On April 6, 2016, the U.S. Department of Labor (“DOL”) published its long-awaited conflicts of interest rule (the “Rule”) aimed at protecting retirement savers by requiring all persons (including investment advisers, broker-dealers, insurance companies, and other persons) who render investment advice to ERISA plans, plan participants and IRA owners to adhere to ERISA’s fiduciary standard obligating such persons to put their own interests ahead of their profits. The Rule is long and controversial and there is the chance that Congress will oppose the adoption of the Rule.
Broker-dealers and insurance companies will be more significantly impacted by the Rule as compared with fee-only advisers because fee-only advisers have historically been subject to the SEC and DOL’s fiduciary standard requiring them to act in their clients’ best interest and because broker-dealers and others rely heavily on commission-based compensation arrangements. Although ERISA otherwise prohibits covered fiduciaries from receiving commission-based compensation (because of the resulting conflicts of interest), the DOL has created the best interest contract exemption (“BICE”) that will permit broker-dealers and other fiduciaries to retain commission-based arrangements as long as the fiduciary enters into a contract with the plan sponsor, plan participant or IRA owner agreeing to be bound by the ERISA fiduciary standard, to adopt policies and procedures designed to address conflicts of interest, and to disclose conflicts of interest and other delineated information.
Clarifications to the 2015 proposal show that the impact of the Rule on fee-only investment advisers will be relatively muted. The primary impact is with regard to rollovers from a retirement plan to an IRA. The DOL believes that there is a conflict with recommending such a rollover. The DOL explained that advisers charging “Level Fees” (fixed asset-based fees) can rely on the BICE to cure the conflict with respect to rollovers without entering into the onerous BICE contract. In order to do so, the adviser must keep documentation as to why the recommendation to roll over assets from a plan or IRA to a Level-Fee arrangement or from a commission arrangement to a Level-Fee arrangement is in the client’s best interest. Specifically, advisers must evaluate the other investment alternatives as well as fees charged in making recommendations on rollovers.
We have expressed concerns over the Rule, especially without similar action from the SEC. Investors are confused over the standard of care owed to them by broker-dealers (suitability) and investment advisers (fiduciary). While broker-dealers will now be deemed fiduciaries to retirement accounts, that duty will not extend to non-retirement accounts. If investors were confused over the standard of care owed to them in the past, it’s hard to imagine that they will understand better now that the standard will be different among their accounts.
There are changes and clarifications from the 2015 proposal that mostly softened the impact on fiduciaries. We will continue to analyze the Rule in more detail and offer additional commentary as developments warrant. Below, however, are some of the noteworthy provisions and changes to the Rule.
- The BICE’s contract requirement affords plan sponsors, plan participants and IRA owners a private right of action against fiduciaries if they fail to satisfy such contractual obligations.
- The DOL provided relief with respect to the implementation timeframe for the Rule and the BICE. While the Rule and the BICE will become effective as of January 1, 2017, many of the BICE requirements will not become mandatory until January 1, 2018, including the contract requirement, the disclosure requirement, and the conflicts of interest policies and procedures requirement.
- The Rule adds clarity and relaxes certain requirements contained in the original proposal. Some include:
- The DOL has clarified that certain categories of education information offered by firms do not constitute “recommendations” constituting fiduciary investment advice covered by the Rule.
- Firms recommending their own services will not be considered to be offering a “recommendation” subject to the Rule as long as they do not otherwise offer investment recommendations, including advice relating to rollovers.
- The DOL clarified that the BICE will be available with respect to advice relating to all asset classes and proprietary products.
- The DOL explained that the BICE’s contract requirement will not apply to ERISA plan sponsors or participants. So the fiduciary can take advantage of the exemption, but doesn’t have to provide the substantial contract otherwise required.
- The DOL streamlined some of the contract execution mechanics and disclosure requirements contained in the BICE in response to comments from the financial services industry.
- The DOL clarified that fiduciaries need not recommend the lowest-cost products if other products are in the client’s best interest.
- Although the DOL has provided the above clarifications and relief that softened the Rule’s impact on broker-dealers and advisers, the agency also increased compliance burdens on those selling variable and fixed index annuities as such fiduciaries must now rely on the more onerous BICE in selling such products (as opposed to the exemption previously available to them).