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Learning Center Experience
By Chuck Lowenstein, Faculty, Kaplan University School of Professional and Continuing Education Published August 2014
Imagine the following scenario
presented to a registered representative of a broker/dealer:
client comes into your office and tells you that she has just received a note
from her employer that, due to separation of service, she will have to decide
what to do with the $150,000 in her 401(k) plan. Another client gives you the
news that he must decide what to do with the $100,000 in his 403(b)
plan now that he has reached mandatory retirement age."
This should be a slam dunk, right? Simply
roll over the funds into an IRA where the client (and you) will have control
without the restrictions and expenses inherent in the qualified plans.
Not so fast! Both FINRA and the SEC
have stated in their 2014 priorities that IRA rollovers from qualified plans are
high on their list of items that will be the subject of member firm
examinations, and you, as the registered representative, are the bull’s-eye in
The primary objective of this article
is to explain exactly what the regulators will be looking for, what practices
they consider potentially abusive, and how to minimize exposure to disciplinary
During the first weeks of 2014, a
literal “shot across the bow” was fired, giving warning that broker/dealers and
investment advisers had better toe the line when it comes to the IRA rollover
transaction. Both the SEC and FINRA have issued warnings to financial
professionals who provide guidance to clients looking to roll traditional
workplace 401(k) accounts into IRAs, and this focus on the importance of proper
guidance should be keeping all financial advisers on their toes. For many, this
means charting a new course in IRA rollover compliance, as even the most
experienced professionals may find themselves in the dark over the new
requirements being ushered in by the industry’s most prominent regulators.
First, it was FINRA with Regulatory
Notice 13-45, technically posted on December 30, 2013, but not widely
circulated until after the first of 2014. Then, only three days later, FINRA
published its 2014 Regulatory and Examination Priorities Letter, and one of the
featured items was qualified plan rollovers. This is the first time in memory
that the regulator has published warnings about the same issue twice in one
Rounding out the attack, on January
9, 2014, the Securities and Exchange Commission published its 2014 examination
priorities for its National Examination Program (NEP). The NEP covers all
markets and entities examined by the SEC and includes the SEC exam program for
SEC-registered investment advisers. Six major bullet points are listed,
including Retirement vehicles and rollovers,
specifically the targeting of retirement-age workers and the use of potentially
misleading professional designations when recommending the movement of assets
from a retirement plan to an IRA “rollover.”
But, these are not the only
regulators getting into the act. According to a January 18, 2014, article in The Wall Street Journal, the Department
of Labor is planning to
propose more stringent rules for advisers on all retirement investments.
Why the sudden interest? Some would say that the primary
catalyst was the March 2013 report by the United States General Accountability
Office (GAO), titled “401(K) PLANS
Labor and IRS Could Improve the Rollover Process for
Participants.” This 70-page
report highlighted some of the industry's shortcomings regarding rollovers.
Investors "often receive guidance and marketing favoring IRAs when seeking
assistance regarding what to do with their 401(k) plan savings when they
separate from their employers," the GAO study said.
also found that service providers’ call center representatives encouraged
rolling 401(k) plan savings into an IRA even with only minimal knowledge of a
caller’s financial situation. “Participants may also interpret information
about their plans’ service providers’ retail investment products contained in
their plans’ educational materials as suggestions to choose those products,”
the GAO wrote in its report.
more, the Labor Department’s current requirements do not sufficiently assist
participants in understanding the financial interests that service providers
may have in participants’ distribution and investment decisions, the GAO said.
The GAO wrote at the time that 401(k) plan participants separating from their
employers may find it difficult to understand and compare all their
distribution options: “Information participants currently receive is either too
generic and without detail, leaving participants without understanding of the
key factors they need to know to make decisions about their savings, or too
long and technical, leaving participants overwhelmed and confused.”
upshot of the report was that the Labor Department and IRS should take certain
steps to reduce obstacles and disincentives to plan-to-plan rollovers. And, the
Labor Department should also ensure that participants receive complete and
timely information, including enhanced disclosures, about the distribution
options for their 401(k) plan savings when separating from an employer.
FINRA comes out with its Regulatory Notice, reminding member firms about their
responsibilities when: 1) recommending a rollover or transfer of assets in an
employer-sponsored retirement plan to an IRA; or 2) marketing IRAs and
properly frame the discussion, FINRA quoted statistics from various sources,
giving an idea of the size of the market.
According to the 2013
Investment Company Fact Book, IRAs account for about 28 percent of all U.S.
retirement assets, which totaled $19.5 trillion at the end of 2012. Approximately
98 percent of IRAs with $25,000 or less are brokerage accounts. These are
generally referred to as “small” accounts and, at least as a percentage of
assets, tend to have the highest costs associated with maintaining the account.
You should not be surprised that rollovers from
employer-sponsored retirement plans are the largest source of contributions to
IRAs. A June 2013 Employee Benefits Research Institute report states that in
2011, assets rolled over into IRAs were almost 13 times the amount of direct
contributions. Considering that the maximum annual IRA contribution that year
was $5,000, or $6,000 for those age 50 or older, it doesn’t take much of a
rollover to be 13 times greater—only $65,000 to $78,000. Even with the current
annual maximums of $5,500 and $6,500, that multiple shouldn’t change.
Although not a part of the FINRA notice, another report
has given much credence to the concerns by the regulators. Cerulli Associates,
a well-known industry research firm located in Boston, released the following
2012, about 3 million American workers rolled over some $289 billion from their
employer-sponsored retirement plans into an IRA or into their new employer’s
bulk of that money—$204 billion, with an average account balance of
$128,400—went into IRAs controlled by broker/dealers or investment advisers.
That is about 70 percent of all of the rollover money.
about $85 billion, with an average account balance of $53,900, went into
self-directed IRAs. And the balance of $1 billion, with an average account
balance $91,000, was rolled into a new employer’s plan. Cerulli went on to say
that by 2017, Americans will roll an estimated $451 billion into IRAs, making
this an $8 trillion marketplace. So, as you can see, we’re talking lots of
money, and that is why the regulators are taking steps to ensure that investors
receive a fair shake.
outlined in both the FINRA and SEC releases, the primary concern is proper
dealing with the potential conflict of interest. When a securities professional
is presented with a client who was a participant in his employer-sponsored
retirement plan, whether a 401(k) or 403(b), who has terminated employment,
either voluntarily or involuntarily, and is now asking for advice on how to
invest their plan assets, it is only natural that that little “devil” in his
brain suggests that he can make lots of money if he only tells the client
rollover the funds to an IRA controlled by him. That may be the best
alternative to meet the client’s needs, but FINRA and the SEC want that
professional to exam those needs and objectives, as well as a number of other
considerations, to determine if, in fact, there might be a better solution.
important to understand that the regulators are not saying, “IRA rollovers are
a bad thing.” What they want securities professionals to recognize is that financial
advisers’ obligations to their customers requires that they do their best to
make the recommendations that are most suitable for the customers.
are four basic choices that a participant has:
1) Leave the money in the former
employer’s plan (if permitted).
2) Roll over the assets to the new
employer’s plan (if there is a new employer and if rollovers are permitted).
3) Roll over to an IRA.
4) Cash out the account value.
important to note that only the first three options allow a participant to
preserve the tax-deferred status of their plan savings. Once the choices are
known, all of the various factors can be evaluated in an attempt to determine
the best course of action for the client. Part of the problem, at least from
the client’s standpoint, is that, according to the GAO report, participants are
subjected to pervasive marketing of IRAs, but may receive limited assistance
regarding their distribution options. This places an even greater
responsibility on the financial professional.
of all, it must be determined if choice 1 is even possible. In many cases, the
magic number is as high as $5,000. Unless the participant’s vested interest in
the plan is large enough, the plan may not allow the funds to remain, or the
plan may even call for a mandatory rollover into an IRA. This information is
relatively easy to find and may be obtained by the client, usually with a quick
phone call or email to the HR department.
same is true with choice 2. First of all, there must be a new employer and,
even if there is, one of the problems pointed out in the GAO report was the
difficulty involved in making the transfer. Some plans flat out don’t allow it
and, in other cases, whether it be a long rollover waiting period or a complex
verification process, too many participants just don’t want the hassle and look
for a simpler, although not necessarily the best, option.
course, choice 3 is quite simple—almost all providers will hold their clients’
hand and do everything step by step with them.
although choice 4 may be best for some, for most under 59½, the taxation of the
proceeds, plus the 10 percent tax penalty, is a factor that ranks at the top of
the discussion. It helps if we analyze the pros and cons of each of these
start with choice 4, first because it is clear that the only real benefit to
the participant is cash. That can be useful, even after paying taxes and
penalties, if there is high-interest debt that can be paid off, or special
expenses, such as medical treatment or education. In fact, if the participant
is at least 55, it is possible to avoid the 10 percent penalty, but that is
only true with an employer-sponsored plan, not an IRA. In fact, rolling over
into an IRA “kills” this option.
1 and 2 are viewed basically the same. One major difference is that the client
already knows the original plan and, if happy with the performance and service,
it is hard to make a case for leaving it and moving the assets to a strange
one. One point that could be made is the consolidation of assets. Many would
prefer having all of the 401(k) assets in one location, rather than in the
plans of several former employers. If analysis of the new employer’s plan shows
lower fees and expenses and/or a wider selection of investment opportunities,
that could also be a good reason to make the switch.
the participant must be careful in making the transfer. If a direct transfer,
there shouldn’t be any tax problems, but, if an indirect transfer, where the
check is made out to the participant, there is the 20 percent withholding rule
and a requirement that 100 percent of the funds be placed into the new plan
within 60 days.
course, the real issue raised by the regulators is rolling over into an IRA.
This is where there are some distinct differences, so let’s point them out:
After looking at these, it seems that the choice is clear—keep
it in the old plan or roll over to the new one. However, we do need to look at
some of the advantages of an IRA rollover.
general, there are more investment options available in an IRA.
As you can see, there are pros and cons to both, and that
is exactly what the regulators want explained to clients. There is much
evidence of participants making choices solely because they didn’t know what
else to do. The job of the financial professional is to educate in this respect
and truly look out for the interests of the client.
That leads us to the undeniable potential for conflicts
of interest. After all, the broker/dealer is in business to make money
executing transactions. The investment adviser is in business to make money
charging for advice. If the client is told that it is in his best interest to
keep the money in the existing plan, or transfer it to the new employer’s plan,
it is doubtful that any compensation will be realized by the firm. No one likes
to work for nothing, but that will happen frequently when the clearest choice
for the customer puts no money in the adviser’s pocket.
The January 9 SEC letter stated, "Investment
advisers and broker-dealers may have incentives to recommend that the assets be
placed with an IRA or other alternative offered by a financial services
firm." FINRA’s concluding statement under conflicts of interest in Notice 13-45 expressed the same idea: “A
financial adviser has an economic incentive to encourage an investor to roll
plan assets into an IRA that he will represent as either a broker/dealer or an
investment adviser representative.”
Avoiding conflicts of interest are done in
two basic ways.
Of course, making recommendations is nothing
new under FINRA Rules. Rule 2111 goes into great depth regarding the procedures
and information necessary to make suitable recommendations. In that vein, FINRA
has made it clear that recommending IRA rollovers is no different from making
any other recommendation to a client; it must be suitable when taking into
consideration the client’s needs and objectives, as well as all of the relevant
factors. One additional consideration is that following the recommendation to
roll over the assets, in most cases, there will be a substantial portion
liquidated and reinvested into new securities. The exchange must, of course, be
This can call for enhanced suitability
monitoring. Some firms will want to create exception reports whenever IRA funds
reach a designated threshold. Others will require clients to complete special
disclosure forms, not unlike those used with penny stocks. Some firms have
limited their activity in this area to educational services only. If this is
the case, training must include steps to take to avoid statements coming under
Rule 2111 and, therefore, triggering the suitability requirements. This is
generally done by ensuring that all material is checked and that no
recommendations are made.
Another stated concern of both FINRA and the
SEC is the use of advertising or other promotional materials urging clients to
roll over their retirement plan assets. FINRA Rule 2210 deals with
communication with the public and requires that misleading or incomplete
information may not be disseminated. As stated earlier, when referring to the
GAO report, there is much more in the way of information presented dealing with
why and how you should roll over than keeping the plan. Furthermore,
advertisements promising “fee-free IRAs” can be misleading if the charges are
bundled into other costs. Just as with
any other communications under Rule 2210, the communication may be deemed
misleading if it omits information needed to cause the description to be fair
and balanced in terms of its comparison to other options. So, if the example of
the “fee-free” account contained a statement in close proximity, in similar
type size, stating “other account fees and charges may apply,” FINRA would find
The final step in compliance is proper
supervision. NASD Rule 3010 (one of the few remaining rules that has not been
converted to a FINRA rule) requires that all member firms have adequate
supervisory procedures to monitor compliance with all applicable rules. The key
tool is the firm’s Written Supervisory Procedures (WSP) manual.
If the firm is going to be promoting or
otherwise handling IRA rollovers, the WPS must specifically deal with how the
firm is going to supervise and train personnel, as well as the controls put in
place to ensure that suitability standards are kept.
Lowenstein is a full-time faculty member
at Kaplan University. The views expressed in this article are solely those of
the author and do not represent the view of Kaplan University.
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