DOL Issues FAQs on the Fiduciary Investment Advice Rule Focused on BICE Compliance | Practical Law

DOL Issues FAQs on the Fiduciary Investment Advice Rule Focused on BICE Compliance | Practical Law

On October 27, 2016, the Department of Labor (DOL) issued FAQs in connection with the DOL's April, 2016 final fiduciary investment advice rule and the related new and amended prohibited transaction exemptions issued in connection with the final rule (PTEs). The FAQs provide guidance on the application of the terms of the PTEs, particularly on the application of the best interest contract exemption (BICE) to advisers and financial institutions.

DOL Issues FAQs on the Fiduciary Investment Advice Rule Focused on BICE Compliance

Practical Law Legal Update w-004-2000 (Approx. 11 pages)

DOL Issues FAQs on the Fiduciary Investment Advice Rule Focused on BICE Compliance

by Practical Law Employee Benefits & Executive Compensation
Published on 29 Oct 2016 • USA (National/Federal)
On October 27, 2016, the Department of Labor (DOL) issued FAQs in connection with the DOL's April, 2016 final fiduciary investment advice rule and the related new and amended prohibited transaction exemptions issued in connection with the final rule (PTEs). The FAQs provide guidance on the application of the terms of the PTEs, particularly on the application of the best interest contract exemption (BICE) to advisers and financial institutions.
On October 27, 2016, the Department of Labor (DOL) issued FAQs in connection with the DOL's April, 2016 final fiduciary investment advice rule and the related new and amended prohibited transaction exemptions issued with the final rule (PTEs). The FAQs provide guidance on the application of the terms of the PTEs, particularly on the application of the best interest contract exemption (BICE) to advisers and financial institutions.

Background

On April 6, 2016, the DOL issued a final rule that replaces the existing regulatory interpretation of fiduciary investment advice under Section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974 (ERISA) (81 Fed. Reg. 20945 (Apr. 8, 2016)) (final rule). In connection with this final rule, the DOL also issued new prohibited transaction exemptions (PTEs) and several amendments to existing PTEs currently used throughout the financial industry for certain investments made by ERISA plans. For more information on the final rule, see Practice Note, Definition of Fiduciary Investment Advice.
Most significantly, the DOL issued BICE, which provides a new PTE that permits investment advice fiduciaries covered under the final rule to receive what would otherwise constitute prohibited compensation for providing investment advice to retirement plan participants and beneficiaries, IRA owners and plan sponsors of small non-participant-directed plans with regard to their purchase of certain investment products, if certain stringent conditions are met.
BICE:
  • Permits investment advisers, financial institutions and their affiliates and related entities to receive compensation for providing investment advice to retirement investors (including IRA owners) regarding certain transactions entered into by the investor to purchase certain investment products without violating ERISA's prohibited transaction rules (see Practice Note, Prohibited Transactions and Exemptions Under ERISA and the Code).
  • Requires covered advisers and financial institutions to comply with the conditions set out in BICE, which differ depending on whether the retirement plan investor is a plan covered by Title I of ERISA, an IRA or plan not covered by Title I of ERISA. These conditions include:
    • Acknowledging the fiduciary status of the financial institution and advisor.
    • Complying with impartial conduct standards, including a best interest standard.
    • Establishing and complying with anti-conflict policies and procedures.
    • Disclosing information about services, applicable fees and compensation.
    • For IRAs and plans not covered by Title I of ERISA, entering into a written contract with the retirement investor stating that the financial institution and its advisers must comply with the above conditions. The written contract must include specific provisions described in BICE and be accessible on the financial institution's website.
For more information on BICE, see Practice Note, Best Interest Contract Exemption.
The DOL also issued one additional new PTE in connection with the final rule for advisers and financial institutions advising retirement plan investors that enter into principal transactions (see Practice Note, Principal Transactions Exemption Under ERISA), along with several amendments to existing PTES (see Practice Note, Definition of Fiduciary Investment Advice: Prohibited Transaction Exemptions and the "Best Interest" Standard).

FAQs on Final Rule and BICE

Following the issuance of the final rule, many practitioners, financial institutions and advisers requested additional guidance from the DOL on the application of the final rule, BICE and related PTEs. The new FAQs provide additional guidance on the application of the terms of and the final rule and new exemptions, including on:

Compliance Dates and Transition Periods

The final rule applies to investment recommendations made on or after April 10, 2017. The FAQs mainly reiterate and expand on the phased implementation approach the DOL adopted for BICE and the principal transactions PTE. On April 10, 2017:
  • The final rule's definition of fiduciary investment advice will apply.
  • BICE and the principal transactions PTE will become available to advisers.
However, there is a transition period extending until January 1, 2018 during which fewer conditions will apply to financial institutions and advisers in order to provide them with additional time to prepare for full compliance (for more information on the requirements during the transition period, see Practice Note, Best Interest Contract Exemption: Applicability Dates and Transition Rules). The FAQs expand on the requirement for the financial institution and adviser to comply with the impartial conduct standards of BICE during the transition period and provide advice during this period that:
  • Meets a professional standard of care as specified in BICE.
  • Is based on the interests to the customer, rather than the competing financial interest of the adviser and firm.
During this period, financial institutions and advisers must also:
  • Charge no more than reasonable compensation.
  • Make no misleading statements about investment transactions, compensations and conflicts of interest.
  • Provide a notice to retirement investors that acknowledge their fiduciary status and describes material conflicts of interest.
  • Designate a person responsible for addressing material conflicts of interest.
On January 1, 2018, the transition period ends and full compliance with BICE and the other PTEs is required for firms and advisers to engage in transactions with retirement investors that would otherwise be prohibited under the final rule. "Full compliance" includes enhanced disclosures, including the execution of a BICE contract for IRA owners and non-Title I plan investors, and the implementation of policies and procedures related to the final rule.

Compliance Date for Pre-existing PTEs

In the final rule, the DOL amended several pre-existing PTEs to require compliance with the impartial conduct standards and, in some cases, to more tightly restrict their availability for certain transactions. The FAQs clarify that financial institutions and advisers must comply with these requirements and standards on April 1, 2017.
There is an additional transition period for certain transactions under PTE 86-128, which generally require a written authorization executed in advance by an independent fiduciary or IRA owner. For IRAs and non-ERISA plans that are existing customers of the financial institution as of April 1, 2017, the fiduciary engaging in the transaction does not need to obtain written consent for those transactions but instead may rely on negative consent, so long as the fiduciary gave the required disclosures and consent termination form to the customer by that date (see Negative Consent for Amending Existing Contracts).

BICE Guidance

The FAQs clarify that BICE is broadly available for a variety of transactions relating to the provision of fiduciary advice in the retail investment market (including advice to retirement plan participants, beneficiaries and IRA owners) and is intended by the DOL to serve as the primary exemption for investment advice transactions involving these retail investors, including:
  • Recommendations regarding all categories of assets.
  • Advice to roll over plan assets.
  • Recommendations on persons the customer should hire to serve as investment advisers or managers.
The FAQs also clarify that the final rule does not automatically treat advisers or firms as investment advice fiduciaries because they:
  • Execute transactions at a client's direction, unless they provide an investment recommendation relating to that transaction.
  • Recommend a particular investment, unless they receive direct or indirect compensation as a result of that advice.
The FAQs provide significant guidance on the application of BICE's more streamlined conditions to level-fee fiduciaries (typically referred to as "BICE-lite") (see Level-fee Fiduciaries). Under BICE-lite, level fee fiduciaries do not have to provide a contract (or put in place new policies and procedures) but must:
  • Provide the written fiduciary acknowledgement.
  • Satisfy the impartial conduct standards.
  • Document the specific reasons for a recommendation of the level fee arrangement.
It explains the scenarios in which level-fee fiduciaries may encounter conflicts of interest requiring reliance on BICE-lite and scenarios in which no relief is available.

Discretionary Investment Advisers and Managers

Although BICE does not provide relief for a transaction to discretionary investment fiduciaries, the DOL clarifies that BICE does provide relief for investment advice to roll over a participant's account by an adviser who serves as a discretionary fiduciary with regard to the plan or the participant's account, even if the adviser will provide fiduciary investment advice following the rollover, so long as the adviser does not exercise any discretionary authority or control regarding the decision to roll over and satisfies the conditions of BICE.
The DOL notes in the FAQs that some of the DOL's existing exemptions would provide relief for otherwise conflicted compensation arrangements entered into by discretionary fiduciaries, including PTE 77-4 and PTE 86-128. The DOL amended these PTEs in connection with the final rule primarily to incorporate the impartial conduct standards as conditions, and, therefore, these PTES now require discretionary fiduciaries to act in the best interest of retirement investors, charge no more than reasonable compensation and avoid misleading statements.

Adviser Compensation Arrangements and Escalating Grids

The FAQs provide financial institutions may use escalating grids or higher commission rates to advisers based on volume if these payment structures:
  • Are not reasonably intended or expected to cause advisers to make recommendations that are not in the best interest of retirement investors.
  • Do not cause advisers to violate the reasonable compensation standard.
The DOL provides factors in the FAQs that financial institutions may use in developing their compensation approach. Regarding "the grid," that is, an escalating grid under which the percentage commission paid to the adviser increases at certain thresholds:
  • Financial institutions should carefully consider the amounts used as the basis for calculating adviser compensation to avoid transferring firm-level conflicts to the adviser (such as by giving the adviser a set percentage of the commission generated for the firm if, for example, different mutual fund complexes pay different commission rates to the firm).
  • Institutions can define compensable revenue that goes into the grid in such a way that it is level within different broad categories of investments based on neutral factors that are not tied to how lucrative the investments are for the firm, assuming appropriate oversight is provided by the institution to ensure that recommendations are based on the customer's interest rather than the adviser's compensation. Neutral factors include:
    • The time and complexity associated with recommending investments within different product categories.
    • Factors that are not based on the financial interests of the firm (that is, the profitability of the investment), but rather on significant differences in the work that justify drawing distinctions between categories of investments (such as annuities as compared to mutual funds). The DOL warns that financial institutions must exercise care to ensure that the different commission structures based on the greater time and complexity associated with a particular product category are justified in practice such that advisers are actually performing additional work and not just receiving additional compensation.
  • Grids with one or several modest or gradual increases are less likely to be problematic than grids characterized by large increases in compensation that may create misaligned incentives for advisers to make recommendations based on their own financial interest.
  • Increases in an adviser's compensation according to the grid steps should generally be prospective and only apply to new investments made once the adviser reaches that threshold. There should not be a retroactive application of an increased compensation rate for past investments.
  • Financial institutions using escalating grids should increase monitoring of adviser recommendations at or near compensation thresholds to ensure that adviser recommendations are driven by the customer's best interest, rather than the adviser's desire for increased compensation.
The DOL also points to Example 4 in the preamble of the BIC exemption for more information on this approach (81 FR 21038).

Discounting Customers and Providing Bonuses to Advisers

The DOL clarifies in the FAQs that BICE does not prohibit financial institutions and advisers from providing discounted prices to customers in certain circumstances assuming the financial institution has established a price or pricing schedule for services that satisfied the reasonable compensation standard, provided that the discounts are not used in a manner that re-introduces conflicts of interest.
The FAQs also provide guidance on the provision of both front-end, signing bonuses and back-end, performance-based bonuses to advisers by financial institutions.

Front-end Signing Bonuses OK

The FAQs provide that financial institutions may provide advisers with signing bonuses that are paid in a fixed sum contingent on the adviser's continued service in good standing, including recruitment incentives like forgivable loans, that are not tied to:
  • The movement of accounts or assets to the firm.
  • The achievement of a particular asset or sales target.

Back-end Performance Bonuses Prohibited

The FAQs provide that back-end, performance-based bonuses, special awards, differential compensation or other actions or incentives that are expressly contingent on the adviser's achievement of sale or asset targets are prohibited. The DOL views these back-end awards as creating acute conflicts of interest that are inconsistent with the BICE requirement that financial institutions adopt procedures reasonably and prudently designed to ensure that individual advisers adhere to the impartial conduct standards.

Grandfathered Back-end Performance Bonus Arrangements

The FAQs essentially grandfather back-end bonus arrangements that were entered into before the date of the FAQs (October 27, 2016) if:
  • The arrangements were entered into as part of a written and binding contract.
  • The financial institution:
    • determines in good faith that it is contractually bound to continue the arrangements after April 1, 2017;
    • engages in stringent oversight of the advisers during the period of the arrangements; and
    • develops special policies and procedures specifically aimed at conflicts of interest introduced by the arrangements and designed to protect investors from harm.
  • The period of time remaining under each arrangement is reasonable and consistent with general industry practices.
  • The arrangements do not otherwise violate the conditions of BICE, ERISA or the Code.
More generally with regard to the recruitment of advisers, the DOL provides that prudent financial institutions will adopt measures to protect retirement investors, including such practices as:
  • Careful screening of potential hires for past misconduct and disciplinary history.
  • Reliance on prudent supervisory policies.
  • Surveillance and technology to identify, review and remediate improper sales practices or account transfers.
  • Training and education on the policies and procedures required to meet the impartial conduct standards.
  • Alerting investors to the potential conflicts and issues associated with recruitment practices and account transfers. In this regard, the DOL points to FINRA Rule 2273 as an example.
  • Discipline and nullification of awards where there is a conclusion of adviser wrongdoing.

Level-fee Fiduciaries

BICE provides streamlined relief for "level-fee fiduciaries" to receive compensation for providing investment advice to retirement plan investors (referred to as BICE-lite). Level-fee advisers are defined as advisers that receive:
  • A fee or compensation that is provided on the basis of a fixed percentage of the value of the assets.
  • A set fee that does not vary with the particular investment. The FAQs clarify that level fees do not include commissions or other transaction-based fees, including third party payments such as 12b-1 fees and revenue sharing payments (even if they provide the same amount or percentage for each investment offered).
The FAQs acknowledge that level-fee fiduciaries do not have the sorts of conflicts that give rise to prohibited transactions or require reliance on a PTE. However, it explains that compliance with BICE-lite would be required in certain situations that create conflicts of interest for level-fee fiduciaries, including:
  • A recommendation that a participant roll retirement savings out of a plan into a fee-based account that will generate ongoing fees for the adviser that he would not otherwise receive. BICE-lite is available for the recommendation to roll over the assets, including if the fees going-forward are "level" and do not vary with the assets recommended.
  • Advice to switch from a commission-based account to an account that charges a level, fixed percentage of assets under management, in certain circumstances. In making these recommendations, financial advisers and advisers must consider:
    • whether the type of account is appropriate in light of the services provided;
    • the projected cost to the customer;
    • alternative fee structures that are available; and
    • the customer's fee structure preferences, in addition to non-price factors.
For more information on level-fee fiduciaries, see Practice Note, Best Interest Contract Exemption: Level-fee Fiduciaries: BICE-Lite.

Level-fee Fiduciaries Recommending Rollovers

One of the conditions required for level-fee fiduciaries is that they document the reasons why the advice was considered to be in the best interest of the investor. The FAQs clarify that in the case of advice to roll over an ERISA plan account to an IRA, this documentation must include consideration of:
  • The retirement investor's alternatives to rollover, including leaving the money in the employer's plan, if permitted.
  • The fees and expenses associated with both the plan and the IRA.
  • Whether the employer pays for some or all of the plan's administrative expenses.
  • The different levels of services and investments available under each option.
The DOL provides that, if the adviser and financial institution make diligent and prudent efforts to obtain the above information on the existing plan but are unable to obtain it or the investor is unwilling to provide it, the financial institution and adviser can rely on alternative data sources, such as the most recent Form 5500 or reliable benchmarks on typical fees and expenses for the type and size of plan at issue. If they rely on alternative data, they must explain the data's limitations and how they determined that the data is reasonable.
The DOL also notes that any investment advice fiduciary advising on the rollover of assets from an ERISA plan to an IRA under BICE must engage in a prudent analysis of the above factors (that is, these conditions are not just limited to level-fee fiduciaries that make rollover recommendations).

Financial Institutions and Level-fee Fiduciaries

The FAQs clarify that an adviser, financial institution and their affiliates may offer both level-fee advisory services for which they can rely on BICE-lite along with commission-based brokerage accounts for which they have to rely on the full BICE.
However, the DOL warns in the FAQs that while the ongoing receipt of compensation by a level-fee adviser does not typically violate the prohibited transaction rules or require compliance with a PTE, certain abusive practices can violate ERISA Section 406(b)(1)'s prohibition on self-dealing and do not satisfy any PTE. The FAQs point to the following examples as practices that are considered abusive in this regard:
  • Recommending fee-based accounts to an investor with low trading activity and little or no need for ongoing monitoring or advice.
  • First recommending a mutual fund with a front-end sales load, and shortly after, recommending the customer move the shares into an advisory account subject to asset-based fees.
The FAQs also state that BICE-lite is not available for financial institutions and advisers that sell only proprietary investments, even if the financial institution pays the same commission to its advisers regardless of the recommended investments.

Bank Networking Arrangements

BICE provides relief for recommendations of other persons to provide investment advice, including "bank networking arrangements," assuming they meet certain conditions. Bank networking arrangements involve the referral by banks and their employees to non-affiliates who are providers of retail non-deposit investment products.
The FAQs provide that referrals to affiliates who are providers of retail non-deposit investment products are not fiduciary investment advice because affiliates are considered the same "person." Because they are not a recommendation of a different person to provide fiduciary investment advice, referrals to affiliates do not typically give rise to a prohibited transaction.

BICE Disclosures

As of January 1, 2018, BICE requires financial institutions to maintain an electronic copy of the required best interest contract with its clients on its website, which must be accessible to the retirement investor. The FAQs provide that the best practice is for the financial institution to maintain an executed copy of the retirement investor's individual contract on its website. However, the DOL acknowledges that a financial institution could use a model contract that does not vary for a class of customers along with an acknowledgement that it is bound by the terms of the model contract in its dealings with specified customers. The DOL warns that if the model contract does not include all mandatory terms with regard to a particular customer or does not express the terms accurately, BICE would not be satisfied.

Negative Consent for Amending Existing Contracts

BICE permits financial institutions to amend existing contracts with customers by negative consent, assuming the amendment is sent to the investor prior to January 1, 2018 and the investor fails to terminate the amended contract within 30 days of the date it is provided. The FAQs clarify that if this negative consent procedure is used, the financial institution may not impose any new contractual obligations, restrictions or liabilities on the investor. They also provide that the contract amendment should be posted electronically in each investor's account with information on the date and means of delivery, though, again, permit model contracts subject to the same rules discussed above.

Disclosure Not Typically Required for Hold and Sell Transactions

The FAQs clarify that the disclosures required under Section III(a) of BICE, which are required to be made before or at the same time as the execution of the recommended investment, are not required to be provided for recommendations to hold or sell any investment products, but only for purchase recommendations.

Disclosures on Request: As of the Date of the Recommendation

The FAQs clarify that if the retirement investor requests a specific disclosure of costs, fees, third party payments or other compensation related to recommended transactions, the information should typically be provided as of the date of the recommendation (rather than the date of the request).

BICE Grandfathering Rules

BICE provides an exemption for specified compensation received in connection with:
  • Investments made before April 10, 2017.
  • Recommendations to continue to adhere to a systematic purchase program established before April 10, 2017.
However, any new advice regarding the grandfathered investments must meet the best interest standard.
The FAQs clarify that dividend reinvestment programs, in which dividends paid with regard to specific shares of stock are solely used to purchase additional shares of stock, would constitute a "systematic purchase program" under BICE.
BICE also provides that grandfathering relief is not available for compensation received in connection with the investment of additional amounts in previously acquired investment vehicles. The FAQs clarify that if an advisor recommends an investment of new monies into such a vehicle, the new deposit does not cause the "old money" in the annuity contract to cease to be eligible for grandfathering relief.

PTE 84-24, BICE & Annuities

Both PTE 84-24 and BICE permit insurance agents and other advisers to receive compensation when they provide investment advice relating to the sale of annuities. PTE 84-24 is available for fixed rate annuity contracts and BICE is available for fixed rate, fixed index and variable annuity contracts.
The FAQs clarify the relationship between the two exemptions and that, after BICE, PTE 84-24 requires insurance agents to comply with the impartial conduct standards. It states that the chief difference is that BICE provides broader relief for compensation received on annuity sales (not just insurance commissions) but requires the execution of the best interest contract in transactions with IRA owners. BICE also requires additional disclosure obligations beyond those required by PTE 84-24.
The FAQs also provide guidance on the use of independent insurance agents by insurance companies and the role of insurance intermediaries, such as independent marketing organizations (IMOs), under BICE. When an insurance company uses independent agents who recommend an annuity under BICE, the FAQs provide that the insurance company effectively stands behind the agent's recommendation to purchase the product and commits to the investor that it has policies and procedures in place that have been designed to ensure that the agent's recommendation will be prudent. However, given that independent agents may recommend products issued by a variety of insurers, the insurance company's responsibility is to oversee the recommendation and sale of its products, not recommendations and transactions involving other insurers.

The Principal Transactions Exemption

The FAQs clarify that parties may request an individual PTE to expand the scope of assets covered by the principal transactions exemption. If granted, that product will be added to the definition of principal traded asset in the class exemption. For more information on this exemption, see Practice Note, Principal Transactions Exemption.

Practical Implications

The FAQs are chock-full of guidance for financial institutions, investment advisers and retirement investors that will need to comply with BICE, among other exemptions. They provide especially useful information for financial institutions that will need to shape new compensation structures and adjust existing compensation structures for their advisors in light of the April 10, 2017 compliance date. The FAQs also provide essential practical details on various technical aspects of BICE, such as the disclosure requirements when advising an investor to roll assets from an ERISA plan to an IRA.
At the end of the FAQs, the DOL emphasizes that its enforcement approach will be marked by an emphasis on assisting (rather than citing violations and imposing penalties) on plans, plan fiduciaries, financial institutions and others who work diligently and in good faith to understand and come into compliance with the new rule and exemptions.
Practitioners, financial institutions and advisers should read the FAQs closely to understand their obligations under the final rule and BICE.