For most financial professionals the new rules will apply, at the least, to recommendations to plan participants to roll over their retirement benefits from a plan to an IRA with the professional’s firm and to recommendations to IRA owners to transfer their IRAs from other firms to the professional’s firm. Those recommendations will almost always be fiduciary advice under the new rules and will involve conflicts of interest because of the compensation earned by the professionals and their firms from the rollover IRAs.

While some firms have decided to only allow their financial professionals to provide rollover education—but not recommendations, most will be supporting rollover recommendations and the requirements under the new rules.

As a result, this article focuses on the requirements imposed on those recommendations under the DOL’s “rule”—Prohibited Transaction Exemption (PTE) 2020-02.

The PTE is a conflict of interest rule. But, “fiduciary” conflicts of interest for retirement accounts (that is, ERISA plans, participants in those plans, and IRA owners) are prohibited under ERISA and the Internal Revenue Code. To allow advice where the conflicts are properly managed, ERISA and the Code allow for exceptions to the prohibited transaction rules, which are called “exemptions”—thus Prohibited Transaction Exemption (PTE) 2020-02.

Before getting into the conditions of the PTE, though, it’s important to know why the DOL concludes that most financial professionals are fiduciaries when they provide advice to plans, participants (including rollover recommendations), and IRAs.

 

The New Definition of Fiduciary Advice

The ERISA and Code regulations have a 5-part test for fiduciary advice. Most of the 5 parts are automatically satisfied by financial professionals when making investment recommendations. But one may or may not be. That is the “regular” basis test. The test is whether the financial professional will be providing financial advice on a regular basis. Most of the time that will be the case, for example, with ongoing advice to IRAs. But in some cases advice won’t be provided on a “regular basis.” In those cases, the financial professional will not be a fiduciary. However, from a firm’s perspective, it may be a practical necessity to treat all recommendations to retirement accounts as fiduciary advice, since the determination of whether the advice is fiduciary or not must be made at the beginning of the relationship.

It may be a practical necessity to treat all recommendations to retirement accounts as fiduciary advice.

The analysis is more complicated for plan-to-IRA rollover recommendations. The relationship usually starts with a rollover recommendation to a participant in a plan. (From the DOL’s perspective, a rollover recommendation is advice to a participant to sell the investments in the participant’s account and take the proceeds out of the plan.) The financial professional then often continues to provide financial advice to the investor as an IRA owner. Does it matter that the advice was given to the investor in two different capacities: plan participant and IRA owner?

Historically, it did. Originally the DOL said that the advice to take the rollover was one-time advice. But the DOL has changed its position. It now says that the recommendation to sell the plan investments (and rollover to an IRA) is connected to the ongoing advice about how to invest in the IRA. In that way, the DOL concludes that the advice if provided on a “regular basis” and the financial professional is a fiduciary for both the rollover recommendation and the IRA investing.

Once that fiduciary determination is made, the commissions or fees from the IRA become conflicts of interest (and prohibited transactions) that require compliance with PTE 2020-02.

 

The Conditions of PTE 2020-02

In order to get the protections of the PTE (and retain the compensation from the IRA), the following conditions must be satisfied:

• The Impartial Conduct Standards must be satisfied. The most demanding of those Standards if the best interest standard of care, which is, in effect, a combination of ERISA’s prudent man rule and duty of loyalty.
• The following written disclosures must be made prior to implementation of the recommendation:
  
  • An acknowledgment of fiduciary status under ERISA and the Code;
  • A disclosure of the services to be provided to the retirement investor;
  • A disclosure of the conflicts of interest of the financial professional and the firm that are relevant to the recommendation (for example, that a rollover recommendation is a conflict of interest);
  • Beginning July 1, a statement of the specific reasons why a rollover recommendation is in the best interest of the retirement investor.
    

• The firm must adopt and enforce these policies and procedures:
  
  • Policies and procedures designed to ensure that the firm and the financial professional satisfy the Impartial Conduct Standards;
    
  • Policies and procedures that mitigate the financial incentives of the firm and the financial professional so that they aren’t incented to put their interests ahead of the interest of the retirement investor.
    
• The firm must conduct a retrospective review each year that is designed to detect and prevent violations of the Impartial Conduct Standards and of the required policies and procedures. The review must be documented in a written report that is signed by a senior executive officer of the firm.
  

 

Key Issues for Compliance

There are a number of important considerations for financial professionals in complying with the conditions of the new PTE. This article focuses on three of those that relate to recommendation of plan-to-IRA rollovers:

• Plan information: The DOL requires that, in order to make a compliant plan-to-IRA rollover recommendation, the financial professional (and the firm) obtain and evaluate information about the plan’s investments, services and costs. The DOL suggests that information can be obtained by asking participants to provide the 404a-5 investment chart for the plan. Unfortunately, the experience is that most participants don’t know what a 404a-5 chart is, or where to find it. That disconnect is probably due to the fact that few plans or providers refer to their investment disclosure chart in terms of 404a-5. But, if that information is obtained, and if the participant provides a copy of a recent quarterly statement, a financial professional will have the information needed to have a compliant process for evaluating whether a rollover is in the best interest of the participant. 
  
   
  What if the participant can’t or won’t provide that information? The DOL says that the financial professional must make a diligent and good faith effort to get the information from the participant, but if the participant doesn’t provide it, and the participant is admonished that it is important, then the financial professional can use “alternative data.” Alternative data is plan information from other sources, e.g., benchmarking reports for similarly situated plans, Forms 5500 previously filed by the plan, and so on. 

It’s important to note that the DOL position is that a compliant recommendation can’t be made without either actual data to alternative data.

• Best Interest Process: Once a financial professional has the needed information, the next step is evaluating information about the investments, services and costs of the plan versus an IRA, in light of the needs and circumstances of the participant. This is meant to be an objective professional process to determine which option is best for the investor. The process should focus on the needs of the retirement investor (based on the investor’s profile) and consider the impact of costs on the investor. For example, the greater the cost of the IRA (as compared to the plan costs), a rollover recommendation will need to be justified by valuable services provided to the IRA and the investor, in order to offset the cost differential. However, it’s possible that, in some cases, other factors could offset the cost differential. The key is that there needs to be value to the particular “retirement investor” that justifies the higher costs. 

Keep in mind that the DOL expects the analysis to focus on the particular retirement investor and not on what might be right for most people.

• Specific Reasons why Rollover Recommendation is in the Best Interest of the Investor: Beginning July 1 of this year, financial professionals (and their firms) will need to provide the participant, in writing, with the specific reasons why the rollover recommendation is in the best interest of the participant. Needless to say, this will need to be done carefully and in a manner that considers the circumstances of that individual. Since the reasons will be provided to the participant in writing, they become evidence of whether the reasons accurately reflected the needs and circumstances of that retirement investor. It is important to think of the reasons in that way, since controversies and regulatory investigations occur years after the fact. As a result, there will be a history of whether strategies to satisfy the needs indicated by the specific reasons were actually implemented. That is not to say, though, that the recommendation will be second-guessed based on events that occurred after the recommendation. The assessment of the quality of the recommendation will be made on the circumstances at the time of the recommendation. 
  

What’s Next: While the general compliance requirements are already in effect, the next big step will be the requirement to provide retirement investors with the specific reasons in writing why a plan-to-IRA rollover or an IRA-to-IRA transfer is in the best interest of the retirement investor. That requirement begins July 1.

But, one more requirement comes after that . . . firms must do annual retrospective reviews about compliance with the PTE. That means that firms will have to review or sample some of the recommendations to determine if the rules were satisfied for those recommendations and, if not, to improve their compliance practices. In addition, if any retirement investors suffered losses due to the noncompliance, those losses will need to be restored to the retirement accounts.

After that, it is likely that the DOL will be issuing a new proposed regulation on the fiduciary definition later this year. For rollovers, the new proposal will probably say that all rollover recommendations are fiduciary advice, without regard to the 5-part test or its “regular basis” requirement. But, by then most financial professionals will, as a practical matter, have been satisfying that standard for months. It’s possible that PTE 2020-02 will be amended to add or modify its conditions, but the current version of the PTE already appears to be highly protective of retirement investors, so there may not be any change or, if some, only at the margins.

 

Concluding Thoughts

The new rules will require more work and thought. However, over time they should become familiar and the “new normal.” There is some continuing complexity, though, which will likely favor financial professionals who objectively assess client needs and focus on providing the services that meet their client’s needs.

 

Postscript: While this article focuses on plan-to-IRA rollover recommendations, the same new rules apply to recommendations to transfer an IRA from another firm, in other words to IRA-to-IRA transfers, which the DOL also labels “rollovers.”