Kevin Knull, CFP® Marcia S. Wagner, Esq. The Fiduciary Rule: What Are the Practical Implications, What Should You Have Done Yesterday and What Should You Do Now?

Agenda Rulemaking Status Proposed Fiduciary Definition Carve-outs from Definition Proposed BIC Exemption Annuities Fee Levelization Robo-Advice Rollovers Managed Accounts Practical Considerations 2

Introduction Broadening of Fiduciary Definition ◦ DOL proposal would broaden scope of advisors deemed to be IRA/plan fiduciaries under ERISA ◦ Targets broker-dealers (BDs) and registered reps (RRs) earning commission-based compensation ◦ Would change IRA marketplace ◦ Would impact registered investment advisers (RIAs) (1) Capturing rollovers and (2) Managed account programs 3

Rulemaking Status Recent Events ◦ DOL proposal published on April 20, 2015 ◦ Public hearings in August 2015 ◦ Final draft sent to OMB on Jan. 28, 2016, and final rule is expected in April or May 2016 Future Outlook ◦ DOL has announced 8-month grace period, taking substantive effect in or around Dec ◦ Congressional efforts to block the DOL have not been successful ◦ Lawsuits are anticipated, but may face challenges 4

Existing Fiduciary Definition Fiduciary Status ◦ Covers person who provides “investment advice” relating to plan assets for compensation ◦ Not a fiduciary if no investment advice is given 5-Prong Definition for “Investment Advice” ◦ Making investment recommendations ◦ On regular basis ◦ Mutual understanding ◦ Primary basis for plan’s decisions ◦ Individualized to plan’s needs 5

Proposed Fiduciary Definition Fiduciary Status ◦ Covers person who provides “investment advice” for compensation to plans, plan fiduciaries, participants, IRAs and IRA owners 4-Prong Definition for “Investment Advice” ◦ Making covered recommendations ◦ Understanding (does not need to be mutual) ◦ Individualized or specifically directed to recipient ◦ For consideration by recipient (need not be primary basis) 6

Scope of “Investment Advice” Covered Recommendations ◦ Investment recommendations, including taking/investing rollovers ◦ Investment management recommendations, including management of rollover assets ◦ Giving appraisal or fairness opinion ◦ Recommending person who provides any of above services for compensation 7

Acknowledging Fiduciary Status Deemed “Investment Advice” ◦ Advisor makes covered recommendations ◦ Represents or acknowledges that it is a fiduciary with respect to advice ◦ No written acknowledgement is required ◦ Fiduciary status applies automatically, even if proposed 4-prong definition is not met 8

Observations on Proposed Definition Proposed Changes to “Investment Advice” ◦ Includes one-time advice (without “regular basis” condition) ◦ No need for "mutual understanding” of parties ◦ Advice merely needs to be specifically directed to recipient (and does not need to be individualized) ◦ Recipient merely needs to consider advice when making decision (even if not “primary basis”) ◦ Expressly revises definition to cover investment management recommendations 9

Carve-outs from “Investment Advice” 6 Carve-outs from Fiduciary Rule ◦ Counterparty to Large Plan ◦ Swap Counterparty ◦ Employees of Plan Sponsor ◦ Platform Providers ◦ Financial Valuations and Appraisals ◦ Investment Education Limitations of Carve-out ◦ Carve-out does not apply if advisor represents or acknowledges fiduciary status 10

Carve-out: Counterparty to Large Plan Conditions for Fiduciary Carve-out ◦ Counterparty provides advice relating to arm’s length purchase/sale, loan or contract ◦ Written representation from plan fiduciary  Plan has at least 100 participants, it has sufficient expertise, and it will not rely on counterparty to act as fiduciary  Not required if plan fiduciary has $100M+ AUM ◦ Counterparty discloses nature of its role ◦ No direct fee from plan or plan fiduciary Carve-out Not For Agency Services (e.g., broker’s receipt of 12b-1 fees) 11

Carve-out: Swap Counterparty Conditions for Fiduciary Carve-out ◦ Counterparty is swap dealer (or security-based swap dealer) or major swap participant ◦ Not acting as “advisor” to plan under Commodity Exchange Act or Securities Exchange Act ◦ Written representation from plan fiduciary that it will not rely on advice from counterparty 12

Carve-out: Plan Sponsor Employees Conditions for Fiduciary Carve-out ◦ Employee may provide advice to plan fiduciary ◦ Must not receive compensation beyond employee’s normal pay ◦ Carve-out is designed to protect employees from potential fiduciary liability 13

Carve-out: Platform Providers Conditions for Fiduciary Carve-out ◦ Carve-out applies to providers of investment platforms for DC plans (recordkeeping platforms) ◦ Platform may market investment alternatives without regard to individualized needs ◦ Must disclose that platform does not provide impartial fiduciary advice ◦ Can identify investment alternatives that meet objective criteria ◦ Can provide objective financial data and benchmark comparisons 14

Carve-out: Financial Valuations Covers valuations/appraisals for: ◦ ESOPs ◦ Pooled Investment Vehicles (such as CIFs) ◦ Regulatory reporting purposes Carve-out applies to both plan and IRA clients 15

Carve-out: Investment Education Similar to Current Safe Harbor (IB 96-1) ◦ Plan Information ◦ General Financial/Retirement Information ◦ Asset Allocation Models ◦ Interactive Investment Materials Observations ◦ Carve-out applies to both plan and IRA clients ◦ Expanded to include retirement income guidance ◦ Education must not recommend specific investment products ◦ Asset allocation models and interactive materials cannot reference plan’s investment alternatives 16

DOL Proposal and Exemptions Need for “ERISA 406(b)” Exemptive Relief ◦ Proposed “investment advice” definition confers fiduciary status on all types of advisors ◦ Prohibited transaction rules ban advisors from earning variable compensation (commissions) ◦ Exemption required for brokers and insurance agents, including advisors to IRAs ◦ DOL proposed Best Interest Class Exemption 17

Best Interest Contract (BIC) Exemption Retail Scope of Proposed Exemption ◦ Permits fiduciary advisor to earn variable compensation (commissions) for services to:  Participants  IRA owners  Sponsors of small, non-participant-directed plans (less than 100 participants) Observations ◦ No exemptive relief for small, participant-directed plans (but such relief is expected in final version) ◦ No exemptive relief expected for large plan sponsors (participant-directed or otherwise) 18

Product Scope of BIC Exemption Covered Products ◦ Bank deposits and CDs ◦ Mutual funds, ETFs, CIFs and insurance company separate accounts ◦ Exchange-traded REITs ◦ Corporate bonds (registered offering) and equity securities (exchange-traded) ◦ Treasury and agency debt securities ◦ Insurance/annuity contracts and GICs Observations ◦ No exemptive relief for privately placed debt, non-traded REITs and alternative investments 19

Required Contract for BIC Exemption Signed before recommendations are made Mandatory Terms for Written Contract ◦ Must state that advisor is fiduciary ◦ Impartial Conduct Standard  Advice is in “best interest” of client  Reasonable compensation  No misleading statements ◦ Warranties  Compliance with law  Policies reasonably designed to mitigate conflicts  No incentives to provide improper advice ◦ No Liability Limit for Contract Violations  Arbitration permitted (with class action rights) 20

Disclosures Under BIC Exemption Written Contract Disclosures ◦ Must identify conflicts ◦ Client’s right to obtain complete fee information ◦ Whether advisor offers proprietary products or receives third party payments ◦ Address of webpage disclosing compensation Three (3) Separate Disclosures ◦ Pre-Transaction: projected cost chart for 1-, 5- and 10-year periods ◦ Annual: investment and fee activity ◦ Webpage: compensation and fee disclosures for all available investments 21

Investment Range and BIC Exemption Required Range of Investments ◦ Advisor must offer broad range of investments covering all reasonably necessary asset classes ◦ But limited range may be permissible  Written finding that range limitations do not interfere with “best interest” standard for advice  Reasonable compensation for services  Written notice of range limitations  Must notify if recommended investments are not sufficiently broad for client’s needs ◦ Examples of range limitations  Offering limited to proprietary products or investments with third party payments 22

DOL Notice for BIC Exemption Required Notice to DOL ◦ One-time notice must be filed with DOL before firm can rely on BIC Exemption ◦ Notice does not need to identify plan or IRA client ◦ DOL approval is not required 23

Potential Issues with BIC Exemption Compliance Issues ◦ Contract: Timing requirement is not practical ◦ Disclosure: Projections may conflict with sec law ◦ Web Page: Covers all available investments? ◦ Incentives: Payouts to RRs must be levelized? Business Issues ◦ Non-Traded REITs: No relief for commissioned sales ◦ Discretionary Advice: No relief for variable compensation arising from investment discretion ◦ Tech/Systems: BIC Exemption may be costly ◦ Client Disputes: Legal claims may increase 24

Observations on BIC Exemption Regulatory Jurisdiction ◦ DOL has no enforcement authority over IRAs, but required contract gives authority to clients ◦ Violation of Impartial Conduct Standard will breach contract (but not BIC Exemption) Impact on Brokers and Insurance Agents ◦ Will regulate advisors without any plan clients (who merely have personal clients with IRAs) ◦ May be difficult for firms to eliminate incentives that encourage improper advice 25

Annuity Products and DOL Proposal Treatment of Annuity Sales ◦ Customary to earn commissions from sale of variable annuities (VAs) and other products ◦ Commission-based advisors will be deemed to be fiduciaries under new DOL rule ◦ Need exemptive relief to continue to earn variable compensation Available Exemptions ◦ BICE and PTE allows fiduciary advisors to earn commissions from annuity sales ◦ PTE has less onerous conditions, but provides limited relief 26

PTE and Annuity Sales PTE With Proposed Amendments ◦ Upside is that it is much easier to comply with than BIC Exemption ◦ No written contract or compliance policies ◦ Upfront disclosure must state commission as % of premium (every 3 years if ongoing deposits) ◦ Fiduciary standard and conflicts disclosures ◦ No relief for VA sales to IRA clients ◦ No relief for revenue sharing 27

BIC Exemption vs. PTE “Compliance Strategy Choice ◦ BICE or for any annuity sales to plans ◦ BICE or for fixed annuity sales to IRAs ◦ BICE only for variable annuity sales to IRAs Practical Considerations ◦ BICE would allow firm’s receipt of sales-based or asset-based revenue sharing payments ◦ Consider using BICE for all annuity sales ◦ Or use BICE for all annuity sales to plan/IRAs on brokerage platform (including VA sales to IRAs), and use PTE for plans on ins. platforms 28

Fee Levelization De Facto Exemption ◦ Fiduciary advisor is permitted to earn transaction-based compensation ◦ However, it must not vary based on investments selected by plan or IRA client ◦ No need for exemption because fee levelization eliminates prohibited transaction to begin with Example ◦ Change compensation formula so that it is fixed (e.g., asset-based commission of 50 bps) ◦ Eliminate any remaining variable compensation 29

Implementing Fee Levelization Potential Areas of Variable Compensation ◦ Commissions and Ticket Charges ◦ Revenue Sharing ◦ Payments from Funds (e.g., sub-TA payments) ◦ Proprietary Products (e.g., sweep vehicle) How To Levelize ◦ Need appropriate universe of investment products that pay levelized amount (e.g., 50 bps) ◦ Restructure revenue sharing as flat dollar payments ◦ Replace proprietary products (or fee credit) 30

Robo-Advice What Is It? ◦ Asset allocation advice based on computer models ◦ Routinely used for participant-level advice and recommending allocations to plan menu options ◦ Potentially available for IRA investors Background on Computer Models ◦ Many use Mean Variance Optimization (MVO) based on work of Harry Markowitz ◦ Monte Carlo simulations can help model the probability of different portfolio outcomes 31

Computer Model Exemption History ◦ TCW Exemption (PTE 97-60) ◦ SunAmerica Opinion (AO A) ◦ Computer Model Exemption (PPA of 2006) Relief from Computer Model Exemption ◦ Allows receipt of variable compensation (1) Commissions (e.g., 12b-1 fees) (2) Proprietary Funds ◦ Advice must be non-discretionary and based on computer model 32

Requirements for Computer Model Computer Model ◦ Based on generally accepted theories ◦ Must not favor investments that generate more compensation for advisor ◦ Must request client’s risk profile information ◦ Must consider all designated investment options Other Requirements for Exemption ◦ Certification by investment expert ◦ Annual audits by independent auditor ◦ Written authorization and disclosures ◦ Reasonable compensation for provider 33

Capturing Rollovers Issues Arising From Cross-Selling ◦ Potential conflicts of interest ◦ Advisor develops relationships with plan sponsor and participants ◦ Exploiting trust to sell at unfavorable terms Potential Impact on Participants ◦ Advisor’s fees on rollover assets may be higher than fees on plan assets 34

DOL Rollover Opinion Advisory Opinion A ◦ Broadly suggests that if advisor is a fiduciary, any rollover advice may trigger prohibited transaction ◦ If advisor is not a fiduciary, rollover advice will not trigger prohibited transaction ◦ Advisor providing “accidental” fiduciary advice would be subject to restrictions Varity v. Howe (Supreme Court) ◦ Fiduciary advisor may communicate to participants in non-fiduciary capacity ◦ Suggests that advisor may capture rollovers when acting in separate non-fiduciary capacity 35

Effect of New DOL Rule on Rollovers Impact on Advisory Opinion A ◦ Would replace DOL’s current rollover guidance ◦ As proposed, any rollover advice would be fiduciary advice ◦ Rollover advice would automatically trigger plan or IRA fiduciary status Relief under BIC Exemption ◦ Would give advisors ability to capture rollovers and earn higher rates of compensation 36

Potential Impact on RIAs Capturing Rollovers ◦ RIAs advising plan clients generally earn higher (and variable) fees when capturing rollovers ◦ Under DOL Proposal, RIA must comply with BIC Exemption Retail Managed Account Programs ◦ Advisors earning any variable compensation from IRA/plan clients must comply with BICE ◦ Solicitors would be fiduciary advisors and must also comply with BICE 37

Focusing on Managed Accounts Impact of DOL Rule ◦ Model Providers and Overlay Managers may be deemed fiduciary advisors under new DOL rule ◦ Recommending Model Providers may be advice e.g., 100 bps for managed account services -30 bps for Model Provider #1 -20 bps for other costs 50 bps net compensation ◦ Recommending cheaper Model Provider may increase firm’s net compensation Other Potential Variable Compensation ◦ Revenue sharing ◦ Commissions and ticket charges 38

Implications for Managed Accounts BIC Exemption ◦ May provide relief for managed account programs with variable compensation ◦ BICE does not provide relief for variable compensation from discretionary advice Fee Levelization ◦ Combination of BICE and Fee Levelization may be necessary ◦ Restructure revenue sharing payments 39

Anticipated Impact on B/D Industry Short-Term Impact ◦ When new rule goes into effect, firms will need to send contract and disclosures to existing clients ◦ No commissioned sales to non-traded REITs ◦ Advisors may decide to decline rollover opportunities ◦ More RRs may migrate to advisory service model ◦ If advisor recommends transition from brokerage to advisory model, BICE may be required (e.g., moving from A share with 25 bps to advisory services for 100 bps) 40

Anticipated Trends in B/D Industry Strategic Courses of Action ◦ Levelize commissions and structure revenue sharing as flat dollar payments ◦ Promote advisory programs featuring institutional mutual funds and variable annuities ◦ Use PTE for all annuity contract sales to plan clients and for fixed annuity sales to IRA clients (with flat dollar revenue sharing) ◦ Modify managed account programs to rely on BICE and/or fee levelization ◦ Robo-advisors relying on Computer Model Exemption for plan and IRA clients 41

ERISA Compliance Planning Timing ◦ DOL’s 8-month grace period for new rule is expected to end in or around December 2016 What You Should Be Doing Right Now ◦ Identify all investment products and advisory services currently sold to plan and IRA clients ◦ Confirm firm has adequate supervisory control over retirement accounts ◦ Identify all instances of variable compensation ◦ Develop strategies (BICE, PTE and Fee Levelization) for brokerage platform and advisory programs with ERISA counsel 42

Implementation BIC Exemption Toolkit ◦ Create model client contracts with mandatory provisions and disclosures ◦ Develop model disclosures ◦ Adopt compliance policies to mitigate conflicts and to ensure advisors do not have incentive to give bad advice ◦ Provide training for advisors with regard to new fiduciary standard, BIC Exemption and firm’s compliance policies ◦ Develop operational restrictions to block impermissible trades (such as commissioned sale of non-traded REITs) 43

Strategic Use of Financial Plans Coordination with BIC Exemption ◦ As proposed, BIC contract must be signed before any investment recommendations are made ◦ Consider using financial plans (with BIC contract) to discuss investments with prospects ◦ DOL is likely to relax this BIC timing requirement, but financial plans may be helpful best practice ◦ Can help demonstrate that advisor is acting in accordance with the new fiduciary standards 44

Conclusions Moving to Universal Fiduciary Standard ◦ DOL is seeking to impose “best interest” fiduciary standard on all types of advisors to plans/IRAs Irony of Policy Goals ◦ New regime would effectively create 2 classes of fiduciaries (with or w/o variable compensation) ◦ Plan and IRA clients may not realize fiduciary advisors can still earn variable compensation 45

Conclusions (cont’d) Expected Impact on Advisors ◦ DOL proposal will affect substantially all advisors because of reach to IRA assets ◦ Costly for broker-dealers and insurance agencies ◦ BIC Exemption disclosures appear to significantly exceed 408(b)(2) fee disclosures 46

Q&A Questions? 47

Important Information This presentation is intended for general informational purposes only, and it does not constitute legal, tax or investment advice from The Wagner Law Group or MoneyGuidePro and their respective affiliates. Financial advisors and other plan service providers should consult with their own legal counsel to understand the nature and scope of their responsibilities under ERISA and other applicable law. 48

Kevin Knull, CFP® Marcia S. Wagner, Esq. The Fiduciary Rule: What Are the Practical Implications, What Should You Have Done Yesterday and What Should You Do Now?