Magazine

Compliance Consult | PLANADVISER May/June 2015

Fiduciary Rule Implications

Most advisers would become fiduciaries

By David Kaleda editors@assetinternational.com | May/June 2015
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Art by June KIm

As you know, the Department of Labor (DOL) re-proposed its fiduciary regulation. If that is finalized as currently written, most advisers will be fiduciaries with respect to individual retirement accounts (IRAs) as well as tax-qualified and 403(b) plans governed by the Employee Retirement Income Security Act (ERISA). The purpose of this article is to consider how the DOL intends to affect adviser behavior in the retirement marketplace through a new exemption called the “best interest contract exemption,” or “BIC,” proposed along with the new regulation. 

The BIC represents a significant shift in the DOL’s philosophy regarding class exemptions. Traditionally, those have allowed fiduciaries—provided they meet the necessary conditions—to receive compensation under circumstances otherwise contrary to the Internal Revenue Code (IRC)’s and ERISA’s prohibited-use, self-dealing, conflict-of-interest and anti-kickback provisions. However, exemptions typically focus on a particular kind of product or service and type of compensation arrangement. On the other hand, the BIC is intended to apply rather broadly to a number of products, services and compensation arrangements that result in payment to a fiduciary that would otherwise be prohibited—i.e., compensation that varies based on investment recommendations or that is paid to the adviser by third parties in connection with such advice—so long as certain contractual, reporting and recordkeeping requirements are met. Also, unlike prior exemptions, the BIC aims to protect a specific class of investors.

The BIC is directed at the provision of advice—not discretionary management services—to certain retail investors the DOL deems to be in need of additional protections. These include participants or beneficiaries in participant-directed plans; the beneficial owners of IRAs; and sponsors, or similar fiduciaries, of non-participant-directed defined contribution (DC) and defined benefit (DB) plans covering fewer than 100 participants. Therefore, by default, the BIC does not apply to advice given to other investors such as sponsors, or similar fiduciaries, of participant-directed plans. The DOL’s basis for excluding those and other plans is that the related fiduciaries are sophisticated and do not need the BIC’s protections.

The exclusion of the sponsor, or similar fiduciary, of any participant-directed plan—especially one covering fewer than 100 participants—from the BIC is a curious decision. It is difficult to understand why the DOL believes the BIC should not apply to such a plan, given the department’s stated policy behind the rule. Consequently, the adviser to such a plan must look to other exemptions, which the proposal has substantially modified. For example, the adviser would not be able to receive 12b-1 fees, revenue sharing and other payments under these other, modified exemptions, yet might be able to if he relies on the BIC.