A quick note on the term financial professionals. The DOL Rule will only be “new” to commission based financial advisors and insurance oriented reps. Financial professionals that are registered as an Investment Advisor Representative through an RIA are already held to this fiduciary standard and inherently adhere to the new DOL Rule.
In addition, FINRA rules only apply to broker-dealers and not fee only advisors or fixed insurance agents. That said, if and when the compliance date for the rule takes effect in April, financial institutions and advisors will be deemed to act as fiduciaries when recommending that a client take a rollover or distribution from an ERISA plan or an individual retirement account (“IRA”).
Much of the trade press commentary has focused on predictions of doom and gloom, waves of class action lawsuits, huge increases in compliance costs, and a sea change in the way advisors interact with customers.
We disagree. For some time now, securities regulators, led by FINRA, have been policing rollover recommendations with enhanced vigor. In our experience, most financial advisors already have adapted their practices to conform to fiduciary standards when recommending rollovers, similar to what the DOL Rule will mandate.
FINRA Regulatory Notice 13-45
The regulatory landscape for rollover advice changed significantly when FINRA issued specific guidance in 2013 “remind[ing] firms of their responsibilities” when recommending rollovers to IRAs and marketing IRAs and associated services. FINRA noted that a recommendation to roll over retirement plan assets to an IRA typically involves securities recommendations subject to FINRA rules regarding suitability, and that related marketing must be “fair, balanced and not misleading.” Highlights of the guidance include:
- IRA rollover recommendations should reflect the investor’s individual needs and circumstances. In evaluating whether to recommend that a client roll over retirement assets to an IRA, an advisor should consider the importance of various factors to particular investors. FINRA identified these factors to include:
- The broad range of investment options available through an IRA, compared to the potentially more limited options available in a client’s existing plan;
- The various investment-related and plan or account fees that a client may incur for investments in an IRA or plan;
- The levels of service available under an IRA and a client’s plan;
- The tax consequences of each option, including with respect to penalties that may be assessed if a client withdraws funds before age 59½, the IRS’s required minimum distribution rules that apply when a client attains age 70½, and the tax consequences of rolling over employer stock held in a plan to an IRA; and
- The different levels of protection that assets held in IRAs and plans have from creditors and legal judgments (such as in the event of a bankruptcy filing).
To properly evaluate these factors, an advisor needs detailed information about the plan in which a client’s assets are currently invested, including information about investment options and related expenses, plan-level fees (including recordkeeping, compliance, and trustee fees), and plan features (including distribution rights and services related to the plan). If the client is eligible to transfer assets to a new employer’s plan, the advisor will need to evaluate similar information about the new employer’s plan.
- Advisors should assess conflicts of interest in recommending IRA rollovers. Financial advisors typically have incentive (receipt of a commission or asset-based fee) to recommend that a client roll over assets to an IRA. Regulatory Notice 13-45 cautions firms “to reasonably ensure that conflicts do not impair the judgment” of advisors about a client’s interests.
- Rollover recommendations must reflect the client’s interest. FINRA’s suitability rule requires advisors to have a reasonable basis to believe that a recommended transaction or investment strategy is suitable for the client. Regulatory Notice 13-45 says that in recommending a rollover an advisor must obtain information about a client’s options, including “tax implications, legal ramifications, and differences in services, fees and expenses,” and that both the immediate consequences and long-range effects of a recommendation should be considered. Although many observers have expressed concern that the DOL Rule will result in more rigorous (and skeptical) regulatory scrutiny of rollover recommendations than exists under FINRA rules, we think otherwise. It is clear that FINRA already has raised the bar for broker-dealers and advisors in a variety of ways in recent years. This moving of the needle can best be summed up by a telling statement in FINRA’s 2015 examination priorities letter:
A central failing FINRA has observed is firms not putting customers’ interests first. The harm caused by this may be compounded when it involves vulnerable investors (e.g., senior investors) or a major liquidity or wealth event in an investor’s life (e.g., an inheritance or Individual Retirement Account rollover). Poor advice and investments in these situations can have especially devastating and lasting consequences for the investor. Irrespective of whether a firm must meet a suitability or fiduciary standard, FINRA believes that firms best serve their customers—and reduce their regulatory risk—by putting customers’ interests first. This requires the firm to align its interests with those of its customers.
Thus it is clear that even without the DOL Rule, advisors are being watched carefully by the regulators in connection with rollover recommendations.
For the first time, the DOL Rule will subject financial advisors to ERISA’s fiduciary standards and prohibited transaction rules with respect to IRA rollover recommendations. While this may seem like an Earth-shattering development, it really is not. Today, most financial advisors have conformed their practices to regulatory expectations (and those who have not should take note and act accordingly). Whether or not the new Administration or Congress take steps to delay, pare back or scuttle the DOL Rule, advisors would be well advised to treat rollover advice as a fiduciary responsibility.
By Jeffrey S. Holik and Paul Alegi. Mr. Holik is a financial services regulatory lawyer with Shulman, Rogers, Gandal, Pordy and Ecker in suburban Washington, D.C. Mr. Alegi is an Investment Advisor with ISC Financial Advisors.
 The final rule is available at: https://www.dol.gov/ebsa/regs/conflictsofinterest.html.
 There has been much speculation about whether the Trump Administration will delay the compliance date or take action to pare back or scuttle the rule.
 The DOL rule defines a recommendation as a communication that, based on its content, context and presentation, would reasonably be viewed as a suggestion that the client engage in or refrain from taking a particular course of action.
 IRS rules provide that if an investor receives a lump-sum distribution of retirement plan assets, including an in-kind distribution of employer stock, and holds the stock in a nonretirement account—the investor will pay tax at the ordinary income rate on the cost basis in the stock. When the stock is sold, the investor will pay tax on the stock’s subsequent appreciation at the more favorable rate for long-term capital gains. In contrast, if the stock is rolled over in kind to an IRA, the stock’s subsequent appreciation (along with its cost basis) will be taxed as ordinary income when it is distributed from the IRA.
 FINRA Rule 2111.