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What the DOL’s Fiduciary Rule Means Now and What You Can Do About It

by Kim Shaw Elliott

You have heard much about the results of the new definition of fiduciary released by the Department of Labor (“DOL”). Few pieces of regulation have been as long-awaited, as hotly contested, or as little understood.

Even the timing of the rule’s provisions requires a scoresheet. After years of planning, proposed rules and withdrawn rules, the DOL released the “final” rule to be effective June 7, 2016, but its provisions were not to be applicable until April 10, 2017. Following the start of the Trump Administration, the applicability date of the new definition was extended to June 9, 2017, with many of the more controversial provisions likely not becoming “applicable” until July 1, 2019. We all wait on the edge of our seats to learn what new form the rule may take when it emerges from the delay.

Highlights of what the new rule means.

In issuing this ground-breaking regulation and later pronouncements, the DOL:

1. Expanded the definition of fiduciary.

Despite some common misconceptions, nothing has changed from the new rule’s definition of fiduciary. Anyone who is paid to provide investment advice is a fiduciary and must act in the best interest of the customer. This is true whenever the advice is provided to a plan, an IRA, HSA or similar IRA-like accounts.

In general, this means that the fiduciary must hold the customer’s interest above his or her own, avoiding all conflicts of interest and receiving only reasonable compensation. A fiduciary must act prudently, essentially meaning that the fiduciary must exercise appropriate due diligence and follow a reasonable process in making decisions. Just as before, a reasonable process does not require perfection in decision-making; it does require collecting facts, identifying options, giving sound consideration to available choices and maintaining a good record of the process.

2. Clarified that commissions and payments from third parties create prohibited conflicts of interest. Only “level” compensation is conflict free.

Commissions have been long-entrenched as traditional forms of compensation for brokerage sales. Commissions are transaction-based, meaning that a commission is paid every time a trade is made and there is no compensation if a trade is not made. Commissions can vary, based upon the type of security that a customer purchases. Bonds may pay different commissions than stocks and one mutual fund may pay more than what another equally appropriate mutual fund might pay. This means that a broker-dealer registered representative could recommend a particular investment that pays him or herself more than what another equally appropriate investment might pay. The DOL believes that this creates an inherent conflict of interest. Since the transactions are conflicted, they are prohibited and subject to substantial penalties. This long-established rule created extensive consternation among the broker dealer community.

Registered investment advisers and their investment advisor representatives are traditionally paid asset-based fees or fixed dollar amounts. These fees are owed regardless of the number of transactions that the advisor recommends be made and regardless of which investments are recommended. Since compensation to the advisor does not vary with the investment recommendation, it is known as “level” compensation.

3. Created new exemptions to permit conflicted compensation, subject to specified conditions.

In response to thousands of complaints requesting relief for traditional forms of brokerage compensation, the DOL conceded in a very clever way. It spoke to the industry, saying that it could continue to pay conflicted forms of compensation, so long as the fiduciary rendering advice meets specified conditions and enters into a Best Interest Contract. This contract is the dreaded BIC. The fiduciary advisor must make lengthy disclosures, commit to acting in the client’s best interest, and maintain policies and procedures to ensure that the advice remains conflict-free. This representation is enforceable in state court. Short forms of the exemption were created for ERISA plans and for the “Level Fee Fiduciary.”

4. Postponed enforcement while the rule is reconsidered; Impartial Conduct Standard survives.

The BIC portion of the rule has been delayed, likely until 2019, or it may be substantially revised or even dropped. Until then, broad transitional relief is available. No BIC contract, written policies and procedures or private right to sue is mandated. The only requirement to avail oneself of the transition exemption is to satisfy the Impartial Conduct Standard. It requires that an advisor:

• Act in the best interest of the client

• Receive no more than reasonable compensation, and

• Make no misrepresentations about services and fees.

On its face, this looks simple. Remember: no formal written policies, procedures or contracts are required. Closer evaluation reveals some gaps, however. How do you know you are acting in the best interest of a client if you have no policies or procedures to guide you? Have you properly disclosed any potential conflicts of interest? Can you tell what is reasonable compensation for services without benchmarking other fees? Might a client misunderstand, or worse, believe that you may have misrepresented about what services you will perform, if you do not describe those services in a well- written, easy to read, agreement?

While not required, having clear policies and procedures, benchmarking your fees and maintaining clearly understandable contracts simply makes sense. Each is a best practice that is likely to increase understanding among parties and to produce happy results. This is nothing new.

What financial advisors, broker dealers and RIAs should do now.

What firms and advisors can do now is simply update sound, time-proven practices:

• Follow a prudent process to meet the requirements of the transitional relief. Review your policies and procedures and update them as required. Define who is a fiduciary and chart a path for how to act in the client’s best interest.

• Update your agreements. Acknowledge your status as an ERISA fiduciary when delivering advice to a plan, IRA or IRA-like account. Make sure they are written in plain, English.

• Review errors and omissions insurance coverage to confirm that fiduciary activity is covered. Many policies exclude this coverage so speak with your agent to confirm whether a special endorsement is required. Review how service to IRAs will be treated.

• Understand all forms of compensation the advisor, the firm and its affiliates receive. Evaluate any form of unlevel compensation such as commissions and third party compensation such as conference support and revenue sharing. Consider what value those payments bring to you, compared to the potential conflicts and disclosures they might require. Review your business plans in light of those findings.

• Record your reasons to recommend any rollover or a conversion from a brokerage account to an advisory account. Draft detailed, check- the- box forms to detail what reasons best meet your client’s needs.

Wouldn’t it have been a best practice to have done these things all along?

About the author:

Kim Shaw Elliott is President and ERISA Counsel of IFP Plan Advisors, a division of Independent Financial Partners, an SEC registered investment advisor serving 1700 retirement plans with over $35 billion in assets under advisement. Kim helps investment advisor representatives successfully navigate the complex rules founded in ERISA, securities law, broker dealer regulation, and tax. She is a three-time graduate of Washington University in St. Louis, which awarded her a JD, LLM- Taxation and MBA.

Posted by: Kim Shaw Elliott | November 21st, 2017 at 10:52am.