Art by Jun Kim
ADVISER QUESTION: I am a registered investment adviser (RIA)
who provides advisory services to retirement plans and participants and to
individual retirement accounts (IRAs). I am not affiliated with a broker/dealer
(B/D) and do not have proprietary products. I understand that the Department of
Labor (DOL) has proposed to amend the regulation defining fiduciary investment
advice. Does this proposal affect me?
ANSWER: Maybe. The proposal expands the definition of
fiduciary investment advice. It could affect you if you recommend a plan
distribution to a participant or provide advice on how to invest assets to be
rolled over or distributed from a plan or IRA, because these suggestions would
now be fiduciary advice. If the advice results in a prohibited transaction (PT)
under the Employee Retirement Income Security Act (ERISA) or the Internal
Revenue Code (IRC), you would need to satisfy the conditions of the DOL’s
proposed “best interest contract,” or BIC, exemption.
Let’s start with how the current rules apply to you.
You are already a fiduciary because you provide
“individualized” investment advice to plans, participants and IRAs. As a
result, you are subject to the fiduciary prohibited transaction rules. Those
rules say that you cannot use your authority to cause yourself or your
affiliate to receive additional compensation or to receive compensation from a
third party in connection with plan transactions. However, it is not a PT if
you charge a flat-dollar or fixed fee based upon a percentage of assets and receive
no other payments resulting from your advice.
You would be a fiduciary under the proposal, too. However,
the proposal also says you would be a fiduciary for recommending a distribution
or advising a participant about the investment of assets to be rolled over to
an IRA. Under a 2005 DOL advisory opinion (2005-23A), the department said these
acts are fiduciary acts if the person making the recommendation is already a
fiduciary to the plan. In that guidance, though, the DOL also concluded that,
if a person is not already a fiduciary in that context, the recommendation
would not be fiduciary advice.
The proposal eliminates that distinction. Under the
proposal, even if you currently provide no services to a particular plan,
participant or IRA, you would become a fiduciary to it or him if you
recommended a distribution or investments for the money to be rolled over. And,
if you received a higher fee as a result of the recommendation, the difference
in compensation would be a PT.
One way to avoid the PT is to charge the same fee in the IRA
as is in the plan. For example, if your fee to a plan is 25 basis points (bps),
then your fee to the IRA could be 25 basis points, too. However, this may be
impractical, because an IRA would typically be much smaller than a plan. Also,
IRA fees are often higher, because advisers frequently provide more robust
investment and financial services in connection with an IRA.
The DOL has proposed exemptions for conditional relief from
some PTs; the previously mentioned BIC exemption could be helpful in avoiding a
PT under these circumstances. The BIC would permit a fiduciary to receive
compensation that varies based upon fiduciary recommendations—e.g., the
recommendation to take a distribution—providing a number of detailed, and difficult,
conditions are satisfied. Among these is a requirement that the fiduciary enter
into a contract with the participant before making the recommendation. The
contract would need to contain a number of provisions, including
acknowledgement of fiduciary status, various warranties and financial
disclosures. (A more detailed discussion about BIC exemptions is beyond the
scope of this article, but we will cover that in a future column.)
The DOL’s proposed investment education “carve-out” from the
fiduciary definition also provides a way to avoid a PT. Services that
constitute investment education—including information about the different forms
of distributions and the important considerations for each—would not be
considered fiduciary advice. Because of that, investment education is a way to
avoid PTs for advising on distributions—and, therefore, the necessity to comply
with the BIC. However, a word of caution: Distribution education is not a vague
concept to be skimmed over in a general discussion. It needs to cover each
distribution alternative and the specific considerations a participant should
take into account in making a decision about those alternatives. The education
should be unbiased and complete.
Fred Reish is chair of the Financial Services ERISA practice
at the law firm Drinker, Biddle & Reath. A nationally recognized expert in
employee benefits law, Fred 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, associated with the firm since 1988, is counsel on the Employee Benefits
and Executive Compensation group. Her practice focuses on all aspects of
employee benefits counseling.