Too many advisors are unwilling or unable to take Prohibited Transaction Exemption 2020-02 (PTE 2020-02) seriously, and it’s a problem.
“That retrospective review is a trap door you can fall through without realizing it.”
Fred Reish
“My concern is not for the big financial institutions—the larger broker-dealers and RIA firms—because they have lawyers in-house and can address these issues,” ERISA expert and Faegre Drinker Partner Fred Reish said at the Broadridge Fi360 Solutions Annual Conference. “As you come downstream to the smaller and mid-market broker-dealers and RIAs, I’m worried they didn’t get fully compliant by the February 1, 2022, deadline.”
Not only that, but the July 1, 2022 enforcement deadline is fast approaching. The PTE language said the advisor must provide an IRA owner or plan participant with a written explanation of why they recommended a rollover.
“It must contain the specific reasons why the rollover is in that individual investor’s best interest right now,” Reish emphasized. “People are having a hard time grasping that. Even worse, I’m afraid they may not even be working on the July issue at all.”
To make matters worse, the February date required that numerous disclosures be made and policies/procedures put in place.
“For example, a rollover recommendation has to be disclosed as a conflict of interest,” he explained. “If you recommend that someone transfers an IRA to you, and they do, it’s a conflict and must be disclosed. Otherwise, you must acknowledge that you’re a fiduciary under the Internal Revenue Code (IRC).”
If the advisor doesn’t satisfy these conditions, the exemption is disallowed and means the advisor that recommended the IRA transfer or the retirement plan rollover committed a prohibited transaction.
They must then make the client whole or return them to (essentially) the same position as if they were still in the plan, yet they can’t roll the money back into the plan.
“If your advisory fee and the underlying investment expenses in the IRA in which you placed them add up to 150 basis points a year, but their retirement plan charged only 50 basis points, how do you pay them that 1% differential for the next 40 years that they might live?” he rhetorically asked. “Advisors are struggling to understand this. It’s hard to get their head around the fact that they can never fully correct it.”
Regulatory ‘trap door’
How aggressively will the DOL enforce the July 1 deadline? It said that between January 1, 2023, and June 30, 2023, advisors must retrospectively review compliance for this year.
“You must reduce that to writing, and a senior officer of the firm has to sign off on it,” Reish said.
If the department sees it and then “audits your audit,” and any mistakes are disclosed, they will force the advisor to correct it—no good faith compliance, no substantial effort, nothing.
“If you don’t disclose that you discovered some mistakes, they could go so far as to say every one of your rollover recommendations was a prohibited transaction because the annual retrospective review is one of the conditions to get the exemptions,” he concluded. “So, that retrospective review is a trap door you can fall through without realizing it.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.