Rollovers from retirement plans to IRAs are the greatest source of dollars flowing into IRAs. Because of the volume of assets involved and the important role these assets play in retirement security, government agencies have increased regulatory requirements and enforcement efforts on IRA rollovers and the financial professionals who recommend them to their clients. Changes made by FINRA, the SEC, and the Department of Labor (DOL) in recent years have been driven by concerns that potential conflicts of interest may result in investment recommendations that do not serve individuals’ best interests, including IRA rollover recommendations. The most recent guidance affecting IRA rollovers was released by the DOL in Prohibited Transaction Exemption (PTE) 2020-02, Improving Investment Advice for Workers and Retirees, and in FAQs regarding the new PTE.1
Conflicted Compensation for Providing Rollover Investment Advice
Under both ERISA and the tax code, financial professionals providing fiduciary investment advice to retirement investors cannot receive payments that create a conflict of interest, such as commissions or other types of compensation that varies based on the recommendation, unless they comply with certain conditions set by the DOL in a prohibited transaction exemption. Effective February 16, 2021, those who provide fiduciary investment advice under ERISA can follow the conditions set forth in PTE 2020-02 to receive compensation that would otherwise be prohibited.
Although ERISA doesn’t technically apply to IRAs, the prohibited transaction rules do. The DOL makes clear that this PTE applies to prohibited transactions that result from both rollover advice and advice on how to invest assets rolled to an IRA. IRA rollover recommendations are a primary concern of the DOL because financial professionals often have a strong economic incentive to recommend retirement investors roll assets out of ERISA-protected plans into an IRA. The aim of the PTE is to make sure that fiduciary investment advice providers adhere to stringent standards designed to ensure their investment recommendations reflect the best interest of investors and mitigate conflicts. One of the conditions under the PTE is that financial professionals document and disclose in writing the specific reasons that a rollover recommendation is in the retirement investor’s best interest. Other conditions include disclosing material conflicts of interest and adhering to the Impartial Conduct Standards (meeting the prudence and loyalty standards, charging no more than reasonable compensation, and avoiding making misleading statements about investment transactions).
“Fiduciary Investment Advice” Under ERISA
A financial professional can become an ERISA fiduciary as a result of their actions, even if they are not appointed as an ERISA fiduciary. Under ERISA 3(21), as explained in the FAQs to PTE 2020-02, a financial professional is considered a fiduciary to the extent they render investment advice for a fee and meet all elements of a 5-part test:
- Render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property
- On a regular basis
- Pursuant to a mutual agreement, arrangement, or understanding with the plan, plan fiduciary or IRA owner, that
- The advice will serve as a primary basis for the investment decisions with respect to plan or IRA assets, and that
- The advice will be individualized based on the particular needs of the plan or IRA.
In the FAQs to the PTE, the DOL states that a financial professional meets the “regular basis” element of the 5-part test in relation to an IRA rollover recommendation if the advice is part of an ongoing relationship or the beginning of an intended future ongoing relationship.
The DOL also re-stated its intention to take further action to potentially amend its definition of fiduciary investment advice and this PTE in the future.
Non-Fiduciaries Subject to Best Interest Regulation
Even if financial professionals do not fall under the definition of an ERISA investment fiduciary and are not subject to the new DOL guidance, they may be subject to new SEC rules that enhance the standard of conduct required of broker-dealers when making investment recommendations to retail customers. The new standard of conduct under the SEC’s Regulation Best Interest goes beyond the previously applicable “suitability” obligation, to bring broker-dealers closer to the fiduciary standards required of a registered investment adviser under the SEC rules or an investment fiduciary under ERISA. The SEC rules apply to recommendations of any transaction or investment strategy involving securities and recommendations to open an IRA or roll assets into an IRA.
Review Your Rollover Services
Financial professionals should continue to work with their internal legal or compliance departments to ensure their IRA rollover service model is in compliance with their firm’s most current policies and procedures, especially in light of the SEC’s and the DOL’s recent guidance. Rollover procedures in general should address conflicts of interest and include evaluating and documenting the considerations associated with a rollover recommendation to ensure the recommendation is in the client’s best interest.
1 Department of Labor, PTE 2020-02, Improving Investment Advice for Workers & Retirees, December 18, 2020, https://www.federalregister.gov/documents/2020/12/18/2020-27825/prohibited-transaction-exemption-2020-02-improving-investment-advice-for-workers-and-retirees; New Fiduciary Advice Exemption: PTE 2020-02 Improving Investment Advice for Workers & Retirees Frequently Asked Questions, April 13, 2021, https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/faqs/new-fiduciary-advice-exemption