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Industry Spotlight > Broker Dealers

How Scottrade Could Have Avoided DOL Rule Charges

By Louis S. Harvey

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Scottrade made a bet that the Labor Department’s fiduciary rule wouldn’t be enforced. It lost. But, for now, there’s another way firms can keep their sales incentives.

Whether or not Scottrade beats the charges it faces under the rule, filed by the state of Massachusetts over the firm’s sales contests, there will be serious consequences for the firm and its advisors. This firm, like many others, elected to adopt the Impartial Conduct Standard of the Labor rule, which prohibits any form of sales incentives. Sales incentives include “quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives.”

At a minimum, for Scottrade the consequences of these charges include the cost of legal defense and the damage to the firm and its affiliates caused by public accusations such as “dishonest and unethical activity.” It is not hard to imagine that the consequences could escalate if other states act in a similar manner and clients achieve class action status or ultimately win awards for damages. Whatever emerges, advisors will be forced to defend these charges to concerned clients and prospects.

While there may be benefit in signing on to widely used practices, in this case there is no protection in numbers. The new Impartial Conduct Standards illustrate the importance for individual firms and advisors to act in their own best interest.

But how does a firm or its advisors operate without sales incentives?

Sales incentives are an essential ingredient of retirement and other investment/insurance businesses. Despite this well-established truism, many firms adopted the Impartial Conduct Standard with the expectation that there would be no enforcement until 2019, by which time the entire rule could be erased. Unfortunately, the no-enforcement policy is limited to the Labor Department and IRS. All 50 states have standing in securities complaints, as do private citizens, making the choice to rely on no enforcement a risky one.

Thanks to the delayed enforcement, firms can still make a choice to retain sales incentives as an essential part of their business. Some firms have already elected to retain sales incentives by replacing the Impartial Conduct Standard with a certified computer model. Fortunately, it is not too late for this firm and others to minimize the consequences by doing so.

The choice firms still face is whether to retain or eliminate sales incentives. Using a computer model, advisors remain free to earn reasonable sales incentives but must rely on the computer model for product selection recommendations. In fact, the computer model itself becomes a sales tool that promises clients impartial and prudent recommendations that are independently certified. On the other hand, using the Impartial Conduct Standards requires that sales incentives ultimately be eliminated.

The choice to use the certified computer model was put into law by the Pension Protection Act of 2006 (“PPA”). The provisions of PPA supersede the Impartial Conduct Standards of the fiduciary rule. Essentially, if a firm is not compliant with PPA, it must adopt the Impartial Conduct Standards and eliminate sales incentives. (You can email us for more information on the PPA and the computer model requirements.)

There are several factors firms should consider in making such a choice. These include the availability and cost of a compliant computer model and adapting it to fit the firm/advisor strategies. It is essential to understand acceptable investment theories, marketing strategies, risk management and required agreements and disclosures.

The following table compares key provisions of the Impartial Conduct Standards with the PPA.

Table: Impartial Conduct Standards vs. PPA

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