The Fiduciary Exemption for Commissions


DOL, fiduciary

The hottest ERISA issue of 2015 is the DOL’s proposal to expand the definition of fiduciary advice. That proposal has become highly publicized because of the White House endorsement and the aggressive Wall Street opposition. Unfortunately, political rhetoric on both sides has dominated the discussion . . . to the detriment of thoughtful analysis. Hopefully, this brief article adds to the “thoughtful” side of the ledger.

The current fiduciary rule – and presumably the proposal — has three basic requirements: a fiduciary must act solely in the interest of the participants and beneficiaries; a fiduciary must act for the exclusive purpose of providing retirement benefits and paying only reasonable expenses; and a fiduciary must engage in a prudent process to make decisions. That’s pretty much it.

While some of the attention is on that standard of conduct, most of the opposition has been to the prohibited transaction rules that apply to fiduciaries. In other words, the greatest controversy isn’t over the fiduciary standard, but instead it is about the fiduciary prohibitions of certain conflicts of interest that apply to fiduciaries.

The most publicized of those prohibitions is that a fiduciary adviser must receive “level compensation,” so that the adviser is not, in effect, able to recommend investments that increase the adviser’s compensation. Obviously, that is a conflict of interest. However, under ERISA and the Internal Revenue Code, it is also a prohibited transaction. While, on the face of it, the prohibition seems reasonable, it has the practical effect of eliminating, or at least severely restricting, many well-established practices by broker-dealers and insurance brokers. In other words, it could be highly disruptive of common current practices.

The financial services industry has lobbied against that prohibition. The DOL is aware of their concerns and has, on the face of it, addressed them. In materials released about the fiduciary proposal, the White House said that it will include an explanation to:

“Preserve the ability of working and middle class families to choose different types of advice: The Department’s proposal will continue to allow private firms to set their own compensation practices by proposing a new type of exemption from limits on payments creating conflicts of interest that is more principles-based. This exemption will provide businesses with the flexibility to adopt practices that work for them and adapt those practices to changes we may not anticipate, while ensuring that they put their client’s best interest first and disclose any conflicts that may prevent them from doing so. This fulfills the Department’s public commitment to ensure that all common forms of compensation, such as commissions and revenue sharing, are still permitted, whether paid by the client or the investment firm.“

Unfortunately, it’s hard to tell if the proposed prohibited transaction “exemption” (that is, an exception to the prohibited transaction rules) will be reasonable. At first blush, it appears that the proposal will require more disclosure about compensation and conflicts of interest . . . and will also require that a fiduciary adviser act in the best interest of the participants. Of course, that’s difficult to measure . . . so the devil will be in the details, in the sense that we won’t know whether the exemption will be workable until we actually see it.

My best guess is that the Office of Management and Budget will release the proposed regulation and exemptions to the public somewhere between late April and mid-June. Other than that, we just have to wait and see.

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Did you know …About the Fiduciary Requirements for Selecting an Insurance Guarantee for your Participants?


fiduciary, prudent

Insurance guarantees for retirement benefits — such as annuities, QLACs, and GMWBs—are increasing in popularity . . . because they guarantee that the money lasts for a lifetime. However, there is not much guidance about the fiduciary process for selecting a particular annuity or GMWB product to provide those guaranteed benefits. We have written a white paper about issues for selecting GMWB products for Lincoln Financial, which can be found at http://bit.ly/1rtMnFX. This article, found here: http://bit.ly/1yOnoS7, discusses key points from the white paper.

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Managing Defined Contribution Plan Investment Policy Statements


fiduciary, prudent

I recently wrote an article for JP Morgan about the fiduciary process for implementing investment policy statements . . . with particular emphasis on the monitoring of investments and investment managers in participant-directed plans. The article outlines a step-by-step approach for identifying investments to be placed on a watch list, the use of the watch list, and the process for determining whether to remove and replace the investment. I believe that the article is both a good outline of ERISA’s requirements for a prudent process and an educational piece for plan fiduciaries. It can be found under the publications section of my blog, here: http://fredreish.wpengine.com/publications/, or directly at http://bit.ly/1MayGaf.

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Navigating Retirement Risks


prudent

American workers are living longer. But a long life has its risks . . . especially the risk that retirement savings won’t last. Bruce Ashton and I have written an article about the sequence-of-returns risk created by market volatility (based on a white paper that Bruce Ashton and I wrote for Milliman). The article contains graphic examples of the impact of gains and losses in the years shortly before and after retirement. You can read the article here.

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Did you know…?


DOL, fiduciary, General

Little has been written about how a plan fiduciary should prudently select insurance companies and guaranteed retirement income for participants. There’s a DOL “safe harbor” regulation, but it doesn’t give fiduciaries a checklist for compliance. To address this, Lincoln Financial hired us to work with an insurance consultant to develop a set of criteria that fiduciaries or their advisors can use to make those decisions. Bruce Ashton and I have written an article about the checklist that can be found here:  Did you know…About the Fiduciary Requirements for Selecting a Lifetime Income Provider?  The article has links to the white paper and the checklist.

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ERISA Issues for Solicitor’s Fees


408(b)(2), DOL, fiduciary, prohibited transaction, service providers

Not much has been written about ERISA considerations for referring investment managers to retirement plans . . . and the receipt of solicitor’s fees for a referral.

However, there are a host of legal issues.

First, the person making the referral is receiving “indirect” compensation (that is, the solicitor’s payment by the investment manager), which makes that person a “covered service provider” or “CSP.” As a CSP, he must make 408(b)(2) disclosures (i.e., services, status and compensation). The failure to make timely disclosures is a prohibited transaction.

Second, the compensation cannot be more than a reasonable amount . . . as measured by the value of the services to the plan. But, what if the CSP doesn’t provide any ongoing services to the plan? Does the “compensation” become unreasonable after five years of payments? Ten years? I am not aware of any guidance on that point.

Third, the referral can result in the CSP becoming an ERISA fiduciary adviser. The DOL takes the position that a referral to a discretionary manager is the same as the recommendation of an investment. If it is individualized, based on the particular needs of the plan (or a participant), the DOL says it’s a fiduciary act. For example, in the preamble to its participant advice regulation, the DOL said:  “. . .the Department has long held the view that individualized recommendations of particular investment managers to plan fiduciaries constitutes the provision of investment advice within the meaning of section 3(21)(A)(ii) in the same manner as recommendations of particular securities or other property. The fiduciary nature of such advice does not change merely because the advice is being given to a plan participant or beneficiary.” That conclusion means that the CSP should engage in a prudent process and its compensation must be “level” (that is, cannot vary depending on which investment manager is recommended). I am not aware of any enforcement activity on these issues. However, the DOL position is clear.

While I have opinions about these unanswered questions, the purpose of this article is to alert people about the issues and risks.

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Aging Boomers and Rollovers to IRAs


DOL, fiduciary, plan sponsors, recordkeeper, registered investment advisers, service providers

As baby boomers approach retirement in a defined contribution world, the regulators are focusing on distributions and rollovers to IRAs. The SEC, FINRA, DOL and GAO have all spoken on the subject. Their conclusion appears to be that plan fiduciaries, advisors and recordkeepers need to reconsider their current practices and, in some cases, change their practices.

Why? The reason is relatively straightforward. As large numbers of 401(k) and 403(b) participants approach retirement, regulators are becoming increasingly aware that they will be moving from a plan environment where they are “bubble wrapped” by plan fiduciaries . . . and have the benefit of being able to select from investments that have been vetted by the fiduciaries and that are, as a result, good quality and relatively low-cost investments. Based on current practices, most of those participants will rollover into IRAs with investments and advisors that are using retail pricing.

In addition, participants will go from a fiduciary environment that is protected from conflicts of interest into a retail environment that allows conflicts of interest. (Note that there is a difference between a conflict of interest and “succumbing” to a conflict of interest. In my experience, most—but not all—advisors provide good advice at reasonable costs.)

The regulators are asking, “Does it make sense for participants to leave the protected environment of retirement plans and go into the retail environment of IRAs?”

To create a worse-case scenario, imagine a 401(k) participant who is defaulted into a target date fund and stayed there during his working career. In effect, the participant has never selected an investment, and it is possible that the participant never learned anything about mutual funds. At retirement, that participant is encouraged to rollover his money into a retail market.

So, where does that leave us? For plan sponsors, I think that it means that they should consider allowing participants to stay in the plan, even after retirement, and should provide flexible distribution alternatives through their recordkeeper. For advisors and recordkeepers, I think that it means that they need to create meaningful educational materials and help participants make the right decisions, depending on the participants’ needs and preferences.

This is just the beginning of this story. There is too much at stake for it to end here. For example, it is estimated that over two trillion dollars will become eligible for distribution between January 1, 2014 and December 31, 2018.

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Re-Proposal of DOL Fiduciary Advice Regulation


DOL, fiduciary, prohibited transaction

As you have undoubtedly heard, the Department of Labor has pushed back the date for the re-proposal of the fiduciary advice regulation to January of next year. In addition, the SEC is working with the DOL to help determine the impact of an expanded fiduciary advice regulation on the ability of investors to continue to receive adequate investment services. Finally, the White House is also evaluating the potential impact of a regulation that expands the definition of fiduciary advice. The big question, of course, is what does all of this mean?

As you might expect, everyone has an opinion on that subject. So, depending upon your personal beliefs, you can find opinions that either agree or disagree with your position. But, the truth is that the people who know aren’t talking, and the people who are talking don’t know.

One plausible explanation is that the controversy concerning the regulation has risen to the point that it is a political liability. In other words, that line of reasoning holds that these activities are signs that the re-proposal is in danger.

However, another line of reasoning is that the regulation remains viable, and probable, but that the politicians and the regulators want to make sure that they get it right. (If that is the case, then “right” probably means that appropriate prohibited transaction exemptions are crafted so that valuable services and quality products are not prohibited.)

If I were a betting man (and, for this purpose, I am), my bet would be that the second scenario is the more likely. I have a hard time believing that all of this political and regulatory effort is being made for a proposal that will be killed. In other words, I think that there is a good chance that the DOL will issue a proposed regulation in the first half of next year. I also think that there is a good chance that the proposed prohibited transaction exemptions that accompany the guidance will be more thoughtful and practical than might be expected.

In any event, if and when we get the proposal, the first thing that I will look at is . . . the proposed prohibited transaction exemption concerning fiduciary investment advice to IRAs. In particular, I want to see what it says about variable compensation and about proprietary investments and products.

 

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Providing Compliant Services


broker-dealers, DOL, registered investment advisers

The increasing regulation of 401(k) distributions and rollovers to IRAs continues to be a subject of great interest to my clients . . . and a considerable amount of work for me. One of the benefits of concentrated work in that area has been an enhanced appreciation of the difficulty of broker-dealers, provider call centers, and RIAs in providing compliant services . . . from a practical perspective.

For example, viewed academically, it is possible to put together a compliant rollover program under FINRA’s guidance in Regulatory Notice 13-45. At the least, that would involve written materials and discussions about the seven factors listed in the guidance. The written materials would be provided to participants to both educate them and to support compliance and supervision. The conversations would be structured to provide a reasonable basis for developing a suitable recommendation, based on the individual needs and circumstances of the participant.

On a practical level, it is feasible for a financial adviser or an investment adviser to engage in that process . . . for a participant with a large account balance. However, that is only a small part of the real world of 401(k) participants. Many of the conversations are with participants with small account balances and, for a provider’s call center, are of limited duration. As a result, the compliance procedures and “scripts” for participants with small account balances are often more difficult to develop than for the individualized treatment that can be financially justified for wealthier participants.

Nonetheless, the regulators—FINRA, the SEC and the DOL—now expect broker-dealers and RIAs to have compliant procedures for “capturing” IRA rollovers. Based on my experience, this is not an easy job. I recommend that, at the least, your procedures incorporate unbiased and relatively thorough educational materials that are given to all participants who are eligible for distributions and a process that solicits the most important information about the needs and circumstances of the participants. Without that kind of approach (or something similar to it), it will be difficult to formulate a suitable or prudent distribution and rollover recommendation.

The FINRA guidance, and the SEC and FINRA 2014 Examination Priorities List, are posted under the “external resources” page on my blog at http://fredreish.wpengine.com/external-resources-2/.

 

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DOL Proposed Guide


408(b)(2), DOL, prohibited transaction

Several of my colleagues and I have provided comments to the DOL about its proposal to require a 408(b)(2) guide   Most other commentators have or will be addressing the policy issue — is it a good idea to require a guide or not?   We avoided the policy issues.   Instead, our comments focused on making the requirements clear and implementable — if the guide requirement is adopted.

For example, we asked that the DOL clarify the requirement to “furnish” a guide and “disclose” changes to the guide later on.   In raising this question, our concern is that the language in the proposal may not clearly express the DOL’s intent.  Without clarity on the meaning of these terms, a service provider might inadvertently violate the requirement.  Since the regulation is a prohibited transaction exemption, an unambiguous statement of the requirements is essential  for us to be able to properly advise our clients on how to comply.

There are a number of other areas on which we requested clarification if the proposal is finalized.  A copy of our comments can be accessed here:  http://www.scribd.com/doc/234166566/060214-Ltr-to-DOL-Re-Proposed-Guide.  The signers of the letter other than me were Bruce Ashton, Brad Campbell, Joan Neri and Josh Waldbeser.

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