February 7, 2018

Policies Under the Fiduciary Rule

What the DOL expects, to ensure firms comply

Reported by Fred Reish and Joan Neri

Art by Tim Bower

QUESTION: I am an adviser who occasionally recommends that an investor roll over ERISA [Employee Retirement Income Security Act] plan assets to an IRA [individual retirement account] that I advise. Also, I sometimes recommend that an investor transfer his existing IRA to one I advise. I know that these recommendations are fiduciary acts under the DOL [Department of Labor] fiduciary rule that result in a prohibited transaction [PT] for which the best interest contract exemption [BICE] is needed. Does the BICE require that I amend my policies and procedures?

ANSWER: During the fiduciary rule’s transition period, June 9, 2017, through July 1, 2019, the BICE does not specifically require that you adopt policies and procedures addressing these conflicts. However, failing to do so will make it more difficult to prove you complied with the exemption. Also, the DOL has stated that it expects such policies to be adopted, and it could view your failure as an indication that you are not making diligent and good faith efforts to comply with the rule—which would mean you’d lose the protection of the current nonenforcement policy provided by the DOL and Internal Revenue Service (IRS).

The only stated requirement in the BICE is that, during the transition period, you need to adhere to the impartial conduct standards (ICS), which consist of three elements:

The recommendation must be in the investor’s best interest—i.e., a standard that mirrors ERISA’s prudent man rule and duty of loyalty;
The fee charged to the IRA must be no more than reasonable compensation for your services; and
No materially misleading statements may be made.

While there is no specific obligation to adopt policies and procedures to ensure compliance with the ICS, the DOL has stated on a number of occasions that it expects financial institutions, such as registered investment advisory (RIA) firms, to adopt them. In its frequently asked questions (FAQ) issued last May, the DOL expressed this expectation in Q&A-6, saying it “expects financial institutions to adopt such policies and procedures as they reasonably conclude are necessary to ensure that advisers comply with the impartial conducts standards.” The DOL also noted that firms “retain flexibility to choose precisely how to safeguard compliance” with the standards “whether by tamping down conflicts of interest associated with adviser compensation, increased monitoring and surveillance of investment recommendations, or other approaches or combination of approaches.”

This language suggests that the DOL expects firms to adopt policies, procedures, supervision and/or compensation practices, as needed, to mitigate any such conflicts. For plan rollover recommendations and IRA-to-IRA transfer recommendations, this would mean the firm should adopt policies and procedures that describe: the conflict of interest that arises when such recommendations are made, the use of the BICE to mitigate the conflict, and the requirements of the BICE that need to be satisfied—i.e., currently, the ICS.

For instance, in the case of a plan rollover recommendation, the policy should reflect the best interest process described in the BICE preamble by requiring that the adviser first consider the investor’s options—i.e., to stay in the plan, roll over to an IRA, take a distribution or transfer to another employer, if permitted—and then compare the services, costs and investments of the plan and the IRA to determine which option best aligns with the investor’s needs and circumstances. Similarly, for IRA-to-IRA transfer recommendations, the policy should require that the adviser compare the services, fees and investments of each to determine which option best suits the investor.

Additional documentation—such as best interest checklists—could be developed to support the basis for the recommendation and then referenced in the firm’s policies. Additionally, the policies could require that the adviser make diligent efforts to obtain information from the investor, such as the plan participant disclosure statement—i.e., the 404a-5 disclosure—in the case of plan rollovers. The firm should also implement practices to train advisers on this process and then monitor the rollover and/or IRA transfer recommendations to insure that the process is undertaken as the policy sets forth.

The IRS and DOL have stated that they will not pursue claims against fiduciaries who are working “diligently and in good faith” to comply with the rule. Establishing such policies is a way to establish diligent and good faith efforts to comply with the rule so this nonenforcement policy can apply. The policy does not prevent private enforcement of the rule. That said, implementing such policies will also put you in a strong position if you need to defend against a private enforcement action brought by an investor.

Fred Reish is chair of the financial services Employee Retirement Income Security Act (ERISA) practice at the law firm of Drinker Biddle & Reath LLP. A nationally recognized expert in employee benefits law, Reish has written four books and many articles on ERISA, pension plan disputes, and audits by the Internal Revenue Service and Department of Labor. Joan Neri is counsel in the firm’s financial services ERISA practice, where she focuses on all aspects of ERISA compliance affecting registered investment advisers and other plan service providers.