If you work in the financial planning or wealth management industry, you are no doubt aware of the upcoming Department of Labor fiduciary rule. This new regulation, slated to take effect in April of 2017, requires financial planners and wealth management firms to put the best interests of their clients first when working with retirement funds like IRA accounts.

 As a financial professional, you already put the best interests of every client first. You work hard for your clients, and you want them to succeed no matter which accounts they are working with. Even so, this new DOL fiduciary rule still applies to you and your firm, and now is the time to get ready.

Understanding the Best Interest Contract

One of the most contentious, and potentially confusing, parts of the Department of Labor fiduciary rule is the so-called "Best Interest Contract." Even though the fiduciary rule was passed some time back, many in the financial planning and wealth management industry are still confused about what the best interest contract is, how to use it and when it is needed.

The standards imposed by the United States Department of Labor are very high, and they are designed to protect individual clients and place strict regulations on financial planners, brokerages, mutual fund companies and wealth management firms. Some in the financial planning industry worry that the new rules and higher standards will forbid the use of some of their most popular products, including certain annuities and managed account programs.

Since annuities and managed account programs are frequently used in the management of retirement accounts, financial planners are right to worry about the future of their businesses and their client relationships. That is where the Best Interest Contract Exemption comes in.

The DOL fiduciary rule, slated to take effect in April of 2017, prohibits financial advisors from receiving variable commissions when performing transactions in the client retirement accounts they manage. For these commissions, common in the financial industry, to be allowable, the transaction in question would have to qualify for the Best Interest Contract Exemption.

Sweeping Implications

The Best Interest Contract Exemption is the most far-reaching relief from the strict regulations of the Department of Labor fiduciary rule. The presence of this exemption should set financial planners' minds at ease and lessen the fear that they will no longer be able to sell their best performing and highest return products. 

This sweeping exemption can be used for all types of assets offered to holders of IRA accounts and other retirement plans. To qualify for the Best Interest Contract Exemption, the financial advisor must be providing non-discretionary investment advice, and the client must understand the nature of the guidance they are being given.

 Not a Comprehensive Exemption

It is important to note that the Best Interest Contract Exemption, also known as BICE, does not provide relief for all variable compensation. To qualify for the exemption, the advice given must be non-discretionary; BICE does not give advisors relief from the variable compensation rules if the guidance they are giving is considered the discretionary advice of a fiduciary advisor.

Understanding the individual nuances of the DOL fiduciary rule in general, and BICE in particular, is no easy task, but it helps to look at a real-world example. Consider the case of a client who has given his or her investment manager permission to invest the assets in their IRA without their explicit prior approval. If the financial planner in question invests those IRA funds in an asset from which they derive variable compensation or revenue sharing, they would be in violation of the new Department of Labor fiduciary rule.

The Best Interest Contract Exemption would not apply in this case, due to the fact that the advice given is considered discretionary. To qualify for BICE, the financial advice must be entirely non-discretionary.

While the Best Interest Contract Exemption is complicated and somewhat nuanced, it will allow financial planners and wealth management firms to continue using many of the compensation models they are used to, while still acknowledging their fiduciary status and their responsibilities to their clients. The entire purpose of the Department of Labor fiduciary rule is to encourage financial planners and wealth management firms to provide their clients with impartial advice, prudent investment guidance, and honest expertise.

Furthermore, the Department of Labor fiduciary rule is designed to reduce potential conflicts of interest by requiring financial planners and advisors to disclose such conflicts and provide clients with information regarding their revenue models and all forms of compensation.

It is also important to note that once the Department of Labor fiduciary rule formally comes into effect in April 2017, the sale of fixed-indexed annuities and variable annuities will only be permitted through the Best Interest Contract Exemption. To invest the retirement funds of their clients in these kinds of annuities, financial advisors will need to use the provisions of BICE. If they fail to do so, they will be in violation of these new DOL fiduciary guidelines.

Four Kinds of Best Interest Contracts

The Best Interest Contract Exemption is complicated enough, but things get even more confusing. There are four distinct kinds of Best Interest Contracts under the DOL fiduciary rule - the full-blown Best Interest Contract, the Disclosure Best Interest Contract, the Streamlined Best Interest Contract and the Transition Best Interest Contract.

Full Blown BIC

The full-blown version of the BIC applies to all advice regarding IRA accounts and non-ERISA plans, and this is the most common type most financial planners will be working with. The disclosure BIC applies to advice given to ERISA plans. Since advice for ERISA plans is already bound by the fiduciary standard, no additional written contract is required.

Streamlined BIC

The streamlined BIC can only be used by level-fee fiduciaries, so it will not apply to the vast majority of financial planning and wealth management firms. Since level-fee fiduciaries generally meet the requirements of the new DOL rule already, they can use the streamlined BIC when advising their clients on their IRA investments.

Disclousre BIC

The “Disclosure” BIC and its slightly easier requirements are available to advisors when serving their ERISA plan clients.  In general, the Disclosure BIC requirements mirror those for the Full Blown BIC.  However, no written contract is required.  Instead, a written statement of fiduciary status and general disclosures on the advisor’s compensation and conflicts must be provided. 

Transition BIC

The transition BIC will only be used during the 2017 transition from current business practices to the implementation of the Department of Labor fiduciary rule. This new rule is slated to take effect in April of 2017, and that is when the transition BIC will come into play.

The upcoming DOL fiduciary rule represents one of the most significant changes in the financial planning industry, and the time to comply is growing short. With the new rule slated to take effect in April, it is important for financial planners, wealth managers, and others to understand its implications and the impact the new regulation is likely to have on them and their compensation models. The Best Interest Contract and Best Interest Contract Exemption provisions are among the most important in the rule, and having a solid understanding of how they work will make the transition period much easier and less complicated.ming Department of Labor fiduciary rule. This new regulation, slated to take effect in April of 2017, requires financial planners and wealth management firms to put the best interests of their clients first when working with retirement funds like IRA accounts.

As a financial professional, you already put the best interests of every client first. You work hard for your clients, and you want them to succeed no matter which accounts they are working with. Even so, this new DOL fiduciary rule still applies to you and your firm, and now is the time to get ready.

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Disclaimer

The above article is meant for information purposes only and is not intended in any way to provide legal or other advice for any specific situation.  Readers always should consult their own tax, accounting and legal advisors before taking any action related to the above article or subject matter.

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