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.
Posts by :
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.)
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.)
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.)
Continue reading “Recommending Rollovers in the Evolving Regulatory Environment (Part 2)”
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)”
In a previous post, we discussed why broker-dealers and their representatives will likely still be fiduciaries to ERISA plans and IRA investors in many cases despite the DOL Fiduciary Rule’s impending death (we say “impending” because, while the Fifth Circuit’s ruling in mid-March vacates the Fiduciary Rule in its entirety, the court’s official order implementing this decision has yet to be issued). To review, this is because broker-dealers and their representatives often satisfy all the prongs of the soon-to-be reinstated 1975 fiduciary regulation’s “Five-Part Test” defining when investment recommendations rise to the level of “fiduciary” advice. Previous industry assumptions that brokers and other “sellers” of investments generally were not fiduciaries under the 1975 regulation should no longer be relied upon. In this post, we’ll examine how the Fiduciary Rule’s impending demise will affect prohibited transaction and compensation issues for broker-dealers in light of their likely continuing status as fiduciaries. Continue reading “Why Fiduciary Status Still Matters in a Post-Fiduciary Rule World: A Look at Prohibited Transactions And Compensation”
The “old” rules will again prevail—but the old rules will not be applied in the old ways, and this will have some significant impacts on broker-dealers.
As the DOL has not asked for a rehearing of the Fifth Circuit’s decision vacating the Fiduciary Rule, or yet sought to appeal the decision, it is widely anticipated that the March 15 ruling will soon take effect, restoring the DOL’s 1975 regulation defining fiduciary investment advice to plan and IRA investors (we say “widely anticipated” because, while the official mandate vacating the Fiduciary Rule is expected soon, it has been delayed while the court considers efforts from certain states and other third parties to intervene in the case). While the SEC has proposed new regulations for broker-dealers, and while we expect the DOL to propose new prohibited transaction exemptions or regulations that will coordinate with the SEC’s actions, it will be at least a year before these initiatives could begin to apply. Continue reading “Old Standard, New Day: The Death of the Fiduciary Rule Doesn’t Mean That Broker-Dealers Won’t be Fiduciaries”
While we won’t know until the end of the month whether the DOL fiduciary rule will survive beyond May 7, there are some activities that won’t be affected, regardless of what happens.
Let’s start by reviewing basics. A fiduciary under ERISA and the Internal Revenue Code (the “Code”) includes one who provides investment advice to an ERISA plan and/or IRA for a fee –an “advice fiduciary.” Before the new DOL fiduciary rule, a broker-dealer or RIA (referred to here as a “firm”) would be considered an advice fiduciary if a five-part test was satisfied: (1) its advisor provided advice for compensation about a security or other property, (2) on a regular basis, (3) pursuant to a mutual understanding, (4) that the advice would form a primary basis for the investor’s decision and (5) it was individualized based upon the investor’s particular needs. If the DOL’s new fiduciary rule does not survive, the five-part test will come back into effect.
Regardless of whether the DOL fiduciary rule or the five-part test applies, there are some things that will remain unchanged:
• Investment Management Services: Discretionary investment management for ERISA plans or IRAs is and will continue to be a fiduciary service. This is because under both ERISA and the Code, there is a definition of “fiduciary” separate and apart from an “advice fiduciary.” That definition says that a broker-dealer or RIA, or its representative, is a fiduciary when it has discretion over ERISA or IRA assets. This means that investment management services for ERISA plans are, and continue to be, subject to ERISA’s prudent man standard of care and duty of loyalty. Also, managing ERISA and/or IRA plan assets is, and will continue to be, subject to the fiduciary prohibited transaction rules in ERISA and the Code. Firms need to have policies, training and supervisory processes in place to ensure that advisors providing investment management services to ERISA plans and/or IRAs comply with these rules, even if the DOL fiduciary rule does not survive.
• Reasonable Compensation: Firms also need to make sure that compensation for services to ERISA plans or IRAs is reasonable, because unreasonable compensation is a prohibited transaction under both the Code and ERISA. This requirement applies to all service providers to plans, participants and IRAs, and to service providers who are not fiduciaries. Firms need to develop systems and data to determine reasonable compensation for different products and services and to manage advisor compensation practices.
• Rollover Recommendations by Fiduciary Advisors: Even if the DOL fiduciary rule does not survive, some rollover recommendations may still be fiduciary acts. Specifically, under a DOL advisory opinion, if an advisor (and the firm) is a plan fiduciary and its advisor recommends that a plan participant take a distribution and roll over to an IRA, the advisor will be a fiduciary for that purpose. As such, the advisor’s recommendation needs to satisfy the ERISA prudent man standard. Additionally, if the DOL fiduciary rule does not survive, there will not be a Best Interest Contract Exemption to “cure” the resulting prohibited transaction. If, on the other hand, the firm is not a fiduciary to the plan and the advisor recommends a rollover, it will not be a fiduciary act if the DOL fiduciary rule does not survive. Firms should examine their current rollover practices and determine what processes will need to be retained to address these issues.
• Ongoing Advisory Services: Providing ongoing investment advisory services to ERISA plans or IRAs based upon the particular needs of the retirement investor will continue to be a fiduciary act even if the DOL fiduciary rule is vacated. The reason is that under most advisory arrangements, the advisor is providing the advice on a regular basis and meeting the other elements of the five-part test. The firm should identify current arrangements that satisfy the five-part test and make sure there are policies and procedures in place to ensure compliance with the prohibited transaction rules and exemptions and, in the case of ERISA plan services, compliance with the prudent man rule and duty of loyalty.
While the possible demise of the DOL fiduciary rule will limit the scope of investment activities that are fiduciary in nature, there are still investment services that will be fiduciary and thus subject to the prohibited transaction requirements. As a result, firms should take steps now to identify those activities and take appropriate steps for compliance.
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:
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.