Compliance Consult | PLANADVISER November/December 2016

Advisers’ Sales Partners

The new rule makes some of them fiduciaries

By David Kaleda | November/December 2016

PAJF16_Article-Image-Comp-Con-_David-Kaleda-Portrait_Tim-Bower.jpgArt by Tim BowerRegistered investment advisers (RIAs) often use unaffiliated solicitors, placement agents and other similar third parties to sell their advisory services or private funds. For example, advisers may utilize the services of those in the financial services industry, as well as accountants, lawyers and various other professionals. As a result of the Department of Labor (DOL)’s final regulation defining “investment advice,” sellers will now, in many cases, be acting as fiduciaries for purposes of the Employee Retirement Income Security Act (ERISA) or the Internal Revenue Code (IRC). Thus, advisers and sellers must consider whether fiduciary status will arise in connection with their sales transactions.

Effective April 10, 2017, a person provides investment advice to an ERISA-covered account or individual retirement account (IRA) if he, among other things, makes an investment recommendation or suggests other persons to provide investment advice or investment management services. The DOL broadly defines a “recommendation” as a “communication that, based on its content, context and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.” Based upon the broad range of communications deemed to constitute a “recommendation,” it appears most advisers will provide “investment advice” under the final regulation.

Notably, while the regulation includes a “hire me” concept whereby a person is not considered to provide “investment advice” when he merely markets his own advisory or management services or those of an affiliate, that concept does not apply to third-party sellers that are unaffiliated with the RIA.

Alternatively, sellers may qualify for the independent fiduciary exception. In the case of an ERISA plan, a seller may qualify if a fiduciary to the plan independent of the seller controls more than $50 million. In the case of an IRA, the exception may apply if the IRA owner is represented by a fiduciary, independent of the seller and adviser, that is a broker/dealer (B/D), bank, insurance company or registered investment adviser.

In either case, the seller must know or reasonably believe that the independent fiduciary is a fiduciary under ERISA or the IRC and is capable of, and responsible for, exercising independent judgment in evaluating the sales transaction. A seller may not state that he acts as a fiduciary; must inform the independent fiduciary that he is not undertaking to provide impartial investment advice; and must disclose the existence and nature of the seller’s financial interests in the sales transaction. Finally, the seller may not receive a fee or other compensation directly from the plan, IRA or IRA owner for the provision of investment advice.

If sellers fail to qualify for the independent fiduciary exception or some other exception, they likely will be considered fiduciaries in connection with a sales transaction involving an ERISA account or IRA. Therefore, sellers must comply with an exemption under ERISA or the IRC, as applicable.

The DOL also issued the Best Interest Contract (BIC) exemption, which allows for streamlined conditions if the seller and its affiliates receive only a “level fee” as defined in the exemption. Alternatively, the seller may comply with the “full” BIC exemption, which involves additional compliance requirements, including various disclosures and warranties.

In all cases, the BIC exemption is available only if the adviser is supervised by a “financial institution,” as defined in the exemption. In the typical situation, a seller would ordinarily be an adviser and the manager would be a financial institution if the manager complies with SEC [Securities and Exchange Commission] Rule 206(4)-3. However, the BIC exemption may not be available in all circumstances. If the exemption is unavailable, a seller, and possibly the manager as well, must look for another possible exemption. Importantly, in the case of an ERISA account, the fiduciary duty and remedial provisions of ERISA will apply regardless of whether the BIC exemption is relied upon.

In summary, the regulation will make most sellers fiduciaries with respect to the sale of advisory services and private funds to ERISA accounts and IRAs, unless an exception, most likely the independent fiduciary exception, applies. This means that persons who would never have conceived of themselves as fiduciaries under ERISA or the IRC will be fiduciaries as of April 10, 2017. Further, in the view of the DOL, sellers are inherently conflicted because they receive no compensation unless they make a sale. Therefore, in order to receive compensation, a seller will most likely need to comply with the BIC exemption or some other exemption in order to receive compensation.

David 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.