SEC rule proposal doesn't include 401(k) sponsors in 'best interest' advice

Plan sponsors are left out of the equation because they don't appear to fall within the definition of "retail" investor, legal experts say

Jun 13, 2018 @ 3:00 pm

By Greg Iacurci

The Securities and Exchange Commission is trying to bridge the gap in investment advice standards for brokers and financial advisers, but the rift remains wide in one particular area: advice to 401(k) plan sponsors.

The SEC proposed Regulation Best Interest in mid-April as part of a broader rulemaking package. It would up the ante for brokers interacting with several retirement-account stakeholders — for example, owners of individual retirement accounts, employees rolling money out of a retirement plan and 401(k) participants deciding how to invest their money in-plan. Instead of just having to choose investments that are suitable for clients, brokers would be held to a more-stringent "best interest" standard, which isn't specifically defined in the proposal.

However, 401(k) plan sponsors are left out of the equation because they don't appear to fall within the SEC rule's definition of "retail" investor, according to legal experts.

This omission would put brokers and RIAs on uneven footing, as they are today without the Labor Department's fiduciary rule, when giving advice to small-business owners about things such as their 401(k) investment lineups. They'd be held to different standards of care — fiduciary duty for RIAs, suitability for brokers — when offering similar services to employers, experts said.

"The commission should clarify that the definition of retail customers include nonprofessional fiduciaries of retirement plans," Doug Fisher, director of retirement policy at the American Retirement Association, said in reference to small businesses sponsoring 401(k) plans.

"Otherwise, what you have in an unlevel playing field," he said. "It feels like a gap."

The American Retirement Association, an umbrella organization that includes the National Association of Plan Advisors trade group, plans to submit a comment letter to the SEC expressing this view, Mr. Fisher said.

(More: 6 big questions about the SEC advice rule)

The Department of Labor's fiduciary rule, which had turned brokers into fiduciaries when giving investment advice to 401(k) plans and participants, was overturned by the 5th Circuit Court of Appeals in March. That decision is expected to become final any day.

Broker-dealers beefed up their policies and procedures in anticipation of the DOL rule. That included receiving a flat fee for 401(k) services (instead of compensation like commissions and 12b-1 fees) and eliminating finder's fees that encouraged brokers to churn 401(k) plans (switch to a new plan provider in order to get another commission). Several firms also mandated that brokers unspecialized in the 401(k) market had to partner with more specialized advisers to deliver investment advice or outsource the advice to a third-party platform.

Under the SEC proposal, it's possible some broker-dealers could revert to the pre-DOL-rule status quo relative to providing advice to 401(k) plan sponsors.

"I think this is one of those areas where people will ask, 'What will happen with the marketplace?'" said Kevin Walsh, an attorney at Groom Law Group.

However, Mr. Walsh said he'd be surprised if firms make changes, at least in the near term. The SEC may also plug the regulatory hole by the time a final rule is released, he said.

Jason Roberts, chief executive of the Pension Resource Institute, said several measures broker-dealers put in place made it easier to supervise brokers, were more profitable and mitigated legal risk. Those measures will probably "stick," Mr. Roberts said, especially level-compensation platforms and additional training programs for brokers.

Further, it would be hard to explain to examiners from the SEC or the Financial Industry Regulatory Authority Inc. why the firm clawed back new procedures to address practices it deemed high-risk, he said.

"By walking away from a change designed to eliminate or mitigate conflict, I can't imagine explaining that to an SEC examiner," Mr. Roberts said.

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