Insights from the experts in investment fiduciary responsibility.

Follow up Q&A from our DOL rule webinars: Rollovers and IRAs

Posted by Duane Thompson on April 25, 2016

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Two weeks ago, we presented two webinars on consecutive days covering the DOL’s recently released fiduciary rule. A recording of that webinar is now available. During that webinar we received over 80 questions. We were not able to answer all of those during the one hour session, but we have compiled and answered them here. The questions are categorized, and we will do separate blog posts during the week to address all of the questions within a given category. These questions are not comprehensive of the rule, they only address the questions that were submitted. Think of them as an addendum to the webinar. For a more comprehensive view of the rule, we recommend you view the recording, as well as download our Executive Summary and Client Memo documents.

In our first Q&A blog post from the webinar, we are tackling each question that had to do with rollovers and IRAs. Not surprisingly, as it represents the biggest change for most advisors, this is the topic with the most number of questions submitted.  Also note: the views expressed herein are strictly informational, do not represent an official position of fi360 on regulatory or legislative matters, and should not be relied upon as legal, compliance or investment advice. 

Q: Would the definition of ‘investment advice’ include a rollover from previous 401(k) to current 401(k)?
A: Yes, any rollover between an ERISA participant’s account to another ERISA plan, or similarly IRA-to-IRA, would be covered.

Q: Does the rollover rule apply to participants terminating employment and requesting advice from a financial advisor or mutual fund call center on rolling their 401k assets into an IRA?
A: Yes.  The new definition of investment advice includes rollovers, transfers and distributions from a plan as well as IRA-to-IRA rollovers.

Q: For firms with discretionary advisory programs, will it be possible to use the best interest contract exemption for the limited purpose of the rollover transaction, and then operate under a level fee advisory agreement once the assets have rolled over?
A: If the firm does not charge variable fees with respect to the participant’s account, then it may be able to use the streamline Level Fee Exemption instead of BICE.  Part of the answer depends on whether the firm already held discretion over the participant’s assets in the plan.  If it did, then BICE would be unavailable.  It also appears that the Level Fee Exemption would be unavailable if the firm held discretion.  Additional clarification may be needed from the Department on this point.

Assuming the firm did not hold discretion of the participant’s assets prior to the rollover, it should be able to use its discretionary advisory program to manage the new account.

Q: How can a level fee plan fiduciary advisor accept a participant’s rollover and manage the IRA rollover assets with a level fee? BIC?
A: There are at least three scenarios in play.  First, if it is the participant’s decision to roll over, and he or she has received no rollover advice, the fiduciary advisor has no conflict of interest.  Some experts also suggest educational advice describing the various options available would not constitute “investment advice.”  However, as a best practice, the fiduciary advisor should confirm in writing that it was solely the participant’s decision. 

Second, if the participant is a new client, then the advisor can rely on the Level Fee Exemption in providing rollover advice.

Third, if the participant is an existing client and the advisor’s compensation will not change as a result of the recommendation to roll over, then there is no conflict of interest and no need to rely on a PTE.  However, given the heightened interest by all regulators in rollover advice, as a best practice it is advisable to document why the rollover was in the best interest of the client. 

Q: If an RIA that does not provide services to the ERISA plan is handling a large rollover for a client, does the RIA need to justify and document the reasonability of the advice?  If so, does the RIA depend on the 404(a)(5) disclosure from the employer's plan?
A: Yes to both questions. 

Whether you are affiliated with an RIA or another regulated entity, the new Rule requires the advisor to justify and document the basis for the recommendation.  The DOL is particularly concerned about rollover advice to a plan participant under the Level Fee Exemption.  If the recommendation is to rollover from the plan to an IRA, the level fee advisor must document why the recommendation was in the best interest of the investor.  Documentation must include consideration of: 1) the alternatives to a rollover, including leaving the money in the current plan, if allowed; 2) comparing fees and expenses associated with the plan and the IRA; 3) whether the plan sponsor pays some or all of the plan’s administrative expenses; and the different levels of services and investments available under each option.

The 404(a)(5) disclosure from the current employer’s plan provides a significant amount of information on investment costs for each designated investment alternative.  The advisor is not required to rely on 404(a)(5), but the form should be a useful ‘yardstick’ in comparing investment expenses with an IRA.

Q: Will rollover analysis be required for any IRA rollover advice? 
A: If you are paid compensation and recommend a course of action, then you will likely be required to conduct a more extensive analysis than was required by regulators in the past.  An advisor under the Level Fee Exemption is required to undertake a fairly detailed analysis of the pros and cons of a rollover to an IRA from a plan.   

An advisor providing rollover advice under BICE would be subject to the Impartial Conduct Standards that requires adherence to the Prudent Investor Standard.  In a nutshell, the advice must reflect “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…”  As a best practice, it is advisable to follow and document the same rollover analysis required under the Level Fee Exemption.

Q: Because BICE is not available to advisors with discretion does that mean that advisors who are fiduciaries on a retirement plan cannot recommend a rollover to an IRA and use BICE to avoid the prohibited transaction issue due to uneven compensation?
A: You said it.  Advisors holding discretion over the participant’s account cannot rely on BICE in recommending a rollover. Consult with your compliance or legal professional for details.

Q: If a participant is in a plan that pays an expense ratio on the funds of 140 basis points, and the firm in turn shares 75 basis points with the broker, is the fee that the broker can charge once rolled into an IRA limited to 140bp or 75bp? 
A: Since you included a broker in the scenario, the assumption is that variable compensation is involved.  BICE does not require the same compensation to be paid after the rollover since its purpose is to provide a safe harbor for commissions.  However, the conditions for using BICE require the firm and advisor to, among other things, charge only reasonable compensation for services and product transactions, to act  in the best interests of the client “and without regard to the financial or other interests” of the firm and advisor. 

Q: Do the regulators give any credence to the service a client receives? Surely they can stay in the lower-cost 401k with limited options, or call a toll-free number for advice.  But there is no distribution or income planning.
A: With regard to rollover advice, the DOL exemption for the Level Fee Exemption requires a comparison between different rollover options that includes an analysis of the different levels of services and investments as well as costs.  The advisor must provide a rationale for why her final recommendation was in the best interest of the client.

BICE does not appear to require the same in-depth analysis of rollover advice, although the firm and advisor are fiduciaries.  Among other things, they must disclose the services provided and describe how the investor will pay.  In addition, the firm cannot charge excessive compensation.

Q: Will the number of rollovers increase, decrease, or be unaffected by the BICE?
A: The debate has only begun on this question.  Counter to current thinking, one industry report suggests that financial advisors will continue to have significant influence over clients’ decisions, and that the rollover trend will continue unabated.  Others think the application of the new fiduciary definition to rollover advice will have a chilling effect.

Q: Would general education about rollover options (leave assets in the account, cash out, roll to new plan or IRA) in marketing materials, in person or on the phone -- with referral to third parties for actual advice -- be considered advice under the Rule?
A: The answer to the first part of your question is straightforward.  No, general education on the rollover options, without the kind of communication that might result in “steering” the participant to a certain action, would not be advice.  However, the second part about referrals for advice raises a red flag.  If the person giving the educational advice is also paid for their referrals, then she could be giving investment advice under the Rule.

Q: What is understood about grandfathering of existing IRAs, particularly rollovers?
A: The DOL discusses grandfathering in the preamble to the new Rule.  In general, all transactions executed prior to Apr. 10, 2017, will be grandfathered, meaning ongoing revenue streams for transactions that were executed for reasonable compensation.  Any new advice or contributions to those products after that date will generally be subject to the final Rule.

Q: If an advisor is a fiduciary to a 401(k) plan, and the plan sponsor hires a new participant, what would the guidelines be if the advisor helped the new participant roll an old 401(k) balance into a rollover IRA?

A: The conditions you describe would be no different than for any other rollover, except that in the case of moving from one ERISA plan to another (or to an IRA), the advisor’s due diligence should include assessing plan costs paid directly by the plan sponsor as a corporate entity; not just by the plan.  Granted these instances are rare, but that is the kind of documentation that the DOL, FINRA or SEC would want to see.

Q: When you talk about the level-to-level exemption, does that mean the fee charged on the rollover IRA must be the same as that charged to the 401(k) plan?  Or does that mean that the fee on the IRA, although higher than on the 401(k), is level?
A: If the advisor’s compensation remains level after a rollover by an existing client, then she would not need the Level Fee Exemption.  If her compensation increases as a result of the rollover (such as the addition of new assets from a new client), but otherwise charges a level fee for her advice, then she would likely need to rely on the Exemption.  Otherwise the increase in her compensation would be a prohibited transaction.

Keep in mind that the advisor’s compensation isn’t the only factor to consider in developing a recommendation.  For example, assume the advisor’s compensation remains the same before and after the rollover, but the other investment expenses for the client increase, such as fund expense ratios, transaction costs, etc.  The advisor would need to document why the account change is in the client’s best interest.

Q: Assume a total plan cost to the participant is 1% and advisor to the plan receives 50 basis points of that amount.  Also assume the advisor recommends a rollover that results in 1.5% total expenses but the advisor continues to receive only 50 basis points.  Does that fall under streamlined Level Fee Exemption?
A: No.  If the advisor charges a level fee and his compensation does not increase as a result of the rollover, he does not need to rely on the Level Fee Exemption.  That’s because no prohibited transaction occurred.  However, he is a fiduciary under ERISA and required to act in the best interest of the client no matter how he is paid.  As such, unless the advisor can document why the higher costs were in the client’s best interest (such as the addition of new advisory services that weren’t available previously), then the advice may be imprudent.

Q: Can tiered AUM fee schedules qualify for the Level-fee Exemption on rollovers?
A: The preamble of the Rule does not directly address tiered fees, such as a discount based on the amount of assets under management.  The Rule’s definition of a level fee under the exemption 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…” As a best practice, it is advisable to disclose to the client your full AUM fee structure so that they are aware of the other options.

Q: If an existing client changes a fund within the portfolio either via a recommendation or on their own, are they now subject to BICE even though they were grandfathered?
A: If the advisor made the recommendation to switch out funds after BICE is in effect, then the grandfather exemption no longer applies.  If the transaction was self-directed by the participant, then the advisor is not responsible.  However, as a best practice documentation is always advisable, particularly if the transaction by the client was made counter to your recommendation.

Q: The relationship between advice to 401(k) plans and rollovers by individual participants is quite different.  Typically, fees are lower for participants in plans than for individuals with IRA accounts.  Is this not level to level?
A: No.  If the rollover recommendation results in more compensation to the advisor, it is not level-to-level advice.

Q: When is it appropriate per DOL that the duty to monitor be limited?
A: The DOL leaves it up to the advisor and retail investor client to determine the scope of engagement, including monitoring.  However, if the engagement does not include monitoring, the DOL indicates that the advisor’s recommendations should not include recommendations that require ongoing monitoring services. From the preamble to the rule, this is particularly a concern with respect to investments that possess unusual complexity and risk, and that are likely to require further guidance to protect investors' interests. 

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