Provider Recommendations
Art by Tim Bower
Advisers are often asked by the named fiduciaries of qualified plans to recommend plan service providers. Not surprisingly, many advisers may be inclined to recommend the same recordkeepers, third-party administrators (TPAs), outsourced chief investment officer (OCIO) managers, etc., to all or most of their clients. In so doing, they raise a question as to whether this has implications under the Employee Retirement Income Security Act (ERISA). The answer to that question depends on whether the adviser acts as a fiduciary in making such recommendations.
ERISA provides that an adviser acts as a fiduciary if he, among other things, supplies investment advice for a fee. The Department of Labor (DOL), by regulation, created a five-part test that determines whether an adviser is giving what ERISA would call investment advice. The first part of the test requires that the person renders advice to a plan as to the value of securities or other property, or makes recommendations regarding the advisability of investing in, purchasing or selling securities or other property. Additionally, the test continues, the adviser provides 2) such advice on a regular basis; 3) pursuant to a mutual understanding; 4) that such advice will be a primary basis for investment decisions; and 5) the advice will be individualized to the plan.
When an adviser recommends a service provider, that entity may or may not be acting as a fiduciary. The threshold question often is whether, in the instance under discussion, the adviser makes recommendations regarding investing in, purchasing or selling securities. In general, this should not be the case when the adviser suggests a provider whose services do not involve investments. Thus, the adviser would not meet the first part of the test by merely recommending a recordkeeper or a TPA.
On the other hand, if the adviser makes a recommendation and there is a connection to plan investments, there’s a greater likelihood that the first part of the test will be met. Notably, the DOL and some courts have a broad view of what it means to make recommendations with respect to investing in, purchasing or selling securities. Therefore, that agency and, possibly, a court will take the position that recommending one or more investment managers, including an OCIO manager, is investment advice even though such recommendation does not directly involve a security. Of course, to provide investment advice for purposes of ERISA, the remaining parts of the five-part test must also be met.
It’s important for advisers to understand whether they act as ERISA fiduciaries when they make service provider recommendations. A fiduciary is subject to the fiduciary provisions of ERISA Section 404 and the enforcement provisions in Section 502. For example, such advisers would have to ensure that the recommendation was prudent, exclusively in the best interest of the plan and its participants and otherwise meets ERISA’s fiduciary duty requirements. Under such circumstances, suggesting the same investment managers or OCIO managers may be completely defensible. However, the adviser should be prepared to explain why such managers were applicable to each and every plan even though the plans may vary in asset size, benefits provided and participant count and demographics.
Additionally, if a fiduciary, the adviser may not be able to receive referral fees or other types of compensation, due to the fiduciary prohibited transaction provisions in Section 406(b), unless he can point to an exemption.
Furthermore, even if the adviser does not make a fiduciary recommendation, his plan sponsor client is a fiduciary. That fiduciary may rely upon the adviser’s recommendation to select a service provider. If it does so imprudently or otherwise contrary to the requirements of ERISA, the client may be held liable for losses to the plan and other remedies under ERISA. Therefore, when advisers recommend a service provider, they should consider the fiduciary implications to their client, particularly if it looks to them as a trusted adviser. Under these circumstances, a preferred recordkeeper or other service provider may not be the best choice for a particular plan even though a good choice for many plans. Additionally, if the adviser receives a referral fee or other compensation from the provider, he may have to disclose the compensation in accordance with ERISA Section 408(b)(2) even when not acting as a fiduciary.
David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C.