IFP Plan Advisors [print-me]

Do You Give Investment Advice to IRAs? Then Take Note, the Fiduciary Rule Means You.

by Kim Shaw Elliott

President and ERISA Counsel, IFP Plan Advisors

We have heard about the DOL’s new fiduciary rule ad infinitum. However, some advisors may continue to miss the message that the reach of the rule extends well beyond traditional, employer-sponsored retirement plans. Anyone giving investment advice for a fee to an IRA, SIMPLE, SEP or similar account is an ERISA fiduciary under the new rule. That likely means every IFP advisor.

“Why is this significant?” you might ask. When acting as an advisor, rather than a registered representative, you have always been a fiduciary, as defined by the Investment Advisers Act of 1940. You are accustomed to acting in your clients’ best interests. Serving as a fiduciary is a key differentiator in how you approach the individuals that entrust you with their financial well-being, compared to a registered representative that must merely offer what is suitable. With that said, becoming an ERISA fiduciary in addition to being an Advisers Act fiduciary brings new responsibilities, exposes you to higher scrutiny of your actions, and imposes a new standard of care.

How You Get Paid May Create a Conflict of Interest

What is a conflict of interest? As with all things in this industry, just follow the money. The new rule includes compensation that is not “level” as a conflict of interest. Unlevel compensation is any form of payment that might vary with the recommendation you make. The brokerage industry is rife with unlevel payment arrangements. Different mutual funds pay different amounts of compensation; sometimes a registered representative might direct a client to different compensation levels within the same mutual fund. Stocks pay commissions that might be different than bonds. Recommending any particular investment might enable the financial professional to receive more money than recommending an alternative. Any of these presents a conflict of interest. Also conflicted is any payment from a third party. Think revenue sharing and 12b-1s.

The ability to withstand conflicts of interest is vastly different under the Advisers Act and ERISA. Under the Advisers Act, an advisor must disclose all conflicts of interests so that a fully informed client may make an intelligent decision for him or herself about whether to proceed with your recommendation, even if it is made in the face of a conflict of interest. By moving ahead with the advice, the client has waived any real or potential conflicts that were disclosed. Not so under ERISA. Any conflict of interest, as defined by ERISA, is a prohibited transaction. Like the name suggests, if the advisor has a conflict, that transaction cannot proceed; it is prohibited. There is no waiver of an ERISA-prohibited transaction. The only way to engage in the conflicted conduct is to comply with a prohibited transaction exemption.

An Exemption Is Needed to Resolve an ERISA Conflict of Interest

Enter the now infamous Best Interest Contract (“BIC”) exemption to permit the prohibited, conflicted compensation. Unlevel compensation such as commissions and third party payments such as 12b-1s is allowed if the full conditions of the BIC are satisfied. Compliance with all but one of the many onerous conditions of the BIC exemption has been postponed until 2018 so we will not repeat them here.

We at IFP do not plan to take advantage of the full BIC exemption because we believe that it is not needed. Fee-based arrangements such as ours are not considered conflicted because an asset-based fee or a flat dollar fee does not vary with the investments an advisor might recommend. We also do not accept payments from third parties. Once you have established an advisory relationship, you are paid the same amount, regardless of what action you suggest to your client, so you do not give conflicted investment advice. Accordingly, your current arrangements with stand-alone IRAs should be able to continue without change because you do not need an exemption. Should you give advice that results in additional compensation to you, an exemption is required.

Rollovers present the classic examples of potential conflicts of interest. You might be paid 25 bps for helping the plan fiduciary select the investment menu for the plan but charge 100 bps to advise an IRA that you suggested the participant roll into. Each fee is a level fee but your compensation is not the same under each arrangement. The DOL interprets the conflict of interest rules to include situations where your pay may increase as a result of your advice, whether that be from something to more something- or even from zero to something. The prohibition is not limited to advice relating to an employer-sponsored plan. Your advice to take any rollover is itself fiduciary investment advice so receiving any compensation as a result of that recommendation can be deemed to be a conflict.

IFP expects to rely on a short form exemption for level fee arrangements such as these that might create a conflict. A full BIC contract would not be required. Just like compliance with the full BIC, all but one of the simplified conditions of the Level Fee Fiduciary exemption have been delayed until next year.

Full Compliance with the New Rule May Be Delayed but New Forms Will Support Best Practices

The condition that has not been delayed for either the full BIC or the Level Fee Fiduciary exemption is the obligation to satisfy the impartial conduct standards. These standards may be distilled to three requirements:

  1. Act in the best interest of the client,
  2. Receive no more than reasonable compensation, and
  3. Make no misleading statements.

Upon first glance, these standards may seem obvious. Look closer, however. Do you know how to prove that you acted in your client’s best interest? What must you do to comply with that standard? How do you determine what is reasonable pay for an IRA? What is an actionable misleading statement?

You must meet the impartial conduct standards, effective June 9, 2017. IFP will help you create and maintain a record of each of the important criteria. While it is not specifically required that you maintain records of the recommendations you make, we believe that it has always been a best practice to do so. Memories fade, facts change and the comfort level a client may have with an advisor shifts over time, so recording the factors you considered at the time of guiding your client is indispensable. We will help you do that by requiring new forms to document your recommendations for:

  1. Rollovers from a qualified plan to an IRA,
  2. Rollovers between IRAs and similar accounts, and
  3. Transfers from commission-based to advisory arrangements.

The Next Steps

Consider moving all your business to a conflict conscious advisory arrangement. Attend our training sessions. Carefully review and then use the new forms. Ask questions about anything about which you are unclear. Continue what you have always done; act in your clients’ best interests.

Posted by: Kim Shaw Elliott | June 21st, 2017 at 1:01pm.