Tweaks to final DOL fiduciary rule help ease implementation without sacrificing core principles

April 6, 2016 was a transformational day in the history of financial services regulation. After more than five years in the making, the DOL’s fiduciary rule was released.

The basic framework of the 2015 proposal remains intact even though the DOL made some important concessions to improve the rule’s workability for securities-licensed personnel who will have to adapt to becoming fiduciaries for the first time. The changes made also help the DOL demonstrate that it has been responsive to concerns expressed by the brokerage and insurance industries and their advocates in Congress.

The final rule sweeps away the essentially unenforceable five-part test for determining fiduciary status. The new definition closes the giant loophole created by the original 1975 requirements that advice be regular and the primary source of decision-making in order for fiduciary status to apply — these provisions are gone.

As a result, virtually everyone who provides investment advice for compensation in the retirement space will be fiduciaries — a big change for securities-licensed representatives who have escaped fiduciary accountability under the old definition.

(More: The DOL rule covered from every angle)

Opponents and others concerned with the DOL’s proposed eight-month deadline for implementing compliance requirements can breathe a little easier, as the compliance deadline has been extended. It’s now 12 months (April 10, 2017) for most of the rule’s requirements and 18 months (January 1, 2018) for the major provisions of the Best Interest Contract Exemption (BIC Exemption or BICE).

At 1,023 pages, the collected documentation released by the DOL for the rule rivals “War and Peace” in scale (1,225 pages in the original edition of the novel). And while the DOL’s tome isn’t a literary masterpiece, it certainly is an impressive body of work. The heft of the final rule comes from a wealth of commentary that explains and provides context for the rule’s provisions and the changes that were made.

While the adopted definition of fiduciary remains largely as proposed, the rule now clarifies the kinds of recommendations that would be considered investment advice, and therefore entail fiduciary accountability.

Two types of investment advice are specified in the rule. The first involves recommendations regarding the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property. This type also includes recommendations about how to invest after a rollover, transfer or distribution is made from a plan or IRA.

The second type of advice involves recommendations pertaining to the management of securities or other investment property. These include recommendations on investment policies or strategies, portfolio composition, the selection of investment managers or advisers, and even types of investment accounts such as selecting between brokerage and advisory accounts. This type also addresses rollovers — whether to rollover, in what amount, in what form, and to what destination.

Most of the carve-outs from the definition of fiduciary that were in the 2015 proposal have been retained and renamed “non-fiduciary communications.” These relate to activities that historically have not been fiduciary in nature and won’t be under the final rule. They include counter-party transactions (sales relationships), platform provider services, swap transactions, recommendations by employees of plan sponsors, and investment education.

The proposed carve-out for investment education came under fire for prohibiting specific plan investment options from being named in asset allocation models or interactive investment materials. The DOL has eased that restriction somewhat by allowing their use subject to oversight by a plan fiduciary who is independent of the service provider. However, direct references to specific investment options are still barred for IRAs unless the adviser is a fiduciary.

The proposed carve-out for appraisals has been removed from the final rule. In its commentary, the DOL explained that it views services to value non-traded and hard-to-price assets as being critical to the due diligence work of fiduciaries. As such, the DOL believes that people who provide appraisal services should be held to a fiduciary standard. For that reason, these services didn’t fit the “non-fiduciary communications” category and have been removed from the rule. The DOL indicated it may undertake a separate rule-making for appraisals in the future (and it sounds like they almost certainly will).

The most closely watched provision in the rule was the Best Interest Contract Exemption (BICE). Elimination of major disclosures and data disclosures such as 1, 5 and 10-year expense projections for investment products from BICE was a big concession.

In addition, the three-way contract between firm, individual adviser and retirement investor was reduced to the more conventional agreement between firm and client. More interestingly, the contractual component of BICE was eliminated for advice to plans and plan participants, who are already covered by a private right of action (to sue for ERISA breaches). The contract requirement remains for IRAs and non-ERISA accounts.

(Related read: DOL chief Thomas Perez gets high marks for guiding fiduciary rule through)

When a BICE must be signed also has been clarified. Recommendations can be suggested prior to execution of the contract. However, transactions can only be executed after the contract is signed.

The ability to sell a limited range of products, generally proprietary, remains available under BICE. Most of the conditions from the 2015 proposal are also in the final rule.

Of major interest to RIAs is the streamlined exemption within BICE for level-fee rollover advice. Retirement advisers who charge a level fee for both the advice they provide to plans and advice they provide to IRA clients have generally been prevented from suggesting an IRA rollover for fear of triggering a prohibited transaction. This is because most advisers charge a higher fee on assets in an IRA than they do for plan assets. Under the proposed rule, BICE could have been used to navigate this situation, but fi360 and other organizations suggested a streamlined solution which the DOL adopted.

Level-fee advisers can take advantage of a new safe harbor by providing written acknowledgement of fiduciary status, following impartial-conduct standards, and documenting why the final recommendation was in the best interest of the client.

One of the big surprises in the final rule was the inclusion of equity-indexed annuities under BICE. It had appeared that indexed annuities would continue to be covered under existing Prohibited Transaction Exemption 84-24, since in the 2015 proposal the DOL only moved variable annuities to BICE. Fixed annuities remain under PTE 84-24, which was itself strengthened.

It was also somewhat surprising that the DOL completely removed its restricted menu of investment products available under BICE. Previously only traditional investments such as bank deposits, CDs, mutual funds, exchange-traded REITS and ETFs were eligible.

Now, any product is available. Importantly, investment selection remains subject to ERISA’s tough prudence standard. This added flexibility for advisers to exercise professional judgment but retained strong fiduciary principles with clear recourse available to investors if fiduciary breaches occur.

Finally, the DOL indicated that an adviser’s monitoring responsibilities can be specifically limited in a client engagement. However, the DOL also made clear that it would be very difficult for a fiduciary adviser to justify not monitoring a recommended course of action that is risky or volatile.

It’s been a long wait between the DOL’s comment period on the rule, and the momentous industry impact now driven home by the final rule’s release. The DOL has proven to be good on its word. It made significant changes to address practical impediments to implementing the rule, without sacrificing core fiduciary principles.

Blaine F. Aikin is executive chairman of fi360 Inc.