Art by June Kim
ADVISER QUESTION: I am a registered investment adviser
(RIA), and I provide investment services to individual retirement accounts
(IRAs). Is that advice subject to the fiduciary rules of the Employee
Retirement Income Security Act (ERISA)?
ANSWER: Yes and no. You are subject to the fiduciary
prohibited transaction (PT) rules of the Internal Revenue Code (IRC)—which are
virtually identical to the PT restrictions of ERISA, but your advice for IRAs
is not governed by ERISA’s fiduciary standard of care. More specifically, the
code has a fiduciary definition but only for purposes of applying the PT rules.
Of course, as an RIA, your conduct is governed by the fiduciary standards under
federal securities laws as well as relevant state laws.
It is important to note, however, that some IRAs are covered
by ERISA and some are not. IRAs that serve self-employed individuals or
small-business owners, their spouses and their employees—whether they are a
Simplified Employee Pension (SEP) IRA or a Savings Incentive Match Plan for
Employees (SIMPLE) IRA—are ERISA plans. In any of those cases, an adviser’s
individualized investment advice is subject to ERISA’s fiduciary standards. On
the other hand, traditional and rollover IRAs—and SEPs and SIMPLE IRAs that
cover only business owners and their spouses—are not ERISA plans, in which case
ERISA’s prudent man rule does not apply.
Now, let’s delve into the details ...
The fiduciary definition is the same for both laws and
includes the advisory services you described—i.e., providing individualized
investment advice for a fee. The key difference between the two laws is that
ERISA imposes a prudent man standard on advisers’ recommendations and the code
does not. But the code and ERISA both have PT rules that apply only to
fiduciaries. As a result, the IRC needs a definition of “fiduciary.” That
definition is in a code regulation written by the Department of Labor (DOL) and
is the same as ERISA’s regulatory definition.
For instance, under the code, a fiduciary investment adviser
to an IRA is prohibited from dealing with the plan assets for his own
interest—the “self-dealing” prohibition. Stated another way, a fiduciary
adviser to an IRA can’t recommend investments that pay him additional
compensation. This self-dealing rule applies to any additional compensation
paid to the adviser or to an affiliate of his.
We have seen unsuspecting advisers inadvertently commit PTs
in IRAs. For example, if you were to recommend an affiliated mutual fund, you
would commit a PT because you and the affiliates are “double-dipping” on
fees—collecting both an advisory fee and an investment management fee on the
same assets. That is prohibited.
However, there are exemptions (PTEs) that may help. Under
PTE 77-4, if certain conditions are met, you or an affiliate could, with
appropriate initial and ongoing disclosures, collect the investment management
fee for a mutual fund you manage as long as you either: 1) waive the IRA fee
for the portion of the assets invested in the mutual fund, or 2) offset the
mutual fund management fee against your IRA advisory fee. Note that this
exemption is limited to mutual funds and would not cover other types of
investments, such as collective trusts, hedge funds or partnerships that pay
fees to you or an affiliate. Also, if the conditions of PTE 86-128 are met, you
may receive fees for effecting or executing securities transactions for an IRA,
in addition to your advisory fee.
Committing a prohibited transaction can be costly. A
fiduciary adviser who engages in a PT under the code must pay back the
prohibited compensation, plus lost earnings on that amount. The adviser must
also file a Form 5330 with the Internal Revenue Service (IRS) and pay an excise
tax of 15% of the amount involved, increased to 100% if the PT is not resolved
within a certain period of time.
The anticipated DOL proposal to expand the definition of
fiduciary investment advice could have a significant impact on advisers to
IRAs. If the definition is expanded, more advisers, and their broker/dealers
(B/Ds) and RIAs, will become fiduciaries subject to these rules. However, there
may be some relief, in the form of new PT exemptions that will be issued as a
part of the fiduciary proposal.
Fred Reish is chair of the Financial Services ERISA practice at the law firm Dirnker, Biddle & Reath. A nationally recognized expert in employee benefits law, Reish has written four books and many articles on the Employee Retirement Income Security Act (ERISA), Internal Revenue Service (IRS) and Department of Labor (DOL) audits, as well as pension plan disputes. Joan Neri, who has been associated with the firm since 1988, is counsel on the Employee Benefits and Executive Compensation Practice Group. Her practice focuses on all aspects of employee benefits counseling.