Disclaimer: The information in this post dates back to October 2016. Read more about where the DOL Fiduciary Rule sits as of January 2022 by clicking here: Temporary Enforcement Policy on New DOL PTE for RIA Firms Advising on IRA Rollovers Is Extended.
Since, the final Department of Labor (“DOL”) fiduciary rule was released on April 8, 2016, there has been steady debate around its impact on registered investment adviser (“RIA”) firms. As we have previously written, the good news for the vast majority of RIA firms is that the new DOL fiduciary rule should not require significant operational changes. This is due to the fact that most investment advisory firms should be able to take advantage of the streamlined “Level Fee Exemption” which does not mandate the use of a Best Interest Contract (“BIC”). This past week, the DOL issued its first of three FAQs in regards to the fiduciary rule. This first set of FAQs helps clarify the use of the “Level Fee Exemption” and we have highlighted the key takeaways for RIA firms below.
Note: RIA in a Box LLC is not a law firm and does not provide legal advice. We strongly advise that all RIA firms that provide services to individual retirement investors, pension plans, profit sharing plans, and/or retirement plans to consult with a qualified Employee Retirement Income Security Act of 1974 (ERISA) attorney in matters relating to Department of Labor (DOL) and ERISA law. This overview is provided for general information purposes only and should not be relied upon to take any action. RIA in a Box LLC does not offer any services or assistance with regards to DOL or ERISA law.
This post below is as October 31, 2016. As the DOL issues additional guidance, we anticipate additional updates and/or modifications will be made to this solely educational overview. Reference Sources: Best Interest Contract Exemption issued by the Employee Benefits Security Administration released on April 8, 2016 and Conflict of Interest Exemptions FAQs published on October 27, 2016. Phased-in deadline for compliance begins on April 10, 2017 with January 1, 2018 the deadline to be in full compliance with the new retirement account advice rules.
This initial round of FAQs provides 34 answers to frequently asked questions. Question numbers 13 to 19 focus on “Level Fee Fiduciaries” and are most relevant to fee-based investment advisers. In this latest release, the DOL further defines a “Level Fee Fiduciary” as follows:
“As defined in the exemption, a “level fee” is a fee or compensation that is provided on the basis of a fixed percentage of the value of the assets or a set fee that does not vary with the particular investment recommended. Level fees do not include commissions or other transaction-based fees. “
To utilize the streamlined “Level Fee Exemption”, the DOL states that an RIA firm must:
“Provide a written acknowledgment of its and its advisers’ fiduciary status to the retirement investor. The financial institution and its advisers must satisfy the impartial conduct standards (requiring fiduciaries to act in the best interest of their clients, charge no more than reasonable compensation, and make no misleading statements) and document the reasons why the advice was considered to be in the best interest of the retirement investor”
In regards to providing investment advice to roll over assets from an ERISA plan to an IRA, the DOL specifies that:
“This documentation must include consideration of the retirement investor’s alternatives to a rollover, including leaving the money in his or her current employer’s plan, if permitted, and must take into account the fees and expenses associated with both the plan and the IRA; whether the employer pays for some or all of the plan’s administrative expenses; and the different levels of services and investments available under each option”
The DOL also provides some additional guidance to “Level Fee” advisors pertaining to roll over scenarios in which the advisor does not have reliable information about the existing plan’s expenses and features:
“This documentation must include consideration of the retirement investor’s alternatives to a rollover, including leaving the money in his or her current employer’s plan, if permitted, and must take into account the fees and expenses associated with both the plan and the IRA; whether the employer pays for some or all of the plan’s administrative expenses; and the different levels of services and investments available under each option. To satisfy this requirement, the adviser and financial institution must make diligent and prudent efforts to obtain information on the existing plan. In general, such information should be readily available as a result of DOL regulations mandating plan disclosure of salient information to the plan’s participants (see 29 CFR 2550.404a-5). If, despite prudent efforts, the financial institution is unable to obtain the necessary information or if the investor is unwilling to provide the information, even after fair disclosure of its significance, the financial institution could rely on alternative data sources, such as the most recent Form 5500 or reliable benchmarks on typical fees and expenses for the type and size of plan at issue. If the financial institution relies on such alternative data, it should explain the data’s limitations and the written documentation should also include an explanation of how the financial institution determined that the benchmark or other data were reasonable. “
The DOL next clarifies that “hybrid” advisors can take advantage of the “Level Fee Exemption” even if they still offer separate commission-based brokerage accounts in other instances:
“An adviser, financial institution, and their affiliates may offer both “level fee” advisory services for which they can rely on the streamlined provisions, as well as commission-based brokerage accounts for which they have to rely on the full BIC Exemption.”
The DOL also confirms that a “Level Fee” advisor can exercise discretionary authority in an IRA account following a roll over:
“The BIC Exemption is available for investment advice to roll over a plan account to an IRA, even if the adviser will subsequently serve as a discretionary investment manager with respect to the IRA, as long as the adviser does not have or exercise any discretionary authority or discretionary control with respect to the decision to roll over assets of the plan to an IRA.”
The DOL next states that the “Level Fee Exemption” can be used when recommending that a client transition from a commission to fee-based account as long as the transition is in the client’s best interest:
“Under the Rule, fiduciary investment advice includes a recommendation regarding the selection of investment accounts (e.g., brokerage or advisory). The BIC Exemption’s relief for level fee fiduciaries includes relief for a recommendation to transfer from a commission-based account to a fee-based account.”
However, the DOL does attempt to limit a potential loophole in which some broker-dealers were hoping to take advantage of the “Level Fee Exemption” by “levelizing” commissions or revenue sharing payments. The DOL notes that in such scenarios the full BIC Exemption will be required:
“For purposes of the exemption, a “level fee” is a fee or compensation that is provided on the basis of a fixed percentage of the value of the assets or a set fee that does not vary with the particular investment recommended, rather than a commission or other transaction-based fee. Third party payments such as 12b-1 fees and revenue sharing payments, even if they provide the same amount or percentage for each investment offered, are transaction-based fees and vary on the basis of a particular investment because they are paid only for the particular investments that are included in the arrangement. If the adviser or financial institution is going to recommend products that generate third party payments, they need to comply with the more stringent provisions of the full BIC Exemption to safeguard the investor from biased advice. “
As RIA compliance consultants, we strongly recommend that all investment advisers make any necessary operational changes in order to qualify the firm to utilize “Level Fee Exemption” to avoid the more stringent “Best Interest Contract” requirement. We do anticipate that the DOL will continue to issue additional guidance in the coming months and encourage all investment advisory firm principals to continue to follow future developments by tracking “The Top 5 DOL Fiduciary Rule Experts Every RIA Firm Should Follow” and by reviewing “How an RIA Firm can Comply with the DOL Fiduciary Rule.”