Retirement Advisers Need Clarity on Conflict-of-Interest Rules

A recent US Government Accountability Office report calling on the IRS to address conflicts of interest for retirement advisers underscores the entangled regulatory requirements and uneven enforcement mechanisms that fiduciaries face.

The GAO report suggests additional enforcement mechanisms for individual retirement accounts. While this might improve participant outcomes, recommending more regulation and oversight at this time introduces additional challenges.

The Department of Labor interprets and enforces the Employee Retirement Income Security Act for employer-sponsored plans such as 401(k)s, but not for IRAs. The IRS has enforcement authority over both employer plans and IRA fiduciaries. The Securities and Exchange Commission and Financial Industry Regulatory Authority also regulate this area. This creates a complex, dynamic regulatory landscape with overlapping requirements.

Under ERISA, fiduciaries must act in participants’ and beneficiaries’ best interests, restricting transactions that present conflicts of interest. Many financial professionals have avoided being considered fiduciaries to bypass these prohibitions, rather than comply with the complex requirements to satisfy a prohibited transaction exemption. The DOL finalized a rule expanding the definition of fiduciary advice in 2016, but that rule was ultimately vacated. In 2023, the DOL proposed a new fiduciary rule, the Retirement Security Rule, which has since been stayed by two Texas district courts.

Attempts by the DOL to clarify and expand on what people and actions fall within the scope of the fiduciary rules through regulation in recent years have been fraught and remain unresolved.

Meanwhile, the IRS enforces rules through excise taxes imposed on prohibited transactions and relies heavily on self-reporting. The DOL uses audits and investigations to identify violations, imposing civil and criminal penalties, and refers violations to the IRS to impose excise taxes.

The IRS, if it’s to follow the GAO’s advice, would need additional resources to develop an investigation process and coordination procedures. Although the IRS received more funding for enforcement under the Inflation Reduction Act, this funding may change next year.

Developing exemptions and model disclosures that could be provided to potential IRA customers to prevent these prohibited transactions from happening might be a better approach, as IRA customers are arguably in the best position to identify such transactions before they occur.

Requiring an adviser to provide a customer with a straightforward written explanation of what types of compensation are and aren’t permitted, based on an approved IRS model, will put pressure on those advisers to avoid compensation arrangements that violate the rules. It also will arm consumers with information to assist them in avoiding advisers that violate the rules.

Plan sponsors and fiduciaries who have been standing by awaiting certainty about the DOL’s fiduciary rulemaking efforts might consider taking a few different steps.

Renegotiate service provider agreements. Consider updating agreements with financial services vendors and other plan service providers to include language taking advantage of new prohibited transaction exemptions, and to prohibit cross-selling of services to plan participants. Doing so may make it easier for plan fiduciaries to identify and avoid prohibited transactions.

During the process, consider discussing the compensation arrangements that will apply to the products to ensure that the plan fiduciary understands any variable compensation, sales-based incentives, and bonuses that may be payable to plan service providers, beyond the required plan fee disclosures.

Reinstate participant education programs. Consider revisiting whether to implement or re-implement participant education efforts, with restrictions to prevent cross-selling and reduce conflicts of interest. This is particularly appropriate if your plan reduced or eliminated participation education programs in response to the 2016 rule. When reinstating any such programs, consider limit marketing of other non-plan services to participants to address the conflicts issues noted in the GAO report.

Evaluate auto-IRA arrangements. Consider assessing arrangements to automatically roll over accounts with small balances when a participant doesn’t respond—especially because the higher $7,000 automatic rollover limit under SECURE 2.0 being implemented by many plans may increase the volume of automatic rollovers.

Consider assessing whether the fees the auto-IRA provider charged to the participant are reasonable in comparison with the market, recognizing there may be operational efficiencies with using a provider affiliated with other plan vendors that could justify a higher fee. It also may be appropriate, though not necessarily required, to evaluate the default investment option in the IRA under standards similar standards to the plan’s qualified default investment alternative

Review communications for separating participants. Consider whether materials provided to participants eligible for a distribution adequately and clearly explain differences between employer-sponsored retirement plans and IRAs, addressing the communication gaps noted in the GAO report. The average participant, and many financial advisers, may not understand the differences between leaving funds in an employer plan or moving them to an IRA.

Educational materials explaining to participants the fees that will be charged if they keep their money in the plan and equipping them to understand both potential investment returns, but also the fees that will be charged can allow them to make better decisions on where to put their retirement savings.

While fiduciary definitions and regulations remain uncertain for both employer-sponsored retirement plans and IRAs, the steps above provide a starting point for plan fiduciaries to protect themselves and their participants. Plan fiduciaries can protect themselves by taking thoughtful, considered, and well-documented steps to ensure their vendors are acting appropriately and educating their participants.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Carly Grey is a shareholder at Ogletree Deakins in Washington, D.C., with focus on employee benefit and executive compensation matters.

Katrina Clingerman is a shareholder at Ogletree Deakins in Indianapolis, and specializes in employee benefits.

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