“Last Minute” Fiduciary Rule Check-In: What Independent RIA Firms Should Do Now

The June 9, 2017, applicability date of the Department of Labor (DOL) Fiduciary Rule (Rule) is almost here. The DOL’s new and amended prohibited transaction exemptions (PTEs) will also be applicable on that date. While the requirements of some PTEs are relaxed during the “transition period” from June 9 through December 31, 2017, there are important obligations that apply. Our previous Alert discusses these issues more broadly.

Some of the more onerous aspects of the Rule and PTEs will not apply to independent RIAs (more on why later). By “independent” RIA firms, we mean those with no broker-dealer affiliate, who also do not manage proprietary funds. But, there are some important considerations that apply to independent RIA firms when their investment adviser representatives give advice to plan and IRA clients on and after June 9. Below we summarize three of the most important ones, with more specific thoughts to follow.

• First, recommendations to take distributions from employer-sponsored retirement plans, and to roll them over to IRAs, will be fiduciary advice. Because these recommendations will usually cause RIAs to receive additional compensation (even if the IRA will be a level fee account), RIAs will need to rely on the “transition” Best Interest Contract Exemption (Transition BICE).
• Second, recommending that an IRA at another institution be transferred to the firm will be fiduciary advice. Again, the limited requirements of Transition BICE will need to be satisfied.
• Third, where the RIA charges different fees for different asset classes (e.g., equities vs. fixed income), recommending an asset allocation to a plan or IRA will influence the RIA’s compensation and, therefore, will result in a prohibited transaction. The RIA can either rely on Transition BICE as to the asset allocation recommendations (as long as the asset allocation advice is non-discretionary), or charge a level “blended” asset management fee to avoid a prohibited transaction in the first place.

Limited Impact on Independent RIAs

The Rule significantly expands the definition of what constitutes “fiduciary” investment advice. Under the regulations in effect before June 9, the advice must be individualized for the client, provided on a regular basis, and with the mutual understanding that it would serve as a “primary basis” for investment decisions. On and after June 9, these requirements no longer apply.

Many independent RIA firms were already fiduciaries under the previous definition, and in the case of ERISA plan clients, have acknowledged their fiduciary status in writing as part of their 408(b)(2) disclosures. And, because the DOL’s “best interest” standard is essentially the same as ERISA’s fiduciary standard, the Rule and PTEs do not significantly change the fundamental requirements that apply to independent RIA firms when advising plans and their participants.

IRAs are not subject to the ERISA rules, including the ERISA fiduciary standard and the 408(b)(2) disclosure requirements. While the DOL does not have jurisdiction over IRA advice generally, it has the authority to issue PTEs that apply to ERISA plans and IRAs alike. The DOL’s Impartial Conduct Standards (i.e., best interest standard, reasonable compensation, no misleading statements) are conditions of the PTEs (not the Rule itself) and apply only if the RIA needs to rely on the PTE. If, for example, the RIA is providing ongoing advice to an IRA for only a level fee, there is no prohibited transaction and the Impartial Conduct Standards do not apply. However, there are some advice activities that will result in a prohibited transaction requiring reliance on a PTE, as discussed below.

Plan-to-IRA Rollovers

On and after June 9, recommendations to take a distribution from a plan and roll it over to an IRA advised by the RIA will be fiduciary advice, as will advice about how the IRA should be invested. This advice will usually result in a prohibited transaction because the RIA will receive additional compensation – i.e., where the RIA provides services for a fee to the IRA but not the plan, or where it provides services to both but the IRA fee is higher (of course, one exception would be where the RIA gives advice on plan and IRA assets for the same fee). This “one time” conflict requires reliance on a PTE – namely, Transition BICE.

Under the BIC Exemption, a simplified approach known as “BICE Lite” is available where the only conflict is the rollover recommendation, and the IRA account is advised or managed for a level fee. During the transition period, the only requirements of the BIC Exemption, including BICE Lite, are the Impartial Conduct Standards. To satisfy these requirements, the RIA will need to consider all relevant factors, including the investments available under the existing plan and the proposed IRA, the different levels of services, and the fees and expenses associated with both the existing plan and the IRA, including whether the employer pays for some of the plan’s expenses. Other factors that differ as between plans and IRAs may be relevant as well, including certain tax rules, distribution options, loan availability and creditor protections.

Although not required until January 1, 2018, we recommend that RIAs follow the basic process required under BICE Lite to document why the rollover is in the investor’s best interest. Firms should consider developing written materials to assist IARs in making these determinations, and maintaining that documentation.

IRA-to-IRA Transfers

Recommendations to transfer an existing IRA from another institution will also constitute advice and require reliance on Transition BICE if it results in additional compensation to the RIA. The process for establishing why the transfer was in the client’s best interest will be similar to the process used for plan-to-IRA rollovers. But, some of the factors (e.g., disparate tax rules, who pays expenses) will not apply to a comparison between two IRAs.

Asset Allocation Recommendations for Managed Assets

Under the Rule, an RIA can recommend its own asset management services, and this is treated as a non-fiduciary “hire me” recommendation. On the other hand, a recommendation on asset allocation or strategy is advice. If the RIA charges different management fees for different investment strategies or asset classes, then the receipt of the fees will result in prohibited compensation unless a PTE is used.

If the RIA merely recommends the strategy and the client makes the ultimate investment decision (i.e., the advice is non-discretionary), then the RIA can use Transition BICE. Transition BICE is not available if the RIA has discretion to determine the investment strategy. Using BICE, the RIA will need to make sure the asset allocation recommendation satisfies the Impartial Conduct Standards. RIAs should document the reasons why the investment strategy was in the best interest of the particular client in view of the client’s financial needs, risk tolerance and investment objectives. It is also advisable for the RIA to have a third party benchmarking service compare the RIA’s fees with the fees of other advisers who provide comparable services.

A second option is for the RIA to “levelize” their management fee across the various asset classes by charging a blended fee. This will avoid a prohibited transaction entirely. This second approach is a viable option for RIAs who cannot use BICE because they have discretion over the selection of the investment strategy. For advice to ERISA plans and plan participants, ERISA’s fiduciary standards will still apply. For IRAs, the DOL’s Impartial Conduct Standards will not apply, since the RIA will not need to rely on a PTE. However, the RIA will still be subject to the fiduciary obligations under the Advisers Act.

While the Rule and PTEs have only limited applicability to independent RIAs, there is potential exposure for some recommendations. Independent RIAs should make sure they have appropriate procedures in place to safeguard compliance with the Rule and PTEs. While the only requirements imposed under Transition BICE are the Impartial Conduct Standards, after the transition period ends, further steps to manage conflicts of interest will be required, including with respect to compensation incentives for individual IARs.