Transitioning to the Transition BIC

For the rest of this year – the “transition period” – most firms will use either the Best Interest Contract Exemption or (more likely) the “transition” version. What will that mean for you?

In his latest blog post, noted ERISA attorney Fred Reish reminds that, following the Labor Department’s delay in applicability date, the new fiduciary definition applies on June 9. At that point, fiduciary recommendations (including recommendations regarding investments, investment strategies, investment managers, distributions and rollovers to ERISA plans, participants or IRA owners) to plans and participants (including rollover recommendations) will be subject to ERISA’s prudent man rule and duty of loyalty and, therefore, any breaches can be enforced as ERISA claims – though not recommendations to IRAs, because, Reish notes, the law does not establish a prudent man and duty of loyalty standard of care for advice to IRAs.

As a result, he notes, if an adviser provides fiduciary services to an IRA for a level fee (for example, 1% per year and no other benefits or compensation is received), the adviser will be subject to the standard of care established by the securities laws. But if the adviser (or supervisory entity, e.g., a broker-dealer) receives compensation that is a prohibited transaction (e.g., commissions, 12b-1 fees, asset-based revenue sharing, etc.), the adviser and the supervisory entity will need the protection of a prohibited transaction exemption.

That’s where – at least during the transition period – Reish anticipates that most firms will use the “transition BICE,” which requires that the entity and the adviser only comply with the Impartial Conduct Standards (ICS). As has been pointed out previously, the ICS has three components:

  • the best interest standard of care;
  • only reasonable compensation; and
  • no materially misleading statements.

In effect, this best interest standard of care brings the ERISA prudent man rule and duty of loyalty to IRAs. That means that advisers and their supervisory entities need to educate themselves on the requirements of a prudent process with a duty of loyalty to the IRA owner. The suitability and know-your-customer requirements are, of course, part of that – but only part, according to Reish.

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Reish highlights some other things to consider:

  • The DOL has historically taken the position that a prudent process must be documented. How will advisers be doing that?
  • Under ERISA, advisers to plans must consider the costs of the investments, a standard that Reish says is likely to be extended to IRAs under the best interest standard. How will advisers to IRAs evaluate the expense ratios of recommended mutual funds and the expenses imbedded in annuities? Will the entities (e.g., broker-dealers) be specifying which software is to be used for that purpose?
  • Under ERISA, the quality of the mutual funds must be considered, both quantitatively and qualitatively. What will that process look like for IRAs, and how will it be documented?

But for now, Reish notes that beginning on June 9, advisers and their supervisory entities must understand and apply these concepts – and considering that the deadline is right around the corner, these are high priority issues.

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