Broker-dealers should consider excluding retirement plan and IRA rollovers from their sales contests and any soft dollars or 12b-1 payments they receive if they want to stay on the right side of the U.S. Department of Labor’s fiduciary rule and prohibited transaction exemption (PTE 2020-02), Faegre Drinker attorneys said during a panel discussion.
To comply with the rule, which is designed to promote investment advice in the best interests of retirement investors, firms and their reps will need to show they have mitigated and disclosed all conflicts of interest especially compensation conflicts by February 1, according to the firm’s panel presentation, “DOL PTE 2020-02: Disclosures and Policies—Common Mistakes.”
While there is no way for a firm to mitigate the fact that it earns money from rollover recommendations, they can mitigate conflicts of interest at the rep level, Faegre Drinker Partner Jeffrey Blumberg said. The change could impact the way broker dealers incent hundreds of thousands of dually-registered representatives.
“A lot of advisory shops like to have sales contests, such as ‘whoever brings in at least a $ 1 million in sales gets to go to this boondoggle.’ Or, ‘whoever brings in at least $5 million gets a bonus,’ whatever that may be. So, if you include rollover assets in that contest or in that assessment, that creates an even stronger incentive for that rep to make sure the money comes over,” Blumberg said.
“A very simple mitigation technique would be to carve those assets out of that type of reward program, whether it’s a bonus or a boondoggle trip or whatever it happens to be,” he added.
Firms should also be careful about any revenue sharing programs when it comes to rollovers. “A lot of bigger RIAs get additional compensation, beyond just the fees they receive from their clients, from some of the products they put clients in, like money market funds, and if they’re also a broker-dealer, 12b-1 fees. Receiving that money in connection with a rollover is a conflict of interest that can be mitigated very simply by excluding those assets or rebating a portion of the advisory fees so the [compensation] you receive is conflict free,” Blumberg said.
If you’re doing rollover recommendations, you should “absolutely” be mitigating this type of compensation, the attorney added.
“In some recent calls with some RIAs, they didn’t realize that if they get payments from custodians, noncash payments, that that could be a conflict of interest ... in terms of what the DOL is looking at,” Faegre Drinker Partner Fred Reish said.
“The DOL rule considers conflicts to be money or anything of monetary value. So if you get a trip, if you get a computer or anything out of the SEC soft dollar definition, that’s a conflict. So there has to be mitigation and disclosure and on and on. So be careful,” he added.
Compliance is crucial since DOL enforcement of rollover violations can carry expensive settlements or litigation that can cost a firm all compensation they’ve earned in addition to damages and even a ban on doing rollover recommendations for up to 10 years if a firm is found to have systemic rollovers violations, the Faegre Drinker attorneys said.