Aggregating a Client's Assets

Art by Tim BowerADVISER QUESTION: I work for a broker/dealer (B/D) firm that is affiliated with a registered investment adviser (RIA). The firm provides brokerage services to both non-retirement and retirement investor accounts such as individual retirement accounts (IRAs) and Employee Retirement Income Security Act (ERISA) accounts. The fee is asset-based, and breakpoints are used to determine the fee (with an incrementally reduced fee charged as asset value exceeds certain prescribed amounts). Can all accounts be aggregated so the investor will get the benefit of a reduced fee?

ANSWER: Aggregating retirement and personal accounts to provide a reduced fee may be well-intentioned but, unfortunately, could result in a prohibited transaction under the Internal Revenue Code (IRC) and ERISA. For instance, such aggregation is prohibited for RIA services. However, a Department of Labor (DOL) prohibited transaction exemption (PTE) permits the aggregation of certain retirement accounts to provide a discount for brokerage services.

By way of background, it is a prohibited transaction under both ERISA and the IRC for retirement account assets to be used by a fiduciary—i.e., the person in control of the account, meaning the investor—to obtain a personal benefit. Here, by combining both retirement and personal account assets to calculate the fee, the investor can take advantage of breakpoints in the tiered fee structures to get the benefit of a fee reduction. This practice is often referred to as “householding.”

Unless a PTE can be used, householding that results in a fee reduction for the investor’s personal account is prohibited, resulting in taxation, interest and penalties to the individual. Technically, the prohibited transaction rules apply to the investor who derives any benefits from a householding arrangement, not to the adviser. However, from a practical standpoint, the adviser will want to avoid fee structures that expose investors to prohibited transactions.

Unfortunately, the DOL has not issued a PTE for householding accounts in the case of investment advisory or investment management services. That said, it is a prohibited transaction for an RIA to household retirement account assets to obtain a reduced fee for personal accounts.

However, in PTE 97-11, the DOL granted relief for householding accounts to provide brokerage services at a reduced fee to an individual for whose benefit an IRA or Keogh plan is established or to beneficiaries who are members of his family—e.g., spouse, lineal descendant, ancestor, brother, sister, etc. Under the PTE, the IRA is broadly defined to include a traditional IRA, a Roth IRA, a SEP [simplified employee pension] and a SIMPLE [savings incentive match plan for employees] IRA, including a SEP and SIMPLE IRA that are covered under ERISA. A Keogh plan, for this purpose, refers to a plan not covered by ERISA, for self-employed individuals. Participant accounts in an ERISA plan—unless it is an ERISA-covered SEP or SIMPLE IRA—are excluded from the exemption, and, therefore, the use of such ERISA assets to obtain a reduced fee for personal accounts is prohibited.

For relief under PTE 97-11, a number of conditions apply, including a requirement that the services offered to the IRA or Keogh plan under the arrangement must be the same as those offered to other customers with account values of the same amount or the same amount of fees generated. PTE 97-11 also requires that the IRA or Keogh plan fees not exceed reasonable compensation.

PTE 97-11 imposes an additional condition with respect to SEPs and SIMPLE IRAs requiring that the investor must have the unrestricted authority to transfer the SEP or SIMPLE IRA to another financial institution. The term “unrestricted authority to transfer” is not defined in PTE 97-11 or any other analogous guidance from the DOL. That said, the plain language suggests that any charges that could be viewed as restricting the transfer of accounts would prohibit SEP or SIMPLE IRAs from being included in a householding arrangement. This likely means that any termination, liquidation, transfer or similar fee or charge imposed with respect to the balance being transferred could constitute an impermissible restriction. There are other conditions for relief under PTE 97-11, but they are beyond the scope of this article.

PTE 97-11 is helpful to advisers who work for B/Ds because it allows fee reductions through householding. However, even if PTE 97-11 is used, advisers should be aware that they may not household ERISA plan accounts to obtain a reduced fee for personal accounts unless those are ERISA-covered SEPs or SIMPLE IRAs.

It’s unfortunate that RIAs may not household retirement accounts to provide discounts to personal accounts. An RIA can avoid the PT, however, if the entire discount from householding is provided to the retirement account.

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, 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.