The Fiduciary Rule and Discretionary Investment Management

By ASPPA Net Staff • July 07, 2017 • 0 Comments
Discretion is said to be the better part of valor — but that’s not necessarily the case with discretionary accounts and the fiduciary regulation.

And, according to a recent blog post, if you’re not sure how the Best Interest Contract Exemption (BIC) applies differently to discretionary accounts and non-discretionary accounts — well, you’re not alone.

In a recent blog post on the fiduciary regulation, noted ERISA attorney Fred Reish says that he’s discovered that “many broker-dealers and RIAs do not understand how the prohibited transaction rules and exemptions (and, particularly, the Best Interest Contract Exemption) apply differently to discretionary accounts and non-discretionary accounts” — and then proceeds to outline the differences and similarities.

In the case of the latter, he notes that ERISA’s prudent man rule and duty of loyalty apply for both discretionary and non-discretionary advice to retirement plans and participants — though ERISA does not generally govern investment advice to IRAs. Reish explains that as a result, absent the need for a prohibited transaction exemption, advisers to IRAs will not be governed by fiduciary/best interest standard of care — that whether discretionary or non-discretionary investment advice is provided to an IRA on a “pure” level fee basis, the adviser (and their supervising entity) would be subject to the fiduciary standards under the securities laws, not the new fiduciary rule.

On the other hand, where there is a financial conflict of interest for non-discretionary or discretionary investment advice to an IRA, a prohibited transaction results — say where the adviser or supervisory entity (or any affiliated or related party) receives compensation in addition to the level fee. Reish cites as examples 12b-1 fees, insurance commissions and trails, proprietary products, asset-based revenue sharing and payments from custodians.

Where these “conflicted” payments are received, and a prohibited transaction occurs, Reish notes, the adviser and the supervisory entity will need an exemption. If the adviser provides non-discretionary investment advice, the Best Interest Contract Exemption (BICE) is available, and that only requires that the adviser and the supervisory entity comply with the Impartial Conduct Standards during the transition period.

However, Reish explains that the BIC cannot be used for prohibited transactions that result from discretionary investment management. In fact, he says, “there are only a few exemptions for discretionary investment management, and none as broad as BICE” — for example, he cites the exemption for the use of proprietary mutual funds.

As a result, Reish opines that many — and perhaps most — financial conflicts (that is, prohibited transactions) that result from discretionary investment management decisions “are absolutely prohibited, because there are not exemptions for the conflicted payments.”

He closes by observing that RIA firms and broker-dealers need to distinguish between discretionary investment management and non-discretionary investment advice. “For the time being, at least, most conflicts of interest for nondiscretionary advisers are permissible, if the Impartial Conduct Standards are satisfied,” Reish notes. However, he cautions that for discretionary investment management, there are few exemptions and most financial conflicts will be prohibited without any available exemptions.

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