Monday, February 3, 2014

Rollovers Remain Under SEC and FINRA Scrutiny

The DOL has previously provided guidance regarding the prohibited transaction rules in the context of cross-selling IRA rollovers. The DOL stated in Advisory Opinion 2005-23A a rationale for drawing a line between:
  • Investment professionals providing plan-level fiduciary advice; and
  • Investment professionals assisting a plan in a non-fiduciary capacity.
The status of the financial adviser as a  "fiduciary" (i.e., the investment adviser platform) or "non-fiduciary" (i.e, the broker-dealer platform) when cross-selling IRA products and services has thus become a gating factor for whether the increased compensation that often accompanies IRA rollover transactions is available from an ERISA perspective.  However, the story does not end here.  The SEC and FINRA have recently reminded the financial advisory community of their concerns about IRA rollovers.

FINRA Regulatory Notice.  On December 30, 2013, FINRA issued Regulatory Notice 13-45 ("Notice"), stating that a top examination priority of 2014 will be to review firm practices when recommending a rollover of assets from an employer sponsored retirement plan to an IRA.  (Interestingly, the SEC has announced that its 2014 examination priorities will include a review of practices by both broker dealers and investment advisers when retirement vehicles and rollover recommendations are involved).  FINRA notes that many participants, upon termination of employment, retirement, or a distribution-triggering event, will roll the assets to an IRA (rather than roll the assets to a new employer's plan or receive a taxable distribution).  When making this decision, a participant may rely on the advice of a registered representative of a broker dealer.  The advice typically involves a "securities transaction" subject to FINRA regulation, including the suitability standard.    

Suitability Standard.  Under FINRA Rule 2111, a recommendation or investment strategy presented by a broker or its representative must be suitable for the customer based on information (obtained through reasonable diligence) relating to the customer's investment profile, such as the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance and any other information the customer may disclose.  Moreover, the requirement of fair dealing is implicit in all broker broker-customer relationships. 

The Notice applies this suitability standard to a broker's recommendation that a retirement plan participant roll over plan assets to an IRA if it entails selling, purchasing or holding securities.  In addition, the information that the participant receives must be "fair, balanced and not misleading."  These standards apply regardless of whether the broker is considered to be a fiduciary for purposes of ERISA.  It remains the case, however, that communications limited to only educational information (similar to the DOL rule under which investment education will not give rise to fiduciary status) will not result in a "securities transaction" subject to the suitability standard.

Factors Relevant to Suitability. The Notice provides several factors to be considered in light of the investor's individual needs and circumstances which are relevant to any recommendation to roll over assets from a plan to an IRA:
  • The increased range of investment options available under an IRA (as well as the benefits of low-cost institutional funds even if the options are more limited in the plan).
  • The fees and expenses charged by the plan versus an IRA.
  • The services provided under each option.
  • The tax characteristics of investing in the plan versus an IRA, such as the ability to withdraw funds without penalty, the minimum distribution rules, and the ability to borrow funds.
  • The legal protections available from creditors available to the plan versus an IRA.
  • The different tax treatment afforded plan participants holding appreciated employer stock in a plan and those who transfer such stock to an IRA. 
The Notice indicates that these examples should not be considered an exclusive list of the factors that may be relevant when analyzing whether to roll plan assets into an IRA.  The Notice also recognizes that financial advisers have an economic incentive to encourage plan participants to roll over plan assets and requires brokerage firms to supervise the activities and communications of their representatives so that this conflict does not impair their judgment.  This means that broker dealers must consider marketing materials and written supervisory procedures in light of IRA cross-selling products and services.

Conclusion. The Notice is certainly another signal IRA rollover activity has risen to the top of the regulatory radar screen at not only the DOL, but FINRA and SEC.  It serves as a reminder that the standards and obligations of non-fiduciary broker dealer firms, though not on the same level as an ERISA fiduciary, are nonetheless substantive and in-place for the benefit of investors.  It further signals the general concerns held by the SEC with regard to the movement of assets from a plan to an IRA at retirement or upon separation of service.  Given the current review by DOL of the "fiduciary" regulation, and the questions around a common fiduciary definition for both DOL and SEC purposes, it remains to be seen how FINRA, DOL and the SEC will ultimately coordinate (or not) on the role of financial service providers with regard to the IRA rollover market.