Much attention has been given to the DOL’s new fiduciary rule for retirement plans, IRAs and rollovers. In particular, people have focused on the requirements for the Best Interest Contract Exemption (BICE), which applies to compensation received for recommendations of investment and insurance products.
While the BICE requirements are substantial, they are placed primarily on the “financial institution” (for example, the broker-dealer or RIA firm). The BICE requirement for individual advisors is much more limited.
Those limited requirements for advisors are the subject of a future posting.
While the burdens imposed by BICE are substantial, it appears that many people are overlooking the equally significant impact of the best interest standard of care. The “best interest” standard is a combination of ERISA’s prudent man rule and duty of loyalty.
While advisors to ERISA plans are familiar with the prudent man rule and the requirement for a prudent process, that will be a new concept for IRAs and rollovers, when the rule becomes effective on April 10, 2017.
Generally stated, the prudent man rule requires that an advisor engage in a prudent process which takes into account qualitative and quantitative issues related to investments, the needs of the investor, the purpose of IRAs (that is, as retirement vehicles), and so on.
The advisor’s conduct is measured against that of a hypothetical person who is knowledgeable about those issues and who reaches an informed and reasoned decision. For example, under ERISA a fiduciary is required to apply generally accepted investment theories and prevailing investment industry practices. Some generally accepted investment theories are: modern portfolio theory; strategic asset allocation; diversification of investments and asset classes; and so on. Based on my experience, many IRAs are not invested in a manner consistent with that approach.
On the other hand, if a retirement investor wants his IRA to be invested in a manner that is not consistent with generally accepted investment theories and prevailing investment industry practices, the investor is entitled to do so. However, for risk management purposes, a fiduciary adviser should obtain written instructions about the limitations being imposed by the investor. Then, the adviser is only a fiduciary for properly carrying out those instructions.
To add a little more detail, here is the definition of the best interest standard of care:
“Investment advice is in the ‘‘Best Interest’’ of the Retirement Investor when the Adviser and Financial Institution providing the advice act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, . . .”
“ . . . based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, . . .”
“ . . . without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.”
The first paragraph of the definition is essentially the same as ERISA’s prudent man rule. It requires a prudent process for developing investment recommendations. The “familiar with such matters” phrase means that the adviser will be measured by the standard of a knowledgeable investor. The “like character” and “like aims” language refers to the purpose of an IRA . . . providing retirement benefits.