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Regulation and Compliance > Federal Regulation > DOL

Wading through the BICE paperwork

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On Sept. 6, Boston-based DALBAR Inc., a financial services market research firm, released a briefing paper, “The Work Behind BICE Paperwork: What You Will Actually Have to Do” (available here).

The paper details how the Best Interest Contract Exemption (BICE) provisions within the DOL fiduciary rule create a significant challenge for financial institutions and advisors, and highlights the activities required to avoid compliance problems.

Related: Compliance in U.S. Department of Labor world: Much ado about nothing?

Increased Litigation Risk

In order to avoid prohibited transactions, BICE-adopters must “communicate commitments, promises and disclosures to qualify for relief,” the study notes. Those commitments and promises to do something — or to avoid doing something — are binding; consequently, BICE “clears the way for litigation for failure to do what is in the best interest contract.”

These conditions create risk exposures for institutions and advisors, says Louis Harvey, DLABAR’s president and CEO. He points out that under BICE, agreements and contracts must be enforceable. “What that means is that any judge in the country can find that there’s a breach of a contract,” he says. “It doesn’t require an ERISA specialist to find a breach of a contract.”

Harvey provides an illustration. The ideal way to serve the clients’ best interest would be to invest their funds in a guaranteed, inflation-adjusted, liquid, tax-favored, high-return investment, which, of course, doesn’t exist. That means advisors’ recommendations will inherently involve trade-offs that factor in multiple considerations about the clients’ finances, goals and risk tolerance. An advisor’s claim to acting in the client’s best interest now must be backed up by evidence of actions the advisor took to understand those considerations and support clients’ interests, says Harvey.

Advisors must be able to prove they followed through because it’s an enforceable contract, he emphasizes — it isn’t just a verbal generalization. “You have to put in writing for your client that you are going to act in their best interest and you are not going to benefit from it,” he says. “It’s a double-edged sword. It’s saying, ‘Listen, I’m going to act in your best interest’ and without evidence that you’ve done that, the client or their litigation attorney can certainly argue that you didn’t, especially if the results turn out to be unfavorable.”

Determining Reasonable Compensation

Under BICE, advisors and financial institutions must estimate the amount of direct and indirect compensation that results from their recommendations. It’s not just a matter of calculating sums, though — the DOL rule requires that advisors and financial institutions “receive no more than reasonable compensation (within the applicable ERISA and Code sections).”

But that statement raises the question: What is reasonable compensation? An obvious response could be to use the industry average for a product or service, but that means 50 percent of revenues are excessive. If institutions decide to reduce their compensation below the average, the new average moves lower so it becomes a perpetual decline, Harvey observes.

Instead of using arbitrary metrics like averages, Harvey argues in favor of applying the principles developed under the Gartenberg rule. (DALBAR has published a briefing paper on reasonable compensation that’s online here). The Gartenberg rule, which the Supreme Court affirmed in 2010, maintains that multiple factors should be considered in determining reasonable compensation. These factors include the nature, extent and quality of services provided; advisor and investment performance; the advisors’ costs and profits and several other factors.

He cites an annuity case to show how these factors can apply. An advisor meets with a client who is seeking guaranteed lifetime income and determines that the client’s needs are best met by an annuity that charges 200 basis points annually. However, another investment can, with the same portfolio, generate the same income but without the guarantee for 85 basis points per year. If the client needs the income guarantee and that guarantee accounts for the cost differential, recommending the more expensive annuity is appropriate.

Approaching the Gartenberg factors this way encourages advisors to take a more holistic view, says Harvey: “It’s saying you’re not going to sell somebody an expensive annuity because they’re too dumb to recognize it. You’re going to provide them with an expensive annuity because that’s the best option for what their particular circumstances are.”

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