Managing Fiduciary Conflicts in the Age of Convergence

In recent years, retirement plan advisers for Employee Retirement Security Act plans and advisers for wealth management clients have joined forces within the same firm. 

This convergence occurs by reason of two business lines within the same organization agreeing to work together, by reason of a merger or other business transaction designed to bring these two advisory practices together, or some other reason.  Among the many challenges involved with integrating these two practices is complying with the fiduciary and prohibited transactions of ERISA and section 4975 of the Internal Revenue Code when providing advisory services to clients. 

David C. Kaleda

This will be even more so the case once the Department of Labor issues its final Advice Regulation later this year, particularly with regard to recommending rollovers or other types of distributions from a retirement plan.

A key advantage of combining the retirement plan advisory business and the wealth management business is the ability to provide full service financial services to the client.  For example, a wealthy small business owner can use a single firm to provide advice on how to establish and operate a retirement plan covering the owner and her employees, how participants in the plan should invest their assets in the retirement plan, and how the business owner should plan for her financial future outside of the retirement plan. 

In many cases, an adviser will find itself in a position where it must make a recommendation to the client business owner to take a full or partial distribution from the plan and rollover the proceeds to an IRA.  Or the adviser may recommend the client take a distribution from the plan or an IRA in order to purchase life insurance or something similar.   Oftentimes, the adviser will have a conflict of interest when she makes that recommendation, e.g., the amount of compensation the adviser or the firm receives changes.

Rollover Regulation

The pending advice regulation, under review by the White House Office of Management and Budget, is squarely aimed at the above-described rollover and distribution recommendations, as well as others. Under current law, the DOL says either a recommendation to take a distribution from a plan and roll it over to an IRA or a recommendation to transfer money from one IRA to another so the adviser can provide ongoing advice or management is the first step in an ongoing relationship that’s investment advice under the DOL’s 1975 regulation.  

However, the Advice Regulation will result in a substantial expansion of the situations in which the adviser provides investment advice.  Many more recommendations will be “investment advice” for purposes of ERISA or the Code.  For example, a single recommendation to take a plan distribution and use the assets to purchase term, whole, or universal life insurance, a product which is not otherwise subject to the jurisdiction of the DOL, would be investment advice. 

The fact that an advisory firm and its advisers may be fiduciaries in a broader set of circumstances may not be off-putting to some.  Indeed, they may already act as fiduciaries under the Investment Advisers Act.  However, the challenge for many firms will be adopting policies and procedures to address prohibited transactions, i.e., conflicts of interest, under ERISA and the Code.  The DOL will require most advisers to comply with Prohibited Transaction Exemption 2020-02 (PTE 2020-02), several modifications to which will be effective at the time DOL makes the Advice Regulation effective. 

Therefore, unlike under the Advisers Act, firms and their advisers must comply with substantial and specific conditions under PTE 2020-02 including an Impartial Conduct Standard, disclosures, policies and procedures, a retroactive compliance review, and specific requirements related to correcting violations of the exemption’s conditions.  These conditions likely go well beyond what a firm and its advisers do to comply with the Investment Advisers Act.

Future State

In conclusion, we should expect to see continued convergence of the retirement and wealth management industries.  We likely will not see a decline in this trend due to the actions of the DOL, or any other regulator for that matter.  However, some firms today and even more in the near future will have to spend a great deal of time and money revamping their compliance policies and procedures to assure compliance with ERISA and the Code, particularly PTE 2020-02. 

Such firms should also expect that over time the DOL will begin using its enforcement authority to investigate firms and their advisers to confirm that they properly identify the instances in which they act as fiduciaries for purposes of ERISA and the Code and that they are in full compliance with PTE 2020-02.

David C. Kaleda, principal, Groom Law Group, Chartered.