Frequently Asked Questions: DOL Fiduciary Rule

The word fiduciary refers to a legal standard that holds certain professional advisors — such as doctors and lawyers — to a requirement that they act in their clients’ best interests. Fiduciaries can be held accountable if they do not uphold this standard.

In the investment advisory context, fiduciary advisors must only recommend investments — such as those in 401(k) plans and individual retirement accounts (IRAs) — that are in their clients’ best interests.
 

The DOL fiduciary rule, which went into effect June 9, expands the definition of investment advice. To be held to the fiduciary standard, advice will no longer be required to:

• be delivered on a regular basis,
• be individualized, or
• serve as the primary basis for investment decisions.

This means that broker-dealers and their registered representatives will ordinarily be treated as fiduciary investment advisors whenever they provide investment-related recommendations to retirement plans, plan participants and IRA owners.

In addition to investment recommendations, the DOL rule also treats as fiduciary advice recommendations:

• to rollover from a plan to an IRA,
• to convert brokerage accounts, such as A and C share mutual fund accounts, to fee-based advisory programs,
• to transfer from one IRA to another, and
• of another investment advisor.
 

By broadening the definition of investment advice, the DOL is expanding the fiduciary standard to include retirement investment services that have previously been held to the less restrictive suitability standard. The new rule requires that a recommendation must be not only suitable but in the client’s best interest.

Registered investment advisors (RIAs) are already subject to a fiduciary standard of care under the securities laws, but will now have to satisfy the fiduciary standard of care under ERISA, including its rules prohibiting certain transactions unless an exemption applies.
 

The rule applies only to retirement investments — 401(k)s, IRAs and other related plans. The Securities and Exchange Commission (SEC) may also adopt a fiduciary rule for the broader investment industry in the future.

The Fiduciary Rule’s Effect on Compensation

The fiduciary rule includes the BIC exemption, which allows advisors to continue to be paid on commission. To qualify for the exemption, the advisor’s firm will have to:

• work in their clients’ best interests,
• adopt policies to ensure that all advice meets impartial conduct standards, and
• earn no more than reasonable compensation.

These are the only requirements of the BIC exemption that became effective June 9. There are no additional disclosure, contract or advisor compensation requirements in place until January 1, 2018, when the additional requirements of the BIC exemption are scheduled to go into effect.
 

Advisors who are considered fiduciaries under the new DOL rule can generally receive a commission or a 12b-1 fee from an IRA or other retirement plan only if they comply with the terms of a prohibited transaction exemption, like the new BIC exemption.

The DOL rule does include a pathway for advisors to continue receiving commission, through the BIC exemption.

The new rule includes a grandfather provision for pre-existing assets, which was effective through June 9. Current and/or new IRA clients who are invested in A and C shares will be able to continue receiving advice after the effective date without having to comply with the new BIC exemption, provided that the advice falls within the grandfather provision.

The grandfather exception potentially applies to:

• hold recommendations on A and C shares made after June 9,
• exchanges after June 9, and
• new purchases that relate to systematic contribution programs established before June 9.

The grandfather exception does not require use of a contract or require new disclosures. It is, however, available only if a hold or exchange recommendation is in the best interest of the investor, the investor pays no more than reasonable compensation and the advisor communicates honestly with the investor.

We believe that the vast majority of investment professionals already act in the best interests of their clients.

This DOL fiduciary rule imposes new compliance requirements, including a BIC, for certain commissionable transactions. The rule exposes advisors to legal liability should they violate the fiduciary standard.

Only part of the DOL fiduciary rule went into effect on June 9. The rest of the rule is scheduled to go into effect on January 1, 2018.

The additional requirements include advisor compensation restrictions. Generally, fiduciary advisors cannot recommend an investment that could affect their compensation. The regulators believe compensation, such as commissions and 12b-1 fees paid by mutual funds, can inappropriately affect the advisor’s judgment in making recommendations. (See the BIC exemption discussion below.)

With the fiduciary rule, the DOL prohibits firms from using quotas, bonuses or contests to compensate advisors. Acceptable pay models include:

• Flat fees
• Compensation based on a percentage of assets

Additional requirements of the BIC exemption are scheduled to go into effect on January 1, 2018. At that time, to qualify for the exemption, the advisor’s firm also will have to:

• disclose important information about the advisor’s services, fees and compensation, and
• agree, in the case of IRAs, that the firm and their advisors will adhere to these requirements in a written contract that is enforceable by investors.

More Information About the Rulemaking Process

Under the Employee Retirement Income Security Act of 1974 (ERISA), the DOL has jurisdiction over employee benefits and retirement accounts.

The SEC has been considering a fiduciary rule for the broader investment industry and is likely to propose new rules now that the DOL has released its final ruling on employee benefit and retirement accounts.

The fiduciary rule goes into effect in two parts:

• The general fiduciary standard went into effect on June 9.
• The full requirements of the BIC exemption go into effect on January 1, 2018.

During the period between the rule’s and the BIC exemption’s effective dates, financial advisors who receive commissionable compensation will need to satisfy only a streamlined version of the BIC exemption — one that does not require a contract or new disclosures.

Because the DOL has the authority to implement the rule without congressional involvement. It is possible that Congress could try to take some action to block or change the new rule. However, such an effort would face an uphill battle.

The new administration will continue to review the fiduciary rule until it is fully implemented on January 1, 2018, and could make further changes. However, a crucial factor would be the extent to which the industry has already moved toward a uniform fiduciary standard.