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The DOL Fiduciary Rule: Part 2 - The Best Interest Contract Exemption - What Is It?

On April 6, 2016, the Department of Labor (DOL) publicly announced its final conflict of interest rule, or the fiduciary rule, as more often referenced  and published the rule in the Federal Register two (2) days later, on April 8, 2016 (the "Final Rule"). Under this new re-proposed definition, more investment advisors would be subject to the ERISA investment advice fiduciary rules, thus subjecting these advisors to a heightened ERISA fiduciary status. ERISA fiduciary standards are considered the highest in the industry, where advisors must act prudently, must act in the best interests of the participants and beneficiaries, and must disclose all conflicts of interests. (See our Blog post from June 26, 2016 for an overview of the Rule.)

However, in adopting this Final Rule, the DOL allowed for some exemptions, most notably the Best Interest Contract Exemption ("BICE"). The BICE does not exempt advisors from the Final Rule's definition of a fiduciary.  The BICE provides relief to advisors providing non-discretionary advice and earn commissions on such advice.

The BICE  is a prohibited transaction exemption promoting investment advice in the best interest of Retirement Investors. Protected "Retirement Investors" include (1) a plan participant or beneficiary; (2) the beneficial owner or an IRA acting on behalf of the IRA; (3) a "retail" fiduciary, defined a as plan or IRA fiduciary that is not an "independent fiduciary with financial expertise;" and (4) small plans or small businesses (generally advisers who are not banks, insurance carriers, registered investment advisers or broker dealers and who provide advice to small businesses that sponsor 401(k) plans, or plans with less than $50 million, as well as advice to participants, can qualify for the BICE).

The Employee Retirement Income Security Act of 1974 ("ERISA") and the Internal Revenue Code ("the Code") both generally prohibit fiduciaries from receiving payments from third parties or from participating in conflicts in interest to affect or increase their own compensation with respect to the plan. Thus, without the BICE, a fiduciary for a plan, an IRA, or any of the other covered plans or products falling under the Final Rule cannot recommend an investment to a Retirement Investor if the fiduciary will receive a fee or other compensation as a result of the recommendation.  

As a condition of receiving compensation that would otherwise be prohibited under ERISA and the Code, the BICE requires financial institutions to acknowledge their fiduciary status and the fiduciary status of their advisors in writing. The financial institution and advisers must adhere to enforceable standards of fiduciary conduct and fair dealing with respect to their advice. In particular, under this standards-based approach, the advisor and financial institution must give prudent and impartial advice that is in the Retirement Investor's best interest, avoid misleading statements, disclose any conflicts of interest and information about the revenue model, and receive no more than reasonable compensation.

In the case of IRAs and non-ERISA plans, the BICE requires that the standards be set forth in an enforceable contract with the Retirement Investor. Under the BICE's terms, financial institutions are not required to enter into a contract with an ERISA Retirement Investor, but they are obligated to adhere to these same standards of fiduciary conduct.  

Likewise, “level fee” fiduciaries that, with their affiliates, receive only a level fee in connection with advisory or investment management services, are subject to more streamlined conditions, including a written statement of fiduciary status, compliance with the standards of impartial conduct, and, as applicable, documentation of the specific reason or reasons for the recommendation of the level fee arrangement. No other disclosures are mandated. This is often referred to as "BICE Lite."

The exemption is designed to cover a wide variety of current compensation practices, which would otherwise be prohibited as a result of the DOL's Final Rule extending fiduciary status to many investment professionals who formerly were not treated as fiduciaries. Rather than flatly prohibiting compensation structures that could be beneficial in the right circumstances—such as commission accounts for investors that make infrequent trades—the exemption permits individual advisors and related financial institutions to receive commissions and other common forms of compensation, provided that they implement appropriate safeguards against the impact of conflicts of interest on investment advice. The BICE strives to ensure that advisors' recommendations reflect the best interest of their Retirement Investor customers, rather than the conflicting financial interests of the advisors and their financial institutions. 

Additionally, financial institutions generally must adopt policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, and disclose basic information about their conflicts of interest and the cost of their advice.

The DOL has implemented a phased implementation approach to the BICE.  The Final Rule goes into effect on April 10, 2017.  However, with respect to the Best Interest Contract Exemption, only part of the exemption goes into effect next April.  Advisors will be required next April to comply with acknowledging their fiduciary status, adhering to the best interest standard, and making basic disclosure of conflicts and interest.  The remainder of the rule will go into full effect on January 1, 2018.

With respect to the BICE, Retirement Investors can effectively bring civil actions under ERISA. The DOL has no jurisdiction over advisors or IRA owners.  However, the DOL has given IRA owners contractual power to enforce the BICE under the Final Rule. Interestingly, the DOL has jurisdiction over the definition of a fiduciary, and its exemptions, for IRAs, but the Internal Revenue Service (IRS) otherwise has jurisdiction over IRAs. Other than this enforcement through litigation, the DOL has not yet indicated how the BICE will be enforced. 

The BICE has significant requirements.  If you have any questions, do not hesitate to contact us.  

© 2016 Kiesewetter Law Firm, PLLC Memphis, Tennessee

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