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®
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Hence, regardless of whether the DOL's "Conflict of Interest" and related rules are delayed (as I anticipate) and later rescinded or substantially modified, firms should put in place procedures for IRA rollover due diligence determinations.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
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.
- 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.”
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).”
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.”
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.”
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.”
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,
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.”
Subjective good-faith simply does not come into play.
“[T]he prudent man standard is an objective standard, and good faith is not a
defense to a claim of imprudence.”
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.”
“[T]he appropriateness of an investment is to be determined from the
perspective of the time the investment was made, not from hindsight.”
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.
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.”
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 ….”
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.”
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….”
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.
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.”
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.”
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.”
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.” 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.”
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.”
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.”
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.”
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.
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.
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.
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.
