The redefinition of the term “fiduciary” by the Department of Labor was treated by some in the industry as tantamount to the second coming of Christ. There were years of discussion and debate ahead of the rule’s release in April about how drastically it would impact advisory practices.
To the contrary, if your firm and its advisors are fee-only (“level-fee fiduciaries” as the fiduciary rule calls it) the impact is minimal. An advisor is a level-fee fiduciary if the only fee received by it and its affiliates in connection with advisory or investment management services to a plan or IRA assets is a “level fee” that is disclosed in advance to the plan or IRA owner. A “level fee” is a fee or compensation based on a fixed percentage of the value of the assets (i.e., AUM-based fee) or a set fee that does not vary with the particular investment recommended.
Knowingly or not, advisors have already been relying on the DOL’s Advisory Opinion 2005-23A when providing rollover recommendations to plan participants. However, the new fiduciary rule supersedes this opinion by identifying any advisor who provides rollover recommendations for compensation as a fiduciary who must avoid engaging in prohibited transactions. If an advisor can increase his or her compensation as a result of a rollover recommendation, it would be a prohibited transaction absent an exemption.
My colleague Max Schatzow shared with me these key points on the impact of the DOL rule on fee-only advisors.
The Best Interest Contract Exemption is the primary means of relief for advisors who provide rollover recommendations.
A level-fee fiduciary relying on the BIC exemption must provide the retirement investor with a written fiduciary statement; comply with the Impartial Conduct Standards; and document the reasons why a rollover from an ERISA plan to an IRA, a rollover from another IRA, or a switch from a commission-based account to a fee-based account, is in the best interest of the client.
The Impartial Conduct Standards
There are three requirements to meet under the Impartial Conduct Standards.
- Prudent Advice. Advisors must “act with the care, skill, prudence and diligence” of a “prudent person acting in a like capacity and familiar with such matters.” In other words, the analysis is whether a prudent professional in a similar role would have given the same advice.
- Reasonable Compensation. Reasonable compensation is measured by comparison to prevailing rates charged among the industry, and does not require advisors to charge the lowest possible fee. However, the DOL has not provided definitive guidance on whether a 1%, 0.75% or 0.50% asset-based fee is reasonable.
- Transparent Communications. Advisors must carefully evaluate all communications to retirement investors including advertising documents, advisory contracts, disclosure documents and day-to-day communications.
What Should Advisors Do?
We recommend that our investment advisory clients take several actions to comply with the fiduciary rule and BIC exemption.
- Amend Policies and Procedures. It will be important to prove to the Securities and Exchange Commission and the DOL that your firm is in compliance. In addition, in the event of litigation with the DOL or a private litigant, having written policies will help prove that your firm takes the best interest standard seriously.
- Adopt Rollover Analysis Form. We have created a customized form to assist advisors with documenting rollover recommendations. To fully comply with the fiduciary rule and BIC exemption, the advisor should analyze the fee structure within the client’s current plan.
- Amend Advisory Agreement. We have drafted language to acknowledge the advisor’s fiduciary status as required by the fiduciary rule is only applicable to retirement accounts. We don’t want to subject our clients to the “prudent advice” standard and other ERISA requirements where it is not specifically required.
- Discuss Issues With Current Broker-Dealer. Registered reps of an unaffiliated broker-dealer should determine how they will comply with the BIC exemption, and whether they will have electronic procedures for agents to comply with the BIC exemption.