Of the 34 Q&As released, 25 Q&As relate to the "Best Interest Contract Exemption" (the BIC Exemption).
Scope of the BIC Exemption. The BIC Exemption is available for all categories of assets in the retail advice market for plans and IRAs, and for advice to roll over plan or IRA assets or to hire an adviser for a plan or IRA. (Q&A 3)
Discretionary advisers. The BIC Exemption is not available for a transaction if the adviser has discretion to cause the plan or IRA to engage in the transaction. However, the Q&As make the following observations:
- Q&A 6 clarifies that a discretionary adviser to a plan can use the exemption to recommend that a participant roll over assets where the adviser will provide fiduciary investment advice to the participant after the rollover, if the other conditions of the exemption are satisfied.
- Q&A 7 provides that an adviser or financial institution can use the exemption to recommend that a participant roll over assets to an IRA where the adviser will serve as a discretionary investment manager with respect to the rollover IRA, if the conditions of the exemption are satisfied.
- In Q&A 8, the DOL lists other exemptions that might apply to a discretionary adviser in particular circumstances, including PTE 77-4 (relating to recommendations of investments in the fiduciary's or an affiliate's proprietary mutual fund) and PTE 86-128 (permitting a discretionary fiduciary or its affiliates to receive commissions for effecting securities transactions for a plan or IRA)
Compensation of advisers under the BIC Exemption. The BIC Exemption applies to "financial institutions" and the individual "advisers" employed or retained by the financial institutions. These advisers include brokers, insurance agents and other sales personnel who deal directly with retirement advisors. This exemption, however, bans "us[ing] or rely[ing] upon quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause advisers to make recommendations that are not in the best interest of the retirement investor." Q&A 9 provides detailed guidance to financial institutions that want to structure the compensation of their individual advisers to comply with this part of the BIC Exemption.
Compensation grids for advisers should be structured so that firm-level conflicts (e.g., the receipt of differing commission rates from different mutual fund providers) are not transferred to the advisers. For example, advisers may not be paid a fixed percentage of the firm's commissions for selling mutual funds if the firm's commissions are higher for selling some funds than others.
Differences in compensation rates based on "neutral factors" (e.g., the additional time that it takes to explain an annuity investment vs. an investment in a mutual fund) are permissible, provided that the financial institution confirms that the neutral factors actually apply in practice.
An "escalating" compensation grid may also be permissible, where the adviser's percentages are higher with a higher volume of sales. But, such escalating features of compensation grids must be carefully structured to avoid incentives for an adviser not to act in the best interest of the investor. For example, the step increases should be modest and gradual, achieving a target level of sales should not affect commissions earned for previous sales, and the firm must carefully monitor and supervise each adviser's recommendations to ensure that they are in the best interest of the plan or IRA.
Robo-advice. The Q&A confirms that the "full" BIC Exemption does not cover advice provided solely by an interactive website based using computer software-based models to make investment recommendations ("robo-advice"). However, recommendations based on robo-advice are permitted under the level-fee version of the BIC Exemption. (Q&A 10)
Discounts. A financial institution may offer fee or commission discounts to individual clients and still comply with the BIC Exemption. The discounted compensation must satisfy the reasonable compensation standard, and the compensation arrangements as a whole must not re-introduce conflicts of interest. (Q&A 11)
Front-end and back-end bonus payments. Under Q&A 12, "front-end" recruitment bonuses paid by financial institutions to their advisers − including deferred bonuses that are contingent on continued service in good standing − are permissible under the BIC Exemption provided that they do not vary based on recommendations made by the adviser or create inappropriate incentives to the adviser.
Conversely, the DOL takes the opposite view on "back-end" awards based on achievement of sales or asset targets: "financial institutions generally may not enter into such arrangements under the full BIC Exemption." Nonetheless, there is grandfather relief for back-end awards entered into "before the date of this guidance" (i.e., before October 27, 2016), where the financial institution is contractually obligated to make the payments. This grandfather relief is subject to conditions: (i) the financial institution must engage in "stringent oversight" of the adviser, (ii) the period of time remaining under the arrangement must be reasonable and consistent with general industry practices, and (iii) the arrangement must not otherwise violate the conditions of the BIC Exemption, ERISA or the Code.
Level Fee BIC. The guidance explains the streamlined conditions that apply to "level fee fiduciaries" under Level Fee BIC. It notes that if firms or their individual advisers are in doubt about their status under Level Fee BIC, they can obtain certainty by complying with the full BIC Exemption. (Q&A 14)
Pursuant to Q&A 15, financial institution relying on Level Fee BIC may also offer commission-based brokerage accounts, if the commission-based arrangement complies with the full BIC Exemption. It has been reported in the Wall Street Journal (October 26) that Morgan Stanley will offer its retirement investor customers both fee-based commission brokerage arrangements and level fee advisory arrangements.
Advisers and financial institutions may not rely on Level Fee BIC for an account if they receive third party payments (e.g., 12b-1 fees or revenue sharing) in connection with investments made in the account. But, such third-party transaction-based payments can be received if the adviser and financial institution comply with all the conditions of the full BIC Exemption. (Q&A 18)
Level Fee BIC also cannot be used for compensation structures that are limited to the sale of proprietary investment products. A financial institution or adviser recommending only proprietary products may rely on the full BIC Exemption, if the conditions of that exemption are satisfied. (Q&A 19)
Bank networking arrangements. An exception under the BIC Exemption allows banks and bank employees to refer retirement investors to non-affiliated persons who would provide retail non-deposit investment products. In the DOL's view, the exemption is not necessary for referrals to affiliated providers, since marketing oneself or an affiliate to provide advisory services is not a fiduciary recommendation (the so-called "hire me" exception). (Q&A 20)
Annuities. The Q&As addressed several questions regarding the sale of annuities by insurance agents and other advisers. These questions consider issues raised under the BIC Exemption and PTE 84-24. (Q&As 21-23; Q&A 32)
BIC Grandfathering Exemption. The BIC Exemption contains a provision that exempts investments made prior to April 10, 2017, and investments made after that date pursuant to a "systematic purchase program" entered into prior to that date. The DOL confirms that investments made pursuant to an automatic dividend reinvestment program would be considered made under a “systematic purchase program” and thus would be eligible for this grandfather protection under the BIC Exemption for investments made prior to April 10, 2017.
If a retirement investor makes a new investment after the April 10, 2017 applicability date in a pre-existing investment vehicle acquired before that date, the new investment will not be grandfathered and will be required to satisfy all of the conditions of the BIC Exemption. But, Q&A 29 confirms that the new investment will not taint the existing grandfathered investment.
Principal Transaction Exemption. This exemption allows an adviser and financial institution to engage in principal transactions and riskless principal transactions involving certain specified debt instruments, if the conditions of the exemption are satisfied. In Q&A 31, the DOL indicates that upon request it will consider extending the Principal Transaction Exemption to certain other assets by granting individual or class exemptions.