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The DOL’s Temporary Enforcement Policy: Potential Traps for the Unwary

The overturning of the DOL’s Fiduciary Rule by the Fifth Circuit last year had two impacts: first, the definition of “fiduciary” for investment advice to plans and IRAs reverted back to the narrower Five-Part Test issued in 1975; second, the Best Interest Contract Exemption (or “BIC Exemption”) and amendments to other exemptions also ceased to exist.

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Fiduciary Status for the Unwary

If you thought that avoiding fiduciary status would be a slam-dunk after the “new” DOL fiduciary advice rule was vacated, think again. The DOL’s old fiduciary regulation is back and it casts an unexpectedly wide net.

Let’s start with the background. The reinstated fiduciary definition says that a broker-dealer and its advisor (a “broker”) are fiduciaries to a plan if a functional five-part test is satisfied: (1) the broker provides advice about investments for a fee or other compensation, (2) on a regular basis, (3) under a mutual understanding, (4) that the advice will form a primary basis for the plan’s decisions, and (5) that the advice is individualized based upon the plan’s particular needs. For this purpose, a “plan” includes not only an ERISA plan, but also an IRA. (In the context of IRAs, being a fiduciary under the five-part test does not itself implicate a standard of care, but does apply to the applicability of certain prohibited transactions.)

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Recommending Rollovers in the Evolving Regulatory Environment (Part 3)

In Parts 1 and 2 of this post, we talked about the current and proposed rules applicable to rollover recommendations by broker-dealers and RIAs. Part 1 discussed the DOL and FINRA rules that apply now. In Part 2, we explained the SEC proposals. In this post, we talk about how to make a compliant rollover recommendation, regardless of which set of rules applies.

(“Rollover recommendation” refers to advice to a retirement plan participant to take a distribution of his or her account and roll it over to an IRA that is being advised by the broker-dealer or RIA.)

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Recommending Rollovers in the Evolving Regulatory Environment (Part 2)

In our first post on this topic, we discussed the existing rules that apply to rollover recommendations by broker-dealers and RIAs. This discussion included the ERISA guidance that remains after the 5th Circuit’s decision vacating the Fiduciary Rule, as well as FINRA’s Regulatory Notice 13-45. In this post, we focus on the SEC’s best interest proposals for broker-dealers and RIAs and where that may take firms in the future. In our next, and final, post in this series, we’ll talk about how to make a compliant rollover recommendation.

(As a reminder, by “rollover” recommendation, we mean a recommendation to a retirement plan participant to take a distribution of his or her account and roll it over to an IRA being advised by the broker-dealer or RIA.)
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Recommending Rollovers in the Evolving Regulatory Environment (Part 1)

With recent developments in the regulatory landscape – the demise of the DOL Fiduciary Rule, the SEC’s proposed Regulation Best Interest (Reg BI) and RIA fiduciary interpretation, and the existing FINRA guidance on rollovers – it’s important for firms to understand the rules for rollover recommendations. This article discusses the rules as they apply to both broker-dealers and RIAs. While there are similarities in the application, there are also material differences.   Continue reading “Recommending Rollovers in the Evolving Regulatory Environment (Part 1)”

Fiduciary Rule Myths

MYTH:  “Advisors must recommend the best available investment.”

We recently pointed out that under the DOL fiduciary rule, it’s a myth that advisors have to recommend the lowest cost investment. They don’t.

Here’s another myth about investment recommendations that isn’t true: advisors have to recommend the best investment to their customers. Presumably, this comes up because of the Impartial Conduct Standards in the Best Interest Contract Exemption (BICE). One of the requirements in those Standards is that a recommendation be in the best interest of the customer. This best interest requirement may lead some to think that advisors have to meet an essentially impossible standard. As with a lowest-cost recommendation, however, a mandate to recommend the best investment is a myth…it just isn’t true. Even the DOL has said so:

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Reasonable Compensation

In a previous post , we debunked the myth that the Fiduciary Rule requires advisors to recommend the lowest-cost investments. In this post, we discuss what is required when it comes to fees and compensation – that they not exceed a “reasonable” level.

Broker-dealers and advisors who rely on the Best Interest Contract Exemption (BICE) need to comply with the Impartial Conduct Standards. These include three requirements: (1) recommendations to plan and IRA investors must be in the “best interest” of the customer, (2) communications with customers must not include materially misleading statements, and (3) the firm’s and advisor’s compensation must be reasonable. If any of these is not met, they have engaged in a non-exempt prohibited transaction.

The reasonable compensation requirement is more than a condition imposed by the DOL. The requirement is statutory. That is, it is imposed under ERISA for employer-sponsored plans. It is imposed under the Code for all service arrangements with both plans and IRAs. The reasonable compensation limit applies to service providers regardless of whether or not they are fiduciaries.

This means two things. First, the requirement is not going away. Because it is embedded in the statutes, it can only be repealed by Congress – not the DOL, the SEC or any state rule – and this is not likely. While the DOL will undoubtedly make changes to BICE and other exemptions during the current transition period, firms and advisors cannot expect the reasonable compensation requirement to go away, or even be changed. Second, it applies to all service relationships. Even for level-fee advice arrangements – which do not have to satisfy BICE or any other similar exemption, compensation must be reasonable.

Reasonable compensation defined
What does “reasonable” mean? The requirement is that compensation be reasonable in relation to the services and benefits being provided. As the DOL explains in the BICE preamble:

At bottom, the standard simply requires that compensation not be excessive, as measured by the market value of the particular services, rights, and benefits the (advisor) and Financial Institution are delivering to the Retirement Investor.

For compensation to be reasonable, it is not necessary to recommend a product that pays the least compensation. It is not necessary that compensation be below average. It just cannot rise to a level that is excessive in relation to the services and benefits provided.

Note that the reasonableness requirement applies to the compensation received by the broker-dealer and to the amount passed on by the firm to the advisor. If, for example, a firm receives an excessive level of commissions for recommending a product, this would violate the standard even if the advisor’s “share” of the commission were within industry norms.

Value of services
The BICE preamble also makes clear that all services and benefits provided can be taken into account – not just the advice services – in determining if compensation is reasonable. The DOL offers the following example:

In the case of a charge for an annuity or insurance contract that covers both the provision of services and the purchase of the guarantees and financial benefits provided under the contract, it is appropriate to consider the value of the guarantees and benefits in assessing the reasonableness of the arrangement, as well as the value of the services.

In other words, the value of the services may be enhanced by the complexities and services associated with a product, and those can be considered in determining whether the compensation is reasonable.

Factors in determining reasonableness
How is “reasonableness” determined? While the requirement is imposed by law, the standard itself is an industry, or market standard. Per the DOL, there are “several” factors involved. They include, but are not necessarily limited to, the:

  •  market pricing for similar services and products
  •  scope of monitoring, if any
  •  complexity of the product

To help determine market standards for compensation, broker-dealers use benchmarking or similar services. In fact, the DOL has said that firms may want to seek “impartial reviews” of their fee structures. At the same time, firms should recognize that “reasonable” and “customary” do not necessarily mean the same thing. That is, in limited circumstances, the markets may not provide competitive pricing. However, where markets are transparent and competitive, the benchmarking information should properly define reasonable compensation.

Finally, firms may wish to consider “re-benchmarking” their compensation structures at reasonable intervals – what is reasonable this year might not be reasonable next year.