Mitigating the Material Conflict of Interest in Rollover Recommendations

In his latest blog post on the Labor Department’s fiduciary rule, Fred Reish takes on the proposed requirement to “mitigate” the conflict of interest inherent in a rollover recommendation.

This is the third installment in this particular series of posts; Reish has already discussed the provisions in the SEC’s proposed Regulation Best Interest (Reg BI) that would impose a best interest standard of care for rollover recommendations, and some of the considerations for developing a best interest recommendation process.

Reish begins by noting that since in most cases a broker-dealer and its representative would not receive any compensation if a participant does not roll over, there is, to use the SEC’s language, a “material conflict of interest involving financial incentives.” In that regard, Reish explains that Reg BI says that a broker-dealer must disclose and mitigate or, alternatively, eliminate the financial incentive conflict of interest.

Reish acknowledges that it’s impossible to eliminate the conflict since if the money stays in the plan, the broker-dealer will not earn anything, but if the money is rolled over, the broker-dealer will receive compensation from the rollover IRA. “As a result,” he writes, “the only practical choice would be to disclose and mitigate.” Though the SEC does not give an example of mitigation of the conflict in the context of a rollover recommendation, Reish explains that the SEC does cite FINRA Regulatory Notice (RN) 13-45 on several occasions.

RN 13-45 requires that a broker-dealer and its representatives make a reasonable inquiry about the participant’s plan account. That requires an analysis of, among other things, the investments, services and expenses in the plan – the same three primary factors listed by the DOL for consideration when making a fiduciary rollover recommendation, Reish notes. “In other words,” he writes, echoing a theme from prior blog posts, “proposed Reg BI (including the references to RN 13-45) and the Best Interest Contract Exemption are remarkably similar.”

The bottom line, Reish notes, is that the best “mitigation” appears to be a process that ensures that the recommendation is in the best interest of, and loyal to, the participant – which means that broker-dealers are in “essentially the same position as they were under BICE.” Specifically, a broker-dealer needs to “gather and evaluate appropriate information about the investments, services and expenses (among other things) in the plan; the investments, services and expenses (among other things) in the proposed IRA arrangement; and the needs, circumstances, risk tolerance, and preferences of the participant.”

Reish concludes by counseling that broker-dealers need to develop a process for doing that, together with policies and procedures, training and supervision – a process that he says should produce “a reasonable and informed recommendation in the best interest of the investor.”

As for RIAs, Reish notes that similar requirements are imposed – which will be the subject of a future post.

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