Don't let the DOL fiduciary rule's grandfathering provision trip you up

It's difficult to count on the grandfathering exemption if advisers plan to make ongoing recommendations in an acccount

May 20, 2016 @ 11:15 am

By Greg Iacurci

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The Labor Department gave advisers some wiggle room in its new fiduciary rule for the “grandfathering” of pre-existing investments in retirement accounts, but advisers should tread lightly — some believe it will be fairly easy to unknowingly run afoul of the rules.

The fiduciary regulation, which raises investment advice standards for retirement accounts such as 401(k)s and IRAs, gives advisers and brokers an exemption — called the “exemption for pre-existing transactions” — for any investment advice rendered prior to the rule's applicability date.

For example, after the rule goes into effect, an adviser recommending purchase of an investment offering variable compensation, such as commissions or 12b-1 fees, would likely have to do so under the enhanced compliance regime of something called the Best Interest Contract Exemption (BICE) to avoid running afoul of the rules and committing a prohibited transaction.

(More: Coverage of the DOL rule from every angle)

However, that same recommendation made under an arrangement prior to April 10, 2017 would be considered grandfathered into the new regulatory regime, so using another exemption such as the BICE wouldn't be necessary.

There are caveats involved, however. One of the most important is that an adviser can't provide additional advice on a pre-existing investment if the recommendation increases the adviser's compensation.

“I think people may inadvertently blow their grandfathering if they give even the most innocuous advice or information” beyond a recommendation to hold an investment, according to Marcia Wagner, principal at The Wagner Law Group. “It's very easy to mess up.”

The grandfathering exemption will be helpful for those accounts that don't need much ongoing maintenance or active management on the part of the adviser, Ms. Wagner said.

“If you're going to touch the account or deal with the client really at all, it will be difficult, I think, over time, to not blow the grandfathering,” Ms. Wagner said.

A recommendation to hold an investment would not break the grandfathering rules. Switching a client into a mutual fund paying the same 12b-1 fee as the previous fund, for example, would also be okay, because the adviser wouldn't be making additional compensation due to the recommendation, according to Chris Finefrock, vice president of investments at independent broker-dealer ValMark Securities, Inc.

Ultimately, those receiving the majority of their compensation from commissions and 12b-1 fees are likely to be the ones who try to keep clients in grandfathered arrangements, so they can avoid having to comply with the BICE, Mr. Finefrock said. The BICE is thought to expose advisers to greater compliance and litigation risk.

Similarly, a recommendation to buy into investments under a systematic purchase program (for example, an arrangement for a client to put $500 per month into an IRA) wouldn't trigger a prohibited transaction — however, that's only if the arrangement was entered into prior to the applicability date.

Any investment arrangement that comes up for renewal and is then renewed after the applicability date could run afoul of the grandfathering provision.

For that reason, David Levine, principal at Groom Law Group, says advisers need to make sure any arrangements were entered into prior to the applicability date, and haven't expired and been renewed after that date. Therefore, advisers may not be able to rely on the grandfathering exemption indefinitely if they need to renew a contract.

“I don't think [the exemption] is that onerous, but they have to be careful,” Mr. Levine said.

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