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The Best Interest Contract Exemption

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COMPLIANCE & ETHICS FORUM FOR LIFE INSURERS The Best Interest Contract Exemption Practice Implications Beth J. Dickstein Robert P. Hardy Sidley Austin LLP Why is an Exemption Needed? The Prohibited Transactions
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COMPLIANCE & ETHICS FORUM FOR LIFE INSURERS The Best Interest Contract Exemption Practice Implications Beth J. Dickstein Robert P. Hardy Sidley Austin LLP Why is an Exemption Needed? The Prohibited Transactions Rules: Under the existing rules, transactions between an ERISA plan or an IRA and certain parties in interest (as defined in ERISA) or disqualified persons (as defined in the Internal Revenue Code) are prohibited and trigger excise taxes or other penalties absent an exemption. Fiduciaries and other service providers to plans and IRAs constitute parties in interest or disqualified persons under these rules. Prohibited Transaction Exemptions: Several existing prohibited transaction exemptions cover various types of sales and services transactions between plans or IRAs and service providers with respect to the plans. However, those exemptions often do not cover the fiduciaries causing or advising the plans or IRAs to engage in the transactions. CEFLI All Rights Reserved. May 10-11, Reasons for the BIC Exemption Under the new definition of investment advice, many Advisers who make recommendations to plans or IRAs will be considered fiduciaries with respect to those plans and IRAs. Under the existing rules, the Financial Institutions that employ or are represented by Advisers often would be considered service providers to the plans or IRAs, but neither the Financial Institutions nor the Advisers would be considered fiduciaries. A primary purpose of the new rules is to trigger fiduciary status for such Advisers and Financial Institutions, especially in connection with recommendations to IRAs. As noted above, the existing prohibited transaction exemptions relating to sales and services transactions typically do not cover the fiduciaries recommending the transactions. Thus, many newly-characterized advice fiduciaries will need to rely on the BIC Exemption to avoid liability for engaging in nonexempt prohibited transactions. CEFLI All Rights Reserved. May 10-11, Changes from the Proposal Covered Assets: The list of assets covered by the BIC Exemption has been eliminated. Note, however, that Advisers and Financial Institutions are admonished to use special care when recommending complex, illiquid, hard to value or high risk investments. Written Contract Requirement: The written contract requirement was retained for IRAs but eliminated for ERISA plans. As described below, however, numerous disclosure requirements still apply with respect to ERISA plans. Timing of Contract Requirement Although the new rules generally are effective April 10,2017, the written contract requirement does not become effective until January 1, CEFLI All Rights Reserved. May 10-11, Impacted Parties Adviser A fiduciary of a plan or IRA solely by reason of providing investment advice, who is an employee, independent contractor, agent, or registered representative of a Financial Institution. Financial Institution The entity that employs the Adviser or otherwise retains such individual and that is a registered investment adviser, bank, insurance company or U.S. registered broker-dealer. Note that the definition of insurance company in the exemption is flawed and will need to be revised. Retirement Investors (1) A plan participant with authority to direct the investment of his or her plan assets or to take a distribution; (2) an IRA owner acting on behalf of the IRA; or (3) a plan fiduciary that is not an expert as described in the regulation defining fiduciary. CEFLI All Rights Reserved. May 10-11, Conduct Standards Best Interest Standard Generally requires the Adviser and Financial Institution to act in accordance with the ERISA prudent man standard, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any affiliate, related entity, or other party. Reasonable Compensation Compensation cannot be in excess of reasonable compensation. No Misleading Statements The Adviser s and Financial Institution s statements regarding compensation and conflicts of interest cannot be misleading. CEFLI All Rights Reserved. May 10-11, Written Policies and Procedures The Financial Institution must maintain written policies and procedures: designed to ensure compliance with the conduct standards; that identify material conflicts and contain measures designed to prevent the conflicts from causing violations of the conduct standards; and that require the Financial Institution to not rely on incentive arrangements that would be expected to cause Advisers to make recommendations that do not comply with the Best Interest Standard. CEFLI All Rights Reserved. May 10-11, Maintenance of a Web Site The Financial Institution must maintain a web site that contains: A discussion of the Financial Institution s business model and material conflicts of interest A schedule of typical contract fees A model contract and required disclosures; A written description of the Financial Institution s policies and procedures If applicable, a list of all product manufacturers and third parties who pay compensation to the Financial Institution Disclosure of the compensation and incentive arrangements for the Advisers CEFLI All Rights Reserved. May 10-11, Written Disclosures Disclosures must include: Statement of the Best Interest Standard Description of material conflicts of interest, including compensation Means to obtain the Financial Institution s policies and procedures Link to web site Information about proprietary products Contact person for concerns Whether the adviser will monitor the recommended investment May be delivered in person, electronically or by mail CEFLI All Rights Reserved. May 10-11, Proprietary Products Additional requirements apply if the Adviser sells proprietary products: Disclosure of the limitations on recommendations and conflicts of interest The Financial Institution must document its conclusions that the sale of proprietary product will not cause its Advisers to receive in excess of reasonable compensation or to recommend imprudent investments The Financial Institution must maintain certain policies and incentive practices Compensation must be reasonable The recommendations must meet the prudent man standard and must not be based on any considerations other than the needs of the Retirement Investor CEFLI All Rights Reserved. May 10-11, Contracts for IRAs Statements that must be included: Fiduciary status of Advisor Compliance with the Best Interest Standard Reasonable compensation No materially misleading statements Warranties regarding compliance with certain standards Signed by IRA owner and Financial Institution Required beginning January 1, 2018 No provisions limiting class actions Not applicable to ERISA plans CEFLI All Rights Reserved. May 10-11, Level Fees Generally no prohibited transaction if fees are level Prohibited transaction could occur if Advisor recommends: moving to a level fee; or rolling money from a plan to a fee-based account. Conditions for Relief (if necessary): Written statement of fiduciary status by Advisor Compliance with the conduct standards Documentation of the reasons that the advice meets the Best Interest Standard CEFLI All Rights Reserved. May 10-11, Grandfather Relief Applies to compensation paid in connection with advice provided prior to April 10, 2017 Conditions: Applicable arrangement has not expired; Investment did not constitute a non-exempt prohibited transaction at time made Compensation does not relate to new investments Compensation is reasonable Any recommendations made after April 10, 2017 meet the Best Interest Standard CEFLI All Rights Reserved. May 10-11, Disclosure to the DOL and Recordkeeping Requirements Prior to relying on the exemption, the Financial Institution must notify the DOL that it will rely on the exemption The Financial Institution must maintain certain records that demonstrate compliance with the exemption CEFLI All Rights Reserved. May 10-11, Applicability Date Generally April 10, 2017 IRA contract requirement and policy and procedure requirement not applicable until January 1, 2018 CEFLI All Rights Reserved. May 10-11, Compliance & Ethics Forum for Life Insurers CEFLI All Rights Reserved. May 9,
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