Some broker-dealers may be tempted to view the DOL’s extension of the transition period for the fiduciary exemption to July 1, 2019, and the extension of the DOL and IRS non-enforcement policies, as an opportunity to relax and take a break from compliance issues for the next 18 months. Unfortunately, that could turn out to be a risky decision.
We are concerned that firms may not be paying sufficient attention to some of the most critical transition issues, including adoption of policies and procedures to ensure compliance with the Impartial Conduct Standards and taking affirmative steps to ensure diligent, good faith compliance with the rules.
It’s important for broker-dealers to keep in mind that the fiduciary regulation itself is in effect, even though the final exemptions were delayed. Also, only some of the conditions of the prohibited transaction exemptions were delayed.
To refresh your memory, transition BICE — the transition version of the Best Interest Contract Exemption — permits firms and advisors to earn variable compensation for sales and investment and insurance services to plans, participants and IRAs. Transition exemption 84-24 permits brokers and agents to receive commissions on sales of insurance products to the same types of clients. To take advantage of these exemptions, however, broker-dealers must satisfy the exemptions’ conditions. During the transition period, both exemptions require compliance with the Impartial Conduct Standards: 1) Advice must be in the best interest of the client; 2) compensation must be reasonable; and 3) misleading statements must be avoided (in the case of transition 84-24, this means disclosure of material conflicts of interest).
There are four issues that we are most concerned about during the transition period:
- Policies and Procedures. Full BICE requires that broker-dealers adopt policies and procedures to ensure compliance with the Impartial Conduct Standards. This requirement does not apply during the transition period. However, the DOL has said in its FAQs that “[d]uring the transition period, the Department expects financial institutions to adopt such policies and procedures as they reasonably conclude are necessary to ensure that advisors comply with the impartial conduct standards.” The “reasonably conclude” language might be read as leaving it to a firm’s discretion whether to take affirmative action to ensure compliance. In the delay announcement, however, they stated the requirement more forcefully: “during the Transition Period, [the DOL] expects that advisors and financial institutions will adopt prudent supervisory mechanisms to prevent violations of the Impartial Conduct Standards.” In other words, the DOL expects firms to adopt policies and procedures during the transition period to ensure compliance. If a broker-dealer has not already done this, it should do so now.
- Good Faith Efforts. In extending the transition period, the DOL also extended the non-enforcement policy. (The IRS has also joined in the non-enforcement policy.) While it will generally not pursue claims against firms and their advisors during the transition period, the DOL made it clear that this would only apply to those “who are working diligently and in good faith to comply with their fiduciary duties and to meet the conditions of the [exemptions].” If not, it said, it would treat them as “being in violation of their fiduciary duties and not compliant with the [exemptions].” The DOL has explained that to demonstrate good faith compliance, they should look to the provisions of the full BIC exemption and that “it remains critically important that firms take action to ensure that investment recommendations are governed by the best interests of retirement investors, rather than the potentially competing financial incentives of the firm or advisor.” It acknowledged that “while firms are not required to rely on [the specific provisions of the exemption] during the Transition Period, such reliance would certainly constitute good faith compliance.”What does this mean? We think it means that broker-dealers cannot ignore the requirements of the full exemptions even though they do not strictly apply during the transition period. This could include, for example, adopting written supervisory procedures and making the disclosures required by the exemptions, though it would not require, in our view, creating a website or entering into best interest contracts with IRA holders.
In Part 2 of this article, we’ll discuss the other two issues of concern: compliance with the transition exemptions and the protections that are not afforded by the non-enforcement policy.