“That could probably justify a commission of twice as much as the other alternatives that could have been recommended, but that were not in the best interest of the retirement investor,” Reish said.
Another approach to reducing the conflict of interest is for firms to develop a well-defined, demonstrably reasonable best interest process for recommending one of the alternatives over the others. For instance, if guaranteed retirement income is an investor’s goal—and the product and allocation of the investor’s financial resources to the particular product were in the best interest of the investor—“a higher compensating recommendation could be justified,” Reish said.
“Both the [Securities and Exchange Commission] and the DOL are allowing flexibility for financial institutions to design their mitigation practices, but that doesn’t mean that a practice that is on paper, but that isn’t effective, will satisfy the requirement,” he added.
The DOL also warned financial services firms about using pay grids that give reps and advisors the opportunity to get higher pay retroactively if they hit a certain sales threshold on the firm’s payout grid.
“If the consequence of reaching a threshold is not only a higher compensation rate for new transactions, but also retroactive application of an increased rate of pay for past investments, the grid is likely to create acute conflicts of interest,” the department said.
Retroactivity “magnifies” investment professionals’ conflicts by increasing the incentive to make the sales necessary to cross the threshold, regardless of the investor’s interest, the department warned.
The danger is particularly great when the sales necessary to cross the threshold would generate compensation for the investment professional that is disproportionate to the compensation professionals would normally receive for recommendations that aren’t at the threshold.
“Grids with one or several modest or gradual increases are less likely to create impermissible incentives than grids characterized by large increases,” the DOL said. “Firms should be very careful about structures that disproportionately increase compensation at specified sales thresholds.”
The new regulations may create “a real change of perspective on mitigation—as opposed to just an enhancement. If so, it will be more demanding than financial institutions have been used to, and that possibility should be considered in developing mitigation ‘solutions,’” Reish said.
“Otherwise, when the DOL investigates compliance with PTE 2020-02, some financial institutions may feel that they are the victims of ‘regulation by enforcement,’” he added.