Bates Research  |  04-29-16

DOL’s New Best Interest Contract Exemption

Guest Post by Expert Dennis Dumas

On April 6, 2016, the Department of Labor (DOL) finalized its new rule and related exemptions requiring all who provide retirement investment advice to retirement plans and IRAs, extending to IRA rollovers, to abide by a "fiduciary" standard. The effective date of the rule is April 2017 with certain provisions phasing in through January 2018.

The final rule broadly defines fiduciary investment adviser, while accompanying prohibited transaction class exemptions allow certain broker-dealers, insurance agents and others that act as investment advice fiduciaries to continue to receive a variety of common forms of compensation (e.g., commissions) as long as they adhere to "fiduciary" standards, i.e., standards aimed at ensuring that their advice is impartial and in the best interest of their customers. According to the DOL, these standards include obligations to avoid misleading statements, manage plan assets prudently and with undivided loyalty to the plans and their participants and beneficiaries, and receive no more than reasonable compensation.

In order to accomplish this, the DOL issued the Best Interest Contract Exemption. Under the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (Code), individuals providing fiduciary investment advice to plan sponsors, plan participants, and IRA owners are not permitted to receive payments creating conflicts of interest without a prohibited transaction exemption.

The Best Interest Contract Exemption creates this exemption. Provided they fall within its terms, the Best Interest Contract Exemption permits firms to continue to rely on current compensation and fee practices like commissions, trailing commissions, sales loads, 12b-1 fees and revenue-sharing payments from investment providers or other third parties, which otherwise would be prohibited under ERISA and the Code for broker-dealers and all others falling within the expanded DOL definition of fiduciary investment advisor.

To fall within the Best Interest Contract Exemption:

  • Financial institutions must acknowledge fiduciary status for itself and its advisers.
  • Financial institutions and advisers must adhere to basic standards of impartial conduct, including giving prudent advice that is in the customer's best interest, avoiding making misleading statements and receiving no more than reasonable compensation.
  • Financial institutions must have policies and procedures designed to mitigate harmful impacts of conflicts of interest and must disclose basic information about their conflicts of interest and the cost of their advice.
  • Financial intuitions must describe material conflicts of interest, fees or charges paid by the retirement investor and a statement of the types of compensation the firm expects to receive from third parties in connection with recommended investments.
    • Investors also have the right to obtain specific disclosure of costs, fees and other compensation upon request.
    • A website must be maintained and updated regularly that includes information about the financial institution's business model and associated material conflicts of interest, a written description of the financial institution's policies and procedures that mitigate conflicts of interest and disclosure of compensation and incentive arrangements with advisers.
  • When providing advice to an IRA owner, the financial institution must commit to these protective conditions as part of an enforceable contract. This is unnecessary for ERISA plan investors who can rely on their advisers' fiduciary acknowledgement to assert their rights under ERISA's statutory protections.

Contract Provides New Enforcement Mechanism for IRAs and non-ERISA Plans

Advisers and financial institutions not adhering to the standards established in the exemption may be sued by retirement investors under the new DOL fiduciary standard rule. There are two mechanisms depending upon the type of retirement plan. IRAs and other non-ERISA plans retirement investors may bring a breach of contract claim under state law based upon the contract the DOL now requires for the exemption. For ERISA plans, participants and beneficiaries, retirement investors may sue based upon ERISA's existing provisions. In essence, by requiring the execution of a contact to fall within the new exemption, the DOL has created a new private right of action under state law that exceeds the enforcement authority granted by Congress.

Looking Ahead

Firms need to take care in drafting their form of contract and implementing the other requirements summarized above that are necessary to fall within the Best Interest Contract Exemption. Going forward, financial institutions and their advisers should be extra vigilant about documenting:

  • The policies and procedures required by the Best Interest Contract Exemption.
  • Their use of a reasonable process and adherence to professional standards in deciding to make the retirement investment recommendation and determining it was in the customer's best interest.
  • The reasonableness of compensation.
  • Their compliance with the policies and procedures.

Bates Compliance Solutions and our Fiduciary Rule team stand ready to assist clients in these endeavors.

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 Fiduciary Rule or Best Interest Contract Exemption, we encourage you to contact Edras Vera, BCS Global Practice Leader at (609) 216-4622 or evera@batesgroup.com or our DOL Fiduciary Rule point person, Alex Russell, at (503) 670-7772 orarussell@batesgroup.com.

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