What is the Best Interest Contract Exemption (BIC Exemption)?
If you are subject to the fiduciary provisions of ERISA and the Internal Revenue Code because you provide fiduciary investment advice, then you are prohibited from receiving certain types of compensation, such as commissions, and from providing advice regarding proprietary products or investments paying additional fees to your financial institution. In order to permit such advice and commission-based compensation, you must meet the conditions of a prohibited transaction exemption. In the new rule, the DOL issued a new class exemption, the Best Interest Contract Exemption (BIC Exemption). This new exemption generally applies to transactions occurring on or after June 9, 2017, though there are reduced requirements during a transition period from June 9 through December 31, 2017. The full conditions apply beginning January 1, 2018. The BIC Exemption can be used with a wide range of transactions, including investment advice generally, and rollover or distribution advice.
A Summary of BIC Exemption Requirements
To rely on the exemption, financial institutions (and by extension, their advisors) must meet conditions in five categories:
- contractual requirements for IRAs/Notice requirements for ERISA plans;
- acknowledgement of fiduciary status;
- adherence to the Impartial Conduct Standards;
- warranties regarding a variety of issues; and
- extensive initial, transactional, and web-based disclosures.
- Contractual Requirements
A written contract is required in the case of IRAs and other plans not covered by Title I of ERISA. The contract is between the financial institution and the advice recipient. Financial institutions and their advisors must agree that they will comply with the standards in the BIC Exemption. This contract is enforceable under state law, and must provide for the right to sue in a class action.
The contract terms may be incorporated into account opening documents, an investment advisory agreement, investment program agreement, insurance or annuity contract or application, or other similar document, or may be in a stand-alone document. Execution of the contract must be prior to or at the same time as the execution of the recommended transaction. However, the contract must cover any advice given prior to the contract date in order for the exemption to apply to such advice. If there already is a contract between the parties, the financial institution may use a negative consent process to amend the service agreement by delivering a proposed amendment to the investor prior to January 1, 2018*. If the investor does not object to the amendment within the specified time period, the investor will be deemed to have agreed to the amendment.
- Acknowledgement of Fiduciary Status
The financial institution must state in writing that it and its advisors are acting as fiduciaries under ERISA or the Internal Revenue Code, or both, with respect to any investment advice being provided.
- Impartial Conduct Standards
The financial institution must affirmatively state that it and its advisors will comply with the following standards:
- the advice they provide to the investor must be, at the time of the recommendation, in the best interests of the investor, which means the advice must reflect the “care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims, based on the investment objectives, risk of tolerance, financial circumstances, and needs of the investor, without regard to the financial or other interests of the advisor, financial institution, any affiliate, related entity or other party” (this is the “Best Interest” standard);
- the financial institution, advisor and their affiliates and related entities may receive no more than reasonable compensation for their services; and
- statements by the financial institution and its advisors to the investor about the recommended transaction, fees and compensation, material conflicts of interest and any other matters relevant to the investor’s decision will not be materially misleading at the time they are made.
The financial institution must provide the investor with a warranty that it has adopted policies and procedures reasonably and prudently designed to ensure that its advisors adhere to the Impartial Conduct Standards described above. The policy and procedures must:
- specifically identify and document the financial institution’s material conflicts of interest;
- adopt measures reasonably and prudently designed to prevent material conflicts of interest;
- designate at least one person (by name, title or function) responsible for addressing material conflicts of interest and monitoring their advisors’ compliance with the Impartial Conduct Standards; and
- require that neither the financial institution nor any affiliate or related entity use or rely on quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause advisors to make recommendations that are not in the best interest of the investor. This generally requires a level fee to be paid to the advisor, though there are some narrow circumstances under which variable compensation may be paid. Further, pursuant to DOL guidance regarding the exemption, compensation grids must use prospective-only, small compensation increases between grid thresholds under the BIC Exemption, and advisor compensation agreements cannot provide for large, backend compensation based on the achievement of production targets.
To rely on the BIC Exemption, financial institutions must disclose the following information, either in the written contract, or, in the case of ERISA plans, in another single written disclosure provided to the plan prior to or at the same time as the execution of the recommended transaction:
- a statement of the best interests standard of care;
- a description of the services provided by the financial institution and the advisor and how the investor will pay for those services, directly or through a third party payment;
- a description of material conflicts of interest;
- a disclosure of any fees or charges the financial institution, its affiliates or the advisor impose upon the investor or the investor’s account and a statement of the types of compensation that the financial institution, its affiliates and the advisor expect to receive from third parties in connection with investments recommended to investors;
- notification to the investor of his or her right to obtain copies of the financial institution’s written description of its policies and procedures, as well as the specific disclosure of costs, fees, and compensation, including third party payments, regarding recommended transactions (this may be described in dollar amounts, percentages, formulas or other means reasonably designed to present materially accurate disclosure of their scope, magnitude and nature);
- a link to the financial institution’s website where the written description of policies and procedures and model contract disclosures may be found free of charge;
- a disclosure to the investor of whether the financial institution offers proprietary products or receives third party payments with respect to any recommended investments, and the extent to which the investment recommendations are limited to proprietary products or investments that generate third party payments;
- the contact information (telephone and e-mail) for a representative of the financial institution that the investor can use to contact the financial institution with any concerns about the advice or service they have received;
- if applicable, a statement explaining that the investor can research the financial institution and its advisors using FINRA’s BrokerCheck database or the Investment Advisor Registration Depository (IARD), or other database maintained by a government agency or instrumentality, or self-regulatory agency; and
- a statement of whether or not the advisor and financial institution will monitor the investor’s investments and, if so, how often and reasons why the investor will be alerted.
Impermissible Contract Provisions
No contract with the investor may disclaim or otherwise limit liability of the advisor or the financial institution for a violation of the contract’s terms. In addition, there cannot be a contract provision requiring the investor to waive or qualify rights to participate in a class action, nor provide for liquidated damages for a breach of fiduciary duty or a contract violation. However, the parties may agree to waive the investor’s right to obtain punitive damages or rescission of recommended transactions to the extent such a waiver is permitted under applicable law. Finally, no contract may contain a provision to arbitrate or mediate individual claims in distant venues.
Level Fee Fiduciaries
If an advisor’s only fee in connection with investment advisory or management services is level and disclosed in advance, then the advisor and financial institution only need to comply with the fiduciary acknowledgement and Impartial Conduct Standards of the BIC Exemption. However, the level fee may consist only of direct fees, and cannot be received in the form of commissions, revenue sharing or other third party payments. Further, the fee charged by the advisor may be the only fee received by the advisor and any of its affiliates.
Exemption for Purchases and Sales, including Insurance and Annuity Contracts
The BIC Exemption authorizes a plan, participant, beneficiary or IRA owner to engage in a purchase or sale transaction (including an insurance or annuity product from an insurance company) with a financial institution that is a service provider or other party in interest or disqualified person to the plan or IRA. The transaction must be effected by the financial institution in the ordinary course of its business, payments for services performed must be reasonable, and the terms of the transaction must be at least as favorable to the plan, participant, beneficiary or IRA owner as the terms generally available in an arms’ length transaction with an unrelated party.
The financial institution must notify the DOL by e-mail (e-BICE@dol.gov) that it is using the BIC Exemption before it receives any compensation in relation to any recommended transactions for which it plans to rely on the BIC Exemption. This is a one-time notification and remains in effect until the financial institution revokes it.
The financial institution must maintain records for six years to show that it has complied with the BIC Exemption. The records must be reasonably available at their customary location for examination during normal business hours by the DOL or IRS, any fiduciary of a plan (or authorized representative or employee of such fiduciary) that engaged in an investment transaction under the BIC Exemption, any contributing employer and any employee organization whose members are covered by the plan, any participant or beneficiary of the plan, an IRA owner, or authorized representatives of plan participants and beneficiaries or IRA owners.
While the BIC Exemption will apply to transactions occurring after June 9, 2017, full compliance will not be required until Jan. 1, 2018. Between June 9, 2017, and Jan. 1, 2018 (the transition period), financial institutions relying on the exemption will find compliance requirements substantially reduced and covered transactions greatly expanded. Using the Transition BIC Exemption requires only that financial institutions adhere to the Impartial Conduct Standards, and exercise enhanced supervision of advisors.
The Impartial Conduct Standards are:
• A recommendation in the Best Interest of the recipient—this means a thorough, prudent and well-documented recommendation that is the result of a fiduciary process taking into account all relevant factors;
• No more than reasonable compensation; and
• No materially misleading statements at the time the recommendation is made.
During the transition period, the Transition BIC permits the receipt of commissions, variable compensation, recommendations regarding proprietary products, and similar “conflicted” compensation and recommendations often not permitted under the “full” BIC Exemption.
Grandfathered Relief for Pre-June 9, 2017 Investments
Rather than adopting a BIC Exemption agreement, it may be possible to continue receiving compensation under pre-June 9, 2017 service agreements if certain conditions are met. Specifically, the continued receipt of compensation based on pre-existing service arrangements is permissible regarding investment transactions that occurred before June 9, 2017, as well as the receipt of compensation for recommendations to continue a systematic purchase program. Compensation related to “hold” or “sell” recommendations is permitted, but "buy" recommendations generally are not eligible for the pre-existing advice exemption unless they involve certain exchanges within a mutual fund family or a variable annuity. Advisors should discuss with their financial institutions whether and how the “grandfather clause” is to be used.