This month’s Professional Issues Committee article is from its newest member, Brian Edstrom, Attorney with JUX Law Firm and former Director of Securities at the Minnesota Department of Commerce. This article should not be construed as legal advice. As with all regulatory matters, please seek the advice of an experienced attorney to ensure compliance.
The DOL Fiduciary Rule, which became (mostly) effective on June 9, 2017, marks a clear shift for broker-dealers. Brokers are now considered fiduciaries under the Employee Retirement Income Security Act of 1974 (“ERISA”) when providing non-discretionary investment advice to clients seeking assistance with retirement accounts or plans. Less clear, however, is the Rule’s impact on RIAs, who already owe a fiduciary duty to their clients under federal and state securities laws.
The Fiduciary Rule imposes new obligations that apply to RIAs, as well as brokers, in certain retirement planning scenarios. Most notably, if a client seeks an RIA’s advice on whether and how to roll over or transfer an employee-sponsored 401(k) into an IRA or other retirement account, the RIA’s recommendation is likely covered by the Fiduciary Rule (a “Covered Recommendation”). RIAs making Covered Recommendations are subject to ERISA’s fiduciary requirements. As ERISA prohibits “self-dealing,” RIAs are prohibited from making Covered Recommendations that may result in an increase to their own compensation, unless they comply with an applicable exemption.
One such exemption is the “level fee fiduciary exemption,” which applies to RIAs that receive only set fees, or fees based on a fixed percentage of the value of assets under management. In addition to meeting these fee requirements, RIAs wishing to rely on the level fee fiduciary exemption must also comply with certain other components of the Fiduciary Rule. Namely, they must abide by Impartial Conduct Standards set forth in the Fiduciary Rule’s Best Interest Contract (“BIC”) exemption, ensure compensation collected from clients is reasonable, and must acknowledge their fiduciary status in a written document shared with their clients. In order to rely on the level fee fiduciary exemption to advise a client on whether and how to roll over a 401(k) plan, level-fee RIAs should also be careful to consider and document the specific reasons why their recommendation is in the best interests of their client.
In December 2013, FINRA issued Notice 13-45 to remind broker-dealers of their responsibilities when recommending a rollover or transfer of assets in an employer-sponsored retirement plan to an IRA. The notice recognizes that clients in this scenario have four primary options: (1) they could leave the money in the employer’s plan, if permitted; (2) they could roll over assets into a new employer’s plan, if one is available; (3) they could roll over to an IRA; or (4) they could cash out the account value. The notice then provides a non-exhaustive list of seven factors a broker should consider when discussing these options with clients to determine a suitable recommendation.
Though Notice 13-45 was directed to broker-dealers, it now also provides useful guidance to RIAs wishing to rely on the level fee fiduciary exemption to comply with ERISA. If a level-fee RIA is approached by a client or potential client seeking recommendations on whether to roll over a 401(k), the RIA should incorporate Notice 13-45 into its client discussions and written materials. Namely, the adviser should discuss each of the four options available to the client and consider the factors FINRA raises to determine which option is in the client’s best interest. Finally, the RIA should carefully document discussions with the client, explaining the RIA’s reasoning behind their ultimate recommendation and why that recommendation is in the client’s best interest.