DOL Fiduciary Rule Watch:  THE IMPORTANCE OF THE LEVEL FEE EXEMPTION

By Dennis Dumas

Bates Group has been highlighting several important aspects of the new DOL Fiduciary rule that will help financial service providers continue to deliver effective, high-quality service to their retirement investors. The importance of understanding and adapting to the ins and outs of the rule cannot be overstated. Changes brought about by the new rule are expected to impact the more than $3 trillion of IRA investments.

The bottom line is that the DOL is encouraging the financial services industry to move in the direction of level fees by making it easier under the new rule to charge those fees rather than traditional forms of compensation like commissions. It accomplishes this by adopting the so-called "level fee exemption."

The Expanded Rule

The DOL extended the application of its fiduciary standard by way of its new rule in order to protect retail 401k and IRA retirement investors, an investment segment which has exploded in number and size since the 1970s, when the DOL last defined the scope of its protections.

To achieve this goal, the DOL also expanded the definition of "fiduciary advice" to include most types of recommendations to retail 401k and IRA retirement investors. Covered activities will include all recommendations to a retirement investor for a fee or other compensation involving the investment of 401(k) Plan or IRA assets or the management of Plan or IRA assets. This includes investment strategies, referrals of other fiduciaries, selection of account arrangements and rollovers or distributions or transfers from a plan or IRA. "Fee or other compensation" is defined very broadly and includes all compensation directly or indirectly received by the financial institution and its affiliates.

When financial institutions and their advisors fall within the rule, they will be prohibited from receiving what has been traditional financial services industry compensation, including commissions, trailing commissions, sales loads, 12b-1 fees, and revenue-sharing payments from investment providers or other third parties. The DOL has provided several important carve outs or exceptions, among them the level fee exemption.

The Level Fee Exemption: Disclosures and Conditions

The level fee exemption presents the financial institution with reduced obligations if it and its advisers only charge a percentage of the value of assets or another fee that does not vary based upon the recommended investment where there is no differential compensation. In the view of the DOL, this fee structure minimizes the adverse impact of potential conflicts of interest inherent in a differential compensation structure.

In order to fall within the level fee exemption, the financial institution and its advisors only need to disclose and charge a level fee and fulfill the following three conditions:

1. Written Statement. Prior to or at the same time as the execution of the recommended transaction, the Financial Institution provides the Retirement Investor with a written statement confirming that the Financial Institution and its Advisers are acting as fiduciaries.
2. Impartial Conduct Standards. The Financial Institution and Adviser comply with the Impartial Conduct Standards of Section II(c) of the Release (described below).
3. Evaluate and document why roll overs and switches are in the best interest of the Retirement Investor.
   1. In the case of a recommendation to roll over from an ERISA Plan to an IRA, the Financial Institution must document the specific reason or reasons why the recommendation was considered to be in the best interest of the Retirement Investor. This documentation must include consideration of the Retirement Investor's alternatives to a rollover, including leaving the money in his or her current employer's plan, if permitted, and must take into account the fees and expenses associated with both the plan and the IRA--whether the employer pays for some or all of the plan's administrative expenses--and the different levels of services and investments available under each option.
   2. In the case of a recommendation to rollover from another IRA or to switch from a commission-based account to a level fee arrangement, the Financial Institution must document the reasons that the arrangement is considered to be in the best interest of the Retirement Investor. This documentation must specifically include the services that will be provided for the fee.

The DOL defines the "impartial conduct standards" in Section II(c) of the Release. These standards require:

• Acting in the best interest of client. The investment adviser must act in the best interest of the Retirement Investor. This is defined as acting with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances and needs of the retirement investor, without regard to the financial or other interests of the investment adviser, financial institution or any affiliate, related entity or other party.
• Reasonable Compensation. Compensation received by the investment adviser or the financial institution (or its affiliates or related entities) with respect to the recommended transaction must not exceed reasonable compensation.
• No Misstatements. The financial institution and its investment advisers may not make any materially misleading statements to the retirement investor about the recommended transaction, fees and compensation, conflicts of interest and any other matters relevant to the retirement investor's investment decisions.

These reduced obligations represent an easier-to-fulfill subset of the Best Interest Contract Exemption requirements discussed in the last Bates Group Client Alert on the new DOL rule.

Looking Forward

The April 2017 initial compliance date of the new rule is around the corner, and time is now running short to jump into action to comply with the significant work to be done. The Level Fee Exemption may play an important role in planning this work.

About

Bates Group LLC has been a trusted partner to our financial services clients and their counsel for over 30 years, delivering superior quality and results on a cost-effective basis. Our regulatory and compliance consulting division, Bates Compliance Solutions (BCS), is comprised of a team of experienced former regulators and compliance professionals, including CAMS-certified individuals. We provide a comprehensive set of compliance, regulatory and risk management products and consulting services along with continuing guidance and support tailored to the specific needs and requirements of our broker-dealer, IA, and hedge fund clients, with a special emphasis on conducting comprehensive reviews and testing of AML compliance programs.

Should you need any assistance in understanding any aspects of the new DOL Fiduciary Rule, we encourage you to contact our DOL Fiduciary Rule point person, Alex Russell, at (503) 670-7772 or arussell@batesgroup.com, or Esdras Vera, BCS Global Practice Leader, at (609) 216-4622 or evera@batesgroup.com.