DOL s Fiduciary Rule Increases Advisor Responsibility

Transcription

1 New Frontiers For Advisors Who Lead the Way First Quarter 2016 DOL s Fiduciary Rule Increases Advisor Responsibility Industry interest has increased around the Department of Labor s (DOL) rule expanding the definition of a fiduciary. This means a large universe of financial advisors who today are not ERISA fiduciaries for their plan and IRA clients will need to be. What Does Fiduciary Really Mean? Industry interest has increased around the Department of Labor s (DOL) rule expanding the definition of a fiduciary. This means a large universe of financial advisors who today are not ERISA fiduciaries for their plan and IRA clients will need to be. On April 14, 2015, the Department of Labor (DOL) proposed a rule to expand the definition of an ERISA fiduciary, which imposes greater obligations and restrictions on advisors to retirement accounts, such as ERISA plans and IRAs. On April 6, 2016, the final rule was released. Most parts of the rule will be effective on April 10, 2017, with some reporting requirements going into effect January 1, It s important to note that the details of the provisions are complex and further guidance is expected from the DOL. HISTORY OF FIDUCIARY STANDARD In 1975, pursuant to ERISA, regulations were established for standards of care for fiduciaries serving ERISA plans and IRAs. These regulations instituted a five-part test for determining whether someone was acting as an ERISA fiduciary. Advisors could serve ERISA plans and IRAs without acting as fiduciaries, however, and over the years, the old definition was criticized for not being broad enough. The narrowness of the rule was emphasized by the shifting nature of how people save for retirement, from direct benefit or pensions to direct contribution, including qualified plans and IRAs. Defined contribution (DC) accounts, such as qualified plans (401k, 403b plans) or IRAs, have increased in popularity. Defined benefit plans (pensions, both public and private) have decreased relative to DC plans. This also means that the responsibility of, and therefore the risk for saving for retirement and maintaining accounts has increasingly been put on the retiree, rather than a large company or the government. This increases the importance of objective and proper advice. 1

2 THE MANY DEFINITIONS OF FIDUCIARY The rule brings into focus the different advisor standards of care, which have been largely unchanged since the original ERISA legislation. These differing standards can cause confusion, especially because the word fiduciary has different definitions and requirements under the SEC and DOL. The key difference is that they are governed by different laws, despite using similar terminology. As mentioned above, the ERISA fiduciary standard under the DOL was established by the ERISA legislation. The Investment Advisor Fiduciary under the SEC was established by the Investment Advisors Act of 1940, and the default suitability standard was established by the Securities and Exchange Act of Below is a summary of the different advisor standards. Advisor Standards SEC Regulated Investment Advisor Fiduciary: a broad duty to act in the best interest of clients, with emphasis on disclosure of conflicts of interest and, in some cases, consent Broker Dealer: subject to a number of rules, including suitability and fair dealing standard, designed to promote proper conduct with customers DOL Regulated ERISA Fiduciary: subject to affirmative requirements to act prudently and with undivided loyalty to the plans and their participants and beneficiaries, and restrictions from a broad range of transactions between the fiduciary (or other parties in interest) and the plan known as prohibited transactions Source: Department of Labor, Securities and Exchange Commission 2

3 Who Are the New Fiduciaries? The rule expands coverage of who is considered an ERISA fiduciary, but the crux of the fiduciary requirements regarding transactions still prove challenging for many advisors. FIDUCIARY DEFINITION The proposal expands the definition to include certain recommendations, most notably, IRA rollover recommendations. The definition of an ERISA fiduciary as it applies to plan or IRA advice providers has changed from the prior restrictive five-part test to a much broader definition. The current five-part test requires that to be a fiduciary a person must: 1. make recommendations on securities or other property 2. on a regular basis 3. pursuant to a mutual understanding that the advice 4. will serve as a primary basis for investment decisions and 5. will be individualized to the particular needs of the plan All five elements must be satisfied for each instance of advice. This narrow definition meant that many FAs who deal with ERISA plans were not ERISA fiduciaries, and advisors could easily disqualify themselves from qualifying as fiduciaries. The new rule is broader. A fiduciary is an advisor who: 1. gives a recommendation relating to a plan or IRA account 2. which is understood to be individualized or specifically directed toward that plan or account 3. for a fee or other compensation, whether direct or indirect This test is noticeably broader and does not require the advice be on a regular basis, a primary basis for decisions and pursuant to a mutual understanding. The threshold question here is whether a recommendation occurred. A recommendation is communication that, based on its content and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action. This definition is intended to be generally consistent with the definition used by FINRA and the SEC FIDUCIARY REQUIREMENTS An ERISA fiduciary must act prudently and with undivided loyalty to the plan or account and any participants and beneficiaries. The crux of the duty is that certain types of transactions are prohibited, including: Dealing with the assets of a plan or IRA in advisor s own account Transactions involving the plan on behalf of a party whose interests are adverse to those of the plan Personal compensation in any form given to advisor from any party dealing with a plan or IRA Advisors often find it difficult to comply with the receipt of compensation requirement. Many common sources of advisor compensation, such as revenue sharing or 12b-1 fees, constitute prohibited transactions under ERISA. 3

4 Are There Exceptions to the Rule? The rule offers several carve-outs, or circumstances when ERISA fiduciary status would not apply, and exemptions, or circumstances when ERISA fiduciary status applies, but prohibited transactions are allowed as long as certain requirements and standards are met. Notable Carve-Outs Sophisticated counterparty Swap transactions Employees of plan sponsor Platform providers Employee stock ownership plans and pooled investment vehicles Investment education Advice given to a plan fiduciary that is licensed and a regulated provider of financial services or has responsibility for $50+M in assets Advice by counterparties in connection with swap transaction Employees of plan sponsor who provide advice to plan (for example, human recourses professionals) Record-keepers and third party administrators Appraisers to employee stock ownership plan and other pooled investment vehicles Providers of certain materials and information to a plan Source: Department of Labor, erisapracticecenter.com The investment education carve-out could be problematic for asset managers providing marketing materials and models that use actual products. The rule requires that when directed toward IRAs those materials may not include advice or recommendations toward specific products. BEST INTEREST CONTRACT EXEMPTION (BIC EXEMPTION OR BICE) The Best Interest Contract Exemption, also known as the BIC exemption or BICE, is one of the most complex and controversial parts of the new rule. The DOL has explained that their intention is not to eliminate commissions or the brokerage model, but that certain aspects of the model create the potential for conflicts. To accommodate this view, the BICE exemption permits financial institutions and advisors to continue to receive non-level compensation. The central tenant of BICE is adherence to the best interest standard that requires prudent advice based on the investment objectives, risk tolerance, financial circumstances and needs of the investor, without regard to financial or other interests of the advisor, financial institution, or their affiliates, related entities or other parties. In summary, to rely on the exemption, financial institutions generally must: Acknowledge fiduciary status with respect to investment advice to the retirement investor Adhere to impartial conduct standards requiring them to: Give advice that is in the retirement investor s best interest Charge no more than reasonable compensation 4

5 Make no misleading statements about investment transactions, compensation and conflicts of interest Implement policies and procedures reasonably and prudently designed to prevent violations of the impartial conduct standards Refrain from giving or using incentives for advisors to act contrary to the customer s best interest Fairly disclose the fees, compensation, and material conflicts of interest, associated with their recommendations There are no limitations on the types of assets eligible for the BICE. For example, advisors can recommend products such as unit trusts, closed-end funds, or REITs and municipal bonds under the new exemption. This is a significant change from the proposed rule, which restricted the types of securities subject to the BICE accounts. However, certain assets may have greater difficulty meeting the BICE conditions. Further, there are additional hurdles under the BICE for proprietary products and products that have third party payments. Despite certain operational improvements in workability from the proposed exemption, the final BICE will still be a high standard to meet, with rigorous procedural and substantive requirements and increased regulatory and litigation risk for broker dealer firms and advisors. LEVEL FEE ARRANGEMENTS The DOL has created a special exemption for level fee fiduciaries. This exemption covers advice to roll over assets from a plan into a fee-based account, or transfer assets from a commission-based account to an account that charges a fixed percentage of assets under management, if both the financial institution and financial adviser are level fee fiduciaries and other conditions are satisfied. The level fee exemption removes certain conditions of the BIC such as warranties and certain disclosures. However, level fee fiduciaries must provide a written statement of fiduciary status, meet compliance with the standards of impartial conduct under the BIC and, as applicable, maintain documentation of the specific reason or reasons for the recommendation of the level fee arrangement. GRANDFATHERING The rule includes a provision on the grandfathering of assets in affected accounts prior to the applicability date. This exemption allows advisors to continue to receive commission compensation on existing business without needing a BIC exemption. Grandfathering only applies so long as advice on those assets is limited to hold recommendations or systematic purchase agreements. The grandfathering rule doesn t negate the fiduciary status, so advisors must still provide a best interest standard of care with respect to the hold recommendations. When transitioning existing accounts into compliance with the BICE, negative consent can be employed with respect to the new contractual terms, warranties and disclosures. The option of negative consent significantly reduces the need to execute another contract for existing client accounts, and therefore, reduces documentation and operational complexities. New accounts after the implementation date are required to affirmatively execute new agreements, including, for accounts for which BIC is expected to be relied upon, BIC contractual terms, warranties and disclosures terms. The full impact and scope of the grandfathering provision is yet to be determined. The tipping points between what can be grandfathered and what triggers the BICE requirements will likely be a source of contention and discussion between the industry and the DOL. 5

6 How Might the Financial Advice Industry Be Affected? This rule will likely have a broad impact on many constituencies in the financial advice industry, including investors, advisors, broker-dealer firms and asset management firms. Let s walk through some likely impacts. INVESTORS RECEIVE GREATER TRANSPARENCY The purpose of the rule is to raise the transparency standards for providing advice, which will benefit the investor. This rule may also prompt the creation of additional low-cost or self-directed programs for different niches of investors. However, the rule may also decrease the profitability of small accounts, increasing the cost of advice for those small account holders and increasing account minimums for full-service advice models. ADVISORS FACE OPPORTUNITIES AND CHALLENGES The rule may mean both big opportunities and challenges for advisors, depending on their current model and planning services. It will likely mean a hastened shift toward fee-based revenue models and the potential to capture money in motion from advisors who decide not to incorporate a fee-based business model. However, it may also mean changing compensation structure and revenue streams for some advisors, as well as process changes that could significantly impact productivity and the day to day of business management. BROKER DEALER FIRMS EXAMINE THEIR BUSINESSES Broker dealer firms will also be competing for money in motion. Those with large fee-based platforms and established fee-based businesses will be better positioned to do so. On the flip side, broker dealers will face greater legal risk due to the broadened applicability of ERISA fiduciary status. They will look to lessen that risk, perhaps by decreasing the amount of fund families incorporated into platforms. Some firms will have to take a hard look at how to remain profitable after altering their revenue streams and making large investments in compliance and due diligence infrastructure. ASSET MANAGEMENT FIRMS OFFER SUPPORT Broker dealer firms and advisors may look to asset managers to offer education and consultative support, which is a great opportunity to strengthen partner relationships. However, many asset managers may face increasing margin pressure and business issues, such as consolidation or alteration of share classes. The statements contained herein reflect the opinions of Nuveen Investments and its affiliates as of the date hereof and may change at any time without notice. These statements should not be construed as specific tax, legal, financial planning or investment advice and are provided for informational purposes only. This publication may also contain information from third party sources. Nuveen Investments does not verify nor guarantee the accuracy or completeness of the information presented ADV-Q-07/16