More On Legal & Compliancefrom The Advisor's Professional Library
- The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.
- Scope of the Fiduciary Duty Owed by Investment Advisors A fiduciary obligation goes beyond the suitability standard typically owed by registered representatives of broker-dealer firms to clients. The relationship is built on the premise that the advisor will always do the right thing for the person or entity receiving advice.
If you’ve been paying attention over the past year, you’ve noticed that regulators and those in Washington are placing increased scrutiny on IRA rollovers.
Are advisors chasing rollover dollars without bothering to consider whether they are appropriate for clients? In some cases, most assuredly yes, but IRA expert Ed Slott said that the SEC and FINRA not only want to stop rollover abuses, they want advisors to become educated on the options available to workers who are either retiring or shifting jobs.
“I’d say over 90% of advisors” don't know the six options available to workers “because mostly they [advisors] begin their careers as salespeople,” and “because advisors are not trained on the tax rules—all they know is a rollover,” Slott told me in a recent interview.
Regulators “are concerned that participants aren't being given all of their options” regarding what they can do with their retirement dollars, he said.
Slott also sees a dire picture for those advisors who don't beef up their knowledge about helping their clients—particularly boomers—enter the distribution phase of their retirements: outright loss of those clients and a failure to bring on new ones.
Capturing boomers’ rollover dollars—which is estimated to be in the trillions—is the “opportunity of a lifetime” for advisors, he said. Boomers, as opposed to their parents, are much more educated on their options, Slott said he's found in the many consumer seminars that he conducts. “I get well-educated questions—as a matter of fact, better questions—from boomers than I do from advisors.”
Boomers Less Loyal to Advisors?
Because boomers are also less loyal than their parents, they won't stick with an advisor who hasn't done his research. “Boomers are willing to break a 20-year relationship with an advisor” if that advisor can't take them into the distribution phase, Slott said. “Maybe they had an advisor who made them some money while they were accumulating, but now they are looking ahead to retirement and to the distributing phase, and they want to make sure they have the right advisor for that phase. Boomers are very willing to move to an advisor that has knowledge in that area.”
Cerulli Associates recently released data showing that IRA rollover contributions in the United States surpassed $321.3 billion at the end of 2012, an increase of 7.3% over the previous year, with a “large portion” of the contributions coming from defined contribution plans.
In 2013, rollovers rose even further to $357.7 billion, an 11.3% increase, Cerulli estimated in its not-yet-finalized 2014 study.
Of the six choices available to workers when leaving a job—an IRA rollover, leave it in the company plan or roll to a new company's plan, take a lump-sum distribution, make a Roth conversion or an in-plan Roth conversion—Slott said that the right choice depends on the participant's circumstances, but “the best option is still usually the IRA rollover, to be fair to advisors.”
But, he added, “there are situations where you have to ask questions, and this is where advisors need to be better educated on the options.”
There are benefits to keeping the money in the employee's current plan, “but it depends on the person.” The biggest benefit to leaving it in the plan or rolling to a new plan is creditor protection, Slott said. “But this is where advisors have to do some homework” because creditor protection is determined by state law.
“If you’re in a state like mine, New York, for example, that's not a problem because New York has creditor protection for IRAs. So it's up to advisors to know their own state's IRA and Roth IRA creditor protection status.” A client such as an executive or doctor who's afraid of getting sued wouldn't want to roll their 401(k) money, which is protected from creditors, to an IRA that may not be protected under state law.
Pressure From BDs
Slott said he's noticed that independent advisors are more receptive to becoming educated on the options, but that pressure is also being put on reps working for broker-dealers to bring in rollover dollars.
After conducting a recent webinar for advisors working for a big financial services firm, Slott said that a young female advisor called him and said, “‘I have to get rollovers in because if I don't bring in $60 million, I get fired.’”
Not understanding the six options is a “big deal,” and the advisor “has one shot to do it right.” If they don't, “the results can be disastrous,” Slott said.
For instance, if an advisor just does an IRA rollover, “when it turns out [the client is] sitting on a ton of highly appreciated company stock and you didn't know about the NUA [net unrealized appreciation] tax break, that client should have probably done the lump-sum distribution and taken the tax break,” Slott said.
The Regulators’ Stance
While the SEC and FINRA have said rollovers are an exam priority this year, the Department of Labor's redraft of its rule to amend the definition of fiduciary under the Employee Retirement Income Security Act (ERISA) will also likely require rollover advice to be fiduciary advice.
Kevin Goodman, national associate director of the BD exam program for the SEC's Office of Compliance Inspections and Examinations, said at the Financial Services Institute's OneVoice conference earlier this year that the SEC would place heightened scrutiny on qualified plan rollovers and sales to seniors to catch potential “abuses.”
“If you look at the numbers, there are burgeoning assets” in rollovers, and there's potential for advisors and brokers to unnecessarily steer clients into one for their own financial gain, Goodman said. “There's also the DOL analysis of how the fiduciary standard may apply in this context. We’ll be looking at this during a lot of exams,” particularly where the agency notices “someone that is highly successful at rollovers.”
Indeed, a Government Accountability Office (GAO) report released last year cited the fact that 401(k) plan participants separating from their employers “may find it difficult to understand and compare all their distribution options,” and that “plan participants often receive guidance and marketing favoring IRAs when seeking assistance regarding what to do with their 401(k) plan savings when they separate from their employers.”
GAO found that service providers’ call center representatives encouraged rolling 401(k) plan savings into an IRA even when those reps had “only minimal knowledge of a caller's financial situation.”
The GAO report concluded that DOL's current requirements “do not sufficiently assist participants in understanding the financial interests that service providers may have in participants’ distribution and investment decisions.”
FINRA said in late January that reviewing firms’ qualified plan rollover practices will be a priority in 2014, and that staff will examine firms’ marketing materials and supervision in this area. FINRA will also evaluate securities recommendations made in rollover scenarios to determine whether they comply with suitability standards under FINRA Rule 2111.
FINRA said that it shared the GAO's concerns that investors may be misled about the benefits of rolling over assets from a 401(k) plan to an IRA. In its Regulatory Notice 13–23, FINRA warned firms and associated persons not to make claims of “free IRAs” or “no-fee IRAs” where investors do pay costs associated with these accounts.
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