Marcia S. Wagner, Esq. The New Fiduciary Rules: - PowerPoint Presentation

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Marcia

S. Wagner, Esq.

The New Fiduciary Rules:What Do You Need to Know and Do Now?

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Agenda

Rollout of New RuleNew Fiduciary Advice DefinitionExclusions from Fiduciary Advice Definition BIC ExemptionPTE 84-24Fee LevelizationRobo-AdviceRolloversManaged AccountsPractical Considerations 2

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Introduction

Broadening of Fiduciary DefinitionDOL’s new rule would broaden scope of advisors deemed to be IRA/plan fiduciariesTargets broker-dealers (BDs) and registered reps (RRs) earning commission-based compensationWould change IRA marketplaceWould impact registered investment advisers (RIAs) (1) Offering rollover advice and

(2) Managed account programs3

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Rollout of DOL’s New Fiduciary Rule

Rulemaking ProcessDOL proposal published on April 20, 2015New fiduciary rule was finalized on April 8, 2016Includes new “investment advice” definition and related prohibited transaction exemptions (PTEs)Phase-in of New RequirementsNew fiduciary rule becomes effective on April 10, 2017Certain PTE condition are phased in on this date, and other conditions go into effect on Jan 1, 2018

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Existing Fiduciary Definition

Fiduciary StatusCovers person who provides “investment advice” relating to plan assets for compensationNot a fiduciary if no investment advice is given5-Prong Definition for “Investment Advice”Making investment recommendationsOn regular basisMutual understandingPrimary basis for plan’s decisions

Individualized to plan’s needs5

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New “Investment Advice” Definition

Required Context for Investment AdviceAdvisor acknowledges it is acting as a fiduciary under ERISA or IRC, orWritten or unwritten understanding that advice is based on particular investment needs of client, orAdvice is directed to specific person(s) regarding advisability of a particular investment decisionRequired Nature of

Investment AdviceAdvisor makes a “recommendation” for a fee or other direct or indirect compensation6

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“Recommendation” Defined

Covered Recommendations to Plan/IRAOn advisability of investing in property, orRelating to management of property including:- IPS, strategies, portfolio composition- Selection of other persons to provide advice- Selection of account (brokerage vs. advisory)- Transfers or rollovers from Plan/IRA

“Recommendation”Reasonably viewed as suggestion to engage in particular course of action (i.e., call to action)7

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Observations on New Definition

Changes to “Investment Advice”Includes one-time advice (without “regular basis” condition)No need for "mutual understanding” of partiesAdvice may address particular investment needs or a particular investment decision (and does not necessarily need to be individualized)Client only needs to receive advice (which does not need to be “primary basis” for decisions)Expressly revises definition to cover investment management recommendations

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Observations on “Recommendation”

“Hire Me” RecommendationsFiduciary advice only covers recommendations for selection of other persons to provide adviceAdvisor’s “Hire Me” recommendation is not conflicted fiduciary adviceRollover Advice Recommending a rollover distribution is fiduciary adviceCovers rollover advice that does not include any actual investment recommendation

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6 Exclusions from “Investment Advice”

Exclusions from “Recommendations”Platform ProvidersInvestment EducationGeneral CommunicationsExclusions from “Fiduciary” DefinitionSellers to Institutional FiduciariesSwap CounterpartiesPlan Sponsor EmployeesNOTE: Exclusion not apply if the advisor acknowledges its fiduciary status

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Exclusion #1: Platform Providers

Requirements for ExclusionDC Plan recordkeepers may market investment options available through their platforms (without regard to individualized needs)Must disclose that platform does not provide impartial fiduciary advice Can identify options that meet objective criteria (where financial interests are disclosed)Can identify sample list of options based on plan size or current options in response to RFP (where financial interests are disclosed)Can provide objective financial data and benchmark comparisons

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Exclusion #2: Investment Education

Similar to Current Safe Harbor (IB 96-1)Plan InformationGeneral Financial/Retirement InformationAsset Allocation ModelsInteractive Investment MaterialsObservationsExclusion applies to both Plans and IRAsAsset allocation models and interactive materials cannot reference specific options unless- They are subject to oversight of plan sponsor

- Options with similar risk/return are identified- Statement on how more info may be obtained12

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Exclusion #3: General Communications

Definition of “General Communications”Reasonable person must not view as investment recommendationExamplesNewsletters, talk showsSpeeches and conferencesResearch or news reportsMarket dataPerformance reportsProspectuses

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Exclusion #4:

Sellers to Institutional FiduciariesScope of ExclusionCovers advice provided by seller of investment product to Institutional Fiduciary of a Plan/IRAInstitutional Fiduciary has over $50mm in AUM or is a bank, insurer, RIA or BDRequirements for ExclusionSeller informs that it is not providing impartial fiduciary adviceSeller does not receive any direct compensationSeller reasonably believes that Institutional Fiduciary is capable and independent

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Exclusion #5: Swap Counterparty

Conditions for Fiduciary ExclusionCounterparty is swap dealer (or security-based swap dealer) or major swap participantNot acting as “advisor” to plan under Commodity Exchange Act or Securities Exchange ActDoes not receive any direct compensationWritten representation from plan fiduciary that it understands:- Advice is not impartial fiduciary advice- It is exercising independent judgment

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Exclusion #6: Plan Sponsor Employees

Advice from Employee to Plan SponsorExclusion applies if employee does not receive compensation beyond employee’s normal payCarve-out is designed to protect employees from potential fiduciary liabilityAdvice from HR Employee to Co-WorkerHR employee’s duties do not include providing adviceHR employee is not licensed (or required to be licensed) under securities or insurance lawNo compensation beyond normal pay

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Comparison to Proposed Rule

GeneralFinal rule follows structure of DOL’s proposalAppraisals are not fiduciary advice and will be addressed in future (including ESOP appraisals)New fiduciary rule is effective April 10, 2017Clarifications in Final Fiduciary DefinitionFiduciary advice may be limited to one-time advice (subject to Best Interest standards)“Hire Me” recommendation is not fiduciary adviceAsset allocation “Investment Education” for IRAs must not refer to specific investments

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Fiduciary Rule and Exemptions

Need for “ERISA 406(b)” Exemptive ReliefNew “investment advice” definition confers fiduciary status on all types of advisorsProhibited transaction rules ban advisors from earning variable compensation (commissions)Exemption required for brokers and insurance agents, including advisors to IRAsDOL has created Best Interest Class Exemption

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Best Interest Contract (BIC) Exemption

Scope of BIC ExemptionAdvisor can earn variable compensation (such as commissions) for non-discretionary adviceCovered “retail” clients include:ParticipantsIRAs (and HSAs, Archer MSAs and Coverdell)Non-ERISA Plans (e.g., Keogh, Solo Plans)ERISA Plans (with less than $50 million)Observations

No relief for variable compensation arising from discretionary advice19

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Framework of BIC Exemption

4 Alternative Versions of BIC“Full Blown” BIC for IRAs and Non-ERISA Plans“Disclosure” BIC for ERISA Plans“Streamlined” BIC for Level Fee Fiduciaries“Transition” BIC for 2017 Transition PeriodObservationsFirms could potentially rely on “Full Blown” BIC for all retirement clients as of April 10, 2017

If feasible, it may be beneficial to use less onerous BIC versions for different client types20

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“Full Blown” BIC:

IRAs and Non-ERISA PlansRequired Terms for ContractFiduciary standard of careGeneral disclosures for compensation and conflictsGiving specific compensation figures upon requestCompliance policies mitigating conflictsMandatory arbitration with reasonable venue is permitted (but must not limit class action rights)Other RequirementsTransaction disclosures for each investmentFocusing on fiduciary standards and conflicts

1-year relief if advising purchase of same productWebpage focusing on business model and conflicts21

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“Disclosure” BIC: ERISA Plans

GeneralRequirements mirror those for “Full Blown” BICBut no written contract is requiredMust give written statement of fiduciary status and general disclosures on compensation and conflictsList of RequirementsWritten statement and general disclosuresGiving specific compensation figures upon requestCompliance policies mitigating conflictsTransaction disclosures for each investment

Webpage focusing on business model and conflicts22

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BIC Compliance Policies

GeneralRequired for “Full Blown” BIC for Non-ERISA Plans and IRAs and “Disclosure” BIC for ERISA PlansDifferential compensation paid from BD firm to rep must be based on neutral factors tied to services (like time or expertise needed to sell investment)ExpectationsDOL appears to be expecting BD firms to change their payout grid for repsFor example, payouts to rep may vary for different investment categories, but not for similar investments in same category (such as VAs)23

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DOL Notice for BIC Exemption

Required Notice to DOLRequired for “Full Blown” BIC for Non-ERISA Plans and IRAs and “Disclosure” BIC for ERISA PlansOne-time notice must be filed with DOL before firm can rely on BIC ExemptionNotice does not need to identify plan or IRA clientDOL approval is not required24

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“Streamlined” BIC: Level Fee Fiduciary

When Does a Level Fee Fiduciary Need BIC?Offering rollover advice to participants when plan sponsor is existing client, resulting in higher feesOffering rollover advice to “off the street” participantsMoving from commission- to fee-based services (e.g., moving from A share with 25 bps to advisory services for 100 bps)Streamlined BIC RequirementsAdvisor gives written statement of fiduciary status

Advisor documents (internally) reason for rollover recommendation being in client’s best interestNo need for compliance policies or other disclosures25

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“Transition” BIC: All Plan/IRA Clients

Relief from April 10, 2017 to January 1, 2018Beneficial for firms who cannot comply with Full Blown, Disclosure of Streamlined BIC by Apr 10th Numerous BIC requirements are waived for transition period (until Jan. 1, 2018)Simplified BIC RequirementsAdvisor provides written statement of fiduciary status and conflict disclosures (electronic or mail)Designation of person(s) responsible for monitoring compliance (“BICE Officer”) No

need for compliance policies or other disclosures26

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Grandfathered Brokerage Transactions

For Transactions Prior to April 10, 2017BD firms and reps may continue to earn commissions (variable compensation)Grandfathered transaction must not have violated prohibited transaction rules when initially executedCompensation must be reasonableNo grandfathering for new investments sold on or after Apr 10, 2017 in connection with fiduciary adviceObservationsGrandfathering rule is part of BIC Exemption rulesUnclear if ongoing commissions are “reasonable compensation” if no future advice is ever provided 27

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Comparison to Proposed BIC Exemption

Improving Administrative FeasibilityContracts are no longer required for ERISA PlansProjected cost charts and annual fee activity statements are no longer requiredSpecific compensation figures only required upon request (and not required in webpage disclosures)ClarificationsBIC relief required when soliciting rollovers from “off the street” participantsDifferential compensation for reps is permitted only if based on neutral factors

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Observations on BIC Exemption

Regulatory JurisdictionDOL has no enforcement authority over IRAs, but required contract gives authority to clientsViolation of Best Interest fiduciary standard will result in contract breach Impact on BrokersWill regulate advisors without any plan clients (who merely have personal clients with IRAs)May be difficult for firms to eliminate incentives that encourage improper advice29

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Annuity Products and DOL Final Rule

Treatment of Annuity SalesCustomary to earn commissions - Fixed annuities- Fixed indexed annuities (FIAs)- Variable annuities (VAs)Commission-based advisors will be deemed to be fiduciaries under new DOL ruleExemption needed for variable compensationAvailable ExemptionsBICE covers commissions from all annuity types

PTE 84-24 has less onerous conditions, but provides limited relief for fixed annuities only30

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PTE 84-24 and Annuity Sales

Benefits and AdvantagesUpside is that it is much easier to comply with than BIC ExemptionNo written contract or compliance policiesBut does not cover VA or FIA sales to Plans/IRAsNo relief for revenue sharingRequirements for PTE 84-24Conflicts disclosures

Disclosure of commission (repeated annually for ongoing deposits)Client must provide written authorization of annuity purchase and acknowledge disclosures31

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Comparison to PTE 84-24 Proposal

2015 DOL ProposalWhile final version only covers fixed annuities, the proposed version of PTE 84-24 also covered:(1) FIA sales to Plans/IRAs(2) VA sales to PlansInstead of annual disclosures (for ongoing deposits), proposal required them every 3 yearsClarifications in Final Version of PTE 84-24Commission disclosure must break out amounts paid to individual advisor and to firm

Commission must be expressed as flat dollar figure if feasible (and as percentage otherwise)32

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Fee Levelization

De Facto ExemptionFiduciary advisor is permitted to earn transaction-based compensationHowever, it must not vary based on investments selected by plan or IRA clientNo need for exemption because fee levelization eliminates prohibited transaction to begin withExampleChange compensation formula so that it is fixed (e.g., asset-based commission of 50 bps)Eliminate any remaining variable compensation

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Implementing Fee Levelization

Potential Areas of Variable CompensationCommissions and Ticket ChargesRevenue SharingPayments from Funds (e.g., sub-TA payments)Proprietary Products (e.g., sweep vehicle)How To LevelizeNeed appropriate universe of investment products that pay levelized amount (

e.g., 50 bps)Restructure revenue sharing as flat dollar paymentsReplace proprietary products (or fee credit)34

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Robo-Advice

What Is It?Asset allocation advice based on computer modelsRoutinely used for participant-level advice and recommending allocations to plan menu optionsPotentially available for IRA investorsBackground on Computer ModelsMany use Mean Variance Optimization (MVO) based on work of Harry MarkowitzMonte Carlo simulations can help model the probability of different portfolio outcomes

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Computer Model Exemption

HistoryTCW Exemption (PTE 97-60)SunAmerica Opinion (AO 2001-09A)Computer Model Exemption (PPA of 2006)Relief from Computer Model ExemptionAllows receipt of variable compensation (1) Commissions (e.g., 12b-1 fees)

(2) Proprietary FundsAdvice must be non-discretionary and based on computer model36

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Requirements for Computer Model

Computer ModelBased on generally accepted theoriesMust not favor investments that generate more compensation for advisorMust request client’s risk profile informationMust consider all designated investment optionsOther Requirements for ExemptionCertification by investment expertAnnual audits by independent auditorWritten authorization and disclosures

Reasonable compensation for provider37

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Capturing Rollovers

Issues Arising From Cross-Selling Potential conflicts of interestAdvisor develops relationships with plan sponsor and participantsExploiting trust to sell at unfavorable termsPotential Impact on ParticipantsAdvisor’s fees on rollover assets may be higher than fees on plan assets38

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DOL Rollover Opinion

Advisory Opinion 2005-23ABroadly suggests that if advisor is a fiduciary, any rollover advice may trigger prohibited transactionIf advisor is not a fiduciary, rollover advice will not trigger prohibited transactionAdvisor providing “accidental” fiduciary advice would be subject to restrictionsVarity v. Howe (Supreme Court)Fiduciary advisor may communicate to participants in non-fiduciary capacitySuggests that advisor may capture rollovers when acting in separate non-fiduciary capacity

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Effect of New DOL Rule on Rollovers

Impact on Advisory Opinion 2005-23AWould replace DOL’s current rollover guidanceUnder new fiduciary rule, any rollover advice would be fiduciary adviceRollover advice would automatically trigger plan or IRA fiduciary statusRelief under BIC ExemptionCommission-based advisors need “Full Blown” BIC to earn compensation from rollover IRAsFee-based advisors may also need relief under BIC Exemption when offering rollover advice

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Potential Impact on RIAs

Capturing RolloversRIAs advising plan clients generally earn higher (and variable) fees when capturing rolloversMay use “Streamlined” BIC as Level Fee Fiduciaries for rollover IRAsStreamlined BIC may also be used when offering rollover advice to “off the street” participantsRetail Managed Account ProgramsAdvisors earning any variable compensation from IRA/plan clients must comply with BICE

Solicitors would be fiduciary advisors and must also comply with BICE41

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Focusing on Managed Accounts

Impact of DOL RuleRecommending investment manager may be deemed advice relating to “management” e.g., 100 bps for managed account services - 30 bps for Investment Manager #1 - 20 bps for other costs 50 bps net compensation

Recommending a cheaper Investment Manager may increase firm’s net compensationOther Potential Variable CompensationRevenue sharingCommissions and ticket charges 42

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Implications for Managed Accounts

BIC ExemptionMay provide relief for managed account programs with variable compensationBICE does not provide relief for variable compensation arising from discretionary adviceFee LevelizationCombination of BICE and Fee Levelization may be necessaryRestructure revenue sharing payments

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Anticipated Trends in B/D Industry

Strategic Courses of ActionLevelizing commissions and structuring revenue sharing as flat dollar paymentsMore RRs migrating to advisory service modelPromoting advisory programs featuring institutional mutual funds and variable annuitiesModifying managed account programs to rely on BICE and/or fee levelization

Support for Smaller Retirement AccountsReducing minimums for advisory programsRelying on Computer Model Exemption (robo-advice) to earn commissions44

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ERISA Compliance Planning

What You Should Be Doing Right NowIdentify all products/services sold to Plans/IRAsConfirm firm has adequate supervisory controlIdentify all instances of variable compensationDevelop compliance strategies (BICE, PTE 84-24 and Fee Levelization) with ERISA counselTiming“Transition” BIC will require disclosures and BICE Officer designation as of April 10, 2017

“Full Blown” BIC will require contracts for IRA and Non-ERISA Plan clients as of Jan. 1, 2018 (negative consent is permitted)45

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Implementation

BIC Exemption ToolkitCreate model contracts for “Full Blown” BIC and model disclosures for “Disclosure” BICAdopt model Transaction and Webpage DisclosuresAdopt compliance policies to mitigate conflicts Consider changes to payout grid for individual advisors to limit differential compensationDevelop system to ensure specific compensation figures will be available upon demandProvide training for advisors with regard to new fiduciary standard, BIC Exemption and firm’s compliance policies

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Strategic Use of Financial Plans

Benefits Under New Fiduciary StandardAdvice from commission-based advisors will need to meet new fiduciary standardConsider using financial plans to ensure recommendations are in “Best Interest” of clientQuality financial plans by their nature can help demonstrate prudence of adviceBenefits Under BIC ExemptionBIC compliance policies must address conflicts and variable compensation issuesRequiring financial plans (before investments are recommended) can help mitigate conflicts

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Conclusions

Moving to Universal Fiduciary StandardDOL is seeking to impose “best interest” fiduciary standard on all types of advisors to plans/IRAsIrony of Policy GoalsNew regime would effectively create 2 classes of fiduciaries (with or w/o variable compensation)Expected Impact on AdvisorsDOL Fiduciary Rule will affect substantially all advisors because of reach to IRA assets

Costly for broker-dealers and insurance agencies 48

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Important Information

This presentation is intended for general informational purposes only, and it does not constitute legal, tax or investment advice from The Wagner Law Group. Financial advisors and other plan service providers should consult with their own legal counsel to understand the nature and scope of their responsibilities under ERISA and other applicable law.

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Marcia S. Wagner, Esq.

A0205886The New Fiduciary Rules:

What

Do You Need to Know

and Do Now?