The Department of Labor has expressed concerns about the escalating payout grids for dually registered advisors—especially the way the grids might encourage financial advisors to push one product over another.
The department is worried about the possible conflicts of interest that might result—conflicts that can harm investors if advisory firms are passing along compensation to their advisors for products that pay the firm the most.
The concerns were raised in new frequently asked questions the department added to its letter on fiduciary advice exemptions.
The department wants advisors to tamp down on such conflicts of interest, one of the goals of its prohibited transaction exemption (PTE 2020-20), which allows financial professionals to accept compensation such as commissions for recommending rollovers from qualified retirement plans and IRAs—as long as the recommendations are in the client’s best interest.
Firms should be “very careful about structures that disproportionately increase compensation at specified thresholds,” the DOL said. This type of compensation can undermine the best interest standard and create incentives for investment professionals to make recommendations based on their own financial interest, rather than on the retirement investor’s interest.
“Financial institutions should carefully review the amounts used as the basis for calculating investment professionals’ compensation to avoid simply passing along firm-level conflicts to their investment professionals,” the DOL said.
The problem with escalating pay grids is they “may transmit firm-level conflicts to the investment professional, who is effectively rewarded for preferentially recommending those investments that generate the greatest compensation for the firm,” the agency said.
According to Fred Reish, a partner with the law firm Faegre Drinker Biddle & Reath: “In effect, the DOL is saying that, if one investment pays more to the firm and another pays less and the firm passes through a set percent of the commission to the investment professional, say 80% of 8% for one product versus 80% of 4% of a different product, the firm has in fact created an arrangement that passes its conflict on to the financial professional.”
How can firms curb this kind of implicit conflict? “One obvious answer is to levelize the investment professional’s compensation regardless of which investment is recommended. While that should effectively mitigate the conflict, it may not be a practical ‘solution,’” Reish said.
Reish said firms could also use “neutral standards” for determining the compensation—for example, paying an advisor twice a commission when it took additional education and twice as long to explain a product to an investor.