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One of the major targets of the new DOL 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[1], 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.

As previously noted, there is generally a financial incentive for advisors to recommend a rollover to an IRA. To meet FINRA requirements, advisors must not let this conflicting interest impair their judgment of what is in a plan participant’s best interest. Firms that employ advisors must have written supervisory procedures designed to ensure that marketing of IRA accounts meet these requirements. Among other things, this will require training of representatives regarding the implications of the rollover decision.

Managed Accounts

Under the new DOL rule, when a registered investment advisor (“RIA”) with an existing plan client offers rollover advice to the plan’s participants, it would be customary for the RIA to earn a higher rate of compensation from the rollovers. For example, a RIA may earn 50 basis points for advising a plan but may earn 100 basis points from rollover IRA assets. Under the DOL’s final rule, the RIA would need the BIC Exemption in order to earn a higher rate of compensation for providing rollover advice. Fortunately, the Streamlined BIC would be available to the RIAs in their capacity as level-fee fiduciaries. As previously discussed, the Streamlined BIC could also be used when RIAs offer rollover advice to “off the street” participants.

RIAs may also need to comply with the BIC Exemption when it comes to retail managed account programs. If a program sponsor or advisor earns any kind of variable compensation from its IRA or plan clients under its managed account program, it would need BIC relief. In addition, solicitors who refer IRA or plan clients to a managed account program would be viewed as fiduciary advisors earning a referral fee under the final fiduciary advice rule. Referral fees would generally be viewed as variable compensation that is tied to the referral, so solicitors would also need to comply with the BIC Exemption once the new rule goes into effect on April 10, 2017.

Managed account programs are tricky in that there are so many moving parts. For example, many programs have multiple investment managers that are accessible to program clients. Because the DOL’s fiduciary rule is so broad, an advisor’s recommendation to a client to select a particular investment manager would be viewed as fiduciary advice relating to the “management” of the client’s investment account. In many advisory programs, variable compensation may arise to the extent that the advisor can increase its net compensation by recommending a cheaper investment manager. If the gross fee for managed account services is 100 bps and an investment manager charges 30 bps for its services and there are 20 bps for other costs, the net compensation for the firm would be 50 bps. However, the firm could potentially increase its net compensation by recommending a cheaper investment manager that charges, let’s say, only 15 bps rather than 30 bps.

Obviously, if model providers charge different amounts for their services, the firm sponsoring the managed account program may have variable compensation issues. Other potential sources of variable compensation include revenue sharing payments, as well as commissions and ticket charges in the case of non-wrap fee advisory programs.

If a managed account program has variable compensation issues, the program sponsor and advisor could always rely on the DOL’s BIC Exemption. The BIC Exemption would give fiduciary advisors, including the program sponsor, the ability to earn variable compensation when providing advice through managed account programs. However, a big weakness of the BIC Exemption is that it does not provide relief for variable compensation arising from discretionary advice. The BIC Exemption only covers providers of non-discretionary advice, and the problem is that many managed account programs involve the delivery of discretionary investment advice.

If the BIC Exemption is not available, a managed account program may need to be modified so that there is fee levelization for the participating fiduciary advisors. In fact, firms may wish to explore using a combination of the BIC Exemption and fee levelization as a compliance strategy for their managed account programs. For example, the BIC Exemption may be utilized for programs that feature non-discretionary advice, and fee levelization may be used for programs that feature discretionary advice. For fee levelization purposes, revenue sharing payments from third party firms could be restructured so that they are based on factors that are not related to sales, such as the level of access that the third party firm will have to the program sponsor’s individual advisor

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(Excerpted from her new book, The Advisor’s Guide to the DOL Fiduciary Rule, published by The National Underwriter Company.)