The Securities and Exchange Commission in early June made the most significant changes to investment-advice standards in more than two decades — and rollovers were no exception.
Regulation Best Interest imposes a new standard for brokers, broadly saying they must make investment recommendations that are in retail customers' best interest. That extends to advice to roll over assets from a workplace retirement plan like a 401(k) to an individual retirement account.
Rollovers constituted one of the major revisions from the proposed SEC rule to the final version issued June 5. Contrary to the initial draft, the final rule lays out explicit steps broker-dealers and brokers must take when making a rollover recommendation.
Most experts agree the new standard for rollovers is higher than the existing "suitability" standard for brokers — although that will ultimately depend on how the SEC and
Financial Industry Regulatory Authority Inc., the brokerage regulator, interpret and police the new rules.
"This does elevate the standard of conduct for broker-dealers in pretty concrete ways," said Aron Szapiro, director of policy research at Morningstar Inc.
The new rules encompass three elements of a rollover recommendation, according to Fred Reish, a partner at law firm Drinker Biddle & Reath. Those elements include recommendations to: take money out of a 401(k) plan (i.e., it's not in an investor's best interest to be in the plan), put that money in an IRA (i.e., the IRA is the best place to put the money), invest the money (i.e., investment choice).
One major point is that a broker must do a comparative analysis between a client's 401(k) and an IRA based on several factors.
Those include: fees and expenses, level of service available; available investment options, ability to take penalty-free withdrawals, application of required minimum distributions, protection from creditors and legal judgments, holdings of employer stock, and any "special features" of the existing account. This list isn't exhaustive, according to the SEC, and some factors may have more or less relevance given the particular client.
The SEC also said broker-dealers can't rely on an IRA having more investment options than a 401(k) as "the basis for recommending a rollover."
Those factors are in addition to other general requirements under Reg BI, such as consideration of a client's investment profile, and the potential risks, rewards and costs of a particular security or investment strategy.
Cost can be a "fairly significant factor" in assessing such recommendations, because IRAs are almost always more expensive than those in 401(k) plans, Mr. Reish said.
The new rollover standard, he added, "looks identical" to the SEC fiduciary standard for registered investment advisers.
"I don't see any difference between the RIA fiduciary standard and the broker-dealer best-interest standard," Mr. Reish said of rollover transactions.
Finra will need to update its rules and regulations to reflect the SEC's new standard, but broker-dealers shouldn't wait to start amending their rollover processes since the implementation deadline is just a year away, Mr. Reish said.
Micha Hauptman, an investor advocate, agrees the new rollover standard represents at least a "marginal improvement over the status quo," since it requires broker-dealers to take a range of factors into account for clients. However, he's worried broker conduct won't "meaningfully change" from current practice.
"[Reg BI] potentially gives brokers the road map to rationalize what they're doing while failing to properly address conflicts of interest that arise," Mr. Hauptman, financial services counsel at the Consumer Federation of America, said of rollovers.
For instance, Reg BI prohibits some — but not all — sales contests and quotas. Product-specific contests are no longer allowed, but ones related to asset accumulation, for example, weren't prohibited. That, Mr. Hauptman believes, may still offer an incentive to brokers to recommend rollovers that aren't in customers' best interests.
