Advisers take note: The Department of Labor’s Prohibited Transaction Exemption 2020-02 will begin to be fully enforced effective July 1.
Jason Roberts, CEO of the Pension Resource Institute and Retirement Law Group in San Diego, explains that the only remaining requirement to be enforced is the mandated development and delivery of a written explanation to rollover clients of the specific reasons as to why the investment professional and financial institution believe the rollover is in the client’s best interest.
Generic reasons, such as access to more investment options in a managed IRA account, won’t cut it. According to Roberts, the DOL expects advisers to follow a review process and to provide detailed explanations for their recommendations. After evaluating the relevant factors, advisers must specify and document the reasons why their advice is in participants’ best interest—before a rollover occurs.
Parts of that process, such as collecting detailed data about a participant’s current plan and outside accounts, could be challenging—at least for the first time an adviser works with a particular client on the rollover issue. In its April 2021 publication of frequently asked questions about PTE 2020-02, the Employee Benefits Security Administration emphasized the data-gathering requirements. As stipulated in FAQ 15, investment professionals and financial institutions should make “diligent and prudent efforts to obtain information about the existing employee benefit plan and the participant’s interests in it.”
So, Are Advisers Ready?
The July 1 enforcement date has been widely publicized, but that doesn’t mean all advisers are ready. John Faustino, head of Broadridge Fi360 Solutions in Pittsburgh, says that some smaller firms are still finalizing their processes.
“About 15% of those we’ve spoken to weren’t aware of the requirements before we discussed them,” Faustino says. “Awareness has been an issue for those with limited retirement regulation expertise.”
Fred Reish, a partner with Faegre Drinker in Los Angeles, notes that compliance and firm size are often linked. He has found that the larger broker/dealers have been working on PTE compliance for a year or more. As a result, they were in full compliance by the early part of this year, and they are ready for the July 1 requirements.
Many larger investment advisers, who generally have fewer compliance issues than the broker/dealers because they have fewer opportunities for potential conflicts of interest to arise, were also largely in compliance early this year and are ready for July 1, Reish says.
“However, as you move down through the midsize and smaller broker/dealers and investment advisers, there are more issues,” Reish notes. “Some are in compliance, some didn’t realize that the first set of conditions actually became applicable on February 1 and some either aren’t aware of these rules or don’t think that they apply to them.”
Developing Internal Frameworks
Advisers shouldn’t treat the rollover evaluation and disclosure lightly, Roberts cautions. He says the stakes are high because “advisers are now operating under the highest standard of care under U.S. law, at least when ERISA-covered plans are involved, and the penalties are serious under both ERISA and the tax code.”
An adviser’s good intentions—or even a successful outcome for the participant—is not the main issue, he adds. “If you miss a step, in terms of the compliance conditions, it results in a violation that potentially triggers disgorgement, interest payments and excise taxes, at a minimum,” Roberts explains. “Firms can also be held liable for losses in the account if the violation caused the losses.”
To avoid compliance problems, Reish says, firms must have disclosures, policies and procedures. He urges firms to create a formal best-interest process for each type of covered recommendation that their advisers make. For example, they need to prepare written disclosures for retirement investors speaking to the fact that a plan-to-IRA rollover recommendation or an IRA-to-IRA transfer recommendation is potentially a conflict of interest, given the possibility of increased compensation for the professional making the recommendation.
“And, for some recommendations, the DOL requires that the best-interest process include the review of certain information; for example, the plan-to-IRA rollover recommendation process must include evaluation of the retirement plan’s investments, services and expenses,” Reish adds.
Firms’ approaches to managing the compliance complexities run the gamut, depending on the size of the firm, volume of rollovers and supervisory resources, says Roberts. Some smaller firms that don’t process many rollovers can track requirements manually using paper forms. Most midsize and larger firms have invested in software to manage workflow and help investment professionals perform the required analyses, he adds.
Reish is seeing interest in this software category, particularly for the information and process required for a plan-to-IRA rollover recommendation. Faustino reports “tremendous demand” for Broadridge’s Fi360’s PTE 2020-02 Decision Optimizer product. Roberts says that, except for the wire houses, the “vast majority” of financial institutions are licensing third-party solutions from a handful of vendors.
“Additionally, one of the requirements is to conduct an annual retrospective review that must be certified by a senior executive officer,” Roberts adds. “Software can significantly streamline this process and facilitate better supervision along the way so there are fewer violations to correct.”
Beware of Problem Areas
Not surprisingly, some firms are experiencing pain points with the July 1 requirements. Faustino says firms that didn’t implement appropriate processes before the February 1 effective date can find the self-correction requirements challenging. The effort to correct, document and notify the DOL of violations is a significant undertaking, he says.
Collecting actual benefit plan data to satisfy the documentation requirement for rollovers from a plan to an IRA is another challenge, says David Porteous, a partner with Faegre Drinker in Chicago. Such information should be readily available as a result of the DOL mandating disclosure of plan-related information to the plan’s participants—the so-called 404a-5 information, he explains. To the extent that data are not readily available, or the client won’t provide the information, firms can rely on alternative plan data, such as the most recent Form 5500.
“But even interpreting that information or getting reliable benchmarks is difficult, depending upon the type and the size of the plan at issue,” says Porteous. “Large plan data, those with more than 100 participants, available on the full Form 5500, is easier to obtain than for smaller plans for which a Form 5500 SF or EZ may be filed but may not contain meaningful information for rollover purposes.”
One Firm’s Experience
There are bright spots. The July 1 requirements aren’t proving overly burdensome at Prime Capital Investment Advisors LLC, which does business as Qualified Plan Advisors, according to Anthony Woodard, chief risk and compliance officer in Overland Park, Kansas. He says the firm has a defined process for making and documenting rollover recommendations; consequently, its advisers are “pretty well-prepared” and there have been “no major headaches” with the rules so far.
The firm uses its rollover recommendation form (formally known as a “Memorandum of Understanding”) with clients to record the adviser’s recommendation, specific reasons for the recommendation, alternatives considered, all information needed and used for the analysis and a consideration of costs.
“This signature-required form, which was introduced at the beginning of this year, is required for all such recommendations and is an essential part of our supervisory and quality-control framework, including the required retrospective review,” says Woodard.
The firm is not currently using any PTE monitoring software, Woodard says, but they are exploring those solutions for plan-to-IRA rollover cases where “despite everyone’s best efforts, the required plan information may not be available and alternative data sources will ultimately be needed,” he explains.