Expect tumult for broker-dealers if DOL fiduciary plan goes through

Prohibited transaction is key: Will give rise to new legal exposure, new comp models

Apr 15, 2015 @ 2:59 pm

By Darla Mercado

It's early days, but retirement plan experts predict a major shake-up in the way broker-dealers do business with small retirement plans and IRAs — all thanks to a prohibited transaction exemption in the Labor Department's new fiduciary duty proposal.

The DOL released its newly minted “definition of fiduciary” reproposal on Tuesday afternoon, adding to it a block of related regulation in the form of prohibited transaction exemptions. In all, the brand-new rule and its exemptions came out to more than 300 pages of text — now open for comments.

Perhaps the most interesting portion of this rule, which would broaden the term “fiduciary,” is the proposed "best interest contract exemption." This exemption permits broker-dealer reps and insurance agents who provide fiduciary investment advice to plan participants, IRA owners and small retirement plans, to receive commissions, revenue sharing and 12b-1 fees — provided they commit to putting the clients' best interests first and disclose conflicts that prevent them from doing so.

At the core of that best interest contract exemption, firms and their reps or agents will have to enter into a contract with clients that will commit both parties to give advice in the best interest of the client. This contract will also show that the firm uses procedures to mitigate conflicts of interest, and the contract will disclose clearly and prominently any conflicts of interest.

What the proposal means to financial advisers?
• Anyone who gets paid for providing individualized advice to a plan sponsor, a participant in a retirement plan or an IRA owner for consideration in making a retirement investment decision is a fiduciary. Doesn't matter if you call yourself a broker, a registered investment adviser, an insurance agent or any other kind of adviser.
• Plan sponsors and providers can continue educating investors in workplace plans and IRAs without being fiduciaries.
• A fiduciary adviser must provide the client with advice that's impartial and in his/her best interest.
• The DOL created a new kind of prohibited transaction exemption, slugged the “best interest contract exemption.” Firms and the individual adviser who operate under this exemption may receive commissions and revenue sharing, but they must commit to putting the client's best interests first and disclose potential conflicts. Hidden fees must also be prominently disclosed.

Further, the exemption permits customers to hold these fiduciary advisers responsible through a private right of action — read: lawsuit — for breach of contract. Though the contract the firm and adviser draw up with the client can require that individual disputes go through arbitration, the contract must also give the client the right to bring a class-action suit if a group of people are harmed.

“This guts a lot of Finra arbitration,” Marcia Wagner, managing director of The Wagner Law Group, said. “It gives the tort bar open reign; this is opening the floodgates of the tort bar to ERISA.”

Though it's difficult to bring a class action suit, as a firm would have to have a systemic issue in order to have the critical mass of injured clients, clients are still able to sue on their own, said Jason C. Roberts, CEO of the Pension Resource Institute.

Don't forget that advisers providing guidance over IRAs will be directly affected by the rule, so expect to see broker-dealer firms make significant updates to their businesses and payment methods if the rule is finalized as is.

“The huge impact is on advice to IRAs,” said C. Frederick Reish, a partner at Drinker Biddle Reath's employee benefits and executive compensation practice group. “[The contract exemption] is an approach to create a federal standard of care, and people are underestimating them. It places quite a burden on broker-dealers to act in the best interest of IRA owners.”


Readers who've kept a close eye on the trials and tribulations of fiduciaries contending with increased fee disclosure know that an additional level of disclosure for conflicts of interest won't be easy to handle.

Fee disclosures "cost a lot of money to get up to speed,” Ms. Wagner said. “This is much more significant and it will change the nature of rollovers. Companies will have to warrant that they disclose all conflicts of interest; you'll have to enter a contract with the client.”

Reps who recommend a rollover will likely need to have the contract in place before they pitch the idea to the investor, Mr. Reish noted.


Legal experts have suggested for some time now that dually registered broker-dealers will migrate their retirement plan business toward the RIA side of the house, where they can charge a level fee and those advisers can act as fiduciaries.

Expect that practice to expand to IRA business.

“The easier way to avoid a lot [of these burdens] is for broker-dealers to allow their advisers to be investment adviser representatives and to charge a level fee,” Mr. Reish said. “I think we'll see more price pressure on IRAs, for advice and on expense ratios for the investments. What's happening in the 401(k) world will happen to IRAs now, but slower.”

Mr. Roberts predicted that there would be three types of service models that reps can provide. One way for reps and their firms to operate would be to act as fiduciaries and receive level compensation. In another way, reps could be held to a fiduciary standard and operate with the prohibited transaction exemption, where they will continue to collect 12b-1s and commissions but must operate in the clients' best interest.

The third case is the worst-case scenario, where reps can only provide education but can't act as fiduciaries, Mr. Roberts said.

Another development that may emerge could be IRA platforms that quarantine the compensation that's available to the rep and his affiliate if the investor uses that platform, he added. This will require more direction from the client as far as how he or she will invest.

“It's a combination of quarantining products and funds and getting a more focused directive from the client,” he said. “The client is instructing you; this is what they want to be advised on, and I'm following that guidance, such that I [as the rep] don't have the discretion to go out and recommend something that is in my best interest.”


Regardless of where the rule stands, firms will face another moment of truth where they will have to consider the extent to which they want to be fiduciaries over those IRA assets.

“I don't see broker-dealers just doing education [on investments],” said Lisa Van Fleet, an attorney with Bryan Cave. “They either have to have full fiduciary responsibility or work in the scope of the exemptions.”

Ms. Van Fleet noted that while firms may consider bifurcating their IRA business, there's no denying that the bulk of investment assets are IRA assets or come from qualified plans, and it may be problematic to have two different compensation plans for those dollars.

“You can have separate rules for IRA and non-IRA, but those IRA investments are significant,” she added. “But I don't see this as being the death of the broker-dealer industry. It won't put them out of business, but it will change the way they do business.”


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