Background

The DOL’s prohibited transaction exemption (PTE) 2020-02 (Improving Investment Advice for Workers & Retirees), allows investment advisers, broker-dealers, banks, and insurance companies (“financial institu­tions”), and their representatives (“investment professionals”), to receive conflicted compensation resulting from non-discretionary fiduciary investment advice to ERISA retirement plans, participants (including rollover recommendations), and IRA owners (all of whom are referred to as “retirement investors”). In addition, in the preamble to the PTE the DOL announced an expanded definition of fiduciary advice, meaning that many more financial institutions and investment professionals are fiduciaries for their recommendations to retirement investors and, therefore, will need the protection provided by the exemption.

Under these standards, a rollover recommendation will ordinarily be nondiscretionary fiduciary advice and result in a financial conflict of interest that is a prohibited transaction under both ERISA and the Internal Revenue Code. But, since the recommendation is nondiscretionary, PTE 2020-02 will provide relief, but only if all of its conditions are met.

However, ERISA’s fiduciary definition and prudent man rule do not apply to government plans, such as government 401(a) plans (often pension plans), 403(b)s (e.g., public schools and universities), and 457(b) plans. While the Internal Revenue Code applies to government qualified plans, there is a special exemption from the usual prohibited transaction rules and, as a result, the exemption in PTE 2020-02 is not needed.

But, that is not the end of the story. Both Regulation Best Interest (Reg BI) for broker-dealers and the Interpretation Regarding Standard of Conduct for Investment Advisers (Adviser Interpretation) say that a rollover recommendation is subject to the SEC’s best interest standard of care. In addition, the recent SEC Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors (Staff Bulletin) explains the Staff’s view that the Reg BI best interest standard and the Adviser Interpretation best interest standard apply in much the same way:

Both Regulation Best Interest (“Reg BI”) for broker-dealers and the fiduciary standard for investment advisers under the Investment Advisers Act (the “IA fiduciary standard”) are drawn from key fiduciary principles that include an obligation to act in the retail investor’s best interest and not to place their own interests ahead of the investor’s interest. Although the specific application of Reg BI and the IA fiduciary standard may differ in some respects and be triggered at different times, in the staff’s view, they generally yield substantially similar results in terms of the ultimate responsibilities owed to retail investors.

In other words, the rollover guidance from the SEC in Reg BI and the Adviser Interpretation, and the guidance in the Staff Bulletin, should be viewed as applied more or less the same to broker-dealers and investment advisers.

The Staff Bulletin applies, as the title suggests, to account type recommendations. And the SEC views rollover recommendations as account type recommendations (e.g., see the Adopting Release to Reg BI). While this relatively short blog article can’t cover all of the key points of the Staff Bulletin, let’s look at one section that applies specifically to rollover recommendations to “retail investors”, which includes participants in retirement plans. (Footnotes are omitted.)

4. Retirement Account Rollover Recommendations
   1. Are there additional factors that I should consider when making a rollover recommendation in order to have a reasonable basis to believe the recommendation is in the retail investor’s best interest?

Yes. When making a rollover recommendation to a retail investor, you must have a reasonable basis to believe both that the rollover itself and that the account being recommended are in the retail investor’s best interest. In addition to the factors discussed above, the staff believes that there are specific factors potentially relevant to rollovers that you should generally consider when making a rollover recommendation to a retail investor. These factors include, without limitation, costs; level of services available; features of the existing account, including costs; available investment options; ability to take penalty-free withdrawals; application of required minimum distributions; protection from creditors and legal judgments; and holdings of employer stock.

Comment: As this suggests with the reference to “In addition to the factors discussed above”, the list of factors in this Part 4 is only partial. To fully understand the SEC staff’s thinking, the Staff Bulletin needs to be read in its entirety. The enumerated factors are not new. There is similar language in FINRA Regulatory Notice 13-45, Reb BI and DOL guidance. Just to comment on two factors that are viewed as very important by all of those regulators, any evaluation of a rollover should consider the costs in the current account (that is, the plan account) and other potential accounts (e.g., a rollover IRA) and the value to the particular retail investor of the services in the current account and in any potential accounts (e.g., in the 401(k) account and in the IRA “account”). In the Adopting Release to Reg BI, the SEC made clear that a generic reason that doesn’t provide value to a particular retail investor would not be sufficient to justify a rollover recommendation for example, the existence of a much larger number of investments in the IRA, but the additional investments aren’t needed by the retirement investor and/or aren’t used in the rollover IRA). But, where services are provided in a rollover IRA and those services are needed by, and valuable to, the retail investor, those services could justify a rollover recommendation.

As with account recommendations more generally, relevant factors should be considered in light of, among other things, the retail investor’s investment profile to develop a reasonable belief that the retirement account or rollover recommendation is in the retail investor’s best interest. In the staff’s view, when making a rollover recommendation, it may be difficult for a firm to assess periodically the adequacy and effectiveness of its policies and procedures or to demonstrate compliance with its obligations to retail investors without documenting the basis for the recommendation.

Comment: While PTE 2020-02 requires (beginning July 1, 2022) that participants be given, in writing, the “specific reasons” why a rollover recommendation is in their best interest, the SEC does not have a similar requirement. However, I think that a reasonable expectation is that SEC examiners will ask for the documentation.

In addition to Reg BI and the IA fiduciary standard, some rollovers also are subject to regulation by the Department of Labor. If you are relying on Prohibited Transaction Exemption 2020-02 (“PTE 2020-02”), you may want to review guidance from the Department of Labor on factors to consider in making a rollover recommendation, as well as relevant documentation requirements.

Comment: Another difference between the DOL and SEC positions is that the DOL’s fiduciary interpretation will not necessarily capture all rollover recommendations (e.g., if there isn’t ongoing financial advice to the rollover IRA), but the SEC’s guidance does cover all rollover recommendations by broker-dealers and investment advisers. That may be a legal distinction without a practical difference, though, since most broker-dealers and investment advisers may treat all rollover recommendations as fiduciary advice.

2. When considering a rollover recommendation, do I have to consider the option of leaving the retail investor’s investments in the employer’s plan?

As discussed above, you must have a reasonable basis to believe that an account recommendation is in the retail investor’s best interest and does not place your or your firm’s interests ahead of the retail investor’s interest. In the staff’s view, it would be difficult to form a reasonable basis to believe that a rollover recommendation is in the retail investor’s best interest and does not place your or your firm’s interests ahead of the retail investor’s interest, if you do not consider the alternative of leaving the retail investor’s investments in their employer’s plan, where that is an option. To evaluate any recommendation to transfer assets out of an employer’s plan, or between individual retirement accounts, you would need to obtain information about the existing plan, including the costs associated with the options available in the investor’s current plan.

Comment: As with the DOL’s guidance, the SEC staff is taking the position that all of the participant/retail investor’s options have to be considered. There are usually four options: leave the money in the current plan, roll it to the plan of a new employer, rollover to an IRA, or take a taxable distribution. As with the DOL, the SEC staff is also saying that broker-dealers and investment advisers must obtain information about the existing plan “including the costs associated with the options available in the investor’s current plan”. Finally, and also similar to the DOL, the SEC staff includes recommendations about the transfers of IRAs.

Concluding Thoughts

While the DOL’s fiduciary rule and the Code’s fiduciary prohibited transactions do not apply to government plans, rollover recommendations are regulated in similar manners by the SEC. Broker-dealers and investment advisers should consider either (i) using their PTE 2020-02 rollover processes and documentation for rollover recommendations to participants in government plans or (ii) adapting, but modifying as appropriate, the 2020-02 forms and processes for that purpose.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.