We will start with a quick overview of the new fiduciary rule itself, including the exemptions that allow certain forms of compensation that would otherwise be prohibited under the Employee Retirement Security Act of 1974 (ERISA) and Department of Labor (DOL) rules. We will work together to understand the practical applications of the rule in very specific situations. We will also talk briefly about the marketplace responses and the litigation status of actions brought by industry against the DOL. And, finally, we will update you on the dates that portions of the regulation become applicable as well as foresight into what changes may occur between now and January 1, 2018.
We are often asked why the DOL rule is regulating what appears to be recommendations under the jurisdiction of the SEC, because the rule deals with advice on investments. The DOL has authority to write rules regarding retirement plans such as defined benefit plans, defined contribution plans, profit-sharing plans, etc., as well as other employee benefit plans, including welfare benefit plans. They also “made a deal” with the Treasury to have oversight of prohibited transactions in the IRA space. We will talk in a few minutes about how that is an issue in some of the litigation. Because of this overlapping jurisdiction, it is important for advisors to be aware of the DOL requirements, any SEC and/or FINRA requirements, and, most especially, the specific requirements of their broker-dealer or other financial institutions.
The final rule expands the definition of fiduciary advice when working with ERISA-covered plan sponsors and plan participants and with individual retirement accounts (IRAs). It also is applicable to other employee benefit plans with investable assets, such as welfare benefit plans, Coverdell accounts, and health savings accounts (HSAs). It does not apply to investment advice offered outside the qualified plan space, unless you’ve advised a distribution from a qualified plan or IRA.
The rule is lengthy and complicated in many respects, and financial institutions (broker-dealers, insurance companies, Registered Investment Advisors [RIAs], and banks) are spending significant time and resources to interpret and implement the requirements placed on financial institutions intending to comply with the rule and its exemptions. On the other hand, it is pretty straightforward: You must work in the client’s best interests, receive no more than reasonable compensation, satisfy the requirements of an exemption if that compensation is conflicted (differs based upon the recommendation made), and fully disclose conflicts of interest.
There are additional and complex requirements of the financial institutions to put in place policies and procedures that mitigate conflicts of interest, disclosures, and retention of records. These requirements are extremely costly (even the DOL estimates $11 billion in costs) and will require new technology and more compliance and supervision of agents and registered representatives. And, finally, the financial institutions’ legal exposure to unwarranted class actions and private rights of action is significantly higher than former ERISA claims procedures. Advisors need to understand the DOL rule and they need to understand how their financial institutions interpret and implement the rule.
Once you have determined that the recommendation you are making is subject to the rule—for instance, discussing implementation of a 401(k) plan to a small business owner—you must then consider how you will be compensated. Your compensation arrangement will determine if you need to rely upon one of the rule’s exemptions in order to execute that comp arrangement. A recommendation is defined as a communication that would reasonably be viewed as a suggestion to take a particular course of action.
Let’s begin with the less complicated one: Prohibited Transaction Exemption 84-24 (PTE 84-24) allows an advisor to receive commissions when recommending a fixed annuity or insurance products—but not when recommending an index annuity or a variable annuity. The advisor must meet the impartial conduct standards (best interest, reasonable compensation, no misleading statements) as well as disclose conflicts and commissions. The definition of commission does not include any revenue sharing, administrative fees, or marketing payments.
The PTE that most advisors working in the retirement space will need to satisfy is called the Best Interest Contract Exemption (BICE). The BICE exemption provides relief from the DOL’s restriction against conflicted compensation (again, compensation that differs based upon the recommendation/investment purchase). As mentioned, there are onerous and costly requirements placed on the financial institutions, and we have already seen very diverse responses in the marketplace as a result.
From the advisor’s perspective, it will be very important to understand when the BICE is necessary for the compensation arrangement agreed to between you and the client, and it will be equally important that you establish processes and record keeping to support that your advice is in the client’s best interest. Training staff will be important, and you may need to upgrade your client databases to be certain that you know which current clients would fall under the rule. We will talk in a few minutes about your new obligations to existing clients and in what circumstances those arrangements are grandfathered under the rule.
The BICE requires that both the advisor and the financial institution acknowledge fiduciary status. The advice must be in the client’s best interest (document, document, document!), the compensation must be no more than reasonable, and there can be no misleading statements. Unfortunately, the DOL has not defined reasonable compensation, though it does note that advisor fees or other compensation may vary based upon the product type and other neutral factors. Financial institutions must warrant that neither the firm nor its advisors will rely upon quotas, bonuses, contests, or other incentive programs that may cause an advisor to make a recommendation not in the client’s best interest. The DOL has provided technical guidance noting that grids based upon increased production should be gradual and should not be retroactive, so we expect to see changes to many industry norms.
Clearly, the DOL has expressed its strong preference for flat fee arrangements or fees based on assets under management. Note that if you have discretionary control over the assets, the BICE is not available—discretionary control requires full fiduciary duty with no conflicts of interest.
The DOL objective was to provide particularly strong protections to IRA holders and to rollover transactions. This is an issue in litigation questioning the DOL’s authority to write fiduciary rules for IRAs. When advising a participant to roll assets from a plan to an IRA—even if charging a level fee for the IRA investments—you must satisfy the BICE’s level-fee fiduciary rules. This is sometimes called the BICE Lite, as it does not require many of the provisions of the full BICE exemption. The level-fee fiduciary rules also apply when changing from a commission arrangement to a level-fee arrangement.
The most significant provision of the BICE exemption is when advising IRA owners. The rule requires that the financial institution and the client enter into a contract—the advisor is not a party to the contract—that acknowledges fiduciary status and that gives the client a private right of action in court rather than reliance on normal ERISA claims procedures. The contract can allow arbitration but must also allow class action complaints. In other words, rather than the DOL being the primary enforcement agency, courts across the country will be determining terms such as best interest and reasonable compensation and what constitutes a breach of fiduciary duty. The BICE contract is required for IRAs but not for employer-sponsored plans, including SEPs and SIMPLEs.
There is a limited grandfather provision that permits advisors and financial institutions to receive otherwise conflicted compensation in connection with advice and transactions made prior to April 10, 2017 (the effective date of this final rule). Please note that the DOL has delayed the applicability date for the rule to June 9, and that between June 9, 2017 and January 1, 2018, many of the requirements have been suspended. The rule allows transfer of funds within family funds as well. Advisors can notify existing clients of their new fiduciary duty without a requirement that the client acknowledge such notice (negative consent).
Not surprisingly, this complex rule dramatically impacts financial institutions as they determine how to establish policies and procedures that mitigate conflicts of interest, create the required website, draft disclosures and the BICE contract itself, and educate/supervise and assure compliance by their advisors. Some have simply exited the retirement space; others are moving to fee-only arrangements; others have created products that are specific to qualified money; and still others are embracing the rule and implementing the technology and systems necessary to continue to serve retirement savers. However, the most important information for advisors is what their own financial institutions are doing, and that is an evolving process.
Department of Labor Seeks Delay of Applicability Date
The White House sent a memo to the department instructing that DOL complete a new analysis of the impact of the rule, specifically to determine whether the rule, as written, will harm investors by reducing access or will increase costs or litigation risks, and whether the rule will create disruptions in the marketplace. If any of these are determined to exist, the department must revise or rescind the rule.
In response to this directive from the White House, the DOL sought a delay in the April 10, 2017 applicability date so that it can conduct a preliminary analysis. The DOL is also seeking additional information and data via comment letters due in June. The DOL finalized its regulation, delaying the applicability date to June 9, 2017. The department also suspended most of the requirements of the exemptions while it completes its review as directed by the White House. We expect to see revisions to the rule, a rescission, and/or additional delays as a result of this new cost-benefit analysis.
Litigation against the DOL:
- In June, NAIFA, NAIFA-Texas, and five NAIFA local associations in Texas (Amarillo, Dallas, Fort Worth, Great Southwest, and Wichita Falls) joined the ACLI in challenging the DOL fiduciary rule in the US District Court for the Northern District of Texas. (The ACLI is the American Council of Life Insurers, the national trade group for life insurance companies.)
- The court heard oral arguments on the summary judgment motions on Thursday, November 17, 2016. The decision of the court was in favor of the Department of Labor and notices of appeal have been filed by the plaintiffs.
Judi Carsrud, of Falls Church, Virginia, is director of federal relations with NAIFA. She meets with members of Congress, regulatory agencies and industry association partners to advocate for a positive legislative and regulatory environment. Her primary advocacy areas include tax and ERISA issues relative to insurance industry products and retirement savings plans.