The Labor Department needs to provide additional guidance regarding these irregularities in time for advisers to plan accordingly.
As is the case with most chief compliance officers these days, I have spent considerable time reviewing 1,000 plus pages of the Department of Labor's new fiduciary regulations and commentary. The following are a few of the significant implications I believe are not receiving the attention they deserve:
1. Say goodbye to solicitors agreements — at least with regard to accounts subject to ERISA.
The Advisers Act and most state codes specifically allow investment advisers to compensate third parties for client referrals but require them to provide potential clients with a “solicitor disclosure document” outlining the solicitor's role and fee.
Under the DOL's new rules, a solicitor's recommendation of a particular adviser in exchange for compensation will become conflicted investment advice. Although the DOL created disclosure regimes for conflicted advice regarding investments, it did not incorporate the solicitor disclosure document requirements to cover advice regarding an investment adviser. As a result, solicitor arrangements, which are valid under federal and state law, will become prohibited transactions under ERISA and — unless the DOL adopts the existing disclosure requirements — unlikely to be used.
2. The rules will create all sorts of problems for dually-registered advisers.
The Financial Industry Regulatory Authority Inc. requires broker-dealers to oversee the outside business activities and private securities transactions of their registered representatives. For dually-registered advisers, this includes supervision of their investment advisory services — even when provided through a separate RIA. If this oversight is deemed “the power to exercise a controlling influence over the management or policies” of the RIA, the broker-dealer would be deemed its “affiliate” under the DOL's new rules.
Therefore, even if an RIA and its dually-registered representative receive a level fee for managing an IRA, the RIA will need to utilize the best-interest contract exemption (BICE) if the representative's broker-dealer is considered an affiliate and collects any fees (12b-1 fees, sub-TA fees, transaction fees, etc.) on the account. However, if the adviser uses a non-affiliated broker-dealer as the account custodian, no conflict would exist — even if that broker-dealer retains the seller's commissions.
This raises a more complex question: Is an RIA subject to the BICE if its dually-registered representative sells a commissioned annuity to an IRA owner through his/her broker-dealer? The logical answer would be no because the RIA cannot legally participate in that transaction and the DOL has advised that was not its intent. However, as currently written, the new rule appears to require compliance with the BICE if the RIA's employed adviser and/or a broker-dealer that qualifies as its affiliate receive unlevel compensation.
3. Retirement plan advisers who receive levelized 12b-1 fees as compensation face conflicting requirements.
The DOL has held a fiduciary's receipt of seller's commissions from mutual funds recommended to a retirement plan would not violate ERISA if they are used to offset a level fee charged to the plan on a dollar-for-dollar basis. While the new regulations continue to permit such arrangements, it is unclear which disclosures would be required.
On the one hand, a levelized 12b-1 fee meets the definition of a level fee because it is based on a fixed percentage of plan assets that will not vary based upon the mutual funds recommended by the adviser. As such, it would seem advisers using a levelized 12b-1 fee should be able to take advantage of the minimal disclosures required for level fee fiduciaries. However, Section IV of BICE rules specifically applies to advisers who recommend investments that generate third-party payments, which are defined to include “sales charges when not paid directly by the plan” and, more specifically, 12b-1 fees.
Therefore, a broker utilizing levelized 12b-1 fees may qualify as a level fee fiduciary but still be forced to comply with the more onerous disclosures required for those who sell proprietary products or receive third-party payments.
Needless to say, firms are racing to develop strategies to ensure they will be able to comply with the new rules. Hopefully, the DOL will provide additional guidance in the near future to address these anomalies in time for advisers to plan accordingly.
Phil Troyer is vice president of compliance at Bukaty Companies Financial Services.
