Dealing with Differential Comp Under the Fiduciary Rule

In a new blog post, ERISA attorney Fred Reish deals with the new rules around differential compensation under the Labor Department’s fiduciary rule.

Reish notes that the DOL’s fiduciary “package” (as he terms it) consists of a regulation that expands the definition of advice and exemptions, or exceptions, from the prohibited transaction (PT) rules. If a recommendation by a fiduciary adviser does not affect the adviser’s compensation, or that of an affiliate, and does not cause a payment from a third party, then no exemption is needed. If it does, Reish reminds us that an exemption must be used – and most often, that will be a Best Interest Contract Exemption (BICE).

Under the BICE, the compensation of broker-dealers can be “variable,” but must be “reasonable,” which Reish notes means that they can receive different payments from different product providers (e.g., mutual funds), as long as the total compensation received by the broker-dealer is reasonable relative to the services provided to the particular plan, participant or IRA owner. The rules for compensating advisers are similar because the compensation of the adviser also must be reasonable (relative to the services that the adviser is providing to the plan, participant or IRA owner in the first year and in succeeding years). But, from that point on, the rules are different, he says.

Reish notes that the starting point for understanding the other rules for adviser compensation is to determine “reasonably designed investment categories” – an investment product or service that, when properly analyzed, should produce a certain level of compensation for the adviser’s services. As an example, he notes that nondiscretionary investment advice about mutual funds probably involves a different set of services and complexity than investment advice about individual variable annuities.

Once that has been done, Reish says that you need to understand that within a particular investment category, the adviser’s compensation must be level.

What if some categories require more work or services than other categories? The Department of Labor says that it is permissible to pay differential compensation among reasonably designed investment categories, as long as the differences are based on neutral factors. Reish notes that the key to understanding these concepts is to realize that the “neutral factors” differential compensation is not a dollar amount. Rather, he argues that it is a ratio established, for both the first and each subsequent year, between the different categories of investments. Where the relative compensation to the adviser for different reasonably designed investment categories could vary according to those ratios, compensation must still be reasonable, he says.

What that boils down to is that an individual adviser’s compensation must be “reasonable,” “level” within an investment category, and “neutral” in differences between investment categories.

All (with some exceptions) by April 10.

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