The focus of this alert is the prohibited transaction exemptions (PTEs) — PTE 84-24 and the Best Interest Contract Exemption (BICE) — that are available to broker-dealers when their registered representatives recommend annuities to IRA investors. The purpose is to address the factors that firms may want to consider in deciding which exemption to use during the “transition period,” currently scheduled to end on December 31, 2017.
We think, however, that there is a good possibility the transition period will be extended beyond the end of this year. At this point, it seems likely that the DOL will propose changes to the fiduciary rule and exemptions. As a practical matter, this means the transition period will be extended, probably to the end of 2018 and possibly even longer.
Since firms and their advisors will need to live with these rules for some time — and since we have no clear idea what the final rules will look like — it’s important to focus on compliance with rules that we do know.
Broker-dealers may decide to use either PTE 84-24 or BICE for the sale of annuities during the transition period, and each has its pros and cons. The following chart summarizes the most important requirements of each exemption (note that the requirements may change after the transition period) and helps illustrate the similarities and differences:
Click here to view table.
Annuity Distributions Under the Fiduciary Rule
All recommendations of annuities to IRA investors are fiduciary investment advice. Recommending to an individual that he or she take a distribution from an IRA — including a rollover — to purchase an annuity is also advice, as is recommending an annuity purchase with required minimum distributions beginning at age 70 1/2. Where the advisor and firm receive a commission or other compensation for the annuity sale, they must rely on a prohibited transaction exemption. This means that either PTE 84-24 or BICE must be satisfied.
Since both exemptions impose the impartial conduct standards (acting in the best interest of the client, receiving no more than reasonable compensation, no misleading statements), these standards will need to be met regardless of which one is used. Broker-dealers may wish to read our previous alert on annuity and insurance distribution for independent insurance agents, which covers the key considerations for meeting the best interest standard.
However, unlike independent insurance agents, who must rely on transition 84-24, broker-dealers are “financial institutions” that are eligible to rely on BICE — that is, broker-dealers have a choice.
Why a Broker-Dealer Might Use Transition 84-24
When the DOL issued the fiduciary rule and BICE in 2016, it also proposed amendments to PTE 84-24 (we refer to this 2016 version of PTE 84-24 as “Amended 84-24”). As part of the regulation delaying the Rule’s applicability date from April 10 to June 9, the DOL postponed most requirements of Amended 84-24 until the end of the transition period, with one exception: It retained the impartial conduct standards requirement during the transition 84-24 period.
The most significant change to Amended 84-24 was the removal of fixed-indexed and variable annuities from the exemption, leaving only the sale of fixed-rate annuities and life insurance. But by delaying that change, Transition 84-24 provides an exemption for all types of annuities during the transition period.
Transition 84-24 may not necessarily require a broker-dealer firm to take on specific fiduciary obligations because, unlike BICE, there is no “financial institution” requirement under 84-24. (While a broker-dealer must supervise the activities of its representatives under FINRA rules, that supervision may not make the firm a fiduciary.) This possible non-fiduciary status is one of the reasons for a broker-dealer to consider using transition 84-24.
Transition 84-24 imposes conditions that may prove problematic:
- It imposes a written disclosure requirement that must be signed by the IRA owner prior to completion of the sale.
- There is a possibility that the broker-dealer that supports the advisor could be a “functional fiduciary,” where its services rise to the level of advice to the IRA owner.
- Amended 84-24 covered distribution and rollover recommendations. This is not explicit in Transition 84-24, creating uncertainty and possibly risks.
- Transition 84-24 limits advisor compensation to sales commissions, which does not include items like bonuses, trips and incentives that cannot be reasonably defined as commissions.
- The treatment (and disclosure requirements) of overrides and gross dealer concessions was clear under Amended 84-24, but is ambiguous under Transition 84-24.
- Though Transition 84-24 imposes the same impartial conduct standards as BICE, it differs in explicitly requiring disclosure of material conflicts of interest. PTE 84-24 says that “[an] insurance agent’s….failure to disclose a Material Conflict of Interest relevant to the services it is providing or other actions it is taking in relation to a Plan’s or IRA owner’s investment decisions is considered a misleading statement.” In other words, failure to affirmatively disclose material conflicts is deemed misleading, which violates the impartial conduct standards.
Why a Broker-Dealer Might Use Transition BICE
BICE may be viewed as offering a number of positives:
- The only requirement imposed during the transition period is adherence to the impartial conduct standards — there is no requirement to disclose material conflicts of interest as there is under transition 84-24.
- There are no written disclosure requirements.
- There is no limitation on advisor compensation, so long as it is reasonable and the recommendation meets the “best interest” standard, that is, as long as the compensation does not improperly incent advisers to give advice that is not in the interest of IRA owners.
- The exemption covers recommendations of distributions and rollovers.
While the limited requirements of Transition BICE make it relatively easy to implement, the explicit imposition of fiduciary status on broker-dealers as financial institutions may be of concern. Also, broker-dealers as financial institutions are required to supervise their advisors and, as part of that requirement, may be obligated to adopt policies and procedures designed to facilitate that supervision.
In Q&A #6 of its last set of FAQs, the DOL confirmed that the impartial conduct standards are the only per se requirements that apply under transition BICE. This suggests that it would be possible to satisfy transition BICE without implementing additional policies and procedures. However, the DOL added:
“…the Department expects financial institutions to adopt such policies and procedures as they reasonably conclude are necessary to ensure that advisers comply with the impartial conduct standards.”
This is the same position the DOL adopted in its regulation delaying the implementation of the fiduciary rule. There, the DOL said it expected that firms will implement changes to their compensation structures and monitor individuals’ sales practices to ensure compliance during the transition period. Since it may be difficult – if not impossible – to ensure that their advisors will adhere to the impartial conduct standards, firms may be required, as a practical matter, to adopt additional policies and procedures, even if they are not explicitly mandated by the impartial conduct standards.
The DOL will almost certainly propose amendments to the fiduciary rule and the exemptions. These changes may relax some of the standards and conditions imposed by the rules as originally adopted. Unfortunately, we don’t know if or when these changes will be made, or, for that matter, what the changes will be. Also, we don’t know for sure if the transition period will be extended, though it seems likely.
So where does this leave broker-dealers in terms of annual sales to IRAs? First and foremost, they need to decide whether to use 84-24 or BICE for those recommendations. Then broker-dealers need to consider adopting practices — and possibly written policies and procedures and training programs — for complying with the impartial conduct standards, which are in effect now. Finally, they need to monitor the implementation of those practices and the compliance of their advisers with the impartial conduct standards. Based on that oversight, broker-dealers may need to make adjustments, such as additional tracking or changes to compensation structures.