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Can an advisor charge variable compensation?

Under the DOL rule, the fiduciary advisor making a recommendation to the participant or IRA owner generally cannot receive variable compensation, though there are certain exceptions. Variable compensation is when one investment pays an amount different from another investment to the advisor recommending the investments. While this type of variable compensation is common and generally permissible for non-fiduciaries, it is prohibited for fiduciaries.

In order to avoid a prohibited transaction, the advisor must generally not be able to affect his or her compensation with the advice provided. For example, if investment A pays the advisor 10 basis points and investment B pays the advisor 20 basis points, the advice is a prohibited transaction, even if the advisor recommends the investment that pays less. Instead, the advisor must receive level compensation--the advisor will make the same amount of compensation regardless of what is recommended.

There are some exemptions that may allow for some variable compensation on a limited basis. For example, Prohibited Transaction Exemption 84-24, used in connection with fixed-rate annuities and insurance contracts, does permit the advisor to receive a commission that could vary from product to product if all of the other conditions are met.

Another example is the Best Interest Contract Exemption (BIC Exemption). Generally, advisors using the BIC Exemption will still be receiving a level fee. The BIC Exemption, however, allows a financial institution, if it chooses to do so, to define certain broad investment categories that would allow, on the basis of a neutral factor, the advisor to charge a higher rate without misaligning the interests of the advisor and the advice recipient. For example, the financial institution (a bank, broker-dealer, registered investment advisor or insurance company) could decide that annuities are a distinct category, and that because it takes longer to properly advise a person regarding an annuity than another category of investment, the neutral factor of time prevents the interests from being misaligned. This would require the financial institution to decide what the right difference in compensation should be, based on the neutral time factor; to develop a policy and procedure governing the process; and to closely supervise advisors utilizing the variable compensation.

Unless you are using an exemption (something advisors should discuss with their financial institutions), compensation generally must be level and not variable.

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