DOL Fiduciary Rule FAQs - Update for Broker-Dealers

November 8, 2016

On October 27, 2016, the Department of Labor (“DOL”) published a set of frequently asked questions (“FAQs”) about the Conflict of Interest Rule, otherwise known as the DOL Fiduciary Rule. The 34 FAQs are based in part on input the DOL received from the financial services industry. With the release of the current FAQs, as well as others expected in the coming months, the DOL intends to clarify parts of the rule and help the industry make decisions that benefit retirement investors.

The DOL presented the questions in several categories, the majority of which relate to different aspects of the Best Interest Contract Exemption (“BIC Exemption”). Other questions address compliance dates and other exemptions, with particular focus on the Principal Transaction Exemption and Prohibited Transaction Exemption (“PTE”) 84-24, which relates to sales in fixed annuities. This alert highlights issues covered by the first batch of FAQs.

Compliance Dates
The DOL Fiduciary Rule will be implemented on April 10, 2017, and the DOL expects broker-dealer firms to comply with the BIC Exemption for the “Transition Period” prior to January 1, 2018. While firms will not be responsible for the contract and disclosure requirements of the BIC Exemption during this period, they still must do the following:

  • Comply with the Impartial Conduct Standards as outlined in the rule:
    • Act in the investor’s best interest
    • Give no misleading statements
    • Charge no more than reasonable compensation
  • Provide investors with the following:
    • Notification that the financial institution and its advisers are acting as a fiduciary
    • A description of the firm’s conflicts of interest
  • Designate a person responsible for addressing material conflicts of interest and ensuring advisors adhere to the Impartial Conduct Standards

One question addresses compliance dates for changes to currently existing PTEs 75-1, 77-4, 80-83, 83-1, 84-24, and 86-128, which in most cases involve adding compliance to the Impartial Conduct Standards. Firms must comply with these revised PTEs as of April 10, 2017.

Best Interest Contract Exemption
Several questions sought clarification of the requirements regarding the BIC Exemption, particularly in relation to advisers that receive a fixed percentage (fee) based on assets under management:

  • The BIC Exemption broadly covers a wide variety of transactions related to the provision of investment advice in retirement plans and IRAs. As transaction-based compensation creates a conflict under ERISA and the Internal Revenue Code (“IRC”), generally firms must use the BIC Exemption in order to receive such compensation.
  • The BIC Exemption does not prohibit receipt of level-fee compensation. However, some recommendations, such as a rollover from a retirement plan or transfer from a transaction-based compensation account (such as a brokerage account), represent a conflict of interest because firms and advisers receive compensation for these recommendations. As a result, recommendations involving transactions into a level-fee account require some form of the BIC Exemption.
  • Level-fee accounts can rely on a streamlined version of the BIC Exemption for “Level Fee Fiduciaries.” They must:
    • provide written acknowledgment that the firm and adviser are acting as a fiduciary,
    • adhere to the Impartial Conduct Standards, and
    • document how the recommendation serves the investor’s best interest.
  • Level-fee accounts for which firms receive additional compensation, such as 12b-1 fees or revenue sharing, must rely on the full BIC Exemption to comply with the rule.
  • Robo-advisers may fall under the Level Fee Fiduciary aspect of the BIC Exemption depending on the circumstances.
  • Firms must adhere to the requirements of the full BIC Exemption when recommending proprietary products.
  • Firms unsure as to whether they qualify as level fee fiduciaries may still comply via the applicable conditions of the full BIC Exemption.

The DOL indicated that firms may consider the following regarding compensation under the BIC Exemption:

  • If a firm has developed a compensation structure that meets the reasonable-basis standard, advisers may discount prices to customers as long as those discounts do not cause any conflicts of interest.
  • Firms can pay different commission amounts based on investment categories, provided they do not offer different compensation within these categories. Firms must base the difference on neutral factors, such as time and complexity in recommending a specific category. The DOL provides the following additional guidance:
    • Neutral factors must not be based on the financial interest of the firm.
    • When compensation varies by category, firms should monitor advisers to ensure they do not recommend certain product categories solely to increase their compensation.
  • The DOL offers the following advice for developing compensation grids:
    • Firms should avoid any incentives that would cause advisers not to give investment advice in the investor’s best interest.
    • Grids with smaller steps or gradual increases provide advisers less incentive to drastically increase compensation than grids with higher thresholds.
    • When advisers attain a higher threshold, firms should not make the higher payout retroactive. Retroactive compensation could increase the likelihood of a conflict.
    • Firms employing a grid with increasing thresholds should monitor advisers as they approach each threshold.
  • The DOL offers the following advice regarding recruitment bonuses for advisers:
    • Firms may pay recruitment bonuses, provided they are not linked to sales, account movements, asset targets, or any incentive that could cause a conflict.
    • The DOL has noted that firms may have a contractual obligation under existing recruitment agreements that provide compensation for activities that would otherwise be prohibited under the rule. After April 10, 2017, firms may rely on the full BIC Exemption for adviser activity covered by such recruitment contracts under the following circumstances:
      • The firm must engage in stringent oversight of the adviser during the period of the agreement.
      • The period of time remaining under the agreement must be reasonable and consistent with general industry practices.
      • The agreement must not otherwise violate the conditions of the exemption, ERISA, or the IRC.

Grandfathering
The DOL made the following comments regarding grandfathering of compensation for investments made prior to April 10, 2017:

  • The rule permits advice to hold investments with dividend reinvestment programs and systematic investment plans.
  • The exemption permits compensation received from the sale of grandfathered assets.
  • The exemption’s grandfathering provisions do not cover investment advice regarding proceeds from the sale of grandfathered assets.

PTE 84-24
This exemption allows for certain compensation for fixed annuities in retirement plans and IRAs. The DOL issued the following comments:

  • The exemption permits rollovers from retirement plans.
  • Although the “reasonable compensation” definition in this exemption differs from the BIC Exemption, the DOL maintains both definitions are based on the reasonable compensation standard defined in ERISA 408(b)(2) and IRC 4975(d)(2). Therefore, the DOL intends to interpret the standard the same way in both exemptions.

Principal Transaction Exemption
The DOL answers a few questions regarding the Principal Transaction Exemption, which covers principal transactions in certain assets between investment fiduciaries and employee benefit plans and IRAs. The exemption allows an adviser and firm to engage in principal transactions and riskless principal transactions involving certain investments. The DOL made the following comments:

  • The exemption covers recommended purchases by a plan or IRA of
    • certificates of deposit,
    • unit investment trusts,
    • debt securities, generally defined as corporate debt securities offered pursuant to a registration statement under the Securities Act of 1933,
    • treasury securities,
    • agency securities, or
    • asset-backed securities that are guaranteed by an agency or government-sponsored entity.
  • The DOL states that parties who wish to engage in a principal transaction under the exemption with an asset not on the above list can apply for an individual or class exemption to expand the scope of assets covered by the Principal Transactions Exemption. The Principal Transactions Exemption specifically contemplates a process by which the definition of “Principal Traded Asset[s]” can be expanded through individual exemptions granted by the DOL.

Other Clarifications
The DOL has also provided some guidance to insurance marketing organizations and insurance-only agents with regard to operating pursuant to the DOL Fiduciary Rule.

The DOL expects to release additional sets of FAQs in the future. Additionally, the DOL states it will continue to work with firms and advisers to help them comply with the rule.

The full text of the 34 FAQs can be found on the DOL website here.

For More Information
For more information, please contact your ACA consultant, or Dee Stafford in the Los Angeles office at (310) 322-8840.