IRS Eliminates Dual-Testing for Broker-Dealers Managing IRAs
Internal Revenue Service
The Internal Revenue Service just eliminated a redundant compliance hurdle for financial institutions managing individual retirement accounts, by allowing carrying broker-dealers to use their existing SEC compliance to satisfy IRS fiduciary requirements.
Until now, nonbank entities wanting to act as IRA trustees had to prove their financial stability through a strict IRS "adequacy of net worth" test.
This test generally required these firms to maintain a net worth exceeding a specific dollar amount or a set percentage of the assets they held in fiduciary accounts to ensure the institution had enough capital to protect everyday Americans' retirement savings.
However, carrying broker-dealers, firms that hold client funds and securities directly, were already playing by a notoriously strict set of rules.
They answer to the Securities and Exchange Commission.
Under the SEC Net Capital Rule, these firms must maintain highly liquid assets to avoid insolvency and cover all liabilities.
Simultaneously, the SEC Customer Protection Rule forces these broker-dealers to physically segregate client cash and securities from the firm's own proprietary business activities.
The IRS has finally acknowledged that these SEC mandates achieve the exact same consumer protection goals as their own net worth test.
Because these rules overlap, the IRS will now accept a carrying broker-dealer's proof of SEC compliance in lieu of the traditional IRS net worth demonstration.
This is a massive operational relief for Wall Street compliance departments.
Firms no longer have to calculate and submit parallel solvency metrics to two different federal agencies.
For business students and young corporate lawyers, this is a textbook example of inter-agency regulatory harmonization.
When federal agencies recognize each other's frameworks, it lowers administrative overhead for the market.
However, this regulatory fast-track is strictly limited in scope.
It applies exclusively to carrying broker-dealers that receive or hold funds and securities for customers.
There is a hard carve-out.
This alternative method is completely unavailable to broker-dealers that operate under an exemption report pursuant to SEC Rule 17a-5(d).
For firms already approved as nonbank trustees, they simply need to notify the IRS if they plan to switch to this SEC-based compliance method.
New applicants can rely on a good faith interpretation of this notice until the formal application procedures are updated.
