Regulatory & Compliance | 07.10.24
New Rollover Reality Set To Kick In
by: Rich Blake
Following various attempts over the years to redefine what it means to have a fiduciary role when touching investors' retirement assets, the U.S. Department of Labor (DOL) recently announced some new rules that, once again, aim to take the bar higher. As a result, a large swath of advisors will find themselves beholden to a fresh round of requirements starting later this year (but accompanied by a grace period lasting through the summer of 2025).
In late April, the DOL declared having finalized Rule 29 CFR Part 2510, or the "Retirement Security Rule: Definition of an Investment Advice Fiduciary.” For starters, it broadens the definition of a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA) while also amending prohibited transaction exemptions (PTE) requirements.
The Big Takeaway
While potentially fraught with unintended consequences, the new rule transforms one-off client events into a matter of elevated import (i.e. subject to federal pension law narrowing down who is considered an advice-giving fiduciary, and when). Specifically, individual retirement account (IRA) rollovers, are at the heart of this whole endeavor.
"This is true even if the person delivering the advice doesn't manage the account where the funds are rolled and/or even if they don't advise on how to invest the rolled funds," said Robert P. Howard Jr., heading a team of co-authors from the law firm of Davis Wright Tremaine.
Market participants have in the past cautioned that this more strident approach will result in less, not more, advice winnowing its way to plan participants facing a rollover decision; Howard added that "only time will tell if this prediction turns out to be accurate."
More Stringent Requirements
With respect to retirement accounts, under the new rule an advisor can be considered an investment advice fiduciary if they provide a recommendation of any securities/investment transaction/investment strategy to a retirement investor under the following circumstances — and be forewarned this regulatory legalese could require a couple of passes so proceed slowly:
The rep/advisor either directly or indirectly (e.g., through or together with any affiliate) makes professional investment recommendations to investors on a regular basis as part of their business, and the recommendation is made under circumstances that would indicate to a reasonable investor in like circumstances that the recommendation is based on review of the retirement investor's particular needs or individual circumstances, reflecting expert judgment to the retirement investor's particular needs or individual circumstances.
More simply put, there's no more five-pronged test to gauge in any given situation whether the advice-giving standard kicks in. One-time advice loopholes are now a thing of the past.
Essentially, the fiduciary bar is set when retirement investors are given a reasonable impression that their best interests at least ostensibly are being advanced.
Additionally, the rule states:
The recommendation must be provided for a fee or other compensation, direct or indirect, which means the person (or any affiliate): receives any explicit fee or compensation, from any source, for the investment advice; or receives any other fee or compensation, from any source, in connection with or as a result of a recommended purchase, sale, or holding or a security or other investment property or the provision of investment advice (such as commissions, revenue sharing, and gifts or gratuities).
Rollover Ramifications
According to the most recently available data from Cerulli Associates, nearly two-thirds of the $845 billion in assets rolled over from defined contribution (DC) plans in 2022 were rolled into IRAs, and involved the assistance of a financial advisor. Some 70% of retirement specialist advisors say participants in their DC plans frequently ask questions about IRA rollover decisions.
“While regulation promoting a fiduciary standard often benefits end-investors, there likely will be pushback on these key provisions from the insurance industry and broker/dealer-based advisors who sell commission-laden annuity products,” said Shawn O’Brien, director, Cerulli, in a report published in late 2023. “Opponents of the proposal note that the Securities and Exchange Commission (SEC) already is enforcing Regulation Best Interest (Reg BI) outside of ERISA-covered retirement plans,” he added.
Some Relief on Annuity Front
In 2022, the DOL began enforcing a rule ("PTE 2020-02") relating to prohibited transaction exemption (PTE) requirements with respect to advisors involved with rollovers, and which required advisors to document, in cumbersome fashion, why a rollover is in the best interest of the participant when there is a conflict of interest.
The new rule, explained the team of authors at Davis Wright Tremaine, amends two exemptions available to investment advice fiduciaries:
- PTE 84-24: applies to the oversight of investment recommendations by independent insurance agents who recommend annuities issued by more than one insurance company, was changed to provide relief for those agents receiving compensation that would otherwise be prohibited for investment advice transactions.
- PTE 2020-02: allows investment advice fiduciaries to receive compensation that would otherwise be prohibited provided that the fiduciaries comply with the exemption's conditions, it saw some changes for clarity's sake and which build on those conditions.
Both exemptions require that investment recommendations adhere to Impartial Conduct Standards, which in turn require that: advice must meet obligations of care and loyalty; the investment professional and firm must charge no more than reasonable compensation; advice must comply with applicable federal securities laws regarding "best execution;" and the advice must be free from misleading statements about investment transactions and other relevant matters.
Additionally, per the new DOL rule, fiduciaries who provide investment advice must also avoid misleading statements about conflicts of interest, fees and investments, follow policies and procedures designed to ensure the advice given is in an investor's best interest, and give investors basic information about conflicts of interest.
Advisory firm representatives having to navigate a new set of hurdles could have a knock-on effect that might leave smaller-balance 401(k) plan investors confronting cold shoulders from plan sponsors who’d rather they exit and from advisors, disinclined to jump through regulatory hoops.
Nearly one-third (30%) of retirement specialist advisors indicate the new PTE 2020-02 requirements make them less likely to recommend an IRA rollover from their DC plan of less than $50,000, according to a Cerulli report from the end of 2023.
Paradigm Shift?
“This legislation seems likely to push the retirement account owner towards an SEC-regulated fiduciary financial adviser on the one hand, or a low-cost online self-directed alternative on the other," says Andrew Barber, an analyst for the wealth management research firm Gravity Exists.
Either way, investors are likely to encounter more lower-fee products, Barber adds.
As for concerns that new regulations will harm investors — making it less likely they receive advice — the same kind of hue and cry came up fifty years ago around the advent of ERISA, when U.S. officials imposed negotiated fees for brokers in place of industry-wide fixed commissions.
"At the time all the brokers said that no retail investor would ever get market access again," Barber said. "But then discount brokerages and, later, online brokers showed up to prosper in the new environment."