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What is the Fiduciary Standard of Care?

In the third of his four-part series on questions raised by the 5th U.S. Circuit Court of Appeals' decision to vacate the DOL fiduciary rule, noted ERISA attorney Fred Reish examines the fiduciary standard of care.

In his most recent blog post, Reish explains that, for purposes of advice to retirement plans and participants, the answer is simple: it’s ERISA’s prudent man rule and duty of loyalty. That standard is statutory and, as a result, it cannot be modified by rule or regulation — by the DOL or SEC, he writes.

Noting that there is a large amount of guidance, both from the DOL and the courts, on how to comply with the standard, he acknowledges that those standards only apply if an advisor is a fiduciary.

Things are more complex for fiduciary advice to IRAs. Reish explains that where an advisor to an IRA owner does not engage in prohibited transactions — for example, charges a reasonable level fee (and the advisor, supervisory entity and all affiliated and relates parties do not receive anything in addition to that fee), there is not a prohibited transaction. “As a result, neither the IRS nor the DOL have a basis for further regulating the advisor,” says Reish. On the other hand, where an advisor (or the supervisory entity, or any affiliated or related party) receives conflicted compensation, that would be a prohibited transaction and an exemption would be needed, he adds.

Generally speaking, there are two forms of conflicted compensation. The first, and most common, is any payment from a third party (for example, a 12b-1 fee from a mutual fund or a commission from an insurance company). The second is sometimes referred to as “variable” compensation (for example, a commission on each recommended transaction in a brokerage account).

Prior to the 5th Circuit decision, Reish writes, the primary exemption for those conflicts was the Best Interest Contract Exemption (BICE), which permitted conflicted compensation if the advisor and the supervisory entity (e.g., a broker-dealer) adhered to the best interest standard of care (and other Impartial Conduct Standards). However, the 5th Circuit threw out not only the fiduciary regulation, but the BICE as well.

Reish opines that the Labor Department will likely issue a new exemption to replace BICE, along with conditions, although what those will be remains to be seen. And he writes that its possible that some standard of care would be imposed — perhaps even the new standard that the SEC was working on (and just published).

One thing is certain, according to Reish: The limitation for reasonable compensation will be a requirement of the exemption, since it’s a statutory provision in both the Internal Revenue Code and ERISA.

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