View the full bio for at the Faegre Drinker website.

Posts by :


Managing IRAs: Charging Different Fees for Different Investments

Key Takeaways:

Registered investment advisers, including dual registrant broker-dealers (collectively “advisers”) who provide discretionary investment management services to individual retirement accounts (IRAs), are fiduciaries under the Internal Revenue Code (the “Code”). While the Code does not have a fiduciary standard of care, it does have a duty of loyalty in the sense that most conflicts of interest are prohibited.

The Code prohibits an investment adviser fiduciary to an IRA from using its authority as a fiduciary to receive additional compensation. This means that an adviser with the authority to make asset allocation decisions in an IRA cannot charge a different fee for different investment categories (e.g., equities vs. fixed income) unless a prohibited transaction exemption is available. Alternatively, there are other compensation structures that can be considered.

 

Advisers who manage IRAs may have discretionary authority to determine the asset allocation among equities and fixed income assets based on the investor’s investment objectives, financial needs and circumstances. The fee charged for this service may be a level fee based on the value of all assets – equity and fixed income; in that case, there would not be a conflict that it was a prohibited transaction. But, let’s suppose the adviser wants to charge one fee for advising on the portion of the investor’s IRA portfolio that is allocated to equities, and a lower fee for the portion allocated to fixed income investments, and the adviser has the discretion to decide how much is allocated to equities and how much is allocated to fixed income. As explained later in this article, the allocation to the higher fees (that is, to equities) is an exercise of discretion that is a conflict and a prohibited transaction because it increases the adviser’s compensation.

Continue reading “Managing IRAs: Charging Different Fees for Different Investments”

Recent State Fiduciary and Best Interest Developments: Pennsylvania’s New Law; Nevada May be Next

Pennsylvania has adopted legislation implementing the model regulation concerning suitability in annuity transactions adopted by the National Association of Insurance Commissioners (NAIC). This brings to 19 the total number of states adopting the NAIC suitability model. Nevada may be the next state to watch. Nevada’s Securities Administrator has indicated that she is resuming work on the state’s fiduciary rule for investment advisers and broker-dealers and expects to release the rule by November. Stay tuned.

Continue reading “Recent State Fiduciary and Best Interest Developments: Pennsylvania’s New Law; Nevada May be Next”

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.

Fiduciary Rule Myths

MYTH:  “Advisors must recommend the lowest cost investment.”

This post discusses what broker-dealers and their advisors need to do to manage the risks in providing investment recommendations to plans and IRAs. In order to manage those risks, though, broker-dealers and advisors need to understand what the rules require. To do that, we need to debunk some “myths” about the rules. Continue reading “Fiduciary Rule Myths”