3 IRA Transactions Exempt From DOL Fiduciary Level Fee Rule

Once the DOL's new fiduciary rule and prohibited transaction exemptions take effect on April 10, 2017, almost all advisors to plans, participants and IRAs will be fiduciaries. As such, they will need to scrutinize their compensation—and that of their supervisory entities (e.g., broker-dealers or RIAs, and all of their affiliates and related parties)—to ensure that no money is being received on top of the advisor's stated fee.

If any other money—e.g., advisory fees to affiliated mutual funds, revenue sharing, 12b-1 fees—is being received, then the advisor and its supervisory entity will need to comply with one of the prohibited exemptions. Most likely, that will be the Best Interest Contract Exemption, or BICE.

While most prohibited transactions can be avoided if the advisor, his supervisory entity and all affiliates and related parties, receive only a level fee, there are three that cannot. Put another way, there are three recommendations that are, per se, fiduciary in nature and that automatically result in prohibited transactions.

Those are:

A recommendation to a participant to take a distribution and roll it over into an IRA.
A recommendation to IRA owner to transfer his IRA to the advisor.
A recommendation to a participant or IRA owner to move from a transaction-based account to a fee-based account.

In BICE, the DOL identified those three recommendations as inherently being prohibited transactions.

For example, for the first type of recommendation—to take a plan distribution and to roll it to an IRA, the advisor would not receive any compensation if the participant did not accept the recommendation (assuming that the advisor was not providing services to the plan), but the advisor would receive compensation from the rollover IRA if the recommendation was accepted.

As a result, it is in the advisor's best interest for the money to be rolled over, but the question is whether it is in the participant's best interest. In some cases, it will be in the participant's best interest, but perhaps not in others. (Note that, even if the advisor is already working with the plan, the money that the advisor is earning on the participant's account inside the plan is probably less than that would be from the rollover IRA. As a result, that fact situation results in a prohibited transaction as well.)

Fortunately, BICE provides exemptions for these three prohibited transactions.

Where the investment advice to the IRA or plan account, after the rollover is completed, will be "conflicted," the advisor must satisfy all of the conditions in BICE. However, if the investment advice to the IRA or account will be "pure" level fee, the requirements are less burdensome. As a result, the "mini" exemption that applies to these three transactions is referred to as "BICE-lite."

With that in mind, let's take a quick look at the considerations for each of those recommendations.

Recommendation 1: Distribution and Rollover

There are several conditions imposed on the advisor. The most demanding is that the advisor document why it is in the best interest of the participant to take a distribution from the plan and roll over to an IRA. BICE specifically lists the following as considerations in developing the recommendation:

A comparison of the services the participant receives from the plan versus those in the IRA.
A comparison of the fees and expenses in the plan versus those in the IRA.
A comparison of the range of investments in the plan versus those in the IRA.

This is not an exclusive list of the considerations, but these factors must be considered in developing the recommendation.

Viewed more generally, the best interest, or prudence, rule requires that the advisor examine the "relevant" factors. (Factors are "relevant" if an independent, knowledgeable person would want to review that information in order to make an informed decision.)

Once that information has been gathered and evaluated, and a recommendation has been developed, the advisor must document why the recommendation is in the best interest of the participant. That documentation should be retained so that, if the transaction is challenged in the future, the advisor can support the analysis.

Recommendation 2: Transfer of an IRA

The considerations for developing a recommendation to transfer an IRA are similar to those for recommending a distribution. For example, the advisor would need to gather and evaluate the relevant information and would need to document why the decision was in the best interest of the IRA owner. However, in this case, the only specific factor identified by the DOL is that the advisor must consider the services that the IRA owner is currently receiving versus the services that will be offered if the IRA is transferred. Keep in mind, though, that there likely are additional relevant factors.

Recommendation 3: Transfer from a Transaction-Based Account to a Fee-Based Account

This recommendation is somewhat different than the first two. Why? Because in this case, the advisor could already be advising with the IRA owner on a commission basis, but then recommend that the IRA owner switch to a fee-based account. That would be considered a fiduciary act, subject to the prohibited transaction rules.

For this evaluation, BICE says that the services in both types of accounts should be considered. However, once again, there may be other relevant factors. For example, I think that it would be difficult to make such a recommendation without consideration of the differences in fees and costs in both types of accounts, as well as the activity in the account.

My view is that the DOL is concerned about the possibility of "reverse churning." In other words, they are concerned about the situation where an investor is put into an account with front-end commissions, but with low trailing payments. Then, after a year or two, the advisor recommends to the IRA owner that the account be switched to a higher fee-based account. In that way, the advisor would receive both the front-end compensation and higher ongoing fees. Recommendations of this type will probably be closely scrutinized.

Once again, the advisor must consider the relevant factors and document why the recommendation is in the best interest of the investor.

Forewarned is forearmed. The rules are changing. Advisors, and their broker-dealers or RIAs, will need to develop new documents, procedures and support services before April 10. It will be difficult to make and document "best interest" recommendations without those materials.

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Fred Reish is a member of the 2016 IA 25 list of the most influential people in and around the industry.

See his most recent blog posts for ThinkAdvisor:

How to Comply With IRA Comp Rules Under DOL Fiduciary

How to Comply With DOL's Best Interest Standard of Care

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