Undisclosed 12b-1 Fees: DOL Versus SEC

On Feb. 12, 2018, the SEC announced a remedial program called the “Share Class Selection Disclosure Initiative.” Are there consequences under the DOL fiduciary rule where an investment adviser receives undisclosed 12b-1 fees?

That’s the focus of the most recent “interesting angle” post from ERISA attorney Fred Reish, in which he looks at the consequences under the fiduciary rule (which he reminds readers became applicable on June 9, 2017) for advisory services to IRAs.

Where a fiduciary adviser has discretion — that is, where the adviser is actually managing the account — Reish notes that the adviser can only receive his or her stated fee. More specifically, they cannot receive anything in addition to the advisory fee that results from the adviser’s investment decisions. Reish reminds us that the Best Interest Contract Exemption (BICE) does not provide an exemption, or exception, for discretionary investment management; it only applies to non-discretionary investment advice. To further complicate matters, Reish explains, the fiduciary rule prohibits the receipt of additional 12b-1 fees for discretionary investment management regardless of whether those fees are disclosed or not.

So, can an advisor (adviser under the term adopted in the fiduciary regulation) deal with the situation? Reish explains that, to the extent that a discretionary fiduciary adviser receives additional payments (e.g., 12b-1 fees), he/she must either offset those payments against the advisory fee — on a dollar-for-dollar basis — or pay the 12b-1 fees over into the IRA. As a result, Reish says, the fiduciary rule is more demanding for discretionary investment management than are the SEC rules.

Non-Discretionary Advice

So, what about non-discretionary investment advice? Reish notes that before the effective date of the fiduciary rule (June 9, 2017), the receipt of any additional payments for non-discretionary investment advice would have been treated the same as the receipt of additional payments for discretionary investment management — which is to say, it would have been prohibited). Now under the transition BIC, he explains that a fiduciary adviser can receive compensation in addition to the advisory fee “so long as the adviser’s total compensation is reasonable” (and assuming that the adviser’s BD/RIA has policies in place such that that additional compensation doesn’t provide inappropriate incentive to make recommendations not in the best interest of the investor, though Reish acknowledges that the condition is not well defined).

At this point, Reish notes that that assumes that the additional compensation was disclosed, which is different than the SEC’s SCSD Initiative, which was designed to provide correction and reporting of the failure to disclose the receipt of additional 12b-1 fees. Reish thinks that in that situation, the DOL would, similar to the SEC, take the position that, if the retirement investor had not authorized the payment of the additional 12b-1 fees, the fiduciary adviser was setting his own compensation without the owner’s approval, and that the receipt of those payments would be a prohibited transaction unprotected by the BICE.

Reish views the DOL fiduciary rule for non-discretionary advice as “similar to the SEC’s, but still more demanding.” He explains that even if the additional 12b-1 fees were disclosed, the fiduciary rule and BICE require that the total compensation be reasonable — and if they weren’t disclosed, he writes, there is a good chance that the fiduciary rule and BICE would be interpreted in a way that results in the 12b-1 fees being prohibited transactions.

When all is said and done, Reish concludes that fully disclosed compensation, if reasonable, is permissible under the fiduciary rule and under the exemptions for non-discretionary investment advice. Secondly, he notes that the receipt of additional amounts, such as 12b-1 fees, is prohibited where the adviser has discretion to manage the account, even if the total compensation is reasonable.

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