Advice for Small Accounts

Art by June KimADVISER QUESTION: I am a registered representative of a broker/dealer (B/D). I cannot serve as a fiduciary to my customers, but, as a practical matter, I do give investment advice. I have heard that, if the Department of Labor (DOL)’s fiduciary proposal becomes a regulation, I will not be able to service small individual retirement accounts (IRAs). Is that true?

ANSWER: As we often say, it depends.

Here, it depends on several factors, including:

• Whether your broker/dealer will allow you to serve as a fiduciary adviser;
• Whether your broker/dealer has affiliated mutual funds and/or receives revenue-sharing payments from mutual funds;
• Whether your broker/dealer can “levelize” 12b-1 fees and other compensation; and
• Whether the DOL modifies the proposed “best interest contract,” or BIC, exemption so that it can be implemented at a reasonable cost.

We should explain some of those points.

First, if your broker/dealer will allow you to serve as a fiduciary adviser for a level fee—i.e., either a set dollar amount or a flat percent of assets—and if it has no affiliated investments or receives no payments from third parties—such as 12b-1 fees or revenue sharing—then you will be a “pure” level-fee adviser. By “pure,” we mean that neither you nor your broker/dealer, nor any affiliate, receives anything over and above your stated fee. In that case, you will be a fiduciary, with a duty of loyalty and an obligation to make prudent recommendations, but there will be no prohibited transaction (PT) issues.

But what if you are paid by commissions or 12b-1 fees, rather than by having the investor—or the IRA—write a check? That’s also possible under the proposed rule, but only if your broker/dealer has the systems in place to properly handle the payments, that is, to levelize its compensation for the advice. For example, let’s say you and the broker/dealer would ordinarily receive 50 basis points (bps) as a fee for a small IRA. If the proposed rules become effective, you could still receive that fee. It would work something like this: You would tell the IRA investor that your fee is 50 basis points a year, based on the IRA assets, and that you will recommend only mutual funds that pay a 50 bps 12b-1 fee. You would explain that, as a result, neither the investor nor the IRA will need to pay any fees since the payments will come from the mutual funds. This is called the offset, or “Frost,” method, based on a DOL advisory opinion to Frost Bank. Keep in mind, though, that this assumes the broker/dealer receives no other money—e.g., revenue sharing—and the advice includes no affiliated mutual funds.

But what if the broker/dealer does receive additional payments—e.g., revenue sharing—or has affiliated mutual funds or insurance products? That’s where the BIC exemption comes into play.

Eliminating Incentives
The concept behind the best interest contract exemption is that, if certain conditions are satisfied, the broker/dealer and its affiliates can make more money than the stated fee. That could include revenue sharing, investment management fees and so on. However, as the BIC exemption is currently written, it is available only if the individual adviser’s fees—in other words, your fees—are controlled in a manner that eliminates incentives to recommend higher-paying products. If the adviser has level compensation, the incentives would be “managed” and the broker/dealer could receive additional compensation. That’s only part of the story, though. There are other conditions in the exemption that are, in our opinion, unworkable. The DOL needs to change those.

Back to the original question: The answer comes down to whether your broker/dealer can accommodate the methods described in this article and whether you are willing to work within those guidelines. For example, if it was reasonable for you to receive 50 basis points as a nonfiduciary representative of a broker/dealer, will it still be reasonable to receive 50 basis points as a fiduciary? Do you feel that the fiduciary burden will increase the amount of your work and/or your possible liability and, therefore, justify higher fees? Those are personal questions.

This article has focused on the proposal’s impact on the individual adviser. There are a number of compliance burdens placed on the broker/dealer that we have not discussed. Hopefully, when the DOL rewrites the proposal, and particularly the BIC exemption, it will make those provisions less burdensome and more practical.

Fred Reish is chair of the Financial Services ERISA practice at the law firm Dirnker, 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.