Once the DOL’s new fiduciary rule and prohibited transaction exemptions take effect on April 10, 2017, almost all advisors to plans, participants and IRAs will be fiduciaries. As such, they will need to scrutinize their compensation—and that of their supervisory entities (e.g., broker-dealers or RIAs, and all of their affiliates and related parties)—to ensure that no money is being received on top of the advisor’s stated fee.
If any other money—e.g., advisory fees to affiliated mutual funds, revenue sharing, 12b-1 fees—is being received, then the advisor and its supervisory entity will need to comply with one of the prohibited exemptions. Most likely, that will be the Best Interest Contract Exemption, or BICE.
While most prohibited transactions can be avoided if the advisor, his supervisory entity and all affiliates and related parties, receive only a level fee, there are three that cannot. Put another way, there are three recommendations that are, per se, fiduciary in nature and that automatically result in prohibited transactions.
A recommendation to a participant to take a distribution and roll it over into an IRA.
A recommendation to IRA owner to transfer his IRA to the advisor.
A recommendation to a participant or IRA owner to move from a transaction-based account to a fee-based account.
In BICE, the DOL identified those three recommendations as inherently being prohibited transactions.
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For example, for the first type of recommendation—to take a plan distribution and to roll it to an IRA, the advisor would not receive any compensation if the participant did not accept the recommendation (assuming that the advisor was not providing services to the plan), but the advisor would receive compensation from the rollover IRA if the recommendation was accepted.
As a result, it is in the advisor’s best interest for the money to be rolled over, but the question is whether it is in the participant’s best interest. In some cases, it will be in the participant’s best interest, but perhaps not in others. (Note that, even if the advisor is already working with the plan, the money that the advisor is earning on the participant’s account inside the plan is probably less than that would be from the rollover IRA. As a result, that fact situation results in a prohibited transaction as well.)
Fortunately, BICE provides exemptions for these three prohibited transactions.
Where the investment advice to the IRA or plan account, after the rollover is completed, will be “conflicted,” the advisor must satisfy all of the conditions in BICE. However, if the investment advice to the IRA or account will be “pure” level fee, the requirements are less burdensome. As a result, the “mini” exemption that applies to these three transactions is referred to as “BICE-lite.”
With that in mind, let’s take a quick look at the considerations for each of those recommendations.
Recommendation 1: Distribution and Rollover
There are several conditions imposed on the advisor. The most demanding is that the advisor document why it is in the best interest of the participant to take a distribution from the plan and roll over to an IRA. BICE specifically lists the following as considerations in developing the recommendation:
A comparison of the services the participant receives from the plan versus those in the IRA.
A comparison of the fees and expenses in the plan versus those in the IRA.
A comparison of the range of investments in the plan versus those in the IRA.
This is not an exclusive list of the considerations, but these factors must be considered in developing the recommendation.
Viewed more generally, the best interest, or prudence, rule requires that the advisor examine the “relevant” factors. (Factors are “relevant” if an independent, knowledgeable person would want to review that information in order to make an informed decision.)
Once that information has been gathered and evaluated, and a recommendation has been developed, the advisor must document why the recommendation is in the best interest of the participant. That documentation should be retained so that, if the transaction is challenged in the future, the advisor can support the analysis.
Recommendation 2: Transfer of an IRA