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Parallels Between the SEC Regulation Best Interest and the DOL Best Interest Contract Exemption (Part 2): Interesting Angles on the DOL’s Fiduciary Rule #91

Parallels Between the SEC Regulation Best Interest and the DOL Best Interest Contract Exemption (Part 2)

This is my 91st article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws—including the SEC’s “best interest” proposals.

This article continues my discussion of the similarities between the SEC’s proposed Regulation Best Interest (Reg BI) for broker-dealers and the DOL’s Best Interest Contract Exemption (BICE).

In addition to the standard of care (best interest and loyalty), Reg BI also has enhanced protections for conflicts of interest. Interestingly, they closely parallel the DOL’s conditions in BICE. For example, Reg BI proposes to require that material conflicts of interest involving financial incentives be eliminated or, alternatively, be disclosed and mitigated. The key word is “mitigated.” While the SEC guidance refers to “financial incentives” and the DOL refers to “compensation,” the outcome is much the same. ERISA and the Internal Revenue Code prohibit compensation that results from fiduciary recommendations, where the compensation is paid by a third party (for example, insurance commissions or 12b-1 fees) or where the compensation is variable, based on the recommendations (for example, commissions on securities transactions). Those types of payments are, in the view of the SEC, “material conflicts of interest involving financial incentives.”

In BICE, the DOL said that fiduciary advisors (which could include broker-dealers and their representatives) needed to have policies, procedures and practices in place to ensure that the compensation did not incent advisors to make recommendations that were not in the best interest of retirement investors. Similarly, the SEC says that broker-dealers must eliminate, or disclose and mitigate, conflicts of interest that involve financial incentives. As examples of “mitigation,” the SEC and DOL both gave the following:

  • Within a particular investment category, compensation could be levelized. For example, the initial compensation and trailing compensation for all mutual fund sales could be set at the same level. As a hypothetical, that might be a 3% initial commission (or load) on all mutual funds, with a uniform 25 basis point trailing 12b-1 fee.

  • Among investment categories, a broker-dealer might base differences in compensation on “neutral” factors. For example, if it took twice as much work to explain and sell a variable annuity contract, that would be a neutral factor that would justify twice as much compensation for the sale of an individual variable annuity. Hypothetically, if reasonable and level compensation for mutual fund sales was 3%, then in my hypothetical, first-year compensation of 6% could be justified for the sale of a variable annuity.

Keep in mind, though, that those are just examples about how the mitigation requirement could be satisfied. If the SEC’s Reg BI is finalized in its current form, broker-dealers will need to implement those policies or adopt other practices that are reasonably designed to mitigate the impact of material conflicts of interest arising from financial incentives associated with investment recommendations. (More technically, the SEC proposes that Reg BI would apply to recommendations of securities transactions and investment strategies that involve investment transactions.) Based on the examples used by the SEC, it appears that the Commission is serious about mitigation of the incentive effect of those payments.

As this article suggests, in order to fully appreciate the SEC’s Reg BI, broker-dealers need to understand the development and history of the DOL’s BICE. There are remarkable parallels. In fact, it would be difficult to understand some concepts, such as neutral factors, without having worked on BICE compliance issues.

However, it also means that broker-dealers who are in substantial compliance with the final BICE requirements–as opposed to the transition rules–have already substantially satisfied the SEC’s proposed rules. That’s good news. It means that the hard work put in by those firms, and the costs involved, will have been worth it. It also means that, for broker-dealers who were not close to being in compliance with full BICE, practices and compensation arrangements developed by others can be used to develop compliant practices for the SEC guidance.

Part 1- Interesting Angles on DOL’s Fiduciary Rule #1

Part 2 - Best Interest Standard of Care: Interesting Angles on the DOL’s Fiduciary Rule #2 

Part 3 - Hidden Preamble Observations: Interesting Angles on the DOL’s Fiduciary Rule #3

Part 4 - TV Stock Tips and Fiduciary Advice: Interesting Angles #4

Part 5 - Level Fee Fiduciary Exemption: Interesting Angles on DOL’s Fiduciary Rule #5

Part 6 - Fiduciary Regulation And The Exemptions: Interesting Angles on the DOL’s Fiduciary Rule #6

Part 7 - Fiduciary Regulations And The Exemptions : Interesting Angles on the DOL’s Fiduciary Rule #7

Part 8 - Designated Investment Alternatives: Interesting Angles on the DOL’s Fiduciary Rule #8

Part 9 - Best Interest Standard and the Prudent Man Rule: Interesting Angles on the DOL’s Fiduciary Rule #9

Part 10 - FINRA Regulatory Notice: Interesting Angles on the DOL’s Fiduciary Rule #10

Part 11-ERISA and the Internal Revenue Code: Interesting Angles on the DOL’s Fiduciary Rule #11

Part 12- Potential Prohibited Transactions: Interesting Angles on the DOL’s Fiduciary Rule #12

Part 13-Investment Policies: Interesting Angles on the DOL’s Fiduciary Rule #13

Part 14- Investment Suggestions: Interesting Angles on the DOL’s Fiduciary Rule #14

Part 15- Best Interest Contract Exemption: Interesting Angles on the DOL’s Fiduciary Rule #15

Part 16 - Adviser Recommendations: Interesting Angles on DOL’s Fiduciary Rule #16

Part 17 - Level Fee Fiduciary: Interesting Angles on DOL’s Fiduciary Rule #17

Part 18- Best Interest Contract Exemption and IRA Advisor Compensation: Interesting Angles on the DOL’s Fiduciary Rule #18

Part 19- Interesting Angles on the DOL’s Fiduciary Rule #19: Advisors' Use of "Hire Me" Practices.

Part 20- Three Parts of "Best Interest Standard of Care": Interesting Angles on the DOL’s Fiduciary Rule #20

Part 21- Retirement Plan Documentation and Prudent Recommendation: Interesting Angles on the DOL’s Fiduciary Rule #21

Part 22-Banks and Prohibited Transactions: Interesting Angles on the DOL’s Fiduciary Rule #22

Part 23-Prohibited Transactions: IRA and RIA Qualified Money: Interesting Angles on the DOL’s Fiduciary Rule #23

Part 24 - Differential Compensation Based on Neutral Factors

Part 25-Reasonable Compensation Versus Neutral Factors: Interesting Angles on the DOL’s Fiduciary Rule #25

Part 26- Interesting Angles on the DOL’s Fiduciary Rule #26- Reasonable Compensation for IRAs: When and How Long?

Part 27 - Definition of Compensation

Part 28 - What About Rollovers that Aren’t Recommended?: Interesting Angles on the DOL’s Fiduciary Rule #28

Part 29- Interesting Angles on the DOL’s Fiduciary Rule #29- Capturing Rollovers: What Information is Needed?

Part 30- Three Kinds of Level Fee Fiduciaries . . . and What’s A “Level Fee?”: Interesting Angles on the DOL’s Fiduciary Rule #30

Part 31 - Interesting Angles on the DOL’s Fiduciary Rule #31: “Un-levelizing” Level Fee Fiduciaries

Part 32 - What “Level Fee Fiduciary” Means for Rollover Advice: Interesting Angles on the DOL’s Fiduciary Rule #32

Part 33- Discretionary Management, Rollovers and BICE: Interesting Angles on the DOL’s Fiduciary Rule #33

Part 34- Seminar Can Be Fiduciary Act: Interesting Angles on DOL’s Fiduciary Rule #34

Part 35- Presidential Memorandum on Fiduciary Rule: Interesting Angles on the DOL’s Fiduciary Rule #35

Part 36 -Retirement Advice and the SEC: Interesting Angles on the DOL’s Fiduciary Rule #36

Part 37 - SEC Retirement-Targeted Examinations: Interesting Angles on the DOL’s Fiduciary Rule #37

Part 38- SEC Examinations of RIAs and Broker-Dealers under the ReTIRE Initiative: Interesting Angles on the DOL’s Fiduciary Rule #38

Part 39- FINRA Regulatory Notice 13-45: Guidance on Distributions and Rollovers: Interesting Angles on the DOL’s Fiduciary Rule #39

Part 40 - New Rule, Old Rule - What Should Advisers Do Now?: Interesting Angles on the DOL’s Fiduciary Rule #40

Part 41 - While We Wait: The Current Fiduciary Rule and Annuities: Interesting Angles on DOL’s Fiduciary Rule #41

Part 42 - Rollovers under DOL’s Final Rule: Interesting Angles on DOL’s Fiduciary Rule #42

Part 43 - BICE Transition: More Than the Eye Can See - Interesting Angles on DOL’s Fiduciary Rule #43

Part 44 - Basic Structure of Fiduciary Package (June 9): Interesting Angles on DOL’s Fiduciary Rule #44

Part 45 - DOL Fiduciary “Package”: Basics on the Prohibited Transaction Exemptions: Interesting Angles on the DOL’s Fiduciary Rule #45

Part 46 - How Does an Adviser Know How to Satisfy the Best Interest Standard?: Interesting Angles on the DOL’s Fiduciary Rule #46

Part 47- “Real” Requirements of Fiduciary Rule: Interesting Angles on DOL’s Fiduciary Rule #47

Part 48- The Last Word: The Fiduciary Rule Applies on June 9- Interesting Angles on the DOL’s Fiduciary Rule #48

Part 49- The Requirement to Disclose Fiduciary Status: Interesting Angles on the DOL’s Fiduciary Rule #49

Part 50- Fourth Impartial Conduct Standard: Interesting Angles on DOL’s Fiduciary Rule #50

Part 51- Interesting Angles on the DOL’s Fiduciary Rule #51: Recommendations to Transfer IRAs

Part 52 - Interesting Angles on the DOL’s Fiduciary Rule #52: The Fiduciary Rule and Exemptions: How Long Will Our Transition Be?

Part 53 - Fiduciary Rule and Discretionary Investment Management: Interesting Angles on DOL’s Fiduciary Rule #53

Part 54 - Interesting Angles on the DOL’s Fiduciary Rule #54: The DOL’s RFI and Possible changes to BICE

Part 55- DOL’s RFI and Recommendation of Annuities- Interesting Angles on DOL’s Fiduciary Rule #55

Part 56-Recommendations of Contributions as Fiduciary Advice: Interesting Angles on the DOL’s Fiduciary Rule #56

Part 57- Relief from 408(b)(2) Requirement on Change Notice: Interesting Angles on the DOL’s Fiduciary Rule #57

Part 58- Recommendations to Contribute to a Plan or IRA- Interesting Angles on the DOL’s Fiduciary Rule #58

Part 59- What Plans and Arrangements Are Covered by the Fiduciary Rule: Interesting Angles on the DOL’s Fiduciary Rule #59

Part 60- What the Tibble Decision Means to Advisers: Interesting Angles on the DOL’s Fiduciary Rule #60

Part 61- Interesting Angles on the DOL’s Fiduciary Rule #61: The Fiduciary Rule, Distributions and Rollovers

Part 62 - Is It Possible To Be An Advisor Without Being A Fiduciary? - Interesting Angles on the DOL’s Fiduciary Rule #62

Part 63-Policies and Procedures: The Fourth BICE Requirement - Interesting Angles on the DOL’s Fiduciary Rule #63

Part 64 -What Does the Best Interest Standard of Care Require?-Interesting Angles on the DOL’s Fiduciary Rule #64

Part 65- Unexpected Consequences of Fiduciary Rule - Interesting Angles on the DOL’s Fiduciary Rule #65

Part 66- Concerns About 408(b)(2) Disclosures: Interesting Angles on the DOL’s Fiduciary Rule #66

Part 67- From the DOL to the SEC - Interesting Angles on the DOL’s Fiduciary Rule #67

Part 68-Recommendations of Distributions - Interesting Angles on the DOL’s Fiduciary Rule #68

Part 69- Compensation Risks for Broker-Dealers and RIAs: Interesting Angles on the DOL’s Fiduciary Rule #69

Part 70-Interesting Angles on the DOL’s Fiduciary Rule #70: The Fiduciary Rule and Recordkeeper Services

Part 71- Senate, Tax Cuts and Jobs Act, income tax rate, Corporate Tax Rate, Passthrough Entities, Foreign Income, Qualified Property, Interest Deduction Limitation

Part 72-Interesting Angles on the DOL’s Fiduciary Rule #72 - The "Wholesaler" Exception

Part 73- Interesting Angles on the DOL’s Fiduciary Rule #73: Recordkeeper Investment Support for Plan Sponsors

Part 74 -Interesting Angles on the DOL’s Fiduciary Rule #74: One More Fiduciary Issue for Recordkeepers

Part 75 - Interesting Angles on the DOL’s Fiduciary Rule #75: The Fiduciary Rule: Mistaken Beliefs

Part 76 - Interesting Angles on the DOL’s Fiduciary Rule #76

Part 77 - Interesting Angles on the DOL’s Fiduciary Rule #77: The Fiduciary Rule: Mistaken Beliefs (#2)

Part 78 - Interesting Angles on the DOL's Fiduciary Rule #78: The Fiduciary Rule: Mistaken Beliefs (#3) 

Part 79 - Interesting Angles on the DOL’s Fiduciary Rule #79-The Fiduciary Rule: Mistaken Beliefs (#4)

Part 80 - Enforceable During Transition?: Interesting Angles on the DOL’s Fiduciary Rule #80

Part 81 - Interesting Angles on the DOL’s Fiduciary Rule #81: The Fiduciary Rule Prohibits Commissions... or Not (Myth #6)

Part 82 - Interesting Angles on the DOL’s Fiduciary Rule #82- Undisclosed (and Disclosed) 12b-1 Fees: The Different Views of the SEC and DOL

Part 83 - Part 2 of Undisclosed (and Disclosed) 12b-1 Fees: Interesting Angles on the DOL’s Fiduciary Rule #83

Part 85 - Interesting Angles on the DOL’s Fiduciary Rule #85

Part 86 - Interesting Angles on DOL's Fiduciary Rule #86

Part 87 - What's Next for DOL's Fiduciary Rule #87

Part 88 -The Fiduciary Rule: What's Next Part 4 #88

Part 89 - The 5th Circuit Decision, Prohibited Transactions, and New Non-Enforcement Policies: Interesting Angles on the DOL’s Fiduciary Rule #89

Part 90 - Interesting Angles on the DOL’s Fiduciary Rule #90

©2018 Drinker Biddle & Reath LLP. All Rights Reserved

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About this Author

Fred Reisch, Drinker Biddle Law Firm, Los Angeles, Labor and Employment Law Attorney
Partner

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.

Fred works with both private and public sector entities and their plans and fiduciaries and represents plans, employers and fiduciaries before federal agencies such as the DOL and IRS. He consults with banks, trust companies, insurance companies and mutual fund management companies on 401(k) recordkeeping services, investment products and...

(310) 203-4047