Magazine

ERISA vista | PLANADVISER November/December 2016

Compensation

Variable fees will be subject to the BIC

By Fred Reish and Joan Neri editors@assetinternational.com | November/December 2016
PAJF16_Article-Image-ERISA-Reish-and-Neri-Portrait_Tim-Bower.jpgArt by Tim BowerADVISER QUESTION: I understand that if my firm and I have level compensation and don’t have any conflicts of interest in providing fiduciary investment advice to individual retirement accounts [IRAs], the only compensation rule is that the amount must be reasonable. But what if my firm has conflicts of interest and I’m under the Best Interest Contract [BIC] exemption? What are the rules about my compensation in that case?

ANSWER:
The compensation rules are complex, but it helps to understand that they center around three concepts—that they be: level, reasonable and neutral. The compensation rules also impact your firm. However, this column focuses on the rules that impact you.

First, let’s explore what level compensation means. By “level fee,” we mean a fee that does not vary based upon the recommendation—e.g., an assets under advisement (AUA) or assets under management (AUM) fee is a level fee. If you, your firm and/or any affiliates receive a level fee in connection with your advisory services, then there is no prohibited transaction (PT) and no need for a BIC exemption. We refer to this as a “pure level-fee” adviser.

In contrast, compensation that varies based upon the recommendation made—such as a commission—is not a level fee. Unless an exemption such as the BIC exemption is used, this variable compensation is prohibited because you are able to increase your compensation by using your fiduciary authority.

Let’s suppose you charge a level advisory fee and you or your firm or an affiliate receive third-party compensation, such as revenue-sharing payments or 12b-1 payments. This could also result in a PT. One way to avoid that is to offset this third-party compensation dollar-for-dollar against your level advisory fee. This offset method was approved by the Department of Labor (DOL) in advisory opinions issued to Frost Bank (Advisory Opinion 97-15A) and Country Trust (Advisory Opinion 2005-10A). Further, the DOL, in its preamble to the BIC exemptions, acknowledged that this offset method may continue to be used to avoid a PT and the need for the BIC exemptions.

Note, however, that if the BIC exemption must be used—for example, for a rollover recommendation—the DOL takes the position that the receipt of third-party payments makes a fiduciary ineligible for the streamlined BIC exemptions available to “level fee fiduciaries.” That said, if you recommend a plan distribution and rollover to an IRA you advise and you or your firm or an affiliate receive third-party payments, you may not use streamlined BIC exemptions even if the third-party payments will be offset against the level advisory fee you will charge for the IRA services.

The second concept is “reasonable” compensation. In order for you to avoid a PT as a service provider to the IRA, your compensation must be reasonable relative to the services provided. Reasonable compensation is the only limitation that applies to you if you are a pure level-fee adviser.

BIC exemptions include this requirement as well. The DOL explains that reasonableness of fees is based upon the particular facts and circumstances, including “the market pricing of service(s) provided[,] … the scope of monitoring and the complexity of the product.” Describing reasonable compensation as a “market-based standard,” the DOL declined to accept a customary standard that, it points out, could include compensation arrangements that are not transparent and bear little relationship to the value of the services.

That said, to evaluate reasonableness, you should consider whether your compensation reflects the value of your services as determined by the competitive marketplace. In other words, you should compare your fees with the fees of other advisers who provide comparable services. We anticipate that providers of benchmarking services will be making data available to advisers to facilitate this comparison.

If you are receiving variable compensation, the BIC exemption imposes another restriction. Specifically, variable compensation is permitted if it is “based on neutral factors tied to the differences in the services” and not to your firm’s own conflicts of interest such as promoting sales of the most lucrative investment products. As explained by the DOL, payments for different investment categories may be appropriate in light of the differences in time, complexity and expertise needed to recommend them—e.g., a mutual fund investment as compared with a complex annuity product that requires more time to explain.

In sum, all three concepts apply under the BIC exemption if you receive variable compensation. The compensation difference between investment categories must be justified by neutral factors, and your compensation must be reasonable and level within each category.

Fred Reish is chair of the Financial Services ERISA practice at the law firm Drinker, Biddle & Reath. A nationally recognized expert in employee benefits law, Reish has written four books and many articles on the Employee Retirement Income Security Act (ERISA), Internal Revenue Service (IRS) and Department of Labor (DOL) audits, as well as pension plan disputes. Joan Neri, who has been associated with the firm since 1988, is counsel on the Employee Benefits and Executive Compensation Practice Group. Her practice focuses on all aspects of employee benefits counseling.