The Department of Labor has released its first series of Frequently Asked Questions, or FAQ guidance, in support of the fiduciary rule.
“Smart regulation is only as effective as its implementation,” wrote Phyllis Borzi, Assistant Secretary of Labor and head of the Employee Benefits Security Administration, in a blog post.
“Our initial focus has been, and remains, broad compliance with the rule,” she said. “These questions are an important part of the regulatory process as they allow the department to clarify important parts of the rule, and head off misunderstandings that could lead to bad results for retirement savers, or financial services professionals.”
The first of a two-date phased implementation of the rule will be April 10, 2017, when all advisors to IRAs and 401(k) plans with less than $50 million in assets will be required to comply with the amended definition of fiduciary under the rule.
On that date, advisors and service providers will have to comply with the rule’s “impartial conduct standards” by providing advice that is exclusively in the best interest of the investor or plan.
In the first phase of the rule’s implementation, advisors will be required to adhere to the standards of prudence and loyalty under the existing definition of fiduciary, charge no more than reasonable compensation, and make no misleading statements on compensation, investment transactions, or conflicts of interests the provider may have.
Advisors and providers will also have to give written notice to investors acknowledging their fiduciary status by April 10, 2017, and have a designated person assigned to monitoring conflicts of interest and the impartial conduct standard, according to the FAQ.
On January 1, 2018, the rule will be fully implemented, and advisors will be required to issue contracts to IRA investors fully detailing conflicts of interest, and the policies and procedure set in place to protect investors from receiving conflicted advice.
Advisors will not have to comply with the BIC Exemption on rollovers of plan assets to an IRA if they do not recommend the rollover.
In other words, advisors can execute a rollover outside of the BIC Exemption if the investor makes the decision on their own. Advisors who do recommend a rollover, and receive any form of compensation for doing so, will have to operate under the BIC Exemption.
Level fee advisors
Advisors that charge a level fee, or compensation based on a fixed percentage of an account’s assets, as opposed to commission-based compensation that varies by investment product, will have to comply with a streamlined version of the BIC Exemption, according to the FAQ.
While receiving ongoing fee compensation after a recommendation to roll assets into an IRA does not, “in and of itself, violate prohibited transaction rules or require compliance with an exemption,” certain “abusive” practices with fee-based accounts can violate the new fiduciary standard, according to the FAQ.
The DOL cites recommending a fee-based account to an investor with low trading activity or no need for ongoing monitoring and advice as an example of abusive conduct. Also, advisors will be in breach of their fiduciary obligations if they take commissions on an asset and shortly after recommend the investor move to a fee-based account.
“Such abusive conduct, which is designed to enhance the adviser’s compensation at the retirement investor’s expense, would violate the prohibition on self-dealing and would not be covered by an exemption,” the FAQ says.
The streamlined level fee provisions of the BIC Exemption require financial institutions to provide written acknowledgment of their fiduciary status to retirement investors.
When level fee advisors recommend a rollover to an IRA, they must document why the recommendation is in the best interest of the client, and include documentation that all of the alternatives to the rollover were considered, including leaving the assets in an employers plan.
Documentation must show that the cost of all options was disclosed to investors, as well as a description of the different levels of service under each option.
Level fee advisors will be required to make “diligent and prudent efforts” to obtain all the information about a 401(k)’s plan services and costs before advising a client to roll over assets.
In the event that information is not accessible to an advisory firm, the DOL says Form 5500 or data from “reliable” benchmarks relative to plans of equal size should be used to determine whether the rollover is in a participant’s best interest.
Pure Robo-advisors can operate without the BIC exemption
The BIC Exemption will not apply to advice generated solely through software models, the FAQ says.
“The Department did not make the full BIC Exemption generally available for such robo-advice based on its view that the marketplace for robo-advice is still evolving in ways that appear to avoid conflicts of interest that would violate the prohibited transactions provisions and that minimize cost,” according the FAQ.
DOL promises to play nice
The first FAQ addresses other aspects of the BIC Exemption in depth, its relevance to the sale of annuities, the role of independent marketing organizations in their distribution, and which advice will and will not be grandfathered under the rule.
The DOL says compliance with the rule will be its first priority, and not enforcement.
“The Department’s general approach to implementation will be marked by an emphasis on assisting (rather than citing violations and imposing penalties on) plans, plan fiduciaries, financial institutions and others who are working diligently and in good faith to understand and come into compliance with the new rule and exemptions,” according to the FAQ. To read the PDF of the FAQ, go to the DOL site.