Interesting Angles on the DOL’s Fiduciary Rule #37


DOL, fiduciary, prudent, SEC

SEC Retirement-Targeted Examinations

This is my 37th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

In 2015, the Office of Compliance Inspections and Examinations (OCIE) of the SEC issued a National Exam Program Risk Alert describing its “Retirement-Targeted Industry Reviews and Examinations Initiative” (ReTIRE). The Initiative announces that the OCIE “will conduct examinations of SEC-registered investment advisers and broker-dealers (collectively, registrants) under the ReTIRE Initiative that will focus on certain high-risk areas of registrants’ sales, investment and oversight processes, with particular emphasis on select areas where retail investors saving for retirement may be harmed.”

In its Risk Alert, the OCIE says:

“The staff intends to use data analytics, information from prior examinations, and examiner-driven due diligence to identify registrants to examine under this Initiative. As part of the examinations or the selection of examination candidates, the staff may focus on the activities of investment advisory representatives and/or broker-dealer registered representatives (collectively, representatives). The risk-based examinations conducted under the ReTIRE Initiative will focus on the services offered by the registrants to investors with retirement accounts in the following areas:

Reasonable Basis for Recommendations. . . .

Conflicts of Interest. . . .

Supervision and Compliance Controls. . . .

Marketing and Disclosure. . . .”

The purpose of this post is to emphasize that there are agencies, in addition to the Department of Labor, that are focused on advisers’ practices for retirement investing and related activities (for example, the recommendation of rollovers). In future posts, I will discuss the OCIE’s focus for those examinations.

For the moment, though, a good approach is to make sure that recommendations regarding plan distributions and rollovers are in the best interest of the participants and that investment practices for IRAs should be consistent with prudent investing in retirement (and should reflect practices such as appropriate portfolio investing, diversification, and mitigation of conflicts of interest).

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

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Interesting Angles on the DOL’s Fiduciary Rule #36


DOL, fiduciary, SEC

Retirement Advice and the SEC

While the DOL’s fiduciary regulation and prohibited transaction exemptions have occupied everyone’s attention over the last year, other regulatory agencies have been focusing on retirement plan issues, as well.

For example, in its “Examination Priorities for 2017,” the SEC has indicated that it will focus on “Senior Investors and Retirement Investments.” Specifically, the SEC says:

As the U.S. population ages and investors become more dependent than ever on their own investments for retirement income, we are devoting increased attention to issues affecting senior investors and those investing for retirement.

  • ReTIRE. We will continue our multi-year ReTIRE initiative, focusing on investment advisers and broker-dealers along with the services they offer to investors with retirement accounts. This year, these examinations will likely focus on, among other things, registrants’ recommendations and sales of variable insurance products as well as the sales and management of target date funds. We will also assess controls surrounding cross-transactions, particularly with respect to fixed income securities.
  • Senior Investors. Today’s Americans are more reliant on returns from their investment portfolios to fund their retirement compared to previous generations. We will evaluate how firms manage their interactions with senior investors, including their ability to identify financial exploitation of seniors. Examinations will likely focus on registrants’ supervisory programs and controls relating to products and services directed at senior investors.

With regard to retirement investments, the most impactful “focus” will be on recommendations and sales of variable insurance products. In the context of individual retirement accounts and annuities, that refers to individual variable annuities. (Also see Retirement-Targeted Industry Reviews and Examinations Initiative, June 22, 2015. Note that the SEC references FINRA’s guidance on rollovers, Regulatory Notice 13-45.)

However, unlike the DOL, the SEC will not focus on the fiduciary process and prohibited transaction exemptions. Instead the SEC will examine for violations of rules that are, in some ways, similar to the fiduciary rule, such as the best interest of the investor, the suitability of the product for the investor’s needs, and disclosures. However, unlike the DOL rule, the securities laws do not include prohibited transactions.

With regard to senior investors, it’s important to keep in mind that the terms “Senior Investors,” “Retirees,” and “IRA Owners” are, in many cases, synonymous. For these investors, the SEC will focus on:

  • The ability of advisers to identify financial exploitation of seniors;
  • Registrants’ supervisory programs and controls related to products and services directed at senior investors.

In terms of qualified assets, this means that the SEC will be looking at the products and services recommended to retirees who are IRA owners. Are the services and products recommended to those IRAs suitable for retirees and were the recommendations in the best interest of the IRA owners? In my opinion, increasing attention will be given to the recommendations of particular investments and strategies to older investors. Those recommendations should be consistent with retirement investing, including appropriate asset allocation.

Forewarned is forearmed.

POSTSCRIPT: Some readers may think that, since this article is about SEC examinations, it is limited to registered investment advisers. However, when the SEC uses the term “registrants,” it is referring to the “more than 4,000 broker-dealers (including approximately 162,000 branch offices and 640,000 registered representatives), more than 12,000 investment advisers (with nearly $67 trillion in assets under management) . . .” (See footnote 2 in Examination Priorities for 2017.)

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

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Interesting Angles on the DOL’s Fiduciary Rule #35


DOL, fiduciary

Presidential Memorandum on Fiduciary Rule

Last Friday, the White House directed a memorandum to the DOL to review the fiduciary regulation and the related exemptions (the “fiduciary rules”).

This article discusses what the memo did and did not do, and what the next steps are.

As a legal matter, the memo was more “show” than “go,” in the sense that it did not delay, withdraw or modify the fiduciary rules. Instead, it directed the DOL to evaluate the rules and to determine if they should become applicable, be modified or be withdrawn.

Shortly after the memo was signed, the Acting Secretary of Labor said that the Department would look into possible legal actions to delay the application of the rule. While that clearly indicates a desire to delay the applicability date beyond April 10th, it also suggests that the DOL has not decided if there is a legal maneuver that could accomplish that result. On the other hand, it could just be government-speak indicating that a delaying action will be coming in the next few days. Either way, I’m a little surprised that the action wasn’t taken immediately.

If it is delayed, that leaves us with the questions of (1) what rules apply now, and (2) will the rules be withdrawn or modified (and, if modified, how)?

The answer to the first question is easy . . . the “old” fiduciary rules are in effect until something is done. The second question is not easily answered. There is a split of opinion about whether the DOL will kill or modify the rules. At this point, we need to wait and see.

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

 

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Interesting Angles on the DOL’s Fiduciary Rule #34


DOL, fiduciary, registered investment advisers

A Seminar Can Be a Fiduciary Act

This is my 34th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions.

Last week, the DOL issued its second set of FAQs on the fiduciary rule and conflict of interest exemptions. For the most part, the DOL’s answers were consistent with the industry’s understanding of the rules. However, a few were particularly interesting. For example, Question 17 asked:

Q17. Would a free dinner seminar offered by an investment adviser as a means of marketing services or investments to a group of retirees or individuals approaching retirement be a widely attended speech or conference within the meaning of the general communications provision of the Rule?

Before giving you the answer, let me explain the significance of the question. If the adviser’s comments at the meeting are considered to be “general communications,” then they are not fiduciary advice. Also, if the meeting is a “widely attended” speech or conference, the comments would be considered general and, therefore, not fiduciary advice. On the other hand, if the seminar is not considered to be “widely attended” and if the adviser’s comments “suggest” a particular course of investment action, then—probably unbeknownst to the adviser, the comments could be fiduciary investment advice. (Of course, to be fiduciary advice, the recommendation must ultimately also cause compensation to be paid to the adviser.)

The DOL answered:

The Department does not consider such free-meal seminars to be widely attended speeches or conferences within the meaning of the general communications provision. Moreover, in the Department’s view, a reasonable person attending such a seminar could view statements by the investment adviser as investment recommendations even if the statements were made to all the attendees. Whether the particular communications at the seminar could reasonably be viewed as a suggestion that the advice recipients engage in or refrain from taking a particular course of action (i.e., a recommendation) would be a matter of facts and circumstances.

In other words, in “free dinner seminars,” an adviser’s comments about investments, insurance products, advisory services, or investment strategies may be fiduciary advice. Forewarned is forearmed.

What if an adviser wants to minimize the risk of being a fiduciary at those meetings? In that case, the discussion would need to be about general market data and the adviser’s services. Keep in mind that, under the “hire me” discussion in the preamble to the fiduciary rule, an adviser can always recommend himself and his firm without becoming a fiduciary. However, the adviser cannot recommend specific products, strategies, etc., without becoming a fiduciary.

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

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Interesting Angles on the DOL’s Fiduciary Rule #33


BICE, DOL, fiduciary, registered investment advisers

Discretionary Management, Rollovers and BICE

This is my 33rd article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions.

Most broker-dealers and RIA firms are familiar with the provisions of the Best Interest Contract Exemption (BICE) and with the fact that, as a general rule, BICE applies only to non-discretionary investment advice. But, that isn’t the end of the story. There are some situations in which discretionary management can be used for recommendations that are covered by BICE. For example, if a representative of a broker dealer or an RIA prudently recommends a distribution and IRA rollover (satisfying the Level Fee Fiduciary conditions), the IRA may be invested using discretionary investment manager. (Note, though, that the discretionary investment management must be provided by a “pure” Level Fee Fiduciary. That means that neither the adviser, the supervisory entity (e.g., the broker dealer or RIA firm), or any affiliated or related party can receive any compensation in addition to the level fee. Those prohibited additional forms of compensation would include, for example, investment management fees for proprietary investments, 12b-1 fees, or revenue sharing.)

The Department of Labor specifically addressed the issue of discretionary investment management for recommended rollovers in its recently issued FAQs — Frequently Asked Questions. Question and Answer 7 stated the following:

Q7. Is the BIC Exemption available for recommendations to roll over assets to an IRA to be managed on a going-forward basis by a discretionary investment manager?

Yes. As noted above, the BIC Exemption does not provide relief for a recommended transaction if the adviser has or exercises any discretionary authority or discretionary control with respect to the transaction. However, it does provide relief for investment advice to roll over a plan account into an IRA, even if the adviser or financial institution will subsequently serve as a discretionary investment manager with respect to the IRA, as long as the adviser does not have or exercise any discretionary authority or discretionary control with respect to the decision to roll over assets of the plan to an IRA, and the other applicable conditions of the exemption are satisfied.

The moral of this story is that the DOL’s fiduciary rule and exemptions are complex. As a result, the guidance should be studied closely, and it is not enough to rely on newspaper articles and speeches to make decisions. In our discussions with broker dealers, RIAs and individual advisers, we have found that there are a number of misconceptions about the rules, including that some people believe that BICE can never be used for discretionary investment management. Obviously, the DOL language quoted in this article debunks that perception.

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

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Inside the Beltway – January 26, 2017


DOL, fiduciary

Please join us for the nineteenth Inside the Beltway presentation, scheduled for January 26, 2017. This is the next session in an ongoing series of free audiocasts presented by Fred Reish and Brad Campbell, of Drinker Biddle & Reath, discussing developments in Washington that directly impact our industry. The presentation is sponsored by Natixis. Click on the linked title, above, to register.

During this session of Beltway we will discuss:

  • Update on the fiduciary rule
  • Update on the special Financial Institution status for IMOs and the sale of fixed indexed annuities
  • Impact of the Congressional proposals for retirement plans
  • Impact on retirement plans of other priorities of the Trump Administration

The audiocast will be recorded and available to all registrants within a week of the presentation. An Outlook appointment request will be sent with registration confirmation.

Questions? Please contact liz.jutila@dbr.com.

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Interesting Angles on the DOL’s Fiduciary Rule #32


BICE, DOL, fiduciary, prudent

What “Level Fee Fiduciary” Means for Rollover Advice

This is my 32nd article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions.

As explained in article #30 in the Angles series, in order to use the simplified, or BICE-lite, alternative for recommending that participants take distributions and roll over to IRAs with the adviser, the adviser must be a “Level Fee Fiduciary.” The Best Interest Contract Exemption (BICE) defines “Level Fee Fiduciary” as:

A Financial Institution and Adviser are ‘‘Level Fee Fiduciaries’’ if the only fee received by the Financial Institution, the Adviser and any Affiliate in connection with advisory or investment management services to the Plan or IRA assets is a Level Fee that is disclosed in advance to the Retirement Investor. A ‘‘Level Fee’’ is a fee or compensation that is provided on the basis of a fixed percentage of the value of the assets or a set fee that does not vary with the particular investment recommended, rather than a commission or other transaction-based fee.

If the financial institution satisfies that definition, an adviser can use the BICE-lite, simplified process for recommending that participants rollover to IRAs. On the other hand, if the compensation does not satisfy that definition, then the adviser and the financial institution (e.g., broker-dealer) must satisfy all of the BICE conditions in order to recommend a rollover without committing a prohibited transaction.

The key words in the definition are: “only fee received.” (For the remainder of this article, I use “adviser” to collectively refer to the adviser, the financial institution, and all affiliates and related parties.) Does that mean that, if the adviser receives other forms of compensation, such as 12b-1 fees, that the adviser cannot levelize his compensation (for purposes of rollover recommendations) by offsetting the 12b-1 fees on a dollar-for-dollar basis? At least one DOL speaker has said that it does. That is, a Department of Labor employee has said that, if any additional compensation is received—even if it is offset, the Level Fee Fiduciary, or BICE-lite, approach is not available.

On the other hand, the definition does permit “compensation that is provided on the basis of a fixed percentage.” If the additional payments are offset against the advisory fee, then the only compensation received by the adviser is the stated level fee.

The preamble to the BIC exemption is worded slightly differently than the exemption:

It is important to note that the definition of Level Fee explicitly excludes receipt by the Adviser, Financial Institution or any Affiliate of commissions or other transaction-based payments. Accordingly, if either the Financial Institution or the Adviser or their Affiliates, receive any other remunerations (e.g., commissions, 12b– 1 fees or revenue sharing), beyond the Level Fee in connection with investment management or advisory services with respect to, the plan or IRA, the Financial Institution and Adviser will not be able to rely on these streamlined conditions in Section II(h).

Interestingly, the preamble, in the first sentence, suggests that no other payments can be received, but in the next sentence suggests that payments cannot be on top of (or “beyond”) the level fee (as opposed to offset against the level fee). The first sentence says that the definition “excludes receipt . . . of commissions or other transaction-based payments.” That seems clear enough (unless you want to argue that an offset effectively trumps the receipt). The next sentence refers to the receipt of “any other remunerations (e.g., commissions, 12b-1 fees, or revenue sharing), beyond the Level Fee . . .”. While not entirely clear, a reasonable interpretation is that, if the additional payments are offset against the Level Fee on a dollar-for-dollar basis, the payment of those additional amounts is not “beyond the Level Fee.” (A similar “levelizing” approach would be to pay over into the IRA any payments received from the investments.)

So, where does that leave us? For the belt-and-suspenders crowd—the very conservative advisers, the ultra-safe answer is to avoid all other payments or benefits. On the other hand, for those advisers who are willing to rely on a reasonable interpretation (or, in other words, to use a belt without suspenders), a possible approach is, in the case where additional payments are received, to offset those additional payments on a dollar-for-dollar basis (or to pay them over into the IRA). Keep in mind, though, this is a legal issue. As a result, advisers should not rely on general articles such as this one. Instead, you need to get individualized legal advice that applies to your particular circumstances and that quantifies the degree of risk, if any, that you are taking.

POST-SCRIPT: One oddity about the stricter interpretation (that is, that any payments cause the “forfeit” of BICE lite) is that, if full BICE compliance is required, there is no conflict of interest to disclose, since the DOL has separately said that the offset method works to eliminate conflicts of interest (i.e., prohibited transactions).

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

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Interesting Angles on the DOL’s Fiduciary Rule #31


BICE, broker-dealers, DOL, fiduciary, prohibited transaction, prudent

“Un-levelizing” Level Fee Fiduciaries

This is my 31st article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions.

In the last article I posted, I discussed the three meanings of “Level Fee Fiduciary.” This article discusses the kinds of payments or benefits that will “un-levelize” a Level Fee Fiduciary.

As a starting point, the definition of compensation, for these purposes, includes any money or things of monetary value. So, it covers both cash and non-cash amounts. However, as the DOL explains, it must be directly or indirectly connected to a recommendation:

The term ‘‘fee or other compensation, direct or indirect’’ means . . . any explicit fee or compensation for the advice received by the person (or by an affiliate) from any source, and any other fee or compensation received from any source in connection with or as a result of the purchase or sale of a security or the provision of investment advice services, . . . A fee or compensation is paid ‘‘in connection with or as a result of’’ such transaction or service if the fee or compensation would not have been paid but for the transaction or service or if eligibility for or the amount of the fee or compensation is based in whole or in part on the transaction or service. [Emphasis added.]

In other words, if an adviser ordinarily charges a level fee (for example, 1% per year) for non-discretionary investment advice or discretionary investment management for plans, participants or IRAs, and receives any additional benefits or payments attributable to those services, the additional payments will un-levelize the adviser’s compensation and result in a prohibited transaction. (However, as explained in the last article, if the payments or benefits are offset dollar-for-dollar, the adviser will re-levelize his or her compensation.)

Some forms of additional compensation are obvious. For example, that includes commissions, 12b-1 fees, revenue sharing, trailing commissions, and so on. Others, though, are more subtle and, therefore, easier to overlook. Those could include trips, gifts, awards, reimbursements, marketing support, conference registrations, and so on. The DOL pointed to some of those payments in its definition of third party payments in the Best Interest Contract Exemption (BICE):

‘‘Third-Party Payments’’ include sales charges when not paid directly by the Plan, participant or beneficiary account, or IRA; gross dealer concessions; revenue sharing payments; 12b–1 fees; distribution, solicitation or referral fees; volume-based fees; fees for seminars and educational programs; and any other compensation, consideration or financial benefit provided to the Financial Institution or an Affiliate or Related Entity by a third party as a result of a transaction involving a Plan, participant or beneficiary account, or IRA. [Emphasis added.]

In the fiduciary regulation, the DOL gave additional examples of compensation as:

. . . including, though not limited to, commissions, loads, finder’s fees, revenue sharing payments, shareholder servicing fees, marketing or distribution fees, underwriting compensation, payments to brokerage firms in return for shelf space, recruitment compensation paid in connection with transfers of accounts to a registered representative’s new broker-dealer firm, gifts and gratuities, and expense reimbursements.” [Emphasis added.]

While advisers to retirement plans have, by and large, been aware of these rules, my experience is that advisers who focus primarily on wealth management, including advice to IRAs, are not familiar with the rules.

To paraphrase Hill Street Blues (for those of you old enough to remember that show) . . . Be careful out there.

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

 

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Interesting Angles on the DOL’s Fiduciary Rule #30


BICE, DOL, fiduciary, prohibited transaction

Three Kinds of Level Fee Fiduciaries . . . and What’s A “Level Fee?”

This is my 30th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions.

The DOL’s use of the phrase “Level Fee Fiduciary” is creating a lot of confusion about the application of the new fiduciary regulation and the Best Interest Contract Exemption (BICE). This article, and the next one, will try to dispel some of that confusion.

The label “Level Fee Fiduciary” has been used for many years for one meaning, but BICE has used it for a different purpose and, depending on your reading, a different definition.

Historically, Level Fee Fiduciary referred to a fiduciary adviser whose compensation was level or, at least, levelized. What’s the different between level and levelized? “Level” refers to an adviser who has a stated fee, for example, 1% per year, and does not receive any other payments. “Levelized” refers to a fiduciary adviser who has a stated fee (e.g., 1%), but who receives payments from third parties as a result of the recommendations — and then levelizes those payments by offsetting them dollar-for-dollar against the 1% fee. In both of those cases, the advisers receive no more, nor any less, than the 1%. Based on two DOL advisory opinions, the offset method works to, in effect, create a level fee. (An alternative method of levelizing is to pay the third party amounts into the plan or IRA; to be safe, that should be mandated in the agreement with the retirement investor.)

The advisers are not committing a prohibited transaction in either of these cases. As a result, the advisers do not need an exemption, or exception, from a prohibited transaction.

BICE then used “Level Fee Fiduciary” in a different setting. In BICE — a prohibited transaction exemption, the rule only applies to three scenarios. Those are: (1) a recommendation to take a distribution from a plan and roll over to an IRA with the adviser; (2) a recommendation to transfer an IRA to the adviser; and (3) a recommendation to switch “qualified money” from a commission-based account to a fee-based account. Each of those three recommendations will result in a prohibited transaction if the adviser receives more compensation if the retirement investor accepts the recommendation. Needless to say, an adviser will almost always make more money (with the possible exception of the case where the adviser is charging the same fee in the IRA as the adviser charged for services to the plan).

For the BICE provisions on these three scenarios (which is sometimes referred to as BICE-lite), the definition of “Level Fee Fiduciary” is:

“A Financial Institution and Adviser are ‘Level Fee Fiduciaries’ if the only fee received by the Financial Institution, the Adviser and any Affiliate in connection with advisory or investment management services to the Plan or IRA assets is a Level Fee that is disclosed in advance to the Retirement Investor. A ‘Level Fee’ is a fee or compensation that is provided on the basis of a fixed percentage of the value of the assets or a set fee that does not vary with the particular investment recommended, rather than a commission or other transaction-based fee.”

In and of itself, that definition could either mean (1) that no other payments can be received by the adviser, or (2) that the adviser could receive other payments so long as they were not on top of, or in addition to, the stated fee (that is, it would be permissible if the additional payments were offset dollar-for-dollar, such that they did not increase the fee). Unfortunately, at least one senior DOL official has said that the Department intended for the language to mean that no additional payments could be received regardless of whether they were offset or not. Keep in mind, though, that the statement of individual DOL employees are not considered to be legal authority.

The third use of the concept of Level Fee Fiduciary is in the Pension Protection Act “level fee” exemption. That involves an entirely different situation. In that case, if the conditions of the exemption are satisfied, an organization can commit a prohibited transaction, so long as the advice is provided by a separate unit that receives only level fee compensation for providing the advice. For example, that separate unit could recommend proprietary funds to IRAs and participants, without violating the law.

So, those are the three scenarios in which an adviser could be labeled as a Level Fee Fiduciary. But, the definitions, the requirements for compliance and the compensation considerations are different for each of the scenarios.

Hopefully, that clarifies the meaning. In my next post, I will talk about the forms of compensation that would cause an adviser’s level fee to become “un-levelized.”

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

 

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Interesting Angles on the DOL’s Fiduciary Rule #29


BICE, DOL, fiduciary, prohibited transaction, prudent

Capturing Rollovers: What Information is Needed?

This is my 29th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions.

The Department of Labor’s fiduciary regulation provides that a recommendation to take a distribution from a plan, and to roll the money over to an IRA, is a fiduciary act. As a result, the recommendation must be prudent and cannot result in a prohibited transaction. However, a prohibited transaction almost automatically occurs, since an adviser typically makes higher fees in the IRA than from the plan (even where the adviser is providing services to the plan). As a result, an exemption is needed, even if the recommendation is otherwise prudent. Fortunately, the Level Fee Fiduciary provision of the Best Interest Contract Exemption (BICE) provides the framework for qualifying for an exemption.

In addition to the fiduciary regulation and BICE, other rules regulate the recommendation of distributions. For example, in Regulatory Notice 13-45, FINRA stated that a recommendation to take a distribution from a plan must be “suitable.” (In effect, FINRA was saying that a recommendation to take a distribution from a plan is tantamount to a recommendation to a participant to liquidate the participant’s investments in the plan; therefore, it is a securities recommendation.) FINRA then provides a number of considerations for advisers to evaluate in making a suitable recommendation. Those factors and considerations are remarkably similar to the considerations in a prudent process under ERISA.

In addition to the FINRA guidance, the DOL issued an advisory opinion (2005-23A) that concluded that a fiduciary to a plan (for example, a fiduciary adviser) who makes recommendations to participants to take distributions and roll over to IRAs is a fiduciary for the purpose of these recommendations. As with the new regulation, that implicates the fiduciary standard of care and the prohibited transaction rules.

With that in mind, the general rule for the prudence of recommending a rollover (as opposed to the prohibited transaction issues) is that a fiduciary adviser engage in a prudent process. But, that begs the question . . . what does an adviser need to do? More specifically, a prudent process produces an “informed” and “reasoned” recommendation. A recommendation is “informed” if the adviser has gathered and evaluated the information that a knowledgeable person would consider to be relevant to the issue. A reasoned decision is one that bears a reasonable relationship to the information that was evaluated.

What are the relevant factors for evaluating whether a participant should take a distribution? In other words, what information does an adviser need to gather and review?

In BICE, the DOL identifies three specific types of relevant information about the retirement plan. (Note that there may be relevant factors in addition to these three, but the DOL is saying that a recommendation to take a distribution would, at the least, need to consider these.) Those factors are: the investments in the plan; the services provided by the plan; and the expenses in the plan. Examples of other relevant matters are whether the plan permits periodic distributions without charge, and whether the participant is invested in company stock in the plan (particularly if the participant has a low basis in the company stock compared to its current value). Those factors, and other relevant matters about the plan, need to be evaluated. Of course, that means that information needs to be obtained.

Where the adviser already provides services to a plan, it should be relatively easy to gather the information. However, if the adviser does not work with the plan, the adviser will need to make a diligent effort to gather that information. (The Department of Labor says in Question 14 of the FAQs that the adviser “must make diligent and prudent efforts to obtain information on the existing plan.” Question 14 goes on to say: “In general, such information should be readily available as a result of DOL regulations mandating plan disclosure of salient information to the plan’s participants (see 29 CFR 2550.404a-5).)”

In other words, the adviser should ask the participant for a copy of the plan’s 404a-5 disclosures (which are also known as participant disclosures and/or the Investment Comparative Chart). That should be readily available to a participant, since those materials are provided to participants when initially eligible and, again, each year thereafter. In addition, an adviser could ask a participant for his most recent quarterly statement, which should reflect any expenses being charged against the participant’s account, as well as how the participant is invested and the account balance. Those statements should also be readily available since, for participant-directed plans, they are provided quarterly.

In addition a participant would have access to materials through the participant’s page on the plan’s website.

In other words, the information is readily available. (Note that the FAQs provide alternative methods of obtaining the information, but only after the adviser has engaged in “diligent and prudent efforts to obtain information,” but has not been able to do so.)

In addition to the information about investments and expenses, an adviser also needs to obtain information about plan services. In many cases, that could be done through interviewing the participant. For example, does the plan have a brokerage account option? Does the plan provide non-discretionary investment advice services or discretionary investment management services? Once that information has been gathered, an adviser should compare it to comparable information about the proposed IRA. While the gathering of information, in and of itself, can take some work, the analysis is the critical step. The information is just the foundation from which to make the analysis.

The key to the analysis and the development of a prudent recommendation is to focus on the best interest of the participant. Also, keep in mind that BICE requires that the adviser document why the recommendation is in the best interest of the investor.

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

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