Rollover, Beethoven – Retirement Account Rules Are Changing

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In his 1956 hit single, “Roll Over Beethoven,” Chuck Berry croons, “Roll over Beethoven, and tell Tchaikovsky the news.” The song was a reference to how classical composers such as Beethoven would roll over in their graves if they knew that their works were being supplanted by rock and roll.


Similarly, in the field of investment advice, the Department of Labor (DOL) upset the proverbial apple cart this year with its new Fiduciary Rule (the Rule). One of the new Rule’s primary targets is investment advice concerning rollovers from a 401(k) or IRA into another IRA. The DOL was concerned with investors getting conflicted advice regarding retirement account rollovers. Prior to the new Rule, an adviser’s recommendation to roll a company-sponsored 401(k) or IRA into an IRA managed by the adviser was generally not considered fiduciary investment advice. Now, such a suggestion would trigger fiduciary responsibility, and the adviser must avoid rollover recommendations or seek one of the so-called “exemptions” under the new Rule.

Unfortunately, there is still a significant amount of uncertainty as to how financial institutions can comply with the Rule. The applicability date of the Rule’s Best Interest Contract Exemptions was recently delayed from January 1, 2018, to July 1, 2019, and much about the Rule could change in that time period.

Like the classical composers in Berry’s song, many professionals in financial services have been disturbed by this new development. The Fiduciary Rule and its new requirements are complex, and the path to compliance is not always clear. In another post, we provided some background information on the Fiduciary Rule. Here, we will discuss some of the steps a level-fee investment adviser must take if it makes rollover recommendations.

Fiduciary Background

At the highest level, compliance with the Rule is a two-part analysis. First, the financial entity must determine whether it is acting as a fiduciary. Black Cypress’s description and analysis of fiduciaries were covered in “What’s All the Fuss About the New Fiduciary Rule?” and “Fiduciary is the New F Word”. Second, if the entity determines it is acting as a fiduciary, then it must determine whether it engages in certain “prohibited transactions.” If so, it must refrain from engaging in those transactions or seek an exemption under the Rule.

“Prohibited transactions” are transactions that present various conflicts of interest between the investor and financial entity. It is important to note that the DOL did not place an absolute prohibition on these transactions. Rather, they are prohibited as a threshold matter unless the financial entity can demonstrate it is acting in the client’s best interest, usually by claiming one of the Rule’s exemptions. The DOL has determined that rollover recommendations are prohibited transactions because “there is a clear and substantial conflict of interest when an Adviser recommends that a participant roll money out of a plan into a fee-based account that will generate ongoing fees for the Adviser that he would not otherwise receive, even if the fees going-forward do not vary with the assets recommended or invested.” Fed. Reg. Vol. 81, No. 68, 21011. Thus, an adviser must avoid rollover recommendations or seek an exemption, one of which (streamlined Best Interest Contract Exemption) is discussed below.

Table 1: Sample Fiduciary Flow Chart for two-part fiduciary analysis:

For the sake of brevity, we will assume that the hypothetical financial entity (an investment adviser) under discussion here is acting as a fiduciary, is a level-fee fiduciary, and wants to make rollover recommendations in compliance with Rule. In practice, each of these assumptions will require significant analysis and guidance from the entity’s legal and compliance departments.

Three Steps to Compliance

There are at least three steps a level-fee fiduciary investment adviser must take to make rollover recommendations in compliance with the Rule. These three steps are part of the streamlined Best Interest Contract Exemption mentioned in Table 1 above.

First, it must give the investor a written fiduciary statement in which the adviser acknowledges that it is a fiduciary with respect to the retirement plan or retirement account(s) to which the level fee fiduciary will provide investment advice. The DOL did not provide a model or template fiduciary acknowledgment.

Second, the adviser must comply with ERISA’s Standards of Impartial Conduct. The Standards require a financial institution to (1) give advice that is in the retirement investor’s best interest, (2) charge no more than reasonable compensation, and (3) make no misleading statements about investment transactions, compensation, and conflicts of interest.

Third, the adviser must document its consideration of the investor’s alternatives to a rollover, including leaving the money in his or her current employer’s plan, if permitted. Specifically, the documentation must take into account (1) the fees and expenses associated with both the plan and the IRA, (2) whether the employer pays for some or all of the plan’s administrative expenses, and (3) the different levels of services and different investments available under each option.

Additionally, if the level-fee arrangement is part of the adviser’s recommendation, the adviser must document the reasons that the arrangement is considered in the investor’s best interest, including, specifically, the services that will be provided for the fee.

Possible Improvements

At Black Cypress, we feel that the Rule is a well-intentioned effort to protect retirement investors, but there are several possible improvements that would make it less costly to investors and less onerous on advisers.

First, the exemptions portion of the Rule could be streamlined by eliminating or reducing the requirement (in the Best Interest Contract Exemption) that an adviser investigate an investor’s current employer-sponsored retirement plan or account before making a rollover recommendation. Advisers may have to go to great lengths to make an “apples-to-apples” comparison of the employer plan and its own investment programs. These efforts cost time and money, and that expense will ultimately be passed on to investors.

Second, the DOL could improve the Rule by creating a more robust exception for marketing communications. We feel that it is unfair to charge an adviser with offering fiduciary investment advice when describing the firm’s investment programs to prospective clients. To be fair, the DOL attempted to carve out an exception for an adviser to “tout the quality of his, her, or its own advisory or investment management services.” Fed. Reg. Vol. 81, No. 68, 20968. However, it will be difficult for an adviser to effectively “tout its quality” without telling a potential investor how it would invest his assets. Such a communication would run the risk of becoming a fiduciary communication under the Rule, exposing the adviser to the risk of legal liability. Risks have costs, and costs are usually passed on to the investor.

Our Take

The Rule, as currently written, imposes unnecessary costs and administrative burdens on investors and advisers. Some advisers will stop offering advice on retirement accounts for fear of repercussions under the Rule. Others may increase their minimum asset threshold to compensate for the increased costs of compliance. In either case, the Rule will make it more difficult for some investors to get sound investment advice. This result will be especially harmful to investors whose retirement accounts are their largest assets.

However, the Rule has not yet been finalized, and the final version may incorporate some of the improvements suggested above. In fact, part of the DOL’s reasoning for delaying full implementation of the Rule was to give itself more time “to consider public comments . . . [and] whether possible changes and alternatives to the exemptions would be appropriate.” We will continue to follow developments in the Rule and keep our clients informed.

Putting the Client First

The overarching goal of the Fiduciary Rule is to require advisers, broker/dealers, and other financial entities to put their clients’ interests first. Black Cypress is in favor of reasonable measures to protect investors, and we will continue to put our clients first, as we always have. In addition to providing excellence in investment advice, we strive to demonstrate expertise in our compliance program, navigating an increasingly complex regulatory landscape. You can find out more about our compliance program in the Who We Are section of our website. Any additional questions can be directed to our Chief Compliance Officer, Jordan M. Roberts, at [email protected].

Article by Black Cypress Capital

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