What Signing a Best Interest Contract Exemption (BICE) Means
The new Department of Labor (DOL) fiduciary rule, which went into effect earlier in 2017, is supposed to make all financial advisers fiduciaries if they are providing advice on retirement accounts. One of the big concerns DOL wanted to address is the inherent conflict of interest created when an adviser's pay is tied directly to which financial product you buy (based on their advice of course).
Variable Commissions Create Conflicts
At the heart of this concern are the variable commissions an adviser, and their company, can receive depending upon what financial product you buy. For commissioned advisers, the adviser/company is only paid if you invest in a financial product. Although this sounds like most other businesses, commissioned advisers can earn more money by directing you to invest in higher-commission investments. These variable commissions create a huge conflict of interest for the advice. (To determine if your financial adviser is paid on commissions, look at their license.)
The Best Advice OR The Biggest Payout?
The conflict arrises when commissioned advisers make their recommendations. Because they are paid on commission by the investment company whose products they are selling, they can control their income by recommending you purchase a financial product with a bigger, juicier commission.
As a result, a commissioned adviser may be influenced to recommend an investment with a higher commission which, although good, is inferior to another investment product. Even if the bias is subconscious. Ultimately, loyalty goes to whomever signs the checks. And commissioned adviser's checks are signed by the investment companies and insurance companies, not by you, the client.
The Fiduciary Solution
To combat this, the DOL required all advisers to be fiduciaries when working with retirement accounts. Being a fiduciary means they owe a loyalty to you, the client, and are legally required to do what is in your best interest, and not their own. It also means the adviser and their company are compensated the same regardless of which investment product they recommend.
The Best Interest Contract Exemption
The DOL rule, however, has a major exemption from the fiduciary rule. If you sign a Best Interest Contract, the adviser gets to continue doing business the old way using the Best Interest Contract Exemption. This means they can be exempted from the regulations put in place to avoid the conflicts of interest created by varying commissions.
Beware the BICE
If your adviser asks you to sign a Best Interest Contract, make sure you understand the implications of the exemption. You should also consider getting a second opinion on the investment recommendation from a fee-only adviser.
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Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. His career provides him with a unique insight on personal financial, having been a VP at a financial institution leading up to 2008, and involved with technology and internet stock research leading up to 2000. He can be reached for comment at info@purposefulfinance.org