ALL POSTS PRIOR TO 2021 HAVE NOT BEEN REVIEWED NOR APPROVED BY ANY FIRM OR INSTITUTION, AND REFLECT ONLY THE PERSONAL VIEWS OF THE AUTHOR.
IRA ROLLOVER DATA GATHERING AND DUE DILIGENCE
UNDER THE U.S. DEPARTMENT OF LABOR’S
BEST INTERESTS CONTRACT EXEMPTION (BICE)
By Ron A. Rhoades, JD, CFP®[1]
Feb. 2017
Since the April 2016 announcement of the U.S. Department of
Labor’s (DOL’s) Final Rule, “Conflicts of Interest” and the associated Best
Interest Contract Exemption rule, increased attention has been focused on
ensuring that rollovers to an individual IRA, from another IRA or from a
qualified retirement plan (QRP), is in the client’s best interests. In addition
to the requirements imposed by the DOL, both the U.S. Securities and Exchange
Commission (SEC) and various state securities regulatory authorities have
increased their scrutiny on IRA rollovers, where a fiduciary duty to the client
(or prospective client) is present. Hence, regardless of whether the DOL's "Conflict of Interest" and related rules are delayed (as I anticipate) and later rescinded or substantially modified, firms should put in place procedures for IRA rollover due diligence determinations.
This memorandum suggests a process for information data
gathering for a QRP-to-IRA rollover, or an IRA-to-IRA rollover, under the DOL’s
Best Interest Contract Exemption ("B.I.C.E.") (effective April 10, 2017, unless delayed as expected). This analysis
incorporates requirements imposed by other sources of law. The suggested process could be adapted to other regulatory regimes, although the requirements imposed upon financial advisors under other regulatory regimes are usually less strict than those applied under B.I.C.E.
A suggested 9-step process is then set forth for the
development of the required due diligence analysis, including possible ways to
document the “value add” of the investment adviser in order to justify the adviser’s
reasonable fees.
A. DOL’s IRA Rollover Requirements,
Generally
When an adviser recommends[2]
to an investor that the investor roll over a qualified retirement plan or a
separate IRA into a new IRA account for which the adviser (or her or his firm)
will receive compensation, the U.S. Department of Labor’s “streamlined
exemption” requirements under its Best Interests Contract Exemption include:
1. Provide the client with a written
statement of the firm’s and the adviser’s status as a fiduciary;
2. Comply with the Impartial Conduct
Standards, which include:
a. The duty of loyalty (i.e., to act in
the investor’s best interests);
b. The fiduciary duty of due care,
augmented by the application of the Prudent Investor Rule;
c. The duty to not charge more than
“reasonable compensation”; and
d. The duty to avoid making statements
that would be misleading at the time they are made; and
3. Undertake an analysis to ensure that
the IRA rollover is in the investor’s best interests, and document that
analysis.[3]
- The DOL’s Written Statement Requirement.
The requirement of providing a
written statement of the firm’s and the adviser’s status as a fiduciary is
easily adhered to. The written statement is not required to be on a separate
form. However, firms should take care to not “hide” the statement of fiduciary
status in long disclosures. Accordingly, I suggest that the statement be found
in either a letter to the client or in an Investment Policy Statement or in any
analysis presented to the client, or other proposal, in which the rollover into
an IRA is suggested. Firms should likely document the receipt by the client of
such written statement; hence, a separate written acknowledgement form may be
utilized (perhaps in conjunction with a prospective client’s receipt of a
firm’s Form ADV Part 2A/2B, privacy policy, and/or other documents).
While no specific language of the
disclosure is required, I suggest the following:
Under U.S. Department of Labor
regulations, (Name of Firm) and its (Financial Advisers, or other title) are
fiduciaries (as that term is defined in the DOL regulations) to you under ERISA
and/or under the Internal Revenue Code with respect to our recommendation to
either rollover or not rollover your qualified retirement plan or IRA account
into an IRA account to be advised upon by our firm, and with respect to any
investment advice provided.
As of the date of this memorandum, it appears that the DOL does not
require level fee fiduciaries to continue to be bound by the Impartial Conduct
Standards following the IRA rollover. This is important, as level fee
fiduciaries would not be bound following
the IRA rollover by the strict dictates of the prudent investor rule.
Hence, unless the DOL changes its prior interpretation, level fee fiduciaries
could add to the last sentence:
“prior to or at the
time of such rollover”
Should you desire to further acknowledge your status as fiduciaries, and
provide an explanation to the client of your fiduciary obligations (as is often
found in firm’s Form ADV, Part 2A), then the following is additional suggested
language that might be included with the disclosure language set forth:
This means that we are required to act in your best interests and with
due care. Further information regarding our fiduciary obligations to you can be
found in our SEC disclosure document (“Form ADV Part 2A”), which is or has been
provided to you.
- The Impact of the Application of the DOL’s Impartial
Conduct Standards, Generally.
The requirements of the Impartial
Conduct Standards are discussed in my separate memorandum, dated Nov. 3, 2016,
titled: “The Key Requirements of the DOL Fiduciary Rules for ‘Level Fee
Advisers.’”
Generally, these requirements
incorporate the general fiduciary duties of due care (augmented by the prudent
investor rule’s strict requirements), loyalty (i.e., act in the best interests
of the client), and utmost good faith (candor, avoidance of misleading
statements). I urge advisers to thoroughly acquaint themselves with the
requirements of the Impartial Conduct Standards, including the requirements of
the prudent investor rule when the Impartial Conduct Standards are to be
applied.
It should be noted that under the DOL
final regulations, the fiduciary duties of advisers are generally not waivable
by the client, nor can such duties be disclaimed by the adviser. While
reasonable limits can be imposed upon the scope of an engagement (for example,
as to the duration of the time during which advice shall be provided), the core
fiduciary duties of due care and loyalty cannot be negated. This is a departure
from the SEC’s general practice in recent years, which has been to permit
waivers and disclaimers provided adequate disclosures are undertaken. The DOL’s
position on the non-use of waivers and disclaimers is more in accord with state
common law for fiduciary relationships of this type; under general fiduciary
law the legal techniques of waiver and estoppel are constrained in
fiduciary-entrustor relationships in which there is a great disparity in either
power or knowledge.
- DOL Data Gathering and Documentation Requirements.
Under BICE, the core data gathering
requirements relate to the requirement to state, in an internal memorandum to
be maintained for six years by the firm, for each IRA rollover, “the specific
reason or reasons why the recommendation was considered to be in the Best
Interest of the Retirement Investor.”
For Qualified Plan to IRA Rollovers. As set forth
in BICE the primary documentation requirements include contrasting between the
investor’s current situation (i.e., maintaining the funds in the current
qualified plan governed by ERISA) and the proposed rollover, and explicitly
include the following:
(1)
the
specific reason or reasons why the recommendation was considered to be in the
Best Interest of the Retirement Investor;
(2)
the
alternatives to undertaking the rollover;
(3)
the
fees and expenses associated with each option;
(4)
whether
the employer pays for some or all of the plan’s administrative expenses; and
(5)
the
different levels of services and investments available under each option.
The DOL, in the first set of FAQs
(dated Oct. 27, 2016) regarding its Conflict of Interest and related rules,
addressed in part the challenges of gathering data from qualified plan
accounts:
Q14. Can an adviser and
financial institution rely on the level fee provisions of the BIC Exemption for
investment advice to roll over from an existing plan to an IRA if the adviser
does not have reliable information about the existing plan’s expenses and
features?
As described in Q13, in the
case of investment advice to roll over assets from an ERISA plan to an IRA, the
streamlined level fee provisions of the BIC Exemption require advisers and
financial institutions to document the reasons why the advice was considered to
be in the best interest of the retirement investor. The documentation must take
into account the fees and expenses associated with both the existing plan and
the IRA; whether the employer pays for some or all of the existing plan’s
administrative expenses; and the different levels of services and investments
available under each option.
To satisfy this requirement,
the adviser and financial institution must make diligent and prudent efforts to
obtain information on the existing plan. In general, such information should be
readily available as a result of DOL regulations mandating plan disclosure of
salient information to the plan’s participants (see 29 CFR 2550.404a-5). If,
despite prudent efforts, the financial institution is unable to obtain the
necessary information or if the investor is unwilling to provide the
information, even after fair disclosure of its significance, the financial
institution could rely on alternative data sources, such as the most recent
Form 5500 or reliable benchmarks on typical fees and expenses for the type and
size of plan at issue. If the financial institution relies on such alternative
data, it should explain the data’s limitations and the written documentation
should also include an explanation of how the financial institution determined
that the benchmark or other data were reasonable.
Although the documentation
requirement is only specifically recited in the level fee provisions of the BIC
Exemption, the documented factors and considerations are integral to a prudent
analysis of whether a rollover is appropriate. Accordingly, any fiduciary
seeking to meet the best interest standard as set out in the exemption would
engage in a prudent analysis of these factors and considerations before
recommending that an investor roll over plan assets to an IRA or other
investment, regardless of whether the fiduciary was a “level fee” fiduciary or
a fiduciary complying with the full BIC Exemption.
For IRA to IRA rollovers, or for any
switch from commission-based account to a level-fee account. The explicit documentation
requirements in BICE are more limited, and include:
(1)
reasons
that the arrangement is considered to be in the Best Interest of the Retirement
Investor; and
(2)
the
services that will be provided for the fee.
As seen above, a greater level of
detail is required for qualified plan to IRA rollovers. However, to determine
if an IRA-to-IRA rollover is in the “best interest” of the investor logically
requires a similar comparative analysis. However, the comparative analysis
might only extend to how the current IRA of the investor is invested (versus a
consideration of all of the alternatives to the rollover), in contrast to how
the IRA will be invested by the firm/adviser following the rollover.
- Requirements Imposed By on IRA Rollovers by Other Laws
and Regulations.
As stated above, the DOL regulations
impose explicit data-gathering and analysis requirements for IRA rollovers,
along with a high standard of due care that encompasses the prudent investor
rule. Yet, other existing laws and regulations impose requirements upon
fiduciaries undertaking an IRA rollover, and these sources of law can be viewed
with an eye to informing the adviser as to the scope of its, her, or his
obligations in connection with IRA rollovers.
1. DOL AO 2005-23A and ERISA’s Duty of Prudence. Previously the DOL issued Advisory
Opinion 2005-23A. This opinion concluded that “a financial planner or
investment manager or adviser, who is selected by a participant to manage the
participant's investments would be liable for imprudent investment decisions
because those decisions would not have been the direct and necessary result of
the participant's exercise of control, even though the participant selected the
person to manage the assets in his or her individual account.”[4]
The Advisory Opinion also stated that “someone who is already a plan
fiduciary responds to participant questions concerning the advisability of
taking a distribution or the investment of amounts withdrawn from the plan,
that fiduciary is exercising discretionary authority respecting management of
the plan and must act prudently and solely in the interest of the participant.
Moreover, if, for example, a fiduciary exercises control over plan assets to
cause the participant to take a distribution and then to invest the proceeds in
an IRA account managed by the fiduciary, the fiduciary may be using plan assets
in his or her own interest, in violation of ERISA section 406(b)(1).”[5]
ERISA’s duty of prudence requires that a fiduciary discharge his duties
“with the care, skill, prudence, and diligence under the circumstances then
prevailing that a prudent man acting in a like capacity and familiar with such
matters would use in the conduct of an enterprise of a like character and with
like aims.”[6]
2. FINRA Regulatory Notice 13-45. FINRA’s Regulatory Notice 13-45
provides that a recommendation that an investor roll over retirement plan
assets to an IRA typically involves securities recommendations subject to FINRA
rules. A firm’s marketing of its IRA services also is subject to FINRA rules.
Any recommendation to sell, purchase or hold securities must be suitable for
the customer and the information that investors receive must be fair, balanced
and not misleading.”[7]
FINRA goes on to state: “A recommendation to roll over plan assets to an IRA
rather than keeping assets in a previous employer’s plan or rolling over to a
new employer’s plan should reflect consideration of various factors, the
importance of which will depend on an investor’s individual needs and
circumstances.”[8]
Noting that its list is not “exhaustive” and that other considerations may
exist in specific circumstances, FINRA then sets forth the following specific
factors that should be considered in connection with the rollover:
a. Investment Options—An IRA often
enables an investor to select from a broader range of investment options than a
plan. The importance of this factor will depend in part on how satisfied the
investor is with the options available under the plan under consideration. For
example, an investor who is satisfied by the low-cost institutional funds
available in some plans may not regard an IRA’s broader array of investments as
an important factor.
b. Fees and Expenses—Both plans and IRAs
typically involve (i) investment-related expenses and (ii) plan or account
fees. Investment-related expenses may include sales loads, commissions, the
expenses of any mutual funds in which assets are invested and investment
advisory fees. Plan fees typically include plan administrative fees (e.g.,
recordkeeping, compliance, trustee fees) and fees for services such as access
to a customer service representative. In some cases, employers pay for some or
all of the plan’s administrative expenses. An IRA’s account fees may include,
for example, administrative, account set-up and custodial fees.
c. Services—An investor may wish to
consider the different levels of service available under each option. Some
plans, for example, provide access to investment advice, planning tools,
telephone help lines, educational materials and workshops.
d. Similarly, IRA providers offer
different levels of service, which may include full brokerage service,
investment advice, distribution planning and access to securities execution
online.
e. Penalty-Free Withdrawals—If an
employee leaves her job between age 55 and 59½, she may be able to take
penalty-free withdrawals from a plan. In contrast, penalty-free withdrawals
generally may not be made from an IRA until age 59½. It also may be easier to
borrow from a plan.
f. Protection from Creditors and Legal
Judgments—Generally speaking, plan assets have unlimited protection from
creditors under federal law, while IRA assets are protected in bankruptcy
proceedings only. State laws vary in the protection of IRA assets in lawsuits.
g. Required Minimum Distributions—Once
an individual reaches age 70½, the rules for both plans and IRAs require the
periodic withdrawal of certain minimum amounts, known as the required minimum
distribution. If a person is still working at age 70½, however, he generally is
not required to make required minimum distributions from his current employer’s
plan. This may be advantageous for those who plan to work into their 70s.
h. Employer Stock—An investor who holds
significantly appreciated employer stock in a plan should consider the negative
tax consequences of rolling the stock to an IRA. If employer stock is
transferred in-kind to an IRA, stock appreciation will be taxed as ordinary
income upon distribution. The tax advantages of retaining employer stock in a
non-qualified account should be balanced with the possibility that the investor
may be excessively concentrated in employer stock. It can be risky to have too
much employer stock in one’s retirement account; for some investors, it may be
advisable to liquidate the holdings and roll over the value to an IRA, even if
it means losing long-term capital gains treatment on the stock’s appreciation.
3. State Common Law; Procedural vs. Substantive Due Care;
Waivers of the Duty of Due Care. Outside of the realm of ERISA, the Investment Advisers Act
of 1940 does not contain a private right of action. Hence, fiduciary breach causes
of action against investment advisers are based upon state common law (i.e., the law derived from reported cases).
While, due to arbitration, a large number of reported court decisions do not exist
under which the boundaries of the common law duties of due care of a financial
or investment adviser have been determined, some general principles can be derived
from similar fiduciary-entrustor relationships in which either fiduciary
investment decisions are made (such as trustee-beneficiary relationships) or
professional advice is provided (such as attorney-cleint relationships).
a. General Duty of Due Care. Due care requires a member to
discharge professional responsibilities with competence and diligence. It imposes the obligation to perform
professional services to the best of an investment adviser’s ability with
concern for the best interest of those for whom the services are performed. The
duty of due care is that of the prudent expert (i.e., prudent financial or
investment adviser), not that of the common man.
b. Procedural vs. Substantive Due Care,
Generally. The duty
of due care has been considered to involve both process and substance. That is, in reviewing the conduct of an
investment adviser in adherence to the investment adviser’s fiduciary duty of
due care, a court would likely review whether the decision made by the
investment adviser was informed (procedural due care) as well as the substance
of the transaction or advice given (substantive due care). Procedural due care is often met through the
application of an appropriate decision-making process, and judged under the
standard, not (necessarily) by the end result.
Substantive due care pertains to the standard of care and the standard
of culpability for the imposition of liability for a breach of the duty of care.
c. Substantive Due Care. The duty of due care is measured by
the ordinary negligence standard. However, the standard of prudence is
relational, and it follows that the standard of care for investment advisers is
the standard of a prudent investment adviser. By way of explanation, the
standard of care for professionals is that of prudent professionals; for
amateurs, it is the standard of prudent amateurs. For example, Restatement of
Trusts 2d § 174 (1959) provides: "The trustee is under a duty to the beneficiary
in administering the trust to exercise such care and skill as a man of ordinary
prudence would exercise in dealing with his own property; and if the trustee
has or procures his appointment as trustee by representing that he has greater
skill than that of a man of ordinary prudence, he is under a duty to exercise
such skill." Case law strongly supports the concept of the higher standard
of care for the trustee representing itself to be expert or professional,[9]
and in this author’s view similar principles are likely to be applied to
fiduciaries under state common law.
d. Procedural Due Care.
One must evaluate the duty of care, unlike the duty of loyalty, by the
process the fiduciary undertakes in performing his functions and not the
outcome achieved. The very word “care” connotes a process. One associates
caring with a condition, state of mind, manner of mental attention, a feeling,
regard, or liking for something. How else may one determine whether an
investment adviser who regularly achieves below average returns, or an attorney
who loses most cases, has performed his duty of care? It is only through
evaluating the steps the fiduciary took while doing his job, and not whether
they resulted in success, that one may judge whether the fiduciary has breached
his duty.
i. Due to the difficulty of evaluating
the behavior of fiduciaries, most often courts turn to an analysis not of the
advice that was given but rather to the process by which the advice was derived.
ii. Nevertheless, while adherence to a
proper process is also necessary, at each step along the process the Investment
adviser is required to act prudently with the care of the prudent investment
adviser. In other words, the investment adviser must at all times exercise good
judgment, applying his or her education, skills, and expertise to the financial
planning issue before the investment adviser. Simply following a prudent
process is not enough if prudent good judgment (and the investment adviser’s
requisite knowledge, expertise and experience) is not applied as well.
iii. For example, various criteria could
be established for the evaluation of mutual funds and exchange-traded funds.
Following the established criteria in contrasting and comparing the benefits of
an IRA rollover would be appropriate, but only if the criteria utilized are
valid. For example, criteria utilized in the selection of pooled investments
should be based upon either fund characteristics that academic research
supports as valid for decision-making, or they should be derived from criteria
produced as a result of the application of common sense.
e. “Good Faith” Alone is Insufficient. Prudence is measured by objective,
not subjective, standards; hence, the “good faith” of the fiduciary is not
pertinent to the determination as to whether due care has been exercised.
“Prudence is thus measured according to the objective ‘prudent person’ standard
developed in the common law of trusts.”[10]
Subjective good-faith simply does not come into play.[11]
“[T]he prudent man standard is an objective standard, and good faith is not a
defense to a claim of imprudence.”[12]
f. Hindsight is Not to be Applied. Note, however, that the courts
recognize that it is simply not possible for a fiduciary to be aware of every
piece of relevant information before making a decision on behalf of the
principal, and a fiduciary cannot guarantee that a correct judgment will be
made in all cases. Moreover, “[t]he ultimate outcome of an investment is not
proof that a fiduciary acted imprudently.”[13]
“[T]he appropriateness of an investment is to be determined from the
perspective of the time the investment was made, not from hindsight.”[14]
g. Determining the Scope of the
Relationship, in the IRA Rollover Context: Can the Scope of Due Care Be
Limited? The
fiduciary duty of due care of a fiduciary adviser is commensurate with the
scope of the relationship. Where the relationship involves the provision of
advice relative to an IRA rollover, given the large number of considerations
that exist (see discussions, above and below) the duty of due care is also
quite broad.
The IRA rollover analysis requires a significant gathering of information
about the client and the source and destination account characteristics and
investment options, as well as the application of expertise, judgment, and effort
by the fiduciary adviser.
Whether the scope of the relationship can be narrowed, such as by
disclaiming the necessity of providing tax advice in connection with an IRA
rollover, or only considering a limited number of facts in the IRA rollover
(when such facts are readily available), is dependent upon state common law’s
views of the limited roles of waivers and estoppel in most fiduciary
relationships in which a great deal of disparity in either power or knowledge
exists.
As seen in the discussion that follows, disclaimers of core fiduciary
duties of due care are disfavored, as are waivers by clients of the core
fiduciary duty of due care, under state common law. While some specific
narrowing of the scope of the fiduciary obligation of due care may be
undertaken, such as by confining the scope of the fiduciary obligation to a
specific time period or event for which advice is to be given, a broad waiver
of the core fiduciary duty of due care is not possible.
i. Why Waivers of the Fiduciary Duty of Due Care Are Not Generally Permitted:
A Case Study. As
evidence of the tremendous difficulty consumers of financial services possess
in understanding financial planning concepts, and the difficulty in making good
decisions even when handed knowledge of investment products, even Wharton MBA
and Harvard students were unable to choose the best S&P 500 Index fund.[15]
As this study confirmed, and as every seasoned financial planner is also aware,
the vast majority of consumers of financial planning services lack the
knowledge to undertake sound financial and investment decisions.
ii. When Bargaining On Issues Related To Waiver, Consumers Must Fend For
Themselves; Specific Procedures Must Be Followed. “While bargaining with their
fiduciaries on the issue of waiver, entrustors must fend for themselves as
independent parties. Their right to rely on their fiduciaries must be
eliminated. In fact, during the bargaining, the entire relationship must be
terminated. Fiduciary law allows such termination of the relationship with
respect to specified transactions only if the parties follow a specific
procedure … In order to transform the fiduciary mode into a contract mode, four
conditions must be met: (1) entrustors must receive notice of the proposed
change in the mode of the relationship; (2) entrustors must receive full
information about the proposed bargain; (3) the entrustors' consent should be
clear and the bargain specific; (4) the proposed bargain must be fair and
reasonable. Thereafter, two other general bargaining conditions apply. One
relates to consenting parties: entrustors must be capable of independent will. The
other relates to the subject matter of the bargain: the proposed bargain must
not cover non-waivable duties.”[16]
iii. Any Attempt at Waiver Must Be Accompanied by Information Necessary for
the Client’s Informed Decision. “Fiduciaries must provide entrustors material information
necessary for the entrustors to make an informed decision regarding the waiver.
This is necessary because, in contrast to contract law, there is no assumption
in fiduciary law that the parties' information about the proposed waiver or
bargain is symmetrical. Asymmetrical information among the parties to a
fiduciary relationship results both from the nature and from the purpose of the
relationship. Fiduciaries possess far more information about their own
activities ….”[17]
iv. Lacking Adequate Consideration, The Validity of Informed Consent Is
Highly Suspect, Especially With Respect to Broad Waivers of Rights. “Because the bargain or waiver is
more likely to be in the fiduciaries' interests, but less likely to be in the
entrustors' interests, the consent, by entrustor's action or inaction, must be
clear. [The] [f]iduciary dut[y] of … care [is a] broad standard rule … in many
cases, a broad waiver of duties is bound to be uninformed and speculative.
Waivers of specific claims or level of losses will be more readily upheld … A
broad waiver of the underlying duties of the [fiduciary] might not be enforced.”[18]
v. Substantive Fairness Must Exist for a Waiver to be Valid. “Even if above requirements are met,
courts will generally not enforce an unfair or unreasonable bargain, but will
require a showing that the transaction is fair and reasonable … A second reason for doubting the
voluntariness of an apparent consent to an unfair transaction could be a
lingering suspicion that generally, when entrustors consent to waive fiduciary
duties (especially if they do not receive value in return) the transformation
to a contract mode from a fiduciary mode was not fully achieved. Entrustors,
like all people, are not always quick to recognize role changes, and they may
continue to rely on their fiduciaries, even if warned not to do so. Lack of
fairness may also signal the absence of more or less equal bargaining power by
the entrustor….”[19]
4. The Duty of Due Care Under the Investment Advisers Act, as
Applied by the SEC. Generally, the Advisers Act incorporates the state common law duties of
loyalty, due care, and utmost good faith.[20]
However, in Santa Fe Industries, Inc. v.
Green, the U.S. Supreme Court stated that although the SEC vs. Capital Gains
Research Bureau case involved a statute, the Advisers Act’s reference to
fraud and the principle of equity implies that Congress intended to establish
“federal fiduciary standards.”[21]
In connection with an investment adviser’s duty of due care, the SEC has
provided the following guidance:
a. “An adviser must have a reasonable,
independent basis for its recommendations.”[22]
b. “Investment advisers owe their
clients the duty to provide only suitable investment advice. To fulfill the obligation,
an adviser must make a reasonable determination that the investment advice
provided is suitable for the client based on the client’s financial situation
and investment objectives.”[23]
i. The SEC has also opined, in applying
the doctrine of suitability, that “[o]btaining
a customer’s consent to an unsuitable transaction does not relieve a
broker-dealer of his obligation to make only suitable recommendations under the
SRO rules.”[24] The
federal fiduciary duty of due care arising under the Advisers Act would mostly
likely be interpreted by the SEC in the same fashion, in that the suitability
obligation, at a minimum, would not be subject to waiver by the client of a
fiduciary investment adviser.
c. “The investment adviser must disclose
its investment process to clients. For example, Item 8 of Form ADV Part 2A
requires an investment adviser to describe its methods of analysis and
investment strategies, among other things. This item also requires that an
adviser explain the material risks involved for each significant investment
strategy or method of analysis it uses and particular type of security it
recommends, with more detail if those risks are significant or unusual.”[25]
d. As a fiduciary, an investment adviser
has “a duty of care requiring it to make a reasonable investigation to
determine that it is not basing its recommendations on materially inaccurate or
incomplete information.”[26]
e. The Advisers Act “does not require an
adviser to follow or avoid any particular investment strategies, nor does it
require or prohibit specific investments.”[27]
These expressions by the SEC of the Advisers Act’s duty of due care
should not be interpreted as the boundaries of the duty of due care. Future SEC
regulations, guidance, or examination findings may provide further insight into
the specific duties investment advisers face in connection with IRA rollovers,
when applying the Advisers Act.
Additionally, it should be noted that the SEC has in recent decades
permitted investment advisory firms to disclaim away, and/or have clients waive,
some of the fiduciary duties that may otherwise exist. Whether this
interpretation of the Advisers Act continues indefinitely into the future is
uncertain, especially given the SEC’s increased focus on the retirement accounts
of individual investors and the ever-changing composition of the Commission
itself.
5. Current SEC Exam Priorities: Retirement Accounts. In June 2015, the SEC’s Office of
Compliance, Inspections and Examinations (OCIE)] launched a multi-year
examination initiative, “ReTIRE,” focusing on SEC-registered investment
advisers and broker-dealers and the services they offer to investors with
retirement accounts.” In its “Examination Priorities for 2016” OCIE indicated
that it “will continue this initiative, which includes examining the reasonable
basis for recommendations made to investors, conflicts of interest, supervision
and compliance controls, and marketing and disclosure practices.”[28]
While OCIE’s 2017 examination priorities have not yet been released, investment
advisers can expect continued scrutiny on IRA rollovers.
- Plan Consultant Suggestions to Not Undertake An IRA
Rollover. Investment
consultants to plan sponsors increasingly suggest, through various
educational materials, that plan participants not engage in IRA rollovers
and, instead, retain the assets in the qualified retirement plan.
Ostensibly this benefits the investment consultant, if fees are tied to
the amount of funds in the plan, by retaining assets. From the plan
sponsor’s standpoint, this only increases the amount of potential
liability should a class-action claim later be asserted, and this may
increase the plan sponsor’s costs if it is directly paying for any of the
plan’s expenses.
The literature on IRA rollovers has been an increased focus of SEC
scrutiny. However, in this author’s review of various brochures and online
information, it is apparent that the advantages and disadvantages of qualified
retirement plan to IRA rollovers are presented quite differently, depending
upon whether the firm authoring the brochure would benefit – or not benefit –
from the IRA rollover.
For example, the excerpt from one brochure, found below and on the next page,
sets forth the “Advantages” and “Disadvantages” of leaving assets in a plan,
versus an IRA rollover, from the perspective of one firm.[29]
Similar disclosures, albeit with greater discussion of the advantages and
disadvantages and perhaps more specific to the specific client, should exist
within any analysis presented in connection with an IRA rollover.
- What Role Does
the Plan Sponsor Have in Connection with IRA Rollovers?
An American Bar Association Section of Taxation 2014 newsletter article,
directed at plan sponsors, concludes that the plan sponsor should be more
greatly involved in distribution decisions by plan participants, including IRA
rollovers:
First, a decision to make a rollover IRA should not be
made lightly, wantonly or unadvisedly: the decision has very important
ramifications for the individual’s future financial security. Even a modest
rollover by a young individual may feature largely when he or she comes to
retire. Second, plan fiduciaries should consider taking steps to explain better
the options available to a participant taking a distribution and to monitor the
types and sources of advice he or she receives in connection with the distribution.
Such precautions may help the participant make a better decision and may also
protect the fiduciary against claims that it failed to satisfy its responsibilities
under ERISA.[30]
While the foregoing recommendation
that plan sponsors “monitor the types and sources of advice” a plan participant
receives in connection with the distribution,” there is no discussion of how
such a monitoring process would be put in place. Any such attempt at
monitoring, given the large number of sources of IRA advice, would seem to
impose an unrealistic and unattainable obligation on the plan sponsor.
Moreover, while a handout or other education listing of general considerations
a plan participant should consider would appear a prudent measure that could be
undertaken by plan sponsors, the inference that a plan sponsor possesses a duty
under ERISA to monitor the advice received by plan participants in connection
with IRA rollovers is not supported by the case law.
The same article goes on the list some
of the advantages and disadvantages of IRA Rollovers:
Advantages and Disadvantages of Rollovers
An IRA rollover has several advantages. It severs the
tie with the former employer, gives the participant the greatest degree of
control, and makes it possible for the participant to take irregular
distributions or to stretch-out distributions to the greatest extent allowed by
the age 70½ minimum distribution rules. However, there are also significant
disadvantages, which are often not fully understood by the participant. First, the
participant is now responsible for the successful long-term investment of the
funds, generally with no review of available options by a fiduciary. Second,
the participant must avoid engaging in any prohibited transaction, as that would
trigger immediate taxation of the entire account. I.R.C. §408(e)(2). Figuring
out how the prohibited transaction rules apply to IRAs is fiendishly difficult,
and many IRA owners succumb to the siren calls of exotic investment vehicles
(bull semen, anyone?). Third, the individual no longer has the benefit of the
ERISA fiduciary responsibility rules, as many victims of Ponzi schemes
discovered to their chagrin. Most cases have held that the duties of an IRA
custodian are limited to those it accepted in its contract with the IRA owner,
a contract almost always drafted by the custodian. Attempts by the DOL and the
SEC to extend fiduciary rules to IRAs and broker-dealers are highly
controversial and appear to be bogged down for the time being. Fourth, employer
plans often offer lower fees, typically provide more transparent fee disclosures,
and give better access to advice.[31]
Again, the article appears to paint a
bleak picture of the risks pertaining to an IRA rollover. This is especially so
since in 2014 many “retirement consultants” to plan sponsors did not assume
fiduciary status; this resulted (and continues to result) in class-action
claims against plan sponsors in which the “retirement consultant” (i.e., insurance company or
broker-dealer, and its agents) is not held accountable for the advice provided
as the standard of care deemed applicable is the low standard of suitability.
One might conclude that while plan
sponsors might possess the duty to educate, generally, plan participants about
IRA rollovers in as objective a manner as possible, such as through brochures
highlighting the advantages and disadvantages of IRA rollovers, no duty likely
exists to “monitor” advice provided by third-parties to plan participants in
connection with a planned QRP to IRA rollover.
- Due Diligence Checklist for QRP/IRA Rollovers to IRA
Accounts for Fiduciaries.
Considering all of the foregoing, the
following items might be included in a checklist for a QRP-to-IRA, or IRA-to-IRA,
rollover due diligence analysis. This checklist is set forth on the pages that
follow.
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IRA Rollover Due Diligence Checklist
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STEP ONE: GATHER
INFORMATION FOR THE SOURCE QRP OR SOURCE IRA ACCOUNT.
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QRP/IRA: Obtain Client’s
Current Holdings. A
list of the prospective client’s current holdings in the QRP or IRA account
should be obtained. Often the plan participant or IRA account holder can
produce this by accessing current holdings information online and providing
an up-to-date statement. At other times the plan participant can provide
her/his last quarterly statement). Prospective clients could also provide a
view of the client’s holdings through account aggregation solutions. For
example, this author utilizes BlueLeaf (www.BlueLeaf.com),
which enables prospective clients to link their accounts to the software;
this permits an integrated view of a client’s holdings, as well as
account-specific views. Generally, unless the information is provided in
other documents, the adviser should ask a participant for his most recent
quarterly statement, which should reflect any expenses being charged against
the participant’s account, as well as how the participant is invested and the
account balance.
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QRP: Ascertain
Loan Amounts.
Ascertain if any loans are currently outstanding against the QRP assets by
the prospective client.
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QRP: Ability of
Prospective Client to Stay with the QRP. Some employers require retired plan participants
to depart from the plan within a certain period of time, or by a certain age.
This information is best found in the Summary Plan Document (SPD) for the
plan, which should be available upon request from the plan administrator (or
plan sponsor).
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QRP: Available
Investments.
Obtain a list of all available investments inside the QRP. Specific attention
should be given to ascertaining whether a Guaranteed Investment Contract
exists within the QRP, and if so both the current rate provided by such
G.I.C. and the liquidity constraints imposed.
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QRP: Employer
Stock. In
connection with the foregoing, the adviser should ascertain if any of the
current holdings in the QRP constitute employer stock.
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QRP: Annuitization
Options.
Ascertain the annuitization options that exist within the QRP.
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QRP: Fees Charged
to Plan Participants. Ascertain the fees charged by third-party administrators,
recordkeepers, and/or retirement plan consultants and/or investment advisers
(other than the investment product fees themselves), that are borne by the
plan participant.
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QRP: Services
Provided by Plan Sponsor. The services provided to plan participants, and any additional fees
charged for such services, which might include but not limited to: (a)
investment educational materials or web sites; (b) educational seminars (and
a summary of the content thereof); (c) asset allocation software, if any; and
(d) financial planning advice – in-person or via software or online portals,
if any.
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IRAs/QRPs:
Investment Policy (Statement). A determination should be undertake as to whether an
investment policy and/or strategy is utilized in connection with the
prospective client’s current investments, such as may be found in a “model
portfolio” suggested by the plan’s investment adviser, or as may be utilized
within a target date (or similar) fund utilized by the prospective client, or
as otherwise may have been suggested to or be utilized by the prospective client.
If an Investment Policy Statement was prepared for the prospective client, a
copy of this document should be obtained.
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STEP
TWO: GATHER INFORMATION ABOUT THE PROSPECTIVE CLIENT.
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Obtain information sufficient to formulate personal
financial statements for the client, to inform the strategic asset
allocation, and to determine suitability.
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Personal
Information.
The prospective client’s name, address, and date of birth should be obtained.
Ideally the names and dates of birth of the prospective client’s spouse,
children, grandchildren, and other close family members and friends (and
pets, too!) should also be obtained.
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Discover the
Prospective Client’s Personal Values and Goals. The prospective client’s
accumulation of wealth is not an end, but rather a means. Hence, ascertaining
the prospective client’s lifetime financial goals is required. This, in turn,
informs the determination of future levels of expenses.
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Personal Health. The presence of any medical
conditions that might influence the prospective client’s ability to
accomplish their goals, and/or affect their life expectancies, should be
explored.
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Statement of
Personal Net Worth.
Enough information should be gathered so that you can summarize the prospective
client’s current assets and liabilities. Liquid assets should be
distinguishable from illiquid or personal use assets. Information on
liabilities, such as interest rate, fixed or variable, payment amount, months
to payoff, and tax-deductibility of interest, should be set forth.
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Statement of
Projected Income and Expenses. Determining an asset allocation for a prospective
client is highly dependent upon the prospective client’s need for funds.
This, in turn, is driven by the client’s projected income, from all sources,
and projected expenses – both currently and during retirement years.
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Complete a RIsk
Tolerance Questionnaire with the Prospective Client. While the ability of such
questionnaires to properly measure a client’s risk tolerance is questionable,
given various behavioral biases individual investors possess, the changing
investment educational level of the client as the process of advising is
undertaken, and the limitations of any set of questions (as to both number,
quality, and understandability), the answers to a risk tolerance
questionnaire will nevertheless provide information that can inform the
determination of a proper strategic asset allocation for the client. Some
state securities regulators require an RTQ, as does the DOL in both the BICE
and streamlined BICE exemptions.
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STEP
FOUR: ANALYZE THE CURRENT INVESTMENT STRATEGY.
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Undertake an
analysis of the client’s current investment strategy.
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STEP
FIVE: ANALYZE THE CURRENT INVESTMENTS (AVAILABLE OR UTILIZED).
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QRPs Only. If the prospective client is
retiring from the company, or has already retired, determine whether the plan
sponsor allows the prospective client to remain with the QRP, and for how
long.
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QRPs Only. Assess any guaranteed investment
contract that provides a fixed return for a period of time with no interest
rate risk. Determine the financial strength of the insurance company
providing this guarantee.
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QRPs Only. Assess and summarize the
characteristics of any lifetime annuitization or other annuitization options
within the qualified retirement plan.
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QRPs Only. Undertake and summarize an
assessment of the Target Date Fund that is most likely to be suitable for the
client. Include a summary of its current asset allocation, fees, and costs.
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QRPs and IRAs. Undertake and summarize an
assessment of each mutual fund, ETF or other investment vehicle currently
utilized by the client.
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QRPs: Services,
Fees, and Costs.
Summarize the services (including but not limited to investment education,
investment advice, distribution mechanisms) of the qualified retirement plan,
as well as the fees and costs associated with such services.
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STEP
SIX. SET FORTH THE INVESTMENT STRATEGY FOR THE DESTINATION IRA.
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STEPS SIX, SEVEN AND EIGHT COULD BE
UNDERTAKEN ONCE BY AN ADVISER, AND UPDATED ANNUALLY. VARIOUS OPTIONS COULD
EXIST THAT PERMIT EASY CUSTOMIZATION FOR PARTICULAR CLIENTS.
Minimize
Idiosyncratic Risk in Your Investment Policy Design. In accordance with the
requirements of the prudent investor rule, your investment strategy should be
designed and be able to minimize idiosyncratic risk through broad
diversification among securities.
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Implementation
Through Low-Cost Investment Securities/Products Should Be Available. Your investment strategy should
be able to be implemented through investment securities or other investment
or insurance products that possess relatively low costs. There are several
investment strategies that possess academic support but which may not be
“investable” due to high costs associated with their implementation.
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Investment Policy
Statement. It
is recommended that a summary of the firm’s investment strategy be set forth
in an Investment Policy Statement (IPS) prepared for the client.
At a minimum, the firm’s Form ADV, Part 2A should
describe the firm’s main investment strategies. This description is usually
in less detail than that provided in an IPS, however.
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Possess Proper
Evidentiary Support for Your Recommended Investment Policy. Set forth a summary of the
generally accepted academic research, back-testing, or a reliable and robust
intellectual analyses that provides the basis for your own investment policy
recommendations.
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STEP
SEVEN. SET FORTH THE MATERIAL FACTS REGARDING EACH SPECIFIC INVESTMENT
RECOMMENDED FOR THE PROSPECTIVE CLIENT.
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Summarize Fees,
Costs of Investment Products Recommended. Set forth the specific investment securities or
products to be utilized in the rollover IRA, and discuss how the strategy and
the specific securities meet the prudent investor rule’s requirements to
minimize idiosyncratic risks and meet the duty to avoid waste (as to fees and
costs).
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STEP
EIGHT. SET FORTH YOUR SERVICES, FEES, AND VALUE PROPOSITION.
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Undertake
Benchmarking of Your Firm’s Services and Fees. Benchmarking of investment
adviser fees against the fees charged by firms offering the same or similar
services is required under BICE. While there is no requirement that the
adviser charge the lowest fee in the marketplace, the adviser’s fees must be “reasonable”
given the level of services provided. There is no requirement that the
results of your benchmarking be furnished to the client.
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Articulate and Set
Forth In Writing Your “Value Proposition.” Why are your fees justified? Your value
proposition should be unique to you, and to the services that you provide.
Many different resources are available on how to articulate your value
proposition; I set forth some below.
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Value Proposition
– From Mitch Anthony:
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“Your value
proposition needs to communicate: • Who you are. • What you do (not how you do it). • What
problem you solve. (You want people to say, “This is exactly what I am
looking for.”) • Who your ideal client is. • Why your approach is more
valuable than other approaches. • Why you can help people reach their goal.
(After all, this is your core competency.)” - Teresa Riccobuono, “Your Value
Proposition: A Precursor to the Elevator Pitch,” Advisor Perspectives (June 4, 2013).
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Brooke Southhall. The editor of RIABiz once
wrote: “The RIA’s ultimate value proposition, therefore, is your belief that
it is your destiny as one to help clients realize theirs.” See http://riabiz.com/a/2011/10/28/what-is-the-value-proposition-of-a-financial-advisor-and-how-is-a-budding-ria-culture-upping-the-ante
Investment Policy
Statement Inclusion. A best practice would be to include your value proposition as part
of the Investment Policy Statement, or perhaps in another document (such as
your Client Services Agreement). In this regard, a more generalized statement
of your value proposition might be more appropriate; care should be taken to
neither promise nor guarantee any quantified “alpha” or “gamma” to the
client.
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Cite to Vanguard’s
Advisor’s Alpha.
See “Putting a value
on your value: Quantifying Vanguard Advisor’s Alpha®.” Vanguard Research
(2016). The full report should be retrieved from: https://www.vanguard.com/pdf/ISGQVAA.pdf
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David Blanchett,
CFA and Paul Kaplan – Morningstar’s Gamma. Their 2014 paper, “Alpha, Beta, and Now…Gamma,” is available at https://corporate1.morningstar.com/uploadedFiles/US/AlphaBetaandNowGamma.pdf. In a later article, David Blanchett wrote: “We
focused on five areas in which advisors can add significant value: (1) Taking
a total wealth framework to determine the optimal asset allocation; (2) Using
a dynamic approach to determine the appropriate portfolio withdrawal in
retirement; (3) Incorporating guaranteed income products (such as annuities)
in an optimal way; (4) Allocating to investment vehicles to maximize tax
efficiency; and (5) Optimizing investment portfolios to incorporate liabilities
(such as the amount of savings needed to properly fund retirement). We showed
that each of these five gamma components creates value for retirees. When
combined, they can be expected to generate 23% more income on a
utility-adjusted basis when compared to a naïve strategy. This additional
income is equivalent to an arithmetic “alpha” of 1.59 percentage points. We
called this gamma-equivalent alpha, and it represents a significant potential
increase in portfolio efficiency (and retirement income) for retirees.”
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STEP
NINE. UNDERTAKE THE COMPARATIVE ANALYSIS.
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KEY PRELIMINARY CONSIDERATIONS IN THE COMPARATIVE
ANALYSIS. The final step in your analysis is comparing your
analysis of the client’s existing QRP options, or IRA account, to the
investment policy and investment products that you recommend, as well as the
services the client currently receives to the services you provide.
Annuitization
Analysis. I
suggest that any analysis include the adviser’s perspective on whether
lifetime annuitization is a worthwhile option for the client to consider.
Contrasting any options available inside the QRP with those typically
recommended by the adviser should be undertaken. In such connection,
insurance company financial strength is a key consideration, and Comdex
scores should (at a minimum) be set forth in the analysis for each insurance
company providing the annuity under consideration. Such an analysis might
also includE an evaluation of the single life, spousal (with and without
reduced benefits to the survivor), term certain, and combinations of the
foregoing, and include further an evaluation of the possible use of CPI
adjustments in the annuity contract to keep pace with increased spending
needs, and might further include the possible use of a staggered approach to
annuitization, and might also include the available of deferred annuities
with payouts commencing at later ages, and including further the risks and
return characteristics of certain annuities, the costs and fees associated
with same, the possible applicability of premium taxes, the various riders
which might be employed and their costs and benefits and limitations
G.I.C. Analysis. Another key component of any
analysis will involve consideration as to whether to use the G.I.C. contract
present in a prospective client’s QRP for a portion of the client’s fixed
income allocation. If so, a partial IRA rollover may be prudent, rather than
a complete IRA rollover.
401(k) Loan
Analysis. If
the prospective client has a loan against his or her QRP, the analysis should
include whether, and how, such loan will be retired.
Liquidity
Analysis. If
the prospective client is not yet age 59½, consideration should be given as
to whether the current QRP loan provisions, if any, might be utilized in the
future as a means of providing interim support, whether a 72(t) election
should be undertaken (and if so, how), and/or whether the QRP plan permits
penalty-free withdrawals at age 55 and thereafter. Greater attention might be
paid to the issue of liquidity where the client possesses an inadequate cash
reserve and/or no access to a home equity or other line of credit should a
future short-term need for cash arise, and if the client does not possess
savings/investments in nonqualified accounts.
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Fees/Cost Comparisons, Taking Into Account Differences
in Education and Other Services Provided. This may form the core of the comparative
analysis. There is no magic format for such an analysis. But with your value
proposition in hand, it should become apparent to most financial advisers
that they can provide a higher level of service than that received by a
prospective client who is in a qualified retirement plan, and that the value
added by their services and advice more than justifies the reasonable fees
charged for those services. [This author provides a free “second opinion” to
most prospective clients. This second opinion includes a comparison of the
client’s existing and proposed portfolios under three primary considerations:
(1) asset allocation (and expected gross returns); (2) fees and costs (and
expected net returns, as a result) utilizing a “total fees and costs”
spreadsheet which includes (for pooled investments) an estimate of
implementation shortfall costs (resulting from transactions within a fund)
and any offsets from estimated securities lending revenue; and (3) portfolio
tax efficiency observations. These are followed by a summary of the adviser’s
value proposition to the client.]
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Other Material Tax/Financial Planning Issues. Part of such a comparative analysis might include the broad variety
of financial and/or tax strategy issues that might be present or might arise.
If such considerations significantly impact the other portions of the
adviser’s value proposition, they would be appropriate for at least a general
discussion. Otherwise, an adviser might simply point out that he/she will
consider these other considerations if the prospective client proceeds to
engage the adviser. Such additional considerations are summarized below.
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Protection from
Creditors and Legal Judgments—Generally speaking, plan assets have unlimited
protection from creditors under federal law, while IRA assets are protected
in bankruptcy proceedings only. QRPs, SIMPLE IRAs, SEP IRAs, and rollover
traditional IRAs are protected in bankruptcy proceedings regardless of
amount; contributory IRAs and Roth IRAs and rollovers from SIMPLE IRAs and
SEP IRAs are protected in bankruptcy proceedings only up to $1,283,025 (as of
April 1, 2016; the amount is increased annually to reflect inflation,
annually). For a more detailed discussion, see http://www.wickenslaw.com/wp-content/uploads/2014/09/Handout-Protection-of-IRA-Qualified-Retirement-Plan-Assets-After-Clark-v-Rameker-8-19-14.pdf.
State laws vary in the protection of IRA
assets in lawsuits, outside of bankruptcy proceedings. The laws for the
client’s likely state of domicile should be researched. See http://www.thetaxadviser.com/content/dam/tta/issues/2014/jan/stateirachart.pdf
(2014).
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Continued
Employment and Required Minimum Distributions—Once an individual reaches age
70½, the rules for both plans and IRAs require the periodic withdrawal of
certain minimum amounts, known as the required minimum distribution. If a
person is still working at age 70½, however, he generally is not required to
make required minimum distributions from his current employer’s plan, if he
is still working. This may be advantageous for those who plan to work into
their 70s.
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Employer Stock—An investor who holds
significantly appreciated employer stock in a plan should consider the
negative tax consequences of rolling the stock to an IRA. If employer stock
is transferred in-kind to an IRA, stock appreciation will be taxed as
ordinary income upon distribution. The tax advantages of retaining employer
stock in a non-qualified account should be balanced with the possibility that
the investor may be excessively concentrated in employer stock. It can be
risky to have too much employer stock in one’s retirement account; for some
investors, it may be advisable to liquidate the holdings and roll over the
value to an IRA, even if it means losing long-term capital gains treatment on
the stock’s appreciation.
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SIMPLE IRA Early
Distribution Penalty. – The 2-year-from-inception restriction on distributions from
SIMPLE IRA accounts should be considered, when pertinent.
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Additionally, this author notes that the prudent
investor rule generally requires that the adviser consider the other accounts
and property of the client. These aspects of the due diligence analysis also
highlight possible additional reasons that justify professional management of
a client’s accounts – at least these aspects of financial and tax planning
are integrated with, or provided alongside, the investment advisory services.
These considerations include, but are not limited to, the following:
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PRESENTATION
OF RECOMMENDATIONS TO THE CLIENT.
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There is no requirement to present the analysis so
undertaken to the client. Indeed, I don’t recommend presenting such a
comprehensive analysis to the client, as it may merely provide fodder for a plantiff’s
attorney.
However, under DOL regulations, the IRA rollover
analysis should be retained in the adviser’s files for six years.
Instead, presenting a proposed Investment Policy
Statement, proposed Client Services Agreement, and a cover letter summarizing
the analysis, recommendations, and value proposition, would be more
appropriate.
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In summary, the
analysis of an IRA rollover is not an easy process. A multitude of
considerations are present. Some of these considerations can be delayed for
more complete analysis after the prospective client has engaged the adviser,
while other aspects of the analytical process must be addressed when
recommending an IRA rollover.
However, much of the analysis
regarding the firm’s own investment policy, investment recommendations,
services, fees, and value proposition (see Steps 6-8 above) can be utilized
over and over again.
Additionally, firms who deal with multiple
IRA rollovers from the same QRPs are likely to be able to streamline their IRA
rollover analysis, at least with respect to those plans.
Larger firms are likely to form units
dedicated to time-efficiently producing IRA rollover analyses.
Some firms will need to hire
additional staff to undertake IRA rollover analyses. Such work might be most
suitable for new graduates of undergraduate financial planning baccalaureate
degree programs, as part of an introductory residency or initial training
program. In addition, interns might be utilized.
Author’s shameless plug … If you are looking for top-quality graduates or (paid)
interns, Western Kentucky University (Bowling Green, KY) graduates a few dozen
each year. Most of our students are originally from the Midwestern and Southern
states (Florida to Virginia, to Illinois, to Louisiana, and then to Georgia).
However, many of our graduates are also open to practicing in the Western or Northeast
regions. Drop me a line if you have a current job opening for a new financial /
investment adviser. Email: ron.rhoades@wku.edu.
Thank you!
--------------------------------------------------------
As always, if you have any suggestions for revised or additional content
for this memorandum, please e-mail me at your convenience. Ron Rhoades: ron.rhoades@wku.edu.
THANK YOU.
[1] Ron A. Rhoades, JD, CFP® serves as Director
of the Financial Planning Program for Western Kentucky University’s Gordon Ford
College of Business. He is an Assistant Professor – Finance, an attorney, an
investment adviser, and a frequent writer on the fiduciary standard as applied
to financial services. A frequent speaker at national and regional conferences,
he also serves as a consultant to firms on the application of the DOL Conflict
of Interest Rules, fiduciary law, and related issues. This article represents
his views only, and not those of any institution, firm or organization with
whom he may be associated. This article
is believed to be correct at the time it is written; subsequent laws,
regulations, and/or developments regarding the interpretation or enforcement of
ERISA, the I.R.C., and DOL regulations should be consulted. Please
direct all questions and requests via email: Ron.Rhoades@wku.edu
[2] The DOL, in its first set of FAQs (dated Oct. 27,
2016) on the rules, stated:
Q4. Is compliance with the BIC Exemption required as a condition of
executing a transaction, such as a rollover, at the direction of a client in
the absence of an investment recommendation?
No. In the absence of an investment recommendation, the rule does not
treat individuals or firms as investment advice fiduciaries merely because they
execute transactions at the customer’s direction. Similarly, even if a person
recommends a particular investment, the person is not a fiduciary unless the
person receives compensation, direct or indirect, as a result of the advice.
If, however, the firm or adviser does make a recommendation concerning a
rollover or investment transaction and receives compensation in connection with
or as a result of that recommendation, it would be a fiduciary and would need
to rely on an exemption. Under the terms of the Rule, a “fee or other
compensation, direct or indirect,” includes any explicit fee or compensation
for the advice received by the adviser (or by an affiliate) from any source,
and any other fee or compensation received from any source in connection with
or as a result of the recommended purchase or sale of a security or the
provision of investment advice services, “including, though not limited to
commissions, loads, finder’s fees, revenue sharing payments, shareholder
servicing fees, marketing or distribution fees, underwriting compensation,
payments to brokerage firms in return for shelf space, recruitment compensation
paid in connection with transfers of accounts to a registered representative’s
new broker-dealer firm, gifts and gratuities, and expense reimbursements.”
[3] Best Interest Contract Exemption, 81 Fed. Reg. 21,079
(April 8, 2016). The actual language of the rule follows:
(1)
Prior to or at the
same time as the execution of the recommended transaction, the Financial
Institution provides the Retirement Investor with a written statement of the
Financial Institution’s and its Advisers’ fiduciary status, in accordance with
Section II(b).
[Section II(b) provides:
“The Financial Institution affirmatively states in writing that it and the
Adviser(s) act as fiduciaries under ERISA or the Code, or both, with respect to
any investment advice provided by the Financial Institution or the Adviser
subject to the contract or, in the case of an ERISA plan, with respect to any
investment recommendations regarding the Plan or participant or beneficiary
account.”]
(2)
The Financial
Institution and Adviser comply with the Impartial Conduct Standards of Section
II(c).
(3)
(i) In the case of
a recommendation to roll over from an ERISA Plan to an IRA, the Financial
Institution documents the specific reason or reasons why the recommendation was
considered to be in the Best Interest of the Retirement Investor. This
documentation must include consideration of the Retirement Investor’s
alternatives to a rollover, including leaving the money in his or her current
employer’s Plan, if permitted, and must take into account the fees and expenses
associated with both the Plan and the IRA; whether the employer pays for some
or all of the plan’s administrative expenses; and the different levels of
services and investments available under each option; and
(ii) in the case of a
recommendation to rollover from another IRA or to switch from a
commission-based account to a level fee arrangement, the Level Fee Fiduciary
documents the reasons that the arrangement is considered to be in the Best
Interest of the Retirement Investor, including, specifically, the services that
will be provided for the fee.
[4] DOL Advisory Opinion 2005-23A (Dec. 7, 2005),
available at https://www.dol.gov/agencies/ebsa/employers-and-advisers/guidance/advisory-opinions/2005-23a.
[5] Id.
[6] ERISA § 404(a)(1)(B), 29 U.S.C. § 1104(a)(1)(B).
[7] Id. at p.2
(citations omitted).
[8] Id.
[9] See Annot.,
“Standard of Care Required of Trustee Representing Itself to Have Expert
Knowledge or Skill”, 91 A.L.R. 3d 904 (1979) & 1992 Supp. at 48-49.
[10] Donovan v.
Mazzola, 716 F.2d 1226, 1231 (9th Cir.1983).
[11] Leigh v. Engle,
727 F.2d 113, 124 (7th Cir.1984).
[12] In
re Dynegy, Inc. Erisa Litigation, 309 F.Supp.2d 861, 875 (S.D. Tex.,
2004). See also Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir.1983),
cert. denied, 467 U.S. 1251, 104
S.Ct. 3533, 82 L.Ed.2d 839 (1984) ("this is not a search for subjective
good faith - a pure heart and an empty head are not enough").”
[13] Marshall v.
Glass/Metal Ass'n & Glaziers & Glassworkers Pension Plan, 507
F.Supp. 378, 384 (D.Haw.1980).
[14] Keach v. U.S.
Trust Co. N.A., 313 F.Supp.2d 818, 867 (C.D. Ill., 2004).
[15] See James J.
Choi, David Laibson, Brigitte C. Madrian, Why Does the Law of One Price Fail?
An Experiment on Index Mutual Funds. ("We report experimental results that
shed light on the demand for high-fee mutual funds. Wharton MBA and Harvard
College students allocate $10,000 across four S&P 500 index funds. Subjects
are randomized among three information conditions: prospectuses only (control),
summary statement of fees and prospectuses, or summary statement of returns
since inception and prospectuses. Subjects are randomly selected to be paid for
their subsequent portfolio performance. Because payments are made by the
experimenters, services like financial advice are unbundled from portfolio
returns. Despite this unbundling, subjects overwhelmingly fail to minimize
index fund fees. In the control group, over 95% of subjects do not minimize
fees. When fees are made salient, fees fall, but 85% of subjects still do not
minimize fees. When returns since inception (an irrelevant statistic) are made
salient, subjects chase these returns. Interestingly, subjects who choose
high-cost funds recognize that they may be making a mistake.")
[17] Id.
[18] Id.
[19] Id.
[20] See In re
Brandt, Kelly & Simmons, LLP, SEC Release, 2004 WL 2108661, at *2
(Sept. 21, 2004) (stating that Advisers Act “incorporate[s] common law
principles of fiduciary duties”).
[21] Santa Fe
Industries vs. Green, 430 U.S. 462, 472 n.11 (1977), discussing SEC v. Capital Gains Research Bureau,
375 U.S. 180, 181 (1963); see also
Transamerica v. Lewis, 444 U.S. 11, 17 (1979) (“As we have previously
recognized, § 206 establishes ‘federal
fiduciary standards’ to govern the conduct of investment advisers ….”).
[22] In the Matter of
Alfred C. Rizzo, Investment Advisers Act Release No. 897 (Jan 11, 1984)
(investment adviser lacked a reasonable basis for advice and could not rely on
“incredible claims” of issuer); In the
Matter of Baskin Planning Consultants, Ltd., Investment Advisers Act
Release 1297 (Dec. 19, 1991) (adviser failed adequately to investigate
recommendations to clients).
[23] Staff of the U.S. Securities and Exchange Commission,
Study on Investment Advisers and Broker-Dealers (January 2011), at pp.27-8.
[24] SEC’s “Staff Study on Investment Advisers and
Broker-Dealers - As Required by Section 913 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act” (Jan. 21, 2011), at p.62, citing In the Matter of the Application of Clinton Hugh Holland, Jr.,
Exchange Act Release No. 36621 at 10 (Dec. 21, 1995) (“Even if we conclude that
Bradley understood Holland's recommendations and decided to follow them, that
does not relieve Holland of his obligation to make reasonable recommendations.”),
aff'd, 105 F.3d 665 (9th Cir. 1997).
[25] Id. at p.28.
[26] See Concept
Release on the U.S. Proxy System, Investment Advisers Act Release No. 3052
(July14, 2010) (“Release 3052”) at 119.
[27] SEC Release
No. IA-2333; “Registration Under the Advisers Act of Certain Hedge Fund
Advisers” (Dec. 2, 2004).
[28] OCIE’s “Examination Priorities for 2016,” available at
https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2016.pdf.
See OCIE Risk Alert,
“Retirement-Targeted Industry Reviews and Examinations Initiative,” June 22,
2015, http://www.sec.gov/about/offices/ocie/retirement-targeted-industry-reviews-and-examinations-initiative.pdf.
[29] MassMutual Investment Group – MI1054 Disclosure
Brochure (2016).
[30] David Pratt, “Points to Remember: IRA Rollovers,” ABA
Section of Taxation Newsquarterly, Spring 2014.
[31] Id.