The standard of care for rollover recommendations has been top of mind for broker-dealers beginning with the issuance of the Department of Labor’s (DOL’s) now vacated fiduciary rule, and more recently with the SEC’s Regulation Best Interest (Reg BI), raising the question of the extent to which the SEC standard of care for rollover recommendations differs from the DOL’s.
The standards appear to be essentially the same – a requirement to act in the customer’s best interest (keeping in mind that Reg BI will not be applicable until June 30, 2020, while the DOL rules are applicable now). However, there are two major differences:
- First, the DOL standard applies to rollover recommendations made only if the firm is a fiduciary to the plan or to the participant. However, the Reg BI standard applies to all rollover recommendations made to a retail customer, regardless of whether the firm is a fiduciary to the plan – plus Reg BI applies to recommendations to participants in non-ERISA plans.
- Second, the SEC and the DOL take different approaches to conflicts of interest. The SEC requires the delivery of a Form CRS, which discloses the firm’s services, fees and conflicts to customers, and mitigation of material conflicts (e.g., where a conflict creates an incentive for an advisor to place his/her or the firm’s interests ahead of the customer’s). In contrast, under the DOL rules, disclosure is not sufficient – the DOL strictly prohibits conflict of interest transactions under its prohibited transaction rules unless an exemption is available.
The Reg BI standard of care applies to recommendations made to a retail customer – such as an individual or plan participant – related to a securities transaction or an investment strategy involving securities; it includes account recommendations. This means that in the rollover context, the Reg BI standard of care applies to advice about whether a participant should roll over plan assets, the account type into which the assets should be rolled and how the assets should be invested. As stated by the SEC, the Reg BI standard of care obligation requires that a broker-dealer have a reasonable basis to believe that taking the assets out of the plan and rolling them over to an IRA is in the best interest of the participant at the time of the recommendation.
The DOL’s standard of conduct only applies if the firm is already an ERISA fiduciary to the plan. (See our blog post Recommending Rollovers in the Evolving Regulatory Environment (Part 1.) An advisor who is not already a fiduciary who recommends a rollover is not considered to be giving fiduciary advice – but this could change if the DOL issues a new fiduciary regulation. If the broker-dealer and/or the advisor are ERISA fiduciaries, the rollover recommendation is a fiduciary act subject to ERISA’s duty of loyalty and prudent man standard of care. And, if it causes the firm to receive additional compensation that it would not have received absent the recommendation (i.e., the IRA advisory fee), the firm may be committing a prohibited transaction.
Although there is no prohibited transaction exemption for this transaction (the Best Interest Contract Exemption, which would have provided relief, was also thrown out by the Fifth Circuit), the DOL has issued a temporary non-enforcement policy. (For more about that policy, review our post The DOL’s Temporary Enforcement Policy: Potential Traps for the Unwary.) Note, however, that the non-enforcement policy does not protect against private rights of action by plans or participants against firms. The good news is we believe the DOL is likely to issue an exemption to replace the non-enforcement policy.
Both ERISA’s prudent man standard and the Reg BI standard require a similar process for rollover advice. Both require that the firm evaluate the participant’s options – leave the money in the plan, take a distribution or roll it over to an IRA (or a new employer’s plan if the participant is changing jobs). The firm must determine which option is in the participant’s best interest, taking into account relevant factors.
This means the firm should develop a process for obtaining sufficient information about the existing plan, the proposed IRA and the participant in order to determine whether a rollover recommendation aligns with the participant’s needs and is in his/her best interest. The advisor should consider asking questions, such as:
- How do the investments in the existing plan and those available in the proposed IRA compare in terms of their quantitative (including costs) and qualitative characteristics?
- Does the existing plan offer participant-level investment services, educational and planning tools, a managed account solution and/or a self-directed brokerage feature?
- What are the fees and expenses charged to the participant under the plan and the proposed IRA, and does the employer pay for some or all of the plan expenses?
- What are the potential impacts of the minimum distribution requirements and asset protection rules?
- Does the plan provide for periodic distributions?
Most of this information should be available on the participant’s disclosure statement (the 404a-5 disclosure) and quarterly statements. The advisor also must consider all types of accounts – both brokerage and advisory – in making a best interest determination.
There is a convergence of the standards of care applicable to rollover recommendations as applied by the DOL and the SEC. At a minimum, the best interest process needed to satisfy these standards should include (1) a comparison of the investments, services and fees in the plan and the IRA; (2) information about the investor’s financial circumstances, needs and preferences (an “investor profile”); and (3) a recommendation that aligns with the investor’s profile. Once this process is undertaken, the firm may find there are circumstances when an advisor has to recommend that the participant leave the money in the plan.
Note: We recently updated the State Fiduciary Duty and Best Interest Developments chart to reflect the finalization of the Massachusetts Advisor Fee Table.