Last Thursday, the Department of Labor (DOL) released a set of 34 frequently asked questions (FAQs) about its new fiduciary rule. This is anticipated to be the first of three sets of FAQs to be issued by the DOL before the end of this year. This particular set of FAQs focuses on questions that have been raised about the exemptions, including the “best interest contract” exemption (BICE) and prohibited transaction exemption (PTE) 84-24. Firms and their advisers must either structure their compensation arrangements to avoid prohibited transactions or they must conform to the conditions in an available exemption.
The following FAQs are of particular interest:
FAQ7 discusses IRA rollovers that will be managed by a discretionary investment manager on a going-forward basis. While the BICE is not available for discretionary investment management of an account, it does, however, provide relief for investment advice to roll over a plan account into an IRA, even if the adviser will subsequently serve as a discretionary investment manager of the IRA. But, this relief only applies if the adviser does not have or exercise any discretionary authority over the decision to roll over assets from the plan to an IRA. TAKEAWAY: Discretionary “level fee” advisers will be required to comply with the “streamlined” BICE requirements in connection with any rollover recommendation, including a recommendation to roll over from an ERISA plan to an IRA, from one IRA to another IRA, or to switch from a commission-based account to a level fee arrangement.
FAQ9 presents multiple permissible compensation systems and payment structures. One of the permissible structures allows for different commission amounts for different categories of investments based on neutral factors, such as the time and complexity associated with recommending investments within the different product categories. For example, a firm may adopt one commission structure for mutual funds, another for annuities and another for complex alternative investments, but only if there is a neutral basis for the distinction. “Neutral factors” are factors that are not based on the financial interests of the firm, but rather on significant differences in the work that justify drawing distinctions between categories and compensation. This commission structure also requires careful ongoing monitoring to ensure that any justifications for creating the categories are borne out in practice. TAKEAWAY: Firms may charge higher fees for complex products that require, for example, greater due diligence, training and closer supervision, but will need to justify the basis for the increased costs and monitor recommendations between categories.
FAQ12 addresses recruitment bonuses or awards to an adviser by a financial institution. “Signing” or “front-end” awards that are not tied to the movement of accounts or assets to the firm or achievement of particular asset or sales targets, but instead are paid as a fixed amount contingent on the adviser’s continued service in good standing at the financial institution are permitted. Such awards and bonuses are not tied to the adviser’s particular recommendations and do not create inappropriate incentives to give advice that is not in the customer’s best interest. In contrast, back-end awards, such as forgivable loans, that are contingent on the adviser’s achievement of sales or asset targets are prohibited because they can create acute conflicts of interest. Back-end recruitment and sales targeted awards entered into before the date of these FAQs may be grandfathered, but only if certain requirements are satisfied. TAKEAWAY: Variable back-end awards, bonuses and similar back-end incentives are not permitted under the BICE and cannot be offered on or after October 27, 2016 (the date the FAQs were issued). If a firm entered into such a back-end recruitment award arrangement before this date and is contractually obligated to honor this commitment, the firm must adopt special policies and procedures to address the inherent conflicts of interest introduced by these arrangements, including establishing an especially stringent system of oversight and supervision of the adviser during the remaining period of the arrangement.
Link to FAQs
Review the full FAQs on the DOL website.
For more information about the FAQs or the DOL rule, please contact Lisa Zimmer at firstname.lastname@example.org or 248.784.5191.