How Regulation Best Interest Could Impact Non-ERISA 403(b) Plans

In April of this year, the Securities Exchange Commission (SEC) proposed a new set of guidelines to better govern relationships between professional financial advisers and broker-dealers and those of their individual clients. These suggestions, collectively dubbed Regulation Best Interest, could reshape the relationships between individual investors and the professionals who advise them by ensuring that a broader swath of those relationships requires the broker-dealer to act in the best interests of the client.

The plan would specifically call for broker-dealers to act in the best interests of “retail customers” when making suggestions related to investment strategy or portfolio management. This targeting excludes ERISA-covered 401(k) plans, but Regulation Best Interest could possibly apply to non-ERISA 403(b) plans. Determining whether a given plan would fall under the rule can be tricky.  In either event, the rollover of assets from a 401(k) or ERISA 403(b) plan to an IRA is likely to be covered under the standard.

Determining Whether a 403(b) Plan is Covered Under Regulation Best Interest

The first step to determining whether a given plan would be subject to the SEC’s rule change is to understand what disqualifies a plan from the protections. Regulation Best Interest is pertinent to relationships between broker-dealers and clients who both receive investment advice from that person and apply the advice for “personal, family or household purposes.”

The second part of that equation eliminates ERISA plans from this new protection, but leaves the door open for non-ERISA 403(b) plans. The second piece of the puzzle involves examining the criteria such a plan must meet to qualify.

A tax-advantaged retirement plan that includes only salary deferrals is not an ERISA plan if the following conditions are met:

a. contributions are made at the employee’s discretion;
b. the employer is not involved with the management of the plan’s assets;
c. the employer is not compensated for facilitating the plan; and
d. all rights implied by the plan can be enforced directly by the employee.

If these conditions are met, the 403(b) account owner would likely be treated as a retail customer under Regulation Best Interest, obligating broker-dealers to place his or her interests first.

Changes to Fiduciary / Best Interest Obligations: 2018 Context

The SEC’s Regulation Best Interest would come along at a time when the Department of Labor’s (DOL) fiduciary rule has been struck down by the courts. Ultimately, both regulatory bodies are out to extend existing protections to those seeking the advice of a financial professional. The central tenets of both are tied heavily to eliminating conflicts of interests between broker-dealers and the retail clients they serve. Regulation Best Interest targets “material conflicts of interest,” which the SEC defines in much the same way as the DOL.

Any system of compensation which would incentivize the advisor to make securities recommendations with his/her own earnings impacted would be suspect for retail customer relationships under the proposition. A commission-based model or other system that would lead an advisor to sell certain investment products over others would constitute a potential conflict of interest. The SEC has stated that it would release a succinct, clear document which would lay out the responsibilities of broker-dealers towards non-ERISA 403(b) plan owners and retail customers, as well as IRA rollovers.

This type of clear “relationship summary” has often been lacking in the past, as fiduciary duty is a notion that has been often redefined by court cases and may be unclear to some investment advisors.

Adoption

While the legal future of the proposed Regulation Best Interest is still uncertain, a variety of institutions may soon consider adopting its principles for themselves. Central to the issue of inclusion under the rules is asset mix within the plan.

Organizations should note that fixed annuities and fixed indexed annuities are considered insurance products, not securities. They therefore fall outside the purview of the SEC. On the other hand, variable annuities are securities and subject to SEC control.

Given that a number of 403(b) plans are strictly comprised of fixed annuities and fixed indexed annuities, insurance companies would do well to take up the mantle of Regulation Best Interest. Based on what’s in the plan, the protection of an individual non-ERISA 403(b) plan owners’ interests may or may not be under the SEC’s responsibility.

Get Impartial Help

Sponsoring a retirement savings plan that meets participant needs and is a cost-effective use of benefits is also very complicated. Expert advice from an independent Registered Investment Advisor, not tied to any particular fund family, a bank or the plan administrator, such as PlanPILOT, can be invaluable. PlanPILOT’s holistic approach helps sponsors reduce their governance and oversight risks with a comprehensive look at the design, education, regulatory effects and more. For more information, contact us at (312) 973-4911.

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