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  • Home>Practice Management>Fiduciary Focus>The Ins and Outs of the DOL’s Best Interest Contract Exemption

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    The Ins and Outs of the DOL’s Best Interest Contract Exemption

    The BICE gives some advisors a broad mandate in how they want to be compensated. Here's what you need to know.

    W. Scott Simon, 03/02/2017

    By the time you read this month's column, we may (or may not) know the ultimate fate of the Conflict of Interest Rule (Rule) which was issued by the U.S. Department of Labor (DOL) on April 8, 2016. With an "applicability date" of April 10, 2017, the best guess as of this writing is that the Rule will remain in limbo for another six months or so, after which time it will be left as is, modified in some way, or outright extinguished. 

    In the meantime, I'll continue my analysis of the Rule as it was written for applicability on April 10. 

    The Best Interest Contract Exemption
    Under the Employee Retirement Income Security Act of 1974 (ERISA), fiduciaries cannot (1) breach the fiduciary duties they owe to plans and plan participants (and their beneficiaries), or (2) engage in prohibited transactions involving self-dealing or receive compensation from third parties for transactions involving a plan or IRA assets. 

    The Best Interest Contract Exemption (BICE) allows fiduciaries to receive variable compensation which ordinarily violates the prohibited transaction rules, since any investment advice rendered could be affected adversely by receipt of this kind of compensation. Such compensation includes: (1) commissions paid by a plan, a plan participant (or its beneficiaries), or an IRA, and (2) sales loads, 12b-1 fees, revenue-sharing or other payments, and commissions from third parties providing investment products.

    The BICE, which is a key feature of the Rule, allows advisors a broad mandate in how they want to be compensated. Everything is hunky-dory in this respect as long as an advisor promises to act in a client’s best interest, is prudent and loyal (two critical fiduciary duties), and doesn’t charge unreasonable compensation.

    Remember, though, that the BICE is not available to fiduciaries that receive variable compensation in exchange for rendering discretionary investment advice pursuant to ERISA section 3(21)(A)(i). For example, assume that an ERISA section 3(38) investment manager (a "kind" of ERISA section 3(21)(A)(i) plan fiduciary) has the power to invest IRA assets without approval from the IRA owner. If the manager earns any compensation, it would violate the prohibited transaction rules. And the manager couldn't obtain protection from the BICE because it’s providing discretionary--rather than non-discretionary--advice.

    The Rule, then, is not concerned with discretionary fiduciaries but with non-discretionary ones pursuant to ERISA section 3(21)(A)(ii). All three elements described in that section--a fiduciary (element 1) that renders (non-discretionary) investment advice (element 2) for compensation (element 3)--must be present in order for the Rule to apply to an advisor communicating with a plan participant or an IRA owner.

    Only Financial Institutions May Utilize the BICE
    Only eligible Financial Institutions may utilize the BICE in rendering investment advice to retail retirement investors. The Rule defines “Financial Institutions” as (1) registered investment advisors (the commonly used term rather than the legal term of "adviser"), broker/dealers, banks and insurance companies; and (2) their respective employees, contractors, agents, representatives, affiliates and related entities. "Retail retirement investors" are defined as (1) ERISA plans (holding less than $50 million in assets; i.e., unsophisticated investors), (2) plan fiduciaries and plan participants (and their beneficiaries), (3) non-ERISA plans such as Keogh plans, IRAs, IRA fiduciaries, HSAs, Archer medical savings accounts and Coverdell education savings accounts.

    W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understandingis the definitive work on modern prudent fiduciary investing.

    Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

    For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

    The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.