New SEC Best-Interest Regulation Affects Retirement Plan Rollovers

Department of Labor may adopt new standard for retirement plan advisors

Stephen Miller, CEBS By Stephen Miller, CEBS June 20, 2019
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updated July 12, 2019

The Securities and Exchange Commission (SEC) has finalized its long-awaited Regulation Best Interest (Reg BI), a new standard of conduct for financial services brokers who make recommendations to retail customers. Those brokers will be required to provide advice that is in the best interests of investors, not merely broadly suitable to them. In addition, they must disclose and minimize conflicts of interest involving fees they may receive from investment funds they sell.

Under a transition rule, brokerage firms must comply with Reg BI beginning June 30, 2020.

Although SEC-regulated investment advisors were already subject to a best-interest standard, the SEC published its "Commission Interpretation Regarding Standard of Conduct for Investment Advisers" that clarifies certain aspects of an investment advisor's fiduciary duty. The SEC also finalized a new requirement that brokers and investment advisors provide retail investors a "relationship summary"–a standardized, short-form disclosure.

Significance for Plan Sponsors

The SEC rule is not directed at retirement plan sponsors and doesn't regulate advice about selecting investments within a 401(k) or similar employer plan. However, "the SEC rule does discuss retirement plan issues, most particularly rollovers and account selection" when participants withdraw money from an employer's 401(k) or similar plan and become retail customers, explained S. Derrin Watson, an Employee Retirement Income Security Act (ERISA) attorney in Santa Barbara, Calif., and counsel to the Ferenczy Benefits Law Center. This would include advice plan participants receive about transferring funds from a 401(k) or similar plan to an individual retirement account (IRA) or a nonretirement securities account.

Because this advice might come from financial services firm representatives involved with administering an employer's plan, employers should be aware of the rule and their oversight responsibilities to monitor such advice, Watson explained.

In addition to retail investment accounts such as IRAs, the SEC guidance also applies to investment recommendations made for an individual’s health savings account (HSA) or Coverdell education savings account (ESA), for instance.

The Department of Labor (DOL) is expected to issue its own regulation later this year, incorporating elements of the SEC rule into guidance for professionals who provide advice to participants in 401(k) and similar defined contribution plans. This follows last year's decision by the 5th Circuit Court of Appeals to uphold a district court ruling that struck down as overly broad a DOL best-interest rule directed at employer-plan advisors.

Preston Rutledge, head of Labor’s Employee Benefits Security Administration, said on June 3 that Labor’s upcoming fiduciary rulemaking would align with Reg BI.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

Fiduciary Oversight

Michael Barry, a senior consultant in the Chicago office of October Three, a retirement plan advisory firm, also believes that although the new rule is primarily of interest to investment professionals, retirement plan sponsors should understand its implications.

For brokers and their affiliated call centers that provide advice to retirement plan participants about, for instance, rolling over assets to an IRA, the SEC's actions "will significantly change the standard of conduct rules and thus are likely to change how brokers and their affiliates interact with plan participants," as well as affect a plan sponsor's responsibility to monitor plan administrators who may be offering rollover advice, said Barry, who wrote an analysis of the new regulation.

As fiduciaries, plan sponsors have a legal obligation under ERISA to monitor the conduct of plan service providers, Barry said. "That duty to monitor may extend to monitoring compliance with federal securities laws. Connecting the dots, under [Reg BI], the federal securities law requirements applicable to retirement plan service providers—including brokers and their affiliates acting as call-center operators—are significantly increased. As a result, what plan fiduciaries must monitor is also changed."

The regulation, for instance, requires brokers to "identify and eliminate any sales contests, sales quotas, bonuses and noncash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time." This also pertains to any "recommendation by a broker-affiliated call-center operator that a retiring participant roll her plan assets into an IRA, or take a plan distribution or a plan loan" to purchase securities, Barry said.

Under the regulation, brokers must have a reasonable basis to believe that the IRA rollover or other distribution is in the best interest of the customer and does not place the financial interest or any other interest of the broker ahead of the interest of the customer. Brokers should consider "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," Barry explained.

When making a rollover recommendation, brokers should consider various factors, such as fees and expenses, level of service available in the new plan, 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.

"The decision to roll over a 401(k) into an IRA may be one of the most significant financial decisions a retail investor could make," Barry said. "Plan sponsors will want to review with broker-related service providers whether and how the new rule will affect the services they provide."

Ensuring Compliance

"Retirement plans need to evaluate the impact in situations where their plan offers participant level advice through the recordkeeper or a third party, likely in one-on-one meetings or via call centers," Samuel A. Henson, vice president and director of legislative and regulatory affairs at Lockton, a national insurance brokerage, recommended.

Because the SEC rule directly touches any participant advice pertaining to rollovers, investment allocations and distributions, "in those situations, the Regulation Best Interest may result in changes to how advice providers interact with plan participants," Henson pointed out, and "a conservative approach is to assume that ERISA's general duty to monitor service providers extends to a plan fiduciary's obligation to ensure the advice provider is complying with these new rules."

If plan sponsors provide participants with access to such advice, Henson offered these recommendations:

  • Request the advice provider comply with the new regulations.
  • Determine if the advice provider appears to be taking proper action.
  • Document this process in your fiduciary files.

In an online post, consultants at October Three observed: "Given participants' ability under ERISA to sue plan fiduciaries for breaches of fiduciary duty, could plan fiduciaries' obligation to monitor compliance with federal securities laws become a target for plaintiffs' lawyers? At this point, we do not know. But the risk cannot (again, at this point) be dismissed."

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