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One of the major targets of the new Department of Labor fiduciary rule is rollover services. Advisors can provide invaluable assistance to participants as they consider whether to roll over 401(k) and other qualified plan monies to IRAs once they leave their employer. However, these services are often rendered in the context of cross-selling, and cross-selling practices by their nature create potential conflicts of interest. It is easy to see the potential abuse that can arise when a firm or business exploits the trust, which it has developed with a client through a longstanding relationship, to sell additional products and services at potentially unfavorable terms to the client.
“Capturing” rollover assets is a classic example of cross-selling. In many instances, an advisor will have developed longstanding relationships with both the plan sponsor as well as the plan’s participants. It would be tempting then, for the advisor to encourage the plan’s participants to roll over their account balances to IRAs as soon as they become eligible to take a distribution from the plan. This temptation arises whenever the advisor can earn a higher level of compensation providing rollover IRA services for the participant than the level of plan-related compensation that would otherwise be earned by the advisor if the participant’s assets had remained with the plan. The U.S. Government Accountability Office has issued several well-publicized reports that investment management services provided to IRAs are highly lucrative and significantly more valuable to advisors than fees generated by employer plans.
The Rollover Opinion
To curb potential abuses associated with “capturing” rollovers, the DOL issued Advisory Opinion 2005-23A (the “Rollover Opinion”). On its face, this interpretive guidance broadly suggested that any rollover-related advice from an advisor providing any fiduciary advice to the plan sponsor or the plan’s participants could result in a prohibited transaction. On the other hand, an advisor who did not serve as a fiduciary could freely advise participants on rolling over their accounts to IRAs and how the rollover proceeds should be invested.
For advisors holding themselves out as providers of fiduciary advice to plan participants, the DOL Rollover Opinion provides that they cannot capture rollover assets from this client base. Furthermore, the DOL Rollover Opinion indicates that advisors providing such fiduciary advice, even if inadvertently, will also be treated as subject to the restrictions described in the Rollover Opinion. However, consistent with the Rollover Opinion’s reliance on the Supreme Court decision of Varity v. Howe, many believed that an advisor engaged to provide plan-level fiduciary services, would not be acting as a fiduciary when acting in a wholly separate non-fiduciary capacity, such as selling personal rollover services unrelated to its status as a plan fiduciary. Unfortunately, the DOL guidance in this area was rather murky.
The DOL’s new fiduciary rule supersedes and replaces the DOL’s existing rollover guidance as articulated in Advisory Opinion 2005-23A. In contrast to this Rollover Opinion, under the DOL’s new and broader definition of fiduciary advice, any and all rollover recommendations would generally be viewed as fiduciary advice. In fact, a recommendation for a participant to take a rollover distribution would be viewed as fiduciary advice, even if the advisor does not include any actual investment recommendations along with the rollover recommendation. The resulting rollover advice would then automatically cause the advisor to become a plan or IRA fiduciary. Financial advisors who earn commissions will need to comply with the full-blown BIC requirements when soliciting rollovers. The BIC Exemption would provide relief if the commission-based advisor earns a higher level of compensation as a result of the rollover, and it would also provide relief for any commissions that are earned on rollover IRA assets.
As previously noted, fee-based advisors may also need relief under the BIC Exemption when offering rollover advice where there is no pre-existing relationship with the participant and plan or recommendations are directed to existing retirement clients to convert from commission-based to fee-based arrangements. The DOL has stated that when a level fee fiduciary recommends a rollover from an ERISA plan to an IRA, a rollover from another IRA, as well as a switch from a commissioned-based account to a fee-based account, in order to qualify for the BIC exemption, the fiduciary must document the reasons why the level fee arrangement was considered to be in the IRA owner’s best interest. In the case of rollover from an ERISA plan, this documentation includes:
- identifying the consequences of alternatives to the recommendation (such as leaving the money in the plan);
- any fees and expenses associated with the plan and the IRA, whether the employer pays for some or all of the plan’s administrative expenses;
- the different levels of services under the plan and the IRA; and
- different investments available under each option.
This analysis and documentation of the retirement investor’s individual needs and circumstances is similar to the requirements of FINRA Notice 13-45. Similarly, where a level fee arrangement is recommended as part of a rollover from another IRA or a switch from a commission-based account, consideration must be given to the services that will be provided for the fee.
Compliance with FINRA Notice 13-45
Advisors making recommendations to roll over plan assets to an IRA should also ensure that they conform with FINRA Notice 13-45 which means that the advice must be reasonably based on its suitability for the plan participant. This requires the advisor to consider the participant’s investment profile, including the participant’s: age;
- investments outside the plan;
- financial situation;
- tax status;
- investment goals and experience;
- investment time horizon;
- liquidity needs;
- risk tolerance; and
- any other information the participant may disclose.
The rollover decision should reflect how the plan from which assets would be distributed stacks up in comparison to the proposed IRA in terms of investment options, fees and expenses, and services (such as advice planning tools). Furthermore, differences with respect to potential withdrawal penalties, protection from creditors and the applicability of required minimum distributions need to be considered.