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Implications of the DOL’s Fiduciary Rule Proposal

2016 marks one of the biggest shifts in how investors receive retirement advice in more than 40 years.

The Department of Labor (DOL) finalized a rule on April 6 that changes the definition of fiduciary when it comes to retirement advice. This ruling marks the most extensive revision to the Employee Retirement Income Securities Act (ERISA) since it was enacted in 1974 and directly impacts how advisors manage their clients’ retirement accounts.

The broader definition of fiduciary will take effect on April 10, 2017, one year after the rule’s publication. At that time, firms will be required to comply with limited conditions of the rule, including acknowledging their fiduciary status, adhering to the best interest standard, and making basic disclosures of conflicts of interest. The full requirements of the ruling are slated to go into effect on Jan. 1, 2018.[1]

At PENSCO, where we custody alternative assets for our clients' IRAs, the DOL fiduciary rule comes up quite often in conversations with clients and financial professionals. To answer some of the questions we received, we've put together information about the rule and its potential implications:

Highlights of the DOL fiduciary rule?

The rule has two main goals:

  1. To ensure financial professionals put clients first when advising on retirement accounts.
  2. To provide transparency around the cost of investment advice and the costs of products that a financial professional recommends.

The rule requires financial professionals who provide advice and receive compensation to act in the “best interest” of their clients when investing their IRAs funds and 401(k)s. This best interest standard is referred to as a fiduciary duty.

Currently, investment advisors, such as Registered Investment Advisers (RIAs) who are registered with the SEC or their state, are held to this fiduciary standard, but individuals such as brokers and insurance agents are held to a “suitability” standard. The suitability standard is considered to be less rigid than a fiduciary standard, but the DOL ruling requires that all financial professionals who provide advice to IRA owners be subject to the same fiduciary responsibility.

As stated in the article “Game Changer, Revisited: The Final Conflict of Interest Rules” by Pete Swisher, CFP, CPC:

Many advisors are fiduciaries, but many are not. Also, many advisors act as fiduciaries some of the time, but not all of the time. The reality is that, for decades, the paradigm of the investment industry has been a powerful aversion to fiduciary status. This has been changing, gradually, for over a decade, but the new 3-21 regulation (DOL Regulation Section 2510.3-21) forces the great mass of putatively non-fiduciary advisors into fiduciary status in both retirement plans and IRAs. 

What are potential impacts of the proposed fiduciary rule?

By expanding what constitutes retirement advice and who would be considered a fiduciary, the rule could have significant impact on brokers and financial professionals who sell to clients using retirement accounts, such as IRAs, as well as retirement plans.

For instance, a broker who recommends a client roll a 401(k) into an IRA would be considered to have given investment advice under the Department of Labor rule change and would be held to a fiduciary standard. These changes could expose financial professionals to expanded legal liability, which has prompted worries that fewer professionals will help clients roll 401(k)s into IRAs in order to avoid any potential liability. There is also concern over the regulatory costs that investment professionals will need to absorb to adhere to the new rule. 

What is the Best Interest Contract Exception (BICE) and how does it relate to alternative assets?

Under the new Department of Labor fiduciary rule[2], certain scenarios now represent prohibited transactions for financial advisors. For instance, the rules bar financial advisors from making the following recommendations:

  • Recommending a client rollover to an IRA that allows the advisor to earn a fee they were not previously earning.
  • Recommending that a client move from a 401(k) or IRA into a higher-fee IRA. In this case, the advisor is recommending the client switch to an IRA with higher costs than the plan that is currently being managed.
  • Recommending a client move from a commission-based account to a fee-based wrap account. This would allow the advisor to collect fees that were not being earned under the previous arrangement.

According to the new DOL fiduciary rule, advisors would not be allowed to accept compensation or payment for a retirement transaction that involves advice, such as the ones listed above, unless the advisor and client sign a  “Best Interest Contract Exemption”—  or BICE.

Using BICE, an advisor commits to providing advice that is in the “Best Interest” of the client, and the advisor is then allowed to engage and receive compensation for these transactions that would otherwise be prohibited.

The rule does present some challenges for capital raisers.

  1. This rule is likely to create a trend toward “level fee” advisors (Advisors who are compensated only by fees charged directly to clients and not via the sale of financial products). Some investors could benefit from a flat fee that is devoid of any hidden advisor incentives. Also, some investors who currently do not qualify for the attention of a high-minimum, account-based advisor will be able to get advice.
  2. The rule will require brokers and advisors to spend considerable time developing new payment structures.

Compliance requirements could be onerous at first; however, the contract required under BICE can be signed at the same time as other account opening documents. There doesn’t have to be a new contract for each interaction with a different employee of the same firm.

According to the DOL, fee-only advisors, whether they charge a fee based on a percentage of AUM or a flat fee, will be subject to more relaxed compliance requirements under BICE for recommending that a client rollover assets from an employer plan to an IRA. This is because these advisors receive the same compensation no matter what investments are included in the IRA rollover. However, new paperwork will be involved because advisors will need to document why the assets were moved from a lower priced 401(k) plan to a higher priced rollover IRA. 

What are the implications for holding alternative investments in an IRA?

Unlike the initial proposed rule, the final rule eliminates the “asset list” from the best interest contract exemption—continuing the ability for advisors to discuss all alternative assets in retirement accounts (such as private placements, non traded REITs, non traded business development companies, etc.). 

Self-directed IRA custodians, such as PENSCO, will still be allowed to custody alternative assets in IRAs. Given the extent of the rule changes, PENSCO expects advisors and brokers to reassess how to handle alternative investments in IRAs. For instance, broker-dealers may look to specialized custodians, such as PENSCO, that have expertise in holding alternative investments in IRAs to custody such accounts.

PENSCO is able to partner with financial institutions to allow them to provide a solution for clients looking to hold alternative assets in their self-directed IRA.

Readers who want to learn more about the Department of Labor's fiduciary rule can visit the DOL's own webpage or read the DOL's fact sheet. In the meantime, PENSCO will be keeping a close eye on the rule and will provide updates about the topic on our Blog throughout 2016. If you have a specific question you would like us to answer, please email or call us at (866) 818-4472.

[1] Department of Labor, April 6, 2016, “White House Fact Sheet: Strengthening Retirement Security by Cracking Down on Conflicts of Interest in Retirement Savings.” 

[2] Nerd's Eye View, April 11, 2016 “Advisor’s Guide To DoL Fiduciary And The New Best Interests Contract (BIC) Requirement