The following blog is the first of a 3-part series on this topic. Parts Two and Three should be read in conjunction with this overview.
FACT ONE: Investment advisers generally earn a substantial portion of their fee income managing funds for retirement plan investors.
FACT TWO: At present, many advisers do everything possible to avoid being deemed an “ERISA fiduciary” under the Employee Retirement Income Security Act.
FACT THREE: Under the new Fiduciary Rule, investment advisers will be deemed ERISA fiduciaries, profoundly changing the way services will be delivered to retirement plan investors; (e.g., IRA owners and 401(k) plan participants).
It is important to understand the impact of the new rules because advisers, as ERISA fiduciaries, will become subject to many new duties and responsibilities and strict prohibitions on common types of transactions and compensation. Basically, the new rules apply to any “private sector employee benefit plan.” In plain English—this means just about all 401(k) plans and individual retirement accounts (“IRAs”).
THE “FIDUCIARY RULE” — Who is now an ERISA Fiduciary?
At the outset, you should know that the new Fiduciary Rule is being phased in over 20 months with full compliance required by the end of next year. However, substantial changes will be required in the meantime.
Under the Rule, advice to a plan, plan fiduciary, plan participant or beneficiary, IRA or IRA owner for a fee or other compensation, direct or indirect, is now “fiduciary investment advice” if the following conditions in both columns (1) and (2) are met:
| (1)
Advice in one of the following categories: |
(2)
An advice provider that either: |
| Investment management recommendations
Recommendations regarding acquiring, holding, disposing of, or exchanging securities or other investment property, including recommendations about how proceeds should be invested after a rollover |
(i)
Renders the advice pursuant to an agreement, arrangement or understanding that the advice is based on the particular investment needs of the advice recipient, or (ii) directs advice to a specific advice recipient regarding the advisability of a particular investment or management decision regarding plan assets
OR |
| Investment recommendations
Recommendations regarding the management of investment property, the selection of persons to provide investment advice or management services, the selection of investment account arrangements and recommendations regarding rollovers, transfers or distributions |
Represents or acknowledges that it is acting as a fiduciary under ERISA or the Internal Revenue Code |
Under the Fiduciary Rule, the question is whether you are making a “recommendation.” The definition of recommendation is complicated but, in sum, it comes down to whether you are giving advice that would reasonably be viewed as a “suggestion” to take (or refrain from taking) a particular course of action. In the Rule’s preamble, the DOL likened it to a “call to action.”
A WORD ABOUT “HIRE ME” PRESENTATIONS
The new Rule does NOT cover general presentations about the adviser’s capabilities and services. You can still have a “hire me” discussion with a prospective client, extolling on the quality of your services without triggering fiduciary status. Be careful, though! The line is blurred. This exception does NOT apply to any investment recommendations you may make in connection with your “hire me” presentation. For example, if you recommend that the recipient of the advice rollover into your programs or a particular security, under the new Rule that advice is almost certainly fiduciary investment advice notwithstanding its context.
THE “BIC” EXEMPTION
For advisers, perhaps the centerpiece of the new Rule is the new Best Interest Contract Exemption—the so-called “BIC Exemption” (or just “BICE”). In brief, it allows advisers who are willing to enter into a written contract meeting certain strict requirements (discussed below) to continue being compensated for “conflicted advice.” In other words, if you are willing to disclose to your retirement account client in writing that you will be receiving compensation that would otherwise be prohibited, the BIC Exemption will allow you to continue being compensated by that client in ways that would otherwise constitute a prohibited transaction under the new Rule. It bears restating—the intent of the BIC Exemption is to allow advisers to continue their existing compensation structures even though such compensation would be impermissible under the new Rule.
As you might imagine, the BIC Exemption is not without its burdens. Its requirements include:
- The contract must be in writing and it must contain a clear acknowledgement of the adviser’s fiduciary status. This will require a clear description of best-interest standard of care and a description of the adviser’s material conflicts of interest and any fees and compensation that the adviser expects to receive.
- The contract must inform the retirement investor of his or her right to obtain copies of the adviser’s written policies and procedures and specific disclosures of costs, fees and compensation associated with the recommended transaction.
- The adviser must provide a link to its website and inform the retirement investor that the website includes model contract disclosures and copies of the adviser’s policies and procedures to ensure that its advisers are meeting the best-interest standard of care.
- The contract must state whether the adviser offers proprietary products or receives third-party payments.
- The contract must provide contact information for a representative of the of the adviser with responsibility for implementing the new Rule and describe whether or not the adviser will monitor the recommended investments. (Ongoing monitoring of recommended investments is not required but may be agreed to by the parties.)
Perhaps the most onerous thing about the BIC Exemption is the required contract creates a new private right of action for IRA owners to enforce the standard of care under this exemption—in other words, a new and somewhat expedited avenue through which you may be sued by IRA owners. This includes the right to bring a class action suit against you on behalf of all your retirement plan investor/clients.
A WORD ABOUT “LEVEL-FEES”
The BIC Exemption has streamlined conditions for advisers that are so-called “level-fee fiduciaries.” An adviser is a level-fee fiduciary if its only fees or compensation is a “level fee” that is disclosed in advance to the investor—i.e., a fee or compensation that is provided on the basis of a fixed percentage of the value of the assets or a set fee that does not vary with the investment recommended. This will benefit fee-only advisers. Note, however, that the exemption still requires a written contract containing an acknowledgement of your fiduciary status and the reasons why you consider the level fee arrangement to be in the client’s best interest.
WHAT THIS MEANS FOR YOUR ADVISORY BUSINESS
The new Fiduciary Rule applies equally to both advisers and brokers. However, advisers are likely to be winners here. To some extent advisers already have experience with the old fiduciary rules on account of having discretion over “plan assets,” so they are further along the learning curve than brokers. Also, advisers are more likely to be able to take advantage of the streamlined “level-fee fiduciary” scheme. The new Fiduciary Rule presents brokers with especially significant challenges. For example, brokers will have to carefully consider whether they are willing to upset the compensation structure they have historically used to pay their registered representatives. If not, to the extent brokers wish to continue advising retail retirement investors (e.g., IRA owners or 401(k) plan participants), they likely are going to have to get comfortable with reliance on the BIC Exemption.
Advisers should be making strategic decisions now on how to best position your business and ensure compliance with the new Fiduciary Rule. Among other things, this means you should be thinking about how you are going to manage the the tasks and responsibilities set forth in our companion piece: COMPLIANCE WITH THE “BEST INTEREST CONTRACT EXEMPTION” UNDER THE NEW FIDUCIARY DUTY RULE — “TO DO” LIST.
CONCLUSION
The voluminous new Fiduciary Rule will fundamentally change the way advisers deliver investment recommendations to retirement plan participants and IRA holders. To be certain, it presents fundamental challenges for advisers, brokers and insurance agents alike—although far more so in the case of brokers and agents. This presents significant opportunities for those advisers who are smart enough to spot them.
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This newsletter is published as a source of information only for clients and friends of The Securities Law Group. It is intended for general informational purposes and should not be construed as legal advice or an opinion on any specific facts or circumstances. The delivery of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship.
The Securities Law Group
James Grand
jgrand@tslg-law.com
415-644-9501
