Are You Ready to Comply With the DOL Fiduciary Duty Rule If It Goes Into Effect on April 10?

We are now six weeks from the April 10 implementation date of DOL’s Fiduciary Duty Rule. While the DOL has filed a proposal to delay the implementation date with the Office of Management and Budget (OMB), and while the industry largely expects the OMB to approve the delay (possibly even this week), as it stands right now, the April 10 implementation date controls.

This means that firms should make sure their preparations are on pace to be completed by April 10, if necessary. Although many firms having been taking a “wait and see” approach to the Fiduciary Duty Rule up to this point, time is getting short, and no one wants to be caught unprepared if the Rule does go into effect on April 10. After all, you can bet that plaintiff’s firms will be ready, even if no one else is.

One element that firms should make sure they can have ready by April 10 is their compensation grids.

The DOL has explicitly stated, in its FAQs issued on October 27, 2016 (found here), that firms may still use escalating grids in their compensation structure (i.e., paying higher commission rates to advisers based on reaching certain thresholds), without violating the Rule. However, the DOL also said that firms must “exercise care” not to incentivize advisers to make recommendations that are not in the retirement investor’s best interest.

Here are a few factors that firms should consider in reviewing and, if necessary, revising their compensation grids:

  • Categories of investments. The DOL has said that firms can pay different commission amounts for different broad categories of investments (e.g., mutual funds versus annuities), so long as the difference is based on “neutral factors,” such as the time and complexity associated with recommending investments within different product categories. “Neutral factors” are factors that are not based on the financial interests of the firm (e.g., the profitability of the investment), but rather on significant differences in the work that justify drawing distinctions between categories and compensation. However, the DOL cautions that “because compensation varies between categories under this model, the financial institution should exercise special care to monitor recommendations between categories.” (FAQs at p. 8.) In other words, firms will need to keep records of why the recommendations were made and ensure they can demonstrate that the transactions were adequately supervised.
  • Size of steps. The DOL has cautioned firms to keep to “modest or gradual increases” rather than “large” increases. Of course, what constitutes “modest” versus “large” may be in the eye of the beholder. (This is one of many areas in which the Rule seems to encourage firms to look at each other for an industry standard. We have previously discussed our antitrust concerns about this aspect of the Rule.) As guidance, the DOL has warned, “financial institutions must exercise care to avoid dramatic increases in compensation that undermine the best interest standard and create misaligned incentives for advisers to make recommendations based on their own financial interest, rather than the customer’s interest in sound advice.” (FAQs at p. 8.)
  • Retroactivity. The DOL has specifically said that increased compensation should only apply to new investments once the threshold is reached. “If the consequence of reaching a threshold is not only a higher compensation rate for new transactions, but also retroactive application of an increased rate of pay for past investments, the grid is likely to create acute conflicts of interest.” (FAQs at p. 9.) In other words, retroactivity simply creates too big an incentive for the adviser to recommend those last few transactions to reach the threshold, regardless of whether those transactions are in the retirement investor’s best interest.

If firms are nervous about an aspect of their compensation, they should remember the overarching concern of the Rule: does the compensation element incentivize the adviser to recommend a transaction that is not necessarily in the retirement investor’s best interest because it will increase the adviser’s compensation? If so, the compensation element should be carefully scrutinized, because it might very well run afoul of the Rule. And always remember that the adviser should be documenting the reasons for his or her recommendations, and the firm should have a designated person reviewing those transactions for potential conflicts of interest.

About Julie Firestone

Julie Firestone is a member of Briggs and Morgan's Business Litigation Section and the Financial Markets Group. Julie practices primarily in the following areas: complex commercial disputes and class actions; securities litigation and arbitration; SEC and FINRA regulatory investigation and enforcement; and shareholder and partnership disputes. Julie represents corporations, investment firms, broker-dealers, insurance companies, issuers of securities, registered representatives and insurance agents in class actions, regulatory proceedings and other adversary matters. She also focuses on customer complaints and regulatory compliance, as well as customer disputes in arbitration. Julie’s legal experience includes matters involving securities fraud, breach of contract, common law fraud, RICO, breach of fiduciary duty, suitability, selling away and unauthorized trading.
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