On August 12, LifeHealthPro chatted with Jason Smith, chief executive officer of Clarity 2 Prosperity, one of six independent marketing organizations (IMOs) seeking to become financial institutions under the best interest contract (BIC) exemption of the Department of Labor’s fiduciary rule.
In this installment, we talk with Bradford Campbell, an attorney at Drinker Biddle who is former assistant secretary of labor for employee benefits and past chief of the DOL’s Employee Benefits Security Administration (EBSA). Counsel to four of the six IMOs, including Clarity 2 Prosperity, Campbell offered new details on the application process, hurdles still to be surmounted, and potential sticking points related to pending litigation over the DOL rule.
Among the last: determining what is reasonable compensation for producers and the legal risks that IMOs and their affiliated agents and advisors face under the rule. The following are excerpts from our interview.
LifeHealthPro: Why were the four IMO applications you’re overseeing necessary?
Campbell: The Department of Labor has dramatically expanded the definition of fiduciary advice so that sales of insurance products subject to state laws would now also be covered by a federal fiduciary standard of care. The compensation that insurance producers traditionally receive, a commission based on a percentage of the sale, would thus technically be illegal under this standard.
The DOL rule provides, however, for a best interest contract exemption that allows agents to get paid via commission, subject to certain conditions. If you follow the BICE’s provisions, you can continue to receive commissions within certain limits.
But the DOL set up the BICE to be a contract between a financial institution and product purchaser. Whereas the insurance agent or broker is involved in executing the contract, a financial institution — an insurer, broker-dealer, registered investment advisor, bank or trust company — must sign the best interest contract.
That’s crated a hole, as many insurance products are marketed through intermediaries — independent and field marketing organizations — that the DOL didn’t recognize as financial institutions under the rule.
The DOL said they intentionally did this, inviting IMOs to apply to them for a special permission to be considered a financial institution. The regulations stipulate what to include in the application, and provide discretion on the time-frame.
We don’t yet know all of the DOL’s conditions for securing FI status. And so whether the 6 IMOs that that applied — including the 4 our law firm is overseeing — can come to a mutually acceptable agreement remains to be seen. But so far, the DOL seems to be very serious about receiving and considering applications and has expressed a desire to move forward.
LHP: Can you detail some of the application hurdles you are familiar with?
Campbell: The DOL wants to be certain that IMOs are following a prudent and deliberative planning process that ensures advisors’ product recommendations are in the client’s best interest.
Every applicant is a bit different. Part of what the rule does is to impose a common standard of care — one more comprehensive than the industry norm — on insurance recommendations. To that end, all DOL-approved IMOs will need to provide more documentation and analysis relating to these recommendations.
LHP: How will IMOs assuage the DOL’s concerns with respect to potential conflicts of interest when paying out a commissions?
Campbell: They’ll have to develop policies and procedures to identify, and take steps to mitigate, all potential conflicts of interest. The BIC exemption states what the DOL is shooting for, but allows for flexibility in the drafting of policies and procedures appropriate for what the companies do. So I think you’ll see them coming out with different solutions.
In addition, the department is concerned about how IMOs and FMOs will supervise their independent agents — whether it be in manner similar to the oversight of broker-dealers and registered investment advisors.
For example, the DOL may be looking to see whether the IMO, before entering into a contract with producers, will be doing background checks on them to ensure they’re credible, appropriately licensed and meet other requirements.
LHP: One contentious issue stemming from the fiduciary rule has to do with determining exactly what is “reasonable compensation.” Has this issue cropped up during the application process?
Campbell (pictured at right): Yes. The industry is concerned that the reasonableness standard is vague, though it has been in existence since the 1970s. The difference is that many of the entities now subject to the fiduciary rule — IMOs and FMOs — have never before been subject to the standard, and they may have to revamp aspects of their business model to comply.
If the DOL prevails in litigation over the rule and the standard remains, then everyone will have to develop approaches to ensure their compensation is reasonable. That will probably include marketplace benchmarking and internal cost valuations used to justify payouts.
LHP: Another big worry is the “private cause of action, that is, enforcement of the fiduciary rule through class action lawsuits against alleged offenders. Have any of the IMO applying for FI status voiced this issue to you?
Campbell: It's absolutely an issue. And it’s one of the biggest concerns that all stakeholders have about the fiduciary rule — that the DOL has effectively outsourced enforcement to the class action bar.
The DOL argues that it's not a new cause of action they've created; this is one of the points of contention in the pending litigation. But without a doubt, the rule's BIC exemption presents a new risk for financial institutions. With a private right of action, you now have the prospect that county judges in class action suits all over the country adjudicating the same allegations and coming to very different conclusions. Thus, a big concern is the actual execution of the rule and the litigation risk it creates. That can be hard to quantify.
LHP: Many speculate that, in the rule's wake, there will be a reduction and/or standardization of commissions or a shift to a flat fee in lieu of a commission to bypass the myriad BIC exemption requirements. Do you agree?
Campbell: There's no question that the new rule and requirements of the BIC exemption will have the effect of changing commissions. Whether that change results in purely level or standardized commissions remains to be seen.
As an example, under the BICE, you can no longer have two similarly situated products — an annuity from company A and comparable annuity from company B — paying different levels of commission. You could, however, have variations in commissions between different product classes, such as a fixed indexed annuity and an indexed mutual fund.
So change that brings standardization to commissions is definitely coming. Whether that results in an overall reduction of total compensation is hard to say. I’ll note only that we should see reductions in incentive compensation allowed under the rule.
LHP: As they seek to qualify as financial institutions under the rule, are you recommending that IMO applicants make certain changes to internal business processes to better align their organizations with the rule's requirements? Or are you mainly focused on filing necessary paperwork and answering questions from the DOL?
Campbell: The answer is both. Part of the application process involves describing the types of activities or steps IMOs will be taking to get into compliance with the rule.
Separately, we’ll need to detail additional steps, beyond those required under the BIC exemption, the companies will be taking if they become financial institutions. These include the processes that will guide their product recommendations and the supervisory structures they’ll put in place to ensure that investors are protected and that agents are acting appropriately.
LHP: Are there legal sticking points we haven't discussed, such as issues to be litigated in the pending lawsuits, which could pose problems for the IMO applicants?
Campbell: There are a number of unclear issues relating to how to comply with the new regulations. The DOL has made fundamental changes affecting a broad swath of the financial services industry — changes that have resulted in a lot of new questions. For example, can you, despite acting in good-faith compliance with the rule, be subject to an undue amount of legal risk in class action cases?
Related: NAFA plots course in DOL rule fight
We're exploring these questions now as we figure out how to draft the BIC contract, and what policies and procedures to adopt. The pending litigation may clarify some of the outstanding issues; for now, everyone is feeling their way through the new regulations.
The bottom line for retirement advisors is that things will be changing significantly between now and next April, when the first phase of the DOL rule takes effect. So it's a time of flux — just 9 months for all parties affected to get in compliance with the rule.