ederated
The Fiduciary Rule is here, and it’s all
about the process and documentation
What You Need to Know About June 9th, the Transition Period and Beyond
After months of rumors, debates, uncertainty and delayed applicability dates, the official word on the Fiduciary Rule
has been given. And the word is…complicated.
Instead of delaying the rule until the Trump Administration
decides whether and how to change it, the Department of
Labor (DOL) decided to implement the rule (with some
transition relief), and then consider how to change it. The
debate about whether this approach is a wise compromise
benefiting retirement savers or a bad decision resulting in
greater confusion and expense is moot—it’s what they have
decided to do. Therefore, financial professionals and their
institutions need to get into compliance. But the question
is, compliance with what?
The new fiduciary provisions and the temporary transition
exemptions are explained in more detail below, but here are
three likely effects of the rule on financial professionals:
1. You’re probably a fiduciary now whether you were
before or not. That means your recommendations to
plans and IRAs must be the result of a prudent, thorough and well-documented fiduciary process that takes
into account all relevant factors.Your financial institution
will likely tell you exactly how it wants you to do this.
2. You’re probably going to have to comply with one
of the temporary transition exemptions. A consequence of being a fiduciary is that traditional commissions and other forms of variable compensation are
generally prohibited. The rule also makes most rollover
advice result in prohibited compensation (even if you
are “level fee”). As a result, you have to follow special
rules, called exemptions, to allow your compensation.
From June 9 to December 31, 2017, there are temporary
transition versions of the Best Interest Contract (BIC)
Exemption and Prohibited Transaction Exemption 84-24
(PTE 84-24) that are much easier to comply with than
the Obama Administration’s previous versions. While
this may allow your financial institution to avoid making
sweeping changes to your compensation methods
(at least through the end of the year), it still requires
compliance with certain new conditions.
3. You’re probably going to see more change coming.
First, the fiduciary rule isn’t finished, even though it has
gone into effect. We don’t yet know what changes the
Trump Administration may make, but it is likely that
they will make changes—potentially quite significant
ones—over the next 12 months or so. Second, the rush
to comply with the June 9th deadline means that your
financial institution made initial decisions that they are
likely to revisit and refine over time.
While the result of the DOL’s decision is major near-term
change, especially with respect to IRA rollovers and IRA
advice, it is important to remember that the rule does
not fundamentally change the current fiduciary relationships advisors have with plans. If you are currently a 3(21)
non-discretionary advisor or a 3(38) discretionary manager,
you are already a fiduciary and the rule does not materially
change that relationship.
If, however, you are a non-fiduciary advisor to a plan or
IRA, you will likely either need to change the services you
are providing to remain a non-fiduciary or accept fiduciary status. If you become a fiduciary to a plan, you need
to update your 408(b)(2) disclosure as close as possible to
June 9th to disclose your new fiduciary status—this specific
requirement does not apply to IRAs. Finally, be aware that
not all financial institutions are making the same changes
because the rule affects each one differently. Pay close
attention to the new instructions you receive from the
home office.
What is Now Fiduciary Advice?
Beginning on June 9th, the fiduciary rule will apply to
investment recommendations, made for a fee, to ERISA
plans; plan participants and beneficiaries; and IRA owners.1
Regardless of whether you were “selling” an investment or
insurance product in the past, the recommendation of that
same investment or insurance product now will be treated
as fiduciary advice. It doesn’t matter what your license is or
who your “normal” regulator is—the DOL rule will apply
in addition to those requirements.
Specifically, financial professionals are giving fiduciary
advice with respect to plans and IRAs if they:
▪ Recommend rolling retirement plan benefits over to
IRAs, including individual retirement annuities;
▪ Recommend investments within plans or IRAs,
whether to the plan committee, individual participants,
or the IRA owner;
▪ Recommend transferring existing IRAs from other
institutions or “roll ins” from other plans to a participant’s
current plan;
▪ Recommend taking distributions from retirement plans
or IRAs;
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▪ Recommend the type of account (i.e. transaction vs.
fee-based); or
▪ Recommend another fiduciary.
What Standard Applies? Is There a Difference
between the ERISA “Prudent Man” Standard and
the New “Best Interest” Fiduciary Standard?
Practically speaking, there is very little difference between
the ERISA “Prudent Man” standard and the new Best
Interest standard. The have nearly identical language and
both require the same prudent, thorough and well-documented process. Generally, the ERISA standard applies to
advice to plans and participants while the new “Best Interest” standard applies to advice to IRAs. However, because
the Best Interest standard applies as a condition of using one
of the exemptions, such as the BIC Exemption or PTE 8424, both can apply at once. The important compliance point
is the fiduciary process, not the name of the standard.
What is the Fiduciary Process Necessary to Make
a Prudent or Best Interest Recommendation?
To make a recommendation that complies with the
fiduciary rule, you have to employ a thorough, prudent
and well-documented process that takes into account all
relevant factors regarding the investment recommendation
and the client’s needs. The financial professional needs to
collect the relevant information about the client, analyze
it and proceed accordingly. Documenting the information
collected and the basis for your recommendation is essential
to demonstrate compliance—if you don’t properly document
your advice, you won’t be able to prove that your recommendation was prudent or in the client’s best interest if
a dispute arises.
Existing forms and questionnaires used to document sales,
such as suitability forms or “Know Your Customer” forms
can form the foundation for a Best Interest fiduciary
process, but it is likely they will need to be augmented
with additional and more comprehensive questions.
information includes the available investments under the
plan, the available services (such as individual investment
advice) under the plan, the distribution options available
under the plan and the administrative and investment fees
and expenses of the plan. This information must be considered in determining that the rollover recommendation is
prudent and in the best interest of the participant.
For example, most 401(k) plans have a limited investment
menu, don’t offer individual advice and often offer only
a “lump-sum” distribution, while the IRA may offer a
wide array of investments (including guaranteed income),
individualized investment advice and monthly distribution.
Investments and fees may be higher or lower in the plan
than the IRA. All of this information is necessary to determine what is in the client’s best interest based on the client’s
needs. If the necessary information can’t be collected from
the participant, alternative means can be used, such as the
plan’s most recent Form 5500 or benchmark information
for similar plans. The net effect of this, in the short term at
least, is that advisors to plans will have ready access to the
information needed to make these recommendations, while
it will be harder for advisors not connected with the plan to
do the same.
Elimination of a Rollover Grey Area for Current Fiduciaries
Previous DOL guidance created a legal grey area for
current plan fiduciaries advising participants in that plan
on rollovers. Prior DOL guidance stated that it “may be”
a prohibited transaction to give rollover advice to a participant in a plan to which you are a fiduciary, but the guidance did not explain how to avoid a prohibited transaction,
or what exemption might apply. As a result, it complicated
rollover advice for current plan fiduciaries. However, as a
consequence of the Fiduciary Rule, the grey area is eliminated. The advice to rollover is fiduciary advice, and while
there likely is a prohibited transaction, either the BIC Exemption or PTE 84-24 will apply. As a result, independent
RIAs, bank trust departments and others who might have
been hesitant about engaging in rollover advice now have
a clear path to do so.
What Does this Mean for Rollovers?
How Do We Use the Transition BIC Exemption
and Transition PTE 84-24?
The fiduciary rule has put an intentional speed bump in
front of rollovers. Not only is rollover advice now fiduciary
advice, requiring consideration of specific relevant factors
about the plan the rollover is coming from, but most rollover advice will result in a prohibited transaction because
the advice is affecting the advisor’s compensation (resulting
in either a new or a different fee). As a result, most advisors
will need to comply with the BIC Exemption or PTE 8424 in connection with a rollover recommendation even if
their fees for advice in the IRA will be level.
The temporary transition exemptions have relatively few
requirements compared to the full exemptions that are
scheduled to apply in 2018. Though the transition PTE
84-24 has certain disclosure requirements (these have always
been part of the exemption), the transition BIC Exemption
does not. On the other hand, transition BIC requires a
financial institution (a bank, broker-dealer, insurance company or registered investment advisor), while PTE 84-24
does not.
Relevant Factors for Rollovers
Requirements of the Transition BIC Exemption
In order to make a prudent or best interest recommendation, the advisor will need to gather and consider information about the plan that the rollover is coming from. This
The transition BIC Exemption is very broad, and can be
used for a wide array of transactions. While PTE 84-24
covers advice only regarding annuities and insurance
contracts, the BIC Exemption covers these as well as
virtually all other investments, including rollovers and
variable compensation generally. For example, the transition
BIC Exemption would permit the receipt of traditional
commissions where compensation varies between share
classes of different mutual funds.
It is important to note that the transition BIC Exemption
is temporary, and permits compensation that the full BIC
Exemption does not allow. This is because the transition BIC
Exemption’s only requirements are the Impartial Conduct
Standards. The full BIC Exemption conditions—such as the
written contract with its representations, warranties, extensive
disclosure requirements and class action lawsuit provision—
do not apply until after December 31, 2017 (and may well be
changed or further delayed before then). The requirements
that do apply, the Impartial Conduct Standards, are:
▪ Advice must be in the client’s best interest – the fiduciary
duties of prudence and loyalty are observed by employing a thorough, well-documented fiduciary process that
takes into account all the relevant factors going into the
recommendation, along with appropriate supervision by
the financial institution;
▪ All compensation must not exceed a reasonable level
– this typically is measured by comparison to industry
standards in light of the services being provided; and
▪ All statements to the client about products, material conflicts of interest (e.g., compensation incentives), fees and
other relevant matters must not be materially misleading.
Financial institutions using the transition BIC need to document that they have reviewed their fees and found them
reasonable. “Reasonable” is not a synonym for “cheapest”—
rather, reasonable fees can be found within a fairly broad
range, and are measured in light of the market rates for
services provided.
Requirements of Transition PTE 84-24
PTE 84-24 is an existing exemption used by the insurance
industry since the late 1970’s for sales of annuities and
insurance contracts to plans and IRAs. It also applies to
rollovers utilizing such products. The transition PTE 84-24
reverts back to the pre-fiduciary rule version of the exemption, except for the addition of the Impartial Conduct
Standards. Therefore, PTE 84-24 is available for recommendations of all types of annuities throughout 2017, including
fixed-rate, fixed-indexed and variable annuities. PTE 84-24
has always included certain disclosure requirements, and
these requirements remain in the transitional version.
In addition to the requirements that have been part
of PTE 84-24 for many years, the Impartial Conduct
Standards apply:
▪ A recommendation in the best interest of the recipient;
▪ No more than reasonable compensation; and
▪ No materially misleading statements at the time the
recommendation is made.2
What about Enforcement?
DOL has announced a non-enforcement policy in which
those who are “working diligently and in good faith” will
not be penalized for violating the rule by DOL during the
transition period (currently ending December 31, 2017).
The IRS and Treasury will also abide by this non-enforcement policy. However, this policy does not apply to the
SEC, FINRA, state insurance commissioners, bank regulators or private litigants, and it does not apply to violations
unrelated to the fiduciary rule.
What’s Next?
The DOL indicated that “in the near future” it would issue
a request for information seeking additional comments and
suggestions as part of its ongoing review of the effects of the
Rule ordered by President Trump. It is likely there will be
additional changes proposed, but at present, there is no way to
predict what those might be. DOL also indicated that it might
extend the transition period beyond December 31, 2017 if
necessary to facilitate changes in the industry or the rule.
Conclusion
Whatever the future may bring regarding the rule, the
foundation of compliance is a prudent, thorough and
well-documented fiduciary process. Ensuring that you have
properly considered the relevant factors and documented your fiduciary process is the most important measure
to take during the transition period because it not only
governs the development of the recommendation, but is
required by the exemptions permitting many common and
continuing forms of compensation.
For most financial professionals, the process and documentation required will be explained by your financial institution
—following their lead during this period of change is vital to
ensure your compliance with the new rule.
Bright Answers to Your Fiduciary Questions
Fiduciary Luminary provides education to help professionals stay current on best practices, tools
to help them master the complexities of practicing as fiduciaries and guidelines for procedures
and client conversations.Visit www.fiduciaryluminary.com for more fiduciary advice.
About the Author
Bradford P. Campbell
Counsel, Drinker Biddle & Reath LLP
Brad concentrates his practice in employee benefits advice and ERISA litigation, focusing on ERISA Title I issues, including
fiduciary conduct and prohibited transactions. A nationally recognized figure in employer-sponsored retirement, health and
other welfare benefit plans, Brad is the former Assistant Secretary of Labor for Employee Benefits and head of the Employee
Benefits Security Administration. As ERISA’s former “top cop” and primary federal regulator, he provides his clients with
insight and knowledge across a broad range of ERISA plan-related issues. He also serves as an expert witness in ERISA
litigation. Brad has been listed as one of the 100 Most Influential Persons in Defined Contribution Plans by 401kWire and as
one of the top 15 ERISA attorneys in the country by a poll of the National Association of Plan Advisers (NAPA) members.
The legal definition is slightly broader, including HSAs and any other entity subject to ERISA Title I, Part 4, and/or Internal Revenue Code Sec. 4975.
For simplicity, we will refer to plans and IRAs, as these are the vast majority of covered arrangements.
2 While the text of PTE 84-24 is slightly different than the BIC Exemption and notes that a failure to disclose a material conflict of interest may constitute
a materially misleading statement, the disclosures already required by the exemption and other laws would appear to address items that would suggest
a material conflict and the Department of Labor has not identified any examples of material conflicts not already disclosed.
1
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