COMPLIANCE & ETHICS FORUM FOR LIFE INSURERS
The Best Interest Contract Exemption
Practice ImplicationsWhy is an Exemption Needed?
•
The Prohibited Transactions Rules:
– Under the existing rules, transactions between an ERISA plan or an IRA and certain “parties in interest” (as defined in ERISA) or
“disqualified persons” (as defined in the Internal Revenue Code) are prohibited and trigger excise taxes or other penalties absent an
exemption.
– Fiduciaries and other service providers to plans and IRAs constitute “parties in interest” or “disqualified persons” under these rules.
•
Prohibited Transaction Exemptions:
– Several existing prohibited transaction exemptions cover various types of sales and services transactions between plans or IRAs and service providers with respect to the plans.
– However, those exemptions often do not cover the fiduciaries causing or advising the plans or IRAs to engage in the transactions.
Reasons for the BIC Exemption
•
Under the new definition of investment advice, many Advisers
who make recommendations to plans or IRAs will be considered
fiduciaries with respect to those plans and IRAs.
– Under the existing rules, the Financial Institutions that employ or are represented by Advisers often would be considered service providers to the plans or IRAs, but neither the Financial Institutions nor the
Advisers would be considered fiduciaries.
– A primary purpose of the new rules is to trigger fiduciary status for such Advisers and Financial Institutions, especially in connection with
recommendations to IRAs.
•
As noted above, the existing prohibited transaction exemptions
relating to sales and services transactions typically do not cover
the fiduciaries recommending the transactions.
•
Thus, many newly-characterized advice fiduciaries will need to
rely on the BIC Exemption to avoid liability for engaging in
non-exempt prohibited transactions.
Changes from the Proposal
•
Covered Assets:
– The list of assets covered by the BIC Exemption has been eliminated. Note, however, that Advisers and Financial Institutions are admonished to use special care when recommending complex, illiquid, hard to value or high risk investments.
•
Written Contract Requirement:
– The written contract requirement was retained for IRAs but eliminated for ERISA plans.
– As described below, however, numerous disclosure requirements still apply with respect to ERISA plans.
•
Timing of Contract Requirement
– Although the new rules generally are effective April 10,2017, the written contract requirement does not become effective until January 1, 2018.
Impacted Parties
•
Adviser
– A fiduciary of a plan or IRA solely by reason of providing investment advice, who is an employee, independent contractor, agent, or
registered representative of a “Financial Institution.”
•
Financial Institution
– The entity that employs the Adviser or otherwise retains such individual and that is a registered investment adviser, bank, insurance company or U.S. registered broker-dealer. Note that the definition of insurance company in the exemption is flawed and will need to be revised.
•
Retirement Investors
– (1) A plan participant with authority to direct the investment of his or her plan assets or to take a distribution; (2) an IRA owner acting on behalf of the IRA; or (3) a plan fiduciary that is not an expert as described in the regulation defining fiduciary.
Conduct Standards
•
Best Interest Standard
–
Generally requires the Adviser and Financial Institution to act in
accordance with the ERISA prudent man standard, based on
the investment objectives, risk tolerance, financial
circumstances, and needs of the Retirement Investor, without
regard to the financial or other interests of the Adviser,
Financial Institution or any affiliate, related entity, or other party.
•
Reasonable Compensation
–
Compensation cannot be in excess of “reasonable”
compensation.
•
No Misleading Statements
–
The Adviser’s and Financial Institution’s statements regarding
compensation and conflicts of interest cannot be misleading.
Written Policies and Procedures
•
The Financial Institution must maintain written
policies and procedures:
–
designed to ensure compliance with the conduct
standards;
–
that identify material conflicts and contain measures
designed to prevent the conflicts from causing
violations of the conduct standards; and
–
that require the Financial Institution to not rely on
incentive arrangements that would be expected to
cause Advisers to make recommendations that do not
comply with the Best Interest Standard.
Maintenance of a Web Site
•
The Financial Institution must maintain a web site
that contains:
–
A discussion of the Financial Institution’s business model
and material conflicts of interest
–
A schedule of typical contract fees
–
A model contract and required disclosures;
–
A written description of the Financial Institution’s policies and
procedures
–
If applicable, a list of all product manufacturers and third
parties who pay compensation to the Financial Institution
–
Disclosure of the compensation and incentive arrangements
for the Advisers
Written Disclosures
•
Disclosures must include:
–
Statement of the Best Interest Standard
–
Description of material conflicts of interest, including
compensation
–
Means to obtain the Financial Institution’s policies and
procedures
–
Link to web site
–
Information about proprietary products
–
Contact person for concerns
–
Whether the adviser will monitor the recommended investment
•
May be delivered in person, electronically or
by mail
Proprietary Products
•
Additional requirements apply if the Adviser sells
proprietary products:
–
Disclosure of the limitations on recommendations and
conflicts of interest
–
The Financial Institution must document its conclusions that
the sale of proprietary product will not cause its Advisers to
receive in excess of reasonable compensation or to
recommend imprudent investments
–
The Financial Institution must maintain certain policies and
incentive practices
–
Compensation must be “reasonable”
–
The recommendations must meet the prudent man standard
and must not be based on any considerations other than the
needs of the Retirement Investor
Contracts for IRAs
•
Statements that must be included:
–
Fiduciary status of Advisor
–
Compliance with the Best Interest Standard
–
Reasonable compensation
–
No materially misleading statements
–
Warranties regarding compliance with certain standards
•
Signed by IRA owner and Financial Institution
•
Required beginning January 1, 2018
•
No provisions limiting class actions
Level Fees
•
Generally no prohibited transaction if fees are
level
•
Prohibited transaction could occur if Advisor
recommends:
–
moving to a level fee; or
–
rolling money from a plan to a fee-based account.
•
Conditions for Relief (if necessary):
–
Written statement of fiduciary status by Advisor
–
Compliance with the conduct standards
–
Documentation of the reasons that the advice meets the Best
Grandfather Relief
•
Applies to compensation paid in connection with
advice provided prior to April 10, 2017
•
Conditions:
–
Applicable arrangement has not expired;
–
Investment did not constitute a non-exempt prohibited
transaction at time made
–
Compensation does not relate to new investments
–
Compensation is “reasonable”
–
Any recommendations made after April 10, 2017 meet
the Best Interest Standard
Disclosure to the DOL and Recordkeeping
Requirements
•
Prior to relying on the exemption, the
Financial Institution must notify the DOL that
it will rely on the exemption
•
The Financial Institution must maintain
certain records that demonstrate compliance
with the exemption
Applicability Date
•
Generally April 10, 2017
•
IRA contract requirement and policy and
procedure requirement not applicable until
January 1, 2018
Compliance & Ethics Forum for Life Insurers www.cefli.org
