The Department of Labor’s April release of its conflict of interest (fiduciary) rule may be more far-reaching in its impact than critics feared.
Among the potential unintended consequences: the universal application of a core component of the DOL rule, the best interest contract or BIC, to all products and producers, irrespective of the rule’s scope.
This was among the scenarios explored during a panel discussion at the 2016 annual meeting of the (AALU), held in Washington, D.C., May 1-3. A highlight of the conference, the “Washington Live” update featured Bradford Campbell, a counsel at DrinkerBiddle, which is advising the AALU on the rule; Caleb Callahan, chief operating officer and executive vice president of ValMark Securities; and Chris Morton, the session’s moderator and AALU’s senior vice president of government Affairs.
The prospect of an all-encompassing BIC standard — a Draconian regulatory regime that individual insurers and broker-dealers might impose on their producers to minimize operational risk — might be too much for affiliated brokers to stomach. And that could prompt a parting of ways.
“Insurers and broker-dealers will be making an institutionally based decision about what’s best for them,” said Campbell. “That may not be what’s best for you as an advisor.”
Eye on the rule’s mechanics
In determining whether the fiduciary rule applies to a transaction, said Campbell, advisors need to ascertain whether a plan recommendation falls under Part 4 of the 1974 Employee Retirement Income Security Act (ERISA), which sets forth standards and rules for the conduct of plan fiduciaries. All ERISA-qualified plans, such as 401(k) and 403(b) plans, are subject too this regulatory regime.
Another issue to consider: whether a plan is subject to Internal Revenue Code (IRC) Section 49-75 prohibited transaction rules. These generally bar transfers between a self-directed IRA or solo 401(k) and a disqualified person. The fiduciary rule also applies if a participant is taking distribution from any of these plans.
Excluded from the rule’s purview are retirement plans for governmental entities, such 403(b)s for school districts. Likewise, the rule doesn’t apply to Safe Harbor 403(b) plans because they’re exempted from ERISA. Additionally exempted are non-qualified “top hat” plans, including life insurance-funded executive bonus and split-dollar plans for highly compensated employees, plus health and welfare plans incorporating group or term life insurance.
Ultimately, the panelists noted, the rule’s applicability will hinge on whether the financial professional is giving advice respecting investable asset.
“If you’re selling a group life insurance plan to an ERISA plan, it’ won’t be subject to rule in that there is no investable asset,” said Campbell. “But if there is investable asset, the rule would cover it.”
The rule extends also — directly or indirectly — to plan distributions. Thus, whereas an IRC Section 1062 executive bonus plan is not covered directly by the DOL rule, advice respecting distributions from one is.
While establishing separate “silos” in which the DOL rule will or won’t apply, its scope may be more far-reaching than anticipated. That’s because insurers and broker-dealers may not be inclined to establish different procedures and documentation for different products, plans and distribution channels.
In this respect, the rule is already having an impact.
Callahan pointed to the recent announcement by American Equity Investment Life to no longer distribute fixed indexed annuities to qualified plans or IRAs through non-FINRA registered producers. The reason: They’re not affiliated with a financial institution (i.e., broker-dealer), which must be party to the rule’s best interest contract (BIC) prohibited transaction exemption (PTE), which allows payments of otherwise “conflicted compensation” (i.e., commissions) if the terms of the BIC exemption are met.
“You’re already seeing disruption not more than three weeks into the final rule,” said Callahan. “The extent of the changes will depend on a carrier’s risk management assessment as to whether they want to risk being a party to the BIC.”
Should more insurers follow American Equity’s path — choosing only to distribute indexed products through FINRA-registered broker-dealers — then producers unaffiliated with a B-D will be left with fewer product options. Campbell suggested, however, that this outcome can be avoided if the DOL provides a special exemption for these producers.
“The DOL may come up with a way to have a supervisory relationship, other than through a broker-dealer,” he said. “We don’t know under what terms that would establish an exemption or how long it might take. We’ll have to stay tuned on this issue.”