Magazine

Compliance Consult | PLANADVISER September/October 2015

Advising Wealthy Individuals

Advisers’ responsibilities under ERISA and state law

By David kaleda editors@assetinternational.com | September/October 2015

PLANADVISER-January-February-2015-Compliance-Consult-June-KimArt by June KimAt some point, a retirement plan advisory firm may want to market advice services to wealthy individuals. In delivering such services, investment of individual retirement account (IRA) assets or rollovers from a retirement plan to an IRA will become part of the conversation. The marketing and delivery of such advice services raises compliance issues under federal and state securities laws, the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (IRC). The regulatory landscape has only become murkier since the Department of Labor (DOL) submitted a proposal to change its regulation that defines the meaning of “investment advice” under Section 3(21) of ERISA and Section 4975(e)(3) of the IRC. The following is a short summary of the key issues to consider.

A person providing wealth management services will often be an “investment adviser,” as defined under the Investment Advisers Act of 1940, or Advisers Act, which establishes the following: An investment adviser is a person who, among other things, for compensation engages in the business of counseling others as to the advisability of investing in, purchasing or selling securities. Often, a broker/dealer (B/D) and its registered representatives will qualify for an exemption under the Advisers Act. However, oftentimes, the provision of advice services to wealthy individuals will result in investment adviser status because the guidance provided will be more than incidental.

If a firm is an investment adviser, it must register with the Securities and Exchange Commission (SEC), if it has $100 million or more of regulatory assets under management (AUM). If its AUM is below that number, the firm should register with the state or states in which it maintains a principal office.

When registered with the SEC, an adviser and his investment adviser representatives are subject to a panoply of reporting, recordkeeping, conduct and anti-fraud requirements. However, state-registered investment advisers are subject only to the Advisers Act anti-fraud provisions and are otherwise subject to applicable state or states’ reporting, recordkeeping and conduct requirements. Therefore, the conduct of the advisory services provided with regard to a wealthy individual’s investment of IRA assets is governed by the Advisers Act or applicable state law. For instance, the firm and its representatives owe a fiduciary duty to the investor, including a duty of undivided loyalty.

The SEC states that the adviser as a fiduciary “must not put himself into a position where his own interests may come in conflict with those of his [client],” though there is an exception to this general prohibition “where the [client] gives informed consent to such dealings.” The SEC or applicable state agency will require firms to have compliance procedures in place that are designed to assure compliance with the Advisers Act or state law.

ERISA and the IRC do not provide for registration requirements. Additionally, IRAs are not subject to ERISA. However, providers of investment advice and discretionary asset management services to IRAs are fiduciaries under the IRC’s prohibited transaction (PT) provisions, which largely mirror those in ERISA.

Under the IRC, the fiduciary may not engage in—or cause the IRA to be engaged in—a number of specified prohibited transactions. These include the fiduciary dealing with the assets of an IRA in his own interest or for his own account, and the fiduciary receiving any consideration from any party dealing with the IRA in connection with the IRA. In order to engage in conduct that is otherwise prohibited, the adviser must meet the requirements of one or more prohibited transaction exemptions, designed to mitigate conflicts, which may be found in the IRC or issued by the DOL. They do not simply allow disclosure as a method to eliminate a conflict, particularly when an adviser acts as a fiduciary. Many of the exemptions place limits on compensation arrangements. An adviser should have procedures in place to assure compliance with the applicable exemptions or take other actions to eliminate conflicts as found in DOL guidance.

Discussions regarding whether a wealthy investor should take a distribution from a 401(k) plan or other retirement plan and roll it over to an IRA will often arise. This has been an area of increased scrutiny by the SEC and FINRA. To the extent an adviser is a registered representative, the firm should carefully review FINRA Regulatory Notice 2013-45, in which that agency provides guidance regarding the substantial steps that should be taken when a rollover recommendation is made. The SEC has stated that its examinations of adviser activities will include reviews of account selection, including rollovers from one account to another. Under current law, ERISA and the IRC may limit the ability of the adviser to provide investment advice in connection with rollovers if the adviser is a fiduciary to the retirement plan.

David C. Kaleda is a principal in the Fiduciary Responsibility practice group at the Groom Law Group in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers. He served on the DOL’s ERISA Advisory Council from 2012 through 2014.