The “non-fiduciary advisors” will have to redefine their working relationships with plan sponsors, which could potentially include higher costs as they align with outside fiduciaries, and / or additional paperwork as they disclose the limitations under the new regulations. This will likely prompt many plan sponsors to re-evaluate their current relationships within their 401(k) plans.
Know What’s Coming
To help plan sponsors prepare for the new regulations, we have outlined a number of pertinent changes that are important to plan sponsors.
The DOL is allowing a phased implementation of the final rules, meaning there will be an allowance for all conditions and applications to be met by January 1, 2018. Plan sponsors can update all former contracts during the grace period between June 9, 2017 and January 1, 2018. However, all education requirements and investment advice provisions went into effect June 9, 2017.
Best Interest Contract Exemption
One of the more complex rules under the new regulations is the Best Interest Contract Exemption (also referred to as BICE or BIC). The purpose of this exemption is to allow certain compensation arrangements (such as commissions, 12b-1 fees and revenue sharing) to continue so long as the clients / participants’ best interests are put first. The exemption also requires those advising plan participants to adopt anti-conflict policies and procedures, and to disclose any potential conflicts of interest.
The challenge for plan sponsors is that while revenue sharing and commissions are not banned, they must be fully disclosed by investment advisors who are bound by a fiduciary standard, along with any possible conflicts of interest.
An example of this is an advisor who works for a major insurance brokerage and also offers retirement plan services and investment options. If the advisor is presenting a proprietary solution of service and investment options, all potential sources of revenue and conflicts must be clearly disclosed. In addition, sufficient evidence must be provided that proves all conflicts were clearly understood and that the advisor was comfortable with the solution presented.
Best Interest Standard
The Best Interest Standard rule requires any party providing investment advice to a retirement plan sponsor and its participants to act as a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA). For plan sponsors, this means that advisors must offer advice that is in the best interest of the plan participants and beneficiaries. Any potential conflicts of interest (such as additional commissions or fees) must be fully disclosed. Failure to disclose conflicts could result in participants suing the advisors and plan sponsors who hire them.
Prior to the new DOL regulations, many financial professionals (especially those working for insurance companies and brokerage firms) were held to a lower standard of “suitability.” This allowed them to potentially suggest investment options that met a client’s general needs, but also paid a greater commission, versus acting in the best interest of the participant.
It is the plan sponsor’s responsibility to:
1) clearly understand how advisors and vendors are being compensated; 2) confirm that the compensation is reasonable; and 3) document any potential conflicts of interest. These should be incorporated into all regular plan reviews.
The new rules allow for investment professionals and retirement plan sponsors to provide general retirement savings education without fear of acting in the capacity of a fiduciary. General education is defined as any activity involving plan design, retirement or general financial information. The line between education and advice begins to blur when the education involves specific investment approaches, so plan sponsors should be cautious in that regard.
To illustrate, consider the use of asset allocation models. Many plans offer employees access to asset allocation models if they answer a few questions about their risk tolerance. When providing education, investment professionals should be sure to use hypothetical examples of how asset allocation models work. Any reference to specific investment options or models may result in the investment professional crossing the fiduciary line. Plan sponsors need to consider what level of information is important to them and to their participants, and what (if any) conflicts exist in the delivery of that information.
The act of rolling over a retirement account may change dramatically under the new DOL regulations. It is often recommended that participants roll their money out of their retirement plan and into an IRA. This was previously allowed under the “suitability” standards, meaning that as long as the recommendation met the general needs of the client, the advisor was free to charge a commission or other type of fee. Under the new regulations, advisors must document their intentions to put a client’s interests first in order to charge a commission. This includes disclosing all conflicts of interest, receiving only reasonable compensation, avoiding misleading statements about conflicts and fees, and refusing financial incentives to act contrary to a client’s best interest.
Defining “reasonable compensation” is where it can get tricky. Advisors will be required to have a better understanding of the 401(k) fee structure compared to the IRA they are suggesting for a rollover. Fee awareness will also be important to vendors who have brokerage accounts. Prior to the new rules, if a participant reached out to a call center, the representative could recommend rolling the participant’s money into an IRA at the brokerage under the “suitability” standards. The new rules will require service providers to determine whether or not they will allow their representatives to act as fiduciaries, and then determine what level of information their representative can give to participants.
These changes will likely result in more people leaving their money in 401(k) plans. This will be especially true of terminated participants who do not roll money into new plans and retired individuals with smaller account balances (under $500,000). One positive to this is that more money staying in plans could result in lower fees as distributions and withdrawals are minimized. However, plans may have more terminated people in them, which could lead to a higher level of fiduciary risk because non-active employees may be more likely to sue a plan sponsor if they are not satisfied with the results. This will put more pressure on plan sponsors to ensure their fiduciary practices are well documented.
Trust, but Verify
The new DOL regulations are intended to protect plan participants, but they will require more oversight and administration from plan sponsors. To ensure that fiduciary responsibilities are clearly defined, plan sponsors should take a “trust, but verify” approach. Good advisors and vendors should already have this documentation in place, but it can be beneficial to get an outside review by industry experts (such as the Retirement Plan Advisory Team at SilverStone Asset Management). We encourage plan sponsors to become familiar with these important changes and to contact our investment professionals to help them manage their plans in accordance with the new regulations.
Securities offered through M Holdings Securities, Inc., a Registered Broker/Dealer, Member FINRA/SIPC. Investment Advisory Services offered through SilverStone Asset Management. SilverStone Asset Management and SilverStone Group are independently owned and are not under common ownership with M Holdings Securities, Inc.
This information is provided for educational purposes only and should not be construed as advice. You should discuss your situation with a financial professional before making any decisions. 0363-2017
This article originally appeared in the 2017 | ISSUE TWO of the SilverLink magazine, under the title “Attention Plan Sponsors | New DOL Fiduciary Regulations” To receive a complimentary subscription to the SilverLink magazine, sign up here.