Art by Tim BowerADVISER
QUESTION: I am a fiduciary adviser to ERISA [Employee Retirement Income
Security Act] plans and IRAs [individual retirement accounts], and I charge an
asset-based fee. I don’t receive any other payment, direct or indirect, in
connection with these services, and my fee satisfies the definition of “level
fee” under the Best Interest Contract [BIC] exemption. May I charge a level fee
for advising on the portion of the client’s portfolio that is allocated to
equities but a lower level-fee for the portion allocated to fixed-income
depends. If you have the authority or responsibility to make recommendations
about the asset allocation in the plan or IRA—that is, about the percentage of
assets to be allocated to fixed-income investments and equities—then this fee
structure results in a prohibited transaction. To receive the prohibited
compensation, you will need to satisfy an exemption such as the BIC.
prohibited transaction rule at issue is the self-dealing rule. Under that rule,
you may not use your fiduciary authority—i.e., your authority to make allocation
recommendations—to cause yourself to earn additional compensation. This rule is
found in both ERISA and the Internal Revenue Code (IRC) and, therefore, applies
to both ERISA plans and IRAs. The rule pertains
to you because you could exercise your fiduciary authority and allocate
more to equities, resulting in additional compensation to you.
compensation under this arrangement, you will need to use a prohibited
transaction exemption (PTE); most often, that will be the BIC exemption—when it
becomes applicable, if ever. However, this exemption will not be available if
you exercise discretion over the allocations. In other words, it can be used
only if you have nondiscretionary investment authority over the investment
allocation decisions and the investor retains the final decisionmaking
Department of Labor (DOL) does not replace the current version of the BIC
exemption, the requirements are so burdensome that using it for this fee
structure would be impractical. While the registered investment adviser (RIA)
firm may receive variable compensation under the BIC—i.e., so long as the
compensation is reasonable for the services—the individual adviser may not.
Instead, the latter’s compensation must be reasonable and level. If the
individual adviser’s compensation varies among different investment categories,
it must be level within each category and must be based on “neutral factors
tied to the differences in the services,” e.g., charging a higher fee for a
complex annuity product than for a mutual fund investment.
To meet this
requirement, you will need to establish that there are neutral factors that
support the higher fee charged for advice about investment in equities. Stated
another way, there will need to be differences in the services provided to
equity, as opposed to fixed-income investments, that justify the higher fee
charged. In most instances, this requirement will be difficult to meet.
there are other onerous BIC requirements, including numerous disclosure
requirements, plus a contract requirement in the case of IRA clients. Class
action lawsuits will also be permitted, you must maintain a website with the
required disclosures, and so on. All that said, it is unlikely that RIA firms
will use the BIC exemption for this fee structure.
there is another solution to consider: Charge a blended fee that is level
across the whole portfolio. For example, you could consider charging 100 basis
points (bps) for advising on an equity-only portfolio, but 80 bps on a
fixed-income-only portfolio. If you intend to recommend a 50/50 asset
allocation to the investor, you could charge, for example, 90 bps for advising
on that portfolio.
if you have several portfolio mixes, you can have an established fee that
reflects the general considerations of each asset allocation. For instance, you
might charge 100 bps on the 80% equity/20% fixed-income portfolio, 95 bps on
the 60% equity/40% fixed-income portfolio, 90 bps on the 50% equity/50%
fixed-income portfolio, 85 bps on the 40% equity/60% fixed-income portfolio,
and 80 bps on the 20% equity/80% fixed-income portfolio.
structure will not result in a prohibited transaction as long as the level fee
is reasonable and is charged across the whole portfolio on an ongoing basis.
is chair of the Financial Services ERISA practice at the law firm Drinker,
Biddle & Reath. A nationally recognized expert in employee benefits law,
Reish has written four books and many articles on the Employee Retirement Income
Security Act (ERISA), Internal Revenue Service (IRS) and Department of Labor
(DOL) audits, as well as pension plan disputes. Joan Neri, who has been
associated with the firm since 1988, is counsel on the Employee Benefits and
Executive Compensation Practice Group. Her practice focuses on all aspects of
employee benefits counseling.