MAY 20, 2016
Frequently Asked Questions: DOL’s Final Fiduciary Rule
The Department of Labor (DOL) released its final fiduciary rule on April 6, greatly expanding the definition of fiduciary investment advice. Capital Group provides answers to frequently asked questions about this new rule.
Please consult with your home office for guidance on the new rule
The Fiduciary Rule Explained
What is a fiduciary?
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.
What changes is the DOL making with the new rule?
The final DOL rule, which goes into effect April 10, 2017, 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 specifically individualized, or
- serve as the primary basis for investment decisions.
Rollover recommendations will also be considered fiduciary advice.
What were the significant changes in the final fiduciary rule over the DOL’s original proposal?
Most significantly, the DOL fiduciary rule allows for a:
- Later compliance date than originally proposed.
- Phase-in period of the new rule.
- Broad grandfather rule for preexisting assets (see discussion of the Best Interest Contract (BIC) exemption below).
Continue to review the Capital Group Policy Spotlight for updates, new developments and insights.
What does the new definition mean?
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. It treats broker-dealers and their registered representatives as fiduciary investment advisors whenever they provide investment-related recommendations to retirement plans, plan participants and IRA owners.
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 DOL rule treats as fiduciary advice:
- Recommendations to rollover from a plan to an IRA.
- Recommendations to convert brokerage accounts, such as A and C share mutual fund accounts, to fee-based advisory programs.
Does the final fiduciary rule apply to all investments?
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
Can a fiduciary advisor receive differential compensation?
Generally, fiduciary advisors cannot recommend an investment that could affect their compensation. The regulators believe compensation, like commissions, and 12b-1 fees paid by mutual funds can inappropriately affect the advisor’s judgment in making recommendations. (See the Best Interest Contract (BIC) exemption discussion below.)
With the final 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
Does the rule eliminate commission compensation entirely?
The DOL rule does include a pathway for advisors to continue receiving commission, through the Best Interest Contract (BIC) exemption.
What is a BIC exemption?
The final fiduciary rule includes a BIC exemption that allows advisors to continue to be paid on commission. To qualify for the exemption, the advisor’s firm will have to:
- Acknowledge that they and the advisor are fiduciaries and that they are working in their clients’ best interests.
- Adopt policies to ensure that all advice meets impartial conduct standards, including ensuring that advisor compensation practices do not encourage inappropriate recommendations.
- Disclose important information about the advisor’s services, fees and compensation.
- 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.
Why would an advisor or intermediary need to use the BIC exemption?
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.
What about existing clients who are invested in A and C shares? Would an advisor or intermediary need to use the BIC exemption to continue receiving 12b-1 fees?
The new rule includes a grandfather provision for preexisting assets, which is effective through April 10, 2017. 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 exception.
What does the grandfather provision cover?
The grandfather exception potentially applies to:
- Hold recommendations on A and C shares made after April 10, 2017.
- Exchanges after April 10, 2017.
- New purchases that relate to systematic contribution programs established before April 10, 2017.
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.
What if I already act in my clients’ best interests?
We believe that the vast majority of investment professionals already act in the best interests of their clients.
This final 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.
More Information About the Rulemaking Process
Why did the DOL, and not the SEC, create this rule?
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.
When will the fiduciary rule go into effect?
The new rule allows advisors to continue doing business under current law — without restriction — prior to the rule’s effective date of April 10, 2017. No new requirements will be effective in 2016.
The rule will go into effect in two parts:
- The general fiduciary standard goes into effect on April 10, 2017.
- 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.
Does the finalized rule need to be voted on by Congress to be passed?
No. 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 the new rule from going into effect. However, such an effort would face an uphill battle.
Could the next presidential administration stop the rule from being implemented?
The next president could stop the rule from being implemented; however, a crucial factor would be the extent to which the industry has already moved toward a uniform fiduciary standard when the new administration takes office.