FINRA’S Reminder About Rollovers: News To Many

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A number of government and regulatory agencies—the Government Accountability Office (the GAO), the Department of Labor (the DOL) and, most recently, the Securities and Exchange Commission (the SEC), and the Financial Industry Regulatory Authority (FINRA) –have focused on the practices surrounding 401(k) rollovers to IRAs. Driven by a concern for aging baby boomers and their retirement needs, regulators believe that industry practices encourage retirees to make rollovers without a full understanding of their options and the relative costs for each option.

This article explores FINRA’s guidance for broker-dealers and their registered representatives and the potential implications for registered investment advisers (RIAs). Couched as a “reminder,” FINRA’s year-end Regulatory Notice 13-45 describes practices that many broker-dealers and their registered representatives will find difficult to implement. Yet, there are steps broker-dealers and their registered representatives can and should take to address FINRA’s concerns. As discussed below, broker-dealers should use the information detailed by FINRA in its Regulatory Notice to develop procedures and documents specific to the broker-dealer’s business model. One example is an educational brochure for participants about their distribution options. Other possibilities are discussed in this bulletin. Broker-dealers may need to develop supervisory procedures related to these materials as well. RIAs should also consider taking similar steps because FINRA’s suitability factors may be viewed as part of the prudent process required of an ERISA fiduciary.


Rollover Practices – An Exam Priority for SEC and FINRA

In the Regulatory Notice, FINRA announced that “recommendation and marketing of IRA rollovers will be an examination priority for FINRA in 2014.” Also, in its 2014 Examination Priorities, the SEC declared that it will examine the sales practices of investment advisers who target retirees to rollover to higher cost investments, as well as the marketing and advertising of IRA rollovers by broker-dealers and investment advisers.

These examination priorities were likely influenced by the GAO’s recent report on participant rollover practices which focused on the lack of complete information and on misinformation provided to participants. Coupled with the expectation that the DOL will expand its guidance on “capturing” rollovers in its re-proposed fiduciary regulation, it is now clear that rollover practices are the subject of increased scrutiny by regulators.
 
Overview of FINRA’s Recent Initiatives
One of the early indications of FINRA’s focus on rollover practices was its October 2013 Report on Conflicts of Interest. In that report, FINRA observed that the distribution from a retirement plan is a “substantial liquidity event” that can be compromised when an advisor has a financial incentive to recommend a rollover. Therefore, the advisor’s recommendations to a retiree “deserve thorough scrutiny and review.”
In Regulatory Notice 13-23, FINRA turned its attention to the marketing of IRA services, stating that marketing communications must be fair and balanced and not mislead. For example, marketing materials cannot indicate an IRA is “free” when account fees will be incurred.
The recently issued Regulatory Notice 13-45 “reminds” broker-dealer firms of their responsibilities for suitable recommendations about distributions and rollovers.  
Regulatory Notice 13-45 – Suitable Recommendations 
FINRA’s guidance can be analyzed as covering two separate actions. The first is the participant’s decision about whether to take a distribution and make a rollover. The second is implementation of the decision to roll over, including advice about investments in the IRA.  
A. The Decision to Take a Rollover 
During the decision-making stage, a participant has four options:
  • Leave the money in the current plan.
  • Transfer the money to a new employer’s plan.
  • Rollover to an IRA.
  • Take a taxable distribution.
Noting the complexity of these choices due to the unique circumstances of each participant, FINRA’s guidance discusses the roles the broker-dealer and its registered representatives may have in this process, drawing a distinction between (i) educational information; and (ii) recommendations. In cases where the broker-dealer and its registered representatives are providing only educational information, FINRA points out that the broker-dealer should provide appropriate training to its associated persons and adopt supervisory procedures to ensure that communications do not constitute recommendations.  
In the case of recommendations, FINRA takes the position that a recommendation to take a distribution and rollover assets to an IRA “typically involves securities recommendations” and therefore must be “suitable” for the participant. FINRA says that the suitability standard applies because the recommendation to take a distribution and make a rollover is, in effect, a recommendation to cash out the participant’s plan account (i.e., sell securities in the plan).
FINRA indicates that the broker-dealer’s recommendation should take into account factors relevant to each of the four options and consider the importance of the factors in the context of the participant’s needs and circumstances. FINRA then lists seven factors which should be considered, noting that the list is not exhaustive:
  • Investment Options. While IRAs may offer a broader range of investment options than retirement plans, FINRA points out, by way of example, that this advantage should be balanced against the often lower-cost investments available through the employer plan.
Comment: Although not specifically highlighted by FINRA, other considerations may be the availability of retirement income products – in or out of the plan – and whether the plan offers a self-directed brokerage account.
  • Fees and Expenses. FINRA describes the full range of expenses that should be considered: plan administrative fees and IRA account fees, investment-related expenses (such as mutual fund expenses) and fees for services (e.g., access to services and advice). FINRA also points out that consideration should be given to whether the employer pays for some or all of the plan’s administrative expenses. 
  • Services. The services available under the plan – investment advice, educational materials, workshops, etc. – need to be considered and evaluated against the services offered under the IRA – brokerage services, person-to-person advice, distribution planning, etc.
  • Penalty-Free Withdrawals. FINRA notes that the participant may be able to take a penalty-free withdrawal under his retirement plan at an earlier age than under the IRA – age 55 vs. age 59½ – or may be able to take a plan loan, which is not available in the IRA.
Comment: Evaluation of some of these factors – loan availability, withdrawals – requires knowledge of the terms of the current plan (and, probably, the new employer’s plan).
  • Required Minimum Distributions. The plan may allow the participant to take a required minimum distribution later than age 70½ if he is still working. FINRA observes that this is not allowed in a non-Roth IRA.
  • Protection from Creditors and Legal Judgments. FINRA also points out that plan assets have greater protection from creditors under federal law than IRAs. However, in some states, IRAs receive similar protection.
  • Employer Stock. If the participant’s plan account includes employer stock that has appreciated in value, then the negative tax consequences of rolling over that stock to an IRA should be considered. On the other hand, the risks of holding too much employer stock in a retirement account should also be taken into account.

Comment: The guidance lists these points as factors that broker-dealers and their registered representatives must consider and evaluate to determine whether a recommendation to take a distribution and rollover is suitable. In practice, broker-dealer firms and their representatives will have a difficult time obtaining this information. Evaluation of these factors may require additional training for registered representatives.


Shortly after issuance of the Notice, FINRA published an investor alert – The IRA Rollover: 10 Tips to Making a Sound Decision” (the FINRA Tips). The FINRA Tips discuss these factors, as well as other issues, that should be considered by the participant. These include the tax implications of rolling into a Roth IRA or traditional IRA and taking a direct rollover as compared to an indirect rollover (i.e., a plan distribution that is rolled over into an IRA within 60 days). The FINRA Tips also point out that participants should be wary of IRA advertisements and that participants need to consider the inherent conflict of interest that exists when an advisor has a financial incentive to recommend a rollover.

B. The Implementation of the Rollover
Once the participant has decided to take a distribution and make a rollover, the implementation of that decision - that is, the investment of rollover money in an IRA - is also subject to the suitability rule. FINRA reminds broker-dealers and their registered representatives that they must consider:
 
The customer’s investment profile, including the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizons, liquidity needs, risk tolerance, and any other information the customer may disclose to the broker-dealer or registered representative in connection with the recommendation. 
 
What Broker-Dealer Firms Should do Now
While broker-dealers and their registered representatives need clarification from FINRA, there are steps that broker-dealers should consider taking to show good faith compliance. One suggestion is for broker-dealers to develop a summary or brochure that is educational, and which discusses the four distribution options and the material advantages and disadvantages of each. This educational information could include the seven factors, the points raised in the FINRA Tips, and other factors relevant to participant decisions. If this communication is unbiased and educational, it should not be considered a securities recommendation and, therefore, would not invoke the suitability standard.

Another suggestion is to have participants sign acknowledgements as part of the IRA account opening procedures. The acknowledgement would cover a number of points, including that the participant received the educational pamphlet and considered the information in making its decision. Some broker-dealers may have a business model that supports evaluation of the seven plus factors. In that case, the broker-dealer should consider developing a checklist for supporting recommendations. We have developed drafts of the educational and checklist materials. Broker-dealers should implement supervisory procedures that are consistent with these materials and procedures.

How Does this Impact RIAs
 
FINRA’s guidance sets a high bar for carrying out the suitability standard – a standard which the industry usually considers less rigorous than the ERISA fiduciary standard. This raises the obvious question – do these same standards apply to RIAs who are investment fiduciaries to plans? It is possible that this question will be answered when the DOL re-proposes its fiduciary regulation. In the meantime, RIAs who help participants with distributions and rollovers should consider the FINRA “factors.”

Topics:  401k, DOL, FINRA, GAO, IRA Rollovers, Retirement, SEC

Published In: Finance & Banking Updates, Labor & Employment Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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