On October 27, the DOL published guidance on the new prohibited transaction exemptions (“PTEs”) issued under the DOL’s rule redefining “fiduciary” in the context of providing investment advice (See “Guidance,” here). Intended as a means to provide protections to retirement investors, the Fiduciary Rule and related PTEs require all those providing retirement investment advice to plans, plan fiduciaries, and IRAs to abide by a “fiduciary” standard that places clients’ best interests before a party’s own profits. The Guidance covers several FAQs derived from input received from the financial services industry and other groups.
The Guidance clarifies that new conditions on all pre-existing PTEs must be met by April 10, 2017. For the two new PTEs — the Best Interest Contract (“BIC”) and Principal Transactions Exemption — the DOL has provided a “transition period” for compliance. Financial institutions and advisers relying on either of these PTEs must meet partial requirements by April 10, 2017. To rely upon one of these exemptions on April 10, 2017, impartial conduct standards must be met. These standards require that advisers and financial institutions:
• Give investment advice that is in the best interest of the retirement investor. The “best interest” component has two standards: prudence and loyalty.
o The prudence requirement sets a professional standard of care for advice given.
o To meet the loyalty standard, advice must be founded on the interests of the retirement investor, not on the competing financial interest of the financial adviser, institution, or firm.
• Charge no more than what is considered “reasonable compensation.” For purposes of the BIC exemption, the DOL intends to incorporate the reasonable compensation standard as set out under ERISA § 408(b)(2), Code § 4975(d)(2), and regulations thereunder. The Guidance explains that in general, “firms can ensure compliance with the standard by being attentive to market prices and benchmarks for the services; providing the investor proper disclosure of relevant costs, charges, and conflicts of interest; prudently evaluating the customer’s need for the services, and avoiding fraudulent or abusive practices with respect to the service arrangement.”
• Provide no misleading statements about investment transactions, compensation, or conflicts of interest.
In addition, financial institutions must:
• Designate an individual to address any material conflicts of interest and monitor advisers’ adherence to impartial conduct standards.
• Provide a notice to retirement investors that includes an acknowledgement of fiduciary status and describes any material conflicts of interest.
Financial institutions and advisers relying upon the new exemptions have until January 1, 2018 to comply with additional contract and disclosure requirements and to implement policies and procedures protecting investors against advice that is not in the investors’ best interests.
Scope of the BIC Exemption (PTE 2016-01)
In large part, the Guidance addresses the BIC exemption allowing investment advisers and their financial institutions to continue using certain investment-related compensation arrangements that would otherwise be prohibited as potential conflicts of interest.
The Guidance states the BIC Exemption serves as the “primary exemption for investment advice transactions” involving retail investments advisers and financial institutions that provide advice on investments to retail investors such as plan participants, plan beneficiaries — including HSA owners –, and IRA owners. The Guidance further explains that the exemption is “broadly available” for recommendations to retail investors concerning “all categories of assets” on “advice to roll over plan assets,” and advice concerning recommendations on who a customer should hire as an investment adviser or manager.
Specifically, the BIC Exemption is available for:
• Investment advice to roll-over an account, even by advisers acting as discretionary fiduciaries for the plan or participant’s account, as long as there is no discretionary authority with respect to the roll-over decision.
• Investment advice to roll-over plan assets into an IRA, even by advisers acting as discretionary fiduciaries for the plan or participant’s account, as long as there is no discretionary authority with respect to the roll-over decision.
• Insurance companies and agents, providing investment advice on fixed rate, fixed indexes, and variable annuity contracts (PTE 84-24 is also available for insurance agents providing investment advice on fixed rate annuity contracts).
• “Level fee fiduciaries” receiving only a “level fee” in connection with providing investment services or advice, if the fee is disclosed in advance to the investor.
• “Robo-advice” in which the provider is a level-fee fiduciary.
Under the DOL Guidance, the BIC Exemption is not available to:
• Investment transactions in which an adviser has or exercises any discretionary authority or control.
• “Robo-advice” that is solely provide through an interactive website (unless, as stated above, the robo-advice provider is a level-fee fiduciary).
Compensation Arrangements Covered by the Exemption
The Guidance cautions against compensation structures that incentivize advisers to promote recommendations that are not in the best interest of retirement investors or that violate what are considered reasonable compensation practices, such as using escalating grids that pay commission rates based on a set percentage of commission generated for the firm or based on profitability to the firm rather than on the value to the retirement investor. If commission rates are to be used, financial institutions are encouraged to base pay upon “neutral factors” that are not founded upon the firm’s financial interests. For example, an acceptable commission structure may be based upon neutral factors such as the “time and complexity associated with recommending investments within different product categories.” Other acceptable incentives include the use of certain price discounts (must satisfy the reasonable compensation standard) and appropriate bonus arrangements (signing awards and “front-end” bonuses unrelated to the movement of firm assets or sales targets).
The Guidance also provides clarity on the BIC Exemption contract and disclosure requirements as well as application of the new Principal Transactions Exemption (PTE 2016-02) for advisers and financial institutions selling or purchasing certain recommended debt securities and other investments from their own inventories either to or from plans and IRAs. The DOL notes that the Guidance is the “first of several” FAQs to be published in the coming months. (See Borzi, DOL Blog post). Consequently, plan sponsors, retirement investment advisers, and plan service providers will want to consult this and any future FAQs issued by the DOL for further guidance on application of the Fiduciary Rule and related exemptions.