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ICS Group is a regulatory compliance consulting firm specializing in providing compliance support to the financial services and insurance industries. We help our clients comply with regulatory requirements and industry standards. Our clients include: registered investment advisers, private equity funds, hedge funds, mutual funds, broker-dealers, insurance companies and state pension plans. Our team of highly experienced compliance professionals know from first-hand experience what regulators are looking for, the industry standards that apply, and how to develop and implement cost-effective business-oriented solutions.
On October 27, 2016, the U.S. Department of Labor (“DOL”) released initial guidance primarily addressing the BIC exemption under the Fiduciary Rule. The Fiduciary Rule expands the scope of the definition of fiduciary for employer-sponsored plans and swept in non-ERISA investment vehicles such as IRAs and HSAs. A key aspect of the expanded definition is the “Best Interest Contract” exemption (BIC) which allows firms and advisers to continue using otherwise prohibited compensation arrangements if they agree to take certain steps to avoid conflicts of interest. To read more about the BIC exemption and the other aspects of the final Fiduciary rule, please refer to ICSGroup’s original article, “DOL Releases Final Fiduciary Rule”.
SUMMARY OF INITIAL GUIDANCE
Provided below is a summary of selected Q&A’s from the DOL’s initial guidance. To read the DOL’s initial guidance in its entirety, click here.
- Is the BIC Exemption broadly available for recommendations on all categories of assets in the retail advice market? (Q3)
Yes, it is available for all categories of assets in the retail advice market for plans and IRAs, and for advice to roll over plan or IRA assets or to hire an adviser for a plan or IRA.
- Is compliance with the BIC Exemption required as a condition of executing a transaction, such as a rollover, at the direction of a client in the absence of an investment recommendation? (Q4)
No. If there is no investment recommendation, the rule does not recognize individuals or firms as investment advice fiduciaries. Similarly, even if an adviser makes a recommendation for a particular investment, the adviser is not a fiduciary unless the person receives compensation, direct or indirect, as a result of the advice.
- Is the payment of recruitment bonuses or awards to an adviser by a financial institution permissible under the full BIC Exemption? (Q12)
Recruitment bonuses will be permitted as long as they are paid as a fixed sum and are tied to length of stay. However, recruitment bonuses contingent on meeting particular asset or sales targets —as most are today—can create “acute conflicts of interest” and will be impermissible. “Back-end awards commonly result in large amounts of income to the adviser that are paid on an ‘all or nothing’ basis, contingent on the adviser’s satisfaction of revenue or asset targets,” the DOL wrote. “Such disproportional amounts of compensation significantly increase conflicts of interest for advisers making recommendations to investors, particularly as the adviser approaches the target.”
- The BIC Exemption provides that financial institutions cannot “….use or rely upon differential compensation or other actions or incentives that are intended or would reasonably be expected to cause Advisers to make recommendations that are not in the Best Interest of the Retirement Investor.” Does this provision categorically preclude financial institutions from paying higher commission rates to advisers based on volume. (Q9)
Brokerage firms can continue to compensate brokers with variable payouts based on production, but only if such variable grid structures “are not intended or reasonably expected to cause advisers to make recommendations that are not in the best interest of retirement investors and…do not cause advisers to violate the reasonable compensation standard.” As an example of conflict-tainted grid payouts, the DOL said that firms cannot give payouts for selling mutual funds that pay firms more for distribution than others. “If, for example, different mutual fund complexes pay different commission rates to the firm, the grid cannot pass along this conflict of interest to advisers by paying the adviser more for the higher commission funds and less for the lower commission funds (e.g., by giving the adviser a set percentage of the commission generated for the firm),” the DOL said.
- The wording of the Principal Transaction Exemption 84-24’s reasonable compensation standard differs from the reasonable compensation standard used in the BIC Exemption. Doe the department intend to interpret them differently and what does constitute unreasonable compensation? (Q33)
Both the BIC Exemption and the Principal Exemption prohibit the receipt of compensation “that is in excess of reasonable compensation…” The DOL stated that the two standards do not differ substantively and that the Department intends to interpret them in the same way. The DOL stated that “the essential question is whether the charges are reasonable in relation to what the investor stands to receive for his or her money.” Furthermore, the DOL suggests, 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.
The rule becomes effective on April 10, 2017; however, financial advisers and institutions will have a transition period with fewer conditions until January 1, 2018. During the transition period, financial institutions and advisers are expected to comply with the parts of the rule that require a firm to ensure that advice is in the best interest of the investor, inform clients of the firm’s fiduciary status, and describe material conflicts of interest.
For more information regarding the DOL fiduciary rule and help with preparing your firm to be fully compliance with the rule, contact ICSGroup. As always, we are here to help.