DOL Digest July 25, 2016

July 25, 2016

Looking after your client’s best interests begins with the decision to recommend either a commission-based account or an advisory fee-based account – and sometimes, you may recommend both for the same household. While there is currently a great deal of movement to fee-based advisory accounts, these accounts aren’t always the right choice for your clients. It’s important to understand your obligations if you recommend a fee-based advisory account.

The U.S. Securities and Exchange Commission (SEC) holds advisors to a fiduciary standard and considers placing clients in accounts with inappropriate fee structures a violation of this standard. The SEC fiduciary standard includes the Duty of Loyalty, which requires advisors to serve the best interests of their clients and disclose all conflicts of interest, and the Duty of Care, which requires advisors to provide only suitable investment advice and act with integrity in the client’s best interests.

Advisory accounts established for retirement will fall under the added layer of the new DOL fiduciary rule effective April 2017, which will now include virtually everyone who provides recommendations in the qualified retirement space, including those making recommendations to ERISA plan fiduciaries, participants, beneficiaries and, most notably, IRAs.

Under ERISA and the new DOL fiduciary rule, a fiduciary must act with care, skill, prudence and diligence, and solely in the client’s best interest. This means fiduciaries will be prohibited from engaging in conflicts of interest, which include receiving commissions or third-party payments (including 12b-1 fees) from product sales, unless the fiduciary qualifies for an exemption. It also means you must act in a prudent manner, as others would, given the same facts and under the same circumstances.

Advisors often recommend a fee-based advisory account to help a client reduce the overall costs of ongoing transactions to rebalance the account. At its core, the investment advisory account is an asset management agreement. These accounts may involve additional services, such as providing ongoing advice for retirement plans, managing an account holistically or trading in other accounts within the household. Consistently and accurately documenting these services and your ongoing actions can help you demonstrate and support that the fee you charge is reasonable under the DOL fiduciary standard.

Two situations in a fee-based advisory account can call into question whether paying a fee rather than a commission is in a client’s best interest.

  1. The first is a lack of trading in the account over an extended period of time. Even the best portfolios require rebalancing or periodically buying and selling assets to maintain an objective or desired level of asset allocation. A lack of trading in an advisory fee-based account may be considered unreasonable compensation, as it may create the appearance that the client is not receiving the basic benefits set forth in the asset management agreement.
  2. The second situation that may result in higher scrutiny of a fee-based advisory account is maintaining a high percentage of cash. When a client requires a large cash balance, whether to save for a house or because of concerns of a bear market, it may be in his or her best interest to place this money in a money market or savings account that collects interest, with no fees to erode the value of the investment.

When lack of trading or large cash balances call into question the decision to continue charging a fee on an account, be sure to document the circumstances that led to the decision, your conversation with the client, including any hold recommendations regarding the cash balance or strategy, and any changes in the client’s life that may trigger another review of the decision to hold cash. We’ll go into deeper detail on documentation best practices in an upcoming issue of the DOL Fiduciary Digest.

Remember, when deciding whether a commission-based or advisory account is in a client’s best interest, consider how the client intends to use the account. Does the client or advisor anticipate a high level of trading activity based on the investment strategy selected? What value does the client place on professional advice and what additional advice is being provided over and above the asset management advice? Compare the cost of a commission-based account against the cost of a fee-based advisory account and document this comparison for the client. Carefully consider the differences between a commission-based brokerage account and investment advisory services, particularly in terms of services provided, costs of those services, and the existing and anticipated level of trading activity.

If you have questions regarding the DOL fiduciary rule, email

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