As the U.S. Department of Labor moves to broaden the circle of advisors bound by ERISA fiduciary requirements, RIAs might be asking: How would this new rule affect us?
Since RIAs are already held to a fiduciary standard, many of them have assumed that the DOL’s final rule would have little or no effect on their business and clients. Well, this assumption could be proven wrong.
The DOLs Proposed Rule Would Complicate Rollovers and IRA Recommendations Made by RIAs
In its proposed form, the rule seeks to mitigate the risks to investors who receive advice from advisors whose compensation varies with the investments they recommend. A new Best Interest Contract Exemption (BICE) is proposed to provide prohibited transaction exemptive relief to advisors receiving variable compensation from their IRA and qualified plan investment recommendations. The provisions of the BICE, including a host of contracts, disclosures, warranties and processes, are quite onerous or—as expressed by most of us who are concerned about the implementation of the rule—“unworkable.”
RIAs who acknowledge their fiduciary status, charge level fees for their advice, and who do not receive payments from third parties or recommend proprietary investments are fully aligned with the best interests of their clients. So where’s the rub?
Under the rule, ERISA fiduciary status is extended to advisors recommending plan rollovers, or recommending themselves as rollover investment advice providers.
So when an RIA’s compensation increases in conjunction with providing rollover-related advice, an exemption under the ERISA prohibited transaction rules will be required, and it is not yet clear whether the BICE will be the only exemption available to the RIA in these situations. Fingers-crossed that the DOL recognizes level-fee advisors are not conflicted in their investment recommendations, and that the final rule offers a less complex and costly alternative for compliance.
Advising clients or prospects on a distribution from a 401(k) plan to an IRA rollover—a mainstay of many a wealth advisor’s business—would appear to cause a prohibited transaction under the proposed rule, because the compensation associated with the advice increases from zero—no previous rollover relationship, no fees received. This would require an exemption strategy.
In addition, absent a “workable” exemption strategy, RIAs who serve as fiduciary advisors to 401(k) plans would be required to charge the same fees when advising participants in these plans on distributions and rollovers. Providing personalized advisory services to an IRA client is clearly a very different service undertaking than advising plan fiduciaries, yet fees between the plan and the IRA would need to be level. RIAs serving 401(k) plans will be hard pressed to continue advising plan participants given these fee constraints. Limiting the ability of these trusted plan advisors to provide professional investment advice to participants with critical decisions to make about what is probably their largest pool of savings is a curious outcome of a rule designed to protect retirement savers.
A special shout out to the American Retirement Association for their much-needed and practical proposal to the DOL of the “Level-to-Level Compensation Exemption,” described in their comment letter, found here.
How Should RIAs Prepare for the New Fiduciary Rule?
RIAs can take a number of steps in preparation for the new rule and evaluate alternative courses of action for when the rule takes effect.
Reassessing retirement relationships and smaller accounts: RIAs should understand how much of their practice is comprised of IRAs and how much revenue is associated with their retirement-related activities. Complying with the new rule will be challenging and it may not be worthwhile to continue focusing on a relatively small retirement business.
RIAs should also take a hard look at their client base and decide whether they can maintain fiduciary relationships with smaller accounts. In some cases, the added liability and compliance requirements of the BICE would be too heavy a price to bear to maintain small accounts. Similarly, fiduciary advisors to 401(k) plans may want to reconsider their participant rollover activities, as they may no longer be adequately compensated given the level compensation requirements.
Developing a compliance infrastructure: If RIAs continue to service IRAs, they must build out a compliance infrastructure to support the BICE requirements. RIAs with limited resources may need to partner with outside entities in this effort—and manufacturing “BICE-in-a-box” solutions may emerge as a cottage industry.
Considering SunAmerica/PPA advice exemption: In general, nothing in the proposed rule affects the viability of other established investment advice program structures for ERISA plan participants and/or IRAs that satisfy applicable law. In its SunAmerica advisory opinion, DOL approved the use of a computer model developed by an independent third-party to provide asset allocation investment advice to 401(k) participants. In addition, under a prohibited transaction exemption in the Pension Protection Act , a fiduciary advisor can offer an “eligible investment advice arrangement” that provides for either levelized compensation or a special computer-based advice model. Compared to the proposed rule and the BICE, the SunAmerica and PPA advice structures could be attractive alternatives for certain advisors and retirement product vehicles.
These are some of our speculations about the effect that the forthcoming fiduciary rule may have on RIAs and how they may consider preparing for this rule.
Kathleen Beichert is head of retirement and third-party distribution at OppenheimerFunds.