Compliance Consult | PLANADVISER May/June 2016

Fee-Only Fiduciaries

Recommendations will be viewed as advice

By David Kaleda | May/June 2016

PAJF16_Article-Image-Comp-Con-_David-Kaleda-Portrait_Tim-Bower.jpgArt by David KaledaEvery adviser is aware that the Department of Labor (DOL) issued its final regulation defining “investment advice” on April 6. Many advisers who are already fiduciaries under the Investment Advisers Act of 1940 assume that the final rule has no impact on them, particularly if they currently receive from their client accounts an “assets under management” (AUM) fee. While the fiduciary final rule may have less of an impact on such advisers, as compared with those who are registered representatives of a broker/dealer (B/D), advisers should not assume they will be unaffected.

Many advisers will need prohibited transaction exemptive relief under the Employee Retirement Income Security Act (ERISA) or the Internal Revenue Code (IRC) in order to get investors onto the platform through which the adviser provides advice and management services to individual retirement account (IRA) owners. In the preamble to the final rule, the department states that an adviser may market his services to potential clients without providing “investment advice,” but to the extent that such marketing includes an “investment recommendation,” this would mean fiduciary investment advice is being given.

Further, the final rule makes clear that, in the DOL’s view, a recommendation to take a distribution from an ERISA-covered plan and roll it over to an IRA (or from one IRA to another) presents a conflict to the adviser that should be addressed through a prohibited transaction exemption. The DOL believes the adviser has a conflict when he gets paid only if the distribution and rollover occurs, regardless of the fact that thereafter his compensation is structured in a manner that normally raises no prohibited transaction issues—e.g., AUM-based fees. Similarly, the DOL views as investment advice recommending that an investor move from an account on which commissions are charged to an account on which an asset-based fee is charged and states that such a recommendation gives rise to a conflict that should be addressed via an exemption.

Based upon the foregoing, retirement plan advisers who can provide advice or management services only after a distribution and rollover from an ERISA-governed plan or IRA occurs should consider whether they make recommendations and, if so, the exemption or conflict mitigation strategy they will use. Notably, the term “recommendation” is defined very broadly to include a “communication that, based on its content, context and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in, or refrain from taking a particular course of action.”

The DOL points to FINRA guidance as to articulating the meaning of “recommendation,” though it stops short of adopting that definition itself. Further, the final rule allows an adviser to provide “investment education” about distributions and rollovers without being deemed a fiduciary, for providing “investment advice,” but this educational exception may be narrowly interpreted by the DOL or a court. Advisers should carefully analyze whether they provide investment advice in the context of discussions regarding rollovers and transfer of accounts from commission-based to asset-based fee structures. If so, a prohibited transaction exemption likely will be necessary.

If an exemption is indeed necessary, the best interest contract (BIC) exemption may be the only exemption available, in many circumstances. Compliance with the BIC exemption can be challenging, but the final rule includes a streamlined, less burdensome version of the exemption if the adviser is a “level fee fiduciary.”

A fee is a “level fee” if it is a “fee or compensation that is provided on the basis of a fixed percentage of the value of the assets or a set fee that does not vary with the particular investment recommended, rather than a commission or other transaction-based fee.” Notably, the level fee can be the “only fee” received by the adviser, the firm and any affiliates “in connection with” advice or management services provided to the plan or IRA. The provisions of the streamlined BIC exemption require, among other things, that the adviser act in the best interest of the advice recipient in making the recommendation and take specific steps to document why the recommendation is appropriate.

In some cases, the streamlined BIC exemption will be unavailable. For example, the fee paid “in connection with” advice or management services provided by an adviser who is supervised by a firm that’s part of a large, complex financial institution often will not be a level fee because of the requirement that it be the only fee received across the entire organization in connection with the advice or management services. In the absence of the streamlined BIC exemption, the adviser and firm may be able to look to compliance with the full BIC exemption to address the above-described conflict.

David Kaleda is a principal in the Fiduciary Responsibility practice group at the Groom Law Group in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers. He served on the DOL’s ERISA Advisory Council from 2012 through 2014.