RIA Compliance Blog
The Department of Labor (DOL) recently released its first set of rolling FAQ guidance regarding its new rules expanding the definition of fiduciary investment advice under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (Code), adopting new prohibited transaction exemptions (PTEs), and amending certain previously existing PTEs. The DOL answered questions regarding the new PTEs and the amendments to existing PTEs under ERISA and the Code. The DOL also reaffirmed the applicability date of April 10, 2017, stating that this date provided adequate time for financial service providers to adjust to the rule changes.
One common area of confusion regarding the new rules was the extent to which the new Best Interest Contract (BIC) exemption would be available for use by discretionary investment managers. One of the conditions to use of the BIC exemption is that the fiduciary not have any discretionary authority or control with respect to the recommended transaction. This excludes a large portion of investment advisers that serve as discretionary investment managers. However, there are limited circumstances in which they can receive protection under the BIC exemption.
The DOL clarified that the BIC exemption can provide relief for a discretionary investment manager’s recommendation to roll over to an IRA where the adviser will provide investment advice so long as the adviser does not exercise any discretionary authority or control regarding the decision to roll over. In other words, the investor must make the final decision to roll over. In addition, the adviser must comply with the other applicable conditions of the BIC exemption. This relief is available even if the adviser will subsequently serve as a discretionary investment manager with respect to the IRA, so long as the adviser meets those same requirements.
Essentially, discretionary managers that receive only a level fee and comply with the streamlined provisions of the BIC exemption for level fee fiduciaries can be protected under the BIC exemption for rollover recommendations. However, the BIC exemption is not available for any other prohibited conflicts of interest that may occur within these discretionary accounts.
Another open question was the requirement for level fee fiduciaries that they document the basis for any rollover recommendations and their determination that the rollover was in the best interest of the retirement investor. Many financial service providers expressed confusion at the level of due diligence that advisers were required to undergo in making this determination. The DOL clarified that advisers must make “diligent and prudent efforts” to obtain information regarding plan fees and expenses or the different levels of services and investments available under each option, and that the information required to fulfill this duty should be readily available as a result of DOL regulations mandating plan disclosure under Rule 404a-5.
The adviser can also rely on alternative data sources to obtain this information such as the plan’s most recent Form 5500, or other reliable benchmarks on typical fees and expenses for plans of this type and size. However, if the adviser relies on these alternative data sources the documentation should include an analysis of the data’s limitations and how the adviser determined it was reasonable.
Many advisers also requested further guidance on what constitutes “reasonable compensation” under the new BIC exemption. The DOL clarified that “reasonable compensation” incorporates the well-established reasonable compensation standard under ERISA 408(b)(2) and Rule 408b-2 thereunder. Under this standard, compensation is not reasonable when it is more than what would ordinarily be paid for like services by like enterprises under like circumstances, taking into account the facts and circumstances existing at the time of the investment advice. The DOL noted that the essential question was “whether the charges are reasonable in relation to what the investor stands to receive for his or her money,” and that firms could ensure compliance with this standard by paying attention to market prices and benchmarks.
Other topics covered in the DOL’s FAQ include broker dealer payment structures and compensation systems, availability of BIC exemption to robo-advice providers, payment of recruitment bonuses or awards in adviser recruitment programs, the BIC exemption web disclosure requirement, and the BIC exemption grandfathering provisions. The DOL concluded by noting that while it has the authority to investigate or audit ERISA and/or Code fiduciaries, it will be primarily focused in the implementation phase on assisting everyone come into compliance with the new rules.
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