Art by Tim BowerADVISER QUESTION: I am a fiduciary investment adviser to
Employee Retirement Income Security Act [ERISA] plans and receive an advisory
fee for my services. I also own a company that provides recordkeeping services
to ERISA plans. May I recommend mutual fund investments to those plans that pay
revenue sharing to my recordkeeper company?
ANSWER: It depends. The receipt of the revenue-sharing
payments can result in a prohibited transaction (PT). However, if you offset
those payments against your recordkeeping fees, that averts the PT.
Under the PT restrictions in ERISA and the Internal Revenue
Code (IRC), you may not use your fiduciary authority to cause yourself or your
affiliate to receive additional compensation or to receive compensation from a third
party in connection with transactions involving plan assets. This is sometimes
referred to as the “self-dealing rule.” In your case, you would be using your
fiduciary authority as an investment adviser to cause your affiliated
recordkeeper to receive compensation from a plan investment—the revenue-sharing
payments from the mutual funds.
However, you can avoid this PT if you offset the
revenue-sharing payments against your recordkeeping fees. In other words, your
recordkeeping company would need to agree to provide its plan services for a
stated fee—which could be a dollar amount or a percent of assets—and also agree
to offset the revenue-sharing payments against the stated fee. By doing so,
neither you nor your recordkeeping company would receive additional
compensation as a result of the investment recommendations. This offset method
was approved by the Department of Labor (DOL) in an advisory opinion issued to
Frost Bank (Advisory Opinion 97-15A).
An alternative would be to agree to pay the revenue-sharing
amounts over to the plan—for example, into an expense recapture account.
However, this “pay-over” method is less commonly used.
A similar issue exists where a fiduciary adviser recommends
a group annuity contract to a plan—and the insurance company makes a payment to
a third-party administrator (TPA) that is affiliated with the adviser. That
payment is a PT unless the Frost offset or “pay-over” method can be used.
The DOL’s position on these issues was confirmed in a
complaint filed against an investment adviser who owned a TPA firm. To quote
from the DOL’s January 2015 press release: “An investigation by the U.S.
Department of Labor’s Employee Benefits Security Administration [EBSA] found
that, from at least 2006 through 2011, [Defendant] caused himself [or his
companies] to be paid certain commissions and fees, the amounts of which were
not properly disclosed to or specifically authorized by the plans or
independent fiduciaries. [Defendant] also failed to use all fees received by
him to offset fees that the plans otherwise would have had to pay and used his
fiduciary authority as investment adviser to cause the plans to remain invested
in a higher fee fund class when the same fund portfolio was available in a
lower fee class. By these actions, [Defendant] breached his fiduciary
responsibilities under ERISA and caused the plans to suffer financial losses
for which he was liable.
“Resolution: The department is asking the court to: require
the defendants to correct the prohibited transactions; restore to the plans all
losses, plus interest; disgorge any and all plan assets obtained; disgorge any
and all enrichment resulting from the breaches; permanently enjoin the
defendants from future ERISA violations; and permanently prohibit the
defendants from serving as fiduciaries or service providers to any
ERISA-covered employee pension or benefit plan.”
Note that the self-dealing rule applies only if the adviser
is a fiduciary. If the adviser is not a fiduciary under today’s rules, then the
payments are allowable under the self-dealing rule. However, to avoid a PT, the
total compensation—both direct and indirect—of the nonfiduciary adviser’s
affiliated recordkeeper or TPA must not be more than a reasonable amount for
the services. If the DOL’s proposed expansion of the fiduciary definition is
finalized, almost all retirement sales practices will be considered fiduciary
advice. As a result, these arrangements—even where an adviser is not a
fiduciary under today’s rules—would become PTs.
Forewarned is forearmed. To avoid the PTs described above,
advisers will need to comply with exemptions or remedies, such as the Frost
offset method. Also, in our experience, some advisers are unaware that these
PTs also apply to individual retirement accounts (IRAs), even under current
laws. With the increasing focus on IRAs, advisers should review their practices
for compliance with the PT restrictions.
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.