A 401(k) Rollover Reckoning

Just before Christmas, the Department of Labor adopted a rule that reinstates the five-part test to determine what is or isn’t investment advice and implements a new prohibited transaction exemption that expands fiduciary advice to include rollover recommendations. The rule went into effect in mid-February, but advisors have until Dec. 20 to comply.

Mike Pedlow, Executive Vice President and Chief Compliance Officer at Kestra Financial is “encouraged” by the rule.

“It’s a nice balance of the DOL trying to come out and finally have a rule people can live with on all sides of the business,” he said. “We especially like that it took into consideration, in its structure, Reg BI, and all the work that we put into Reg BI because we spent a year and a lot of money putting that together.”

The rule requires advisors to make recommendations using impartial conduct standards: that the advice is in clients’ best interest, that the advisor’s compensation is reasonable, and that they make no materially misleading statements. The rule also gives retirement advisors an opportunity to expand their relationships with participants, according to Tolen Teigen, Chief Investment Officer of FinDec, which provides boutique TPA, recordkeeping, and consulting services to financial advisors.

“From the retirement plan advisors’ perspective, this is a much-needed exemption to allow them to continue working with their clients through retirement and not just to retirement,” Teigen said. “Without this exemption, retirement plan advisors would not be able to transfer 401(k) assets to an IRA and continue working with their clients through their clients’ retirement years. This rule now puts the focus on the client-advisor overall relationship, and aligns the advice to the best interest of the client without regard to where the money is housed.”

That opportunity doesn’t come without challenges, though. Allison Brecher, General Counsel at Vestwell, was less sanguine about the impact on advisors’ operations.

“The new rule takes an aggressive position about when the DOL will consider advice about rollovers from a 401(k) plan to an IRA to constitute fiduciary investment advice,” she said by email. “The new rule forbids an advisor who recommends investing in a proprietary mutual fund from charging a sales commission, and [requires] independent fiduciary approval for proprietary products.”

Sheryl O’Connor, CEO and Co-Founder of IncomeConductor, a retirement income fintech platform, agreed that the fiduciary exemption “appears to bring the retirement plan side of the business more closely in line with the ‘Best Interest’ rules in place on the wealth side,” but warned that “the devils are in the details.”

“There are so many conditions around what would actually be acceptable,” she told 401(k) Specialist. “As with other regulations, the rule is going to be further clarified, and possibly revised by the Biden administration. The U.S. Department of Labor will shape the actual application of the rule in the future.”

Future guidance

The timing of the rule—passed in the dwindling days of the Trump administration—and political climate of late led many in the industry to believe that the fiduciary rule would be rescinded after President Joe Biden took office.

“We fully expected, as did, I think, most people, that the rule would be delayed based on the Biden administration’s memo.

So we were somewhat taken aback when that didn’t happen,” Pedlow said. On Jan. 20, Biden issued a “regulatory freeze” for new rules to give incoming appointees time to review them.

Douglas Kamin, managing director at Foreside, a financial services compliance and consulting firm, doesn’t believe the new administration’s decision to allow the rule to stand is a good signal of any future action.

“I don’t know that we can read too much into it. Clearly, if you look at the pace of items that the Biden administration is reviewing, they’ve been on a tear,” he said.

He added that he wouldn’t be surprised to see additional guidance “given the fact that the Biden administration appears to be reviewing all interpretations of rules that were promulgated or provided during the last administration.”

It’s also possible that future guidance will come from judges rather than the executive branch.

“It’s almost three years to the day since the U.S. Court of Appeals struck down the last fiduciary rule that DOL updated,” Kamin said in March. “Last time, they came out with a whole new rule, addressing many of the same topics, and it got struck down. So, I think it’s quite possible that the new interpretation will also be tested in the courts.”

Vestwell’s Brecher is hoping to see some kind of guidance before that happens.

“Since the new rule is designed to protect investors from conflicted advice, it will be helpful to see guidance from the current administration. For example, there are other ways an advisor can be conflicted other than by receiving a sales commission, such as internal employee bonuses or other incentives,” she said.

Rollovers

One of the biggest changes in the rule is the expansion of fiduciary responsibility for rollover recommendations.

“The DOL’s new interpretation that rollover advice may constitute fiduciary investment advice for purposes of ERI[1]SA really will compel financial services companies to reconsider how they provide rollover advice to investors with retirement investments,” Kamin said.

Rollover considerations can be complex.

On top of investment options, fees and expenses, and clients’ liquidity needs, advisors also need to consider participants’ current and future financial situations. There may be other issues they need to consider.

“The protection from creditors, or legal judgments, is different in a 401(k) than an IRA, and that’s really dictated by the state, so although most advisors don’t serve as legal counsel for their clients, that may be a consideration,” Kamin said.

Foreside offers a rollover suitability questionnaire to its clients to help make sure they’re covering all these issues with participants.

Kestra’s Pedlow stressed that for the many advisors who already consider themselves fiduciaries, whether they call themselves one or not, the biggest change will be in documenting what they’re already doing.

“We’ve long embraced that a rollover recommendation is, in most cases, a fiduciary act,” Pedlow said. “We’ve got built-in IRA rollover forms disclosures that the client signs in a process to review those recommendations as they’re coming into our organization, so really for us the important thing to kind of tick and tie is acknowledging in writing that we’re a fiduciary, which  a requirement under the PTE.”

Some advisors may find that the rule doesn’t change their daily operations much.

Steve Bogner, managing director and partner at Treasury Partners, is responsible for corporate retirement plan advisory services. His firm uses a fiduciary audit file with a “massive checklist” that helps the firm document every component of a plan to make sure it adheres to the firm’s high standards.

“We at Treasury Partners didn’t need to be told this,” Bogner said of the rule’s requirement to act in clients’ best interests. “We were running our business this way before any of this.”

‘Reasonable’

Bogner believes that the DOL’s primary objective regarding the rule is to ensure “general plan hygiene, advisory hygiene, to make sure that you’re running a clean ship.”

The rule’s requirement that fees be reasonable has been tricky for some advisors in the past.

“Advisors have gotten better at figuring that out, I think,” Bogner said. Some advisors needed a push to begin considering how reasonable their fees were, “and now when I look at 5500s, I see that most advisors are on board, and they understand what ‘reasonable’ is.”

“There’s an extra level of care in terms of what happens when you take money out of a plan,” Bogner said. “The biggest difference for a lot of advisors is going to be documenting a rollover,”

Bogner said. “If you’re going to be charging a fee that’s in excess of what the retirement plan was charging, you have to be able to prove that what you’re doing is reasonable, and in the best interest of the client.”

What should advisors do now?

Advisors who have already “put the work in to do Reg BI preparedness, there’s not a whole lot that they’re going to have to do” to comply with this rule, Kestra’s Pedlow said. The key for advisors going forward is documentation. Advisors need to “make sure that they are documenting well the rationale behind the decision, or the recommendations that they’re making,” he added, including cost comparisons and reasonable alternatives.

He urges advisors to evaluate their document management systems to make sure they can keep up with the new requirements.

“If advisors don’t already have a good system for capturing that, whether it be a CRM system, or some other kind of homegrown system that they’ve developed over time, then it’s already past time for them to put that effort in,” he said.

Although plan sponsors are often the entity retirement advisors have the most regular contact with, Bogner said, “it’s all about, can we get plan participants to the finish line.”

Vestwell’s Brecher suggested that advisors “use this as an opportunity to review their Form ADV (because that gets filed with the SEC and is therefore publicly available), as well as their marketing materials and policies to make sure they are consistent about what their conflicts of interest policies [say] and how they disclose conflicts, which is one of the Form ADV sections.”