Why plan sponsors need to navigate the exemptions maze of the new fiduciary rule

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The Department of Labor’s recent extension of the applicability of the fiduciary rule has sent the retirement industry into a tizzy, in large part because the rule will go into effect, as is, on June 9. The department has said it will implement the rule first and then fix it later, based on what is and isn’t working.

Fred Reish, a partner in Drinker Biddle & Reath’s Employee Benefits and Executive Compensation Practice Group, chair of the Financial Services ERISA Team and chair of the Retirement Income Team, says that the 60-day extension granted by the DOL was a “recent and surprising development.”

The fiduciary rule redefines who is a fiduciary when it comes to financial advice, including broker-dealers and advisers who work with IRAs for the first time.

“On June 9, the fiduciary regulation, as first published a year ago, becomes applicable — lock, stock and barrel,” Reish says. “Not one comma has changed, unless and until it is revised as part of the review and analysis that the DOL is doing to these rules.”

So, what does that mean? It means that any recommendation of investments or investment strategy to an IRA, plan or participant is going to be fiduciary advice, he says. Any recommendation of insurance products or a referral to another fiduciary is fiduciary advice. Any recommendation to take a distribution or rollover to an IRA or take money from one plan to place in another plan will be considered fiduciary advice.

The difference between what would have gone into effect on April 10, and what will go into effect on June 9, are the exemptions. The DOL has implemented what it calls a “transitional set of exemptions” that are less onerous than what was originally included in the fiduciary rule. Advisers will be governed by the so-called prudent man rule and the duty of loyalty.

For example, when an adviser recommends a distribution from an ERISA retirement plan to an IRA, until the end of 2017, companies will comply with the rule by devising a prudent process that includes gathering information about the investments, services and expenses in the plan. They must also project what the investments services and expenses in the IRA are going to look like and conduct a comparative analysis of the two; and determine what the needs and circumstances of the plan participant or plan are moving forward. Once those three things are determined, they need to be evaluated and a prudent recommendation has to be made.

“The department threw us a curve ball,” says Bradford Campbell, a partner in Drinker Biddle & Reath’s Employee Benefits and Executive Compensation Practice Group. Instead of following President Trump’s February memorandum that requested a review of any negative impacts that would result from the fiduciary regulations and then repeal, replace or modify the rule based on that review, the DOL “decided to let it go forward and decide if they need to amend it or replace it down the road,” he adds.

The amendments made to the rule will allow financial institutions to continue to take in traditional forms of compensation under relatively easy-to-meet exemption requirements through the end of the year, Campbell says. The transitional best interest contract exemption allows advisers and companies that provide financial advice to meet an impartial conduct standard instead of the complicated best interest contract exemption that was included in the final rule. That means that companies will have to make recommendations that are in the customer’s best interest, avoid misleading statements and charge no more than reasonable compensation for services.

“Am I in a cluster in the middle or an outlier? If I’m an outlier, is our fee reasonable?” says Campbell. That means not just looking at what others charge but at the services you are offering, he adds. How much does it cost to offer these services with a reasonable profit on top that can justify the higher fees?

“You have to have something in your file that means you looked at the questions, that you have done the work to establish your fees are reasonable,” Campbell says.

The other big prohibited transaction exemption is the 84-24, which covers the sale of annuities and insurance contracts. Under the original rule, the 84-24 exemption couldn’t be used for variable annuities or fixed income annuities. Those would have to go through the best interest contract exemption. That created problems for independent insurance agents, who would then have to have the backing of a larger financial institution to be able to enter into a BIC exemption.

As part of the fiduciary rule delay, the DOL says that companies can revert to the previous 84-24 rule with the addition of the impartial conduct standard. That rule covered variable annuities, fixed income annuities and all other annuities.

“The burden of proof is on the person claiming the exemption,” Reish says. “If you are an adviser, you will have to prove your compensation was reasonable. It is not up to the investor to prove it was unreasonable. There is a shifting of the burden of proof. It has real significance.”

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