The Delay of the Fiduciary Exemptions: Now Is Not the Time to Relax (Part 2 of 2)

This is Part 2 of our post on important issues for broker-dealers during the extended transition period for the fiduciary exemptions. In Part 1, we discussed the need to develop written supervisory procedures under the Best Interest Contract Exemption (BICE) and the importance of engaging in – and being able to demonstrate – diligent and good faith efforts to comply with the exemptions.

Two other important issues are how to demonstrate compliance with the transition exemptions and the protections that are not afforded by the non-enforcement policy.

1. Demonstrating Compliance. Transition BICE and transition 84-24 are exemptions from the prohibited transaction rules of ERISA and the Internal Revenue Code. If you comply with the applicable conditions – mainly the Impartial Conduct Standards – during the transition period, the exemption applies. But the DOL and the courts have said that the burden of showing compliance with the conditions falls on the party claiming the exemption. In other words, a broker-dealer that is seeking to rely, for example, on transition BICE and thus receive conflicted compensation should be able to prove that it complied with the Impartial Conduct Standards and that it has policies and procedures designed to ensure compliance. (As a reminder, the Impartial Conduct Standards are: (1) advice must satisfy the best standard of care; (2) compensation must be reasonable; and (3) misleading statements must be avoided (in the case of transition exemption 84-24, there must be disclosure of compensation and material conflicts of interest).)

This means that a broker-dealer will need to document the steps the firm and its advisors have taken to meet the exemption conditions. For example:

  • In the case of investment recommendations of asset allocations and the selection of mutual funds and ETFs, the use of reputable software programs can be evidence of compliance.
  • In the case of a recommendation to a participant to take a distribution and roll it over to an IRA, the advisor will need to gather and evaluate information on the investments, services and fees in both the plan and the IRA, plus information about the participant’s financial situation, goals and needs.

In both cases, the broker-dealer must store and be able to retrieve the information.

2.  What’s Not Covered by the Non-Enforcement Policy. The DOL and IRS have indicated – and reaffirmed in the recent extension – that they would not pursue claims against firms and their advisors during the transition period so long as broker-dealers are working diligently and in good faith to comply with the Impartial Conduct Standards. That is helpful, but the non-enforcement policy does not bar individual retirement investors from asserting claims against broker-dealers (for example, alleging that the broker-dealer and advisor did not act in the investor’s best interest or did not satisfy the other Impartial Conduct Standards).

The potential for individual claims should not be underestimated. Here’s why:

  1. Advice to plans. If a broker-dealer is advising a plan or participants, the plan, plan fiduciaries and participants have rights under ERISA to pursue individual claims. This would include, for example, a claim by a participant that advice to take a distribution and roll it over was not in the participant’s best interest and that the broker-dealer and advisor did not follow the steps necessary to engage in a prudent process (for example, a participant could allege that the broker-dealer and advisor did not obtain information about the plan’s investments, services and expenses).
  2. Advice to IRAs. During the transition period, the requirement under BICE to enter into a contract with an IRA owner – which creates the right to a private cause of action – does not apply. So, in the case of IRAs, it is not clear how retirement investors would enforce the best interest standard. Broker-dealers should nonetheless consider the possibility of claims brought in FINRA arbitration with creative causes of actions (for example, claimants may allege that, by accepting conflicted compensation, the broker-dealer committed to adherence to the Impartial Conduct Standards, including the best interest standard).

As we said in Part 1, this is not the time to relax. Broker-dealers and their advisors need to comply with the Impartial Conduct Standards. They should take steps to diligently implement those Standards and documenting their policies, supervision practices and development of their best interest recommendations.

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.

About the Author: Fred Reish

Fred Reish represents clients in fiduciary issues, prohibited transactions, tax-qualification and Department of Labor, Securities and Exchange Commission and FINRA examinations of retirement plans and IRA issues.

About the Author: Sandra D. Grannum

Sandra Dawn Grannum concentrates her practice on securities, broker/dealer arbitration, litigation, mediation and regulatory defense. She is co-chair of the Commercial Litigation Team.

Sandy has tried complex multimillion-dollar arbitrations before FINRA, AAA and JAMS across the country. She has represented brokerage firms, banks, clearing firms, and associated persons in over 60 arbitrations before the NASD and FINRA which have been tried through award. In addition, she has successfully pursued cases in state and federal courts and in adversarial proceedings before bankruptcy courts.

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