This is my 50^{th} 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.
When the Department of Labor announced that the fiduciary rule and the transition exemptions would apply on June 9, it also issued a non-enforcement policy and a set of Frequently Asked Questions (FAQs) and Answers. The FAQs are titled “Conflict of Interest FAQs (Transition Period).”
For the most part, the FAQs are benign and helpful. However, FAQ 6 raises some significant issues for broker-dealers and RIA firms. In relevant part, FAQ 6 states:
During the transition period, the Department expects financial institutions to adopt such policies and procedures as they reasonably conclude are necessary to ensure that advisers comply with the impartial conduct standards. During that period, however, the Department does not require firms and advisers to give their customers a warranty regarding their adoption of specific best interest policies and procedures, nor does it insist that they adhere to all of the specific provisions of Section IV of the BIC Exemption as a condition of compliance. Instead, financial institutions retain flexibility to choose precisely how to safeguard compliance with the impartial conduct standards, whether by tamping down conflicts of interest associated with adviser compensation, increased monitoring and surveillance of investment recommendations, or other approaches or combinations of approaches. For example, some firms have indicated that they intend to rely upon or build on existing regulatory compliance structures to monitor their advisers’ sales practices and recommendations, document the bases for those recommendations, and ensure that the impartial conduct standards are met (e.g., by subjecting transactions involving conflicts of interest to heightened scrutiny and surveillance).
As a general rule, the Best Interest Contract Exemption (BICE) requires only that broker-dealer and RIAs comply with the Impartial Conduct Standards. The Impartial Conduct Standards are:
The best interest standard of care.
No more than reasonable compensation.
No materially misleading statements.
However, the quoted language from FAQ 6 has the effect of adding a fourth requirement. It is that RIAs and broker-dealers, as financial institutions, adopt the policies and procedures “as they reasonably conclude are necessary to ensure that advisers comply with the Impartial Conduct Standards.”
That language should not be ignored. That is because, among other reasons, the non-enforcement policy requires that financial institutions, such as broker-dealers and RIAs, make a “diligent and good-faith” effort to comply with BICE. Since this additional requirement is imposed as a condition of BICE, it seems difficult to imagine that the non-enforcement policy would be available to a broker-dealer or RIA who did not adopt appropriate policies, procedures, practices and supervision.
Then, the question is, what is “appropriate”? The quoted language provides several alternatives. Those are:
Review and determine that existing policies, procedures and supervision is adequate for ensuring that the impartial conduct standards are met.
Review and revise existing policies, procedures and supervision, as needed.
Adjust adviser compensation to reduce and/or to otherwise manage the effects of conflicts of interest that arise from varying levels of compensation.
Heightened scrutiny, surveillance and supervision of transactions involving conflicts of interest.
Monitoring advisers’ sales practices and recommendations, including documenting the basis for recommendations.
A combination of the above and/or possibly other reasonable practices.
As I read this requirement, a good approach is for a financial institution to review its existing policies, procedures, compensation practices and supervision, and document why they will “ensure that advisers comply with the Impartial Conduct Standards.” No particular approach is required for doing that, but appropriate steps should be taken. (By the way, I specifically mention documentation of the decision because financial institutions may be required to demonstrate that they complied with this requirement. Also, under ERISA, the DOL has specifically stated that documentation is an integral part of a prudent process, and it appears likely that those requirements will apply to fiduciary services under BICE, as well.)
During the transition period, it is possible, perhaps even likely, that the DOL will accept any reasonable efforts to comply with this requirement. In other words, the DOL will probably apply a “reasonable efforts” standard, rather than a “strict compliance” standard. However, the attorneys who represent investors—most likely in arbitrations—will probably push for a higher standard. With that in mind, the broker-dealers and RIAs need to think about the policies, procedures, compensation practices and supervision that will appropriately manage the risk in that more demanding scenario.
The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.
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 on DOL’s Fiduciary #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 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 22-Banks and Prohibited Transactions: Interesting Angles on the DOL’s Fiduciary Rule #22
Part 24 - Differential Compensation Based on Neutral Factors: Interesting Angles on DOL’s Fiduciary Rule #24
Part 25-Reasonable Compensation Versus Neutral Factors: Interesting Angles on the DOL’s Fiduciary Rule #25
Part 27 - Definition of Compensation: Interesting Angles on DOL’s Fiduciary Rule #27
Part 28 - What About Rollovers that Aren’t Recommended?: Interesting Angles on the DOL’s Fiduciary Rule #28
Part 29- Capturing Rollovers: What Information is Needed?: Interesting Angles on the DOL’s Fiduciary Rule #29
Part 31 - “Un-levelizing” Level Fee Fiduciaries: Interesting Angles on the DOL’s Fiduciary Rule #31
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 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 47- “Real” Requirements of Fiduciary Rule: Interesting Angles on DOL’s Fiduciary Rule #47
Part 49- The Requirement to Disclose Fiduciary Status: Interesting Angles on the DOL’s Fiduciary Rule #49
Part 51- Recommendations to Transfer IRAs: Interesting Angles on the DOL’s Fiduciary Rule #51
Part 54 - The DOL’s RFI and Possible changes to BICE: Interesting Angles on the DOL’s Fiduciary Rule #54
Part 55- DOL’s RFI and Recommendation of Annuities- Interesting Angles on DOL’s Fiduciary Rule #55
Part 58- Recommendations to Contribute to a Plan or IRA- Interesting Angles on the DOL’s Fiduciary Rule #58
Part 60- What the Tibble Decision Means to Advisers: Interesting Angles on the DOL’s Fiduciary Rule #60
Part 61- The Fiduciary Rule, Distributions and Rollovers: Interesting Angles on the DOL’s Fiduciary Rule #61
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-The Fiduciary Rule and Recordkeeper Services: Interesting Angles on the DOL’s Fiduciary Rule #70
Part 71- Recordkeepers and Financial Wellness Programs: Interesting Angles on the DOL’s Fiduciary Rule #71
Part 72-The "Wholesaler" Exception: Interesting Angles on the DOL’s Fiduciary Rule #72
Part 74 -One More Fiduciary Issue for Recordkeepers: Interesting Angles on the DOL’s Fiduciary Rule #74
Part 75 - The Fiduciary Rule: Mistaken Beliefs-Interesting Angles on the DOL’s Fiduciary Rule #75
Part 77 - The Fiduciary Rule: Mistaken Beliefs (#2): Interesting Angles on the DOL’s Fiduciary Rule #77
Part 78 - The Fiduciary Rule: Mistaken Beliefs (#3): Interesting Angles on the DOL’s Fiduciary Rule #78
Part 79 - The Fiduciary Rule: Mistaken Beliefs (#4)- Interesting Angles on the DOL’s Fiduciary Rule #79
Part 80 - Enforceable During Transition?: Interesting Angles on the DOL’s Fiduciary Rule #80
Part 83 - Part 2 of Undisclosed (and Disclosed) 12b-1 Fees: Interesting Angles on the DOL’s Fiduciary Rule #83
Part 85 -The Fiduciary Rule: What’s Next (Part 1)? : Interesting Angles on the DOL’s Fiduciary Rule #85
Part 86- The Fiduciary Rule: What’s Next (Part 2)?: Interesting Angles on the DOL’s Fiduciary Rule #86
Part 87 - The Fiduciary Rule: What’s Next (Part 3)?: Interesting Angles on the DOL’s Fiduciary Rule #87
Part 88 -The Fiduciary Rule: What’s Next (Part 4)? : Interesting Angles on the DOL’s Fiduciary Rule #88