United States: DOL Issues First Guidance On Fiduciary Rule

Last Updated: November 7 2016
Article by Hillel Cohn

On October 27, 2016, the U.S. Department of Labor (DOL) issued initial guidance on its new fiduciary rules, which are scheduled to become effective on April 10, 2017.  The guidance was issued in the form of FAQs and is expected to be the first of three rounds of guidance to be published by DOL prior to the effective dates of the new rules.1

Perhaps not surprisingly, the FAQs address in large part a variety of compensation questions which are top of mind for both broker-dealer firms, and their financial advisers.

Background

In April 2016, the DOL greatly expanded the scope of persons who would be deemed fiduciaries under ERISA2 and Internal Revenue Code (the "Code") when dealing with retirement plans and IRAs.  As revised, any broker-dealer or financial intermediary ("Financial Institution") that makes any suggestions as to how or where a retirement investor should invest may be a fiduciary.  In addition, the individual financial advisers or registered representatives employed by Financial Institutions (FAs) may be fiduciaries.  Given the prohibitions under ERISA and the Code regarding self-dealing by fiduciaries, the expanded definition effectively proscribes the use of commissions and other variable compensation  in dealings with retail retirement investors unless the transaction can fit into an available exemption.  Of particular interest when dealing with retail retirement investors are two new exemptions released by DOL in April 2016:  the Best Interest Contract Exemption ("BIC Exemption") and the Principal Transactions Exemption ("Principal Exemption").  Each exemption requires the Financial Institution and FAs to adhere to "Impartial Conduct Standards" and imposes a number of other requirements.  The Impartial Conduct Standards require the Financial Institution and the FA to act in the best interest of the retirement investor, to avoid unreasonable compensation and to make full and fair disclosure of all material facts, including all fees and any material conflicts of interest.

Guidance from the FAQs

The FAQs address a number of important topics as summarized below.

Scope of BIC Exemption

The FAQs confirm that the BIC Exemption is potentially available for transactions in all categories of assets.

What Constitutes Unreasonable Compensation?

Both the BIC Exemption and the Principal Exemption prohibit the receipt of compensation "that is in excess of reasonable compensation..."  The FAQs advise that "the essential question is whether the charges are reasonable in relation to what the investor stands to receive for his or her money."  DOL suggests that, to avoid the receipt of unreasonable compensation, Financial Institutions should be attentive to market prices and benchmarks, prudently evaluate the retirement investor's needs, make sure they make full disclosure of all charges, costs and conflicts of interest and stay alert to potential abusive practices involving customer fees and charges.

Incentive Compensation for FAs

DOL advised that Financial Institutions may continue to use incentive compensation for their FAs and still comply with the BIC Exemption.  However, DOL strongly cautioned that any such arrangements must be carefully structured and monitored to avoid creating, or allowing the continuation of, incentives for FAs to act in a manner which would not be in the best interest of the retirement investors.

DOL advised that it would be improper to base incentives to FAs on the relative profitability to the Financial Institution of certain products.  For example, a Financial Institution should not pay a FA a higher commission for selling Fund A as compared to Fund B if the funds are similar products but Fund A has a higher payout to the Financial Institution.  Rather, incentives should be based upon "neutral" factors, such as the amount of work involved or other factors justifying distinctions in the amount of compensation payable to FAs for certain categories of products.

DOL also cautioned that any volume-based incentive grids should not include provisions which might tempt FAs to act imprudently.  For example, increases in payout percentage as the FA progresses up the grid should be "modest" and there should be no retroactive application of higher payout percentages to transactions completed before the FA qualified for the higher payout level.

Recruitment Bonuses

DOL advised that signing bonuses used to hire FAs should be compatible with the new rules, provided that the bonus is not contingent upon any sales or similar production target.  Back-end loaded recruitment bonuses which largely depend upon reaching certain production levels are viewed by DOL as creating "acute conflicts of interest that are inconsistent" with the BIC Exemption.

Level Fee Fiduciaries

In the FAQs, DOL acknowledged that a Financial Institution may manage some accounts on a Level Fee Fiduciary basis, while managing other accounts on a commission basis.

DOL confirmed that the fees of a Level Fee Fiduciary who is compensated on the basis of a percentage of assets under management or a similar model (AUM) would not be prohibited transactions under the new rules.  As a result, a Level Fee Fiduciary need not comply with the BIC Exemption in order to charge a fee based on AUM.  However, Level Fee Fiduciaries are still fiduciaries under the rule and they need to act in the best interest of their retirement investors.  In this regard, a recommendation to roll over an IRA, or to change a commission-based account to a flat fee account, may entail a conflict of interest for the fiduciary who stands to benefit from a stream of fees generated by the new account.  As a result, such recommendations could be prohibited transactions.  The BIC Exemption includes a "short-form" provision which enables the Level Fee Fiduciary to comply by acknowledging in writing its fiduciary status, adhering to the Impartial Conduct Standards and documenting the basis for the recommendation to roll over or open a new account.

DOL further advised that a Financial Institution seeking to qualify as a Level Fee Fiduciary may not receive transaction-based payments from third parties in connection with any accounts managed on a level fee basis, nor may it limit its investments to proprietary products.  Third-party payments would be viewed as the equivalent of commissions and would require the Financial Institution to comply with all provisions of the BIC Exemption.  Similarly, the conflicts associated with proprietary product are viewed by the DOL as inconsistent with the status of a Level Fee Fiduciary if its compensation is in any manner contingent upon recommending proprietary products.

Bank Networking Arrangements

The new rules permit a bank to receive payments from an unaffiliated broker-dealer with whom it has a networking arrangement provided that the bank complies with the Impartial Conduct Standards.  In the FAQs, DOL advised that a referral by a bank to an affiliated broker-dealer would not, in and of itself, be viewed as investment advice, but rather would be viewed as marketing the services of an affiliate which would not trigger fiduciary concerns.

Effective Date

As expected, DOL advised that it does not intend to delay the effective date of the new requirements.  The new rules will become effective on April 10, 2017, although compliance with some of the new contract provisions is deferred to January 1, 2018.  DOL indicated that it will continue to work with the industry during the initial compliance period with a view to assisting rather than sanctioning those who are making a good faith effort to comply. In light of the significant penalties that can arise from violations of these complex new requirements, the financial industry will certainly welcome a cooperative approach from DOL.

Conclusion

The FAQs provide helpful guidance on a number of issues.  However, they do not address most of the questions raised by investment bankers and product sponsors regarding underwriting and distribution arrangements for many investment products.  Hopefully, the succeeding FAQs will address these issues.

Footnotes

1. https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-rules-and-exemptions-part-1.pdf.

2. The Employee Retirement Income Security Act of 1974, as amended.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Hillel Cohn
Similar Articles
Relevancy Powered by MondaqAI
Morrison & Foerster LLP
Morrison & Foerster LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Morrison & Foerster LLP
Morrison & Foerster LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions