The new rule from the Department of Labor changed the definition of “fiduciary” on June 7, and effectively treats all people who provide investment advice for compensation with respect to retirement plans or IRAs as fiduciaries subject to ERISA.
The Best Interest Contract Exemption, which will apply to transactions made on or after April 10, 2017, allows fiduciaries to receive various forms of compensation that, in the absence of an exemption, would not be permitted under ERISA and the Internal Revenue Code.
The rule permits advisors who qualify as “level fee fiduciaries” to use BICE without executing a best interest contract if the only fee or compensation they receive is a “level fee that is disclosed in advance to the retirement investor.” Level fees could either be calculated as a percentage of AUM or as a set retainer fee, and may not include any commission or revenue sharing compensation.
Non-level fee fiduciaries seeking to rely on BICE must comply with each of the following five general requirements detailed below:
1. Acknowledge fiduciary status in writing. While it is already incredibly common for RIAs to include such acknowledgments in their advisory agreements, this requirement is intended to terminate the argument (by, for example, a broker-dealer rep) that investment advice has been provided in a non-fiduciary capacity or “salesperson” capacity in which only a suitability standard would apply.
2. Adhere to “Impartial Conduct Standards.” Compliance with Impartial Conduct Standards requires advisors to comply with the following:
a. Give advice that is in the retirement investor’s “best interest.” This particular requirement generated great consternation among financial industry professionals over the last six years. Thankfully, it does not hold advisors to the draconian obligation to find the absolute best and cheapest investment product for a particular retirement investor, which would be evaluated and litigated with the benefit of hindsight.
Rather, under BICE, investment advice is in an investor’s best interest when the individual or entity rendering the advice acts with the “care, skill, prudence and diligence under the circumstances then prevailing” of a prudent person in a similar scenario “without regard to the financial or other interests” of the advice giver. In other words, the analysis is whether a similar prudent professional in a similar role would have given the same advice.
b. Charge no more than reasonable compensation. Much like the best interest standard above, “reasonable compensation” is measured by comparison to prevailing rates in the industry and does not require advisors to charge the lowest possible fee. If an advisor’s fee is challenged as being unreasonable, the advisor may defend the reasonableness not only by corollary to other similarly situated advisors (e.g., geographic area, size, complexity of the engagement), but also based on other services it provides as part of its investment management duties (e.g., limited financial planning and consulting, non-discretionary consulting to family members without additional charge).
c. Make no misleading statements about investment transactions, compensation and conflicts of interest. While this prong seems straightforward, its inclusion signals the intent of the DOL to provide it (or a retirement investor) with a cause of action to challenge an advisor’s reliance on BICE and therefore trigger excise tax and personal liability for the fiduciary (as applicable). Therefore, advisors should carefully evaluate all communications to retirement investors in advertising documents, advisory contracts, disclosure documents and even day-to-day communications, and lean toward over-disclosure whenever possible.
3. Implement policies and procedures reasonably and prudently designed to prevent violations of the Impartial Conduct Standards. Even though BICE takes effect in 2017, advisors are not required to implement these policies and procedures until Jan. 1, 2018. Once that requirement takes effect, however, they will be required to have in place policies and procedures subject to DOL examination and enforcement. A violation of this prong could result in the total revocation of BICE, rendering all related activity a prohibited transaction subject to enforcement and remedies. It is critical that policies and procedures are narrowly tailored to ensure compliance with the three prongs of the Impartial Conduct Standards described above.
4. Refrain from using incentives for advisors to act contrary to the customer’s best interest. Simply put, this prohibits advisors from offering “quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause advisors to make recommendations that are not in the best interest of the retirement investor.”