Financial institutions should prepare for increased regulatory scrutiny.
The Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC) released their examination priorities for 2014 on January 2 and January 9, respectively. Among both organizations’ priorities are practices related to recommendations to transfer, or “roll over,” assets from an employer-sponsored retirement plan to an individual retirement account (IRA). These announcements follow FINRA’s Regulatory Notice 13-45, which was issued on December 30, 2013 and which provides guidance on brokers’ responsibilities concerning IRA rollovers. FINRA also recently issued an investor alert, “The IRA Rollover: 10 Tips to Making a Sound Decision,” highlighting issues (including tax consequences, fees and expenses, and conflicts of interest) that FINRA believes an investor should be aware of in deciding whether to roll over assets to an IRA. Broker-dealers and registered investment advisers that offer advice and recommendations regarding IRA rollovers should prepare for increased regulatory scrutiny of their services and should consider reviewing their practices and marketing materials against applicable FINRA and SEC guidance and regulations.
A person with savings invested in an employer-sponsored retirement plan, such as a 401(k) plan, may be eligible to roll over certain distributions from the plan to an IRA without having to pay taxes on the distribution. This may occur when, for example, the person leaves his or her employer and is eligible to receive a lump-sum distribution from the plan. In addition to an IRA rollover, the individual may also have the option to keep his or her investment in the employer-sponsored plan, transfer the account to another employer’s plan, or take a cash distribution. Individuals may contact financial professionals or other experts (e.g., a broker-dealer or an investment adviser) for guidance on the various options and their costs and benefits.
Last year, the U.S. Government Accountability Office (GAO) published a report urging the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS)—the primary regulators of employer-sponsored retirement plans and, with respect to the IRS, IRAs—to take action to improve the rollover process for participants. The GAO report was particularly critical of the information and disclosures that financial services firms provide to participants when counseling them on distribution options. Specifically, the GAO report concluded that financial services firms generally encourage IRA rollovers without fully explaining the options available to their clients and without making sound determinations that an IRA rollover is in particular investors’ best interests. The GAO particularly noted that “[much] of the information participants receive is through the marketing efforts of service providers touting the benefits of IRA rollovers and is not always objective.” Perceived issues with the IRA rollover process have become of increasing concern because assets held in IRA accounts represent an increasing percentage of all U.S. retirement assets and currently exceed those held in employer-sponsored 401(k) plans (and other similar plans) and traditional pension plans.
FINRA and SEC Examination Priorities
FINRA, in its 2014 examination priorities, stated that it “shares the GAO’s concerns that investors may be misled about the benefits of rolling over assets . . . to an IRA.” FINRA indicated that it will review brokers’ marketing materials and supervision with respect to IRA rollover practices and will evaluate securities recommendations made in the context of IRA rollovers to determine whether they comply with FINRA’s suitability standards under Rule 2111. FINRA further urged brokers to review its guidance in Notice 13-45 (discussed in more detail below) and its prior guidance in Notice 13-23 regarding marketing materials that claim an IRA is “free” or has “no fee.”
Similarly, the SEC’s 2014 examination priorities indicate that it will focus on the practices of broker-dealers, as well as investment advisers, with respect to IRA rollovers. The SEC, noting that advisers and broker-dealers “may have incentives to recommend that assets be placed with an IRA or other alternative offered by a financial services firm,” will:
Thus, both broker-dealers and investment advisers should be prepared for examiners to focus on their practices with respect to IRA rollovers. Officials from both FINRA and the SEC have indicated that they may focus on those firms, or representatives within a particular firm, that have been particularly successful at encouraging clients to roll over assets to IRAs. Broker-dealers and investment advisers should review their practices with respect to recommendations, investor education, disclosures, marketing materials, supervision, and training to determine whether any changes should be made.
FINRA Regulatory Notice 13-45: Rollovers to Individual Retirement Accounts
FINRA issued Notice 13-45 to “remind [broker-dealer] firms of their responsibilities” when recommending rollovers to IRAs and marketing IRAs and associated services. FINRA noted that a recommendation to roll over retirement plan assets to an IRA typically involves securities recommendations subject to FINRA rules regarding suitability and that related marketing must be “fair, balanced and not misleading.” Highlights of Notice 13-45’s guidance include:
To evaluate these factors, a broker-dealer may need to obtain detailed information about the plan in which a client’s assets are currently invested, including information about investment options and related expenses, plan-level fees (including recordkeeping, compliance, and trustee fees), and plan features (including distribution rights and services related to the plan). Further, if the participant is also eligible to transfer assets to a new employer’s plan, the broker-dealer may find it necessary to obtain and evaluate similar information about the new employer’s plan as well. Based on these factors, FINRA seems to expect that representatives should have some knowledge of a number of areas that may go beyond their traditional training, including taxation of retirement distributions, bankruptcy protection of retirement assets, and the rules governing qualified retirement plans (including a particular plan’s provisions). FINRA also notes that the list of considerations above is not exclusive and other considerations may apply depending on a client’s circumstances.
Notice 13-45 further indicates that written supervisory procedures and training programs should be reviewed and updated as necessary in light of Notice 13-45’s guidance. FINRA followed Notice 13-45 with the investor alert, “The IRA Rollover: 10 Tips to Making a Sound Decision,” which includes tips for investors that generally parallel the concerns that FINRA raised in Notice 13-45.
The issuance of Notice 13-45 and the inclusion of IRA rollovers as examination priorities, along with the recent GAO report discussed above, are consistent with the trend toward increasing regulatory scrutiny of the IRA market. IRA rollovers are also receiving attention from the DOL, which indicated in its comments to the GAO report that its pending project to revise its regulation on the definition of a “fiduciary” may address many of the GAO’s concerns. Because IRA rollovers will likely increase as more Americans reach retirement age, we can expect further regulatory activity in this area—including possibly from the IRS. Accordingly, in light of the converging regulatory scrutiny involving IRA rollovers, broker-dealers and investment advisers—as well as other financial institutions that provide IRA services—should consider reviewing and updating their IRA rollover practices, marketing activities, supervisory procedures, and training programs.
Morgan Lewis—with its strong practice in the regulation of financial institutions, including experience in fiduciary and tax issues related to IRAs and employee benefit plans—is uniquely qualified to assist with this review. If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers: