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Documenting Rollover Recommendations: The DOL and SEC Requirements

The Department of Labor (DOL) and the Securities and Exchange Commission (SEC) are focusing on rollover recommendations and their impact on plan participants. The DOL has historically taken the position that a recommendation by a fiduciary advisor is subject to the ERISA prudent man rule and the duty of loyalty (known in combination as a best interest standard), and has recently expanded the definition of who is a fiduciary advisor. The SEC says that rollover recommendations by investment advisers and broker-dealers are subject to its best interest requirements. This article discusses the recent DOL guidance and the SEC’s Regulation Best Interest (Reg BI).

In both documents, the DOL and the SEC have expressed opinions about documentation for those recommendations. The DOL makes documentation an explicit requirement of its proposed prohibited transaction exemption for fiduciary investment advice. The SEC encourages documentation in the preamble to Reg BI. Neither mandates the information that needs to be reviewed and documented, but both provide lists of relevant data in the preambles to their guidance. In this post, we discuss the requirement and provide a chart of the information that should be considered.

The DOL Requirement

The DOL’s proposed fiduciary advice prohibited transaction exemption has an explicit documentation requirement for rollover recommendations. The proposed exemption requires that:

The Financial Institution [for example, broker-dealer or RIA] documents the specific reasons that any recommendation to roll over assets from a Plan to another Plan or IRA…, from an IRA … to a Plan, from an IRA to another IRA, or from one type of account to another (e.g., from a commission-based account to a fee-based account) is in the Best Interest of the Retirement Investor. (Section II(c)(3))

While the factors to be documented are not addressed in the proposed exemption, the DOL discusses the issue in the preamble. It states that

The requirement is designed to ensure that Investment Professionals take the time to form a prudent recommendation, and that a record is available for later review(Emphasis added.)

The DOL then lists factors that should be considered, as reflected in the chart provided later in this post. The DOL also discusses the efforts a fiduciary advisor should expend to obtain the necessary information:

In evaluating a potential rollover from an ERISA-covered Plan, the Investment Professional and Financial Institution should make diligent and prudent efforts to obtain information about the existing Plan and the participant’s interests in it.

Finally, the DOL addresses what happens if the information cannot be obtained, as shown in the chart.

The SEC Requirement

In the preamble to Reg BI, which applies to broker-dealers, the SEC says the following (in text preceding footnote 415):

…the decision to roll over a 401(k) into an IRA may be one of the most significant financial decisions a retail investor could make.  Thus, a broker-dealer should discuss the basis of such recommendations with the retail customer.   Similarly, we encourage broker-dealers to record the basis for their recommendations, especially for more complex, risky or expensive products and significant investment decisions, such as rollovers and choice of accounts, as a potential way a broker-dealer could demonstrate compliance with the Care Obligation. (Emphasis added.)

Unlike the DOL, the SEC merely “encourages” broker-dealers to maintain records of the basis for a rollover recommendation rather than requiring it. The purpose of such records, the SEC says, is so that the broker-dealer can show later on, presumably during an examination, that it was acting in the customer’s best interest in making the recommendation.

In the adopting release for Reg BI, the SEC lists various factors that a broker-dealer should consider. These factors are listed in the chart below.

While Reg BI has a detailed discussion of the need to keep records for rollover recommendations, the SEC’s Interpretation Regarding the Standard of Conduct for Investment Advisers (the RIA Interpretation) does not address the need to develop and maintain documentation. That said, it is important to note that RIAs are held to a fiduciary standard that is at least arguably higher than the broker-dealer best interest standard. In light of this, it is a fair assumption that the SEC would not hold RIAs to a lower standard than that expected of broker-dealers. That view is bolstered by a public statement issued by SEC Chairman Clayton in June 2020, where he said:

In meeting their respective obligations under Reg BI and the Advisers Act, broker-dealers and investment advisers should review their operations to be sure they are making recommendations or providing investment advice to retail investors that is in those investors’ best interest….I believe firms should ensure that, particularly under current conditions, focus is being applied in the following areas, to the extent they are included in a firm’s recommendation or advice to a retail investor:

Rollovers and withdrawals from 401(k) and other plans. Reg BI’s application to recommendations of rollovers of and withdrawals from retirement accounts is one of its most significant enhancements over the status quo.

Chairman Clayton is in essence applying the same standards and, presumably, the same regulatory requirements to both broker-dealers and RIAs and highlights this similarity in the context of rollovers. As a result, it would be prudent for RIAs to gather and evaluate the same information that the SEC describes (below) for broker-dealers, and to maintain that information, as well as the reasons for recommending a rollover.

Information to Consider

DOL List

SEC List

Whether to roll over

 

The Financial Institution should consider

the Retirement Investor’s alternatives to a rollover, e.g., leaving the money in the current employer’s Plan, if permitted, and selecting different investment options

Whether to roll over

 

Broker-dealers should

  • consider whether to make a recommendation to open an IRA, or to roll over workplace retirement plan assets into an IRA versus

  • keeping assets in a previous employer’s workplace retirement plan or rolling over assets to a new employer’s workplace retirement plan, and

  • consider a variety of factors, the importance of which will depend on the particular retail customer’s needs and circumstances

  • in order to compare the retail customer’s existing account to the IRA offered by the broker-dealer.

Factors for rollover from plan to IRA

 

  • the fees and expenses associated with both the Plan and the IRA

  • whether the employer pays for some or all of the Plan’s administrative expenses

  • the different levels of services and investments available under the Plan and the IRA.

Factors for rollover or account change

 

  • suitability information plus

  • additional factors specifically salient to IRAs and workplace retirement plans, in order to compare the retail customer’s existing account to the IRA, which “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

    • any special features of the existing account.

Rollover from another IRA or change from a commission-based account to a fee-based arrangement:

 

  • the services that would be provided under the new arrangement.

Not addressed

 

 

However, under Reg BI and the RIA interpretation, the consideration of cost is an essential element of developing a recommendation.

If the Retirement Investor is unwilling to provide the information or information is not otherwise available, Investment Professional must provide:

 

  • a full explanation to the Retirement Investor of the significance of the information

  • an explanation of the assumptions used and their limitations to the Retirement Investor

  • a reasonable estimation based on publicly available information of

    • expenses

    • asset values

    • risk and returns

Not addressed

 

 

While the SEC has not addressed this issue, we believe that it is likely that it would adopt the DOL’s analysis, considering the DOL’s experience and expertise in this area.

Conclusion

When financial professionals make rollover recommendations, whether from a plan to an IRA or from one IRA to another, they and their firms should maintain records of the factors reviewed and evaluated in making the recommendation. The DOL mandates documentation; the SEC suggests it for broker-dealers (and, as a result, it could be viewed as a good risk mitigation practice for RIAs). While neither the DOL nor the SEC specify the information that must be considered, both have provided examples of important factors. For the most part, the lists are very similar. As a result, broker-dealers and RIAs should consider reviewing both the SEC and DOL lists of factors and developing a checklist of factors to be used in the process of evaluating the rollover alternative that is in the best interest of a participant.

© 2020 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume X, Number 324
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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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