firms, certain patterns are developing in their efforts to satisfy the requirements of the DOL’s fiduciary rule and the exemptions.

This article looks at some of those “solutions” and comments on the areas where there is some agreement . . . or at least a majority opinion.

The DOL’s rule will, when finalized, regulate investment advice to plans and participants, investment advice to IRAs, and recommendations about distributions from plans and IRAs.

In this post, I look at the decision being made about advice to plans.

Interestingly, it appears that the changes will impact plans much less than IRAs and rollovers. The plan solutions fall into two categories. The first is that RIAs and broker-dealers will provide level-fee investment advice to plans. In some of those cases, a broker-dealer may need to act under its RIA registration. The level fee will be accomplished, by and large, either through expense recapture accounts or by payment from plan assets.

Note that, for purposes of this article, the words “level fee” actually refer to a “levelized” fee. For example, the broker-dealer or RIA could charge a flat fee (in terms of basis points or dollars) to the plan and be paid by the plan. Or, the broker-dealer or RIA could receive additional payments (for example, insurance commissions or 12b-1 fees) and either offset those against the flat fee or pay those amounts over into the plan. Both of those have the effect of “levelizing” compensation. But, it’s not enough to just do it. There needs to be an agreement to offset or pay over.

A second common solution is that advisers will be required to work with providers who have third-party 3(21) nondiscretionary and/or 3(38) discretionary investment advisers on their platforms. For example, representatives of a broker-dealer would be required to recommend that plan sponsors use the platform’s third-party fiduciary adviser to select and monitor the plan investments. In that way, an adviser and the broker-dealer will not be fiduciaries for purposes of selecting the investments. Note, though, that under the fiduciary rule, a recommendation of a fiduciary adviser (e.g., the 3(21) or 3(38) platform adviser) is, in its own right, fiduciary advice.

That’s a quick update for now. As this article suggests, these circumstances and decisions are evolving. So, keep tuned.

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More Thoughts on Distributions and Rollovers


DOL, fiduciary, prohibited transaction

After my last post, I was asked another question about distributions and rollovers under the DOL’s proposed fiduciary regulation. Here’s the question and my answer:

Question: One thing I have heard is that all IRA Rollovers will fall under the DOL ERISA fiduciary standards with this rule.  Have you heard that?  Or, would all IRA Rollovers be covered under the new fiduciary definition, but not necessarily be ERISA covered?

Answer:  That’s generally correct, but it’s more complicated than that.

For ERISA tax-qualified plans, under the new rules a recommendation to take a distribution from a plan will be fiduciary advice subject to the prudent man rule and a duty of loyalty to the participant. And, the process must comply with the fiduciary prohibited transaction rules. That means that a fiduciary adviser can’t earn more from the rollover IRA than the adviser was earning from the participant’s account in the plan (unless the adviser satisfies a prohibited transaction exemption).

However, a recommendation to a participant to take a distribution from a government plan would not be subject to these requirements, since government plans are not governed by ERISA.

On the other hand, a recommendation to an IRA owner to transfer or withdraw money from an IRA is subject to rules similar to those for ERISA plans. That’s because a recommendation to withdraw or transfer IRA money is fiduciary advice under the Internal Revenue Code, and if the adviser benefits financially from that recommendation, the adviser must satisfy one of the exemptions. The relevant exemptions impose the Best Interest standard of care (which is a combination of ERISA’s prudent man rule and duty of loyalty).

These are major changes. Almost all advisers will need to change their practices to adapt to the new rules.

 

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