Insights from the experts in investment fiduciary responsibility.

DOL Webinar: Your Fiduciary Rule Questions Answered – Part 3

Posted by Duane Thompson, AIFA®, Senior Policy Analyst, fi360, Inc. on November 12, 2015

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On Oct. 15, fi360 sponsored a webinar with an update on the Department of Labor’s proposed fiduciary rule.  Since we were unable to respond to all of the written questions posed by attendees, we are posting our responses here in this 3rd in a series of blogs.  The DOL is expected to issue a final rule during the first half of next year.

Keep in mind that the information provided below is for educational purposes, not as legal or compliance advice, and that the final rule will have some changes.  So with these caveats, here are our responses. 

1.    What’s going on with ERISA in regards to rollover abuses with cross-selling and capturing rollover assets?
In a nutshell, a lot.  The conflict of interest rule would dramatically broaden the sweep of fiduciary coverage for these activities – essentially making thousands of securities brokers (and call centers) ERISA fiduciaries when providing investment advice on taking a distribution from a 401(k) plan and rolling the assets into an IRA.  
DOL Advisory Opinion 2005-23A warns that fiduciary advisors to a plan that provide advice to on roll over assets may be subject to ERISA’s prohibited transaction rules.  By exercising de facto discretion over plan assets, the DOL reasons that the fiduciary may be using plan assets in its own interest by collecting an advisory fee.  In addition, a U.S. Government Accountability Office report in 2013 found that call center representatives encouraged IRA rollovers without making a reasonable due diligence inquiry as to whether participants would benefit by staying in the plan or rolling over into another plan.
The GAO report as well as heightened interest by the SEC and FINRA in marketplace abuses likely influenced the Department’s decision to add fiduciary coverage in the revised proposal to rollover advice.

2.    Under BICE, doesn't the advisor have to report the [investment performance] returns to the SEC?
No, there is no requirement that recordkeeping under BICE must be proactively reported to the SEC by a registered investment adviser.  However, it doesn’t mean that an SEC examiner won’t request this information in an audit.  Of course, the RIA would have to be subject to BICE in order to maintain those records.  If a level fee is charged, then BICE may be irrelevant.
You may be thinking about the SEC’s books and records rule that requires retention of records used to calculate the performance or rate or return of certain accounts or securities in advertisements, i.e., communications distributed to 10 or more persons by a registered investment adviser. 
If subject to BICE, firms and their agents would be required to disclose to the individual retirement investor, prior to the transaction, an “all-in cost and anticipated future costs of recommended assets” over various holding periods.  Separately, the firm is required to maintain a public Web page that shows overall the direct and indirect compensation payable to the advisor, the firm, and any affiliate in connection with each asset available to the plan, participant or IRA holder. 
As such, the cost estimates required to be disclosed to the individual retirement investor under BICE would not meet the SEC’s threshold of a communication to 10 or more persons, nor do we believe that merely disclosing the cost of asset transactions on a public web site (as opposed to advertising investment performance) overlap with SEC performance requirements. 

3.    How do you feel the BICE exemption is going to impact professional trusted advisors that represent a captive insurance carrier who must sell proprietary products that are commission-based?
The DOL’s special conditions for the sale of proprietary products under BICE underline the challenge of managing this conflict successfully as a fiduciary, no matter how ‘trusted’ the advisor is perceived by her clients or others.  Case law demonstrates that ERISA does not prohibit the use of proprietary products in plans, and Dodd-Frank confirms the ability to offer only a limited range of products without triggering an automatic fiduciary breach – at least under securities law.
As proposed, BICE requires firms and their agents offering a limited lineup of investment products to meet additional conditions.  These requirements include the firm making a “specific written finding” that the products available do not prevent its advisors from offering advice that meets ERISA’s prudence standard.  Moreover, the advisor must consider various suitability factors and provide unbiased advice “without regard to the financial or other interests” of the firm or advisor, according to the rule’s preamble.
A recent Morningstar cost-impact analysis of the rule on industry concludes that the rule will challenge “certain alternative asset managers and life insurance companies that pay for distribution.”  
That’s a long way of answering ‘yes.’  BICE is likely to disrupt the commission-based business model, at least until case law provides a baseline standard for what kind of incentive compensation is ‘reasonable’ and consistent with ERISA’s ‘sole interest’ standard.

4.    Would complex annuities or structured notes be [included in the] complex products ban?
The rule proposal, to our knowledge, does not address or define “complex annuities.”  Variable annuity transactions would be subject to BICE and fixed annuities to an existing prohibited transaction exemption, 84-24.  However, PTE 84-24 would be modified by adding fiduciary conditions under the new rule.
The definition of ‘Asset,” for purposes of meeting BICE requirements, does not mention structured notes specifically, but since they typically have a derivative component, are unlikely to be available.  Products excluded from BICE under the ‘Asset’ definition include “a security future or a put, call, straddle, or other option or privilege of buying an equity security from or selling an equity security to another without being bound to do so.”

It’s important to note that the product ban applies only to transactions subject to BICE.  Fiduciary advisors charging reasonable ‘level fees’ for advice generally would be able to recommend a wide variety of products, limited only by ERISA’s duty of prudence and the duty of loyalty to act solely in the plan or participant’s interest.

5.    How can you execute a contract before any of the services are discussed?  Did you mean delivered?
Industry critics have asserted that the DOL rule would prohibit a discussion of services prior to execution of a contract.  Consumer groups supporting the rule disagree with that interpretation, but have said that their main concern is with ensuring that the contract is in force prior to a transaction, not before services or products are discussed.  We believe that the final rule will clarify this approach but also ensure that the retirement investor has sufficient time to review conflicts of interest before approving one or more transactions.  


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