July	21,	2015

BY	EMAIL

Office	of	Exemption	Determinations

Employee	Benefits	Security	Administration

United	States	Department	of	Labor

122	C	St.	NW,	Ste.	400

Washington,	D.C.	20001

Office	of	Regulations	and	Interpretations

Employee	Benefits	Security	Administration

United	States	Department	of	Labor

200	Constitution	Ave. NW

Washington,	D.C.	220210

RE:	Docket	ID	EBSA-2014-0016;	RIN	1210-AB32

Attn:	Conflict	of	Interest	Rule,	Room	N–5655;	D-11712

Dear	Sir	or	Madam:

Fund	Democracy	greatly	appreciates	the	opportunity	to	comment	on	the	

Department’s	proposed	Best	Interest	Contract	Exemption	(“BIC	exemption”).

1

During	the	last	two	decades,	the	conflicted	structure	of	broker-dealer	compensation	

has	deteriorated	to	the	point	where	it	is	an	annual,	multi-billion	dollar	drain	on	our	

economy.		Securities	regulators	have	repeatedly	floated	proposals	to	address	these	

concerns	but	have	in	every	case	failed	to	follow-through,	leaving	the	Department,	

with	its	unique	mandate	to	protect	Americans’	retirement	security	and	to apply	the	

heightened	legal	duties	that	ERISA	requires,	no	choice	but	to	take	decisive	action.		I	

applaud	the	Department	for	its	untiring	diligence	through	a	long	rulemaking	

process	and	unwavering	stand against	an	unprecedented	onslaught	by	paid	

lobbyists	and	self-interested	firms.

This	letter	reflects	more	than	two	decades of	experience,	covering	a	wide	range	of	

professional	perspectives, with	the	issues	addressed	by	the	Department’s proposed	

BIC	exemption	and	related	proposals.

2		As	to	the	Department’s	proposal	regarding	

																																																							 1 I	am	the	founder	and	president	of	Fund	Democracy,	a	non-profit	organization	

2 I	have	worked	on	these	issues	in	many	capacities	over	the	last	25	years,	including	

testifying	before	Congress,	submitting	comment	letters,	publishing	commentaries,	

delivering	presentations,	providing	consulting	services,	acting	as	an	expert	witness	

in	private	litigation	and	public	enforcement	matters	(including	revenue	sharing	

cases	brought	by	the	California	Attorney	General	and	Massachusetts	Secretary	of	

States’	Securities	Division),	developing	policy	as	an	Assistant	Chief	Counsel	at	the	
2

its	interpretation	of	term	“fiduciary” under	ERISA,	I	hereby	submit	as	an	attachment	

to	this	letter	my	prior	comments	provided	to	the	Office	of	Management	and	Budget.3		

The comments	in	this	letter	address	a	number	of	important	aspects	of	the	

Department’s	proposed	exemption,	and	I	expect	to	supplement	them	during	the	

course	of	the	Department’s	staggered	comment	period.	Part	I begins with	a	

discussion	of	the	history	of	Class	B	shares and	related	recommendations.		Part	II	

illustrates how	some	conflicted	fee	arrangements	may	affect	financial	advisers’	

recommendations	to	their	clients.		I	evaluate	the	enforcement	of	the	Best	Interest	

Contract	in	private	claims	in	Part	III	and	make	related	recommendations.		Part	IV	

provides	five	general	recommendations	regarding	the	overall	structure	of	the	BIC	

exemption.		In	Part	V,	I	discuss	specific	provisions	of	the	BIC	exemption	and	make	

related	recommendations.		For	convenience,	I	have	provided	a	table	of	contents

below.

								 I.		Class	B	Shares	and	the	Efficacy	of	Enforcement	.		.		.		.		3

II.		Conflicted Fee	Arrangements		. .		.		.		.		.		.		.		.		.		.		.		.		.		.		6

A.		Transaction	Fees .		.		.		.	 .		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		7

B.		Front-End	Loads	&	12b-1	Fees	 . .		.		.		.		.		.		.		.		.		.		.		9

C.		Revenue	Sharing 		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.	 14

D.		Education	and	Training	(aka	Travel	and

Entertainment)	.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.	 .		.		.		19

E.		Exponential	Payout	Grids			.		.		.		.		.		.		.		.		.		.		.		.		.		.		23

III.		Private	Litigation	and	the	Enforceability																																

of	the	Best	Interest	Contract 		.		.		.		.		.		.		.		.		.		.		.		.		.		.		25

A.		Fiduciary	Claims	in	Arbitration		.		.		.		.		.		.		.		.		.		.		26

B.		BIC	Enforceability	 .		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		26

																																																																																																																																																																				

SEC,	advising	broker-dealers	in	private	practice	on	compliance	matters,	teaching	

law	classes	and	in	working	for	a	St.	Louis-based	financial	planner.		I	am	not	being	

compensated	in	any	way	for	these	comments,	and	I	believe	my	comments	reflect	an	

objective	view	of	the	best	interests	of	investors.		I	have	a	conflict	of	interest,	

however,	in	that	the	Department’s	proposal	may	require	substantial	changes	in	the	

practices	of	the	registered	investment	adviser	that	employs	me.		The	Department	

should	assume	that	the	same	principles	that	I	recommend	be	applied	to	brokerdealers	should	be	applied	equally	to	investment	advisers.		My	comments	are	focused	

only	on	broker-dealer	issues	due	to	time	constraints	and	because	that	is	where	the	

Department’s	proposal	will	have	the	greatest	effect.	

3 See Letter	from	Fund	Democracy,	Consumer	Federation	of	America,	Public	Citizen’s	

Congress	Watch,	AARP	and	Americans	for	Financial	Reform	to	Sylvia	Burwell,	

Director,	Department	of	Management	and	Budget	(Oct.	18,	2013).
3

IV.		Differential	Compensation Standards			.		.		.		.		.	 .		.		.		30

A.		Permit	Broker-Dealer-Level	

Differential	Payments		 .		.		.		.		.		.		.		.		.		.		.		.	 .		.		.		.		30

B.		Permit	Differential	Compensation between

Categories	of	Investments .		.		.	 .		.		.		.		.		.		.		.		.		.		.		31

C.		Prohibit	Non-Neutral	Differential

Compensation	within	Investment							

Categories.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		31

D.		Prohibit Non-Neutral	“Reimbursed”	Travel	

and	Entertainment	Expenses		.		.		.		.		.		.		.		.		.		.		.		.		33

E.		Treat	Branch	Managers	as	Financial	

Advisers .		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		34

									 V.		Best	Interest	Contract	Exemption	Terms	.		.		.		.		.		.		.		35

A.		Reasonableness	Requirement		.		.		.		.		.		.		.		.		.	 .		.		35

B.		Mitigating	the	Impact	of	Material	

Conflicts	of	Interest 		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		36

i. Materiality Standard .		.		.		.		.		.		.		.		.		.		.		.		.		.		.		.		36

ii. “Mitigate	the	Impact” .		.		.		.		. .		.		.		.		.		.		.		.		.		.		.		38

I. Class	B	Shares	and	the	Efficacy	of	Enforcement

It	is	helpful	to	begin	with	a	bit	of	history	and	context.		The	financial	industry	claims	

that	the	Department’s	proposal	will	cause	substantial	damage	to	its	compensation	

practices	and	to	investors.		In	considering	this	claim,	the	Department	may	wish	to

review	the	history	of the	sale	of	mutual	fund	Class	B	shares.		Class	B	shares	generally	

are	no	longer	sold	because,	as	described	further	below,	securities	regulators’	

enforcement	divisions	have	used	settled	enforcement	actions	to	banish	Class	B	

shares	from	the	marketplace.		Without	any	public	comment,	rulemaking	process	or	

specific	regulatory	guidance,	enforcement	staff	have	effectively	eliminated	a	

conflicted	compensation	structure.

Class	B	shares	impose	a	deferred	sales	charge	that	declines	over	time	and,	typically,	

a	1.00%	12b-1	fee.		The	fund	distributor	usually	pays	the	selling	broker-dealer	a	

fixed	concession	that	equals	a	percentage	of	the	purchase	amount,	and	the	brokerdealer,	in	turn, pays the	selling	financial	adviser	a	percentage	of	that	amount.		One	

fund	complex,	for	example,	pays	a	4.00%	concession.4		If	an	investor	purchased	

																																																							 4 This	letter	uses	actual	funds	and	disclosures	but	does	not	identify	the	entities	in	

order	to	focus	attention	on	what	are	industry-wide	practices.	To	the	extent	the	

practices	or	disclosures	of	particular	entities	reflect	negatively	on	them,	it	should	be	

noted	that	these	practices	and	disclosures	are	common	in	the	industry	and,	in	most	

cases,	legally	permissible.
4

$100,000	in	Class	B	shares,	the	broker-dealer	would	be	paid	$4,000	and	the	adviser	

about	$1,600	assuming	a	typical	40%	payout	rate (payout	rates	can	be	lower	and	

significantly	higher).		In	contrast,	if	the	investor	purchased	Class	A	shares,	discounts	

on	the	commission	paid	would	result	in	a	lower	concession.		For	example,	the	same	

fund	that	pays	the	Class	B	4.00%	concession	pays	only	a	3.00%	concession	on	a	

$100,000	investment,	which	would	reduce	the	broker-dealer’s	compensation	by	

$1,000	and	the	adviser’s	by	$400.

Not	surprisingly,	some	advisers	recommended	large	purchases	of	Class	B	shares	

solely	because	the	adviser was	paid	higher	compensation	than	if	Class	A	shares	were	

recommended.		Some	broker-dealers’	sales	were	predominantly	Class	B	shares,	

which	indicated	a	firm-wide	culture	of	maximizing	compensation	to	the	detriment	

of	investors.		Disclosure	of	the	amount	of	the	differential	payments	received	by	

advisers	on	account	of	Class	B	shares	has	never	been	required or	proposed	to	be	

required	by	the	SEC	or	FINRA.		Nor	have	such	compensation	structures	ever	been	

prohibited	or	proposed	to	be	prohibited	by	either	agency.

However,	the	SEC’s	and	FINRA’s	enforcement	staff	saw	an	established compensation	

structure	that	amounted	to	a	kind	of	fraud	on	investors, and	they	took	action.		They	

sued	firms	and	entered	into	a	series	of	non-litigated	settlements	that	raised	the	cost	

of	selling	Class	B	shares.		Initially,	broker-dealers	developed	procedures	that	

prevented	very	large	purchases	of	Class	B	shares.		The	enforcement	actions	

continued,	however,	and	many,	if	not	most	industry	participants	ultimately	decided	

against	selling	Class	B	shares.

Yet	SEC	and	FINRA	rules	continue	to	permit	the	sale of	Class	B	shares,	which	are	

with	mathematical	certainty	almost	never	the	best	option	for	an	investor.5		The	

regulators	also	permit	a	variety	of	differential	compensation	structures,	as	

discussed	below,	that	are	similar	to	the	Class	B	compensation	structure.		The	SEC	

and	FINRA	also	continue	to	permit	conflicted	fee	structures	without	disclosure	by	

the	funds	or	broker-dealers	of	amount	of	the	differential	compensation.		To	their	

credit,	the	agencies’	enforcement	divisions	continue	to	bring	enforcement	actions	on	

the	basis	of	various	differential	compensation	arrangements.		

In	some	cases,	these enforcement	actions	have,	as	with	Class	B	shares,	made	de	facto

regulatory	policy.		As	a	result	of	these	enforcement	actions,	the	SEC	is	able	to	claim	

that	broker-dealers	“must”	“disclosure	information	about	revenue	sharing	

																																																							 5 See	Edward	S.	O’Neal,	Mutual	Fund	Share	Classes	and	Conflicts	of	Interest	between	

Brokers	and	Investors,	10	PIABA	Bar	Journal	63,	67	– 68	(Spring	2003); John	

Rekenthaler	and David	McClellan, Mutual	Fund	Share	Class	Limits	and	Share	Class	

Suitability,	Morningstar,	Inc.,	at	11	– 12	(May	15,	2006)	available	at	

http://corporate.morningstar.com/US/documents/MethodologyDocuments/Metho

dologyPapers/ShareClassLimitsandSuitability.pdf.
5

arrangements	for	the	sale	of	mutual	funds.”6		It	cites	no	rule	or	regulatory	guidance	

to	that	effect,	but	only	a	series	of	enforcement	actions.7		There	is	no	specific	rule	that	

requires	revenue	sharing	disclosure	or	any	specific	guidelines	as	to	what	it	must	

include,	but	prudent	broker-dealers	generally	provide	online	disclosure	of	

information	about	certain	conflicted	fee	practices	in	order	to	mitigate	their	public	

enforcement	risk	and,	in	the	retirement	plan	context,	to	mitigate	private	liability	

risk	(differential	compensation	and	private	liability	risk	are	discussed	in Part	III,

infra).

The	history	of	Class	B	shares	and	the	apparent	SEC/FINRA policy	of	largely	

regulating	differential	compensation structures	through	enforcement	are	

instructive.		The	history	of	Class	B	shares	is	relevant	here	for	a	number	of	reasons:

• It	provides	a	recent	example	of	regulators	directly	causing	the	kind	of	

dramatic	changes	in	conflicted	compensation	practices	that	the	Department	

should	seek	to	achieve for similarly	conflicted	practices.		

• It	shows	that	a	major	change	in	compensation	structures	recently	occurred	

without	any	outcry that	the	industry	or	investors	were	harmed	materially,	if	

at	all.		

• This	change	occurred	without	any	objections	that	small	investors	would	be	

harmed,	notwithstanding	that	the	elimination	of	Class	B	shares	has	reduced	

compensation	for	small	investors who	would	have	been	sold	Class	B	shares	

(although	not	disproportionately,	because	the	Class	B differential	depends	on	

the	purchase	amount	exceeding	Class	A	commission	breakpoints).		

• It	shows	the	SEC	and	FINRA,	which	the	industry	claims	to	prefer	as	

regulators	of	differential	compensation, choosing	to	ban	conflicted	

compensation	practices	through enforcement	actions	rather	than	seeking	to	

regulate	them	through	rulemaking	subject	to	public	comment.		

• Finally,	the history	of	Class	B	share	militates	for	more	aggressive	

enforcement	action	by	the	Department.		

																																																							 6 Certain	Broker-Dealers	Deemed	Not	to	Be	Investment	Advisers,	Rel.	No	34-51523,	

70	F.R.	20433	at	note	93	(Apr.	19,	2005).		It	is	no	coincidence	that	the	most	accurate,	

complete	disclosure	of	differential	compensation	by	a	fund	complex	is	provided	by	a	

firm	that	has	been	sued	by	both	the	California Attorney	General	and	FINRA	in	

connection	with	its	revenue	disclosure	practices.	

7 Id.
6

In	my	view,	the	Department	should,	in	conjunction	with	its	rulemaking,	identify	and	

bring	enforcement	actions	against	advisers	who	oversee	commission-based,	

discretionary	IRAs	(i.e.,	fiduciaries	under	ERISA)	that	are	invested	with	the	fund	

complexes	that	make	the	largest	differential	payments.		These	are	prohibited	

transactions,	yet	they	are	rarely	subject	to	an	enforcement	action.		To	be	frank,	

while	the	industry	views	penalties	under	ERISA	as	severe,	it	does	not	view	the	

Department	as	posing	a	relatively	significant	enforcement	threat.		The	Department	

has	been	remiss	in	not	more	vigorously	enforcing	existing	law	as	a	means of	

mitigating conflicted	fee	arrangements and	providing	a	stronger	record	on	which	to	

conduct	the	present	rulemaking.		This	must	change	if	the	Department	wishes	to	

accomplish	its	overall	policy	goals.	

II. Conflicted	Fee	Arrangements	

This	part	of	my	comments	describes	various	differential	compensation	

arrangements	in	the	mutual	fund	context.		As	a	general	rule,	the	conflicts	these	

arrangements	create	are	significantly	milder than	those	created	by	compensation	

arrangements	for	sales	of	variable	annuities	and fixed	index	annuities,	and,	at	the	

extreme	end	of	the	conflicted	fee	spectrum,	non-traded	REITs,	non-traded	business	

development	companies,	and	tenant-in-common	investments.8		Nonetheless,	there	

is	no	doubt	that	conflicted	fees	in	the	mutual	fund	industry	are	significant	enough	to	

affect	and	do	affect	financial	advisers’	recommendations	to	their	clients.		The	

Department	does	not	describe	the	detailed	characteristics	of	these	conflicted	fee	

arrangements	or	state	exactly	what	abusive	practices	would	be	inconsistent	with	

BIC	exemption.		This	reflects,	in	part, the	principles-based	approach	that	the	

industry	claims	to	prefer,	but	it	is	an	approach	that	the	industry	is	also	using to	

undermine	the	Department’s	initiative, and	it	ultimately	may	undermine	the	efficacy	

of	its	proposal.

If	the	Department’s	rulemaking	is	to	be	effective,	it	is	my	view	that	it	must	provide	

detailed	examples	of	how	current	financial	incentives	work	and	explain	why	these	

arrangements	are	not	consistent	with	the	BIC	exemption.		This	is	not	so	much	to	

inform	firms	how	to	be	in	compliance	as	it	is	to	prevent	firms	from	claiming	that	the	

																																																							 8 See	generally Dan	Jamieson,	Broker-Dealers	Derive	Big	Income	From	RevenueSharing	Deals (May	11,	2015)	(discussing	direct-participation	programs	such	as	

non-traded	REITs	and	business	development	companies)	available	at www.famag.com/news/broker-dealers-derive-big-income-from-revenue-sharing-deals21717.html;	Tim	Husson,	Craig	McCann	and	Carmen	Taveras,	A	Primer	on	NonTraded	REITs	and	other	Alternative	Real	Estate	Investments,	Securities	Litigation	and	

Consulting	Group	(2012) (as	much	as	20%	of	an	initial	investment	in	a	non-traded	

REIT	is	paid	in	fees,	and	additional	fees	are	generated	by	buying,	selling,	developing,	

or	managing	properties);	Tim	Husson,	Craig	McCann,	Edward	O’Neal	and	Carmen	

Taveras,	Large	Sample	Valuations	of	Tenancies-in-Common,	Securities	Litigation	and	

Consulting	Group	(2013) available	at http://ssrn.com/abstract=2398958.
7

Department’s	purportedly	“inadequate”	and	“unrealistic”	guidance	excuses	their	

noncompliance.		The	Chairman	and	CEO	of	broker-dealers’	primary	regulator	has	

opined	that	neither	firms	nor	arbitrators	could	know	what	the	Department’s	rule	

requires,	thereby	creating	an	independently	significant	hurdle	for	private	and	public	

enforcement	of	broker-dealers’	fiduciary	duty.9		This	charge	must	be	countered	with	

concrete	examples	of	abusive	compensation	arrangements	and	how	they	are	

affected	by	the	BIC	exemption.	

The	following	discussion	uses	a	specific	investment	scenario	to	illustrate	how	

differential	compensation	works in	practice.		It	assumes	a	small	investor	who	seeks	

a	recommendation	for	a	lump	sum	investment.		The	investor	is	a	65-year-old,	

financially	unsophisticated,	recently	widowed	retiree	whose	only	current	and	

prospective	income	is	$18,000	each	year	in	social	security	payments.		He	has	

received	a	$100,000	payout	on	his	wife’s	life	insurance	policy.		This	investor	is	an	

example	of	the	small	investor	whom	the	brokerage	industry	claims	will	be	harmed	

by	the	Department’s proposal.		He	is	also	an	example	of	the	kind	of	investor	who	is	

most	vulnerable	to	sales	abuses.		He	hopes	to	use	the	life	insurance	proceeds	to	

generate	a	small	amount	of	additional	income	for	his	remaining	days	while	leaving	

some	money	to	his	children	and	looks to	a	financial	adviser	to	make	a	

recommendation	on	how	to	invest	it.		How	might	a	financial	adviser	respond?		

A.	 Transaction	Fees

The	adviser	could	recommend	that	he	invest	in	a	fairly	recent	investment	option	

often	referred	as	a	managed	payout	fund.	 Using	an	actual	no-load	version	of	such	a	

fund,	the	adviser	could	enter	the $100,000	investment	amount	in	the	fund	

company’s	online	income	estimator	for	the	fund,	which	will	show	an	estimated	

monthly	income	of	$296,	or	$3,552	annually.		The	fund’s	expense ratio	is	0.42%,	

which	means	that	he	would	pay	approximately	$2,000	in	fees	over	a	five-year	period	

(the	estimated	monthly	income	is	net	of	these	expenses).		This	recommendation	

provides	an	effective	one-stop	solution	that	would	require	little	ongoing	advice,	

provide	liquidity	and	hold	out	the	possibility	that	the	client	could	leave	an	

inheritance	for	surviving	family	members.		Each	of	these	would	be	a	typical	common	

concern	for	such	a	client.	

However,	the	typical	financial	adviser	normally	would	not	recommend	such	an	

investment,	nor	should	the	financial	adviser	be	expected	to.		The	financial	adviser	

could	not	make	a	living	based	on	such	advice.		The	managed	payout	fund	would	be	

treated	by	the	broker-dealer	as	a	“transaction	fee	fund.”		This	means	that	the

broker-dealer	would	charge	a	one-time	$50	fee	for	making	the	investment.		Some	

part	of	that	may be	paid	to	the	financial	adviser (at	least	one	broker-dealer	does	not	

pay	any	part	of	the	transaction	fee	to	the	adviser),	but	there	is	no	publicly	available	

information	on	what	that	payment	would	be.		Whatever	the	payment	was,	it	would	

																																																							 9 See	infra discussion	at footnote	27.
8

not	provide	a	feasible	compensation	model	for	a	financial	adviser.		A	financial	

adviser	might	hear	out	the	client	on	his	situation	and	generously	agree	to	put	him

into	a	managed	payout	fund,	possibly	spending	less	than	an	hour	on	the	transaction.		

But	this	kind	of	a	transaction	does	not	reflect	a	viable	overall	business	model	for	a	

broker-dealer.	

The	broker-dealer	would	receive	additional	compensation	in	connection	with	the	

transaction,	but	publicly	available	information	suggests	that	the	financial	adviser	

would	not	benefit	in	any	way	as	a	result.		The	addition	compensation	would	be	what	

are	known	as	sub-accounting	fees	that	all	funds	pay	to	broker-dealers	for	

maintaining	shareholder	accounts.10		Broker-dealers	invest	their	clients’ assets	in	

mutual	funds	through	a	single	omnibus	account,	and	manage	each	client’s	account	

with	the	fund	at	the	broker-dealer	level.		These	are	payments	are	discussed	further	

in	Part	II.		At	this	point	in	the	analysis,	these	fees	are	relevant	because	it	may	be	that	

a	broker-dealer,	between	the	transaction	fees	and	sub-accounting	fees,	could	

profitably	operate	such	a	no-load	business.		

The	financial	adviser	could	generate	additional	revenue	with	a	more	traditional	

recommendation	to	invest	equal	amounts	in	a	U.S.	equity	fund,	bond	fund	and	cash	

fund.		This	would	be	a	reasonable	recommendation.		This	allocation	may	hold	out	

the	potential	for	greater	long-term	growth	than	the	managed	payout	fund,	which	

would benefit	a	client	who	may	live	another	40	years.		The	three	transactions	would	

generate	$150	in	transaction	fees,	and	may	push	the	adviser’s	compensation	to	over	

$100.		However,	this	allocation	would	require	a	fair	amount	of	ongoing	oversight	to	

help	the	client	manage	both	the	allocation	among	the	three	funds	and	the	rate	of	

withdrawals	from	the	cash	account.		This	alternative	provides	higher	compensation,	

but	it	may	actually	be	less	economically	viable	for	the	adviser	because	of	the	

additional	investment	of	time	required.

The	point	of	this	discussion,	and	reason	for	using	this	client,	is	to	illustrate	how	

difficult	it	may	be	for	someone	in	this	situation	to	get	good	advice.		The	client’s	

situation	is	actually	relatively	simple,	but	there	is	generally	no	service	model, other	

than	a	pro	bono or	special	client	part	of	a	financial	practice,	that	can	accommodate	

this	client	other	than	broker-dealer	load-fund	model.		This	example	provides	useful	

insight	into	what	the	Department	should	be	sure	to	permit	as	part	of its	rulemaking,	

that	is,	the	servicing	of	this	kind	of	client.

On	one	level,	banishing	conflicted	fees	would	require	that	broker-dealers	offer	only	

no-load	funds	such	as	the	funds	discussed	above.		This	could	mean	that	the	client	

went	without	any	advice.		A	less	pure	approach	might	be	to	require	broker-dealers	

to	pay	the	same	compensation	to	financial	advisers	with	respect	to	all	products	sold	

by	the	broker-dealer.		This	would	prevent	the	financial	adviser	from	offering	the	no-

																																																							 10 A	broker-dealer	typically	charges	an	approximate	fee	of	either	$18	per	account	or	

0.18%	of	fund	complex	assets	held	at	the	broker-dealer.
9

load	options	discussed	above.		Rules	should	not	prevent	broker-dealers	from	selling	

lower	cost	products to	the	extent	they	can	do	so	profitably.		Good	public	policy	also	

should	allow	for	higher	payments	when	services	that	require	more	time	or	more	

complex	analysis.		Otherwise,	the	client	will	likely	receive	the	lowest	quality	advice.

Accepting	these	positions	suggests certain	guidelines	for	regulating	broker-dealers’	

conflicted	compensation.		One	guideline	is	that	there	can	be good	reasons	to	allow	

financial	advisers’	recommendations to	be	able	to	affect	their	compensation.		

Allowing	differential	compensation	allows	broker-dealers	to	provide	a	higher	of	

lower	level	of	service	depending	on	the	client’s	needs.		It	also	allows	the	brokerdealer	the	ability	to	offer	a	category	of	products,	such	as	no-load	funds,	that	produce	

less	compensation,	while	also	offering	products	that	pay	higher	compensation.	

However,	financial	advisers	should	not	be	permitted,	to	the	extent	practicable,	to	

make	personalized	recommendations	of	a	specific	mutual	fund	from	a	brokerdealer’s	selection	of	preferred	funds	where	the	adviser’s	compensation	depends	on	

the	particular	fund	recommended.		In	that	scenario,	the	laws	of	economics	will	

result	in	more	shares	of	funds	that	pay	higher	compensation	being	sold	than	would	

be	sold	if	compensation	had	not	been	differential,	but	without	any	factors	such	as	

the	time	invested	or	analysis	conducted	to	justify the	differential	compensation.		As	

discussed	below,	the	cost	to	investors	is	substantial.

B.	 Front-End	Loads	&	12b-1	Fees

For	the	reasons	discussed	above,	this	discussion	assumes	that	the	financial	adviser	

will	recommend	one	or	more	load	funds,	and	will	recommend	the	purchase	of	Class	

A	shares.		As	a	general	rule,	Class	A	shares	would	provide	the	most	cost-effective	

option	for	a	long-term	investor such	as	the	client and,	with	the	elimination	of	Class	B	

shares,	there	is	a	high	likelihood	that	a	financial	adviser	will	recommend	Class	A	

shares.11

Class	A	shares	typically	charge	a	front-end	load,	or	FEL,	that	is	deducted	from	the	

initial	investment,	and	a	12b-1	fee,	which	is	deducted	on	an	ongoing	basis.		The	FEL	

can	vary	greatly,	while	the	12b-1	fee	as	a	rule	does	not	exceed	0.25%	of	assets	and	

typically	is	exactly	or	close	to	that	amount.		These	charges	are	prominently	disclosed	

in	the	fee	table	near	the	front	of	the mutual	fund	prospectus	as	a	percentage,	but	not	

as	a	dollar	amount.		Nor	does	the	fee	table	disclose the	amount	paid	to	the	brokerdealer.		Near	the	end	of	the	prospectus,	the	fund	discloses	amount	paid	to	the	

broker-dealer	out	of	the	FEL,	which	is	often	called	the	“concession,”	“gross	dealer	

concession” (“GDC”) or	“dealer	re-allowance,”	and	represents	most	of	the	total	FEL	

																																																							 11 The	adviser	might	recommend	Class	C	shares,	which	might	pay	higher	

compensation	to	the	broker-dealer	and	the	adviser,	which	probably	(but	not	

necessarily)	would	be	inappropriate	for	this	client.		This	problematic	conflict	is	

beyond	the	scope	of	the	analysis	in	this	letter.		
10

(the	fund’s	distributor,	usually	an	affiliate	of	the	fund	company,	retains	the	

difference).		

Funds	also	pay	part	of	the	12b-1	fee	to	the	broker-dealer,	but	this	information	is	not	

required	to	be	and	generally	is	not	disclosed.		Nor	is	there	much	publicly	available	

information	on	the	amount	paid.		Based	on	a	review	of	available	information	

sources,	it	appears	that,	as	a	rule,	a	12b-1	fee	concession	is	paid	to	the	brokerdealer,	and	this	concession	represents	all	or	substantially	all	of	the	0.25%	fee.12		

This	fee	pays	for	ongoing	shareholder	services	provided	by	the	broker-dealer.

Broker-dealers	pay	part	of	the	FEL	concession	to the financial	adviser	who	is	

responsible	for	the	sale.		The	amount	is	usually	a	percentage	of	the	adviser’s	total	

concessions	for	the	preceding	12	months	according	to	a	“payout	grid.”		The	specific	

dynamics	of	the	payout	grid	are	discussed	in	Part	II.E.		What	is	relevant	here	is	that,	

as	a	rule,	the	primary	source	of	compensation	– and	potential	conflict – is	the	FEL.		

Although	most	broker-dealers	publicly	disclose	information	about	the	mutual	fund	

compensation	and	payments	to	their	advisers,	they	do	not	disclose	the	amount	of	

their	concessions,	but	refer	to	the	mutual	fund	prospectus	for	that	information.		Nor	

do	they	disclose	the	amount	they	pay	their	advisers	or,	more	importantly,	the	

differential	in	payments	that	may	result	from	the	recommendation	that	the	adviser	

makes.	

It	appears	that	most	broker-dealers	also	pay	part	of	the	12b-1	fee	concession	to	

financial	advisers and	the	amount	is	based	on	same	payout	grid.		However,	some	

broker-dealers	appear	not	to	pay	their	advisers part	of	the	12b-1	fee.		For	purposes	

of	this	analysis,	I	have	assumed	that	the	broker-dealer’s	12b-1	fee	concession	is	

0.25%,	and	the	adviser’s	payout	percentage	is	40%.

The	financial	adviser	would	be	very	likely	to	recommend	a	load	fund	from	the

broker-dealers	list	of	preferred	funds.		Preferred	funds	are	load	funds	managed	by	

fund	companies	that	make	sales-based	payments	out	of	their	fees	to	broker-dealers	

in	addition	to	FEL	and	12b-1	fee	concessions paid	by	the	funds.		These	payments	are	

known	as	“revenue	sharing”	and	are	discussed	in	Part	II.C.		Financial	advisers	

																																																							 12 In	1999,	the	ICI	surveyed	funds	regarding	the	use	of	12b-1	fees	and	found	that	

63%	were	used	for	compensating	broker-dealers	and	32%	for	administrative	

services	provided	by	third	parties. See Use	of	Rule	12b-1	Fees	by	Mutual	Funds	in	

1999,	9	Fundamentals	(April	2000)	available	at https://www.ici.org/pdf/fmv9n1.pdf. An	SEC	economist,	Lori	Walsh,	has	stated	that	brokers	are	typically	paid	

“a	small	(typically	0.25%)	annual	commission	paid	for	by	a	12b-1	plan,”	but	it	is	not	

entirely	clear	that	she	intended	by	this	statement	to	identify	the	precise	amount	of	

the	broker’s	concession.		See	Lori	Walsh,	The	Costs	and	Benefits	to	Fund	Shareholders	

of	12b-1	Plans: An	Examination	of	Fund	Flows,	Expenses	and	Returns,	at	n.14	

(undated)	available	at	

https://www.sec.gov/rules/proposed/s70904/lwalsh042604.pdf.
11

generally	sell	only	preferred	funds.		As	one	broker-dealer	has	disclosed:	“Virtually	

all	of	[broker-dealer’s]	transactions	relating	to mutual	funds	(outside	of	advisory	

programs),	529 plans	and	insurance	products	involve	product	partners	that	pay	

revenue	sharing	to	[broker-dealer].”

Returning	to	the	client	and	his $100,000	investment,	the	financial	adviser	may	

recommend	a	managed	payout	fund,	or	a	2015	target	date	fund or	retirement	

income	fund,	which	generally	serve the	same	purpose.		One	2015	target	date	fund	

offered	by	a	large	fund	complex charges	a	5.75%	FEL,	a	0.24%	12b-1	fee,	and	has	a	

waived	expense	ratio	of	0.71%.		(Where	a	fund	waives	certain	fees, this	analysis	

assumes	the	full	amount	of	stated	12b-1	fees	unless	the	waiver	applies	specifically	

to	the	12b-1	fee.)

The	broker-dealer’s	FEL	concession,	which	is	disclosed	near	the	end	of	the	

prospectus,	is	5.00%,	respectively.		However,	breakpoints	(commission	reductions)	

are	available	at	investments	of	$25,000,	$50,000	and	$100,000.		For	simplicity,	in	

this	analysis	I	have	applied	breakpoints	up	to	but	not	including	$100,000	in	order	to	

be	able	to	apply	breakpoints	while	also	using round	numbers	in	illustrating	

compensation	differentials	(i.e.,	I	could	use	a	$99,999	investment	and	produce	

virtually	identical	results, but	the	data	would	be	more	difficult	to	work	with).

Broker-dealers	have	an	economic	incentive	not to	apply	breakpoint	discounts	

because	their	compensation	is	reduced.		They	also	have	an	incentive	not	to	apply	

other	standard	discounts,	which	generally	are	available	for	assets	invested	in	the	

same	complex, re-invested	dividends, re-investment	of	redemptions	in	the	same	

fund	complex,	across	the	investor’s	family	members,	and	pursuant	to	an installment	

investment	program.		As	a	result	of	this	conflict	of	interest,	the	evidence	shows	that	

brokers	and	financial	advisers	routinely	deny	investors	the	breakpoints	to	which	

they	are	entitled.		In	2003,	the	SEC,	NASD	and	NYSE	reported	findings	on	

overcharges	on	mutual	fund	purchases.13 The	agencies	found	that	in	almost	onethird of	transactions	that	were	eligible	for	discounts,	the	broker	did	not	provide	the	

discount.14		Three	firms	withheld	the	discount	in	every	single	eligible	transaction.

15		

Little	seems	to	have	changed	in	the	last	decade.		Just	two	weeks	ago,	three	large	

brokers	paid	more	than	$30	million	to	settle	claims	for	overbilling	investors	for	fund	

																																																							 13 See	Joint	SEC/NASD/NYSE	REPORT	of	Examinations	of	Broker-Dealers	Regarding	

Discounts	on	Front-End	Sales	Charges	on	Mutual	Funds,	SEC,	NASD	and	NYSE	(March	

2003)	available	at	

https://www.finra.org/sites/default/files/Industry/p006438.pdf.

14 Id.	at	15	(investors	were	overcharged	in	32%	of	eligible	transactions).

15 Id.	at	2.
12

purchases.16		No	fines	were	imposed.		The	firms	were	not	required	to	admit	any	

violations.		While	FINRA’s	enforcement	chief	applauded	the	brokers	for	their	

“extraordinary	cooperation”17 and	claimed	that	they	would	make	“full	restitution,”	

his	agency	required	restitution	only	for	transactions	since	January	1,	2015,	despite	

its	finding	that	overbilling	had	occurred	at	least	since	July	2009.18		No	individuals	

have	been	held	responsible.		In	2014,	another	large	broker	paid	almost	$90	million	

in	restitution	and	fines	for	overcharging	investors	in	mutual	fund	transactions.19		

Not	only	does	overbilling	continue	to	be	commonplace,	securities	regulators	appear	

to	be	quite	forgiving	of	this	practice.		In	light	of	broker-dealers’	routine	withholding	

of	commission	discounts,	the	Department	should	state	explicitly	that	this	practice	

will	render	the BIC	exemption	unavailable.	

Assuming	that	breakpoints	are	applied	to	the	client’s	investment,	the	FEL	and	FEL	

concession	would	be 4.50%	and	3.75%,	respectively.		The	broker-dealer	would	

receive	a	one-time	$3,750	payment	and	annual	payments	of	$229,	for	a total	of	

$4,896	over	five	years.20		Under	a	40%	payout,	the	financial	adviser	would	receive	a	

one-time	$1,500	payment	and	$92	annually,	or	$1,958	over	five	years.		The	client’s	

expenses	over	five	years	(on	his post-FEL,	$95,500	investment),	assuming	the	fund’s	

waived	expense	ratio	of	0.71%,	would	be	$3,390.		The	client’s	annual	income	from	

the	fund	would	depend	on	the	fund’s	performance.		It	is	statistically	more	likely	than	

not	that	the	client’s	income	would	be	less,21 but	not	substantially	less,	than	the	

																																																							 16 See FINRA	Orders	Wells	Fargo,	Raymond	James,	and	LPL	Financial	to	Pay	More	

Than	$30	Million	in	Restitution	to	Retirement	Accounts	and	Charities	Overcharged	for	

Mutual	Funds,	FINRA	News	Release	(July	6,	2015)	available	at	

http://www.finra.org/newsroom/2015/finra-sanctions-wells-fargo-raymondjames-and-lpl-30-million.

17 Wells	Fargo,	Raymond	James,	LPL	to	Repay	Investors	More	Than	$30	Million	for	

Mutual	Fund	Overcharges,	Investment	News	(July	6,	2015)	available	at

http://www.investmentnews.com/article/20150706/FREE/150709950/wellsfargo-raymond-james-lpl-to-repay-investors-more-than-30.

18 FINRA	News	Release,	supra note	16.	

19 See FINRA	Fines	Merrill	Lynch	$8	Million;	Over $89	Million	Repaid	to	Retirement	

Accounts	and	Charities	Overcharged	for	Mutual	Funds,	FINRA	News	Release	(June	16,	

2014)	available	at https://www.finra.org/newsroom/2014/finra-fines-merrilllynch-8-million-over-89-million-repaid-retirement-accounts-and.

20 The	FEL	concession	is	applied	to	the	$100,000	purchase	amount;	asset-based	fees	

are	applied	to	the	actual,	post-FEL	investment	amount	of	$95,500.		Here	and	

elsewhere	in this	letter, totals	may	not	total precisely	because	of	rounding.

21 In	this	context,	I	use	the	term	“statistically”	in	the	probabilistic	sense.		

Importantly,	this	ignores	reasonable	judgments	about	whether	a	particular	fund	
13

payout	from	the	no-load	fund	because	the	expense	ratio	is	higher	and	the	amount	

invested	is	lower.		It	could	be	materially	higher	or	materially	lower.	

The	Department’s	proposal	generally	does	not	address	whether	this	is	a	reasonable	

outcome	for	this	client,	or	whether	the	expenses	are	too	high,	or	whether	the	

broker-dealer	or	adviser	are	overpaid,	although	the	BIC	exemption’s	“reasonable”	

fee	requirement	is	arguably	implicated	here	(and	clearly	would	not	violated	if	

measured	according	to	market	rates).		What	the	Department	seeks	to	address	is	how	

the	adviser’s	recommendation	may	be	influenced	by	conflicted	compensation	

arrangements.			

In	this	situation,	the	adviser	may	have	recommended	the	target	date	fund	because	it	

paid	higher	compensation.		Another	preferred	fund,	a	retirement	income	fund

offered	by	a	different	large	fund	complex,	imposes	a	5.00%	FEL	and	a	0.30%	12b-1	

fee.		It	has	a	breakpoint	at	$50,000.		This	particular	fund	discloses	concessions	only	

in	the	SAI,	a	document	that	is	not	delivered	to	investors	except	upon	request.		The	

fund’s	SAI	states	that	the	FEL	concession	is	4.01%.	The	$50,000	breakpoint	FEL	is	

4.50%,	and	the	concession	is	3.51%.		The	SAI	also	discloses	that	the	12b-1	fee	

concession	is	0.25%,	which	allows	the	total	concessions	to	be precisely	calculated	

for	the	client’s	purchase.		The	broker-dealer	would	receive	a	one-time	$3,510	

payment	and	annual	payments	of	$239,	for	a	total	of	$4,704	over	five	years.		Under	a	

40%	payout,	the	financial	adviser	would	receive	a	one-time	$1,404	payment	and	

$95	annually,	or	$1,881	over	five	years.		The	client’s	expenses	over	five	years,	

assuming	the	fund’s	waived	expense	ratio	of	1.03%,	would	be	$4,918.		It	is	

statistically	more	likely	than	not	that	the	client’s	income	would	be	less,	but	not	

substantially	less,	than	the	payout	from	the	no-load	managed	payout	fund	and	the	

load	2015	target	date	fund	because	the	expense	ratio	is	higher.		It	could	be	

materially	higher	or	materially	lower.

By	recommending	the	2015	target	date	fund	rather	than	the	retirement income	

fund,	the	adviser	appears	to	have	received	an	additional	$77	over	five	years.		The	

broker-dealer	has	received	an	additional	$192.		Coincidentally,	the	client	is	

statistically	likely	to	receive	higher	income	payments	from	the	fund	that	appears	to	

pay	higher	compensation	to	the	adviser.		Thus,	at	this	point	in	the	analysis	the	

broker-dealer,	adviser	and	client	are	better	off,	although	there	is	no	way	to	know	

whether	the	adviser	recommended	the	higher	paying	fund	because	it	was	a	better	

option	for	the	client	or	simply	because	it	paid	higher	compensation.

There	are	many	alternative	recommendations	that	would	substantially	increase	the	

broker-dealer’s	and	adviser’s	compensation.	 For	example,	the	adviser	could	

recommend	that	the	client	invest	in	a	diversified	group	of	equity,	bond	and	cash	

funds	in	different	fund	complexes.		This	would	be	a	reasonable	allocation	for	the	

																																																																																																																																																																				

manager,	management	style	or	asset	allocation	may	generate	superior	performance	

for	the	client.
14

client,	and	the	adviser	could	reasonably	claim	that	the	best	fund	in	each	asset	class	

happened	to	be	offered	by	a	different	complex.		The adviser’s	true	purpose,	

however,	might	be	to	generate	higher	commissions	by	evading	breakpoints.		By	

investing	in	four	or	five	funds	in	different	complexes,	the	adviser	could	increase	the	

applicable	FEL	concession	in	some	funds	from	3.75%	to	5.00%,	and	thereby	

increase	adviser’s	immediate	commission	by	hundreds	of	dollars.		

An	adviser	could also	generate	higher	commissions	by	recommending	investments	

in	riskier	asset	classes.		Funds’	FEL	commissions	typically	range	from	1.00%	for	

short-term	bond	funds to 3.00%	for	bond	funds	to	5.00%	for	equity	funds.		The	

adviser	would	claim that	a	riskier	portfolio	was	needed	to	generate	higher	longterm	growth	and	mitigate	the	effects	of	inflation – the	client	may	live	for	another	40	

years	-- but the	adviser’s	true	motivation	may	be	solely	to	double	their	

compensation.		As	these	examples	illustrate,	key	factors	that	should	have	no	effect	

on	an	adviser’s	recommendation	– the	selection	of	the	fund	complex	and	specific	

fund,	the	number	of	funds,	and	the	allocation	among	asset	classes	– can	have	a	

substantial	effect	on	the	size	of	the	adviser’s	payout.	

Importantly,	none	of	these recommendations	would	provide	the	basis	of	a	

successful	claim	against	the	broker-dealer	or	adviser.		Neither	the	Department	nor	

the	client	would	be able	to	show	that	any	of	these recommendations “ran	counter”	

to	the	Best	Interest	of	the	client	(or,	under	securities	law,	that	it	was	unsuitable	or	a	

violation	of	a	fiduciary	duty).		The	adviser	could	justify	each	recommendation	as	

reflecting	generally	accepted	investment	theory	and	reasonable	opinions	about	the	

qualities	of	each	recommended	fund.		Without	a	smoking	gun	admission,	the	

adviser’s	actual	intent	would	be	irrelevant.	

The	foregoing	illustrations actually	understate the	problem	of	conflicted	fees.		

Concessions	paid	to	broker-dealers	are	fairly	transparent	and	easy	to	calculate	in	

comparison	with	other	forms	of	differential	compensation	paid	to	broker-dealers	by	

fund	companies.		These	less	visible	conflicted	fees	make	it	even	more	difficult	to	

evaluate	the	adviser’s	financial	incentives.		In	fact,	the	fund	that	appears	to	pay	the	

adviser	higher	compensation	may	actually	be	far	less	remunerative	overall	once	

other	conflicted	fees	are	taken	into	account.		This	is	the	problem	of	revenue	sharing.		

C.	 Revenue	Sharing

Mutual	funds	are	permitted	to	pay	for	distribution	activities	only	pursuant	to SEC	

Rule	12b-1	under	a	12b-1	plan	through	fees	identified	as	“distribution”	fees	in	the	

mutual	fund	fee	table.		Yet	a	fund	may	pay	substantially	more	for	distribution	

services	through	the	“management”	fee	than	it	pays	in	“distribution”	fees.		The	SEC	

permits	fund	companies	to	use	their	management	fees	to	pay	for	fund	distribution	

on	the	fiction	that	the	payments	are	made	from	the	fund	companies’	“legitimate”	

profits and	not	out	of	fund	assets.		Some	fund	companies	appear	to	make	

distribution	payments	that	represent	more	than	half	of	the	so-called “management”

fee.
15

The	SEC	does	not	require	fund	companies	to	tell	shareholders	how	much	of	the	fee	

that	shareholders	pay	the	companies	to	manage	a	fund is	actually	used	to	promote	

its	shares.		The	SEC	requires	that	the	fund	prospectus	include	the	following	

disclosure	(usually	repeated	verbatim),	which	reveals	little	useful	information:		

If	you	purchase	the	Fund	through	a	broker-dealer	or	other	financial	

intermediary	(such	as	a	bank),	the	Fund	and	its	related	companies	

may	pay	the	intermediary	for	the	sale	of	Fund	shares	and	related	

services.	These	payments	may	create	a	conflict	of	interest	by	

influencing	the	broker-dealer	or	other	intermediary	and	your	

salesperson	to	recommend	the	Fund	over	another	investment.	Ask	

your	salesperson	or	visit	your	financial	intermediary’s	Web	site	for	

more	information.

This	disclosure	appears	in	a	section	of	the	prospectus	called	“General	Description	of	

the	Registrant”	(the	“Registrant”	is	the	fund),	many	pages	removed	from	the	

description	of	revenue	sharing	arrangements	that	generally	appears	near	the	end	of	

the	prospectus	(to	the	extent	that	such	a	description	is	provided).		This	description	

is	not	required	by	the	instructions	in	the	mutual	fund	registration	statement,	Form	

N-1A.		In	fact,	the	phrase	“revenue	sharing,”	which	is	a	ubiquitous	term	of	art	in	the	

fund	industry,	appears	nowhere	in	the	51-page	instructions	to	Form	N-1A.		Rather,	

the	description	of	revenue	sharing	that	appears	in	fund	prospectuses	and	SAIs	has	

developed	as	a	prudent	industry	response	to	the	threat	of	enforcement	action,	not	

because	the	SEC	or	FINRA	has	articulated	a	specific	rule	requiring	it.

The	description	therefore	follows	no	standard	format	and	varies	greatly	in	the	

amount	of	detail	provided.		The	description	generally	acknowledges	that	the	fund	

company	makes	payments	for	distribution	to	broker-dealers	in	addition	to	FEL	and	

12b-1	concessions.		It	also	states	that	it	covers	expenses	for	education	and	training	

events	for	broker-dealers,	which	are usually	characterized	as	serving	purpose	of	

selling	fund	shares.		The	description	generally	acknowledges	that	these	payments	

create	or	may	create	a	conflict	of	interest	for	the	investor’s	financial	adviser.		As	a	

general	rule,	these	descriptions	do	not	attempt	to	sugarcoat	the	existence	of	this	

conflict,	much	less	deny	it,	in	contrast	with	broker-dealer	disclosure	that	often	

misrepresents	the	financial	incentives	that	these	payments	create	and	the	resulting	

conflict	of	interest.	

Beyond	this	basic	disclosure,	funds	may	also	disclose	the	specific	terms	of	their	

revenue	sharing	arrangements.		The	target	date	and	retirement	income	funds	

discussed	above	provide	such	disclosure.		The	fund	company	for	the	target	date	

fund	generally	makes	a	one-time	payment	of	up	to	0.10%	of	the	purchase	amount	

plus	an	ongoing	payment	of	up	to	0.02%	of	assets	held	at the	broker-dealer.22		The	

																																																							 22 The	fund	company	has some	discretion	to	pay	less	than	this	amount.		The	

aggregate	revenue	sharing	payments	for	the	fund	complex	in	2013	were	less	than	
16

fund	company	makes	additional	payments	for	training	and	education,	but	does	not	

disclose	the	amount.		Over	five	years,	these	payments	would	increase	the	brokerdealer’s	compensation	on	a	$95,500	investment	by	approximately	$191,	bringing	

the	total	including	the	FEL	and	12b-1	fee	concessions	to	$5,087.	

The	fund	company	for	the	retirement	income	fund	pays	revenue	sharing	of	up	to	

0.25%,	which	appears	to be	a	combination	of	a	one-time	percentage	of	the	purchase	

amount	and	an	ongoing	payment	of	a	percentage	of	assets	held	with	the	brokerdealer (the	one-time and	ongoing	payment	combination	is	most	common	revenue	

sharing	model	in	the	industry).		I	assume	that	these	payments	are	0.15%	and	0.10%,	

respectively,	which	based	on	my	research	should	be	about	average.		The	fund	

company	makes	additional	payments	for	training	and	education,	but	does	not	

disclose	the	amount.	Over	five	years,	these	payments	would	increase	the	brokerdealer’s	compensation	by	$621,	bringing	the	total	including	the	FEL	and	12b-1	fee	

concessions	to	$5,324.

The	additional	revenue	sharing	changes	broker-dealer’s	financial	incentive.		The	

target	date	fund	pays	$192	more	based	on	FEL	and	12b-1	fee	concessions,	but	the	

retirement	income	pays	more	-- $237	more	– once	revenue	sharing	is	taken	into	

account.			This	gaps	would	widen the	longer	the	investor	holds	the	fund	and	as	the	

fund	appreciates	in	value	(the	expense	calculation	in	the	prospectus	assumes	a	5%	

annual	appreciation).		Over	ten	years,	an	investment	in	the	retirement	income	fund	

would	pay	$667	more	than	if	the	investment	had	been	made	in	the	target date	fund.		

The	retirement	income	fund	would	pay	more unless	the	fund	were	sold	(ignoring	

the	broker-dealer’s	compensation	for	the	re-investment	of	the	proceeds)	in	about	

two	years	or	less.		

Some	fund	companies	make	revenue	sharing	payments	that are	more	than	twice	the	

rate	charged	by	the	fund	company	that	sponsors	the	retirement	income	fund.		If	the	

revenue	sharing	one-time	and	ongoing	payments	were	0.30%	and	0.20%	rather	

than	0.15%	and	0.10%,	the	retirement	income	fund	investment	would	generate

$1,760	more	in	payments	over	five	years	than the	target	date	fund	investment.		The	

target	date fund’s total	five-year	revenue	sharing	payments	would	be	$191,	in	

comparison	with	the	retirement	income	fund’s	total	revenue	sharing	payments	of	

$621,	or	69%	higher.

If	one	extrapolates	this	analysis	to	$1	billion	in	purchases,	it	is	easy	to	see	how	

recommendations	driven	by	the	financial	incentives	created	by	differential	

compensation	could	increase	a	broker-dealer’s	revenues	by	tens	of	millions	of	

dollars.		Recommending	the	retirement	income	fund	would	increase	the	brokerdealer’s	69%,	i.e.,	69%	of	the	revenue	sharing	payment	would	be	attributable	to	the	

payment	differential.		Broker-dealers	generally	do	not	disclose	their	total	revenue	

																																																																																																																																																																				

0.02%	of	assets	(it	is	not	clear,	however, whether	this	includes	assets	not	held	at	a	

broker-dealer).	
17

sharing	receipts,	but	two	fairly	large	broker-dealers	have	disclosed	recent	annual	

mutual	fund	revenue	sharing	totals	of	$210.1	million	and	$152.3	million.		If	the	same	

percentage	of	each	firm’s	revenue	were	attributable	to	differential	payments,	the	

conflict	of	interest	would	account	for	$145.0	million	and	$105.1	million	of	their	

revenue	sharing	receipts,	respectively.		We	know	this	is	not	the	case.		Disclosures	

show	that	the	latter	firm	sells	far	more	shares	of	the	target	date’s	target	date	fund	

complex	than	any	other	complex,	which	reflects	well	on	the	majority	of	its	advisers.		

However,	in	my	view	it	is	very	likely	that	part	of	the	firm’s	$152.3	million	in	revenue	

sharing	is	attributable	to	the	purely	self-interested	minority	of	its	1,000+	financial	

advisers.	

A	statistical	analysis	could	show	clearly	the	extent	to	which	differential	payments	

affected	advisers’	recommendations,	and	such	an	analysis	based	on	publicly	

available	data	might	be	feasible,	with	sufficient	resources,	for	a	limited	number	of	

firms.		Broker-dealers	could easily	do	such	an	analysis,	which	would	go	directly	to	

the	heart	of	the	Department’s	proposal,	but	they	have	not.		Rather,	they	have	

generated	a	constant	stream	of	quantitative	conclusions	that	do	not	address	the	

central	policy	question	underlying	the	Department’s	proposal	and	are	not	provided	

with	the	underlying	data	with	which	the	data’s accuracy	could	be	confirmed.		If	

differential	payments	do	not directly affect	advisers’	recommendations,	it	would	be	

a	simple	task	for	the	industry	to	prove	it.

This	discussion	has	not	yet	addressed	the	effect	of	revenue	sharing payments	on	

financial	advisers’ incentives.		Broker-dealers	generally	state that	revenue	sharing	

does	not	“directly” affect	financial	advisers’	compensation.		This	likely	means	that,	at	

a	minimum,	payout	grids	generally	are	not	applied	to	revenue	sharing.		However,	

when	a	lawyer	uses	the	term	“directly,”	it	usually	means that	applying	this	qualifier	

is	legally	necessary.		In	other	words,	broker-dealers	do	not	state simply	that	revenue	

sharing	does not	affect	advisers’	compensation,	that	are	only	able	to	state	that	it	

does	not	“directly”	affect	their	compensation.		

It	is	very	likely	that	differential revenue	sharing	has	an	indirect effect	on	advisers’	

compensation,	and	the	effect	may	be	substantial.		The	structure	of	advisers’	

compensation,	as	discussed	further	in	Part	II incorporates numerous	factors,	many	

of	which	are	undecipherable	to the	uninitiated.		These	factors	may	partly	or	

substantially	incorporate	revenue	sharing	differentials.		Fund	complexes	that	pay	

higher	revenue	sharing	may	provide	enhanced	travel	and	entertainment	benefits	to	

advisers.	 Revenue	sharing	affects	both	the	broker-dealer’s	overall	profitability and	

the	branch’s	profitability,	which	may affect	the	adviser’s	income.		Branch	managers	

may	receive	compensation	that	is	directly	tied	to	revenue	sharing,	and	they	have	

many	means	of	influencing	advisers’	recommendations,	including	through	their	

control	over the	allocation	of	inherited	accounts	(left	by	departing	advisers)	and the	

size	of	adviser’s	expense	accounts.

23 Branch	managers	evaluate	each	adviser in	the	

																																																							 23 See Trevor	Hunnicutt,	In	2014, Carrot	and	Stick	for	Advisers	at	Wells	Fargo,	

Investment	News	(Dec.	19,	2013)	(“[broker-dealer]	also	recently	increased	the	extra	
18

adviser’s	role	as	an	employee and	in	their	role	a	regulatory	supervisee.		Branch	

managers	influence	their	advisers	in	all	of	the	ways	that	daily,	personal,	intra-office	

contact	provides	opportunities	for	bosses	to	influence	employees	(“Sam,	I	know	you	

like	the	target	date	fund,	but	the	retirement	income	fund	will	do	just	as	good	job	for	

your	client	and	help	out	the	firm	at	the	same	time.		Let’s	be	a	team	player	here!”).		

In my	view,	there	is	a	very	high	likelihood	that	differential	revenue	sharing	affects	

financial	advisers’ compensation.		This	means	that	it	is	also	likely	that	many	brokerdealers	are	misrepresenting	their	advisers’	conflicts of	interest.		Broker-dealers	

routinely	attempt	to	create	the	impression	that	revenue	sharing	differentials	have	

no	effect	on	advisers’	financial	incentives.		For	example,	one	broker-dealers	states:	

It	is	important	to	understand	that	none	of	the	revenue	sharing	

payments	received	by	Commonwealth	is	paid	or	directed	to	any	

advisor	who	sells	these	funds.	 Commonwealth	advisors	do	not	

receive	a	greater	or	lesser	commission	for	sales	of	mutual	funds	for	

which	Commonwealth	receives	revenue	sharing	payments.	 Because	

Commonwealth's	advisors	receive	no	direct	increase	or	change	in	

compensation	from	selling	shares	of	one	fund	over	another,	we	do	not	

believe	that	they	are	subject	to	a	conflict	of	interest	based	on	the	

amount	of	compensation	each	advisor	receives	when	recommending	

one	fund's	shares	over	another's.

Note	that	each	sentence	is	carefully	crafted	to	apply	only	to	direct	payments	of	

revenue	sharing.		This firm’s	advisers	could	indirectly	receive	higher	compensation	

or	enhanced	benefits	in	every	one	of	the	ways	described	in	the	preceding	paragraph,	

yet	this	firm’s	lawyers would	claim	that	this disclosure	is	technically	accurate.		The	

firm	also	admits	that	certain	funds	pick	up	the	$15	transaction	fee that	would	

otherwise	be	paid	by	the	adviser.		Rather	than	also	conceding	such	a	direct	subsidy	

gives	the	adviser	a	financial	incentive	to	prefer	those	funds	(advisers	have	

frequently	made	exactly	this	point	in	the	financial	press),	the	firm	states that	“[w]e	

																																																																																																																																																																				

money	added	to	advisers’	expense	accounts	for	drawing	up	financial	plans	for	

customers	by	10	percentage	points.		[Broker-dealer]	said	it	is	also	adding	funds	to	

its	high-performing	advisers’	expense	accounts.	The	base	rate	for	those	accounts	

will	be	$500,	but	advisers	who	meet	performance	goals	or	earn	higher	revenue	can	

receive	more.	For	instance,	an	adviser	who	earns	$500,000 but	meets	one	of	six	

performance	goals	will	receive	$1,500.	Any	adviser	who	earns	$850,000	in	fees	and	

commissions	will	receive	$10,000,	and	advisers	who	produce	$1.5	million	or	more	

will	receive	$15,000.”);	Trevor	Hunnicutt,	3	Wirehouses	Raise	Stakes	to	Court	Rich,	

Investment	News	(Dec.	8,	2013)	(describing	broker-dealer	increasing	expense	

accounts	based	on	a	financial	adviser’s	productivity)	available	at	

http://www.investmentnews.com/article/20131208/REG/312089988.
19

believe	that	this	offset	does	not	compromise	the	advice	your	advisor	gives	you.”24		In	

my view,	the	SEC’s	and	FINRA’s	tolerance	for	this	kind	of	disclosure	is	inexplicable.	

Such	disclosure	may	violate	the	BIC	exemption’s	Section	II(c)(3)	condition	that	

broker-dealer	statements	“not	be	misleading,” and	the	Department	should	say	as	

much	when	it	next	provides guidance	on	the	exemption.	

One	reason	that	it	is	highly	likely	that	broker-dealers	indirectly	pay	advisers	more	to	

recommend	higher	revenue	sharing	funds	is	that entities	that	exist primarily	to	

maximize	profits	for	their	shareholders	have	a	strong	tendency	structure	their	

employee’s	compensation	so	as	to	increase	profits.		It	is	unrealistic	to	believe	that	

broker-dealers’	that	can	increase	their	profits	by	selling	higher	revenue	sharing	

funds	will	not	use	the	indirect	incentive	mechanisms	described	above.		Their	

primary	regulators	do	not	prohibit	these	incentive	mechanisms.		Foregoing	these	

mechanisms	may	put	them	at	a	competitive	disadvantage.		

Perhaps	the	adviser’s	compensation	in	the	example	above	is	in	no	way	affected	by	

revenue	differentials,	in	which	case	the	adviser	would	recommend	the	“better”	fund	

because	it	pays	him	or	her	the	most	compensation	based	on	FEL	and	12b-1	fee	

concessions,	rather	than	the	fund	that	pays	the	broker-dealer	the	most	overall	

compensation when	revenue	sharing	is	included.		But	simply	framing	the	issue	in	

this	way	illustrates	why	differentials	that	are	not	based	on	any	difference	in	the	

services	provided	are	patently	improper.		The	impossibility	of	answering	this	

question	also	illustrates	the	failure	of	securities	regulators	to	require	meaningful	

disclosure	of	advisers’	financial	incentives,	and	why	disclosure	along	the	lines	

required	in	the	Department’s	proposal	is	necessary.		There	is	no	way	to	know,	

between	the	two	funds	described	above,	what	the	adviser’s	ultimate	financial	

incentives	are.	

D.	 Education	and	Training	(aka	Travel	and	Entertainment)

Part	of	broker-dealers’	standard	fund	compensation	comprises	payments	from	fund	

managers	that	are	generally	characterized	as	reimbursement	for	the	cost	of	

education	and	training	events.		These	fund	managers	are	generally	the	same	fund	

managers	who	enter	into	the	revenue	sharing	arrangements	described	above,	but	in	

their	disclosure	documents	broker-dealers	treat	payments	for	education	and	

training	separately	from	revenue	sharing.		

																																																							 24 Ironically,	the	same	firm’s	disclosure	regarding	the	direct	conflict	of	interest	that	

travel	and	entertainment	benefits	create	is	unusually	candid:	“The	marketing	and	

educational	activities	paid	for	with	revenue	sharing,	however,	could	lead	our	

advisors	to	focus	more	on	those	funds	that	make revenue	sharing	payments	to	

[broker-dealer]	— as	opposed	to	funds	that	do	not	make	such	payments — when	

recommending	mutual	fund	investments	to	their	clients.”
20

Unlike	revenue	sharing,	the	amount	of	payments	for	education	and	training	as	a	rule	

is	not	disclosed.		One	broker-dealer	that	provides	such	disclosure	states	that	each	of	

the	highest	level	preferred	fund	companies	pays	an	annual	minimum of	$750,000

(the	next	tier	pays	$350,000).		Assuming	$1	billion	in	assets,	a	$700,000	payment	

would	equal	an	annual	rate of	0.07% of	assets.		This	particular	broker-dealer	

probably	holds	far	more	than	$1	billion	in	assets	for	a	number	of	fund	companies,	

but	the	fund	companies	that	pay	the	$750,000	fee	are	not	among	the	12	fund	

companies	with	the	largest	amount	of	assets	with	the	broker-dealer,	and	many	are	

far	down	that	list.		Some	of	them	may	have	less	than	$1	billion	in	fund	assets	held	at	

the	broker-dealer.	 Thus,	there	is	a	reasonable	likelihood	that	one	or	more	fund	

companies	pays	more	than	0.07% annually,	and	a	high	likelihood	that	some	pay	less	

than	0.01%.			

In	their	fee	disclosure	documents,	broker-dealers	consistently	employ	the	same	

tactics	to	make	education	and	training	events	seem	to	have	no	effect	the	firm’s	or	

the	adviser’s	financial	incentives.		These	“events”	typically	take	the	form	of	an	allexpenses	paid	trip	to	an	urban	center	or	tourist	destination	where	advisers	are	feted	

by	revenue	sharing	fund	companies.		These	are	the	same	fund	companies	whose	

revenue	sharing	payments,	as	described	above,	broker-dealers	claim	have	no	

“direct”	effect	on	advisers’	financial	incentives.		Broker-dealer	disclosure	as	a	rule	

includes	no	mention	of	the	travel	and	entertainment	aspect	of	these	events	and	

often	no	admission	that	these	benefits	may	create	a	conflict	of	interest	for	advisers.	

Yet	there	is	no	disputing	that	these	travel	and	entertainment	benefits	are	benefits	

provided	to	advisers	in	connection	with	the	sale	of	fund	shares.		

Broker-dealers	also	consistently	attempt	to	make	education	and	training	events	

seem	to	be	nothing	more	than	reimbursement	of	out-of-pocket	expenses	that	the	

broker-dealer	would	not	otherwise	have	incurred.		Some	broker-dealers	attempt	to

create	the	impression	that	the	payments provide	no	benefits	to	advisers	at	all.		For	

example,	the	following	comprises one	broker-dealer’s	entire	discussion	of	these	

benefits:	

We	focus	on	a	select	group	of	mutual	fund	families	providing	them	

greater	access	to	our	financial	advisors	to	provide	training,	

educational	presentations	and	product	information.	In	return	for	

these	increased	services,	these	sponsors	compensate	the	firm	in	the	

form	of	revenue	sharing	payments	and	ticket	charge	subsidies.

This	description	is	typical.		It	is	the	fund	families	that	provide	the	training	an	

education,	i.e.,	provide	the	services,	but	the	description	states	that	the	fund	families	

pay	the	broker-dealer	“in	return”	for	the	services	that	the	fund	families	provide.		

The	actual quid	pro	quo	is	that	these	fund	companies	are	paying	the	broker-dealers	

for	marketing	opportunities	and	the	chance	to	promote	sales	of	their	funds’	shares	

with	financial	advisers.		The	disclosure	contrasts	sharply	with	another	firm’s	candid	

disclosure	that	“marketing	and	educational	activities	paid	for	with	revenue	sharing .	

.	.	could	lead	our	advisors	to	focus	more	on	those	funds	that	make	revenue	sharing	
21

payments	to	[broker-dealer]	— as	opposed	to	funds	that	do	not	make	such	

payments	— when	recommending	mutual	fund	investments	to	their	clients.”		That	is	

well	said.

The	intent	of	broker-dealers’	typical disclosure	about	education	and	training	events	

is	to	create	the	impression	that	these	are	the	equivalent	of	out-of-pocket	expenses	

that	otherwise	would	not	be	incurred,	which	would	mean	they	provided	no	benefit	

to	the	broker-dealer	or	the	adviser.		They	make	these	events	seem	almost	like	a	

burden	to	advisers,	when	in	fact	broker-dealers	require	advisers	to	earn the	right	to	

attend.		Consider	the prospectus	for	the	retirement	income	fund	discussed	above,	

which	specifically	notes:	

Although	an	intermediary	may	seek	revenue-sharing	payments	to	

offset	costs incurred	by	the	firm	in	servicing	its	clients	who	have	

invested	in	the	fund,	the	intermediary may	earn	a	profit on	these	

payments.

(emphasis	added).		This	statement	expressly	warns	the	reader	against	interpreting

“reimbursement	of	expenses”	to	mean that	broker-dealers	and	advisers	do	not	

benefit from	these	“reimbursements.”		The	fund	even	goes	so far	as	to	state	

explicitly	that	they	may	“profit”	from	the	arrangements.		Most	broker-dealer	

disclosure	attempts	to	create	precisely	the	opposite	impression.		It	may	very	well	be	

misleading	broker-dealer	disclosure	that	the	fund	is	seeking	to	counter.	

The	broker-dealer’s	brief,	obtuse	description	of	how	its	“training	and	education	

program”	provides	“greater	access”	to	financial	advisers	starkly contrasts with the	

way	it	describes	the	same	program	to	its	advisers:	

[Broker-dealer]	respects	the	effort	and dedication	it	takes	to	achieve	

at	the	highest	level,	and	we	reward	your	success when	you	make	it	

happen.	We	do	so	in	many	ways,	including	enhanced	payouts,	

recognition	at	national	conferences	and	in	our	corporate	materials,	

and	inclusion	in	special	events.

One	such	event	is	our	annual	meeting	for	top	advisors	and	branch	

managers.	This	exclusive	event	presents	the	opportunity	to	socialize	

and	network	with	top	[#1	Level	Producer] executives	and	

top-producing	peers	from	across	the	country,	in	a	relaxed	

environment.

We	also	recognize	top	performers	with	additional	rewards,	including	

invitations	to	our	annual	[Mutual	Fund]	National	Conference	and	

direct	access	to	our	Top	Producer	Customer	Service	Desk.	When	you	

are	among	our	top-three	levels	of	producers,	you	will	also	enjoy	[#1	

Level	Producer],	[#2	Level	Producer] or	[#3	Level	Producer]
22

recognition,	which	acknowledges	your	status	as	one	of	"the	best	of	the	

best,"	and	affords	you	access	to	unique	benefits	and	rewards.

(emphasis	added).		The	broker-dealer’s	recent National	Conferences	have	

taken	place	in	Las	Vegas	and	Nashville,	and	have	included	speakers	such	as	

Condoleeza	Rice	and	David	McCullough.		This	fall’s	conference	in	San	Antonio	

will	feature	Malcolm	Gladwell.		Advisers	who	qualify	for	#1	Level	Producer

or	#2	Level	Producer	status (those	who	are	among	the	broker-dealer’s “topthree	levels	of	producers”)	receive	free	airfare,	four	nights	free	at	the	hotel	of	

their	choice,	and	a	free	program	at	the	Knibbe	Ranch	for	two.	 Based	on	the	

firm’s	public	disclosures,	one	pictures	the	adviser	attending	one	of	these	

education	and	training	events as	Shakespeare’s “whining	schoolboy	.	.	.	

creeping	like	snail	unwillingly	to	school.”		The	firm’s	internal	description	of	

the	Las	Vegas	event	paints	a	very	different	picture,	where	top	producers	

received round-trip	airfare,	five	nights	at	the	Venetian,	dinner	at	the	Bellagio	

Resort	and	two	tickets	to	the	Cirque	de	Soleil	show	“O.”

The	sponsors	of	the	2015	event	will	include	half	of	the	mutual	fund	companies	that	

are	listed	as	participating	in	the	broker-dealer’s	revenue	sharing	program,	under	

which	the	fund	manager	pays	the	broker-dealer	up	to	0.25%	of	the	purchase	price,	

up	to	0.45%	of	assets	on	an	ongoing	basis,	and	$10	ticket	charge	(purchase	fee)	

subsidy.	

Broker-dealers	often	say	nothing	about	the	conflict	of	interest	that	travel	and	

entertainment	benefits	create	for	advisers.		Some	deny	that	there	is	any	conflict	at	

all.		For	example,	the	broker-dealer	referenced	immediately	above	concludes its	

mutual	fund	revenue	sharing	disclosure	as	follows:

Financial	advisors	of	[broker-dealer] do	not	receive	additional	

compensation	in	connection	with	sales	of	the	certain	mutual	funds	

compared	to	other	mutual	funds	[sic].25

The	statement	is	misleading because, as	the	disclosure	concedes	elsewhere, the	

advisers	have	an	incentive	to	sell	funds	that	pay	higher	sales	loads	and	12b-1	fees.		

The	only	way	that	this	statement	could	be	true	would	be	to	interpret	“certain	

mutual	funds”	to	mean,	literally,	individual	funds,	in	the	sense	that	for	every	single	

(“certain”)	fund	there	is	another	fund	for	which	the	adviser	would	receive	the	same	

compensation	if	that	fund	were	sold	instead.		

																																																							 25 At	least	one	other	broker-dealer	makes	exactly	the	same	misleading	

representation	that	its	financial	advisors	“do	not	receive	additional	compensation	in	

connection	with	sales	of	the	certain	mutual	funds	compared	to	other	mutual	funds	

[sic].”
23

The	statement	is	also	misleading	because	the	travel	and	entertainment	provided	to	

top	producers	as	described above	is	paid	with	revenue	sharing	payments,	and	part	

of	the	top	producers’	production	is	generated	by	selling	those	funds.		The	statement	

may	be	technically	correct	in	the	sense	that	no	sale	of	a	specific	fund	paid	directly	

for	the	trips,	but	the	sentence	implies	that	advisers	have	no	financial	incentives	

favor	revenue	sharing	funds.		In	fact,	the	reason	that	the	fund	companies	pay	for	

advisers’ travel	and	entertainment	is	that	the	fund	companies	believe	that	this	will	

result	in	more	sales of	their	funds’ shares.	 This	is	exactly	what	they	say	in	their	

prospectuses.

The	broker-dealer’s	disclosure	is	also	misleading	because	the	clearest	information	

about	travel	and	entertainment	benefits	does	not	appear	until the	eighth	and	final	

page	of	the	document,	whereas	the	disclosure	discussed	above	ends	on	page	3.		The	

investor	could	not	reasonably	be	expected	to	understand	the	disclosure	at	the	end	of	

the	document	to	elaborate	on	the	disclosure	provided	earlier.		On	page	8,	the	

broker-dealer	reveals,	under	the	ambiguous	heading	“PRODUCT	EXPENSE	

REIMBURSEMENTS”	that:	

[Broker-dealer] and	your	financial	advisor	may	be	reimbursed	by	

sponsors	of	mutual	funds,	variable	annuities,	variable	universal	life,	

asset	managers,	and	direct	investment	sponsors	for	expenses	

incurred	for	various	promotional	activities	including	but	not	limited	

to	sales	meetings,	conferences	and	seminars	held	in	the	ordinary	

course	of	business.

Although	product	sponsors	make	an	independent	determination	of	

what	they	will	spend	on	such	items,	some	sponsors	may	allocate	their	

promotional	budgets	based	on	prior	sales	and	asset	levels.		

The	disclosure	again	does	not	acknowledge	that	these	programs	are	a	form	of	

reward	for advisers,	but	at	least	it acknowledges that	financial	advisors	are	

reimbursed	for expenses	(again,	as	if	a	“reimbursement”	were	not	a	kind	of	

payment).		It	also	states that	sponsors	“may	allocate	their	promotional	budgets	

based	on	prior	sales	and	asset	levels.”		Yet	there	is	still	no	acknowledgment,	much	

less	accounting	of	financial	advisers’	financial	incentives	to	sell	revenue	sharing	

funds, in	the	form	of	five	nights	at	the	Venetian	and	dinner	at	the	Bellagio	followed	

by	Cirque	de	Soleil.

E.	 Exponential	Payout	Grids

Financial	advisers’	compensation	generally	is	based	mainly	on	a	payout	grid	that	

provides	for	the	adviser	to	be	paid	higher	amounts	as	their	production increases.		

“Production”	means the	gross	dealer	concessions	(“GDCs”)	earned	by	the	brokerdealer	on	the	adviser’s	sales.		In	the	mutual	fund	context,	the	broker-dealer	might	be	

paid	a	5.00%	concession	on	a	5.75%	front-end	load,	and	the	adviser	would	receive	a	

percentage	of	that	concession	ranging	from	20% to	100%.		The	percentage	paid	on	
24

the	preceding	12	months’	GDCs	typically	rises	as	the	adviser’s	total	production	rises,	

which	creates	a	ratcheting	effect	on	the	adviser’s	compensation.	

For	example,	a	financial	adviser	who	generates	$399,999	in	gross	dealer	

concessions	in	a	12-month	period	may	be	entitled	to	be	paid	40%	of	that	total,	or	

about	$160,000.		If	just	before	the	end	of	the	12-month	period	the	adviser	reaches	

the	$400,000	breakpoint,	the	adviser’s	percentage	payout	will	increase	not	only	for	

the	immediate	transaction,	but	also	for	all	prior	transactions	in	the	12-month	

period.		If	the	sale	that	crossed	the	breakpoint	was	a	$20,000	purchase	of	a	fund	that	

paid	a	typical	5.00%	concession	on	a	5.75%	commission,	the	adviser’s	GDCs	would	

reach	$400,999.		If	the	payout	grid	provided	that	at	$400,000	in	production	the	

payout	rises	to	42%,	the	adviser	would	be	paid,	as	the	result	of	that	transaction,	a	

total	of	$8,420:	$420	for	the	$20,000	purchase	and	an	additional $8,000	commission

(2	percentage	points on the	prior	$399,999	in	GDCs).		A	financial	incentive	that	pays	

an	adviser	an	$8,420	commission	on	a	$20,000	purchase	– the	functional	equivalent	

of	a	42.1%	commission – should	not	permitted.		There	are	no	neutral	factors	that	

justify	such	huge	exponential	differential	compensation.	

The	exponential	effect	of	payout	grids	can	create	even	more	distorted	incentives.		

For	example,	in	2012	a	broker-dealer	posted	a	payout	grid	(the	most	recent	

available	grid	for	the	broker-dealer	on	the	Internet)	that	provided	for	a	breakpoint	

increase	at	$400,000	in	GDCs	from	32%	to	42%.		Applying	the	same	facts	described	

above,	the	adviser	would	be	paid	$40,420 in	commissions:	a	$420	commission	on	

the	$20,000	purchase	and	an	additional	$40,000	commission	on	the	prior	$399,999	

in	GDCs.		The	payment	would	be	the	functional	equivalent	of	a	202%	commission.		It	

is	per	se	inconsistent	with	a	fiduciary	duty	for	an	adviser	to	be	able	to	earn a	

$40,420	commission	on	a	$20,000	purchase.		

The	incentives	under	this	scenario generally	would	exist	only	when	an	adviser	was	

about	to	separate	from	the	firm	because	otherwise	a	sale	at	the	end	of	any	12-month

period	will	only	affect	only	compensation	from	the	first	month.		In	other	words,	

compensation	for	months	2,	3	and	so	on	will	depend,	respectively,	on	production	in	

month	12	and months	13,	14,	and	so	on	– i.e.,	not	just	month	12,	as	the	example	

assumes.		Put	another	way,	each	month’s	sales	presents	the	last	opportunity	for	the	

adviser	to	affect	commissions	earned	from	purchases	11	months	before.		If	the	

$400,999	in	GDCs	were	spread	evenly	over	the	12	months,	the	additional	

commission	generated	for	the first month’s	sales	that	is	attributable	to	the	final	

$20,000	purchase	would	be	approximately	1/12	of	the	$40,000	total	for	the	entire	

12-month	period,	or	$3,333.		Under	this	assumption,	the	total	payment	to	the	

adviser	would	be	$3,753,	or	18.8%	of	the	purchase amount	– almost	nine	times	more	

than	adviser’s	regular	$420	commission.		

Such	absurdly	distorted	incentives	should	not	be	permitted	for	any	securities	

transactions,	much	less	when	advisers make	recommendations	about	how	their	

clients	should	invest	their retirement	assets.		Yet	these	payout	grids	are	legally	

permissible	and	widely	used.		This	is	this	kind	of	compensation	structure	that	
25

clearly	encourages	recommendations	that	are	made	without	regard	to	the	investor’s	

best	interest.	

The	Department should	consider	expressly	stating	that	ratcheted	payout	grids,	or	

large	incremental	payout	increases may	be	inconsistent	with	procedures	that	are	

reasonably	designed	to	mitigate	conflicts	of	interest.		Broker-dealers	do	not	describe	

payout	grids	in	their	mutual	fund	fee	disclosure	documents,	which	suggests	that	

neither	they	nor	securities	regulators	view	the	grids	as	raising	any	issues	that	

require	disclosure,	much	less	substantive	regulation.		However,	payout	grids	can	

create	financial	incentives	that	create	a	high	risk	that	advisers	will	make	

recommendations	without	any	regard	to	the	investor’s	best	interest.		

III. Private	Litigation	and	the	Enforceability	of	the	Best	Interest	Contract

The	Department’s	proposal	places	heavy	emphasis	on	the	private	enforceability	of	

broker-dealers’	fiduciary	duties	under	the	Best	Interest	Contract.	 As	the	

Department	recognizes,	a	right	without	a	remedy	is	no	right	at	all.		Investors	must	

be	able	to	enforce	their	rights	under	the	BIC	for	the	Department’s	rulemaking	to	

work.		Yet investors	who	hold	IRAs	have	no	private	right	of	action	under	ERISA’s	

prohibited	transaction	rules.		The Department’s	correction	of	its	interpretation	of	

“fiduciary”	under	ERISA	will	materially	strengthen	investors’	claims	in	arbitration.		

However,	in	my	view	it	will	be	extremely	difficult	for	investors	to	enforce	the Best	

Interest	Contract	in	arbitration.	

Before	turning	to	that	issue,	one	must	consider	why	investors	contract	claims	will	be	

litigated	in	arbitration	rather	than	in	court.		Virtually	all	broker-dealers’	customer	

account	agreements	include	mandatory	arbitration	provisions.		These provisions	

prevent	investors	from	bringing	individual	claims	in	court.		They	must	submit	

disputes	to	arbitration,	and	the	arbitration	forum	must	be	FINRA	arbitration.	

FINRA	takes	the	position	that,	mandatory	arbitration	clauses	notwithstanding,	

investors	have	the	right	to	bring	class	actions	in	court.		However,	investor	claims	

against	broker-dealers	are	not	likely	to	satisfy	the	legal	requirement	that	class	

members	demonstrate	commonality.		Many	of	the	facts	supporting	a	contract	breach	

claim	will	be	specific	to	individual	clients,	which	will	likely	defeat	a	class	action	

based	because	of	the	class’s	inability	to	establish	sufficient	commonality.		For	

example,	the	investor	would	have	to	show	that	the	financial	adviser	provided	advice	

that	established	fiduciary	status	under	the	Department’s	revised	definition	of	

“fiduciary,”	which	normally	would	require	proof	of	individualized	interactions	and	

communications	between	the	investor	and	both	the	financial adviser (one	scenario	

in	which	commonality	may	be	proved	is	a	claim	based	on	call	center	scripts).		As	a	

practical	matter,	private	enforcement	will	occur	exclusively	in	FINRA	arbitration	

proceedings.	
26

A.	 Fiduciary	Claims	in	Arbitration

Fiduciary	claims	are	the	most	common	claim	brought	in	arbitration	proceedings	

against	broker-dealers.		To	succeed,	the	investor	must	prove	that	the	broker-dealer	

was	a	fiduciary	and	violated	its	fiduciary	duty.		Notwithstanding	broker-dealers’	

public	claims	that	they	support	a	fiduciary	duty,	they	expressly	deny	owing	a	

fiduciary	duty	in	virtually	every	case	in	which	a	fiduciary	relationship	is	alleged	for	a	

nondiscretionary	account.26		Investors	must	devote	part	of	their	case	to	proving	the	

existence	of	the	kind	of	common	law	relationship	of	trust	and	confidence	that	

establishes	common	law	fiduciary	status.		

The	Department’s	correcting	of	the	definition	of	fiduciary	to	include,	essentially,	all	

personalized	recommendations	regarding	ERISA	assets should	settle	the	question	of	

whether	the	broker-dealer	was	a	fiduciary	as	to	those	assets.		Investors	fill	find	it	

much	easier	to	prove	the	broker-dealer	was	acting	as	a	fiduciary.		Investors	

therefore	should	be	materially	more	likely	to	prevail in	arbitration.

This	is	an	admittedly	subjective	assessment.		There	is	no	empirically	useful	data	on	

how	and	why	arbitrators	make	decisions	because	FINRA	does	not	require	that	they	

publish	opinions	explaining	their	judgments.		Nonetheless,	arbitration	lawyers	

generally	believe	that	a	fiduciary	claim,	once	fiduciary	status	is	proved,	is	more	

likely	to	result	in	an	award	to	an	investor.		If	the	broker-dealer	was	not	acting	as	a	

fiduciary,	the	investor	generally	must	show	that	the	recommendation	was	

unsuitable	or	fraudulent.		In	court,	both	claims	require	proof	of	both	the	brokerdealer’s	intent	(extreme	recklessness	will	suffice)	and	the	investor’s	reliance.		Many	

lawyers	believe	arbitrators	apply the	same	distinction	between	fiduciary	claims	on	

the	one	hand,	and	suitability	and	fraud	claims	on	the	other,	although	it	may	be	that	

they	do	not	necessarily	apply	the	specific	legal	concepts	of	intent	and	reliance.		The	

Department’s	facilitating	proof	of	fiduciary	status	should	materially	improve	

investors’	changes of	obtaining	an	award	of	damages	in	arbitration.		This	alone	may	

be	the	single	most	important	element	of	the	Department’s	rulemaking.

B.	 BIC	Enforceability

However,	providing	fiduciary	status	is	separate	from	proving a breach	of	the	Best	

Interest	Contract.		In	my	opinion,	there	is	a	significant	risk	that	plaintiffs	counsel	

will	be	disinclined	to	bring	BIC breach	claims	and	arbitrators	will	be	disinclined	to	

enforce	the	terms	of	the	BIC.		Introducing	ERISA – a	complex	law	that	is	based	on	

																																																							 26 See Joseph	C.	Peiffer	and	Christine	Lazaro, Major	Investor	Losses	Due	to	Conflicted	

Advice:	Brokerage	Industry	Advertising	Creates	the	Illusion	of	a	Fiduciary	Duty,	Public	

Investors	Arbitration	Bar	Report	(Mar.	25,	2015)	(citing	numerous	examples	of	

broker-dealers’	contradictory	public	and	litigation	positions)	available	at	

https://piaba.org/system/files/pdfs/PIABA%20Conflicted%20Advice%20Report.p

df.	
27

different	principles	from	those	that	guide	securities	regulation	– into	arbitration	

poses	risks	for	investors.		Arbitrators	are	not	likely	to	have	much,	if	any	experience	

with	ERISA’s	prohibited	transaction	rules,	prohibited	transaction	exemptions,	or	

heightened	fiduciary	standard.		FINRA	does	not	require	that	arbitrators	be	attorneys	

or	have	any	real	legal	training (although	panel’s	chair	is	normally	an	attorney).		Nor	

does	FINRA	provide	arbitrator	with	guidance	regarding	the	substantive	law	to	be	

applied.		Experienced lawyers	have	difficulty	applying	ERISA;	this will	be	

particularly	challenging	for	arbitrators.		

Once	fiduciary	status	is	established,	the	investor	is	halfway	to	making	a	common	law	

fiduciary	duty	case.		It	is	not	clear	that	adding	a	contract	breach	claim to	the	mix	

would	improve	the	likelihood	of	recovery.	 An	arbitration	is	a	court	of	equity.		

Arbitrators	develop	a	feel	for	the	fairness	of	competing	positions	based	on the	

coherence	of	the	story	presented	by	each	side	in	the	course	of	a	hearing.		Although

counsel	will	present SEC	and	FINRA	rules	and	guidance	regarding	conduct	that	

violates	these	rules,	they	will try	not	to	rely	too	heavily	on	legal	nuances and	close	

reading	of	rules	or	statutes.		In	any	case,	these	sources	of	law	generally	reflect	

intuitive	standards	of	fair	and	honest	commercial	conduct.

These	factors	may	disadvantage	BIC	claims,	which	will	require	more	technical	legal	

analysis	than	the	standard	mix	of	fiduciary,	suitability,	fraud	and	supervisory	claims	

that	are	typically	core	elements	of	an	arbitration	complaint.		Contract	claims	are	less	

intuitive	because	contracts,	by	their	nature,	often	seek	to	alter	the	default	rules	of	

standard	commercial	practice.		Deeply	conflicted	fees	are	standard	commercial	

practice	in	the	financial	services	industry	and	will	be	viewed	that	way	by	

experienced	arbitrators.

A	BIC	claim	also	may	be	less	susceptible	to	arbitration’s	heightened	emphasis	on

oral	advocacy.		As	a	general	rule,	arbitrations	are	largely	won	and	lost	based	on	

what	happens	in	the	hearing,	not	on	pre- and	post-hearing	analysis	of	contracts,	

briefs	and	other	documents.	 More	than	one	arbitrator	has	reminded	counsel,	while	

emphasizing	the	importance	of	proceeding	slowly	and	deliberately,	that	arbitrators	

are	not	paid	for	time	spent	outside	of	the	hearing.		In	view	of	these	factors,	an	

investors’	overall	claim	may	be	weakened	by	adding	a	complicated	contract	claim	to	

the	mix	that	requires	additional	legal	arguments	that	depend	heavily	on	arbitrators	

doing	more	work	outside	of	the	hearing.	

Thus,	in	my	view	plaintiffs	counsel	will	face	a	close	call	when	considering	whether	a	

BIC	claim	– even	if	the	breach	is	clear	– is	worth	the	additional	investment	of	

resources	and	risk	of	diluting	or	confusing	the	investor’s	common	law	fiduciary	

case.		Establishing	a	breach	of	contract	will	likely	depend	heavily	on	proof	of	a	

financial	adviser’s	financial	incentives	and	the	broker-dealer’s	procedures	for	

mitigating	the	conflicts	that	they	create.		This	line	of	proof	is	not	central to a	

common	law	fiduciary	duty violation,	where	the	substance	and	suitability	of	the	

recommendations	are	far	more	important	than	conflicted	compensation.		More	

expansive	discovery	will	be	necessary	to	prove	a	contract	breach	claim,	which	will	
28

require	a	greater	investment	of	time	and	resources,	both	for	plaintiffs	counsel	in	

preparing	their	case	and	for	the	arbitration	panel	in	hearing	it.		

Moreover, a	finding	that	a	recommendation	was	unsuitable	generally	involves	an	

investment	that	lost	an	identifiable	monetary	sum,	which	provides	an intuitive	link	

between	liability	and	damages.		In	contrast,	the	specific	damages	that	would	arise	

from	BIC	breach	are	not	intuitive.		Courts	have	consistently	had	difficulty	with	

claims	that	the	remedy	for	a	recommendation	tainted	by	a fiduciary’s	conflict	of	

interest	is	necessarily	recovery	of	investment	losses	unless	the	plaintiff	can	show	

that	an	unconflicted recommendation	would	have	avoided	the	investment	losses.		

Thus,	arguing	for	an	award	based	on	conflicted	fees	may	confuse	the	intuitively	

stronger argument	for	an	award	based	on	unsuitable	advice.		Whereas	courts	are	

adept	as	maintaining	the	independent	standing	of	each	claim	and	producing	findings	

on	individual	counts,	no	such	discipline	applies	in	the	arbitration	context.		A	weak	

BIC	claim	could	actually	drag	down	a	strong	common	law	fiduciary	claim.

There	is	also	a	risk	that	FINRA	arbitrators	may	be	influenced	by	FINRA’s	opposition	

to	the	Department’s rulemaking.		In	recent	remarks	that	were	widely	reported	in	the	

financial	press,	FINRA’s	chairman	and	CEO	delivered	a	harsh critique	of the	

Department’s	proposal.		He	suggested	that	FINRA	arbitrators	could	not	fairly	

conclude	that	a	broker-dealer	breached	the	fiduciary	contract	due	the	

impracticability	of	compliance	and	the	inadequacy	of the	Department’s guidance.27		

He	stated	that	“the	current	Labor	proposal	is not	the	appropriate	way”	to	achieve

the	goal of	establishing	a	fiduciary	standard	and	that in	the	proposal “there	is	

insufficient	workable	guidance	provided	either	to	the	firm	or	the	judicial	arbiter	on	

how	to	manage	conflicts	in	most	firms’	present	business	models.”		He	also	

specifically	questioned	whether	a	“judicial	arbiter”	could	“evaluate	which	

compensation	practices	‘tend	to	encourage’”	a	breach	of	the	fiduciary	contract	and	

faulted	the	Department for	the	“shortage	of	useful	guidance”	and	the	“shortage	of	

realistic	guidance.”	

These	comments	may	adversely	affect	investors’	contract	breach	claim.		Diligent	

defense	counsel	will	contend	that	it	is	not	clear	that	their	client’s	conduct	was	a	

breach	of	the	BIC	and	use FINRA’s	concurrence	that	Department’s	guidance	is	

“insufficient,”	not	“useful”	and	not	“realistic”	to	support	their	position.		Counsel	will	

present	FINRA’s	questioning	whether	a	“judicial	arbiter”	would	have	the	ability	to	

evaluate compliance	with	the	fiduciary	contract	as	a	direct	message	to	arbitrators	

that	they	should	not	hold	broker-dealers	to	its	terms.	 These	statements	will	be	a	

prominent	exception	to	FINRA’s	longstanding	position	that	it	will	not	direct	

arbitrators	as	to	what	substantive	law	to	follow,	and	arbitrators	will	take	note.		

																																																							 27 See Remarks	of	FINRA	Chairman	and	CEO	Richard	G.	Ketchum	before	the	2015	

FINRA	Annual	Conference,	Washington,	DC	(May	27,	2015)	available	at

https://www.finra.org/newsroom/speeches/052715-remarks-2015-finra-annualconference.
29

In	a	FINRA	proceeding	operated	by	FINRA	arbitrators	in	which	plaintiffs	counsel	

rely	heavily	on	FINRA	rules	and	guidance,	the	provenance	of	statements	by	the	

FINRA	chairman	and	CEO	are	likely	to	be	afforded	heightened	deference.		These	

statements	will	be	effective	litigation	tools	even	if	the	Department’s	final	guidance	is	

crystal	clear.		The	only	way	these	statements	may	be	mitigated	is	an	express	

statement	by	FINRA	(or	possibly	the	SEC)	disavowing	them.

Such	an	about	face	is	unlikely,	as	FINRA’s	institutional	hostility	to	the	Department’s	

proposal	has	deep	roots.	 Many	of	FINRA’s	members	view	the	proposal	as	an	attack	

on	their	core	business	model,	and	their	rhetoric	reflects	deep	ideological	and	

cultural	opposition	to	it,	as	well	as	a	rejection	of	the	Department’s	competence	to	

regulate	in	this	area.		The	FINRA	policymaking	staff	is	fully	aware	of	the	fact	that	the	

Department’s	proposal,	to	be	frank,	is	an	implicit	indictment	of	decades	of	SEC and	

FINRA	policymaking.		Broker-dealers’	conflicts	of	interest	and	financial	incentives	

have	been	a	significant	focus	for	securities	regulators	since	the	Tully	Report	in	the	

late	1990s,	and	securities genuinely	believe	that	they	have	made steady	progress	in	

this	area.		In	fact,	they	have	not.		They	have	instead	allowed	the	creation	and	growth	

of	a	deeply	conflicted	compensation	model	that	threatens	Americans’	retirement	

security.	

In	summary,	although	I	do	not	share	the	common view	among	investor	advocates	

that	mandatory	arbitration	should	be	abolished,	it	is	my	view	that	mandatory	

arbitration	probably	will	not	offer	an	effective	forum	for	private	enforcement	of	the	

BIC.		The	Department	should	consider	certain	steps	to	address	this	problem.		First,	

the	Department	should	consider,	apart	of	the	present	rulemaking,	whether	

mandatory	arbitration,	or	at	least	FINRA	arbitration,	is	consistent	with	the	goals	of	

providing	the	heightened	protection	of	investors	that	ERISA	mandates.		In	my	view,	

it	is	not.		Investors should	be	entitled	to	bring	claims	involving	IRA	assets.		However,	

courts	have	demonstrated	a	strong	bias	against	permitting	individual	consumers	to	

assert	their	rights	in	court.		It	is	not	clear	that	the	Department’s	exercise	of	its	

administrative	authority	would	survive	the	strong	judicial	preference	for	

arbitration.		

Second,	the	Department	should	consider	shifting	inspection	and	enforcement	

resources	to	the	identification	and	prosecution	of	prohibited	transactions	that	arise	

from	breach	of	the	BIC.		A portfolio	of	well-reasoned	judgments	in	enforcement	

proceedings	would	provide	the	kind	of	record	that	would	make	BIC	enforcement	in	

arbitration	significantly	more	viable.		A	separate	benefit	is	that	enforcement	actions	

are	both	more	likely	to	succeed	and	result	in	meaningful	monetary	damages	than	

private	claims	in	arbitration.		Public	enforcement	actions	would	provide	legal	

counsel	and	compliance	professionals	with	significant	motivation	and	leverage	to	

push	their	broker-dealer	clients	to	minimize	conflicts	of	interest.	 A	major,	

immediate	inspection	and	enforcement	effort	commencing	on	effective	date	of	the	

new	fiduciary	standard	may	be	critical	to	the	long-term	efficacy	of	the	Department’s	

rulemaking.
30

Third,	the	enforceability	of	the	BIC	will	be	constrained	if	the	Department	does	not	

soften	its	principles-based	approach.		This	approach	is,	of	course,	what	the	industry	

claims	to	prefer.		One	reason	is	that	the	industry	knows	that	it	will	be	very	difficult	

to	persuade	a	FINRA	arbitration	panel	that conflicted	compensation	practices	that	

have	been	used	for	decades	without	objection	by	the	SEC	or	FINRA	(their	

enforcement	divisions	excepted)	violate	a	broker-dealer’s	fiduciary	duty.		If	the	

Department	intends	that	the	fiduciary	contract	be	enforceable	in	arbitration,	it	must	

expressly	identify	the	required	characteristics	of	differential	compensation,	and	

provide	explicit	examples	of	conduct	that	constitutes	a	breach	of	the	BIC.

IV. Differential	Compensation Standards

The	Department	provides	various	tests	for	evaluating	differential	compensation,	

and	those	tests	may	apply	differently	to	the	broker-dealer,	affiliates	and	financial	

advisers.		In	my	view,	these	tests	should	be	substantially	reformulated	as	discussed	

below.		The	following	recommendations	should	be	viewed	as	a	package,	i.e.,	the	

following	pragmatic	concessions	to	broker-dealers’	business	model	are	contingent	

on	strengthening	the	Department’s	proposal	in	certain	respects.	

A.	 Permit	Broker-Dealer-Level	Differential	Payments

In	my	view,	the	Department	should	make	it	clear	that	a	broker-dealer	could	comply	

with	the	BIC	exemption	without	making	any	material	changes	to	the	terms	under	

which	it	receives	compensation.		The	most	costly	way	to	comply with	the	BIC	would	

be	to	ensure	that	the	adviser’s	recommendation	has	no	effect	on	the	broker-dealer’s	

compensation.		It	is	at	this	level	that	compensation	arrangements	are	most	deeply	

embedded and most	dependent	on	integrated	systems and compliance	structures,	

and	require the	most	interparty	coordination,	and	policy	and	procedure	changes	

require	negotiations	between	independent	entities.		Internal	fee	leveling	would	be	

for	less	costly.		

At	least	some	broker-dealers	believe	that	fee	leveling	at	the	broker-dealer	level,	to	a	

greater	or	lesser	extent,	is	required.		This	may	be	the	Department’s	intent.		However,	

in	my	view	it	would	be	sufficient	for	a	broker-dealer	to	make	a	contractual	

commitment	that	its	advisers	have	no	financial	incentive	to	make	a	recommendation	

that	generated	any	greater	benefit	for	the	broker-dealer or	adviser than	another	

recommendation.		Admittedly,	profit-making	entities	have	a	strong	incentive	to	find	

ways	to	cause	their	employees	to	maximize	the	entity’s	profits.	 No	matter	what	

rules	the	Department	finally	adopts,	conflicted	recommendations	by	advisers will	

always	be	with	us.		But	as	a	practical matter,	to	mandate	fee	leveling	at	the	brokerdealer	level	would	be	make	the perfect	the	enemy	of	the	good	– and	achieving	fee	

leveling	inside the	broker-dealer	would	be	much	than	good.
31

B.	 Permit	Differential	Compensation	between	

Categories	of	Investments

It	is	also	my	opinion	that	the	Department	should	take	the	position	that	differential	

compensation	between	categories	of	investments	is	permitted	under	the	BIC	

exemption.		What	would	distinguish	one	“category”	from	another	is	the	time	

invested	and	quality	and	nature	of	analysis	conducted	by	the	financial	adviser	and	

the	firm	– what	the	Department	calls	neutral	factors.		Broker-dealers	have	claimed	

that	the	proposal	prohibits	conflicted	fee	differentials	between	mutual	funds	and	

variable	annuities,	and	variable	annuities	and	fixed	index	annuities.		It	is	my	

understanding	that	these	differentials	are permitted under	the	BIC	exemption.28		

These	categories	involve	differences	in	the	time	invested	and	analysis	conducted	by	

the	adviser.		Paying	differential	(higher)	compensation	would	be	consistent	with	

recommending	a	category	of	investment that	required more	time	and	analysis.

Admittedly,	this	distinction	does	nothing	to	mitigate	the	conflict	created,	for	

example,	by	paying	financial	advisers	more	for	selling	variable	annuities	than	for	

selling	mutual	funds.		Variable	annuities	are	the	most	frequently	abused	product	in	

the	securities	industry,	and	the	abuse	is	greater	in	the	IRA	context	where	the	

investor	already	enjoys	tax	deferral.		Under	this	recommended	approach,	variable	

annuities	in	IRAs	will	be	recommended	primarily	because	of	the	additional	

compensation	they	pay.		But	it	is	not	clear,	as	a	practical	matter,	how	honest	brokerdealers	can	be	prevented	from	being	paid	more	for	providing	more,	different,	or	

higher	quality	services.		And	eliminating	differentials	that	serve	no	purpose	other	

than	to	create	incentives	to	act	contrary	to	investors’	interests	should	be the	

Department’s primary	focus.		The	Department	should	adopt	this	policy	and	identify	

examples	of	categories	of	investments	between	which	differentials	would	be	

permitted	under	the	BIC	exemption.

C.	 Prohibit	Non-Neutral	Differential	Compensation	

within	Investment	Categories

Taking	a	very	different	tack,	the	Department	should	state	expressly	that	differential	

compensation	that	does	not	reflect	neutral	factors	(e.g.,	a	greater	investment	of	time,	

or	higher	quality	or	more	complex	analysis)	is	not	consistent	with	the	BIC	

exemption.		It should	go	without	saying	that financial	advisers should	not	be	in	the	

position	of	deciding	between	recommending	one	or	two	U.S.	equity	funds	where	one	

will	result	in	a	substantially	higher	payout.		This	is	simply	indefensible.	 This	kind	of	

conflicted	fee	arrangement	makes	a	mockery	of	FINRA’s	requirement	that its	

members	“observe	high	standards	of	commercial	honor	and	just	and	equitable	

principles	of	trade.”		

																																																							 28 See Example	4,	80	F.R.	21791	(higher	compensation	for	advice	regarding	

annuities	than	advice	regarding	mutual	funds	would	be	permissible).	
32

In	my	view,	under	the	current	proposal	broker-dealers	could	continue	to	provide	

financial	advisers	with	financial	incentives	to	make	recommendations	solely	on	the	

basis	of	the	adviser’s	compensation.		As	discussed	further	in	Part	V,	the	BIC	

exemption’s	tests	of	fiduciary	compliance	will	permit	broker-dealers	and	their	

financial	advisers	to	continue	to	receive	differential	compensation	that	serves	no	

economic	purpose	other	than	encouraging	recommendations	based	solely	on	the	

firms’	and	advisers’	financial	best	interest.		In	short,	the	Department’s	principlesbased	approach	goes	too	far	and	will	allow	broker-dealers	to	satisfy	the	key	tests	of	

compliance	with	the	BIC	exemption	without	materially	changing	the	scope	and	

intensity	of	their	conflicted	fee	arrangements.		

Provided	that	differential	compensation	is	permitted	at	the	broker-dealer	level	and	

between	investment	categories,	the	long-term	cost	of	industry	compliance	with	a	

prohibiting non-neutral	differential	compensation	under	the	BIC	exemption	would	

be	a	fraction	of	the	benefits	to	America’s	retirees.		Notwithstanding	industry	claims,	

these	benefits	will	inure	to	small	investors as	conflicted	advice	is	suppressed.		

The	limited	data	on	conflicted	fee	arrangements	shows	why	small	investors	will	

benefit.		One	large	broker-dealer	that	discloses	both	the	rate	and	amount	of	revenue	

sharing	payments	by	fund	company	shows	that	the	majority	of	its	sales	are	of	funds	

in	the	fund	complex	that	produces	the	least	revenue	per	dollar	invested.		The	second	

lowest revenue	sharing	fund	complex	represents	the	second	highest volume	of	sales.		

If	non-neutral	differential compensation	is	prohibited	under	the	BIC	exemption,	

there	is	no	doubt	that	sales	of	funds	in	higher	revenue	sharing	fund	complexes	will	

decline,	but	only	because	the	sales	of	these	funds	that	currently	occur	solely	as	a	

result	of	differential	compensation will	decline.		Sales	of	those	funds	that	reflect	

investors’	best	interests	will	be	unaffected	because	the	rulemaking	will	change	only	

the	differential	that	advisers	are	paid	for	selling	these	funds.		Fund	complexes	that	

rely	heavily	on	differential	compensation	may	fail.		But	this	will	not	be	the	result	of	

regulatory	overreaching.		It	will	be	the	painful	but	wealth-creating	effect	of	allowing	

free	market	forces	to	cull	the	herd.	

The	broker-dealer	industry	claims	that	the	rulemaking	will	force	small	investors	

into	unaffordably	expensive	fee-based	programs.		Yet	broker-dealers	are	already	

putting	the	lie	to	that	claim.		One	major	broker-dealer that	is	a	tiny	fund	manager

recently	sold	proprietary	fund	assets	that	placed	it	fourth	among	all	fund	complexes	

for	the	calendar	year.

29		This extraordinary	achievement was apparently

																																																							 29 See	Trevor	Hunnicut,	Edward	Jones'	Proprietary	Funds	Are	Outselling	Nearly	All	

Active	Managers,	Investment	News	(July	16,	2015)	(broker-dealer	charging	1.50%	

wrap	program	fee	plus	investment	expenses	of	0.30%)	available	at	

http://www.investmentnews.com/article/20150716/FREE/150719935/edwardjones-proprietary-funds-are-outselling-nearly-all-active.		The	firm	stated	that	it	“has	

been	migrating	funds	in	its	mutual-fund	advisory	program,	the	industry's	second	

largest,	in	an	effort	to	simplify	trading	and	lower	costs.”		Id.		A	substantial	part	of	the	

program’s assets	are	managed	by	the	same	fund	company	that	manages	the	majority	
33

accomplished	by	substantially	undercutting	the	2.00%-and-higher	asset-based	fee	

that	is	common	among	broker-dealers’	fee-based	programs.		The	operative pricing	

innovation appears	to	be	the	use	of	a	bare	bones	fund	management	fee	that	actually	

pays	for	portfolio	management	rather	than	revenue	sharing.		

This	kind	of	market	upheaval	shows	a	broker-dealer that,	while	publicly	decrying	

the	purportedly	industry-destroying,	small-investor-crushing effect	of	the	

Department’s	rulemaking, has	adopted a	fee	structure	that	better	serves	the	

interests	of	small	investors and	is	putting	the	firm’s	competition	in	its	rearview	

mirror.		While	other	broker-dealers	appear	paralyzed,	held	in	a	trance	by	the	shrill,	

mindless war	cries	of	lobbyists	and	industry	groups,	this	broker-dealer is	already	

conquering	the	post-rulemaking	world.		This	example	illustrates	how	the	

Department’s	rulemaking	will	tip	the	competitive	balance	toward	fund	companies	

and	broker-dealers	that	use	fees	to	provide	superior	services	to	shareholders	and	

clients	rather	than	solely	to	create	conflicted	financial	incentives	for	financial	

advisers.

D.	 Prohibit Non-Neutral “Reimbursed”	Travel	and	Entertainment	

Expenses

As	discussed	above,	broker-dealers	generally	attempt	to	characterize the	so-called	

“reimbursement” of	expenses	for	education	and	training	as	not	creating a conflict	of	

interest	for	advisers.		In	fact,	these	travel	and	entertainment	benefits	do	create	a	

conflict	of	interest,	as expressly	recognized	by	some	broker-dealers.30		Fund	

prospectuses	often	expressly	state that	these	payments	are intended	to	promote	the	

sale	of	shares.		

In	my	view,	the	Department	should	directly	address	the	conflict	of	interest	that	

these	travel	and	entertainment	benefits	create.		FINRA	has	crafted	a	finely	tuned	

noncash	compensation	rule	that prohibits	some	abuses	but	ultimately	has	the	effect

of	insulating	these	practices	from	liability	under	the	securities	laws.		It	is	therefore	

incumbent	upon	the	Department	to	dispel	the	rule’s	implication of	regulatory	

approval.		Travel	and	entertainment	benefits	should	be	specifically	identified	as	

creating	an	impermissible	conflict	of	interest	to	the	extent	that	the	benefits	do	not	

reflect	neutral	factors.

																																																																																																																																																																				

of	non-proprietary	funds sold	by	the	firm.		In	other	words,	the	program	essentially	

keeps the	same	portfolio	manager	but	internalizes the	distribution	expense	

structure in	a	way	that	will	make	it	easier	to	pay	level	fees	to	its	advisers.

30 See footnote	24,	supra.
34

E.	 Treat	Branch	Managers	as	Financial	Advisers	

I	strongly	recommend	that	the	Department	expressly	extend	to	branch	managers	

the	same	basic	requirements	that	apply	to	financial	advisers.		The	Department	

generally	applies	its	proposals	according	to	three	categories:	the	broker-dealer,	

broker-dealer	affiliates,	and	financial	advisers.		The	category	of	affiliates,	rather	than	

financial	advisers,	appears	to	cover	branch	managers.		Although	branch	managers	

generally	will	not	be	fiduciaries	under	the	proposal,	they	should	be	treated	as	such	

under	the	BIC	exemption	because	they	will	influence,	often decisively,	

recommendations	made	by	their	financial	advisers,	and	they	directly benefit	from	

exercising	that	influence.	

Branch	managers	routinely	have	direct	contact	with	advisers’	clients.		They	meet	

and	interact	with	them	in	their	offices.		They	comment	on	the	services	provided	by	

their	advisers,	including	investment	recommendations.		Even	if	they	are	not	located	

in	the	same	office	with	the	adviser,	the	branch	manager	will	have	direct	contact	with	

clients.		Compliance	with	FINRA’s	supervisory	rules	will	alone	trigger	direct	

communications	with	clients.		Branch	managers	oversee	all	client	transactions	in	

their	branch	to	ensure	suitability,	among	other	things,	and	they	often	are	required	

to	provide	direct,	prior	approval	of	individual	transactions.			

Branch	managers	also	directly	influence	their	advisers’	recommendations.		In	some	

cases	they	do	so	as	a	matter	of	proper	training	and	oversight.		In	other	cases, they	do	

so, unfortunately,	to	promote	the	branch	manager’s	financial	interests.		Brokerdealers	have	a	long	history	of	evading	rules	designed	to	mitigate	advisers’	conflicts	

of	interest	by	incentivizing	branch	managers	to	maximize	the	broker-dealer’s	

revenues.		For	example,	broker-dealers	may	directly	compensate branch	managers	

based	on	the	amount	of	revenue	sharing	payments	their	branch	generates.		

Alternatively,	they	may	calculate	a	branch’s	profitability	based	in	part	on	revenue	

sharing	payments,	or	increase	the	branch’s	expense	account	based	on	the	amount	of	

revenue	sharing	generated.

Branch	managers	have	many	ways	to	incentivize	their	advisers	to	make	

recommendations	that	increase	the	manager’s	compensation,	including	through	the	

allocation	of	accounts	inherited	from	a	financial	adviser	who	has	left	the	firm.		The	

branch	manager	may	control	the	size	of	the	adviser’s	expense	account	and	whether	

the	adviser	is	eligible	to	attend	conferences	hosted	by	revenue	sharing	fund	

companies.		Advisers	are	at	the	mercy	of	their branch	managers	with	respect	their	

employment	evaluations.		Branch	managers	also	evaluate	advisers’	legal	compliance	

as	their	regulatory	supervisor.		Finally,	most	employees	intuitively	understand	the	

benefits	of	keeping	the	boss	happy.		The	influence	of	branch	managers	is	one	reason	

that	broker-dealers	can	claim	only	that	revenue	sharing	does	not	“directly”	affect	

advisers’	compensation.		Branch	managers’	actions	are	one	way	revenue	sharing	

differentials	may	indirectly affect	advisers’	compensation.
35

The	Department	should	view	financial	advisers	and	their	branch	managers	as	a	de	

facto	unit	for	purposes	of	advisers’ recommendations	to	clients.		The	branch	

manager’s	financial	incentives	should	be	viewed	as	the	financial	adviser’s	incentives	

for	purposes	of	evaluating	the	effect	of	differential	compensation	arrangements.		

The	current	proposal	does	not	adequately	prevent	broker-dealers	from	being	in	

compliance	with	the	BIC	exemption	while	using	differential	compensation	

structures	to	the	branch	manager	level to promote	conflicted	advice.	

V.	 Best	Interest	Contract	Exemption	Terms

The	BIC	exemption	incorporates	a	number	of	tests	for	compliance	with	the	Best	

Interest	Contract.		As	discussed	below,	in	certain	respects	the	drafting	of	these	tests	

may	undermine	effectiveness	of	the	BIC	exemption	and	the	enforceability	of	the	Best	

Interest	Contract.		

A.	 Reasonableness	Requirement

It	is	a	condition	of	BIC	exemption	that	a	recommendation	not	be	expected	to	result	

in	compensation	to	the	adviser,	broker-dealer	or	certain	affiliates	that	exceeds	

“reasonable	compensation	in	relation	to	the	total	services”	provided.		As	applied,	

this	test	would	require	that	the	compensation	not	be	unreasonable	in	the	usually	

accepted	commercial	sense.		In	the	common	law,	an	unreasonable fee	generally	

must	be	proved	to	be	a	fee	that	“shocks	the	conscience,”	“could	not	have	been	

negotiated	at	arms-length,”	or	“bears	no	rational	relationship	to	the	services	

provided.”		It	will	be	a	fee	that	is	substantially	higher	than	the	highest	routinely

charged	fee	in	the	context	and	strongly	suggests	the	exploitation	of	an	

unsophisticated,	vulnerable	investor.		It	will	not	turn	on	differential	comparisons,	

i.e.,	on	the	fact	that	an	adviser	may	be	paid	two	or	three	time	as	much	for	

recommending	one	fund	over	another.	

A	fee	will	be	deemed	per	se reasonable	if	it	does	not	exceed	express	or	implied	legal	

limits	and	appears	to	be	consistent	with	securities	regulators’	express	or	tacit	

approval.		For	example,	an	FEL	it	will	not	be	unreasonable,	as	a	matter	of	law,	if	it	

complies	with	limits	imposed	by	FINRA	Rule	2830.		Nor	can	a	12b-1	fee	be	

unreasonable	that	complies	with	these	limits.		The	terms	of	revenue	sharing	

arrangements	are	similarly	protected	by	the	implied	regulatory	approval.		They	are	

widely	disclosed,	yet	neither	the	SEC	nor	FINRA	has	expressed	any	disapproval	of	

the	amounts	involved.		Discussion	of	the	level	of	revenue	sharing	fees	has	been	

notably	absent	from	SEC	and	FINRA	enforcement	actions	involving	revenue	sharing.		

FINRA	guidance	makes	it	clear	that	the	travel	and	entertainment	benefits	described	

above	are	permissible.		These	fees and	benefits,	and	the	significant	conflicts	that	

they	create,	are	deemed	by	FINRA	to	be	consistent	with	just	and	equitable	principles	

under	FINRA	Rule 2010.		It	is	extremely	unlikely	that	a	FINRA	arbitration	panel	

would	contradict	the	considered	views	of	securities	regulators	that	the	highest	

levels	of	fees	currently	charged	are,	in	fact,	legally	impermissible.
36

In	my	view,	the	BIC	exemption’s	reasonableness	requirement	will	have	no	effect	on	

the	current	range	of	compensation	levels	paid	to	financial	advisers,	broker-dealers,	

or	their	affiliates.		Based	on	disclosed	arrangements,	a	broker-dealer	may	receive	

ongoing	asset-based	12b-1	and	revenue	sharing	fees	that	alone exceed four	or	five	

times	the	total	expense	ratio	of	some	mutual	funds.		The	reasonableness	

requirement	will	only	affect	fees,	if	any, that	are	substantially	higher	than such	

existing	fee	arrangements.		The	Department	should	not	view	the	success	of	feebased	class	actions	in	the	retirement	plan	context	as	being	applicable	here.		They	are	

not.		It	would	be	extraordinary	for	an	attorney	to	encounter	a	“reasonable	fees”	

breach	in	the	IRA	context	that	was	worth	litigating.

This	is	not	to	say	that	the	reasonableness	standard	can	be	modified	to	address	the	

Department’s	primary	concerns	regarding	fee	differentials.		In	my	view,	it	cannot.		It	

is	not	suited	to	serve	the	purpose	of	addressing	conflicted	fee	arrangements.		Nor	

can	it	be	modified	in	a	workable	manner	to	serve	this	purpose (and	the	Department	

may	have	no	intent	that	it	serve	this	purpose).		There	is	no	harm	in	including	the	

reasonableness	requirement,	but	it	will	not	materially	advance	the	Department’s	

goals.	

B.	 Mitigating	the	Impact	of Material	Conflicts	of	Interest

The	broker-dealer	and	adviser	must	warrant,	in	the	Best	Interest	Contract,	that	the	

broker-dealer	has	adopted	procedures	that	are	reasonably	designed	to	“mitigate	the	

impact	of	Material	Conflicts	of	Interest.”		As	discussed	below,	the Department	should	

consider	certain	revisions	to	this	formulation.		The	Department	also	should	keep	in	

mind	that,	because	breach	of	the	warranty	does	not	vitiate	the	availability	of	the	BIC	

exemption,	this	warranty	will	be	enforceable	only	in	arbitration,	where	proving	that	

a	certain	set	of	procedures	is	not	“reasonably	designed”	to	accomplish	some	

purpose	will	be,	to	be	frank,	extremely	difficult.		As	discussed	above in	Part	III,	

arbitration	may	already	be	an	inhospitable	venue	for	enforcement	of	the	Best	

Interest	Contract.		In	my	view,	the	“reasonably	designed	procedures”	requirement	

will	be	practicably	enforceable	only	if	made	a	condition of	the	BIC	the	breach	of	

which	removes	the	protection	of	the	exemption.		

i.	 Materiality Standard	

In	my	view,	the	BIC	exemption	should	not,	for	a	number	of	reasons,	use	the	term	

“material.”		The	Department’s	proposal	states	that	a	“material	conflict	of	interest”	

exists	when	an	adviser	or	financial	institution	“has	a	financial	interest	that	could	

affect	the	exercise	of its	best	judgment	as	a	fiduciary	in	rendering	advice.”		The	lay	

meaning	and	securities	law	meaning	of	“material”	are	inconsistent	with	the	“could	

affect”	standard.		Requiring	procedures	only	for	“material”	conflicts	may	eviscerate

the	exemption.	

The	use of	the	lay	term	“material”	seems	to	contemplate	a	markedly	narrower	

category	of	financial	incentives	than	the	category	of	incentives	that	“could	affect”	the	
37

adviser’s	judgment.		The	term	“material”	implies	a	set	of	financial	incentives	that	

would	be	both	more	likely to	affect	an	adviser’s	advice	and	have	a	greater	effect on	

an	adviser’s	advice	than	financial	incentives	that	“could”	affect	the	adviser’s	

judgment.		The	conflicts	of	interest,	i.e.,	differential	compensation,	that	the	

procedures	address	should not	be	limited	by	a	broker-dealer’s	subjective	judgment	

about which	differential	compensation	arrangements	rise	to	the	level	of	being	

material.		The	laws	of	economics	tell	us	that	when	rational	actors	are	compensated	

more	highly	for	one	recommendation	than	another,	especially	where	there	is	no

difference	in	the	services	provided,	there	will	be	more	of	the	first	recommendation.		

Regardless	of	whether	the	lay	meaning	of	“material”	is	consistent	with	the	“could	

affect”	definition,	the	securities	law	meaning	of “material”	clearly	is	not.		Under	the	

federal	securities	laws,	the	category	of	information	that	would	be	material	would	be	

substantially smaller	that	the	category	of	information	that	could	affect	a	person’s	

conduct.		Securities	law	provides	that	information	is	material	when	there	is	a	

“substantial	likelihood”	that	it	would	be	considered	“important”	to	a	reasonable	

investor.31		The	set	of	financial	incentives	that	“could	affect”	an	adviser’s	judgment	is	

much	larger	than	the	set	of	financial	incentives	that	would	create	a	“substantial	

likelihood”	of	being	“important”	in	the	adviser’s	exercise	judgment.		

It	is	the	securities	law	meaning	of	“material”	that	will	likely	apply	in	arbitration	

proceedings.		There	are	few	terms	of	art	under	the	securities	laws	that	are	as	firmly	

and	deeply	embedded	as	the	term	“material.”		Whether	something	is	material	is	

frequently	a	dispositive	issue	in	private	securities	litigation.		Although	it generally	is	

not	a	core	issue	in	arbitration,	arbitrators	will	be	familiar	with	the	meaning	of	the	

term	in	the	securities	context	and	will	tend	to	assume	that	meaning	in	applying	the	

BIC	exemption.	

In	my	view,	the	materiality	standard	is	not	appropriate	in	the	conflicted	

compensation	context.		In	a	quintessential	securities	law	claim,	there	is	nothing	

about	an	asserted	misrepresentation	or	omission	that	makes	it	more	or	less	likely	to	

be	material.		A	statement	or	omission	is	inherently	neutral	until	placed	in	context.		

The	plaintiff	therefore	must	prove	materiality.		In	contrast,	differential	

compensation	is	differential	precisely	for	the	purpose	of	selling	shares.		Most	mutual	

fund	prospectuses	use	these	words	to	explain	why	they	make	revenue	sharing	

payments	and	pay	for	advisers’	travel	and	entertainment.		The	fund	companies	

intend	that	higher	compensation	result	in	increased	sales	by	creating	financial	

incentives	for	advisers	that	have	no	relationship	to	the	time	invested	or	nature	of	

analysis	conducted	by	the	adviser.		Non-neutral	differential	compensation	always	

could	affect	an	adviser’s	advice	because that	is	always	the	only	reason	for	nonneutral differentials.		If	an	investor	can	show	that	a	financial	adviser	is	paid	more	for	

selling	one	fund	than	another,	there	should	be	a	presumption	that	the	differential	

payment	could	adversely	affect	the	financial	adviser’s	judgment	that	shifts	the	

																																																							 31 TSC	Industries,	Inc.	v.	Northway,	Inc.,	426	U.S.	438,	449	(1976).
38

burden	to	the	broker-dealer	and	adviser	to	make	a	prima	facie showing (without	

necessarily	proving)	that	there	are	neutral,	time	and	analysis	factors	that	explain	the	

differential.

In	my	view,	the	Department	therefore	should	remove	the	term	“material”	from	the	

BIC	exemption,	including	from	Section	III(c)(1)(A),	which	requires	disclosure	of	

“material”	compensation.		All	direct	and	indirect	adviser	compensation	should	be	

disclosed.		Adviser	compensation	depends	on	an	extremely	complex,	finely	tuned	set	

of	performance	measurements	that	to	a	lay	person	or	arbitrator	will	seem	not	only

immaterial,	but	trivial.		They	will	ask:	How	could	one-hundredth	of	a	basis	point

affect	a person’s	behavior?		Without	a	doubt,	it	will.		That	is	why	this	differential	

exists.		The	very	existence	of	seemingly	infinitesimal	compensation	increments	

represents	the	expert	and	universal	view	of	broker-dealers	that	incremental	

benefits	that	appear	to	be	trivial	will	have	a	desired	effect	on	advisers’	conduct.		

Why	would	a	broker-dealer	invest	a	great	deal	of	time	and	effort	in	crafting	and	

constantly	revising	minute,	incremental	benefits	for	advisers	if	it	believed	that	this	

would	have	no	effect?		They	would	not	and	do	not.		It	is	a	cliché	that	most	self-made	

millionaires	become	millionaires	by	watching	every	penny.		So	do	broker-dealers,	as	

they	should.		Courts	have	stated	that	revenue	sharing	payments	are	too	small	to	

influence	broker-dealers’	and	advisers’	conduct,	yet	revenue	sharing is	paid	for	

precisely	the	purpose	of	influencing	their	conduct.		Either	these	courts	are	very	wrong	

or	the	financial	industry	is	deeply	misguided.		In	my	view,	the	market	knows	better	

than	the	judiciary	what	motivates	salespeople.		If	non-neutral	differential	

compensation	did	not	affect	advisers’	conduct,	there	would	be	no	non-neutral	

differential	compensation.

It	may	not	be	sufficient	merely	to	remove	“materiality”	descriptors	from	the	

proposal.		The	Department	should	consider	expressly	stating	that	the	differences	in	

compensation	do	not	need	to	be	material	to	require	procedures	that	are	reasonably	

designed	to	mitigate	their	impact.		As	noted,	the	presumption	should	be	that	

differential	payments	tend	to	influence	an	advisers’	judgment.		Otherwise,	brokerdealers	and	financial	advisers	will	successfully	argue	in	arbitration	that	the	

differential	compensation	must	be	substantially	likely	to	be	important	in	the	

adviser’s	exercise	of	judgment.		Arbitrators	who	have	applied	securities	law	

standards	for	decades	may	reflexively	accept	that	argument.		The	standard	should	

be	the	“could	affect”	standard,	and	broker-dealers’	procedures	should	be	required	to	

be	reasonably	designed	to	prevent	conflicts	of	interest defined	as	compensation	that	

could	affect	the	adviser’s	judgment taking	into	account	neutral	factor	justifications	

for	the	differential.

ii.	 “Mitigate	the	Impact”

Another difficulty with the “reasonably designed procedures” requirement is the use of 

the “mitigate the impact” qualifier. As a general rule, “reasonably designed procedures” 

requirements are most effective when they are unqualified. In other words, the 

requirement should be to develop and implement procedures that are reasonably designed 
39

to prevent any occurrence of the misconduct or practice. Adding additional qualifiers 

such as “mitigate” (rather than prevent) and “impact” to the already qualifier of 

“reasonably” designed weakens the effectiveness of a procedures requirement. Soft 

procedures requirements weaken compliance, make litigation more likely, and 

disadvantage firms that are truly committed to compliance relative to firms that are not. 

To illustrate, the use of the term “mitigate the impact” rather than simply “mitigate” 

suggests that, once a conflict of interest is identified, the broker-dealer must determine 

the impact, for it is only the impact, not the conflict of interest, that must be “mitigated.” 

As a matter of textual construction, the use of the term “impact” suggests a further 

winnowing of the conflicts of interest category. It also suggests that there must be 

evidence of an effect, that is, of advisers’ recommendations actually being influenced by 

conflicted fees. A broker-dealer could conduct a legally sufficient statistical analysis that 

concluded that there was no “impact” from conflicted fees even when there was, or 

define “impact” so narrowly as to permit substantial room for abuse. This is not the 

intent of the procedures requirement. I strongly recommend that the Department delete 

the term “impact.” The procedures should be reasonably designed to mitigate conflicts of 

interest, not to mitigate their “impact.” 

The term “mitigate” may also be problematic because it requires only procedures that are 

reasonably designed to lessen in force or intensity, or reduce conflicts of interest. This 

standard would undermine the procedures requirement because it presupposes that 

procedures may be designed to allow known conflicts of interest to exist even when there 

are no neutral factors that justify them. The standard also would be difficult to enforce 

because it allows the broker-dealer to exercise too much discretion in determining when 

it is appropriate to pay differential compensation that could affect an adviser’s best 

judgment. 

As many of the foregoing comments suggest, the Department should adopt a standard 

that requires procedures that reasonably designed both to mitigate conflicts of interest 

and to prevent conflicts of interest that are not justified by neutral factors. While the 

Department includes the neutral factors standard in the BIC exemption, they are used

only to illustrate a non-exclusive way to comply with the exemption.32 Instead, 

differential payments (other than at the broker-dealer level and across investment 

categories) should be per se inconsistent with the BIC exemption unless there are 

neutral factors that could reasonably justify them. 

*		*		*		*		*		*		*		*		*		*		*		*

As	noted	above,	these	comments	do	not	address	many	issues	on	which	I	expect	to	

comment	over	the	course	of	Department’s	extended	comment	period.	 Although	in	

my	view	the	Department’s	should	be	improved	in	certain	respects,	the	core	proposal	

is	sound and	holds	out	the	potential	to	create	substantial	benefits	for	investors.

Americans’	retirement	security	has	become	increasingly	fragile	over	the	last	few	

																																																							 32 See Example	4,	80	F.R.	21791;	BIC	Exemption	Section	II(d)(4).	
40

decades,	in	no	small	part	due	to	a	permissive	regulatory	culture	that	has	allowed	

abusive	compensation	structures	to	flourish.		As	the	amount	of	retirement	assets	in	

IRAs	has	grown,	these	compensation	structures	have	increasingly	undermined	

Americans’	retirement	security.	 The	Department	must	act	to	address	conflicted	

compensation	practices	that	cost	investors	billions	of	dollars	every	year.

Thank	you	again	for	the	opportunity	to	comment	on	the	Department’s proposal.		I	

would	be	pleased	to	discuss	these	comments	or	related	issues	with	the	Department	

staff	and	may be	contacted	at	662-915-6835 or	mbullard9@gmail.com.	

Respectfully,	

Mercer	Bullard

Attachment:	as
Fund	Democracy

Consumer	Federation	of	America

Public	Citizen’s	Congress	Watch

AARP

Americans	for	Financial	Reform

October	18,	2013

The	Honorable	Sylvia	Matthews	Burwell

Director

Department	of	Management	and	Budget

725	17th Street,	NW

Washington,	D.C.	20503

Dear	Director	Burwell,	

We	are	writing	on	behalf	of	Fund	Democracy, Consumer	Federation	of	

America,	Public	Citizen’s	Congress	Watch,	AARP and	Americans	for	Financial	

Reform to	respond	to and	comment	on	certain	statements	made	in	a	letter	from	

members	of	Congress	to	the	Office	of	Management	and	Budget dated	August	2,	2013

(“Congressional	Letter”). The	Congressional	Letter	relates	to	the	Department	of	

Labor’s	intent	to	amend	its	interpretation	of	“investment	advice”	under	ERISA	in	

order	to	ensure	that Americans	are	adequately	protected	when	provided	advice	

about	their	retirement	accounts.	We	strongly	support	this	long	overdue	initiative	

and	encourage	the	OMB to	expedite	its	review when	it	receives	the	Department’s	

proposal.

In	contrast,	the	Congressional	Letter	asks	that	OMB	delay the	Department’s	

initiative	pending	fiduciary	rulemaking	by	the	SEC.	It	justifies	this	proposed	action	

based	on	the	unfounded	argument	that	“uncoordinated	efforts	undertaken	by	the	

agencies	could	work	at	cross-purposes	in	a	way	that	could	limit	investor	access	to	

education	and	increase	costs	for	investors,	most	notably	Main	Street	investors”	who	

invest	through	Individual	Retirement	Accounts	(IRAs).	The	Congressional	Letter	

ignores	assurances	that	the Department	has	provided	that	it	will	address	legitimate	

industry	concerns	with	regard	to	the	rule’s	potential	impact	on	retail	accounts.		

Moreover,	while	the	Letter	bases	its	argument	on	the	alleged	impact	of	Department

rulemaking	on	IRAs,	its	proposed	“solution”	would	deprive	all	retirement	accounts	

as	well	as	traditional	pension	plans	of	the	important	benefits	the	Department’s	

rulemaking	will	create. The	Letter is	suggesting	nothing	less	than	that	the	

Department’s	ability	to	exercise	its	authority	under	ERISA	should	be	bounded	by	the	

standards	that	the	SEC	may	eventually adopt	under	securities	laws.	Its	proposal	

must	therefore	be	judged	in	this	light.

The	Congressional	Letter’s	request	to	the	contrary,	there	is	no	reasonable	

basis	for	delaying	the	Department’s rulemaking	until	the	SEC	rulemaking	is	
2

complete.1 Such	a	delay	would	harm	investors	and further	undermine	Americans’	

already	shaky	retirement	security.	As	discussed	below,	ERISA	establishes	different,	

higher standards	for	retirement	accounts	than	those	that	apply	under	the	federal	

securities	laws.	It	would	be	inconsistent	with	the	spirit	and	letter	of	ERISA	to	limit	

its	standards	based	on	standards established	by	the	SEC.

We	are	most	concerned	regarding	the	Congressional	Letter’s	implication that	

the	fiduciary	duties	that	apply	under	ERISA	should	be	lowered to	a	securities	law	

standard	that	is	appropriate	for	general	retail	investment	advice but	not	for	advice	

regarding	retirement	assets.	This	proposition	directly	contradicts	ERISA,	which	

expressly,	intentionally	and	appropriately	imposes	and	has	always	imposed	a	higher	

fiduciary	standard	on	providers	of services	to	Americans	with	respect	to	the	

accounts	on	which	they	are	relying for	their	retirement	security.	The	SEC’s	ongoing

initiative	under	the	federal	securities	laws	seeks	to	remedy	a	deficiency	in	the	

regulation	of	broker-dealers.	We	are	dismayed	by	the	suggestion	that	this	purpose	

should	be	turned,	instead,	to compromising the	protections	that	apply	to	retirement	

accounts.	

ERISA’s	Higher Fiduciary	Standard

We	are	particularly	dismayed	by	the	Congressional	Letter’s	assertion that:

Congress	clearly	intended	that	a	single	standard	should	apply	to	

retail	accounts,	including	retirement	accounts,	based	on	specific

guidelines	enumerated	in	Section	913 [of	the	Dodd-Frank	Act].

We	find	no	evidence	to	support	this	claim. Section	913,	by	its	express	terms,	

addresses	only	the	legal	standards	that	apply	to	broker-dealers	and	investment	

advisers	under	the	securities	laws.	The	purpose	of	Section	913	was	to	require	the	

SEC	to	evaluate the	regulation	of	broker-dealers	and	investment	advisers	under	the	

securities	laws	and	to	authorize	rulemaking	on	that	subject.	Section	913	was	

prompted	by	the	anomaly	that	broker-dealers	provide	the	same	personalized	

investment	advice	to	clients	as	investment	advisers	provide,	but	broker-dealers	are	

subject	to	a	lower	suitability	standard.	There	is	nothing	in	the	text	of	Section	913	or	

its	legislative	history	that	supports	the	view	that	it was	intended	to	address	

fiduciary	standards	under	ERISA.

Congress	has,	in	fact,	clearly	and appropriately	imposed	a	higher	legal	

standard	with	respect	to	the	accounts	on	which	Americans	rely	for	their	retirement	

security	than	the	standard	that is	imposed under	the	federal	securities	laws.	An	

																																																							 1 See	generally Legislative	Proposals	to	Relieve	the	Red	Tape	Burden	on	Investors	and	Job	Creators,	

before	the	Subcommittee	on	Capital	Markets	and	Government	Sponsored	Enterprises,	Committee	on	

Financial	Services,	United	States	House	of	Representatives	(May	23,	2013)	(testimony	of	Mercer	

Bullard).
3

ERISA	fiduciary	is	required	to	act	solely	in	the	best	interests	of	the	ERISA	client,2

whereas	a	fiduciary	under	the	securities	laws	is	required	only	to	act	in	the	best	

interests	of	the	client.	The	Supreme	Court	has	specifically	stated	that	“ERISA	

imposes	higher-than-marketplace	quality	standards	.	.	.	,	requiring	a	plan	

administrator	to	‘discharge	[its]	duties’ in	respect	to	discretionary	claims	processing	

‘solely	in	the	interests	of	the	[plan's] participants	and	beneficiaries.’”3

Under ERISA,	fiduciaries	are	also explicitly prohibited from	engaging	in	a	

wide	range	of	transactions	that	are	permitted,	with	adequate	disclosure,	for	

fiduciaries	under	the	securities	laws.4 For	example,	ERISA	fiduciaries	are	generally	

prohibited	from	engaging	in	principal	transactions	with	their	clients,	whereas under

securities	law	fiduciaries	may	do	so	with	appropriate	disclosure.	These	ERISA	

prohibitions	establish	a	demonstrably	higher	standard	than the	standard imposed	

under	the	securities	laws.	Insurance	agents,	broker-dealers	and	investment	advisers	

who	are	currently	ERISA	fiduciaries	have	been	able	to	comply	with	these	higher	

standards	for	years,	including	with	respect	to	services	provided	to	IRAs.	The	

Congressional	Letter	asserts that	the	Department’s	original	proposal	would	have	

“eliminated	access	to	meaningful	investment	services	for	millions	of	IRA	holders,”

but	this	assertion	is	contradicted	by	the	fact	that	all	types	of	financial	professionals	

have	for	decades	been	complying	with	precisely	the	same	rules	that	the	

Department’s	rulemaking	would	impose	on	new	ERISA	fiduciaries	to	IRAs.5

There	is	No	ERISA	“Conflict”	with	Securities	Law

																																																							 2 ERISA	Section	404(a)	requires,	for	example,	that	an	ERISA	fiduciary	discharge	its	duties	“solely	in	

the	interests	of	the	participants	and	beneficiaries	.	.	.	with	[]care,	skill,	prudence,	and	diligence.”	

Section	404(a)	does	not	apply	to	most	individual	retirements	accounts	(“IRAs”)	because	they	are	not	

employee	benefit	plans	and	therefore	would	not	apply	to	IRAs	under	the	Department’s	proposal.

3 Metropolitan	Life	Ins.	Co.	v.	Glenn,	554	U.S.	105,	106	(2008).	See	Lorraine	Schmall,	Defined	

Contribution	Plans	after	Enron,	41	Brandeis	L.J.	891	(2003)	(“ERISA fiduciaries are	held	to	

a higher standard	than	are	ordinary	trustees”)	(quoting	Susan	J.	Stabile,	Breach	of	ERISA	Fiduciary	

Responsibilities:	Who's	Liable	Anyway? 5	Empl.	Rts.	and	Employ.	Pol'y	J.	135	(2001)).

4 Pension	benefit	plans	are	subject	to	the	prohibited	transaction	rules	in	ERISA	Section	406,	unless	

exempt	under	Section	408	or	one	of	the	many	exemptions	granted	by	the	Department.	IRAs	are	

subject	to	the	prohibited	transaction	rules	in	I.R.C.	Section	4975(c),	which	generally	mirror	the	rules	

in	ERISA	Section	406.	

5 Some	have	criticized	the	Department’s	rulemaking	on	the	ground	that	it	“extends”	ERISA’s	

prohibited	transaction	rules	to	IRAs	and	thereby	encroaches	on	the	SEC’s	jurisdiction.	In	fact,	there	is	

no	question	that	Section	4975(c)	already applies	to	IRAs	and	those	who	currently qualify	as	

fiduciaries	with	respect	to	IRAs.	That	includes	many	insurance	agents	and	broker-dealers	that	are	

currently	ERISA	fiduciaries	and	are	managing	to	serve	their	ERISA	clients	with	IRAs	in	compliance	

with	ERISA.	The	change	that	the	Department	proposes	to	make	would	expand	the	category	of	IRA	

fiduciaries	that	are	subject	to	Section	4975(c).
4

It	is	also	incorrect to	imply	that	any	Department	proposal	under	ERISA	

would	“conflict”	with	the	securities	laws.	The	original	proposal	included	no	conflict	

with	the	federal	securities	laws.	Nor	has	any	spokesperson	for	the	Department	

made	any	statement	that	even	suggests	any	such	conflict.	Nor	has	any	commentator,	

to	our knowledge,	identified any	possible	conflict	that	the	fiduciary	rulemaking	

might	create.	The	most	recent	potential	conflict	between	a	DOL	rule	and	the	rule	of	

another	agency	(the	CFTC)	was	quickly	resolved	before	the	CFTC rule	became	final.

Critics	of	the	Department	have	adopted	the	term	“conflict”	to	describe	what	

is	not	a	conflict	at	all,	but	rather	a	standard	under	ERISA	that	Congress	decided	

should	be	higher	than	the	parallel	standard	under	the	federal securities	laws.	The	

Department	should,	indeed	must, hold fiduciaries	under	ERISA	to	a	higher	standard	

than	applies	under	the	federal	securities	laws.	This	does not	create	a	conflict in	any	

meaningful	sense,	but	simply	reflects	the higher	standard	the	Congress decided	to	

impose	when	investment	assets	are	specifically	intended	for	retirement	and,	not	

incidentally,	subsidized	through	deferred tax	collections.

Securities	law	and	ERISA	are	different	regulatory	schemes	because	they	

should	be	different.	The	public	interest	in	tax-subsidized	employee	benefit	plans and	

IRAs is	far	greater	than	for	securities	investments	in	general.	Investment	regulation	

takes	on	greater	importance	in	the	context	of	retirement	benefits,	where	losses	

resulting	from	misconduct	have	greater	adverse	individual	and	societal	

consequences	than	losses	associated	with	securities	investments generally.	The	

Department’s	application	of	ERISA’s	fiduciary	duty	therefore	should	not	be	expected	

to	conform to	securities	regulation,	just	as	the	SEC’s	application	of	the	fiduciary	duty	

under	the	securities	laws	should	not	be	expected	to	conform	ERISA’s	requirements.

Each	standard	is	appropriately	designed	to	fit	the	context.

Retirement	Accounts	Should	be	Provided	Greater	Legal	Protection

Indeed,	it	is	difficult	to	understand	how	one	could reasonably	disagree	with	

the	proposition	that	services	provided	as	to	Americans’	retirement	assets	should	be	

held	to	a	higher	legal	standard.	Social	Security	is	facing	an	actuarial	shortfall,	billions	

of	dollars	of municipal	retirement obligations	are	unfunded,	and	Americans	are	

living	longer	and	not	saving	enough	for	retirement. At	the	same	time,	Americans	are	

being	encouraged	to	invest	their	retirement	savings	in	high-risk	hedge	funds6 and	

franchises.

7 The	Department	is	doing	what	it	should	have	done	long	ago;	it	is

																																																							 6 See,	e.g.,	Arleen	Jacobius,	Carlyle	brass:	It's	'Unfair'	to	Deprive	DC	Investors	of	Private	Equity	

Investments,	Pension	&	Investments	(Sep.	26,	2013)	available at

http://www.pionline.com/article/20130926/DAILYREG/130929900/carlyle-brass-its-unfair-todeprive-dc-investors-of-private-equityinvestments?newsletter=daily&issue=20130926#utm_source=Newsletters&utm_medium=email&ut

m_campaign=P%26I%20Daily%20Plan%20Sponsor.

7 See,	e.g.,	Rodney	Brooks,	Using	Your	401(k)	or	IRA	to	Start	That	Dream	Business,	USA	Today	(Sep.	23,	

2013)	available	at
5

repealing	its	own,	extralegal	narrowing	of	the	meaning	of	investment	advice to	

ensure	that	ERISA’s	fiduciary	provision	can	do	its	job	of	protecting	Americans’	

retirement	security.	

The	Congressional	Letter’s	implication	that	retirement	assets	should	receive	

no	more	protection	that	any	investment	is	striking	in	light	of	the	most	recent	

research	on	investment	fraud.	Earlier	this	month,	FINRA	released	a	study	showing	

that	84	percent of	Americans	had	been	solicited	with	one	of	11	types	of	blatantly	

fraudulent offers, with	11 percent losing	a	significant	amount	of	money	after	

engaging	with	an	offer.

8 Forty-two	percent	of	respondents	found	“claims	of	

achieving	‘typical’ returns	of	110%	per	year”	appealing.	Forty-three	percent	found	

claims	of	“fully	guaranteed”	investments	to	be	appealing. In	view	of	the	stunning	

susceptibility	of	Americans	to	the	most	obvious	forms	of	fraud,	one	can	only	imagine	

how	likely	they	are	to	follow	the	advice	of	non-fiduciary	investment	professionals	

when	investing	for	their	retirement.

A	GAO	study	released	earlier	this	year	documented	fraud	and	abuse	in	

precisely	the	kinds	of	transactions	to	which	ERISA’s	fiduciary	duty	should	apply.9

The	GAO	found	that	call	center	representatives	– employees	of	the	most	vocal	

opponents	of	the	DOL	proposal	– “encouraged	rolling	401(k)	plan	savings	into	an	

IRA	even	with	only	minimal	knowledge	of	a	caller’s	financial	situation.” Excerpts	

from	GAO	calls	to	representatives	reveal	a	pattern	of	misconduct.	Representatives

claimed	that	401(k)	plans	had	extra	fees	and	that	their	IRAs	“had	no	fees,”10 or	

argued	that	IRAs	were	always	less	expensive,	notwithstanding	that	the opposite	is

																																																																																																																																																																				

http://www.usatoday.com/story/money/columnist/brooks/2013/09/23/retirement-entrepreneur401k-pension/2833897/.

8 Financial	Fraud	and	Fraud	Susceptibility	in	the	United	States,	Applied	Research	and	Consulting	for	

FINRA	Investor	Education	Foundation	(Sep.	2013)	available	at

http://www.finra.org/web/groups/sai/@sai/documents/sai_original_content/p337731.pdf.	See	also

Investor	Fraud	Study	Report,	NASD	Investor	Education	Foundation	(May	12,	2006)	available	at	

http://www.sec.gov/news/press/extra/seniors/nasdfraudstudy051206.pdf.

9 Labor	and	IRS	Could	Improve	the	Rollover	Process	for	Participants,	Government	Accountability

Office,	GAO-13-30	(March	2013)	(“GAO	Report”)	available	at	

http://www.gao.gov/assets/660/653506.txt.	See	also	Conflicts	of	Interest	Can	Affect	Defined	Benefit	

and	Defined	Contribution	Plans,	Government	Accountability	Office,	GAO–09–503T	(Mar.	24,	2009)	

available	at http://www.gao.gov/new.items/d09503t.pdf.

10 “Finally,	misleading	statements	also	make	it	difficult	to	understand	IRA	fees.	Calls	made	by	our	

investigator	to	401(k)	plan	service	providers,	most	of	which	offer	IRA	products,	found	that	7	of	30	

call	center	representatives	(representing	firms	administering	at	least	34	percent	of	IRA	assets	at	the	

end	of	the	1st	quarter	in	2011)	said	that	their	IRAs	were	‘free’	or	had	no	fees	with	a	minimum	

balance,	without	clearly	explaining	that	investment,	transaction,	and	other	fees	could	still	apply,	

depending	on	investment	decisions.	In	our	review	of	10	IRA	websites,	we	found	5	providers	that	

made	similar	claims,	often	with certain	conditions	such	as	a	$50,000	minimum	balance	or	consent	to	

receive	electronic	statements	explained	separately	in	footnotes.”	GAO	Report,	supra (footnotes	

omitted).
6

generally true:	IRAs	are	more expensive	for	investors,	on average,	than	401(k)	plans.

Broker-dealers	routinely	hold	themselves	out as	fiduciaries	– the	same	standard	

that	their	employers	do	not	want	to	have	to	meet	in	practice.	The	GAO	study	showed	

that	providers	of	401(k) plans undercut	their	own	plans in	order	to	push	their	

higher-cost	IRA	options	on	unsuspecting	investors. These	studies	suggest	that,	

rather	than	seeking	to	undermine	legal	protections	for	Americans’	retirement	

accounts,	Congress	should	be	seeking	to	strengthen them.	

Investors’ vulnerability	to	fraud	is	most	acute,	and	the	need	for	fiduciary	

protection is	greatest, in	the	context	of	retail	accounts,	such	as	IRAs, that	are	subject	

to	ERISA.	One	reason	is	that	retail	accounts	are	provided	less	protection	than	

employee	benefit	plans	under	ERISA	because	they	are	not	subject	to	section	404’s	

heightened	fiduciary	standard11 (and	would	continue	to	be	exempt	under	the	

Department’s	proposal).	Another	reason	is	that	retail retirement	accounts	lack	the	

buffer	provided	by	the employer	in	an	employee	benefit	plan.	Unlike	salespersons,	

employers	generally	do	not	have	the	substantial	conflicts	of	interest	and	economic	

stake	in	fees	paid	in	connection	with	employees’	investments	(with	the	exception	of	

employer	stock).	A	committee	of	fiduciaries	selected	by	the	employer	chooses the	

plan’s	investment	options	and	generally	negotiates lower	fees	than	those	charged	in	

IRAs.	In	contrast,	as	the	GAO	has	confirmed,	some	broker-dealers	advise	retirees	to	

rollover	their	401(k)	plan	assets	into	higher	cost	IRAs that	directly	benefit	the	

broker-dealer.	The	broker-dealers	that	would	be	subject	to	a	fiduciary	duty	under	

the	Department’s	proposal	have	significant	conflicts	of	interest and	economic	

incentives	to	act	in	their	own	best	interests	rather	than	their	clients’.	Retail	accounts	

therefore	are	in	greater	need	of	protection	under	the corrected	interpretation	of	

“investment	advice”	that	the	Department	expects	to	propose.	

We	recognize	that	the	prohibited	transaction	rules	of	ERISA,	especially	as	

applied	to	small,	retail	accounts, raise legitimate	concerns	for	financial	services	

professionals.	However,	this	has	been	true	for	many	years	in	a	wide	range	of	

circumstances	that	the	Department	has	successfully	addressed	by	granting	

appropriate	exemptions.	The	Department	has	a	long	history	of	appropriately	

accommodating	business	practices, consistent	with	the	protection of	Americans’	

retirement	accounts,	through	carefully	tailored	prohibited	transaction	exemptions,	

known as	“PTEs.” Assistant	Secretary	Borzi	has	specifically	noted	that	such	

exemptions	require	a	finding	that	they	are	in	the	best	interests	of	investors	and	

stated	unambiguously	that	“[w]e	think	that	there	are	types	of	compensation	that	

would	otherwise	be	prohibited	under	a	flat	prohibition	that	we	will	be	able	to	make	

that	finding	for.”12 She	has	repeatedly	made	it	clear	that	there	will	be	PTEs	in	the	

																																																							 11 See	supra	note	2. 12 Diana	Britton,	Borzi	Hints	at	Exemptions	to	DOL	Fiduciary	Rule,	WealthManagement.com	(Apr.	29,	

2013)	available	at http://wealthmanagement.com/imca-2013-annual-conference/borzi-hintsexemptions-dol-fiduciary-rule/.	
7

proposal	that	will	be	designed	to	accommodate	existing	business	practices.13 We	

agree	that	the	proposal	should	include	appropriately	designed	PTEs.	However,	

without	knowing	the	content	of	these	exemptions	– that	is,	without	waiting	until	the	

proposed	rules	has	actually	been	proposed	– the	Congressional	Letter’s	concerns	

regarding	the	proposal’s	effect	on	current	business	practices	are	premature; we	

urge that	OMB	not	similarly prejudge	the	Department’s	proposal.

There	is	No	Limiting	Effect	on	Investor	Education

The	Congressional	Letter	contends	that	the	Department’s	proposal	“could	

limit	investor	access	to	education.” We	agree	that	the	Department	should	not	

impede	investors’	access	to	education,	but	the	proposal	would	have no	such	effect.	

The	concern	that	investment	advice	could	be	deemed	to	include	investor	education	

has	long	been	addressed	by	an exclusion from	the	definition	of	investment	advice	

under	a	longstanding	Department	position.14 Investment	advice	does not	include	

descriptions	of	investment	options	or	information	regarding	asset	allocations,	asset	

class	returns,	diversification,	risk	and	return,	or	risk	tolerance.	It	does	not	include	

asset	allocation	models	based	on	generally	accepted	investment	theories	that	

provide advice	regarding	asset	classes’	historical	returns	and	volatility	and their	

appropriateness	for	investors	with	different characteristics.	Nor	does	investment	

advice	include	interactive	worksheets	that	allow	investors	to	estimate	future	

income	needs	and	test	different	asset	allocation	strategies.	

The	Department’s	original	proposal	expressly	adopted	the	existing	exclusion	

for	investor	education	from	the	definition	of	investment advice.	This	means	that	this	

exclusion	would	apply	to	new	fiduciaries	under	its	proposal.	Providers	of	IRAs,	for	

example,	would	be	able	to	provide	all	of	the	educational	information	to	investors	

that	current	fiduciaries	have	found	sufficient	for	years.	We	are	not	aware	of	any	

examples	of	investor	education	having	been	“limited”	under	the	existing	

interpretation	and	are	confident	that	if	there	were problems,	the	Department	would	

ensure	that	such	education	did	not	trigger	fiduciary	status.	

DOL’s	Overly	Narrow	Interpretation	of	“Investment	Advice”

																																																							 13 See	Borzi:	DOL	Fiduciary	Rule	Won't	'Outlaw'	Commissions,	Financial	Advisor	(Sep.	10,	2013)	

(proposal	will	include	new	PTEs)	available	at	http://www.fa-mag.com/news/borzi--dol-fiduciaryrule-won-t--outlaw--commissions-15408.html;	Darla	Mercado,	DOL's	Borzi	Says	Fiduciary	Rule	Will	

Be	Simple:	Clients	Come	First,	Investment	News	(June	19,	2013)	(Assistant	Secretary	Borzi	stating	that	

the	proposal	will	include	new	PTEs)	available	at	

http://www.investmentnews.com/article/20130619/FREE/130619875#;	Karl	Thunemann,	

Exemptions	from	Conflict	of	Interest	Will	Be	Part	of	New	Fiduciary	Proposal,	RIABiz	(May	7,	2013)	

(statement	of	ERISA	attorney	Fred	Reish:	“Phyllis	Borzi	has	been	saying	— for	over	a	year	— that	

there	would	be	exemptions	with	the	new	proposal”)	available	at

http://www.riabiz.com/a/22106168/borzi-exemptions-from-conflict-of-interest-will-be-part-ofnew-fiduciary-proposal.

14 29	C.F.R.	§	2509.96-1	(1996).
8

If	there	is	a	comparison	to	be	made	between	ERISA	and	the	federal	securities	

laws,	it	should	focus	on	the	significant flaw	in	the	Department’s longstanding	

interpretation	of	the	term	“investment	advice.” The	Department	has	narrowly	

interpreted	the	term	not to	apply	to	advice	provided	in	connection	with	a	one-time	

transaction or	to	advice	that	is	not	the	“primary	basis”	for	the	client’s	investment	

decisions.	Under	the	federal	securities	laws,	there	is	no	question	that	the	term	

“investment	advice” includes	providing	advice	as	to	a	single	transaction.	This	is	so	

clear	that	Congress	created	an	exemption	for	broker-dealers	from	the	definition	of	

“investment	adviser”	in	the	Investment	Advisers	Act	precisely	because	investment	

advice	so	clearly	includes one-time	advice	for	which	a	broker-dealer	is	paid	a	

commission.	Under	the	Advisers	Act,	“investment	advice”	also	includes	advice	that	is	

not	the	“primary	basis”	for	a	client’s	transaction.	

Logic	would	dictate	that	the	Department	interpret	“investment	advice”	under	

ERISA	similarly	to	cover	such	obvious	cases – if	not	interpret it more	broadly for	the	

protection	of	America’s	retirees.	But	the	Department	has interpreted that	term	in	a	

way	that	is	inconsistent	with	the	statute.15 There	is	no reasonable	basis	for	the	

Department’s	narrowing	the	plain	meaning	of	“investment	advice;”	this	error	should	

have	been	corrected	long	ago.	Congress’s	concern	should	be	the	Department’s	delay	

in	correcting	its	interpretation of	the	meaning	of	investment	advice,	which	directly	

conflicts	with	the	ERISA,	rather	than	the	possibility	that	broker-dealers	will	actually	

be	subject	to	the	ERISA	standards	that	Congress	has	always	intended	to	apply	to	

Americans’	retirement	accounts.	We	anticipate	that	these	short-comings will	be	

addressed	in	the	revised	rule	proposal.

The	SEC	Timetable

The	Congressional	Letter’s	suggestion	that	the	Department	delay	its	long	

overdue	rulemaking	pending	SEC	action	is	also	troubling	in	view	of	the	SEC’s	record

on	related	rulemaking	initiatives.	The	Commission	has	been	promising	rulemaking	

to	establish	a	fiduciary	duty	for	broker-dealers	for	years,	yet	no	proposal	has	ever	

been	issued.	More	than	three	years	after	Dodd-Frank	Section	913	became	law,	the	

Commission	has	only	just	asked	for	information	on	the	effects	of	a	fiduciary	

rulemaking.	If	past	practice	is	any	indication, there	is	no	guarantee	that	any	rule	

proposals	will	be	forthcoming.	The	SEC’s initiatives regarding	revenue	sharing	

payment	disclosure and	12b-1	fees	– two	of	the	primary	practices	that	the	

Department	is	expected to	address	– have	been	languishing	for,	respectively,	nine

and	thirteen	years.16 In	contrast,	the	SEC	did	not	hesitate	to	adopt a	“temporary”	

																																																							

15 Definition	of	the	Term	“Fiduciary,”	Employee	Benefits	Security	Administration,	75	F.R.	65263,	

65264	(Oct.	22,	2010)	(Department’s	interpretation	of	“investment	advice”	significantly	narrows	the	

plain	language	of	section	3(21)(A)(ii)”).

16 See Confirmation	Requirements	and	Point	of	Sale	Disclosure	Requirements	for	Transactions	in

Certain	Mutual	Funds	and	Other	Securities,	and	Other	Confirmation Requirement	Amendments,	and	

Amendments	to	the	Registration	Form	for	Mutual	Funds,	Securities	Act	Rel.	No.	8358	(Jan.	29,	2004)
9

rule	that	lowers	standards	applicable	to	broker-dealers’	principal	trades	with	their	

advisory	clients.	This	so-called	“temporary”	rule	has	been	extended,	in	clear	

violation	of	the	Administrative	Procedures	Act,	three times	for	a	total	of	six years17

without	ever	responding	to	public	comments	on	its	deficiencies.

18 On	each	occasion,

the	SEC	has	imposed	a	“sunset”	date,	but	this	is	clearly	a temporary rule	on	which	

the	sun	may never	set.	Given	the	SEC’s	record	of	delay	and	inaction,	requiring	the	

Department	to	wait	on	the	Commission	to	conduct	fiduciary	rulemaking	is	the	

practical	equivalent	of	prohibiting	the	Department’s	rulemaking	altogether.	

*		*		*		*		*		*		*

We	urge	the	OMB	to	base	its	ultimate	review	of	the	Department’s	reproposal	

on	the	facts,	rather	than	the	myriad	of	myths	and	falsehoods	that	have	characterized	

much	of	the	debate	regarding	the	original	proposal. We	recognize	that	there	were	

problems	with	the	original	proposal,

19 but	that	proposal	has	been withdrawn. We

see	no	reason	not	to	accept the	Department’s acknowledgment of	the problems	with	

the	original	proposal	and	its intent	to	address	those	problems	in	any	reproposal.

Secretary	Perez	has	promised	the	Senate	that	he	will	carefully	review	any	

reproposal	and	ensure	that	it	fully	reflects	industry	and	investor	concerns.	We	see	

no	reason	for	OMB	to	undermine the	specialized	expertise	that	the	Department	

brings	to	bear	on	regulatory	issues	affecting	Americans’	retirement	security.	Finally,	

we	have	no	doubt regarding	the	continued	vitality	and	appropriateness of	

Congress’s	undisputed	policy	of	applying	higher	standards	when	financial	services

professionals	advise	Americans regarding	their	retirement	assets.	

																																																																																																																																																																				

available	at	http://www.sec.gov/rules/proposed/33-8358.htm.	The	SEC	has	been	promising	12b-1	

fee	reform	since	February	2000,	when	it	conceded	that	current	rules	fail	to	require	disclosure	of	

payments	received	by	brokers	for	recommending	fund	shares	and	stated	that	it	had	directed	its	staff	

to	make	recommendations	on	how	to	fix	this	problem.	See Brief	of	the	Securities	and	Exchange	

Commission,	Amicus	Curiae,	in	Donald	Press	v.	Quick	&	Reilly,	Inc.	(2d	Cir.)(Feb.	2000).	The	SEC	

proposed	12b-1	reforms	more	than	three	years	ago,	but	has	not	taken	any	further	action.	See	Mutual	

Fund	Distribution	Fees;	Confirmations,	Investment	Company	Act	Rel.	No.	29367	(July	21,	2010)	

available	at	http://www.sec.gov/rules/proposed/2010/33-9128.pdf.		

17 The	“temporary”	rule	was	originally	“adopted”	in	2007.	See	Advisers	Act	Rule	206(3)-3T	(Temporary	

Rule	Regarding	Principal	Trades	with	Certain	Advisory	Clients)	(Dec.	21,	2012) available	at	

http://www.sec.gov/info/smallbus/secg/206-3-3-t-secg.htm.	The	“temporary”	rule	was	extended	to	

Dec.	31,	2010	in	2009,	to	Dec.	31,	2012	in	2010,	and	to	Dec.	31,	2014	in	2012.	See	id.

18 See,	e.g.,	Letter	from	Mercer	Bullard,	Fund	Democracy,	and	Barbara	Roper,	Consumer	Federation	of	

America	to	Nancy	Morris,	Secretary,	SEC	(Nov.	30,	2007)(commenting	on	adoption	of	temporary	rule	

regarding	principal	trading	restrictions)	available	at http://www.sec.gov/comments/s7-23-

07/s72307-18.pdf

19 Mercer	Bullard,	DOL's	Fiduciary	Proposal	Misses	the	Mark,	Morningstar.com	(June	14,	2011)	

available	at http://news.morningstar.com/articlenet/article.aspx?id=384065.
10

Thank	you	for	your	consideration	of	our	comments.	We	would	appreciate	an	

opportunity	to	meet	with	you,	at	your	convenience,	to	discuss	them	further.	Please	

feel	free	to	contact	Mercer	Bullard	(662-915-6835)	or	Barbara	Roper	(719-543-

9468)	if	you	have	any	questions	regarding	this	letter	or	would	like	to	arrange	a	

meeting,	or	if	we	can	otherwise	be	of	assistance.

Respectfully	yours,	

Mercer	Bullard 								Barbara	Roper

Founder	and	President 								Director	of	Investor	Protection

Fund	Democracy 								Consumer	Federation	of	America

																																																															

Lisa	Gilbert 							David	M.	Certner

Director 							Legislative	Council	and	Policy	Director

Public	Citizen’s	Congress	Watch 							AARP

Lisa	Donner

Executive	Director

Americans	for	Financial	Reform

CC:	

The	Honorable	Mark	Begich

The	Honorable	Ben	Cardin	

The	Honorable	Tom	Carper

The	Honorable	Kirsten	Gillibrand

The	Honorable	Kay	Hagan

The	Honorable	Amy	Klobuchar

The	Honorable	Claire	McCaskill

The	Honorable	Mark	Pryor

The	Honorable	Jon	Tester

The	Honorable	Mark	Warner	

The	Honorable	Thomas	E.	Perez

The	Honorable	Phyllis	Borzi