This article was originally posted on May 16, 2017, and has since been revised in light of the DOL FAQs 5-2017.  Revisions are indicated by strikethrough (for deletions) and in italics for new information.    

The June 9, 2017 deadline imposed by the Department of Labor’s (DOL) Fiduciary Rule is coming up fast, and there are probably a number of financial services firms scratching their heads about what they need to do to comply.  That’s not surprising, given the many twists and turns this complicated rule has taken since the original proposal was released in October 2010.   Labor Department Secretary Alexander Acosta said in a Wall Street Journal opinion piece on May 22 there will be no more delays in the Fiduciary Rule’s applicability date.  Of course, there’s still the possibility that the rule could be repealed if the GOP’s proposed Financial Choice Act ultimately gets passed, but consumers have already received some serious schooling on the conflicted advice that some financial advisors provide.  (See John Oliver’s Last Week Tonight Video about the fiduciary standard.)   So advisers may be seeing clients demanding more disclosure regarding fees and conflicts of interest.

Just to recap, back in April, the DOL issued a regulation delaying the applicability date of the Fiduciary Rule until June 9, 2017.  The applicability date of all of the new and amended prohibited transaction exemptions, including the Best Interest Contract Exemption (“BICE”) was also extended until June 9, 2017.  But the DOL also has significantly reduced the compliance burdens during the transition period (from June 9, 2017 to January 1, 2018).  Financial institutions that want to rely on the prohibited transaction exemptions cited in the Fiduciary Rule now no longer will have to provide transition disclosures, appoint a BICE officer, or create transition agreements, but they will have to comply with the Impartial Conduct Standards.

What do you need to know?

As of June 9, 2017:

1. Insurance agents, registered representatives of broker dealers and solicitors will now be considered ERISA fiduciaries when giving advice to clients with retirement assets. Investment advisers and investment adviser representatives have always been subject to fiduciary duties.
2. Firms that receive payments in addition to an investment management fee can continue to receive those fees. They will need to rely on the Best Interest Contract Exemption (BICE), which means that they must comply with impartial conduct standards (at least until January 1, 2018, when additional requirements kick in).
3. New referral arrangements can result in prohibited transactions if payments are made in connection with ERISA-covered plans and IRAs. Referral fees paid in connection with investment recommendations relating to retirement assets made before June 9, 2017 are permitted, so long as they are disclosed.
4. IRA rollover recommendations are now considered investment advice, requiring documentation evidencing why the recommendation is in the best interest of the investor.
5. Insurance agents selling non-annuity insurance contracts and annuities to retirement investors can rely on Prohibited Transaction Exemption 84-24 (“PTE 84-24”). Additional disclosure will be required, including the agent’s initial and recurring compensation, expressed as a percentage of the commission payments. The retirement investor must acknowledge receipt of that information and affirm the transaction in writing.    The DOL’s Conflict of Interest FAQs (Transition Period) states that the applicability of the 2016 amendments are delayed until January 1, 2018, except for the impartial conduct standards, which are applicable on June 9, 2017.  “Accordingly, parties may rely on PTE 84-24, subject to the existing conditions of the exemption and the impartial conduct standards, for recommendations involving all annuity contracts during the transition period.”

What do you need to do?

Financial services firms and their representatives that offer products and services to retirement plans, plan participants, and IRA owners will be subject to the DOL’s new fiduciary definition for providing investment advice and required to act in the best interest of these retirement clients.

These firms and their representatives need to:

1. Decide whether they are going to be level fee fiduciaries, and make sure they are not receiving any other payments in connection with advice to retirement plan assets
2. Determine whether the fees charged are reasonable based on the market
3. Adopt impartial conduct standards (if the firm is going to rely on BICE)
4. Develop process for documenting that IRA rollover transactions are in the best interest of the client (whether or not the firm is going to rely on BICE)
5. Educate, train and supervise financial advisers

Special Considerations for Hedge Fund and Private Equity Fund Managers

The impact of the Fiduciary Rule on private fund managers accepting retirement plan investments is not clear, since the DOL did not provide a specific exemption for investments in private funds.  It could be argued (and I would argue) that offering an investment in a private fund is not “a recommendation” as contemplated under the Fiduciary Rule, since it is not based on meeting the particular investment needs of a client.  To bolster this argument, a fund manager should consider including representations in the subscription agreement stating:

• the owner understands and agrees that the fund manager is not offering impartial fiduciary advice
• the owner has sufficient financial expertise to make the decision to invest
• the owner understands and agrees that fund manager is not providing specific advice or a recommendation as to whether the owner should invest in the fund

How do you know what you need to do?

1.  Level Fee Fiduciaries: If an adviser (i.e., investment adviser representatives, registered representatives of broker dealers, insurance agents, etc.) and his/her supervisory entity (i.e., registered investment advisers, broker-dealers, insurance companies, etc.) is a level fee fiduciary, then he or she can provide investment advisory services to retirement investors generally without engaging in a prohibited transaction.  However, if the level fee fiduciary provides advice on rolling over a client’s assets from an employer-provided retirement plan to an IRA, then the adviser would have to comply with the streamlined BICE requirements, i.e., “BICE-lite”;  the adviser has to provide written disclosure to the client of its fiduciary status, and comply with the impartial conduct standards.  During the transition period, June 9, 2017 to January 1, 2018, the adviser is only required to comply with the impartial conduct standards in order to rely on BICE.

If the firm and its representatives are going to be level fee fiduciaries, then the firm has to make sure that the firm nor its representatives are receiving fees from any other sources when managing retirement assets.  This means commissions, 12b-1 fees; trailing payments; revenue sharing payments from fund companies; solicitor’s fees; payments and other products and services from custodians. If any of those payments, or any other benefits (including as trips, gifts, or marketing allowances), are received by the adviser, his or her firm, or any affiliated or related party, partially or entirely as a result of recommendations to retirement clients, then the firm is not a level fee fiduciary, and must comply with full-blown BICE or another prohibited transaction exemption to continue to receive those payments.  It’s a good idea for firms to review all sources of income to make sure you are not missing any legacy relationships.

2.  Reasonable Fees: All advisers to clients with retirement assets (level fee or not) must meet the reasonable compensation standard as of June 9, 2017.  Firms should develop a process for reviewing fees being charged to clients on all investment products and services being offered.  The firm must have documented proof that it has reviewed and compared its fees to other similarly situated advisers (e.g., same geographic area, size complexity of engagement). Investment advisory firms are required to disclose their fee schedules on the Form ADV; therefore, other investment adviser firms can check out what their competitors charge using the Investment Adviser Public Disclosure Website (IAPD).  Firms can also consider any additional services provided to clients such as financial planning and consulting in determining whether the fees are reasonable based on the services provided.

Keep in mind an investment advisory firm does not have be the cheapest, but its compensation must not be excessive based on the going market rates for services rendered. The costs should be comparable to firms offering similar services.

3.  Adopt impartial conduct standards: The Impartial Conduct Standards requires that the fiduciary meet the following conditions relevant to ERISA plans and IRAs:

• Provide prudent investment advice
• Charge only reasonable compensation and
• Avoid misleading statements

As noted in the DOL’s most recent FAQs,

“(E)ven if a fiduciary adviser recommends proprietary products or investments that generate commissions or other payments that vary with the investment recommended, the adviser can meet the impartial conduct standards by ensuring that the recommendations are prudent; the investment advice is based upon the customer’s financial interests, rather than the adviser’s competing financial interests in the transaction; the communications are free from material misrepresentations; and the associated fees and charges are reasonable. Of course, to the extent the adviser limits recommendations to proprietary products or receives compensation that varies with the product recommended, the adviser should be candid about the compensation and the limits on investments.”

Prudent Advice:  Firms that want to rely on BICE have to be able to prove that they are providing prudent investment advice.  To meet this standard, financial advisory firms should perform two levels of due diligence. First, the firm must decide and document that the investment product being offered to retirement investors meets the standard of prudence, and second, the firm must decide and document that the product is appropriate for that particular investor at that time.

Recommendations:

• Document the due diligence performed on investment products being offered to clients. Has a comparison been done to determine whether products being offered meet client’s investment goals, have a decent performance record, and fees being charged are reasonable compared to the market?  Has the firm considered the risks and conflicts associated with the products, and does it have procedures in place to monitor risks and police any associated conflicts of interest.  The most important thing is to have documentation that the firm has done its homework.
• Evaluate the types of products and services the firm offers to determine whether they are appropriate for specific types of clients. Consider developing guidelines for financial advisers, including a recommended list.  Recommendations of products should be based on pre-determined guidelines, not on incentives.
• Supervise advisors to retirement investors to make sure that the recommendations are appropriate.

Reasonable Fees:  As previously discussed, firms have a duty to charge only reasonable compensation, so it’s important to have written documentation to show that its fees are in line with the market.

No misleading statements:  Given the emphasis by regulators like the SEC and FINRA on marketing and advertising, most financial service firms already have processes in place for reviewing client communications.  The process should require a review of all communications to retirement investors, including advertisements, websites, advisory contracts, disclosure documents and day-to-day communications.

Recommendations:

• Develop standardized templates to be used, and require periodic reviews and updates
• Review communications for consistency — Form ADV, website, disclosures provided to potential clients, and advisory contracts should all include consistent information

4,  Develop a process for documenting that IRA rollover transactions are in the best interest of the client (whether the firm is going to rely on streamlined BICE or full-blown BICE). Advisers recommending that clients roll over their assets from an employer-sponsored 401(k) plan to an IRA managed by the adviser will need to document the reasons why the rollover was considered to be in the retirement investor’s best interest.  The documentation should:

• compare fees and expenses of 401(k) plan and IRA
• determine whether the employer pays some or all of the plans’ administrative expenses
• compare the levels of services and investments available under each option and
• consider the individual needs and circumstances of the retirement investors

Recommendations:

• Gather information about the client’s current financial situation and investment goals, as well as information about client’s current 401(k) plan in order to prepare a comparison of fees and expense, services and investments options of the plan to the IRA solution the firm recommends.
• Educate the client on options regarding the assets in 401(k) plan, and the advantages and disadvantages of each. FINRA’s Investor Alert, The IRA Rollover: 10 Tips to Making a Sound Decision” provides an excellent, unbiased summary.
• Provide client with a side-by-side comparison of fees and expenses, services and investments options of the client’s current 401(k) plan to the IRA solution the firm recommends.
• Discuss the advantages and disadvantages of each of the options of an IRA rollover as they apply to that client’s specific situation. FINRA Regulatory Notice 13-45 is a good starting point, since it provides a checklist of items to be considered when discussing an IRA rollover

As an example, I have included a document that includes disclosures, a format for comparing an employer-sponsored retirement plan and an IRA, and an example of how to document the discussion of the various options with the client.  See the Rollover IRA Checklist.

5,  Educate, train and supervise financial advisers

There are a number of resources out there to help educate financial professionals on the requirements of the DOL’s Fiduciary Rule.  Hardin Compliance Consulting partnered with Focus 1 Associates to create an hour-long webinar, and an accompanying article.

Firms need to train their financial advisors on the specifics of their policies and procedures for adhering to the requirements of the rule, and compliance with the prohibited transaction exemptions such as BICE and PTE 84-24.  Understand that this may take time to sink in, so it is important that firms focus on supervising their representatives to ensure that the policies and procedures are followed.

Recommendations:

• Develop a supervisory structure to ensure that recommendations made to retirement investors are in line with the guidelines developed by the firm. This could include a process for reviewing and approving recommendations for retirement investors before implementation, or auditing a random sample after accounts have been opened.  Consider periodic testing as to whether recommendations made are in line with firm guidelines.
• Review accounts opened after new policies and procedures are in place to see whether representatives understand these new requirements. Lessons learned from the review process should be incorporated into additional training.  It takes time to adjust to change and sometimes it takes more than one training session for a new procedure to sink in.  Be prepared to provide refresher courses periodically.

The most recent FAQs indicate that the DOL intends to be merciful during the transition period.  The FAQs states:

The Department’s general approach to the June 9 implementation will be marked by an emphasis on compliance assistance (rather than citing violations and imposing penalties). This includes issuing a new temporary enforcement policy for the transition period, under which the Department will not pursue claims against fiduciaries who are working diligently and in good faith to comply with the fiduciary duty rule and exemptions. The temporary enforcement policy also includes confirmation from the Treasury Department and the IRS that the IRS will not apply § 4975 (which provides excise taxes relating to prohibited transactions) and related reporting obligations with respect to any transaction or agreement to which the Labor Department’s temporary enforcement policy would apply.

Good luck preparing for the new realities as of June 9, 2017.

Need Further Assistance?

Please feel free to contact Hardin Compliance Consulting at 1.724.935.6770.