Best Interest: Rollover Recommendations (Part I)

The SEC has issued its final Regulation Best Interest (Reg BI), Form CRS Rule, RIA Interpretation and Solely Incidental Interpretation. I am discussing the SEC’s guidance in a series of articles entitled “Best Interest Standard of Care for Advisors.”

This article discusses how the Care Obligation in Reg BI applies to recommendations to roll over accounts in 401(k) plans to IRAs. When Reg BI applies, beginning June 30, 2020, rollover recommendations to participants in “workplace retirement plans” will be subject to the Best Interest standard.

It’s important to note, though, that Reg BI still permits education and information that stops short of being a recommendation. However, the education and information cannot be a disguised recommendation.

In its adopting release for the final Reg BI, the SEC explains:

Regulation Best Interest also applies to recommendations to open an IRA or to roll over assets into an IRA. Thus, the Care Obligation will require a broker-dealer to have a reasonable basis to believe that the IRA or IRA rollover is in the best interest of the retail customer at the time of the recommendation and does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer, taking into consideration the retail customer’s investment profile and other relevant factors, as well as the potential risks, rewards, and costs of the IRA or IRA rollover compared to the investor’s existing 401(k) account or other circumstances. (Emphasis added for importance.)

Comment: Reg BI explicitly applies to rollover recommendations and, thus, the Care, Conflict, Disclosure and Compliance Obligations apply . . . and each must be independently satisfied. This post focuses on the Care Obligation.

In order to satisfy the Care Obligation, a broker-dealer and its advisors must take “into consideration the retail customer’s investment profile and other relevant factors.” But that begs the question . . . what are the relevant factors? That is answered below.

This language quoted above lists some of the relevant factors: costs in the plan and the IRA, risks and rewards, and the investor’s existing 401(k) account. The requirement to consider a participant’s existing 401(k) account” is new and not entirely clear. One plausible interpretation is that the “existing 401(k) account” refers to the investments held in the participant’s account. That information is available on the statements that 401(k) participants receive each quarter.

Reg BI goes on to list the other non-exclusive factors for broker-dealers and their advisors to consider:

When making a recommendation to open an IRA, or to roll over workplace retirement plan assets into an IRA rather than keeping assets in a previous employer’s workplace retirement plan (or rolling over assets to a new employer’s workplace retirement plan), broker-dealers should consider a variety of factors, the importance of which will depend on the particular retail customer’s needs and circumstances.

In addition to the Factors to Consider Regarding a Recommendation to a Particular Retail Customer discussed above, as well as the Retail Customer’s Investment Profile, broker-dealers should consider a variety of additional factors specifically salient to IRAs and workplace retirement plans, in order to compare the retail customer’s existing account to the IRA offered by the broker-dealer.

These factors should generally include, among other relevant factors: Fees and expenses; level of service available; available investment options; ability to take penalty-free withdrawals; application of required minimum distributions; protection from creditors and legal judgments; holdings of employer stock; and any special features of the existing account. (Emphasis added to highlight key issues.)

Comment: In order to do this comparative analysis, broker-dealers and their advisors need to gather the relevant information. In addition to the information about the “existing 401(k) account” discussed above, most, if not all, of the information about the plan will be on the 404a-5 disclosure statement provided by the plan to participants when they start participating and then again annually. This has proven to be a difficult task for broker-dealers; however, they should be able to obtain the information by using commercial rollover services.

The SEC goes on to admonish broker-dealers:

With respect to available investment options, we caution broker-dealers not to rely on, for example, an IRA having ‘‘more investment options’’ as the basis for recommending a rollover. Rather, as with other factors, broker-dealers should consider available investment options in an IRA, among other relevant factors, in light of the retail customer’s current situation and needs in order to develop a reasonable basis to believe that the rollover is in the retail customer’s best interest.

Comment: Apparently, commentators told the SEC that some broker-dealers were recommending rollovers based solely on the availability of a greater range of investments in their IRAs. The SEC’s response is that more investment options, standing alone, does not satisfy the best interest standard. Instead, an analysis of all the relevant factors must be made.

Conclusion

When Reg BI applies on June 30, 2020, the requirements for making rollover recommendations will be more demanding than current rules. It won’t be enough for the recommendation to be suitable; instead, the recommendation must be in the best interest of the participant and a careful, skillful and diligent process must consider the retail customer’s investment profile, the costs, the rewards and risks, and the relevant factors.

Some broker-dealers will opt to provide rollover education. However, for those who will allow their advisors to make recommendations, the first step for compliance is to build a process that collects and considers the “relevant” information.