The Essence of the Fiduciary Proposal . . . for Advisors

By now, you’ve probably read about some of the details of the Department of Labor’s fiduciary proposal. This article isn’t about the details; it’s about the essence. What’s the big picture?

First, the proposal significantly expands the definition of fiduciary advice. As a result, almost every person who makes an investment recommendation to a plan, a participant or an IRA owner will be considered a fiduciary.

For “pure” level-fee advisors (which are typically RIAs), there won’t be any change for their services to plans, participants or IRAs . . . with one exception. The exception is “capturing” rollovers.

For any advisor—broker-dealer, RIA, insurance broker—who makes a recommendation to a participant to take a distribution and roll over, and who will be paid more in the IRA than from the plan, it will be a prohibited transaction. In other words, the recommendation of a rollover will be considered fiduciary advice under the new proposal.

However, there is an exemption—the Best Interest Contract Exemption (BICE)—that allows for recommendations concerning rollovers, if they are in the best interest of the participant and if the advisor satisfies a number of contractual and disclosure requirements. However, it will be difficult to satisfy those requirements.

As a result, it is likely that most advisors will decide to provide “education” about distribution alternatives and about the most important considerations for participant in making those decisions. Education is treated differently than a recommendation. If a participant is provided unbiased and relatively complete education about his options, it will not be considered a recommendation. As a result, a participant can make a decision to roll over into an IRA and, after the roll over, the advisor can help with the IRA investments. In this context, “education” needs to be unbiased and complete in material regards. For risk management, it should be documented.

For non-level fee advisors, for participants, IRAs and certain plans, BICE is available — but compliance is complex and difficult. (An advisor is not a level-fee advisor if his compensation could vary depending on the recommendations that are made, or if his supervisory entity –for example, the broker-dealer or an affiliate—makes more money because of the recommendation, e.g., a management fee for an affiliated mutual fund manager.) For non-level fee advisors, the BIC exemption only provides relief for investment recommendations to participants, IRAs and small pooled plans (e.g., profit sharing plans). However, BICE does not provide relief for recommendations to participant-directed plans (e.g., 401(k) plans). For those plans, advisors must be level fee (or get relief from a different exemption).

One of the BICE requirements is that the advisor’s compensation (with limited exceptions) needs to be level. As a part of that, there cannot be any bonuses, incentives, etc., for the advisor to encourage the sale of proprietary products, investments that pay revenue sharing to the broker-dealer, and so on.

However, if BICE is satisfied, the compensation of the supervisory entity and its affiliates is not required to be level.

Another requirement is that there be a contract with the investor (for example, the IRA owner) where the advisor and the broker-dealer agree to adhere to the new “best interest” standard of care. (That standard is remarkably similar to the fiduciary standard under ERISA.)

In addition, there are stringent financial disclosures before the sale, before each new transaction, and after the end of each year. For example, after the end of each year, the investor must be given the dollar amount of all expenses resulting from the investment recommendations (for example, in the IRA) and the dollar amount paid to the advisor and the supervisory entity in the preceding year.

My belief is that very few, if any, RIAs or broker-dealers currently have the systems in place to be able to do that kind of reporting . . . and that it would be very expensive to create the systems.

There are other requirements that make compliance with BICE even harder, but this gives you the basic idea.

At this point, there is about another 60 days left in the comment period. After that, there will be hearings. If the regulation does become final, which is a distinct possibility, it will probably be in the first or second quarter of next year, with an “applicability” date of late 2016 or early 2017.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

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