Fiduciary Benchmarks, provider of fee-benchmarking solutions, has published the first in a series of white papers authored by Employee Retirement Income Security Act (ERISA) attorneys Fred Reish and Bruce Ashton, of Drinker Biddle and Reath.
The analyses will be published quarterly and the first is available now, asking the question, “Who has the job of determining whether an adviser’s compensation is reasonable … the plan sponsor or individual account owner or the adviser?”
As the pair explains, ERISA and the Internal Revenue Code have always required the use of suitable products and the assessment of only rational compensation for financial advisers and investment managers regardless of their contractual fiduciary status or service offering. However, the pending implementation of the Department of Labor’s (DOL) strengthened conflict of interest standard, paired with the rash of retirement plan fee litigation filed in recent years, has added even more significance to the question: Who is responsible for determining whether an adviser’s compensation is reasonable?
Just as important, Reish and Ashton warn, is determining what type of a process can be deemed reliable for determining fee reasonableness under ERISA’s tighter standards, as well as what type of records will be satisfactory?
“The ‘reasonable compensation’ requirement is highlighted by the Department of Labor’s expanded definition of fiduciary advice and the related prohibited transaction exemptions,” the pair explains. “As a result, an adviser’s responsibility for determining and having evidence of the reasonableness of its compensation has been heightened.”
Ashton and Reish observe that the fiduciary rule’s exemptions raise an issue that financial advisers, “by which we mean broker-dealer representatives, investment adviser representatives and insurance agents,” may not have addressed in the past: Who has the job of determining whether an adviser’s compensation is reasonable, the plan sponsor or IRA owner or the adviser? “The short answer is, it depends.”
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According to the Fiduciary Benchmark’s analysis, what has changed under the new DOL standard is the obligation of a fiduciary adviser to a plan or IRA, whose firm (referred to as a financial institution) will receive variable compensation or third party payments.
“These advisers must rely on the Best Interest Contract Exemption (BICE), which requires the financial institution to warrant that its and the adviser’s compensation is reasonable,” Reish and Ashton write. “Other exemptions contain a similar requirement … For plans, this creates a dual obligation to make sure that compensation is reasonable. The plan sponsor retains its ERISA obligation to do so, and the adviser and the financial institution have the BICE obligation.”
Pertaining to IRAs, the analysis suggests the prohibition against an adviser receiving unreasonable compensation remains as in the case above, “but the obligation to make sure (and to warrant) that the compensation is reasonable is heightened under BICE (and other exemptions).”
According to Reish and Ashton, advisers will likely have to defend fees if challenged, but it is important to point out that the adviser’s obligation is actually to make disclosures, “not warrant that his compensation is reasonable.”
“It is still up to the plan sponsor to make the determination of reasonableness,” they conclude.
The first white paper can be downloaded (after free registration) here.
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