Rollover Rules for 457(b) Plans
Art by Tim Bower
Question: I’m a registered investment adviser who provides investment advisory services to participants in retirement plans, including government plans. Occasionally, I recommend that a plan participant in a 457(b) plan roll over his or her account to an individual retirement account I will manage. Is this considered fiduciary advice under the Employee Retirement Income Security Act and/or the Internal Revenue Code and therefore requiring compliance with Department of Labor Prohibited Transaction Exemption 2020-02 in order to avoid a prohibited transaction? If not, are there other fiduciary rules that apply?
Answer: The ERISA fiduciary standard along with the prohibited transaction rules of ERISA and the IRC do not apply to government plans, and, therefore, PTE 2020-02 relief isn’t needed, in the case of, for example, a rollover recommendation. But, under the Securities and Exchange Commission’s Interpretation Regarding Standard of Conduct for Investment Advisers, a rollover recommendation—including one involving a 457(b) plan account—is subject to the SEC’s best interest standard. And the SEC best interest standard and the DOL best interest standard have many similarities.
The ERISA fiduciary definition and duties of prudence and loyalty do not apply to government plans, including government tax-qualified plans—e.g., 401(a) pension plans, 403(b) plans for public schools and universities, and 457(b) plans.
However, the SEC’s rules must also be considered. Under its above-mentioned interpretation, a rollover recommendation is subject to the SEC’s best interest standard of care. The commission’s recent Staff Bulletin: Standards of Conduct for Broker/Dealers and Investment Advisers Account Recommendations for Retail Investors provides additional details about compliance with this standard including its similarity to the Reg BI standard. As explained in the bulletin, the adviser interpretation best interest standard and the Reg BI standard “generally yield substantially similar results in terms of the ultimate responsibilities owed to retail investors.” Also, like the DOL did, the SEC applies the term “rollover” broadly to include recommendations for retirement account rollovers and IRA-to-IRA transfers.
In the Staff Bulletin, the staff explain that, in making a best interest rollover recommendation, all relevant factors must be considered in light of the retail investor’s investment profile, including “costs; level of services available; features of the existing account, including costs; available investment options; ability to take penalty-free withdrawals; application of required minimum distributions; protection from creditors and legal judgments; and holdings of employer stock.”
These factors are similar to those enumerated by the DOL in its guidance. For instance, both agencies emphasize the importance of evaluating and comparing the costs and the services in the retail investor’s current plan or account and in the potential account—e.g., the rollover IRA. In the Adopting Release to Reg BI, the SEC made clear that a generic reason such as the IRA offering more investment choices would be insufficient to justify a rollover recommendation where the additional investments would not be needed or used. However, where the services in the new account are valuable to the investor as based on his investment profile, then those services could justify a rollover recommendation.
Further, like the DOL, the SEC staff guidance says that all of the retail investor’s options need to be considered and evaluated as part of the best interest process. The individual’s options include leaving the money in his current plan; taking a taxable distribution; rolling the money over to the potential IRA; and, if the investor is switching jobs, rolling the money into his new employer’s plan.
One difference between the DOL best interest process under PTE 2020-02 and the SEC best interest process is that the PTE requires that participants be given written disclosures of the “specific reasons” why the rollover recommendation is in their best interest. Although the SEC has no similar requirement, there’s a reasonable expectation that its examiners will ask for that documentation. Also, a fair reading of the Staff Bulletin is that an adviser would have specific reasons about why a rollover recommendation is in the best interest of a retirement plan investor, even if those reasons don’t have to be reduced to writing. Even there, though, a written record is evidence of compliance.
In conclusion, although neither ERISA’s nor the IRC’s prohibited transaction rules apply to government plans, and therefore the PTE’s relief is not needed, the SEC regulates rollover recommendations of both private-sector and government plans in a similar manner. To satisfy the SEC’s best interest standard, you should consider using a process similar to that required under the PTE.
Fred Reish is chairman of the financial services ERISA practice at law firm Faegre Drinker Biddle & Reath LLP. Joan Neri, a nationally recognized expert in employee benefits law, is counsel in the firm’s financial services ERISA practice.