Best Interest Standard of Care for Advisors #69: Compliance with PTE 2020-02: Factors to Evaluate for an IRA-to-IRA Rollover Recommendation (Part 5)

The Department of Labor’s “Fiduciary Rule,” PTE 2020-02: The FAQs

This series focuses on the DOL’s new fiduciary “rule”, which was effective on February 16. This, and the next several, articles look at the Frequently Asked Questions (FAQs) issued by the DOL to explain the fiduciary definition and the exemption for conflicts of interest.

Key Takeaways

  • The DOL FAQs generally explain PTE 2020-02 and the expanded definition of fiduciary advice.
  • In FAQ 15, the DOL discusses the factors to be considered for a “rollover” recommendation. While most of the articles in this Best Interest series have focused on plan-to-IRA rollovers, the DOL’s definition of “rollover” includes a transfer—or rollover—from an IRA to another IRA. This article discusses IRA-to-IRA “rollover” recommendations.
  • The requirement that a rollover recommendation satisfy the best interest standard of care has applied since February 16 because the DOL non-enforcement policy delays the application of the conditions of PTE 2020-02, but does not delay the fiduciary definition.

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 retirement plans, participants and IRA owners (“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 will be fiduciaries for their recommendations to retirement investors and, therefore, will need the protection provided by the exemption.

In PTE 2020-02, the DOL defined “rollover” recommendation as:

…any recommendation to roll over assets from a Plan to another Plan or an 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)….

The PTE requires that, for all “rollover” recommendations, the Financial Institution must provide the participant or IRA owner with the “specific reasons” why the rollover is in the investor’s best interest. Here’s how that was explained in the preamble:

The Financial Institution also must provide documentation of the specific reasons that any recommendation to roll over assets from one Plan or IRA to another Plan or IRA, or from one type of account to another, is in the Retirement Investor’s best interest

Unfortunately, neither the PTE nor the preamble provided much information about the process for determining whether a recommendation to rollover or transfer an IRA to another IRA is in the best interest of the investor. However, the PTE contains a best interest definition that provides some help:

Advice is in a Retirement Investor’s ‘‘Best Interest’’ if such advice reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, and does not place the financial or other interests of the Investment Professional, Financial Institution or any Affiliate, Related Entity, or other party ahead of the interests of the Retirement Investor, or subordinate the Retirement Investor’s interests to their own.

So, we know that the recommendation must be based, at least in part, on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor.

But, neither the preamble nor the PTE provide guidance on what should be reviewed as a part of that process (other than the information about the investor’s needs and circumstances).

Fortunately, in April the DOL issued FAQs that further explain the fiduciary interpretation and the conditions of the exemption.

This article discusses the part of FAQ 15 that applies to rollover or transfer recommendations from one IRA to another IRA. The first article in this subseries, Best Interest #65, quoted the full Q & A. In FAQ 15 the DOL discussed rollovers generally and then focused on IRA-to-IRA recommendations:

For rollovers from another IRA or from a commission-based account to a fee-based arrangement, a prudent recommendation would include consideration and documentation of the services under the new arrangement. As relevant, the analysis should include consideration of factors such as the long-term impact of any increased costs; why the rollover is appropriate notwithstanding any additional costs; and the impact of economically significant investment features such as surrender schedules and index annuity cap and participation rates.

The bolded language makes it clear that the DOL expects a comparative analysis of the existing IRA (at another firm) and the “contemplated” IRA at the Financial Institution that will receive the transfer/rollover. While there isn’t a literal requirement that the Financial Institution or the Investment Professional develop an IRA investment strategy as a part of a rollover recommendation, it is hard to imagine consideration of increased costs and whether the rollover is appropriate notwithstanding any additional costs without knowing what the costs are in the IRA and what they will be (at least approximately) in the IRA at the Financial Institution.

That reasoning suggests that the Financial Institution and the Investment professional should obtain a copy of the retirement investor’s current IRA statement, develop a an approach of how the assets could be invested in the best interest of the retirement investor, and then do the cost comparison described in FAQ 15.

If the analysis concludes that it would be in the best interest of the retirement investor to transfer the IRA to the Financial Institution, the investor should then be given, in writing, the “specific reasons” why the recommendation is in the investor’s best interest.

Notes:

The best interest analysis involves more than just looking at the costs. But this article focuses on cost because it is a material factor and the expectation will be that it was given weight in the analysis.

A recommendation to transfer an IRA is already subject to the new fiduciary definition and the temporary non-enforcement policy (that is, the Impartial Conduct Standards). That has been the case since February 16, 2021. However, the requirement to provide the retirement investor (e.g., the IRA owner), in writing, the specific reasons why the rollover is in the investor’s best interest becomes applicable when the non-enforcement policy expires (which is currently scheduled for December 20).

Concluding Thoughts

Most of the attention for complying with PTE 2020-02 has been given to rollover recommendations from ERISA retirement plans to IRAs, which is reasonable. However, the other definitions of rollover recommendations also need to be considered. Of the remaining types of “rollovers,” the most common is a recommendation to transfer an IRA from another firm. With a little over two months left until the PTE’s requirements fully apply, attention should be given to the other rollover recommendations.

In addition to the PTE conditions discussed in this article, the Financial Institutions (e.g., RIAs, broker-dealers, banks and trust companies) need to satisfy the following:  fiduciary acknowledgement, policies and procedures on compliance with the PTE’s conditions, disclosures of conflicts and services, policies and procedures for mitigation of the financial incentives for the Financial Institution and Investment Professionals, and the retrospective review and report.

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

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