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AdvisorNews - April 2017

The Ins and Outs of the DOL’s Best Interest Contract Exemption

The BICE gives some advisors a broad mandate in how they want to be compensated. Here's what you need to know.

  1. Scott Simon, 03/02/2017

By the time you read this month's column, we may (or may not) know the ultimate fate of the Conflict of Interest Rule (Rule) which was issued by the U.S. Department of Labor (DOL) on April 8, 2016. With an "applicability date" of April 10, 2017, the best guess as of this writing is that the Rule will remain in limbo for another six months or so, after which time it will be left as is, modified in some way, or outright extinguished. 

In the meantime, I'll continue my analysis of the Rule as it was written for applicability on April 10. 

The Best Interest Contract Exemption
Under the Employee Retirement Income Security Act of 1974 (ERISA), fiduciaries cannot (1) breach the fiduciary duties they owe to plans and plan participants (and their beneficiaries), or (2) engage in prohibited transactions involving self-dealing or receive compensation from third parties for transactions involving a plan or IRA assets. 

The Best Interest Contract Exemption (BICE) allows fiduciaries to receive variable compensation which ordinarily violates the prohibited transaction rules, since any investment advice rendered could be affected adversely by receipt of this kind of compensation. Such compensation includes: (1) commissions paid by a plan, a plan participant (or its beneficiaries), or an IRA, and (2) sales loads, 12b-1 fees, revenue-sharing or other payments, and commissions from third parties providing investment products.

The BICE, which is a key feature of the Rule, allows advisors a broad mandate in how they want to be compensated. Everything is hunky-dory in this respect as long as an advisor promises to act in a client’s best interest, is prudent and loyal (two critical fiduciary duties), and doesn’t charge unreasonable compensation.

Remember, though, that the BICE is not available to fiduciaries that receive variable compensation in exchange for rendering discretionary investment advice pursuant to ERISA section 3(21)(A)(i). For example, assume that an ERISA section 3(38) investment manager (a "kind" of ERISA section 3(21)(A)(i) plan fiduciary) has the power to invest IRA assets without approval from the IRA owner. If the manager earns any compensation, it would violate the prohibited transaction rules. And the manager couldn't obtain protection from the BICE because it’s providing discretionary--rather than non-discretionary--advice.

The Rule, then, is not concerned with discretionary fiduciaries but with non-discretionary ones pursuant to ERISA section 3(21)(A)(ii). All three elements described in that section--a fiduciary (element 1) that renders (non-discretionary) investment advice (element 2) for compensation (element 3)--must be present in order for the Rule to apply to an advisor communicating with a plan participant or an IRA owner.

Only Financial Institutions May Utilize the BICE
Only eligible Financial Institutions may utilize the BICE in rendering investment advice to retail retirement investors. The Rule defines “Financial Institutions” as (1) registered investment advisors (the commonly used term rather than the legal term of "adviser"), broker/dealers, banks and insurance companies; and (2) their respective employees, contractors, agents, representatives, affiliates and related entities. "Retail retirement investors" are defined as (1) ERISA plans (holding less than $50 million in assets; i.e., unsophisticated investors), (2) plan fiduciaries and plan participants (and their beneficiaries), (3) non-ERISA plans such as Keogh plans, IRAs, IRA fiduciaries, HSAs, Archer medical savings accounts and Coverdell education savings accounts.

The Rule does not pertain to investment advice that's rendered to 529 plans, non-ERISA 403(b) plans, 457 plans or non-qualified, non-ERISA plans. The BICE is irrelevant in such cases.

Requirements of Financial Institutions Utilizing the BICE
A Financial Institution generally must file a one-time notice with the DOL that it’s utilizing the BICE. There’s no need, however, to specifically identify any plan or IRA, nor is DOL approval required. Financial Institutions seeking to rely on the protections of the BICE are required to:

>Adopt "Impartial Conduct Standards," which must:

>Adhere to a Best Interest Standard similar to ERISA's fiduciary duties, including: prudent advice which is based on the investment objectives, risk tolerance, financial circumstances and needs of a retail retirement investor;

>Such advice must be rendered without regard to financial or other interests of the advisor, Financial Institution, or their affiliates, related entitles or other parties;

>Bar recommendations of transactions that will result in the receipt of unreasonable compensation; and

>Prohibit materially misleading statements.

Adopt "Anti-Conflict Policies and Procedures," which cannot allow:

  1. Material conflicts of interest that cause advisors to violate the Impartial Conduct Standards; or
  2. The use of compensation, personnel or other actions that incentivizes advisors to make recommendations not in the best interest of retail retirement investors.

In addition:

>Anti-conflict policies and procedures must be in writing and readily available free of charge to retail retirement investors on the Financial Institution’s website;

>Any material conflicts of interest in a transaction must be described;

>Recommendations of proprietary products and those that generate third party payments must be disclosed; and

>A retail retirement investor must be informed that it may obtain disclosure of detailed costs, fees or any other compensation in a transaction--but only if such investor requests it.

The Best Interest Contract
There are certain situations in which a simplified or streamlined version of the BICE--a "best interest contract" (BIC)--applies when investment advice is rendered.

There are four versions of a BIC: (1) a full-blown BIC, (2) a disclosure BIC, (3) BIC Lite, and (4) a transition BIC. Only a Full-Blown BIC requires a formal written contract while the other BIC versions require only assorted disclosures, representations and the like--although these are important and can be extensive.

A Full-Blown BIC Pertains to IRAs and Applicable Non-ERISA Plans

What's commonly referred to as a "Full-Blown" BIC pertains to situations where an advisor gives advice to IRAs and applicable non-ERISA plans which do not have the protections of ERISA.

The terms that a Financial Institution must include in a Full-Blown BIC include:

>A statement of the fiduciary Best Interest Standard of care;

>An acknowledgement of fiduciary status in writing;

>General disclosures on compensation and potential conflicts of interest;

>Compliance policies that mitigate conflicts of interest;

>Detailed compensation figures--but only if requested by a retail retirement investor;

>Mandatory transaction disclosures for each investment made that focus on fiduciary standards and conflicts;

>Mandatory arbitration with reasonable venue (e.g., not in Fairbanks, AK, unless a resident of AK); and 

>No language limiting a retail retirement investor’s class action rights.

A Financial Institution must also make available on its website descriptions of any conflicts of interest and the advisor’s business model.

A Disclosure BIC Pertains to ERISA Plans
What's commonly referred to as a "Disclosure" BIC pertains to situations where an advisor gives advice to ERISA plans. In such cases, an advisor isn't required to sign a written contract since an enforcement mechanism to police any such advice that may be imprudent is already found in ERISA section 502(a)(2) and (3), which contains a direct right of action against a plan fiduciary for a prohibited transaction or breach of fiduciary duty. What is required is a written statement of the plan fiduciary's compensation and fiduciary status. An advisor is also required to provide the same general disclosures on compensation and potential conflicts of interest as under the Full-Blown BIC.

A BIC Lite for Level Fee Fiduciaries
The DOL defines a ‘‘level fee’’ as a "fee or compensation that is provided on the basis of a fixed percentage of the value of the assets or a set fee that does not vary with the particular investment recommended, rather than a commission or other transaction-based fee."

What's commonly referred to as a "BIC Lite" pertains to situations where the only fee received by a Financial Institution, an advisor, or any affiliate in connection with advisory or investment management services to a retirement plan or IRA assets is a level fee. Fee levelization eliminates the prohibited transaction (i.e., no variable compensation is present) to begin with, so there’s no conflict of interest which removes the need for a Full-Blown BIC.

And yet, even a fee-only advisor is prone to a conflict in an IRA rollover situation where it suggests to an investor that the investor roll over assets into an account that will pay the advisor higher fees as a result. In this kind of situation, a BIC Lite may be utilized.

A BIC Lite can apply in cases where a level-fee advisor has an existing relationship with a retirement plan or even where the advisor solicits participants not connected with the plan for IRA rollover services.

An advisor relying on a BIC Lite is required to provide a written statement of fiduciary status and a written rationale for why its recommendation is in the best interest of the retail retirement investor. But no written contract is necessary nor are other disclosures, nor is there the need for, say, compliance policies.

Financial Institutions are still required to acknowledge fiduciary status in writing and adhere to standards of fiduciary conduct such as the Impartial Conduct Standards and Anti-Conflict Policies and Procedures.

A Transition BIC

A transition BIC is available to advisors that wish to utilize a Full-Blown BIC but will not be able to comply with its requirements by April 10. In general, numerous requirements applicable to other BIC versions are waived until January 1, 2018. But first, we have to get through 2017 to see what the ultimate fate of the Rule will be.


DOL Issues Temporary Enforcement Relief for Fiduciary Rule Non-Compliance

By Fred Reish, Bruce Ashton, Brad Campbell, Joshua Waldbeser, Sandra Grannum, Joan Neri and Elise Norcini

It is possible that the delay to the Department of Labor (DOL) Fiduciary Rule applicability date will not be effective before April 10. If that were to happen, it could cause enormous confusion and noncompliance. In an effort to head off these problems, the DOL has published Field Assistance Bulletin 2017-1 (the FAB), which provides some limited temporary relief.

So, what does this mean for advisers and financial institutions? The FAB recognizes the industry’s concerns about having to comply with the Rule during a temporary “gap period,” as well as the possibility that it could find out only immediately prior to April 10 that no delay would occur. The FAB assures advisers and financial institutions that they will not face possible DOL enforcement merely because they elect to “wait and see” what happens. The FAB makes clear that the DOL still intends to issue a final delay regulation before April 10, but it provides at least some breathing room for the industry in light of the uncertainty.

Specifically, the FAB provides that the DOL will not take enforcement action for non-compliance with the Fiduciary Rule, including its related exemptions, in two cases:

  1. “Gap” Period: If the DOL decides to delay the Fiduciary Rule but the delaying regulation is not finalized until after April 10, the Fiduciary Rule would briefly become applicable during the resulting “gap period.” This would trigger fiduciary status and prohibited transactions for many advisers and financial institutions that waited for the DOL to complete the regulatory process. During the gap period (April 10 until the delay is finalized), the FAB states that DOL will not take enforcement action related to the Rule.
  2. No Delay: If DOL decides to let the Fiduciary Rule become applicable on April 10 with no further delay, advisers and financial institutions would have a “reasonable period” after that decision is announced to begin complying with the Rule. Further, the FAB states that the “Transition Period” disclosures required under the Best Interest Contract Exemption (BICE) and the DOL’s exemption for principal transactions could be provided during the 30-day “cure period” that these two exemptions recognize where disclosures are inadvertently omitted.

In fact, it appears that the DOL is hoping that advisers and financial institutions relying on BICE (or the principal transaction exemption) will hold off on providing retirement investors with Transition Period disclosures until after the delay (if any) is finalized. In the FAB, the DOL expressed its concern over investor confusion resulting from disclosures that communicate uncertain applicability dates and “conditional” acknowledgements of fiduciary status.

Finally, the FAB states that the DOL will consider additional relief as necessary, including a potential prohibited transaction exemption. As we explain below, we believe additional relief will be needed, because the enforcement policy set forth in the FAB provides relief only from DOL enforcement, not from prohibited transaction excise taxes or private litigation.

Does the FAB Provide Absolute Protection?

No. The FAB provides no protection or assurances against action by other regulators or the private sector. Unless the DOL issues a class exemption providing relief for prohibited transactions occurring during a “gap period” (or a “reasonable period” after the decision not to delay the Rule is published, if this should occur), the enforcement policy alone won’t provide relief for “conflicted” advice to IRAs or for excise taxes resulting from prohibited transactions involving ERISA plans. The DOL has no jurisdiction over the enforcement of the prohibited transaction rules for IRAs, or the assessment of excise taxes, which is handled by the IRS in all cases.

As a statement of the government’s intent, however, the FAB is a very important first step. It puts the DOL on record as wanting to avoid negative consequences that would result from a temporary application of the Rule. We applaud this, and hope DOL will build on this foundation, providing an even stronger statement of its intentions to hold harmless those who act in good faith.

What Should Advisers and Financial Institutions Do Now?

Despite the limited relief, advisers and financial institutions may want to proceed with their compliance efforts. While we believe the Rule will probably be delayed, the delay would only be until June 9. During the 60-day delay period, the Rule will be re-reviewed. It may be ultimately modified or revoked, but the final result is far from certain.

Second, it is important to remember that compliance with the current fiduciary and prohibited transaction rules is required in the meantime. The publicity surrounding the Rule has resulted in fiduciary status and “conflicted” recommendations from advice fiduciaries becoming more closely scrutinized.

If no delay occurs (which is unlikely, in our view), compliance with the Rule would be required within a “reasonable period,” even with respect to DOL enforcement. For disclosures required during the BICE Transition Period, the 30-day cure period could be regarded as a safe harbor of sorts. In other cases, the FAB does not explain what the DOL would consider a “reasonable” period, but it could be quite short.

The FAB provides some flexibility for institutions to consider whether to wait and see what happens in early April, but the relief is not absolute. Advisers and financial institutions should follow further developments closely, and we intend to provide updates to our financial services clients as they unfold.

For more information, please read the temporary enforcement policy in its entirety.




How will you offer value under the fiduciary rule?

Advising in a post-DOL fiduciary rule world

Mar 21, 2017 | By Caroline Marwitz

With fee transparency front and center under the fiduciary rule, advisors must be specific about their value proposition.

LAS VEGAS -- Advisors packed the ballroom at the NAPA 401(k) Summit to hear three industry experts discuss the rule that is on everyone's minds.

Morgan Stanley director Edward O’Conner, Prudential Investments VP Joe Gill, and GRP Associates CEO William Chetney offered a lively discussion of the Labor Department’s fiduciary rule.

In the brave new world of fee transparency that has emerged, advisors are forced to be specific about the value they offer, even as technology rears its threatening head in the form of robo-advisors. 

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How can advisors add value and thereby justify their fees?

How about Health Savings Accounts?

Chetney asked how many in the audience were considering incorporating HSAs. A few hands went up among the thousand-plus in attendance – maybe 25 percent, if even that.

“With HSAs, the economics would be a challenge. The vast majority will be cash management accounts,” O’Connor said. “Are they economically viable for an advisor? I don’t know. Maybe you need to get into HSAs and figure out how to make a decent living and bolt it onto a 401(k).”

How about partnering?

Gill polled the audience: “Do you think partnering with non-specialist advisors is effective?” The audience was nearly evenly split, Yes and No.

“Conceptually, it makes sense,” Chetney said. He pointed out what has already been accomplished in the industry: “We got people to join plans. Employers didn’t want to do it. Employees didn’t want to do it. It was all the foot soldiers. To have those conversations, to make them better consumers, we can’t do it—the partnerships are where it can be done. If we want to talk to 75 million Americans, we have to engage in these partnerships.”

But it’s not easy, O’Connor added. “Building a proposition to those generalists, packing it, making sure they don’t get you in trouble, proving and showing success -- you have to grind this out.” Still, he said, “I encourage you to leverage other generalists to get more business.”

Will the fiduciary rule affect how firms are recruiting?

Even if the rule is killed, a higher standard of care has been established in the industry. Recruiting deals will have to be restructured, O’Connor said.

But the challenge, Gill pointed out, is “How are we going to organically grow advisors in the DC business if we’re headed toward the specialist model?”

It’s hard for a young professional to enter the field and build a viable business, O’Connor said. “The days of ‘here’s a phone book, good luck,’ are gone. Bring in those young professionals, have them work together with the 50 year olds, have them partner together. You get the best of both worlds—working for a big company but on a team you’re building up.”

The advisor role

So what is the role of the advisor in a post-fiduciary-rule world?

Pulling everything together, Gill said. “Cracking the code – ‘you’ll get X from Social Security, you’ll get X from this plan, X from that plan.”

Posing questions, O’Connor said. See it as an opportunity. “We need to talk more broadly about retirement. We need to position ourselves a lot more broadly than the DOL is 'wonking about' right now.”

“If you stake out your territory, say okay this is coming, presell it to clients, you’re doing better and creating value to support the fees you want to charge,” Chetney said.



Final Extension of Applicability Date

April 5, 2017

On April 4, 2017, the Department of Labor (“DOL”) released for public inspection its final regulation extending the applicability date of the Fiduciary Rule from April 10, 2017 to June 9, 2017 as well as providing additional transition relief through the end of the year (the “Final Extension”). While the Final Extension is a welcome development, it creates a series of significant new challenges for the retirement services industry. Below, we first describe the specific changes in the Final Extension. Then, we outline the challenges.


Description of the Final Extension

June 9, 2017 Applicability Date. Under the Final Extension, the Applicability Date of the Fiduciary Rule (i.e., the definition and exemptions) has been extended by 60 days -- until June 9, 2017.


Relief Conditioned on “Impartial Conduct Standards.” The conditions for exemptive relief during the new Transition Period (from June 9, 2017 through January 1, 2018) are amended for the Best Interest Contract Exemption (“BIC”) and Principal Transaction exemptions (respectively, PTEs 2016-01 and 2016-02). From June 9, 2017 through January 1, 2018, the sole condition for relief will be adherence to the “Impartial Conduct Standards.” Each of the remaining conditions for exemptive relief during the Transition Period is eliminated, including the transition notice. There is no explicit recordkeeping requirement nor a need to designate a BIC compliance office or officers during the Transition Period, but many financial institutions are likely to voluntarily adopt recordkeeping and monitoring procedures. Importantly, the written disclosure requiring acknowledgement of fiduciary status, disclosure of limitations placed on the universe of recommendations, disclosures of Material Conflicts of Interest are no longer required during this Transition Period.


Robo Relief. Transition period relief is unavailable to Robo-advisers. However, DOL has effectively conformed the conditions of PTE 2016-01 section II(h) “level fee” relief to the new conditions applicable during the Transition Period for Robo-advisers by requiring only compliance with the Impartial Conduct Standards and not the written acknowledgement of fiduciary status condition.


Continued Availability of PTE 84-24 for Variable Annuities and Fixed Indexed Annuities. The Applicability Date for PTE 84-24 has been moved back to January 1, 2018 for everything except the application of the Impartial Conduct Standards. This means that for the remainder of 2017, PTE 84-24 can be used to cover the sale of fixed indexed and variable annuities. Likewise, the narrowed scope of relief to Insurance Commissions and Mutual Fund Commissions also does not go into effect until 2018. This will be welcome relief for those in the annuity business.


Other Exemptions. The effective date for the changes to PTE 75-1, 77-4, 80-83, 83-1, and 86-128 will be June 9th. The relief previously offered by these class exemptions will be significantly curtailed in some instances. Please see our prior alerts regarding those changes.


No Change in Duration of Transition Period. The Transition Period for the Fiduciary Rule continues to sunset as of January 1, 2018.


Challenges Presented by the Final Extension

While many in the retirement services industry had hoped for a longer delay or at a minimum, a series of delays, DOL signaled that it will not be further delays of the new June 9, 2017 Applicability Date and may instead use the time available in the remainder of calendar year 2017 to complete the updated legal and economic analysis as instructed by President Trump’s memorandum of February 3, 2017 (the “President’s Memorandum”) for the January 1, 2018 full compliance period. In the preamble, DOL states,


“Under this final rule extending the applicability dates, stakeholders can plan on and prepare for compliance with the Fiduciary Rule and the PTEs’ Impartial Conduct Standards beginning June 9, 2017. At the same time, stakeholders will be assured that they will not be subject to the other exemption conditions in the BIC Exemption and the Principal Transactions Exemption until at least January 1, 2018. The Department will aim to complete its review pursuant to the President’s Memorandum as soon as possible before that date and announce its intention on whether to propose changes to the Rule or PTEs, provide additional relief, or to allow all the conditions of the PTEs to become applicable as scheduled on January 1, 2018.


? Because the Fiduciary Rule will be applicable prior to the completion of the analysis required by the President’s Memorandum, DOL may be able to take the position that the retirement services industry is able to comply with the Fiduciary Rule. Additionally, because there is no delay to the end of the Transition Period from January 1, 2018, DOL may be able to argue that making changes to the Fiduciary Rule or related exemptions would drive up compliance costs at no industry savings. That is, by January 1, 2018, the financial services industry will be expected to have finished spending the $5 billion in anticipated start-up costs.


DOL may be unwilling to accept analysis completed prior to the completion of its 2016 Regulatory Impact Analysis when conducting the updated economic analysis required by the President’s Memorandum. The DOL dismissed comments challenging DOL’s cost estimates stating that they “largely echo comments made in response to the Fiduciary Rule when it was proposed in 2015, and that were addressed in considerable detail in the 2016 RIA.”


While the Final Extension offers some relief, it is a mixed bag. When the President’s Memorandum was published, many hoped that we would be closer to rescinding or revising the Fiduciary Rule by now. However, DOL has been able to continue moving forward with the rule as a result of its string of successes in court where the Fiduciary Rule has been challenged as well as its dearth of political oversight as the first Secretary of Labor nominee had to withdraw, and Alexander Acosta, the second nominee, has yet to be confirmed. We will continue to press for a more workable rule and will continue to provide updates.



What is the Difference Between a 3(16), 3(21), and 3(38) Fiduciary?

Nov 13, 2015

Business owners and corporate executives named as the fiduciary on their company’s 401(k) plan are often busy and lack the proper expertise to manage the plan. They may seek to reduce their liability for the plan by outsourcing administration to qualified experts that can serve as co-fiduciaries. There are three general types of fiduciaries for 401(k) plans, with different duties and liabilities: 3(16), 3(21), and 3(38).

While an investment advisor can serve in either 3(21) or 3(38) fiduciary capacity, and in some cases both, only a third party administrator may act as a 3(16) fiduciary. Administrators acting as 3(16) fiduciaries can reduce the liability for the plan sponsor more than 3(21) or 3(38) fiduciaries are able under ERISA.

What is a 3(21) Fiduciary?

An investment advisor offering investment advice for the plan typically falls under ERISA section 3(21). Anyone who manages the plan assets or renders investment advice for a fee is considered a 3(21) fiduciary. This type of fiduciary does not necessarily reduce liability for a plan sponsor, but they may help the sponsor do a better job of running the plan and avoid liability.

What is a 3(38) Fiduciary?

An advisor acting in ERISA section 3(38) capacity has discretionary control of the plan’s assets. This investment manager has a fiduciary duty to prudently manage the plan’s assets. They select, monitor, and replace investments for the plan. A 3(38) fiduciary must be a bank, an insurance company, or a registered investment adviser (RIA).

Advisors acting in either 3(21) or 3(38) capacity accept fiduciary responsibility and adhere to ERISA’s requirement to serve in the interest of plan participants and meet the prudent standard of care requirements. Plan sponsors retain the responsibility to select and monitor the advisor, regardless of their advisor’s fiduciary status.

How is a 3(16) Fiduciary Different?

While both types of advisors provide investment advice for the plan, a 3(16) fiduciary has a responsibility to ensure the plan is created and managed according to ERISA requirements. If there is no administrator, the plan sponsor takes on this role automatically. The 3(16) administrator typically handles reporting and disclosure requirements, summary plan descriptions, participant disclosures, as well as the plan’s Form 5500 filing.

By working with both an investment advisor acting in a fiduciary capacity, as well as a plan administrator acting in 3(16) capacity, plan sponsors may reduce their fiduciary liability and improve the compliance of their company’s plan.