As we continue down the path of understanding the Department of Labor’s new Conflict of Interest Rule (as it was called in their press conference), one of the more misunderstood (or at least most questioned) areas of the rule is around the grandfathering provision on what is known as prohibited transactions. The confusion is very understandable, given the 1,023-page rule. But unfortunately, I’ve heard that some in our industry are pushing the envelope by promoting their products to take advantage of that confusion. Since I’ve been getting lots of questions, I thought it may be helpful to provide some perspective.
The rule, released on April 6, 2016, was originally seen as a “gift to” Wall Street (according to the headlines), and lobbyists were praised for doing their jobs to lessen the restrictions. However when you dig into the rule, you find that all the main components of the rule survived the commentary and feedback process.
In fact, after April 10, 2017, when the law goes into effect:
- Every advisor advising qualified accounts, whether they are transaction only or fee only (or both) will have to comply with the Rule and, in most cases (for example, in connection with all new qualified accounts) rely on the Best Interest Contract (BIC) exemptions either transitional/level-fee or contractual.
- Transaction-based advisors can recommend transactions in all asset classes (including annuities, A-shares and non-traded REITs), as long as they use the contractual BIC exemption, including making the required best-interest determination in each case.
- Advisors who make a recommendation that will earn them a fee not previously received (on covered assets) will be considered a prohibited transaction and they will have to use a BIC exemption (either contractual or transactional).
There is no question that this will have a profound effect on our industry and many advisors and firms are already gearing up to meet the challenge and opportunity.
Does what happened before 4/10/17, stay before 4/10/17 ?
Most of the questions that I have gotten about those grandfathering issues go something like this:
“I heard that IRAs in existing commissionable products can stay where they are, without ongoing BIC screens, but any new IRA business, transfers to advisory, or rollovers will have to go through whatever BIC screening process after 4/2017.”
“Is it true that original transactions are grandfathered and the ONLY thing requiring a BIC exception would be new transactions that create new commissions in that account? In other words, ongoing maintenance of the client is ‘BIC free’ and same as always because the vast majority of activities and cash flows in that account would NOT create new commissions?”
The answer to these questions is as difficult as the rule is. The answer starts with how the advisor wants to conduct business going forward and if they ever want to have unrestricted conversations with their client again beyond, potentially, reconfirming advice provided prior to 4/10/17. The important focus is on providing investment advice, including a recommendation to hold the current position. To be clear, any new compensation earned after 4/10/17 in connection with advice on qualified accounts would be subject to the full BIC exemption, unless the advice does not involve additional contributions and otherwise qualifies for the grandfather exception.
Getting real (it’s not a “do nothing” provision)
Let’s create a scenario that we can walk through to understand the grandfathering clause and how it can/will work going forward. Let’s say that Advisor A sells an annuity or loaded fund prior to 4/10/2017 and receives a commission. The product has a trailing fee of 25bps. After 4/10/17 the advisor:
- Will probably have to notify the client of the rule’s implementation and that they will be operating as normal and will continue to receive compensation from the products that were previously recommended (this can be done as a negative consent letter or notice).
- May not provide any advice on the qualified account, as this may trigger a fiduciary action and thus need a contractual BIC exemption. Please note that telling the client to stay put in the investment could be considered advice.
- May not receive additional compensation from the account (for example, in the form of an increase in dollar cost averaging) or would be subject to requiring a contractual BIC exemption. However, DCA would not in itself be a cause for a BIC, if it was set up before 4/10/2017.
- May not change broker dealers and expect the compensation to continue, as discussing the account (and suggesting a transfer) would be advice on the account and thus trigger a contractual BIC exemption.
The grandfather rule is nothing more than a solution to delay the inevitable BIC exemption.
I can’t imagine an advisor selling a client, then never servicing or even talking to that client again, beyond limited conversations that may only allow the advisor to recommend the same investment (or same fund complex and share class). The grandfather clause is really a way for advisors who aren’t prepared to get their clients ready for the new law.
Be out in front
Why wait? Why invoke a grandfather clause when you don’t have to? Rather than waiting, why don’t you own the rule? Get out in front of it and make the changes to your business that will build economic viability. Use the rule to differentiate yourself. Don’t worry about grandfathering; worry about the future conversations with your clients and how your advice will help them achieve their goals.