The Investment Advice Rule has two main parts: a new prohibited transaction exemption allowing advisors to provide conflicted advice for commissions; and a reinstatement of the "five-part test" from 1975 to determine what constitutes investment advice.
In an October bulletin, the DOL announced a six-week delay of "prohibited transactions claims against investment advice fiduciaries who are working diligently and in good faith to comply with the Impartial Conduct Standards for transactions that are exempted in PTE 2020-02."
That delay expires Feb. 1 and advisors need to be aware of compliance traps associated with the impartial conduct standards. They include: a best interest standard, a reasonable compensation standard, and a requirement to make no materially misleading statements.
Faegre Drinker experts held a virtual panel discussion recently on the biggest mistakes they see clients making. Eleven of them, in fact.
Mistake #1: Failure to recognize “implied recommendations.”
It all depends on the circumstances of each client as to the significance of the communications, explained Joshua Waldbeser, partner with Faegre Drinker.
Basic education on retirement plan rollover options is permissible, but advisors must adhere to objectivity, the panel noted.
"Basically, the more individualized the communication is, and the more you are analyzing data, the more likely it is to be a recommendation. The more likely it is to be advice," Waldbeser said. "The more generic it is, and the more you're just presenting objective information, the less likely it is to be a recommendation."
Mistake #2: Not realizing that a rollover includes IRA to IRA transfers, and more.
There are several different transactions, such as retirement plan to retirement plan transfers, that are the same as regular rollovers, the panel noted. That means they must comply with best-interest standards, said Fred Reish, partner with Faegre Drinker, with disclosure of conflicts and so on.
"If you recommend to transfer from an IRA to a plan, and you're the advisor for the plan, and you're going to make fees off the plan, that is a fiduciary recommendation with a conflict of interest," he said.
Mistake #3: Not realizing that IRA has a meaning broader than Individual Retirement Account.
The definition of IRA is very broad, explained Joan M. Neri, counsel for Faegre Drinker, and includes not only what we always think about individual retirement account, but also an individual retirement annuity, an Archer medical savings account, a health savings account, and a Coverdell education savings account.
"So all of these types of accounts, the breadth of these definitions have to be kept in mind when looking at your operating procedures and trying to determine which rollover recommendations are prohibited transactions," she added.
Mistake #4: Not realizing when a prohibited transaction occurs.
If you provide fiduciary advice that results in compensation to you, or an affiliate, that would not have resulted absent the advice, then a prohibited transaction has occurred.
"It's important to recognize here that we're talking about fiduciary advice causing additional compensation," Waldbeser stressed.
Mistake #5: Not realizing that conflicts must be mitigated.
When it comes to an IRA to IRA transfer, conflicted advice is mitigated through a deliberate process, Reish explained. And it includes collecting investor information, information about the investor's present IRA plan, consideration of other investments and services, and an analysis of old IRA statements to perform a best-interest analysis.
Come July, there will be another step, Reish said, to put into writing the reasoning behind the recommendation you make.
"Well, that's also a pretty good mitigation technique, because a participant will look at them and say, I agree or I don't agree with the reasons for the transfers," Reish said.
Mistake #6: Using a deficient fiduciary acknowledgement.
New rules require a clear written statement that the firm and the advisor are fiduciaries under ERISA law. This is a simple disclosure that can be handled a number of ways, the panel agreed, but should not be overlooked.
Mistake #7: Failing to assess reasonableness of compensation.
There are two points to consider when it comes to compensation, Neri said. One, the compensation to the advisor handling the rollover must be based on what other advisors are receiving for doing commensurate transactions. Many firms are employing a benchmarking analysis to come up with this number.
Secondly, "I think some firms forget that is that the fee is also part of the best-interest analysis," Neri said. "You're supposed to be comparing the fees, the services, the investments in the plan and comparing those to the IRA. And part of that comparison of fees needs to take into account the fees you intend to charge in the IRA."
Mistake #8: Basing the best interest recommendation on what the investor prefers.
As he advises clients, Reish said he is hearing some form of decisions being what "the investor prefers," and that will not be an acceptable answer to a regulator's question.
"You need to get away from preferences and talk about why you as a firm and as an advisor, believe that recommendation is in the best interests of that particular individual based on their circumstances," Reish said.
Mistake #9: Forgetting that the best interest analysis includes costs.
Some advisors are "forgetting that there's other aspects to this that need to be evaluated and reshape the best interest analysis," Neri said. "You do have to show that you considered costs. And as I said, you have to consider your fees as part of that analysis. Look beyond that, and look at the services and other features you're providing that outweigh those costs."
Mistake #10: Not making diligent and prudent efforts to obtain all information.
The rule requires "diligent and prudent" efforts to obtain the necessary information to support a best-interest recommendation. Things like the investor's current circumstances, as well as detailed information of a plan's investments, services and expenses.
"Unfortunately, I'm seeing a fair number of people just read those words, 'diligent and prudent,' right out of the rule," Reish said. "Like, 'I asked for it and he didn't give it to me, therefore, I'm going to use other data.'"
The question is how far does an advisor have to go to get the information from a reluctant investor? The DOL doesn't answer that question.
"At the very least, you have to give an admonishment to the participant saying, 'You know, if you don't give me that information, I'm going to have to go with information like averages or outdated information," Reish said. "And that could affect the quality of the recommendation I give you.'"
Mistake #11: Failure to document the best-interest process.
"Does the DOL under the PTE [prohibited transaction exemption] require that every recommendation be documented thoroughly? No, absolutely not," Waldbeser said.
"But it does indicate that when you're talking about things like rollovers or other very material recommendations, or recommendations that are might be particularly complicated, even if only as a risk management step, you may want to document that."
InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected] Follow him on Twitter @INNJohnH.