Creating Advisor Incentives Under the New DOL Fiduciary Rule

Lou Ebinger
Lou Ebinger

Two people looking over some graphs and charts

On April 10, 2017, the first compliance deadline of the U.S. Department of Labor’s (DOL) fiduciary rule to address conflicts of interest in retirement advice will go into effect. The rule is designed to reduce the impact of financial advisor conflicts of interest, and it has significant implications for the way financial advisors are compensated.

As the effective date quickly approaches, many financial institutions are feeling the burden of creating new strategies to incentivize advisors while minimizing their compliance risk.

The Fiduciary Rule

First, let’s take a step back.

The Employee Retirement Income Security Act (ERISA) was enacted in 1974, and basic rules governing retirement advice were created the following year. At that time, 401(k) plans were not available and defined benefit pension plans dominated the market. Financial advisors were not considered “fiduciaries” of their retirement investor clients in recommending how employee benefit plan assets should be invested.

Due to the rising popularity of 401(k) participation, many individuals now require retirement advice from financial advisors. This has caused the DOL to revisit the definition of fiduciary to include “a person who provides investment advice or recommendations for a fee or other compensation with respect to assets of an employee benefit plan or IRA.”

When the DOL fiduciary rule is implemented, advisors and the institutions that employ them must clearly identify themselves as fiduciaries of the retirement investors they serve and must follow specific requirements when recommending a financial product that results in payment from the supplier of the financial product.

The Cloud on the Horizon

The impact of this rule is significant, because many advisors currently receive commission-based compensation in exchange for incremental sales of certain financial products.

Recognizing that advisors may continue to be paid by a supplier of a financial product, the DOL created the Best Interest Contract Exemption (BICE). The BICE allows advisors to receive commissions in exchange for selling a financial product only if the advisor and their financial institution meet certain requirements.

One of the requirements is to implement policies and procedures that ensure the advisor is making an investment recommendation that is in the best interest of the investor. Financial institutions are able to establish procedures that allow for financial advisors to receive commission-based compensation—as long as they are strictly supervised and based on “neutral factors.”

In the words of the DOL, advisors must be compensated in a way that “ensure[s] that [a]dvisors are making recommendations between different categories based on the customer’s financial interest, and not on the differential compensation the [a]dvisor stands to make.”

Now it’s time to get down to strategy. Financial institutions have to begin strategizing now in order to create incentive programs that comply with the fiduciary rule before the April deadline.

A Look at Incentive Strategy

Now, let’s get back to those key words: neutral factors.

How do you build an advisor incentive based on neutral factors? The key is to award the advisor based on total assets rather than for specific products sold to the investor. Assuming that the advisor’s financial institution complies with the other aspects of the rule, here are a few examples of rule structures to reward advisors:

  • Tiering total asset sales: Advisors are placed in tiers based on total asset sales for a defined period of time. Each tier may include payouts for unique goals that represent incremental growth.
  • YOY incremental growth of total assets: Advisors are required to achieve a minimum qualifier and/or a stack-ranking of incremental growth.
  • Stack-ranking of total asset sales: Stack-ranking of advisors may be based on a specific count and/or percentage of advisor audience and include a minimum qualifier reward, but must be irrespective of total sales based on product type.
  • Total assets sold over a defined period: Advisors are required to achieve a minimum qualifier and/or a stack-ranking of incremental growth over any period of time and total sales may represent a total unit count and/or total sales revenue of the entire portfolio. The advisor earns the same percentage on the same payment schedule, regardless of how the retirement investor’s assets are allocated between different investments (e.g., equity securities, proprietary mutual funds, and bonds underwritten by entities not related to the financial institution).
  • Training completion and overall product portfolio quality: Advisors are required to complete training based on a financial institution’s needs, and awards are tied to the overall product portfolio.
  • Investors’ client satisfaction metrics: Advisors are required to achieve a minimum qualifier based on incremental growth of certain client satisfaction metrics and/or a stack-ranking of advisors based on top scores.
  • Loyalty and commitment: Advisors are recognized and rewarded for elevating the customer experience through enhanced services and business development tools such as exemplary customer service, training completion, strategic marketing tools and technology

These examples provide an idea of the many options still available to financial institutions. Implemented rule structures may be much more complex, combining several factors and utilizing elements that capture opportunities to calculate a return on investment (ROI).

The bottom line is that although the new fiduciary rule may cause some growing pains within the financial market, the use of strategic, compliant incentives could help alleviate the transition.

The materials appearing in this article are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Use of and access to these materials do not create an attorney-client relationship between the author and the user. The opinions expressed at or through this site are the opinions of the individual author and may not reflect the opinions of ITA Group.

Lou Ebinger

Lou Ebinger

Lou Ebinger is ITA Group’s General Counsel.