The IRS and Treasury Department have said they won’t enforce the fiduciary advice prohibited transactions during the transition period – as long as the requirements of the DOL non-enforcement policy are met. Fred Reish looks at what that means.
In his most recent “Interesting Angles” blog post (No. 48, if you’re keeping count), Reish notes that the non-enforcement policy, as outlined in Field Assistance Bulletin [FAB] 2017-02), provides that the DOL will not enforce the fiduciary standard or the exemptions during the transition period (from June 9 to Dec. 31), so long as the Financial Institution is making diligent and good faith efforts to comply.
That said, Reish also cautions that the failure to make diligent and good faith efforts to comply will result in the loss of the benefit of the non-enforcement policy.
Recommendation Evaluation
Reish explains that beginning on June 9, recommendations of investment or insurance products or services to qualified accounts must be evaluated two ways.
1. Is the Recommendation Prudent and Loyal?
Recommendations to ERISA-governed retirement plans and participants (including rollover recommendations) are subject to ERISA’s prudent man rule and duty of loyalty. ERISA protections apply, and claims can be asserted based on breaches of the fiduciary rule. Retirement plan advisors should be familiar with this. However, IRAs (other than SEPs and SIMPLEs) are not governed by ERISA and, therefore, the fiduciary standard does not automatically apply. However, it’s not that simple. Keep reading.
2. Does the Recommendation Result in a Prohibited Transaction and, if so, Are the Conditions of an Exemption Satisfied?
Reish explains that any fiduciary recommendation that results in a payment from a third party (such as a mutual fund or an insurance company) or increases the compensation of the adviser or financial institution is a prohibited transaction, and thus an exemption will be needed. The two most common exemptions are 84-24 (which applies to annuities and insurance products) and the Best Interest Contract Exemption, or BICE. Both require that the adviser adhere to the Impartial Conduct Standards, though 84-24 has other requirements, including disclosure compensation and written approval by the retirement investor. Those Impartial Conduct Standards are:
- The best-interest standard of care (which is, in its essence, a combination of ERISA’s prudent man rule and duty of loyalty).
- The financial institution and the adviser can receive no more than reasonable compensation.
- The adviser and financial institution cannot make materially misleading statements.
IRA Effect?
That first standard means that the exemption effectively imposes a fiduciary standard of care. Failing that, the exemption is lost and any compensation paid to the financial institution and adviser must be restored to the investor’s account. As a result, Reish concludes that even though IRAs are not subject to ERISA’s prudent man rule, the exemption has the same effect as if advice to IRAs were subject to ERISA.
Ultimately, Reish notes that financial institutions (including broker-dealers, RIAs, banks and trust companies, and insurance companies) need to institute policies and procedures for compliance with these rules, including training of their representatives about how to satisfy the duties of prudence and loyalty.
