Exemptions Provide Key to Unlocking DOL Fiduciary Rules

The new Department of Labor (DOL) fiduciary proposal has been in the forefront of many financial advisors’ minds for some time now—the switch from the broadly applicable suitability standard to a best interests fiduciary standard will surely bring about changes in the way advisors practice. Despite this, the rules themselves are much more complex than they may initially seem, and the best interests standard merely scratches the surface of the new regulatory regime. 

The changing standards, and rules regarding disclosure of fees and conflicts of interest, will add complications to the advisor’s practice, but the exemptions to the rules themselves can prove equally important—and understanding those exemptions can make all the difference in the world to the advisor’s success as the new rules become reality.

The New Fiduciary Rules: A Primer

The new DOL rules impact a broad range of individuals—according to DOL guidance, they will operate to apply a fiduciary standard to any individual (including brokers, RIAs and insurance agents, among others) who receives compensation for providing advice that is individually tailored or specifically directed to a plan sponsor, participant or IRA owner if that advice is geared toward helping the recipient make a retirement investment decision.

Implementation of the DOL’s fiduciary rules means, essentially, that advisors will now have a professional duty to act in the best interests of their clients, despite the fact that the client’s best interests may deviate from those of the advisor (especially with respect to fees or commissions). This differs from the current suitability standard that requires that advisors have a reasonable basis for recommending investments to the client based on an examination of the client’s financial position.

While the suitability standard requires that advisors act fairly in dealing with clients, it is not as demanding as the fiduciary standard, and the potential liability for failing to comply is less clearly defined.  Importantly, a fiduciary under the DOL rules cannot receive any payments that could create a conflict of interest unless they are able to satisfy the requirements for a prohibited transaction exemption (PTE).

The Exemptions to the Rule

Perhaps the most important of the newly proposed PTEs is the best interest contract exemption, which basically allows financial advisory firms to continue to set their own compensation practices as long as they put their clients’ best interests first and disclose any potential conflicts of interests.

This means that commission-based fees, revenue sharing and 12b-1 fees, to name a few, will remain permissible as long as the requirements of the exemption are satisfied.

The best interests contract exemption (BICE) requires that the advisor enter into a formal contract with the client that commits the advisor to act in the best interests of the client (specifically, to avoid any misleading statements about fees and conflicts of interest).

Further, the advisor must “warrant” that the firm has adopted policies designed to mitigate any conflicts of interests (meaning that the firm has identified conflicts and compensation structures that could cause the advisor to fail the bests interests standard, and has adopted procedures to mitigate their impact). Any conflicts, including hidden fees, must be clearly disclosed to the client.

A second exemption allows advisors to continue to provide general retirement education to clients without triggering the fiduciary standard. DOL guidance gives the example of an advisor who provides general information about the mix of assets that an average person should have based on age, income and circumstances, but makes clear that discussing specific investments would trigger the fiduciary standard.