NASD Rule 3110 - Books and Records
Application of NASD Rules 3110, 2510, 2310, and IM 2310-2 to a default IRA account established by plan sponsor in accordance with Department of Labor safe harbor provisions.
March 17, 2005
Tamara K. Salmon
Senior Associate Counsel
Investment Company Institute
1401 H Street, N.W.
Washington D.C. 20005
Re: Application of NASD Rules to Default IRAs
Dear Ms. Salmon:
This letter responds to your February 15, 2005 letter in which you ask for interpretative guidance regarding the application of several NASD rules to Individual Retirement Accounts (IRAs) established pursuant Section 401(a)(31)(B) of the Internal Revenue Code, as amended by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and governed by regulations recently adopted by the Department of Labor (DOL).
Certain employer-sponsored retirement plans require mandatory distribution of an account of $5,000 or less at the time an employee leaves employment. Under EGTRRA, if the employee participant in such a plan fails either to elect a cash distribution, or to direct the plan sponsor to roll the proceeds of the account into another eligible retirement plan, the plan sponsor must transfer the account balance to a qualified IRA.
DOL Regulation 404a-2 provides a safe harbor pursuant to which a plan sponsor is deemed to have satisfied his or her fiduciary responsibilities under ERISA in connection with the transfer of an account to a default IRA.1 The regulation places strict limits on the types of investment products into which the rolled-over funds may be invested, and requires that the chosen investment must be "designed to preserve principal and provide a reasonable rate of return" and must "seek to maintain, over the term of the investment, the dollar value that is equal to the amount invested". The safe harbor also limits permissible investment products to those offered by certain institutions, including FDIC-insured bank or savings associations, credit unions, certain guaranteed insurance companies, and registered investment companies. The safe harbor also requires a written agreement between the plan sponsor and the IRA provider regarding fees and expenses, and guaranteeing the right of the plan participant to enforce the terms of the agreement against the account provider. Before the default IRA can be established, the plan sponsor must notify the participant in writing using the participant's most recent mailing address in the records of the employer and plan sponsor.
Application of NASD Conduct Rules to Default IRAs
Your letter seeks interpretative guidance that an NASD member will not be deemed to be in violation of NASD Rules 3110, 2510, 2310, and IM 2310-2 by virtue of opening a default IRA at the direction of a plan sponsor and in compliance with EGTRRA and DOL Regulation 404a-2, even though the account is opened (1) without the express authorization of the account holder (the plan participant) and (2) with only limited information about the account holder.
NASD Rule 3110(c) requires that for each account held by a member firm, the firm must make reasonable efforts to obtain certain information about the account holder before the settlement of the initial transaction, including his or her current employer, address, and whether the account holder is an associated person of another member. When a default IRA is opened pursuant to EGTRRA, however, the member firm may only be able to receive limited information relating to the plan participant who will be the beneficial owner of the account. In addition, Rule 3110(f) requires that members deliver a copy of any customer agreement that contains a predispute arbitration clause to the customer within a specified period of time. Rule 2510 requires a member firm to obtain written authorization from a customer in connection with any account transaction, including opening the account. Rule 2310, NASD's suitability rule, requires firms to make reasonable efforts to obtain certain information from the customer, and to have a reasonable grounds for believing that a recommendation is suitable for a customer based on the customer's financial situation and needs. IM-2310-2 defines fraudulent activity to include effecting unauthorized transactions in a customer's account.
Because the transfer of covered distributions to default IRAs is mandated by EGTRRA, in the view of NASD staff, a plan sponsor acting in a fiduciary capacity in accordance with the safe harbor of Regulation 404a-2 is deemed to be authorized by federal rules to have the capacity to act on behalf of the account holder for purposes of the authorization, notice and delivery provisions of the rules at issue. Therefore, a member firm may satisfy Rule 3110(c) based on information provided by the plan sponsor, and may satisfy the delivery requirements of Rule 3110(f) by providing a copy of an agreement containing a predispute arbitration agreement to the plan sponsor within the specified time.2 Likewise, the statute provides the necessary authorization for opening and maintaining an account under both Rule 2510 and IM-2310-2. NASD notes, however, that firms must obtain required signatures and additional information from, and make delivery of necessary documents to, the account holder if and when he or she asserts ownership or control over the account.3
With respect to Rule 2310, NASD staff believes that an investment in a default IRA, initiated by the Plan Sponsor in accordance with a recommendation of a member firm, that complies with the terms of Regulation 404a-2's safe harbor is de facto suitable, and a member need not obtain any additional information for the purposes of making a suitability determination with respect to qualifying accounts.
NASD notes that the guidance contained in this letter applies only to potential regulatory issues that might arise as a direct result of compliance with EGTRRA and Regulation 404a-2 and does not extend to unrelated violations of the same or other rules.
I hope this letter is responsive to your inquiry. Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the NASD Board of Governors. This letter responds only to the issues you have raised based on the facts as described herein, and does not address any other rule or interpretation of NASD, or all the possible regulatory and legal issues involved.
Associate General Counsel
1 Fiduciary Responsibility Under the Employee Retirement Income Security Act of 1974 Automatic Rollover Safe Harbor, Final Rule, 69 Fed. Reg. 58018 (Sept. 28, 2004) (DOL Adopting Release).
2 This interpretation applies solely to the delivery requirement for agreements containing predispute arbitration clauses. The staff takes no position with respect to the enforceability of such clauses, and is not deeming the plan sponsor to be an agent of the account holder for the purposes of enforceability. The staff also notes that nothing in this letter should be construed to prohibit a firm from executing a predispute arbitration agreement with the account holder if and when the account holder exercises control over the account.
3 NASD notes that this is consistent with the approach taken by the Department of Treasury and other federal regulators with respect to information required to be obtained by banks and financial institutions at the time of account opening by the USA PATRIOT Act. See DOL Adopting Release.