Thought Leadership in Action

To comply with the requirements of the DOL, the advisory practice must be prepared to do the following by January 1, 2018.

Conduct the Practice as a Fiduciary

At the highest level, the DOL Fiduciary Rule states that the advisor must act as a fiduciary to the client. To do so, the advisor must be “prudent” and “loyal.” Prudence requires that the advisor operates with a high standard in terms of monitoring, managing, and advising the client of the status of the investment property. Loyalty requires that the advisor make decisions that are beneficial to the client first and foremost and that would not be considered in the primary interest of the advisor at the expense of the client.

Partner with a “Financial Institution” to Execute the Best Interest Contract

The DOL Fiduciary Rule creates significant financial liability for the distribution partner. Under the DOL Rule, the advisor must work with a “Financial Institution” that assumes all of the legal risks of the advisor who fails to act as a fiduciary. The Financial Institution countersigning the Best Interest Contract is obligated to put in place a platform, procedures, and oversight of the complete sales process that will ensure that the advisor is acting as a fiduciary. This will obviously have a significant impact on many advisory practices at a very detailed level.

Consider Most Communications To Be “Recommendations”

Under the new law, any communication between an advisor or his or her firm/staff and a client could be considered investment advice if the communication in some way can be associated with the sale of a product that yields a fee or other direct or indirect compensation. This includes any communications regarding the advisability of investing in a new security or investment property or the selection of a certain asset class leading to that recommendation. It also includes recommendations regarding the management of a currently owned asset, arguably even if the advice does not yield a recommendation with a proximate compensation.

Justify the Asset Class Selection Through Needs Analysis and/or a Financial Plan

Under the new legal framework, the advisor must expect to have to do more comprehensive due diligence on the client’s situation. This will likely involve the use of a platform to support either needs analysis leading to an asset class recommendation or the development of a more comprehensive financial plan for the client. For example, an advisor will have to provide much more contextual detail as to why a client should put qualified money into a variable annuity where the tax advantage is a redundant feature. The justification for such a recommendation can be any number of other reasons—guaranteed income, risk aversion coupled with a desire to participate in some market upside, etc.—but these will almost certainly have to be detailed to justify the selection of an asset class with an above-average form of variable compensation.

Demonstrate That the Product Selected Pays “Reasonable Compensation”

The DOL Rule requires that the advisor receives “reasonable compensation” for a product. The law indicates that reasonable compensation is dictated by the market for that product and that the compensation must be shown to be appropriate based on neutral factors such as time and expertise required during the recommendation, case design, planning, and sales process. Primarily, a Financial Institution cannot pay more to an advisor for a specific carrier/product simply because that product generates a higher commission or payout. This requirement means simply that the advisor must pick a defensible product in terms of commission payout that is not an outlier relative to the payout of other similar products.

Disclose the Details of Compensation and Any Conflicts of Interest

The DOL Rule requires significant disclosures regarding the compensation paid to an advisor, along with any potential conflicts of interest regarding compensation paid and products recommended. The advisor must disclose all aspects of compensation to the client and be completely transparent about any instances in which the selection of a product pays any form of compensation.

Facilitate a “Best Interest Contract” Between Your Financial Institution and Your Client

The advisor will have to facilitate the execution of a Best Interest Contract (BIC) between the Financial Institution and the client. Since this contract makes the Financial Institution liable for the advisor’s activities and essentially guarantees to the client that the advisor is acting as a fiduciary, it is a significant commitment.

Provide Ongoing Access to “On Demand” Disclosure

One final disclosure that must be made available to all clients is the “On Demand” disclosure, a web-based document provided by the Financial Institution. This disclosure provides information about the Financial Institution’s relationship with carriers and other third parties making payments in return for recommended investment products. The disclosure must provide the firm’s business model and it must include a schedule of typical account or contract fees and service charges, a model contract, and a description of the firm’s compliance policies and procedures. This disclosure, in addition to specific details to the client, will also be made public to promote transparency in the marketplace.

Allow Oversight of the Financial Institution Co-Signing the Best Interest Contract

Practically speaking, the advisor must anticipate an impact on the day-to-day operations aligned with the operating details noted above. However, there will most likely be significant variance among Financial Institutions in how they interpret and implement the DOL Rule. For example, one Financial Institution may opt to build and support a platform for needs analysis, which must be completed for each client, and use the results of this process to determine the asset and/or products the advisor can sell. In contrast, another Financial Institution may allow the advisor to independently complete a financial plan coupled with a product selection process and to submit these details to the BIC Compliance team for review. The specifics of the platform will vary by the legal interpretation and the overall approach determined by the Financial Institution.

Comply with Cybersecurity Concerns

To compound the challenge of implementing a DOL solution in the field, the advisor must increasingly take into account the requirements of cybersecurity. This is specifically true for advisor firms that support registered representatives but also, as a general practice, a requirement for all advisory firms that wish to protect the practice.