April 2016 Final DOL Fiduciary Retirement Investment Advice Regulation

For Certain Tax Deferred Investments Intended To Reduce Adviser Conflicts Of Interest


Rights Reserved Alson R. Martin

Lathrop & Gage LLP

10851 Mastin Boulevard

Suite 1000

Overland Park, KS 66210-1669

I………. EXPANDED FIDUCIARY DEFINITION FOR TAX DEFERRED RETIREMENT ASSETS & NEW RESTRICTIONS ON ADVISERS’ CONFLICTS OF INTEREST……………… 1

A…….. Effective Date………………………………………………………………………………………….. 1

B…….. Prohibited Transaction Exemptions……………………………………………………………… 2

C…….. Pre-Existing Transactions…………………………………………………………………………… 2

D…….. Impact On Plan Sponsors…………………………………………………………………………… 2

E……… Expanded Fiduciary Status………………………………………………………………………… 2

F……… Fiduciary Investment Advice For Nontaxable Accounts………………………………… 2

G…….. Fiduciary Investment Adviser…………………………………………………………………….. 3

H…….. Fee Or Other Compensation……………………………………………………………………….. 3

I………. Recommendation………………………………………………………………………………………. 4

II…….. EXCEPTIONS FROM FIDUCIARY DEFINITION……………………………………………… 5

A…….. Actuaries, accountants, and attorneys historically have not been treated as ERISA fiduciaries for plan clients and are not fiduciaries or investment advisers by reason of providing actuarial, accounting, or legal services…………………………………………… 5

B…….. HR Employees & Other Advisors……………………………………………………………….. 5

C…….. ERISA 404(c)…………………………………………………………………………………………… 5

D…….. “Order-Taking.”………………………………………………………………………………………… 5

E……… Platform Providers…………………………………………………………………………………….. 5

F……… General Communications…………………………………………………………………………… 6

G…….. Investment Education……………………………………………………………………………….. 6

H…….. Asset Allocation Models And Interactive Investment Materials……………………… 7

I………. Appraisals & Valuations…………………………………………………………………………….. 7

J………. Marketing By Advisers……………………………………………………………………………… 7

K…….. Transactions with Independent Plan Fiduciaries with Financial Expertise………… 7

L……… In-House Reports By Employees………………………………………………………………… 8

M…….. Execution Of Securities Transactions…………………………………………………………… 9

III……. MANAGED ACCOUNTS…………………………………………………………………………………… 9

IV……. PROHIBITED TRANSACTION EXEMPTION (PTE) 84-24 FOR MUTUAL FUNDS & INSURANCE & CERTAIN ANNUITIES……………………………………………………………. 9

V…….. BEST INTEREST CONTRACT EXEMPTION (BICE) – A NEW PROHIBITED TRANSACTION EXEMPTION…………………………………………………………………………. 10

A…….. Current Conflicted Compensation Methods Can Continue Within Limits………. 10

B…….. BICE Requirements………………………………………………………………………………… 11

C…….. Required BICE Transaction Disclosures…………………………………………………….. 12

D…….. Required BICE Web Disclosures………………………………………………………………. 13

E……… Required Elements of the BICE Contract………………………………………………….. 13

F……… BICE New Client Disclosures…………………………………………………………………… 14

G…….. Prohibited Provisions……………………………………………………………………………….. 15

H…….. Transactions Excluded From BIC Exemption…………………………………………….. 16

April 2016 Final DOL Fiduciary Retirement Investment

Advice Regulation For Certain Tax Deferred Investments

Intended To Reduce Adviser Conflicts Of Interest.

 

A White House Council of Economic Advisers analysis found that advisor conflicts of interest result in annual losses of about 1 percentage point for affected investors, about $17 billion per year. A 1% lower return would reduce savings by more than 25% over 35 years. In other words, instead of a $10,000 retirement investment growing to more than $38,000 over that period after adjusting for inflation, it would be just over $27,500.  As a result of these conclusions, the DOL proposes a new 2016 final rule to reduce these conflicts of interest and expand the fiduciary standards beyond qualified retirement plans to other tax-exempt types of vehicles – IRAs, HSAs, MSAs, and ESAs.  403(b) plains maintained by non-government employers are covered as well.  Thus, the DOL’s  fiduciary recommendation and conflict of interest rules cover many tax exempt retirement investments governed by ERISA or Internal Revenue Code § 4975 or both.

The fiduciary can be a broker, registered investment adviser, insurance agent, or other type of adviser. Common forms of compensation in use today in the financial services industry, such as commissions and revenue sharing, are permitted under the Best Interest Contract Exemption (BICE), whether paid by the client or a third party such as a mutual fund.  But when effective, BICE will require advisers to comply with new requirements and present them with some legal uncertainty.  BICE has a relaxed standard for level fee advisors, as will be discussed below.  The IRS can impose the prohibited transaction excise tax on impermissible compensations, and plans and individuals in ERISA plans (most IRAs are not ERISA plans) harmed may exercise ERISA remedies for damages.

Financial institutions must adopt policies and procedures designed to mitigate any harmful impact of conflicts of interest, and disclose basic information about their conflicts of interest and the cost of their advice. Level Fee Fiduciaries that receive only a level fee in connection with advisory or investment management services are subject to fewer conditions, including a written statement of fiduciary status, compliance with the standards of impartial conduct, and, as applicable, documentation of the specific reason or reasons for the recommendation of the Level Fee arrangements.

  1. EXPANDED FIDUCIARY DEFINITION FOR TAX DEFERRED RETIREMENT ASSETS & NEW RESTRICTIONS ON ADVISERS’ CONFLICTS OF INTEREST.
    1. Effective Date. The final fiduciary rule becomes applicable on April 10, 2017. The new definition of investment advice will be effective April 10, 2017. The revised prohibited transaction exemptions will generally become available on that date.  The new Best Interest Contract Exemption (BICE) provides for a transition period, from the April 2017 applicability date to January 1, 2018, under which not all of its conditions apply. During this transition period, firms and advisers must still promise to comply with the impartial conduct standards, provide a notice to retirement investors that acknowledges fiduciary status and describes material conflicts of interest, and designate a person responsible for addressing material conflicts of interest and monitoring advisers’ compliance with the impartial conduct standards. The notice will need to disclose whether proprietary products or investments generating third party payments are being recommended and the limitations this places on the universe of investment recommendations. Full compliance with the exemptions will be required on January 1, 2018.
    2. Prohibited Transaction Exemptions. The regulations contain a new Best Interest Contract Exemption (BICE) and amend  other prohibited transaction class exemptions (PTCEs) applicable to fiduciaries that would allow certain broker-dealers, insurance agents and others who provide investment advice to continue to engage in certain transactions and to receive common forms of compensation that otherwise would be prohibited as conflicts of interest.
    3. Pre-Existing Transactions. Compensation received as a result of the provision of investment advice in connection with a transaction effected before (or entered pursuant to a systematic program established before) April 10, 2017 is generally exempt from the Final Regulation, if it has not come up for renewal, so long as (1) no additional advice is provided after April 10, 2017, (2) the investment was not a non-exempt prohibited transaction, (3) the investment adviser’s compensation does not exceed reasonable compensation, (4) the compensation is not received in respect of amounts invested after April 10, 2017 – this may require new IRA rollover funds to go into a new IRA, and (5) any advice provided after April 10, 2017 (such as hold recommendations) with respect to the investment product is in accordance with the Best Interest fiduciary standard.
    4. Impact On Plan Sponsors. Plan sponsors are not directly impacted by these new regulations.  Plan sponsors are not required to do anything and the duties of employers have not changed.  However, employers can be jointly liable for advisers’ compensation that is a prohibited transaction.
    5. Expanded Fiduciary Status. The regulation covers IRA assets as well as retirement plan assets.  Under ERISA §3(21), a person is a fiduciary to the extent that person renders investment advice for a fee or other compensation, direct or indirect, with respect to any plan or IRA assets.  Many financial services providers are not classified as fiduciaries under current law and therefore (1) may receive commission income, revenue-sharing payments or other similar forms of compensation that would otherwise be prohibited by ERISA and the Code, and (2) are not subject to fiduciary claims under ERISA. Under this regulation, 29 CFR § 2510.3–21, that changes. Brokers and others will not be able to receive commissions, 12b-1 fees, revenue sharing, and similar compensation under ERISA and the Code unless the financial services provider satisfies the BIC Exemption (“BICE”), the Principal Transaction Exemption, or other prohibited transaction exemptions, discussed in more detail below.
    6. Fiduciary Investment Advice For Nontaxable Accounts. Brokers can still use the less stringent suitability rules for taxable accounts. The final regulation states that a person provides investment advice if that person for a fee, direct or indirect, (i) provides a recommendation concerning the buying, selling, holding, or exchange of plan or IRA assets, or (ii) makes recommendations regarding the management of plan or IRA assets. The new fiduciary rules cover ERISA plans that are maintained by private employers as well as the tax-qualified arrangements described in Section 4975 of the Internal Revenue Code. Investment advice thus includes providing investment or investment management recommendations to a health savings account (HSA), Archer Medical Savings Accounts (MSA), or education savings account (ESA) owner as well as 403(b) plans maintained by private employers.. The rule expressly provides that management recommendations include recommendations regarding account type (brokerage vs. advisory) and distributions or rollovers (including the amount and form) from plans or IRAs to another plan or IRA, even if a specific investment product is not recommended. A recommendation of a specific fiduciary adviser (e.g., the 3(21) or 3(38) platform adviser) is fiduciary advice. However, a general recommendation to a plan participant, IRA, HAS, MSA or ESA owner to use the services of an unspecified adviser is not a fiduciary act.

One-time advice is covered; It no longer needs to be provided on a regular basis or pursuant to a mutual understanding, and a disclaimer of fiduciary status will not work.

  1. Fiduciary Investment Adviser. A person is a fiduciary investment adviser in connection with a recommendation, if the recommendation is made either directly or indirectly (e.g., through or together with any affiliate) by a person who:
  2. Represents or acknowledges that he or she is acting as a fiduciary within the meaning of ERISA or the Code with respect to the advice described in Section (a)(1);
  3. Renders the advice pursuant to a written or verbal agreement, arrangement, or understanding that the advice is based on the particular investment needs of the advice recipient; or
  4. Directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

The final rule does not require a meeting of the minds as to the extent to which the recipient will actually rely on the advice, but the parties must understand that the advice is individualized or specifically directed to the particular advice recipient for consideration in making investment decisions.  There is no requirement that the advice be specific to the needs of the plan, participant or beneficiary or IRA owner; rather, the advice only needs to be specifically directed to such recipient.  There is now no requirement that the advice be provided on a regular basis.

Advice to the general public is not fiduciary investment advice.

  1. Fee Or Other Compensation. Fiduciary status under ERISA requires that the investment advice be provided for a “fee or other compensation, direct or indirect.”  The final rule defines this phrase to mean “any explicit fee or compensation for the advice received by the person (or by an affiliate) from any source, and any other fee or compensation received from any source in connection with or as a result of the purchase or sale of a security or the provision of investment advice services, including though not limited to, commissions, loads, finder’s fees, revenue sharing payments, shareholder servicing fees, marketing or distribution fees, underwriting compensation, payments to brokerage firms in return for shelf space, recruitment compensation paid in connection with transfers of accounts to a registered representative’s new broker-dealer firm, gifts and gratuities, and expense reimbursements.  A fee or compensation is paid ‘in connection with or as a result of’ such transaction or service if the fee or compensation would not have been paid but for the transaction or service or if eligibility for or the amount of the fee or compensation is based in whole or in part on the transaction or service.”
  2. Recommendation. The preamble to the regulation provides that recommendation (29 CFR § 2510.3–21(b)) means 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 that is individualized or specific to the Plan. The more tailored the communication is, the more likely it will be viewed as a recommendation. The determination of whether a “recommendation” has been made is an objective rather than subjective inquiry. A series of actions, directly or indirectly (e.g., through or together with any affiliate), that may not constitute a recommendation when viewed individually may amount to a recommendation when considered in the aggregate.  It also makes no difference whether the communication was initiated by a person or a computer software program.”
  3. Investment Recommendations. “A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA.”  Recommendations to purchase group health, disability, term life, or similar insurance policies that do not have an investment component are not covered. Providing a selective list of securities to a particular advice recipient as appropriate for that investor is a recommendation as to the advisability of acquiring securities even if no recommendation is made with respect to any one security.
  4. Investment Management Recommendations. “A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services; selection of investment account arrangements (e.g., brokerage versus advisory); or recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer or distribution should be made.”
  • Investment management recommendations include communications relating to investment policies or strategies, portfolio composition and the selection of investment account arrangements, such as the choice of a brokerage or advisory account. Recommendations of persons or firms to perform investment management services for plans or IRAs are examples of recommendations on investment management.
  1. Fiduciary status is not avoided by recommending a rollover but not making any recommendation as to how the rollover should be invested. This supercedes Advisory Opinion 2005-23A. Fiduciary status also exists if an adviser recommends specific rollover investments.
  2. Service Provider Recommendation Of Investment Adviser – Is Service Provider A Fiduciary? The recommendation of an IRA or retirement plan investment adviser by another service provider is not a fiduciary act unless the service provider is paid compensation for such recommendation. However, if the recommendation is part of the service provider’s regular services, for which it earns a fee, the service provider would likely be a fiduciary adviser.
  3. EXCEPTIONS FROM FIDUCIARY DEFINITION.
  4. Actuaries, accountants, and attorneys historically have not been treated as ERISA fiduciaries for plan clients and are not fiduciaries or investment advisers by reason of providing actuarial, accounting, or legal services.
  5. HR Employees & Other Advisors. The regulation does not alter ERISA Interpretive Bulletin 75-8, D-2 at 29 C.F.R. § 2509.75-8 (1975), which explains that a plan sponsor’s human resources personnel or plan service providers who have no power to make decisions as to plan policy, interpretations, practices, or procedures, but who perform purely administrative functions for an employee benefit plan, within a framework of policies, interpretations, rules, practices and procedures made by other persons, are not thereby investment fiduciaries with respect to the plan.
  6. ERISA 404(c). ERISA § 404(c) provides an exemption for plan fiduciaries from the consequences of participant direct investments but does not provide relief from liability for a fiduciary investment adviser for investment advice provided to a participant or beneficiary.
  7. Order-Taking.” As under current rules, when a customer calls a broker and tells the broker what to buy or sell without asking for advice, that transaction does not constitute investment advice. In such circumstances, the broker has no fiduciary responsibility to the client.
  8. Platform Providers. This exception does not apply to advice by as platform provider directly to a plan or IRA participant because there is not independent fiduciary to review it.  A recommendation does not include offering a platform of investments without regard to the individualized needs of the plan or its participants and beneficiaries, as long as the plan fiduciary is independent of the person who markets or makes available the investment alternatives and the platform provider discloses in writing that it is not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity.

If a platform provider communicates that a particular platform is “appropriate” for a specific plan, that communication will likely constitute a fiduciary recommendation.

Other communications and activities related to providing an investment platform that are considered exempt recommendations include identifying investment alternatives meeting objective criteria specified by a plan fiduciary, such as investment funds of a certain size or with expense ratios below a particular threshold. A provider can also respond to requests for identification of investment alternatives with a particular type of asset or credit quality. The exception for these activities is conditioned on the provider’s written disclosure of any financial interest it may have in the alternative investments and the precise nature of this interest. In addition, the provider would be permitted to furnish, on an exempt basis, objective financial data for investment alternatives, as well as independent benchmarks.

The regulation permits responding to an RFP or similar solicitation by identifying a limited sample set of investment alternatives based on the size of the employer plan or the current investment alternatives designated under the plan, provided the response is in writing and discloses the provider’s financial interest in these investments, if any.

Selection and Monitoring Assistance.  Certain common activities that platform providers may carry out to assist plan fiduciaries in selecting and monitoring investment alternatives that they offer to participants are not recommendations, such as (a) identifying investment alternatives meeting objective criteria specified by the plan fiduciary (e.g., expense ratios, fund size, or asset type or credit quality), (b) in response to a request, identifying a limited or sample set of investment alternatives based on only the size of the plan or employer, the current designated investment alternatives, or both, or (c) providing objective financial data regarding available alternatives to the plan fiduciary.  With respect to the first two examples, the person identifying the investment alternatives must disclose in writing whether the person has a financial interest in any of the identified investment alternatives and, if so, the precise nature of that interest.

  1. General Communications. A recommendation does not include the furnishing of “general communications” that a reasonable person would not view as an investment recommendation, including general circulation newsletters, television, radio, and public media talk show commentary, and remarks in widely attended speeches and conferences; research reports prepared for general distribution, general marketing materials, general market data, including data on market performance, market indices, or trading volumes, price quotes, performance reports, or prospectuses.
  2. Investment Education. Furnishing or making available educational information and materials to a plan, plan fiduciary, participant, beneficiary or IRA owner will not constitute the provision of investment advice, regardless of who provides the information (e.g., plan sponsor, fiduciary or service provider), the frequency with which the information is shared, the form in which it is provided (e.g., on an individual or group basis, in writing or orally, via a call center, or by way of video or computer software), and whether an identified category of information and materials is provided or made available alone or in combination with other categories identified, or the type of plan or IRA involved.

The final rule incorporates much of Interpretive Bulletin 96-1.  The categories of investment education information and materials include, but are not limited, to certain:  (a) plan information that, for example, describes the terms or operation of a plan or IRA; (b) general financial, investment and retirement information (such as effects of inflation and historic differences in rates of return between different asset classes); (c) asset allocation models; and (d) interactive investment materials (that, for example, provide a means to estimate future retirement income).

  1. Asset Allocation Models And Interactive Investment Materials. The items can identify a specific investment product or specific alternative available under plans and be considered  education (and not a fiduciary investment recommendation) if provided to plan participants, but not to IRA owners, and:  (1) the alternative is a designated investment alternative under an employee benefit plan; (2) the alternative is subject to fiduciary oversight by a plan fiduciary independent of the person who developed or markets the investment alternative or distribution option; (3) the asset allocation models and interactive investment materials identify all the other designated  investment alternatives available under the plan that have similar risk and return characteristics, if any; and (4) the asset allocation models and interactive investment materials are accompanied by a statement that identifies where information on those investment alternatives may be obtained.  The final rule does not, however, deem such communications “education” and not fiduciary investment recommendations when made to IRA owners.
  2. Appraisals & Valuations. Appraisals and valuations are not investment advice.
  3. Marketing By Advisers. A person or firm can tout the quality of his, her or its advisory or investment management services and recommend that a plan or IRA investor enter into an advisory relationship with the adviser without triggering fiduciary obligations.  However, when a recommendation to “hire me” effectively includes a recommendation on how to invest or manage plan or IRA assets (e.g., whether to roll assets into an IRA or plan or how to invest assets if rolled over), that recommendation would trigger fiduciary obligations.
  4. Transactions with Independent Plan Fiduciaries with Financial Expertise. Fiduciary status does not attach to advice and recommendations made to an expert plan fiduciary (including a fiduciary of an entity that holds plan assets) in an arm’s-length sale, purchase, loan, exchange, or other transaction related to the investment of securities or other property where there is generally no expectation of fiduciary investment advice, provided several conditions are satisfied.  A person is not a fiduciary solely because of the provision of any advice to an independent fiduciary of a plan or IRA with respect to an arm’s length sale, purchase, loan, exchange, or other transaction involving the investment of securities or other property, if, prior to entering the transaction the person providing the advice satisfies the following requirements:
  1. The person knows or reasonably believes that the independent fiduciary of the plan or IRA is: (A) certain regulated and supervised banks; (B) an insurance carrier which is qualified under the laws of more than one state to perform the services of managing, acquiring or disposing of assets of a plan; (C) a registered investment adviser; (D) a registered broker-dealer; or (E) any other person acting as an independent fiduciary that holds, or has under management or control, total assets of at least $50 million. The person may rely on written representations from the plan or independent fiduciary to satisfy this condition.
  2. The person knows or reasonably believes that the independent fiduciary of the plan or IRA is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. The person may rely on written representations from the plan or independent fiduciary to satisfy this condition.
  3. The person fairly informs the independent plan fiduciary that the person is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with the transaction and must fairly inform the independent plan fiduciary of the existence and nature of the person’s financial interests in the transaction.
  4. The person knows or reasonably believes that the independent fiduciary is a fiduciary under ERISA or the Code, or both, with respect to the transaction and is responsible for exercising independent judgment in evaluating the transaction. The person may rely on written representations from the plan or independent fiduciary to satisfy this requirement.
  5. The person does not receive a fee or other compensation directly from the plan, plan fiduciary, plan participant or beneficiary, IRA or IRA owner for the provision of investment advice (as opposed to other services) in connection with the transaction.
  1. In-House Reports By Employees. A person is not an investment advice fiduciary if, in his or her capacity as an employee of a plan sponsor of an ERISA plan, employees of an affiliate of such plan sponsor, employees of an employee benefit plan, employees of an employee organization, and employees of a plan fiduciary, the person provides advice to a plan fiduciary or to an employee (other than in his or her capacity as a participant or beneficiary of a plan) or to an independent contractor of a plan sponsor, affiliate and plan, provided the person receives no fee other compensation, direct or indirect, in connection with the advice beyond their normal compensation for work performed for the employer.

This rule protects internal employees, such as human resources professionals, who routinely may develop reports and recommendations for investment committees and other named fiduciaries of sponsors’ plans.  This exceptions covers employees even if they are not the persons ultimately communicating directly with the plan fiduciary (e.g., employees in financial departments that prepare reports for the CFO who then communicates directly with a named fiduciary of the plan).

Similarly, the exclusion also covers communications between employees (e.g., human resources department staff) communicating information to other employees about the plan and distribution options in the plan subject to certain conditions.  Specifically, the exclusion covers circumstances where an employee of the plan sponsor of a plan, or as an employee of an affiliate of such plan sponsor, provides advice to another employee of the plan sponsor in his or her capacity as a participant or beneficiary of the plan, provided the person’s job responsibilities do not involve the provision of investment advice or investment recommendations, the person is not registered or licensed under federal or state securities or insurance laws, the advice they provide does not require the person to be registered or licensed under federal or state securities or insurance laws, and the person receives no fee or other compensation, direct or indirect, in connection with the advice beyond the employee’s normal compensation for work performed for the employer.

  1. Execution Of Securities Transactions. A broker or dealer registered under the Exchange Act, a reporting dealer who makes primary markets in securities of the United States Government or of an agency of the United States Government and reports daily to the Federal Reserve Bank of New York its positions with respect to such securities and borrowings thereon, or a bank supervised by the United States or a State, shall not be deemed to be a fiduciary with respect to a plan or IRA solely because such person executes transactions for the purchase or sale of securities on behalf of such plan in the ordinary course of its business as a broker, dealer, or bank, pursuant to instructions of a fiduciary with respect to such plan or IRA, if several conditions are met.
  • MANAGED ACCOUNTS.

There are many separately managed account (“SMA”) program sponsors who receive variable compensation from SMA managers they recommend (or advisers select) within a wrap program.  The prohibited transaction rules focus on whether an adviser has a financial incentive to steer a retirement investor client to a particular investment solution. If advisers have an incentive to steer clients to a particular SMA manager, because the individual adviser or the firm can earn a higher level of net compensation, a prohibited transaction may occur.  The DOL’s Best Interest Contract exemption will allow advisers to earn this type of variable compensation, but advisers will need to modify their programs to meet the BIC Exemption, discussed below.

If SMA manager fees or model fees are charged on top of the investment advisory program fee, the question becomes whether the program fee constitutes variable compensation. In this situation, a program sponsor might be paid 1% while the model managers may be paid separate fees that vary by manager. Assuming pricing is transparent and the adviser earns the same net compensation regardless of which SMA manager is selected, the adviser has level compensation and there is no prohibited transaction.

  1. PROHIBITED TRANSACTION EXEMPTION (PTE) 84-24 FOR MUTUAL FUNDS & INSURANCE & CERTAIN ANNUITIES.

PTE 84-24 covers transactions involving mutual fund shares or insurance or annuity contracts sold to plans or IRA investors by pension consultants, insurance agents or brokers, insurance companies and mutual fund principal underwriters, and the sale of insurance products and, effective April 10, 2017, only fixed rate annuities by fiduciary advisers. Variable annuity contracts and fixed indexed annuities were transferred from 84-24 to BICE.

PTE 84-24 only applies to insurance and annuity commissions.  It does not permit the receipt of sales-based or asset-based revenue sharing payments, administrative fees or marketing payments from insurance companies. For mutual funds, the exemption covers commissions and sales loads, but does not apply to the receipt of 12b-1 fees, revenue sharing payments, administrative fees, or marketing fees. Relief for those payments must be sought under the more strict BICE rules.

The requirements of 84-24 are:

  • The adviser must acknowledge in writing that he is a fiduciary and must agree to adhere to the best interest standard of care, a combination of ERISA’s prudent person rule and ERISA’s duty of loyalty. Thus, the recommendation of a particular insurance company must be prudent and the recommendation of the particular insurance contract must also be prudent.  Unlike BICE, it is not be necessary for the adviser to enter a written agreement with the plan or IRA or adopt formal policies and procedures to mitigate conflicts of interest.
  • The adviser’s compensation must be no more than reasonable and the adviser cannot receive any additional financial incentives, for example, trips, awards, or bonuses. The compensation payable to advisers was expanded from commissions to include accruals of health benefits and retirement benefits. Advisers who recommend or sell insurance and annuity contracts should obtain benchmarking information about similar sales and the commissions that are reasonable under those circumstances.
  • The adviser’s statements cannot be materially misleading. The failure to describe a material conflict of interest is deemed to be misleading.
  • The adviser must disclose his compensation.
  • Before the sale is made, disclosures must be delivered to the plan fiduciary or IRA owner in writing, and the fiduciary or IRA owner must acknowledge the disclosures and approve of the transaction in writing. These include:
  • Relationships. Whether the adviser’s ability to recommend annuity contracts is limited by any agreement with the insurer or, if they are affiliates, the nature of the limitation and relationship must be disclosed;
  • Commission. The individual adviser’s commission must be expressed as a flat dollar figure to the extent feasible. Otherwise, it must be expressed as a percentage of the premiums for the first year and renewal years. The net commission for the individual adviser and the override payable to the firm (which is the remaining portion of gross dealer concession) must be separately disclosed; and
  • Charges. Any charges or penalties (such as surrender charges) that may be imposed in connection with the purchase, holding or sale of the annuity contract must be disclosed.

Following these disclosures, a plan fiduciary or IRA owner must acknowledge in writing that it has received the disclosures and that it is approving the annuity sale on behalf of the plan or IRA. In the case of additional purchases through ongoing deposits under the same contract, new transaction disclosures must be provided annually. Similar disclosures and acknowledgments must be made with respect to sales of mutual fund shares, both at the time of the sales transaction and annually.

  1. BEST INTEREST CONTRACT EXEMPTION (BICE) – A NEW PROHIBITED TRANSACTION EXEMPTION.
  2. Current Conflicted Compensation Methods Can Continue Within Limits. Under ERISA and the Internal Revenue Code, individuals providing fiduciary investment advice to plan sponsors, plan participants, and IRA owners and certain other tax-exempt plans are not permitted to receive payments creating conflicts of interest without a prohibited transaction exemption (PTE). Qualifying under the terms of this BIC exemption, which requires acknowledging fiduciary status, allows an adviser classified as a fiduciary to earn all types of variable compensation in connection with advice provided to plan and IRA clients. Compliance with the BIC Exemption (BICE) will expose investment advisers to significantly increased compliance costs and obligations and increased litigation risk. BICE permits the recommendation of “proprietary products” and investments that generate “third-party payments” so long as the conditions of the exemption are satisfied. A proprietary product is any product that is managed, issued or sponsored by the financial institution or any of its affiliates. A third-party payment includes commissions and fees (such as revenue-sharing payments, referral fees, and volume-based fees) that a fiduciary receives from parties that are unrelated to the IRA or plan.
  3. BICE Requirements.

BICE allows existing, potentially conflicted compensation, such as commissions, revenue sharing, 12-b-1 fees, etc. to continue for most any type of investment, including equity indexed annuities, if the following conditions are met:

  • A firm acknowledges fiduciary status for itself and its advisers in writing.
  • For IRAs and non-ERISA plans, including HSAs, MSAs and ESAs, the Impartial Conduct Standards must be set forth in an enforceable contract with the retirement investors. The fiduciary must acknowledge the fiduciary status of the firm and its advisers in the written contract. The contract must cover any advice given before its execution.
  • Basic standards of impartial conduct must be adhered to in giving advice. These are enforceable standards of fiduciary conduct and fair dealing with respect to their advice and compensations structure. The financial institution also must adopt policies and procedures designed to mitigate harmful impacts of conflicts of interest, and must disclose basic information about their conflicts of interest and the cost of their advice.
  • Advisers must act in the best interests of the retirement investor. Best interests means (1) acting with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment, objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, and (2) without regard to the financial or other interests of the investment adviser, financial institution or any affiliate, related entity, or other party.
  • The financial institution and its investment advisers may not make any materially misleading statements to the Retirement Investor about the recommended transaction, fees and compensation, conflicts of interest, and any other matters relevant to the Retirement Investor’s investment decisions.
  • The financial institution must maintain for six years the records necessary to enable the DOL, the IRS and plan fiduciaries, sponsors and participants to determine whether the conditions of the exemption have been satisfied.
  • Compensation must be reasonable (not fully defined). Under the BIC, advisers can recommend a commissionable product—which they have a monetary incentive to recommend—but must disclose their conflict of interest and document the rationale for the advice that fulfills the “best interest” mandate of being a fiduciary. “Best interest” does not have a precise meaning and could invite litigation.
  • Limitations on the universe of investments the adviser may recommend must be disclosed.
  • Procedures and policies must be in place to mitigate investor harm due to conflicts of interest.
  • Both potential conflicts and details of compensation must be disclosed.
  • The Employee Benefits Security Administration must be notified by email before a BIC is being used in an advising relationship.
  • The financial institution and its investment advisers may not (1) disclaim any responsibility, obligation or duty under ERISA to the extent doing so would be prohibited by ERISA, (2) waive or disclaim the Retirement Investor’s right to bring or participate in a class action, (3) require arbitration or mediation in distant locations, or (4) otherwise unreasonably limit the ability of the Retirement Investor to assert claims safeguarded by the exemption.
  • BICE creates special streamlined rules for “Level Fee Fiduciaries.” A level fee fiduciary is one whose compensation is based on a fixed percentage of the assets or a set fee that does not vary based on the particular investment recommendation. Since such arrangements are less prone to conflicts of interest. No contract is required. Level Fee Fiduciaries must provide the investor with a written statement of fiduciary status, follow the Impartial Conduct Standard, and comply with the Best Interest Standard, including why the investment decision was in the best interest of the client. The words “level fee” actually refer to a “levelized” fee. For example, the broker-dealer or RIA could charge a flat fee (in terms of basis points or dollars) to the plan and be paid by the plan. Or, the broker-dealer or RIA could receive additional payments (for example, insurance commissions or 12b-1 fees) and either offset those against the flat fee or pay those amounts over into the plan. Both of those have the effect of “levelizing” compensation. There must be an enforceable agreement to offset or pay over. In the case of a rollover recommendation, for level fee advisers whose compensation doesn’t vary with the investments they use, these advisers must conduct a detailed analysis of whether a rollover is in a client’s best interest. The new rule requires advisers to consider whether the client might be better off remaining in his or her 401(k) plan and weigh fees as well as services and investment options available under each alternative. Advisers must document this analysis, although it has not specified any particular format or method for generating or retaining the documentation.
  • Advisers will need to comply with the BIC exemption if they are already providing plan-level services for a fee, to the extent that they will earn a higher fee rate on rollover IRA assets
  1. Required BICE Transaction Disclosures. For BIC exemption purposes, plan and IRA clients must receive the following disclosures before or when each recommended transaction is executed:
  • A description the Best Interest standard of care owed by the individual adviser and firm;
  • A description of all conflicts of interest;
  • Information regarding the client’s right to obtain a description of compliance policies within 30 days (or prior to the transaction if an upfront request is made);
  • Information regarding the client’s right to obtain specific compensation information (dollar amount or formula) for any recommended transaction within 30 days (or prior to the transaction if an upfront request is made); and
  • Disclosure that model BIC contracts and compliance policies are posted on a website and the availability of a link.

While these disclosures are required for each investment recommendation, they do not need to be renewed for subsequent recommendations for the same investment product made within one year unless there are material changes. In addition, they do not need to be provided if the adviser is a level-fee fiduciary or with respect to certain advice made under a bank networking arrangement.

  1. Required BICE Web Disclosures. Advisory firms seeking to qualify under the BIC exemption must also post the following information on the firm’s public website, updating it on a quarterly basis:
  • A description of the firm’s business model and its associated conflicts;
  • A schedule of typical fees and charges;
  • Model BIC contracts (for non-ERISA plans and IRAs) or model BIC exemption disclosures (for ERISA plans), which must be reviewed on a quarterly basis and updated within 30 days;
  • A description of firm compliance policies;
  • A list of all product sponsors that make third party payments, and an explanation of such arrangements;
  • Disclosure of compensation and incentive arrangements for individual advisers, and provision of a “full and fair description” of payout grids (without referring to a specific adviser’s payout); and
  • Upon request, provision of a copy of the firm’s compliance policies.

These disclosures may use dollar amounts, formulae or reasonable ranges of value to describe the firm’s arrangements with product sponsors and individual advisers. Such disclosures must enable clients to make an informed judgment about the significance of the firm’s compensation practices and conflicts. Further, they may cross-reference and link to other public disclosures, such as the ADV brochure. The Web Disclosures are not required for level-fee fiduciaries or bank networking arrangements.

  1. Required Elements of the BICE Contract. Where a BICE contract is required to be in writing for IRAs and non-ERISA plans, the following provisions must be included in its terms:
  • Acknowledgement of Fiduciary Status.
  • Impartial Conduct Standard. The contract must state that: the firm and its advisers will provide investment advice that is in the “Best Interest” (as defined below) of the retirement investor, the recommended transaction will not result in unreasonable compensation for the firm or advisers, and statements relevant to the transaction (e.g., concerning compensation or conflicts of interest) will not be materially misleading.
  • Warranties Relating to Compliance Policies.

(i)         The firm’s policies are reasonably designed to ensure its advisers will meet the Impartial Conduct Standards.

(ii)        All conflicts are identified and documented in the formulation of the policies.

(iii)       The policies are designed to prevent violations of the Impartial Conduct Standards.

(iv)       A responsible person or persons (“BIC Officer”) will be designated for monitoring compliance and addressing conflicts of interest.

(v)        Individual advisers may earn differential compensation only if the policies are reasonably designed to avoid a misalignment of client’s interests with adviser’s interests.

(vi)       The DOL has indicated that differential compensation is only permitted to the extent it reflects “neutral factors” relating to differences in services, such as the time or expertise needed to sell particular categories of investments (such as variable annuities). An individual adviser may not receive a higher payout from a particular investment, simply because the product generates higher commission-based compensation for the firm.

  1. BICE New Client Disclosures. The following disclosures must appear in the BIC contract itself or in a separate single written disclosure statement provided to the retirement investor along with the contract.
  2. A description of the Best Interest standard of care owed by the individual adviser and firm. This new fiduciary standard, which combines ERISA’s prudent man standard of care with the duty of loyalty, requires an adviser to provide investment advice that reflects “the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser . . . .”
  3. A description of the services to be provided.
  4. An explanation of how the client will pay for services (e.g., direct or third party payments, commissions or fees, etc.).
  5. Disclosure of all conflicts of interest.
  6. General information on fees and charges, including third party payments from investments must be disclosed.
  7. Information with respect to the client’s right to obtain a description of compliance policies within 30 days (or prior to the transaction if an upfront request is made).
  8. Information that the client has a right to obtain specific compensation information (dollar amount or formula) for any recommended transaction within 30 days (or prior to the transaction if an upfront request is made).
  9. Disclosure that model BICE contracts and compliance policies are posted on a website and provision of a link.
  10. Disclosure of any proprietary products or investments generating third-party payments, and the extent to which recommendations are limited to such products or   investments.  If a firm limits the individual adviser’s recommendations to proprietary products or investment products that generate third party payments, the following additional requirements will apply:
  • Written Statement for Client. Before or when the recommended transaction is executed, the client must receive a statement that explains how the recommendations are limited to such investment products.
  • Internal Documentation. The firm must document its limitations on the universe of recommended investments, its related conflicts, and any services it will provide to product sponsors for third party payments. It must conclude that any related compensation is reasonable and any conflicts will not cause imprudent advice, and it must document the basis for its conclusions.
  1. Provision of contact information for the firm’s representative who can address concerns relating to services.
  2. If applicable, an explanation of how regulatory information may be available on FINRA’s BrokerCheck or IARD.
  3. A description of if (and how often) the client’s investment will be monitored for recommended changes.
  4. Prohibited Provisions. These include:
  5.  Limits on the liability of the individual adviser or firm for contractual violations.
  6. Limitation of the client’s right to participate in class action lawsuits.
  7. Mandatory arbitration clauses with an unreasonable venue.

However, waivers of the right to receive punitive damages or rescission awards are permitted.

 

  1. Transactions Excluded From BIC Exemption. There are several types of transactions that are excluded from the BIC Exemption, in which case financial institutions and investment advisers must rely on another exemption or otherwise avoid a prohibited transaction. For example, so-called “Principal Transactions” are not eligible for the BIC Exemption, but are instead eligible for the Principal Transaction Exemption (discussed below). A “Principal Transaction” generally involves the purchase or sale of an investment product if an investment adviser or financial institution is purchasing from or selling to a plan or IRA on behalf of the financial institution’s own account (or the account of a related person). However, Riskless Principal Transactions are eligible for either the Principal Transaction Exemption or the BIC Exemption. In general, a “Riskless Principal Transaction” is one in which a financial institution, after having received an order from an investor to buy or sell a principal traded asset, purchases or sells the asset for the financial institution’s own account to offset the contemporaneous transaction with such investor.

The BIC Exemption also does not apply to transactions in which (1) the investment adviser has any discretionary authority or control over the plan or IRA assets or (2) the investment adviser, financial institution or any of their affiliates is the sponsor, named fiduciary or plan administrator of the plan or IRA.

Finally, the BIC Exemption does not apply to online wealth management services that provide automated, algorithm-based portfolio management advice without the use of human financial planners (“robo advice”), unless such robo advice is provided by a “Level Fee Fiduciary” that complies with several conditions.