Best Interests Standard of Care for Advisors # 61: Interim Compliance with PTE 2020-02: The Standards of Impartial Conduct | Faegre Drinker Biddle & Reath LLP
The DOL ‘Fiduciary Rule’, FAQ 11: Standards of Impartial Conduct
This series focuses on the new DOL fiduciary “rule”, which came into effect on February 16. This article and the following articles examine frequently asked questions (FAQs) published by the DOL to explain the fiduciary definition and the conflict exemption. of interest.
Key points to remember
- The DOL FAQs generally explain PTE 2020-02 and the expanded definition of fiduciary boards.
- FAQ 11 deals with the Standards of Impartial Conduct, which must be met from February 16, 2021 to December 20, 2021 under the DOL Non-Enforcement Policy (with IRS approval), and then on December 21, the Standards of impartial conduct become one of the conditions for full compliance with PTE 2020-02.
DOL’s Prohibited Transaction Exemption (PTE) 2020-02 (Improved Investment Advice for Workers and Retirees) allows investment advisers, brokers, banks and insurance companies (“financial institutions”) and their representatives (“investment professionals”), receive conflicting compensation resulting from non-discretionary fiduciary investment advice to pension plans, members and IRA owners (“pension investors”). In addition, in the preamble to the PTE, the DOL announced an expanded definition of fiduciary boards, which means that many other financial institutions and investment professionals will be fiduciaries of their recommendations to retirement investors and, therefore, will have need the protection provided by the exemption.
In April, the DOL published FAQs that explain the fiduciary interpretation and the conditions of the exemption.
This article covers FAQ 11, a question and answer from DOL on impartial standards of conduct. The standards of impartial conduct must be met between February 16 and December 20 to obtain the remedy offered by the DOL’s non-enforcement policy. After December 20, the standards of impartial conduct must still be met … as one of the conditions of PTE 2020-02.
Here’s what the DOL said in FAQ 11:
Q11. What are the standards of impartial conduct?
Standards of Impartial Conduct are consumer protection standards that ensure that financial institutions and investment professionals adhere to fiduciary standards and basic standards of fair dealing. The standards specifically require that financial institutions and investment professionals:
- Give advice that is in the “best interest” of the retirement investor. This best interests standard has two main components: prudence and loyalty;
- Under the Standard of Care, boards must meet a standard of professional care as specified in the text of the exemption;
- Under the fairness standard, advice providers cannot put their own interests ahead of those of the retirement investor, or subordinate the interests of the retirement investor to their own;
- Charge only reasonable compensation and comply with federal securities laws regarding “best execution”; and
- Do not make any misleading statements about investment transactions and other relevant matters.
This article examines the best interest and reasonable compensation requirements.
First, with respect to the requirement that financial institutions (for example, registered dealers and investment advisers) receive only reasonable compensation, a determination of “reasonableness” is based on the services provided and the charges for those services in an open and competitive market. When compensation and costs are transparent and common, determining reasonableness is not that difficult. Even there, however, financial institutions may want to consider comparing industry data to have evidence of the reasonableness of their compensation for each type of business (for example, annuities, mutual funds, brokerage transactions). Since this requirement is a condition of an exemption (and an exemption is, in fact, an exception to a rule), the burden of proof shifts to the person claiming the protection of the exemption or, in other words, the burden of proof of reasonableness rests with the registered dealer or investment adviser.
When the compensation of the financial institution and the investment professional is not fully transparent to a retired investor, determining reasonableness may be more difficult. Since the PTE includes compensation paid to the financial institution, as well as to the investment professional, payments such as income sharing from mutual funds and insurance companies (which may not be fully transparent to a retirement investor) are included in determining reasonable compensation. . Even less transparent may be the payments (including commissions) from private equity funds, hedge funds and similar investments. Since the rules on prohibited transactions apply to recommendations to plans, participants and owners of the IRA, the reasonable compensation limit also applies to these three categories of investors, i.e. tell “retired investors”.
While most financial institutions have worked hard to develop practices and policies to comply with rollover requirements, the impact of the new DOL rules on IRAs has not received the same attention, at least in my experience.
With respect to the best interest standard, the PTE defines “best interest” as follows:
Advice is in the “best interest” of a retirement investor if such advice reflects the care, skill, prudence and diligence in the circumstances then prevailing that a prudent person acting in the same capacity and familiar with such matters would use in the conduct of a business of the same nature and having the same purposes, based on the investment objectives, risk tolerance, financial situation and needs of the retired investor, and does not place the financial or other interests of the investment professional, financial institution or any affiliate, related entity or other party before the interests of the Retirement Investor, or subordinate the interests of the Retirement Investor to theirs. (I underline.)
The words in bold are a textual repetition of the ERISA prudent man rule and can reasonably be considered to incorporate this standard into the best interest standard of the PTE. In this regard, the words “care, skill, prudence and diligence” have been interpreted to require trustees to engage in prudent processes. In this regard, a prudent process requires that an investment trust professional and a financial institution collect the “relevant” information and assess that information in the best interests of the retirement investor. The words “familiar with these matters” are sometimes referred to as the “prudent expert” rule, although the standard is not that high. Instead, it means the process and recommendation will be measured by what a hypothetical person, who knows the profile of the retirement investor and the options available, would have done. And, as this suggests, the “relevant factors” are those that the hypothetical “prudent person” who “knows these matters” would have considered relevant, or important, in making a particular recommendation to the particular retirement investor.
The bottom line is that investment professionals and financial institutions are in the best position to demonstrate compliance with the best interest standard if there is a process that appropriately collects and evaluates information relevant to the particular recommendation. And, although documentation of this process is generally not required (with the exception of recommendations for renewal), it would be a good risk mitigation approach to preserve the relevant information that was reviewed and served as the basis. to the recommendation.
Standards of impartial conduct – a holdover from Obama-era fiduciary rule – are a critical part of complying with DOL’s new interpretation of fiduciary boards and all of the prohibited transactions that result from those recommendations. While “reasonable compensation” is a requirement that requires attention, most compensation practices for registered dealers and investment advisers will already meet this standard. “At-risk” compensation will be payments that are higher than the usual range of costs and compensation for particular services or investments, with a higher potential risk of compensation associated with complex and non-transparent investments.
Another element of the standards of impartial conduct — the best interests standard — is best understood as a process requirement emphasizing the information necessary to make a prudent decision and the duty to put the interests of the investor through. pension before the interests of the financial institution and the investment professional. Although documentation of this process is generally not required, financial institutions should consider retaining documentation for risk management purposes (especially for recommendations of complex and / or high risk investments).