For about a year now, the industry has witnessed much conjecture and debate about the proposed Department of Labor’s Conflict of Interest rule, also known as the “Fiduciary Rule.” The rule attempts to broadly categorize anyone offering investment advice to retirement plans or IRAs as a fiduciary. It is in the final stages of review with the Office of Management and Budget and is expected to pass.
The mechanics of how this works are seemingly straightforward. An advisor recommending a rollover of retirement assets into an IRA or similar account would be considered a fiduciary. That matters because a fiduciary cannot make a recommendation that would cause his or her income to increase. The rule indicates a five-prong test to determine if a person is advising retirement assets. If any of the following apply, you are now considered a fiduciary:
- If you advise on the purchase or sale of securities or property in a retirement account;
- advise taking a distribution from a plan or IRA;
- manage securities or property including rollovers from a plan or IRA
- appraise or offer a fairness opinion of the value of securities or property if connected with a specific transaction by a plan or IRA; or
- recommend a person who is going to provide investment advice for a fee or other compensation.
Retirement plan sponsors should take note because if you read the rules correctly, it suggests anyone (including laymen) offering advice to a plan participant or an owner of an IRA would likely be considered a fiduciary and could be held personally liable for their recommendations or advice.
Registered Investment Advisors may not see a significant change in business practice. We are already considered fiduciaries. However, broker/dealers (B/D) may not have it as easy. B/Ds are generally not considered fiduciaries to retirement plans or IRA assets, they are instead held to a less stringent “suitability” standard. In the light of the proposed rule, one of the chief issues B/Ds face is how to handle variable income and commissions. Changing their business model to accept level income would likely be an onerous undertaking. There is an unattractive alternative. Under the DOL’s Best Interest Contract (BIC) exemption, the broker/dealer may be exempt from the fiduciary rules if certain requirements are met. These include:
- obtaining a written contract prior to the offering of any advice,
- supplying the prospect information and costs for every investment they could own,
- providing performance information on each investment,
- fully disclosing compensation arrangements and
- maintainging this information for a period of six years.
In addition to this, the aforementioned information must be maintained a public website. Consider the amount of work and man-hours it would take to become compliant with the BIC exemption. Because of this, it is expected that smaller B/D’s will exit the industry or merge with larger providers.
One of the controversial rules surrounds the “seller’s carve out” and its impact on small business retirement plans (plans with either less than $100 million in assets or 100 participants). Under the rule as proposed, the advisor is not considered a fiduciary to the investments of these small business plans. I question why every plan, irrespective of size, wouldn’t be required to have a fiduciary. After all, under this specific rule, if the DOL is trying to protect consumers, why protect some of them and not all of them?
In closing, we at Parsec have been watching this unfold for months and are eager to see the final form of the rule. Perhaps an unintended consequence is that many customers and retirement plans may have to reconsider their advisory relationship. Regardless of the new rule, it is important to always put the best interest of your clients first. Parsec will be prepared for whatever the DOL comes up with.
Neal Nolan, CFP®, AIF®
Senior Financial Advisor
Director of ERISA Services