It’s not yet a done deal, but DALBAR expects the best interest contract (BIC) exemption in the proposed fiduciary definition by the Department
of Labor (DOL) to soon become a reality. As the industry waits to see if and
when the definition will be implemented, compensation models are an area of
intense scrutiny.
The financial services market research and evaluation firm is
rolling out new tools and a self-paced program for advisers to take, to learn
what they must do to remain compliant in the face of new regulation if they continue
providing advice. Aimed at advisers who work with individual retirement accounts
(IRAs) and Employee Retirement Income Security Act (ERISA) plans, the course
helps them see best ways to implement the BIC exemption; provides guidance
tools for the transition to a new compensation model; examines ways to maintain
and increase compensation under the BIC exemption; as well as how to minimize time
and cost of compliance.
Background and an overview of the implications of the BIC exemption
are discussed in two free briefs: “BICE Requirements Summary” and “Creating a
Successful Best Interest Contract Practice.” The requirements summary lays out
the choices that financial advisers must make to comply, remain competitive and
profitable in the BICE environment. The practice brief highlights the changes
that will be required to meet the obligations and implications of a best interest
contract, including: business models, small accounts, business development,
marketing communications, risk management and compliance.
“As the regulatory changes under consideration
by the Labor Department and IRS [Internal Revenue Service] get closer to
reality the discussion must shift to how to operate successfully in the new
environment,” says Cory Clark, head of research and due diligence at DALBAR.
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An appellate court has dismissed a
plan sponsor’s lawsuit claiming its plan provider charged excessive fees
to retirement plan participants.
Affirming a district court’s
decision that McCaffree Financial Corp. failed to state a claim, the 8th
U.S. Circuit Court of Appeals agreed that Principal Financial Group was
not acting as a fiduciary under the Employee Retirement Income Security
Act (ERISA) when it entered into a contract with McCaffree to offer
separately managed accounts for McCaffree’s retirement plan for
employees.
The contract between McCaffree and Principal provided
that plan participants could choose to invest their accounts among
various separate accounts which invested in Principal mutual funds.
Principal reserved the right to limit which separate amounts it made
available to participants and McCaffree also had the ability to limit in
which accounts employees could invest. Principal presented 63 accounts
that could be included in the contract, and this was narrowed down to 29
accounts made available to plan participants.
The contract also
provided that participants would pay both management fees and operating
expenses to Principal. Principal assessed the management fees as a
percentage of the assets invested in a separate account, and this
percentage varied for each account according to its associated mutual
fund. In addition, Principal could unilaterally adjust the management
fee for any account, subject to a cap specified in the contract, and
would have to provide participants with at least 30 days’ written notice
of such change.
McCaffree entered into the contract in 2009. In
2014, it filed a lawsuit alleging that Principal charged participants
invested in these separately managed accounts “grossly excessive
management fees and other fees” in violation of its fiduciary duties
under ERISA.
The appellate court said that to first state a claim
of breach of fiduciary duty, a plaintiff must first plead facts
demonstrating the defendant is a fiduciary. Principal was not a named
fiduciary to the plan.
NEXT: Five arguments rejected
McCaffree argued that Principal’s selection of 63 separate accounts
in the initial investment menu constituted both an exercise of
discretionary authority over plan management and over plan
administration, so it owed a fiduciary duty to make sure fees for the
accounts were reasonable. However, the appellate court noted that the
contract clearly identified each account’s management fee and authorized
Principal to pass through expenses to participants. The court said
sister circuits have held that a service provider’s adherence to its
agreement with a plan sponsor does not implicate any fiduciary duty
where the parties negotiated and agreed to the terms of the agreement in
an arm’s-length bargaining process. Up until it signed the agreement
with Principal, McCaffree remained free to reject its terms and contract
with another service provider.
McCaffree
argued that Principal acted as a fiduciary when it selected from the 63
accounts identified, the 29 accounts made available to plan
participants. The company contends this winnowing process, after the
parties entered into the contract, gave rise to a fiduciary duty to
ensure the fees associated with the accounts were reasonable. The court
found that McCaffree did not assert that only some of the 63 accounts
had excessive fees or that during the winnowing process, Principal made
sure participants only had access to the higher-fee accounts. The action
subject to complaint is that excessive fees were charged for all the
accounts in the contract, so McCaffree cannot base its excessive fee
claims on any fiduciary duty Principal may have owed while selecting the
29 accounts, the court concluded.
The appellate court also
rejected McCaffree’s argument that Principal’s discretion to increase
fees and adjust amounts charged to participants supports its claim that
Principal was a fiduciary. Again, the court said the company failed to
plead any connection between this and its excessive fee allegations.
McCaffree did not allege that Principal exercised this authority,
resulting in excessive fees.
Similarly, the court found
McCaffree’s allegation that Principal was a fiduciary because it
provided participants with “investment advice” was unrelated to the
context of the lawsuit. McCaffree also argued Principal inadequately
disclosed the additional layer of management fee for the underlying
Principal mutual funds in which the separate accounts were invested, but
the court found the mutual fund fees were not subject to complaint, so
this argument does not apply to the decision whether Principal was a
fiduciary for actions relating to the complaint.
The decision in McCaffree Financial Corp. v. Principal Life Insurance Company is here.