Reg BI’s Impact on 403(b)s

Although 403(b) plans have similarities to 401(k) plans, there are significant differences when it comes to applying the Securities and Exchange Commission’s Regulation Best Interest. Those differences stem from the division of 403(b)s into ERISA [Employee Retirement Income Security Act] plans and non-ERISA plans. 

According to a March report from the Government Accountability Office (see sidebar), ERISA plans held 57% of the estimated $1.1 trillion in 403(b) assets as of year-end 2020. 

Most private-sector tax-exempt organizations’ 403(b)s are subject to ERISA. Still, these plans may operate as non-ERISA, provided they meet two conditions. First, the plan’s contributions must come solely from employee contributions. Second, the plan must qualify for a limited employer involvement safe harbor, which prohibits contributions by the employer and limits its involvement with the plan. 

Public K–12 schools, colleges and universities, and certain religious institutions and affiliated organizations such as hospitals and universities, are generally not subject to ERISA, though religious organizations’ plans may elect ERISA coverage and its requirements.

ERISA status influences how advisers interact with a 403(b) plan. In the plans that are subject to ERISA, the adviser works with the plan sponsor, and the relationship looks much like one with a 401(k) sponsor. Advisers’ service of non-ERISA plans has traditionally taken a different approach. In those instances, sponsors often have had little involvement with the plan: The providers and advisers secured relationships with the individual participants. 

Historically, for one example of how this worked, the various departments of a school district might have each maintained a list of approved 403(b) vendors authorized to enroll that group of employees into their products. Advisers, many of whom were selling annuities, met one-on-one with the employees and enrolled them into a payroll savings plan. “These advisers would sit in the teachers’ lounge all day long, trying to talk to teachers, to sign them up for the 403(b) plan,” says Jennifer Tanck, an attorney and executive vice president at Pensionmark Financial Group in Santa Barbara, California.

There is a subset of non-ERISA 403(b)s that resemble ERISA 403(b)s in their operation, says Tanck, citing, for example, some church plans and educational institution plans. Here, sponsors take a more paternalistic view and treat the participants much as an ERISA-plan sponsor would. But they still toe the line to avoid becoming technically subject to ERISA. 

In other cases, though, sponsors’ lack of involvement has shifted the funding and management decisions completely to the participants, Tanck says. “When we look at the non-ERISA 403(b) space, it can be the employee/plan participant who’s responsible for administering her own mini plan.”

An Insurance Loophole?

Reg BI “absolutely applies” to advisers’ discussions about rollovers and distributions with ERISA 403(b) participants, just as it does with 401(k) participants, Tanck says. 

Further, the one-on-one adviser-to-participant arrangement prevalent in non-ERISA plans would seem to be just the situation Reg BI was designed for. That is the case when the adviser has a broker/dealer or registered investment advisory affiliation and the distribution or rollover advice involves securities, but the widespread use of annuities in non-ERISA 403(b) plans creates a question about the regulation’s application, Tanck notes. Before the annuity regulations were changed in 1974, participants could invest only in annuity products. After 1974, plans could include mutual funds, but non-ERISA plans, especially those of K–12 public schools, have tended to stick with annuities. 

The SEC regulates variable annuities as securities, but fixed annuities and fixed-index annuities are insurance products. Additionally, some salespeople working in the non-ERISA market may be licensed solely as insurance agents with no B/D or RIA affiliation. In these cases, the adviser or agent is subject to state insurance regulations but is outside the SEC’s and Reg BI’s jurisdiction. 

It can get complicated, Tanck says, citing an example of a non-securities registered insurance agent who recommends the rollover of the account’s fixed annuity as the focal point of a transaction. “In my view, because this agent is not a broker/dealer registered representative, the transaction does not fall within the purview of Reg BI,” Tanck says. “If the agent did have a Series 6 license, but he was still recommending the rollover of the non-ERISA 403(b) assets into a fixed annuity, only the recommendation of the potential liquidation of securities within the plan would be subject to a Reg BI analysis and not the actual fixed annuity rollover recommendation, due to the non-securities nature of that piece of the transaction.” 

How Reg BI Is Working So Far

Assuming Reg BI applies to a specific situation, has the landscape changed for 403(b) advisers, products and approaches to the market? Scott Dauenhauer, owner of Meridian Wealth in Murrieta, California, thinks not. “I haven’t seen any shift in the relationship sales professionals have with 403(b) participants—it’s business as usual,” says Dauenhauer, who has worked in the 403(b) industry since 1998 and consulted with the California State Teachers Retirement System on its 403(b) programs. “Maybe they have to do a bit more paperwork. Their compliance departments see to it that they can sell the same low-quality products but in a way that complies with the new rules. Products haven’t shifted.”

As far as the required disclosure of potential conflicts of interest, Dauenhauer maintains that companies’ efforts have skirted the regulation’s spirit. “Reg BI requires mitigation or disclosure,” he says. “Most have chosen disclosure because that’s easier and more profitable. But that disclosure is not done in a meaningful way, in my experience. It seems to me the disclosure is made in either a reference to an online document of disclosure that’s written in a manner to obfuscate and mislead or the same thing but in paper form. 

“If anything,” he says, the situation “is worse because now these salespeople go around saying that Reg BI requires them to work in the best interest of their customers, but it doesn’t. It doesn’t require a sales professional to offer the best product. If it did, we’d have seen a huge shift in who services the 403(b) market over the past few years, but we haven’t.”

Tanck’s assessment of Reg BI’s impact is more positive. “I don’t think it’s the same old, same old,” she says. 

“It’s not so much that I think the sales practices have changed,” she adds. “I think there’s better documentation of the sales process and better disclosure to the client.” —Ed McCarthy

Art by Anja Sušanj