One ERISA lawyer perhaps said it best after digesting the Department of Labor’s recently released 700-page fiduciary redraft: “There is so much to say. I don’t know where to begin.”
While industry officials see improvements in the DOL’s long-anticipated, controversial redraft of its rule to amend the definition of fiduciary under the Employee Retirement Income Security Act, they see new problems, as well as retained snafus that appeared in the original 2010 version.
Labor Secretary Tom Perez said in releasing the proposed rule in mid-April that it ensures that those who are providing clients with “retirement investment advice are working in your best interest,” and that the plan also provides for “streamlined, flexible ways to comply with that goal” by allowing advisors to enter into a “new and enforceable best interest contract before they can receive any payments that might bias their advice.”
The Best Interest Contract Exemption (BICE), Perez said, “is a straightforward agreement” that ensures clients know they’ll get advice on investing their retirement savings that puts “their interests first.”
The new best interest contract “creates a guardrail” requiring those giving advice to put their “clients’ best interest first. For many broker-dealers, they don’t have that guard rail” in place now, Perez said.
Fred Reish, partner and chairman of the financial services ERISA team at Drinker Biddle & Reath in Los Angeles, pointed out that the DOL’s revised plan can impact advisors when giving retirement advice to plans, participants and IRA owners, as well as advice on rollovers.
As Reish explained, (and he isn’t known as an ERISA guru for nothing), DOL’s proposal would require almost all advisors to plans and IRAs to be fiduciaries. “Generally, advisors can only charge a ‘level’ fee for their investment advice. BICE is an exception to that rule (or as ERISA and the Internal Revenue Code say, an exemption).”
The exemption covers conflicted situations where, for example, the advisor can make more money by recommending certain investments over others or by recommending investments managed by an affiliate (which would mean more money for the corporate family because of the management fees), Reish said.
To take advantage of BICE, “the advisor and his entity (e.g., the financial advisor and his broker-dealer) would need to enter into a contract with the investor. For example, the investor could be an IRA owner or a 401(k) participant,” Reish said.
DOL states in its proposal that the BICE exemption promotes “the provision of investment advice to retail investors that is in their best interest and untainted by conflicts of interest.” The exemption “would permit receipt by advisors and financial institutions of otherwise prohibited compensation commonly received in the retail market, such as commissions, 12b-1 fees and revenue sharing payments, subject to conditions designed specifically to protect the interests of the investors.”
Impact on RIAs, Broker-Dealers
For the most part, Reish said that RIAs who are already following the law will not be impacted by the proposed changes except when dealing with rollovers. If RIAs do provide advice or make recommendations “on rollovers, that is, to take plan distributions, and if their fees are higher in the IRA, that will be viewed as a prohibited transaction conflict of interest.” As a result, they will need to comply with BICE.
For smaller, independent broker-dealers, Reish said that the disclosure requirements and other conditions of BICE will prove “so burdensome that they may decide to allow their advisors to be fiduciaries and then levelize fees for services to plans, participants and IRAs.”
For larger broker-dealers with affiliated mutual fund managers or insurance companies, they will also likely be required to comply with BICE, Reish said, which will be “burdensome and expensive” if BICE becomes finalized as currently drafted. The most difficult aspect of BICE, Reish added, is “the financial disclosures.”
Kent Mason, a partner with Davis & Harman in Washington, said that while the redraft’s framework “could work conceptually” in its current form, “it would have the same effects as the original 2010 proposal—cutting off the option for low- and middle-income individuals and small businesses to receive” investment assistance.
DOL’s exemption approach, Mason argued, “does not work, thus effectively creating the same result as 2010.” Under the original proposal, the problem was that almost all financial professionals providing investment assistance “would become fiduciaries and thus subject to the ‘prohibited transaction’ rules.”