In June 2019, the SEC finalized its “best interest” rulemaking package, including:
- Regulation Best Interest: The Broker-Dealer Standard of Conduct (“Reg BI”), governing recommendations to retail customers by broker-dealers;
- Interpretation Regarding Standard of Conduct for Investment Advisers (“RIA Interpretation”); and
- Form CRS Relationship Summary; Amendments to Form ADV (“Form CRS”).
Compliance with Reg BI and the Form CRS requirement is mandatory as of June 30, 2020. The RIA Interpretation, on the other hand, simply reflects and clarifies the SEC’s view on the duties that RIAs owe their clients as fiduciaries under the Advisers Act – and thus is “effective” already.
It is no surprise that rollovers are a point of emphasis in the final rules – this was also true of the proposed rulemaking. The final rules apply to rollovers from all “workplace retirement plans,” including both 401(k) and other ERISA-covered plans, and non-ERISA plans such as governmental 403(b), 457(b) and pension plans.
What Hasn’t Changed?
To avoid repetition, we assume that readers have at least browsed our Spring 2019 article, which addressed rollovers in the context of the proposed SEC rulemaking, and we pick up from there.
First, as anticipated, the final rules embrace certain existing aspects of SEC and FINRA guidance, as well as the vacated DOL fiduciary regulation. For rollovers from 401(k), 403(b) and other participant-directed plans, the rules indicate that advisors must make a reasonable determination that a plan-to-IRA rollover would be in the best interest of the customer. (For ease of reading, we use “advisors” to include both investment advisers and broker-dealers. As that suggests, in our view, the requirements for rollover recommendations are the same under both Reg BI and the RIA Interpretation.) In that regard, advisors should take into account both:
- certain factors summarized in our previous articles, which, according to Reg BI’s release for the final regulation, “should generally include, among other relevant factors: fees and expenses; level of service available; available investment options; ability to take penalty-free withdrawals; application of required minimum distributions; protection from creditors and legal judgments; holdings of employer stock; and any special features of the existing account,” and
- the customer’s profile, including at least his or her “age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, (and) risk tolerance.”
This determination must be reasonably comprehensive and tailored to the participant. It is not merely a matter of counting the factors that would favor an IRA against those that would favor leaving the customer’s savings in the employer’s plan, as the SEC observes that “certain factors may have more or less relevance, or not be relevant at all,” from case-to-case. And certainly, it is not sufficient to assume that an IRA is a superior choice across-the-board owing to one or two boilerplate differences. For example, Reg BI’s release warns that: “…we caution broker-dealers not to rely on, for example, an IRA having ‘more investment options’ as the basis for recommending a rollover.”
Similarly, the SEC’s final rules likewise confirm that for broker-dealers and investment advisers alike:
- rollover recommendations involve material conflicts of interest which must be disclosed to retail investors; and
- copies of Forms CRS must be furnished to investors when (or before) a recommendation is made to roll assets from a workplace retirement plan into an IRA, and regardless of whether the rollover IRA would be a new account, or merely an addition to an existing IRA.
Finally, while there is greater discussion of the process for rollover recommendations in Reg BI than in the RIA Interpretation, in our view there is no meaningful difference in the standards for broker-dealers and investment advisers. We discuss why we believe this is true in our previous articles, and nothing in the final rules would cause us to revisit that conclusion.
What Has Changed?
First, unlike the proposed rules, the SEC’s final rules make it clear that recommendations of “account types” are subject to the best interest requirement. The Reg BI release explains that:
“We are modifying Regulation Best Interest to expressly apply to account recommendations including, among others, recommendations to roll over or transfer assets in a workplace retirement plan account to an IRA…and recommendations to take a plan distribution for the purpose of opening a securities account.” (Emphasis added)
This expanded scope raises some subtle but important distinctions. In particular, FINRA Regulatory Notice 13-45, which interprets FINRA’s existing suitability standard in the context of rollovers, states that:
“A recommendation concerning the type of retirement account in which a customer should hold his retirement investments typically involves a recommended securities transaction, and thus is subject to Rule 2111. For example, a firm may recommend that an investor sell his plan assets and roll over the cash proceeds into an IRA. Recommendations to sell securities in the plan or to purchase securities for a newly opened IRA are subject to Rule 2111.” (Emphasis added)
Under Reg BI, the SEC explains the difference as follows:
“…FINRA’s suitability standard applies to recommendations of rollover decisions that involve securities transactions, but not necessarily in the absence of a securities transaction…Regulation Best Interest explicitly applies to account recommendations as an “investment strategy involving securities,” including recommendations of securities account types, as well as rollovers or transfers of assets from one account to another.” (Emphasis added.)
In short, it’s clear that all rollover recommendations by broker-dealers will be subject to Reg BI’s best interest requirement regardless of whether or not they involve securities transactions. And, since all advice by investment advisers is subject to their best interest standard, all rollover recommendations by investment advisers and broker-dealers are subject to the standard.
Second, the SEC’s final rules state explicitly that costs must always be considered – in addition to potential risks and rewards – when making any recommendation to a retail customer. Since rollover IRAs are usually more expensive than plan accounts, the additional cost must be justified by additional benefit(s) for the participant based on the participant’s needs and objectives.
What Should Advisors and Firms Be Doing Now?
So what does all this mean in a practical sense?
Broker-dealers are required to be in compliance with Reg BI by June 30, 2020. And the RIA Interpretation reflects the SEC’s already-existing views of RIA responsibilities under the Advisers Act – in other words, it’s applicable now.
Many firms have already established protocols for collecting and analyzing plan (and IRA) information, and documenting their “best interest” determinations for rollovers in preparation for the DOL’s vacated fiduciary rule and Best Interest Contract Exemption (BICE). And advisors who are fiduciaries to ERISA plans are likely to be using that process in practice, to ensure compliance with the DOL/IRS temporary enforcement policy outlined in Field Assistance Bulletin (FAB) 2018-02 (discussed in our previous articles).
Since the considerations under the DOL and SEC rules largely overlap, these practices should, at very least, provide a starting point. Furthermore, since the SEC rulemaking does not differentiate between rollovers from ERISA plans and non-ERISA plans (only ERISA plans are within the DOL’s enforcement jurisdiction), these practices now need to be expanded to rollovers from governmental 403(b), 457(b) and other ERISA-exempt plans.
One word of caution: Unlike the former DOL rule, the SEC rulemaking does not specifically address whether an advisor can rely on benchmarks or similar data (e.g., as to plan expenses, types of investments, etc.) in cases where plan-specific information is not available. It’s not clear at this time whether the SEC considers this a permissible practice.
Likewise, because the SEC rules cover rollover recommendations from defined benefit plans and non-participant directed defined contribution plans, practices may need to be updated for those types of rollover recommendations.
For example, relevant factors for a DB plan include:
- the additional risk of withdrawing the benefits from the plan, particularly if the benefits are insured by the Pension Benefit Guaranty Corporation;
- whether or not the investor would benefit from the guaranteed income the plan offers; and
- any reductions/adjustments of the plan benefit where it is withdrawn in a lump sum prior to the individual’s normal retirement age.
However, the appropriate “best interest” factors to be considered for rollover recommendations from DB plans and non-participant-directed DC plans has not been developed in the law. As a result, firms and advisors will need to thoughtfully establish criteria for the factors to be considered in developing such recommendations.
Finally, the SEC does not require a “best interest” determination for rollovers that are not recommended by the advisor. It is permissible to provide individual clients with full, fair, and balanced educational materials on the considerations for rolling over, leaving their money in the plan or transferring the account to the plan of a new employer. Firms and advisors may wish to develop, or improve, existing materials to document these situations – in particular where it may be difficult for an advisor to make the “best interest” finding, including where plan information is missing or the plan isn’t participant-directed.
Joshua J. Waldbeser and Fred Reish are Partners in the law firm Drinker Biddle. This article originally appeared in the Winter issue of NAPA Net the Magazine.
