October 16, 2017

October 13, 2017

Subscribe to Latest Legal News and Analysis

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

Unexpected Consequences of Fiduciary Rule

This is my 65th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

The fiduciary and best interest standards of care, as well as the prohibited transaction rules, will impact advisors in some unexpected ways. That is particularly true of investment advice to IRAs. Here is an example.

When plan or IRA assets are held by a custodian, an advisor often has the ability to recommend either transaction-fee (TF) mutual funds or no-transaction fee (NTF) mutual funds. The recommendation of either TF or NTF funds is a fiduciary act for plan assets, and it will be a best interest act for IRA assets—if the advisor or his or her firm receives any payments beyond a stated advisory fee that is level. (In effect, the payments from the custodian “unlevelize” the advisory fee.)

For both the prudence and best interest standards of care (which are virtually identical), an advisor must consider whether it is prudent to recommend a TF fund or an NTF fund. The issue is that NTF funds typically have a higher expense ratio, while TF funds charge an initial transaction cost but usually have a lower expense ratio. As a general statement, NTF funds would be appropriate for short-term holdings, while TF funds would be more cost-effective for longer term holdings.

To further compound matters, there are also prohibited transaction issues. Some custodians pay money to advisors if the advisors select NTF funds (because, I assume, the custodians make more money on NTF funds). The Department of Labor would consider those payments to be prohibited transactions, since they result from an advisor’s recommendation and since they generate payments above and beyond the advisor’s stated level fee.

However, not all is lost. Under the Best Interest Contract Exemption (BICE), where an advisor receives additional compensation that is prohibited under these rules, the additional compensation is permissible, if the conditions of the exemption are met. One of the BICE conditions is that the total compensation cannot be more than a reasonable amount. Note that, for plan purposes, the additional compensation would need to be disclosed in the advisor’s 408(b)(2) disclosures. In addition, and for both plan and IRA assets, it is possible, perhaps even likely, that an assertion could be made that undisclosed compensation is impermissible (since, arguably, the advisor is setting its own compensation as a result of the nondisclosure). As a result, an advisor should disclose, at the beginning of the fiduciary relationship, all of the compensation which the advisor will or may receive.

However, there are two other conditions for BICE. The first is that the advisor cannot make any materially misleading statements about the transactions or the compensation. The second is that the advisor must adhere to the best interest standard of care. That standard of care includes deciding whether the prudent recommendation is to use TF or NTF funds. If those conditions are not satisfied, the additional compensation is impermissible, at least from the perspective of the Department of Labor.

To make matters even more complex, the Best Interest Contract Exemption only protects compensation resulting from non-discretionary advice. So, for example, if the advisor is the one who decides to use NTF funds, that decision amounts to discretion. In that case, BICE would not be available to permit the prohibited payments from the custodian.

Now that the final fiduciary rule applies (as of June 9, 2017), advisors need to review all of their sources of compensation directly or indirectly from “qualified” assets (that is, plans, participants or IRAs). The changes are more far-reaching than most people think.

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

©2017 Drinker Biddle & Reath LLP. All Rights Reserved

TRENDING LEGAL ANALYSIS


About this Author

Fred Reish, Partner, Drinker Biddle,  Employee Benefits & Executive Compensation
Partner

C. Frederick Reish is a partner in the firm's Employee Benefits & Executive Compensation Practice Group, Chair of the Financial Services ERISA Team and Chair of the Retirement Income Team.  His practice focuses on fiduciary issues, prohibited transactions, tax-qualification and DOL, SEC and FINRA examinations of retirement plans and IRA issues.

Fred's experience includes advising insurance companies and investment managers of the development of products and services that are consistent with ERISA's...

(310) 203-4047