Many registered investment advisors (RIAs) breathed a sigh of relief after the Department of Labor (DOL) issued its fiduciary ruling. While the new rules certainly fall less heavily on RIAs, they are not off the hook for potential compliance problems, particularly when it comes to IRA rollovers.
I recently spoke at length with Jason Roberts, an attorney and founder of the Pension Resource Institute in Manhattan Beach, California, about several potential exposures.
Impartial conduct standards
When a client is changing jobs or retiring, a typical conversation about the client’s employer-sponsored retirement plan covers two distinct topics. The first is the distribution decision and the advisability of leaving the money in the plan. A natural part of that conversation likely involves the option to roll over the funds to an IRA that the advisor will manage. Assuming the money is rolled over, the second topic is how the client should invest the rollover funds.
In both instances, under the new rules the RIA needs to state that he or she is serving in a fiduciary capacity under ERISA. That’s not the end of the requirements, however, Roberts cautions. The advisor must adopt and “in fact comply with” the impartial conduct standards, which have three primary components.
First, the advice must be in the client’s best interest and not for the benefit of the financial institution (the RIA in this case). There is a potential problem here if the RIA’s compensation from the client goes from zero basis on the in-plan assets to 100 basis points (or other amount) after a recommended distribution and rollover. Receiving that difference—the “delta”—is a prohibited transaction, says Roberts.
The RIA needs to, among other things, document the basis for the determination that the advice was in the client’s best interest. Advisors aren’t required to share with clients the documents supporting their rationale—it’s a “books and records” requirement and it’s technical, Roberts explains. He gives an example: If the RIA is operating under the streamlined exemption, it’s not enough to analyze clients’ costs and benefits of remaining in their current plan. If they have changed jobs and can roll their balance to the new employer’s 401(k), the advisor must also consider the costs and benefits of the new plan in addition to the benefits and limitations of an IRA rollover. “Not only do you have to do that in an objective and complete manner but in performing that analysis, the DOL says we want you to factor in things specifically as to whether or not the employer of that current plan may be covering all or some of the administrative costs for the employees,” he points out.
Second, the RIA firm, the advisor and any affiliates cannot receive any more than reasonable compensation in connection with the recommended transaction or transactions. That is a departure from the Advisors Act, Roberts notes. Under the Advisors Act, the RIA would disclose fees and clients then would decide whether or not to do business with the advisor. The new rules put the affirmative obligation on the advisor to be prepared to defend his or her compensation as reasonable or risk losing the Best Interest [Contract] Exemption.
The third requirement is that the RIA must not make any materially misleading statements with respect to the advice, compensation received or conflicts of interest.