Five Key Components of the New DOL Regulations

THE FINAL CONFLICT OF INTEREST RULE CHANGES HOW FINANCIAL INSTITUTIONS AND ADVISORS MUST OPERATE

On April 6th, 2016, the Department of Labor (DOL) issued the final version of the “Conflict of Interest” Rule. Starting with the Rule’s infancy in 2010 and its well documented follow up in the 2015 proposal, the focus of the Department of Labor has remained steady in striving to protect Retirement Investors by expanding stringent fiduciary standards to a broader scope of financial Advisors.

While some uncertainty persists, the following article will highlight some of the most important aspects contained in the much anticipated final “Conflict of Interest” Rule.

1. The Core of the Rule Reaffirms Fiduciary Classifications

In the final Rule, the DOL reaffirms its fiduciary classification as any Advisor who receives direct or indirect compensation in correlation to providing advice to a retirement investor. In addition to the distinction of compensation, the Rule further identifies advice as:

? A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging securities or other investment property, or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA;

? A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., brokerage versus advisory); or recommendations with respect to rollovers, distributions, or transfers from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer or distribution should be made.

Purposefully casting their net wide, the DOL notes Advisors and Financial Institutions who previously may have engaged in prohibited transactions will now need to comply with Impartial Conduct Standards. As with the proposed Rule, the DOL maintains a provision that effects an exception to the prohibited transaction consequences in the form of the Best Interest Contract (BIC) Exemption. Through the exemption, firms may generally continue with their current business models as long as they meet certain standards set forth in the Rule.

However, use of the BIC Exemption will allow Retirement Investors to have recourse in the form of a civil action should the defined standards of the exemption not be adhered to. Of most significance is the DOL’s extension of its claimed authority over IRAs and other non-ERISA plans like Keogh plans.

2. The Rule Expands Best Interest Standards Coverage.

By casting this wide net that identifies newly-found fiduciaries, the impact of the Rule encompasses various retail investors. These investor types include individual plan participants and beneficiaries, IRA owners, HSA owners and “retail” fiduciaries. Retail fiduciaries are defined as plan fiduciaries with assets of less than $50 million, fiduciaries of both participant-directed and non-participant directed plans and participants who invest in self-directed brokerages and are not considered “independent.” The Rule notes that Independents with arm’s-length transactions who may have activity that qualifies as a fiduciary may avoid being classified as a fiduciary. In contrast to the proposal, the final Rule includes small participant-directed plans in the “retail” fiduciary definition.

3. The Implementation Period is Extended with a Phased-In Approach.

While the Rule becomes effective June 7, 2016, the DOL has outlined a phased-in approach to implement the required changes. The DOL has extended its applicability date to one year after the final ruling, April 10th, 2017, with a transition time frame primarily for compliance with the BIC Exemption January 1, 2018. On April 10th, 2017, investment providers not currently fiduciaries who are described within the context of the Rule are officially re-designated from non-fiduciary to fiduciary status.

During the transition period, it is expected that Financial Institutions and Advisors, among other things, must acknowledge their Fiduciary status, comply with Impartial Conduct Standards, and disclose any Material Conflicts of Interests. The Rule allows that during the transition period, there is relief from the prohibited transactions of ERISA and the Code consistent with the current five-part test that defines an investment advice fiduciary. On January 1, 2018, the Rule stipulates that the transition period no longer allows current prohibited transaction exemption provisions and the full conditions of the exemption would be required.

4. The Best Interest Contract Exemption May Allow Some Firms to Maintain Current Business Practices.

The BIC Exemption remains in the final regulation, but has some nuances that were not in the proposal. Firms may generally rely on the exemption to maintain current business practices. Additionally, Advisors who recommend annuities such as variable and fixed index annuities that are not considered ‘fixed rate’ must also rely on the exemption.

In order to leverage the exemption, firms must first notify the DOL of their reliance on the exemption. Firms and their Advisors must also follow ‘best interest’ standards including acknowledging fiduciary status, creating and adhering to policies that ensure compliance with Impartial Conduct Standards, charging reasonable compensation, refraining from incentives and disclosing all fees and conflicts of interest associated with investment recommendations.

The final Rule now allows for the BIC to be included in account opening documents as a two-party contract executed between the Firm (not the Advisor) and the Retirement Investor, as long as it is signed prior to the execution of any transactions. Any advice rendered prior to the execution of the BIC is covered by the BIC.

Furthermore, existing accounts are grandfathered when the Retirement Investor is sent a copy of the BIC, who then has 30 days to accept the terms by negative consent in place of a physical signature.

5. Insuring a Firm is Compliant is an Ongoing Effort.

Financial Institutions are required to establish comprehensive systems to monitor, evaluate and insure that Advisor recommendations meet the prudent standards of care as set forth in the Ruling, as well as maintain that all advice continues to be in the best interest of the Retirement Investor.

With Retirement Investors having the right to leverage ERISA mediation guidelines for fiduciaries and the ability under the BIC Exemption to bring lawsuits, including class action lawsuits, against Advisors and firms that utilize the BIC, continued scrutiny for compliance will be a significant concern to all firms. Clearly, the risk of expensive litigation has increased dramatically for all of those deemed to be fiduciaries under the Rule.

This piece is a preliminary snapshot of the regulations and is not intended to be a full analysis. Firms should consult with counsel for more specific details on how certain aspects of this Ruling may affect their business.