November 30, 2020

Volume X, Number 335

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Applicability of Regulation Best Interest to Retirement Plans

The SEC’s Regulation Best Interest (Reg BI) applies to recommendations by a broker-dealer to “retail customers.” As the term suggests, a retail customer is a “natural person” (or the legal representative of a natural person) who uses the recommendation “primarily for personal, family, or household purposes.” This means that advice given to legal entities and advice related to investing the assets of a business are not covered by the regulation. But what about recommendations provided to retirement plans?

This is a simple question, but the answer is a bit complicated. There are really three answers:

  • Retirement plans aren’t retail customers. The SEC states that “workplace retirement plans are not generally covered by the definition of retail customer.” (See footnote 254 in the Adopting Release of Reg BI.) It also says in the preamble that “institutions and certain professional fiduciaries are not covered for purposes of Regulation Best Interest.” So, for example, advice to sponsors and fiduciaries of 401(k) plans about their investment lineups would not be covered by Reg BI (though it could be fiduciary advice under ERISA).

  • The SEC says that plans “generally” are not covered. Does this mean that sometimes they are covered? Yes. A sole proprietorship or a self-employed individual’s retirement plan is considered a retail customer, because effectively the advice is given to the sole proprietor or to the self-employed individual or his or her legal representative. (See footnote 62 in the preamble.) But what about the “personal, family or household purpose” part of the definition? The SEC answers unequivocally that “retirement savings is a personal, household or family purpose.”

  • Participants in plans are retail customers for purposes of Reg. BI. In the Adopting Release of Reg BI, the SEC says:

    “…the definition of retail customer will include a natural person receiving recommendations for his or her own retirement account, including but not limited to IRAs and individual accounts in workplace retirement plans, such as 401(k) plans and other tax-favored retirement plans.

    In other words, if a broker-dealer makes covered recommendations to a participant in a 401(k) plan or to an IRA owner, the recommendation is being made to a retail customer (and is subject to the Reg BI best interest standards). In a footnote, the SEC adds a host of other similar types of accounts (beyond just 401(k)s and IRAs) (see footnote 254 of the Adopting Release): individual retirement annuities, SEPs, SIMPLE IRAs, 457 plans, 403(b) plans, Archer Medical Savings Accounts, Health Savings Accounts, Coverdell education savings accounts and 529 plans. If a broker is giving covered advice for any of these accounts, it is treated as advice to a retail customer and is thus subject to the Reg. BI requirements.

To summarize: Recommendations to plan fiduciaries and sponsors are not covered by Reg BI (unless they are sole proprietor plans), but the participants in those plans are.

That leaves us with the question of what kinds of recommendations to participants are subject to Reg BI. Recommendations about how to invest their retirement accounts are clearly covered. But the SEC emphasizes that rollover recommendations also are subject to Reg BI’s standards. The SEC states that it intends for:

“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…”

In other words, Reg. BI and its requirements fully apply to recommendations to a participant to take a distribution from his 401(k) account, whether or not it is rolled over to an IRA; and Reg. BI applies to the recommendation to roll the account over to an IRA. On the other hand, the SEC does clarify that “a general conversation about retirement planning, such as providing a company’s retirement plan options to a retail customer, would not by itself rise to the level of a recommendation.”

None of this should be a big surprise to broker-dealers and their representatives, but it is important to make sure that the requirements for acting in the best interest of the customer, providing adequate disclosures and the Form CRS, mitigating advisor incentives, and maintaining policies, procedures and records are followed when working with plan participants and IRA holders. This is especially true for recommendations to take assets out of a plan and transfer them to another account.

© 2020 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume X, Number 300
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TRENDING LEGAL ANALYSIS

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About this Author

Fred Reish, Drinker Biddle Law Firm, Los Angeles, Labor and Employment Law Attorney
Partner

Fred Reish represents clients in fiduciary issues, prohibited transactions, tax-qualification and Department of Labor, Securities and Exchange Commission and FINRA examinations of retirement plans and IRA issues.

Fred works with both private and public sector entities and their plans and fiduciaries and represents plans, employers and fiduciaries before federal agencies such as the DOL and IRS. He consults with banks, trust companies, insurance companies and mutual fund management companies on 401(k) recordkeeping services, investment products and...

(310) 203-4047
Bruce Ashton, Drinker Biddle Law Firm, Los Angeles, Employment Benefits Attorney
Partner

Bruce L. Ashton has more than 35 years of experience handling employee benefits matters. His practice concentrates on representing plan service providers (including RIAs, independent record-keepers, third-party administrators, broker-dealers and insurance companies) in fulfilling their obligations under ERISA. His experience includes representing public and private sector plans and their sponsors, negotiating the resolution of plan qualification issues under IRS remedial correction programs, advising and defending fiduciaries on their obligations and...

310-203-4048
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