What is ‘reasonable’ cost under DOL’s fiduciary rule? Well, it depends

Inherent to acting in a client's best interest is ensuring costs are reasonable, an ERISA concept brokers need to understand.

What is “reasonable” compensation? It’s a question brokers may not have considered prior to the Labor Department’s recent push to regulate investment advice in retirement accounts.
However, brokers need to start paying attention, because this seemingly simple question will have a big influence on the way they are able to do business in qualified retirement accounts going forward.
The Department of Labor on Wednesday issued its landmark “fiduciary” rule, which says intermediaries giving investment advice in accounts such as 401(k) plans and IRAs must adhere to a “fiduciary” standard as laid out under the Employee Retirement Income Security Act of 1974. Until now, brokers have been able to operate under a less-stringent “suitability” standard.

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

Fiduciaries are obliged to act in their clients’ best interest, and explicit in this discussion is the notion of receiving reasonable compensation for services.
The idea of reasonable compensation has been baked into ERISA since the law’s inception more than 40 years ago, and is therefore something knowledgeable fiduciary 401(k) plan advisers understand intuitively. However, for non-fiduciary brokers, who will now be fiduciaries courtesy of the DOL’s new rule, it may not be as intuitive, said Jason Roberts, chief executive of the Pension Resource Institute, an ERISA compliance consulting firm.
That lack of knowledge could trip up the unwary, and trigger prohibited transactions that ultimately result in lawsuits. Which brings us back to the initial question — what is “reasonable”?
The perhaps-frustrating answer: It depends.
“There’s no hard-and-fast rule,” according to Michael Davis, former deputy assistant secretary at the Labor Department. “What’s reasonable for one engagement might be completely unreasonable for another.”
“The Department doesn’t typically prescribe numerical targets,” Mr. Davis said. It can be dangerous to be too prescriptive, so the DOL has built flexibility into its rule, he added.
Reasonable compensation has been a sticking point in many of the now-burgeoning 401(k) fee lawsuits, in which plan fiduciaries are targeted for alleged excessive investment management and record-keeping fees charged. Lawyers for plaintiffs are able to frequently allege fiduciary breach in these circumstances due to the “gray spot” in the interpretation of reasonable cost, according to David Levine, principal at Groom Law Group.
In the absence of a specific road map of rules to follow, having and documenting a process to come to a determination is key, Mr. Levine added.
“It’s always a situation of facts and circumstances in how you make that determination,” said Blaine Aikin, executive chairman at fi360 Inc., a fiduciary consulting firm.

To demonstrate the decision-making process an adviser could use, let’s consider a hypothetical situation in which an IRA adviser is recommending a 401(k) plan participant roll over assets to an IRA, a fiduciary recommendation under the new DOL rule. Determining if this is in the individual’s best interest requires assessing a few particulars: For example, does the prospective client want holistic wealth management services, and are those services available in the 401(k) plan, Mr. Roberts said.
Let’s say the rollover is ultimately deemed to be in the client’s best interest, and the adviser is now making 100 basis points of additional compensation due to that rollover. The adviser needs to be able to articulate why that cost is reasonable, according to Mr. Roberts. A number of determinations are involved: online versus in-person advice; the scope of the services; the frequency of meeting; even the expertise and experience of the adviser, Mr. Roberts explained.
“It strikes me that really the only way to test that is to look at the market,” said Bruce Ashton, partner in law firm Drinker Biddle & Reath’s employee benefits and executive compensation practice group. “What is the market charging for comparable services?”
This type of benchmarking is a common practice among 401(k) fiduciaries to determine reasonable cost for a particular service, whether it be administration, investment management or advisory. And there are firms such as Fiduciary Benchmarks Insights Inc. that can provide benchmarking reports to help with this type of analysis.
But benchmarking is largely uncharted territory in the IRA market, because enforcement of prohibited transactions with respect to reasonable compensation in the retail retirement market was largely absent prior to the DOL’s new regulation, ERISA attorneys said.
“The IRA context will be tougher, because right now there aren’t, so far as I know, benchmarking services that actually look at IRA compensation,” Mr. Ashton said.
What’s considered “reasonable” in the IRA market might be different from the 401(k) market, Mr. Davis said.
“I think there’ll be a lot of evolutionary learning around how it’s all going to work,” he said.