Navigating sales incentives will be among the toughest parts of abiding by the Department of Labor’s investment advice rule.
That is one of the tricky aspects identified by a panel discussing “Prohibited Transaction Exemption 2020-02: Registered Broker Dealer Compliance Considerations” presented by LIMRA, LOMA and SRI on Wednesday.
Panelist Fred Reish, an ERISA expert with Drinker Biddle, said sales contests will be particularly difficult for broker-dealers to sustain under the DOL’s prohibited transaction exemption 2020-02.
“You can bet that it'll be pretty closely scrutinized,” Reish said of sales contests. “You really want to make sure that you have all your ducks in a row in terms of compliance and supervision. … How can we manage this to make sure the recommendations are in the best interest of the participant, as opposed to the investment professional achieving something, compensation, within the context of the sales contest? So, they're dicey.”
Broker-dealers and other distributors are scrambling to understand how to work with PTE 2020-02 before the enforcement grace period ends on Dec. 20, although the exemption went into effect on Feb. 16.
The rule was expected to align with the Securities and Exchange Commission’s Regulation Best Interest. Distributors and experts have been trying to understand what they should focus on to ensure compliance.
'The Incentive Effect'
Although the DOL has issued FAQs for PTE 2020-02, sometimes the department has deepened the mystery with some of its pronouncements.
One of the differences that has become clear is that the DOL rule in many respects is closer to ERISA’s prudent person rule than Reg BI, such as with the DOL’s best interest standard of care, Reish said. That is one of the reasons that distributors who follow the SEC’s rule should not assume that they are meeting the DOL rule by default.
In the case of sales contests, for example, distributors will have to show they are mitigating conflicts of interest, which is more prominent in the DOL rule.
“I worry about that, because Reg BI doesn't have a definition of mitigation,” Reish said. “But the DOL rule basically says you have to dampen the incentive effect, and in a way that makes you think they're expecting considerable, serious, dampening of the incentive effect.”
Broker-dealers might find they have to keep compensation to a narrow range for the products on their shelf, which likely means fewer products available to sellers. That would help show that compensation was not likely to play a role in selecting one variable annuity over another.
This gets tricky when the consumer’s choice affected whether the seller got paid or not, or an “all or nothing” scenario.
“Certain things cry out for heightened supervision, for example, rollovers, because that's an all or nothing scenario,” Reish said. “The money stays in the plan, you might make nothing on it. But if a rolls to an IRA, then you will make money on it. I would pay particular attention to those all or nothing types of scenarios as requiring a really robust process, good supervision.”
The balance might be difficult to strike, he said. To be completely sure they were erring on the side of caution, a distributor could be so conservative that it could interfere with doing business.
“I don't think we're ever going to get to a bright line comfort level where I'm on this side of the line,” Reish said. “It's going to be looking at the various factors: how compensation is managed, what kind of process you require for a certain recommendation, asset allocation, rollover.”
Reasonable Person Judgment
The rule of thumb remains a reasonable person judgment of whether a distributor’s process is reasonably designed to mitigate conflict of interest and to produce the best recommendation.
Reish acknowledged that following some of the rules by the letter can induce a bit of heartburn, Reish said of required written disclosures.
“For example, a written disclosure by the broker-dealer and the investment professional is that they are fiduciaries, which I imagine is giving folks quite a bit of indigestion,” Reish said, “because one of the things that can be difficult to determine in a particular case is whether you're a fiduciary or not. But then, upfront, you've got to make a declaration in writing, they are a fiduciary.”
The webinar was the second of five that LIMRA, LOMA and SRI is presenting to clarify the DOL rule and the exemptions, particularly as the department issues FAQs.
Steven A. Morelli is a contributing editor for InsuranceNewsNet. He has more than 25 years of experience as a reporter and editor for newspapers and magazines. He was also vice president of communications for an insurance agents’ association. Steve can be reached at [email protected]
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