Best Interest Standard and Recommendations of Rollovers and Withdrawals

On June 15, SEC Chairman Clayton issued a statement partially entitled:  “Need for Increased Care when Recommending 401(k)/IRA Rollovers and Withdrawals . . .”. As that title suggests, the Chairman’s statement covers areas where the SEC will focus on recommendations when Reg BI applies on June 30. One of those areas of “increased care” is the recommendation of rollovers (and other withdrawals) from retirement plans.

The best interest standard for investment advisers became applicable last year. As a result, the Chairman’s statement already applies to rollover recommendations by investment advisers.

One part of the statement is entitled:  “Areas Where Increased Care May be Necessary When Making Recommendations to Main Street Investors“. In that part, the statement says:

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. In this regard, and without limiting areas where review may be necessary generally, 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. Recommendations to retail investors to roll-over or transfer assets from one type of account to another, or to take withdrawals from an account, should be approached with care. Firms should be particularly attuned to their regulatory obligations in light of the additional flexibility Congress recently provided investors to take withdrawals from certain accounts.

 The Coronavirus Aid, Relief and Economic Security (CARES) Act allows eligible participants in certain tax-advantaged retirement plans to take early distributions of up to $100,000 during this calendar year without being subject to early withdrawal penalties and with an expanded window for paying the income tax they owe on the amounts they withdraw. By waiving early withdrawal penalties and other limitations tied to retirement accounts, Congress provided investors with substantial flexibility to access these plans in order to weather financial hardships related to the pandemic. However, to use that relief effectively, investors must navigate certain rules and make significant spending and investment decisions.

 The SEC’s Office of Investor Education and Advocacy noted in a recent investor alert that some promoters are recommending that investors take CARES Act withdrawals or otherwise roll-over retirement funds to invest in products they are soliciting. Firms should recognize that these recommendations are subject to Reg BI and ensure that their policies and procedures meet the requirements of Reg BI, the Advisers Act and Form CRS, as appropriate.

Observations:  I have three observations about this part of the Chairman’s statement.

First, and to quote from the statement: “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.” If there is any doubt about the SEC’s expectations for the care required in making rollover recommendations, this statement should make it clear that, under Reg BI, those expectations are heightened.

Second, Reg BI describes, in some detail, the process that the SEC expects broker-dealers (and, by analogy, investment advisers) will use in developing rollover recommendations. Broker-dealers and investment advisers should study the SEC’s rollover discussion in Reg BI and develop compliant processes for making rollover recommendations.

Third, the statement specifically mentions the CRDs (coronavirus related distributions) in the CARES Act. That suggests that the SEC has received reports of questionable activity related to those types of distributions and will be looking at them more closely.

Reading between the lines, I think that the Chairman is saying “forewarned is forearmed” . . . the SEC will be looking at these recommendations and distributions.

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.