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DOL fiduciary rule: Challenges for RIAs under the BICE

Recommendations to roll over retirement-plan assets, to transfer IRAs and advice generating additional payments like 12b-1 fees are trouble areas for RIA firms

Sep 29, 2017 @ 3:53 pm

By Fred Reish

On Aug. 31, the Department of Labor proposed to extend the applicability date for the full best-interest contract exemption to July 1, 2019. In all likelihood, that proposal will be finalized before the end of the year.

With that in mind, what is the current state of the DOL fiduciary rule? How does it apply to registered investment advisers? And, what are the primary challenges for RIAs under the rules now in effect?

The final fiduciary regulation, which became applicable June 9, already applies to investment advice to retirement plans and participants. And, if investment advice to an IRA results in compensation to the RIA firm or adviser that's prohibited (any compensation resulting from fiduciary advice or paid by a third party, like a commission or 12b-1 fee), an exemption is needed to allow for that compensation. Most likely, that exemption will be the "transition" version of BICE.

While many of the BICE requirements are being delayed, "transition" BICE applies now and stays in effect until June 30, 2019. That means that, if an RIA has financial conflicts of interest (which are called "prohibited transactions" in the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code), the RIA will need to comply with BICE's transition requirements.

Those requirements are that the firm and its advisers adhere to the "Impartial Conduct Standards," which are: using a best-interest standard of care; receiving no more than reasonable compensation; and not making materially misleading statements. In addition, the Labor Department says an RIA needs to have compensation practices and policies that ensure firms adhere to the best-interest standard.

The new rules apply to some transactions that are not obvious, such as recommendations to transfer IRAs, recommendations to take distributions and roll over to IRAs, and referrals to discretionary and non-discretionary investment advisers. RIAs need to be aware of the types of recommendations subject to the rules and the compliance issues for those recommendations and associated compensation.

That's the law. But, what about practical applications?

In my practice, I have seen a number of issues under these rules for RIAs. Here are three common ones:

Recommendations to plan participants to take distributions and roll over to IRAs with the adviser

This is considered to be a fiduciary recommendation under ERISA and, since a registered investment adviser will earn more when the money is in the IRA, it is a prohibited transaction requiring the BICE. At a minimum, that means the RIA needs to consider the services, investments, and fees and expenses in both the plan and IRA, and the financial circumstances, investment objectives, needs and risk tolerance of the participant. After review and analysis of those factors, a recommendation can be made, so long as it's prudent and loyal. The burden of proof of compliance is on the RIA.

A recommendation to transfer an IRA

The analysis for this recommendation is similar to that for a recommendation to take a plan distribution. However, the analysis may be easier, since the investments, services and expenses in the current IRA may be similar to those in the recommended IRA (as opposed to a recommendation to take a distribution, which often involves consideration of lower fees and expenses in the plan). Again, the data needs to be gathered and analyzed in light of the investor's circumstances. After that analysis, a recommendation can be made, so long as it is prudent and loyal.

Recommendations of investments or providers that generate additional payments

While advisers to retirement plans are usually familiar with the prohibited transaction rules concerning additional compensation, that is not necessarily true of advisers to IRAs. However, under the prohibited transaction rules in the Internal Revenue Code, additional payments resulting from investment advice are prohibited. That can include, for example, payments from investments and service providers (such as 12b-1 fees, marketing allowances, trips and gifts, and payments from record keepers, custodians, or other entities).

Where non-discretionary investment advice is provided, BICE will provide relief for those payments, so long as the additional payments are adequately disclosed and the aggregate compensation of the firm and the adviser is reasonable. However, BICE does not provide relief where an account is managed on a discretionary basis.

The new rules dramatically "change the game." That is particularly true for advice to participants and IRAs. As a result, RIA firms and their advisers must understand the new rules and how to comply with those rules.

Fred Reish is a partner at the law firm Drinker Biddle & Reath.

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