Category Archives: Service Providers

Best Practices for Plan Sponsors #4

What is the Baseline for A Committee to Act in the Best Interest of its Participants? (Part 3)

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the fourth of the series about Best Practices for Plan Sponsors.

 In my last two posts (Best Practices for Plan Sponsors #2 and Best Practices for Plan Sponsors #3), I discuss the NYU case and the “bad” and “good” behavior of committee members. I concluded my last post with the point that process matters. Of course, it was unspoken that I was referring to a good process. This article discusses the fundamentals of a good process and the lessons learned from the NYU decision.

  • The NYU committee met quarterly.

There isn’t a prescribed timing for fiduciary meetings; the requirement is that plan fiduciaries, usually committee members, meet with the frequency necessary to properly do their job. Some aspects of the job, such as review of investments, may require more frequent meetings . . . at least annually, although quarterly would, under ordinary circumstances, clearly satisfy the requirement. An exception would be if a significant change occurred between meetings, for example, the sale of the mutual fund manager, the resignation of the mutual fund manager (where the fund was managed by a single manager), or other changes that could immediately impact an investment.

On the other hand, the monitoring of service providers may not require the same frequency. Absent extraordinary circumstances, annual reviews should ordinarily satisfy the fiduciary requirement (and, even there, it may not need to be that often). Of course, there are some exceptions for unusual events. One of those would be where an employer is receiving complaints from participants that, if valid, would raise concerns about the quality of the service provider, or the timely delivery of the services.

In any event, quarterly meetings are a reasonably good practice for risk management purposes.

  • The committee used an adviser with expertise with similar plans.

There is not a requirement that plan committees use advisers. Instead, it is a best practice. However, if committee members lack the expertise needed to prudently select and monitor a plan’s investments and to evaluate their expense ratios (including share classes), the committee members need to obtain that expertise from another source. Needless to say, good risk management dictates that the source be independent of the investments, in the sense that the source of information not be related to the mutual fund management company or to an organization that receives money from the mutual funds.

If an adviser has conflicts of interest, the committee has the added burden of identifying the conflicts and determining whether the participants will be adversely affected by those conflicts. It’s beyond the scope of this article to fully discuss the selection of advisers, but a starting point is that, when an adviser is paid directly by the plan or the employer, the potential of conflicts is reduced (and perhaps eliminated). On the other hand, where the adviser is paid from the investments, there is an obvious conflict, in the sense that the adviser is incentivized to recommend mutual funds or other investments that provide higher compensation. That’s not to say that all commissioned advisers (or other advisers who receive third party payments) will succumb to the conflicts. However, committee members need to know that they have a legal duty to understand and evaluate conflicts of interest.

  • The committee adopted and followed an investment policy statement.

There is not a legal requirement to have an investment policy statement (IPS). However, it is a best practice. A well-prepared IPS will describe the steps to be followed by a committee in evaluating the quality and costs of the investments. In effect, it will walk committee members through the process of investment selection and monitoring. As a part of that, the IPS should have specific criteria for different types of investments. However, at least in my view, an IPS should specifically state that the provisions are “guidelines” for the committee and that the expectation is that the committee will use its judgment and discretion, as opposed to strict adherence to the guidelines. That reflects my view that a qualitative analysis cannot always be defined by numbers and percentages. In fact, the court in the NYU case said the same, when it discussed the difficulty of benchmarking one of the investments.

These are important steps in a prudent process. However, the committee in the NYU case also made some mistakes. Based on the judge’s description, some of the committee members were not engaged and did not see themselves as being responsible for making fiduciary decisions. Instead, they viewed themselves as providing information and administrative services to the committee. Those people should not have been on the plan committee. Committee members should understand that they are fiduciaries and owe duties of prudence and loyalty to the participants. There is nothing wrong with having administrative personnel attend the meetings, but there is something wrong with a fiduciary that has a ministerial mindset.

The NYU case covered a number of issues, some of which are not discussed here. However, the discussions in this article, and the preceding two articles, are a primer for plan committee members. Advisers should help them understand the good and the bad of the NYU case.

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The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.



Best Practices for Plan Sponsors #3

What is the Baseline for A Committee to Act in the Best Interest of Its Participants? (Part 2)

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the third of the series about Best Practices for Plan Sponsors.

This is my second article about the case of Sacerdote v. New York University. As I discussed in my last post, the Court’s opinion pointed out the deficiencies in the understandings and conduct of some committee members. However, the Court ultimately ruled in favor of the plan fiduciaries and against the plaintiffs. Why was that?

Despite the deficiencies (or “bad practices”) of some committee members, others on the committee were engaged and knowledgeable. Obviously, that was an important factor. However, there was more than that. The Court noted that “Between [the adviser’s] advice and the guidance of the more well-equipped Committee members . . . , the Court is persuaded that the Committee performed its role adequately.

In other words, while the involvement of the more informed and better engaged committee members was critical, the committee’s use of a knowledgeable adviser was also important. I can tell you that it was a well-regarded advisory firm with considerable expertise with retirement plans. It’s not clear that, absent the work of the adviser, NYU would have won the case.

One of the claims in the lawsuit was that NYU did not use RFPs as often as it should have. As explained by the Court, “Plaintiffs assert that more frequent RFP processes for both Plans would have exerted competitive pressure on recordkeeping vendors, resulting in either a reduction in fees by an existing vendor or a better deal altogether.” While there were a number of factors reviewed by the Court, one of the important ones was that the committee had successfully negotiated for reductions in recordkeeping fees. As explained by the Court, “In addition, plaintiffs ignore that over the course of several years, NYU’s recordkeeping fees consistently decreased as NYU obtained repeated rate reductions.

Plan committees should benchmark their service providers or issue RFPs on their service providers at appropriate intervals. But that begs the meaning of “appropriate intervals.” A common benchmark is for the costs of service providers to be reviewed every three years. However, the legal requirement is that the plan expenses for service providers be monitored at appropriate intervals. More precisely, that means that they should be monitored when a change in circumstances suggests that monitoring could result in lower costs for comparable services. That could occur as a plan grows or as the competitive marketplace reduces the expenses of service providers.

While the law does not require that committees select the lowest cost providers, committees should use RFPs, benchmarking, and negotiations to ensure that their plans are reasonably priced as compared to comparable plans (for example, plans of a similar size and with similar average account balances).

Another claim was that the committee failed, in its monitoring process, to remove two underperforming funds that allegedly had high fees and poor performance. The Court disagreed, noting that the plan’s adviser provided regular reports on the funds, that the committee discussed the funds at multiple meetings, and that the process was consistent with the plan’s investment policy statement. With regard to one fund – a real estate fund, the Court found that the structure of the fund was designed to be more conservative than a common REIT benchmark. In a sense, the Court concluded that a committee could prudently select a more conservative investment alternative, which might have a lower overall return, if the committee felt that it was appropriate for the plan and the participants.

The second fund was a widely-diversified equity fund including both domestic and international securities. The Court noted that it was “challenging to find an appropriate benchmark.” The Court then went on to say “The Committee focused on the difficulties with benchmarking that the [investment] presented due to its composition. It determined that, as a result of these benchmarking difficulties, the [investment] was one that warranted ‘specialized discussions.’ Such discussions occurred.

While the Court looked at a number of benchmarks, and considered other factors, it appears that the committee’s attention to the unique nature of the fund, the on-going discussions in that regard, and the assistance of the adviser were critical factors. The moral to this part of the story is that a given benchmark may not tell the whole story, and that committee discussions, with help from an investment adviser, can provide better insights than the use of a benchmark (and particularly of a benchmark that does not directly apply to the investment under consideration).

In reflecting on this decision, I have several thoughts. My next post will discuss those. For the moment, though, an important point is that committee processes really matter. Prudence is about the process. This decision confirms that. Committees should have robust discussions about plan investments, service providers, and expenses. The discussion should be documented in committee minutes.

All in all, this decision is a “laboratory” about fiduciary responsibility. There was good and bad, and both provide important information to advisers and committee members.

To automatically receive these articles in your in box, you can sign up on my blog at Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.


Best Practices for Plan Sponsors #1

Best Practices for Plan Sponsors: Projection of Retirement Income

I am writing two series of articles that together are called “The Bests.” One is about Best Practices for plan sponsors, while the other is about the Best Interest Standard of Care for advisors. Each series is numbered separately to make it easier to identify the subject that is most relevant to you.

This is the first of the series about Best Practices for Plan Sponsors.

“Best Practice” is above and beyond the legal requirements. Best Practices are not mandated; they are elected.

While the most obvious Best Practices are automatic enrollment and automatic deferral increases, I want to start with the projection of retirement income for participants. That’s partially because it is in a current legislative proposal—in the Retirement Enhancement and Savings Act (RESA), and also because, in my opinion, it doesn’t receive the attention that it deserves.

Under current rules, participants in 401(k) plans receive quarterly reports of the balances and the investments in their accounts. While that is important information, it is only part of the story. Let me explain what I mean.

An account balance is a statement of wealth. It is a snapshot of how much money is in the participant’s account at a given point in time. However, it does not provide the most important information, which is whether the participant is on course to have a financially secure retirement. To provide that information, participants need projections of retirement income and “gap analysis.” A projection of retirement income would tell a participant how much their current behavior—including account balance and deferral rate—will provide as retirement income. Then, gap analysis could be automatically provided to participants. Gap analysis provides a benchmark for retirement adequacy (for example, a 70% income replacement ratio); whether the projected income is at that level or not; and, if the projection is lower than the benchmark, the analysis suggests a deferral increase to close the “gap.”

Some people object to retirement income projections because they might be inaccurate. We need to get beyond that. Let’s just accept that the projections will be inaccurate, since they are based on actuarial assumptions, which are educated guesses about the future. But, let’s also agree that the projections will be directionally correct. In other words, the projections will provide valuable information to participants about whether they are saving enough to reach their goals. And, since the projections will be updated every year, participants can make adjustments along the way based on updated information.

On the subject of actuarial assumptions, let’s also agree that the typical participant doesn’t know how to do actuarial calculations and may not even know what assumptions to use. For example, retirement income projections involve assumptions about retirement age, investment earning rates, inflation, and so on. Providers and plan sponsors are, generally speaking, in a much better position to be able to determine which assumptions are reasonable for those purposes. (Incidentally, RESA proposes to create a fiduciary safe harbor for retirement income projections—and the Department of Labor is directed to provide the assumptions to be used.)

Others may argue that calculators are available on websites to enable participants to generate retirement income projections. While that is true, the reality is that participants haven’t, by and large, used those calculators. While some might argue that participants have that responsibility, I am not of that school of thought. I agree that people should be responsible for themselves. But, I don’t agree that we should continue to rely on services that aren’t working. Let’s do things that work, rather than taking dogmatic approaches.

So, my view of the future is that, if retirement income projections and gap analysis are offered to participants, with annual updates, we will have better outcomes . . . because participants will be empowered to make smarter decisions about deferral rates, investing, retirement ages, and so on.

While retirement income projections are not mandated at this time, most providers offer that service. In fact, some have offered them for years and have done so successfully . . . particularly in the 403(b) area. As a result, sponsors have the opportunity to voluntarily provide that service to participants, and advisors have the opportunity to educate plan sponsors about the availability and importance of that service. Those are Best Practices.

To automatically receive these articles in your in box, you can sign up on my blog at Just enter your name and email address under the “sign up for our e-newsletter” option, and click on the button to subscribe.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.


Interesting Angles on the DOL’s Fiduciary Rule #66

Concerns About 408(b)(2) Disclosures

This is my 66th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

Because of the change in the definition of fiduciary advice (which applied on June 9, 2017), all advisors to retirement plans need to review their prior 408(b)(2) disclosures to see if changes are necessary. That particularly applies to broker-dealers and life insurance brokers and agents.

The first level of review should be to determine whether their prior 408(b)(2) disclosures to ERISA retirement plans affirmatively stated that they were not fiduciaries to the plans that they served. If so, those broker-dealers, insurance brokers and agents need to send out new 408(b)(2) disclosures that affirmatively disclose their new-found fiduciary status (assuming that their advisors became fiduciaries under the new rule, which would ordinarily be the case). However, if the old disclosures were silent about fiduciary status or non-status, the prior disclosures would only need to be reviewed to determine if they adequately describe the services that would be considered to be fiduciary advice. Those services would include, for example, making investment recommendations, referring to other investment advisors or managers, or providing selective lists of investments. (Actually, the definition is much broader, and also includes suggestions of investments, investment policies, or investment strategies.)

Also, the review should include consideration of whether the 408(b)(2) statements adequately disclose compensation. I have been reviewing 408(b)(2) disclosures for a number of broker-dealers. As a part of that, I noticed that compensation was often described in ranges, sometimes very broad ranges. That reminded me of the language in the preamble to the 408(b)(2) regulation, which said:

“A few commenters also asked whether compensation or costs may be disclosed in ranges, for example by a range of possible basis points. The Department believes that disclosure of expected compensation in the form of known ranges can be a ‘‘reasonable’’ method for purposes of the final rule. However, such ranges must be reasonable under the circumstances surrounding the service and compensation arrangement at issue. To ensure that covered service providers communicate meaningful and understandable compensation information to responsible plan fiduciaries whenever possible, the Department cautions that more specific, rather than less specific, compensation information is preferred whenever it can be furnished without undue burden.” [Emphasis added.]

I leave it to the reader to decide whether the ranges in the following types of disclosures are narrow enough. Keep in mind, though, that the purpose of the 408(b)(2) disclosures is to allow the responsible plan fiduciaries to determine (i) whether the compensation paid to the advisor and affiliates is reasonable in light of the services being rendered, and (ii) the nature and extent of the conflicts of interest. With that in mind, do you think that the following types of disclosures are narrow enough to provide information that allows the plan fiduciaries to make those determinations?

  • For mutual funds, the broker-dealer may receive between 0% to 10% front-end commissions.
  • As ongoing trailing commissions, the compensation may range from 0% to 2% per year.
  • The compensation for managed accounts will not exceed 2.5% per year.

Since the test for evaluating those statements is one of “reasonableness,” each reader can form his or her own opinions. But, keep in mind the dual purpose of the disclosures. Then, think about whether the disclosures adequately inform the responsible plan fiduciaries, so that they can make prudent decisions on behalf of their plans and their participants.

Needless to say, I am concerned that some service providers may be making disclosures that don’t satisfy the standards. As a result, I suggest that broker-dealers, RIAs, and insurance agents and brokers review their disclosures to make sure that they are comfortable that the necessary information is being provided to plan fiduciaries.

Forewarned is forearmed.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.


Interesting Angles on the DOL’s Fiduciary Rule #61

The Fiduciary Rule, Distributions and Rollovers

This is my 61st article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

Now that it seems likely that the fiduciary rule and the transition exemptions will continue “as is” until at least July 1, 2019, it’s time to re-visit the fiduciary rule and the requirements of the transition exemptions. This article focuses on the requirements for recommending that a participant take a distribution and roll it over to an IRA with a financial institution and its advisor. (Practically speaking, the financial institutions will likely be broker-dealers, RIA firms, and banks and trust departments). For ease of reading, this article uses “advisor” to refer to both the entity and the individual.

In order to recommend that a participant take a distribution, the financial institution and advisor must satisfy ERISA’s prudent man rule and duty of loyalty. That is because a recommendation to a participant is considered to be advice to a plan. Among other things, that means that, if the advisor violates the rules, there is a cause of action under ERISA for breach of fiduciary duty (as opposed to the Best Interest Contract Exemption, where a private right of action is less certain).

If the advisor will earn more money if a participant’s benefits are moved to an IRA, that will be a prohibited transaction. As a result, the advisor will also need to comply with the condition of an exemption, most likely the Best Interest Contract Exemption (BICE). The transition version of BICE requires that an advisor adhere to the Impartial Conduct Standards. Of those standards, the most significant for this purpose is the best interest standard of care. Since the best interest standard of care and ERISA’s duties of prudence and loyalty are substantially similar, this article just refers to the best interest standard (even though both apply). The best interest standard requires that an advisor obtain the information that is relevant to making a prudent and loyal recommendation about a distribution. The Department of Labor has said that, at the least, that includes the services, investments, and fees and expenses in both the plan and the IRA. In addition, the best interest standard requires that the plan and IRA information be evaluated in light of the needs and circumstances of the participant.

The information about the services, investments, and fees and expenses in the plan is the most difficult to obtain. Fortunately, that information can be found in the participant’s plan disclosure statements. Additional important information is in the participant’s quarterly statements.

But, what if the participant can’t locate the information? Realistically, that should be a rare case, since plan sponsors are required to distribute the disclosures at the time of initial participation and annually thereafter.

But, what if the participant can’t find those disclosure materials? In a set of Frequently Asked Questions, the DOL responded that an advisor must make “diligent and prudent efforts” to obtain the plan information. If the participant can’t find those materials, then it seems likely that, at the least, a diligent and prudent effort would require that the advisor inform the participant that:

  1. The information is usually available on the plan’s website and they could obtain it from that source.
  2. The information is available from the plan sponsor upon request to the benefits personnel.

If neither of those options is successful, or if the participant is unwilling to take those steps, the advisor can use information from the Form 5500 or from industry averages. (Interestingly, 5500 data is not considered primary data for this purpose. It can only be used after a diligent and prudent effort has been made to obtain current plan data from the participant.)

Even where 5500 data or average plan data is used, there are additional considerations:

  • The advisor must provide “fair disclosure” of the significance of using the primary plan data, that is, current information about the plan from, e.g., the participant disclosure forms.
  • Plan averages must be based on “the type and size of plan at issue.” As a result, the advisor will need to know the type and size of the plan.
  • The advisor must explain the alternative data’s limitations.
  • The advisor must explain “how the financial institution determined that the benchmark or other data were reasonable.”

However, it would likely be a rare case that alternative data could be used. If a financial institution finds that its advisors are consistently using alternative data, that suggests that the advisors are not making “diligent and prudent efforts” to obtain actual plan data. The consequence of non-compliance is that the compensation paid from the rollover IRA is prohibited and cannot be retained by the financial institution or the adviser. There could also be an ERISA claim for breach of fiduciary duty.

An additional issue is that the “alternative data” may only include information about fees and expenses. In order to perform a best interest analysis, the advisor must also have information about a plan’s services and investments. For example, does the plan offer a brokerage account where, if the participant desired, the participant could have access to a wider range of investments? Another example is whether the plan offers discretionary investment management for participants’ accounts. If it does not, that may be a valuable service offered by the IRA; but, if it does, the expenses and the quality of those services in the plan and IRA should be compared.

As this article suggests, there are more issues than appear at first blush.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.


Interesting Angles on the DOL’s Fiduciary Rule #52

The Fiduciary Rule and Exemptions: How Long Will Our Transition Be?

This is my 52nd article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

The fiduciary regulation that dramatically expanded the definition of fiduciary investment advice went into effect on June 9. As a result, virtually all advisers to plans, participants and IRAs are now fiduciaries, or will be as soon as they make the next investment recommendation to one of those qualified accounts. At the same time—June 9, the “transition” transaction exemptions were effective.

If viewed out of context, the fiduciary regulation, as currently written, will continue in effect for years to come. However, the transition exemptions will only apply until December 31, when the full exemptions will apply, with their many and demanding requirements. But, that’s out of context.

When viewed in context, the situation looks much different. For example, the Department of Labor will be publishing the Request for Information asking, among other things, about the potential impact of the fiduciary rule and changes that may be needed. Not to be outdone, the SEC has asked a series of questions about a possible fiduciary standard for all investment advice within its purview. The SEC and DOL have indicated that they will be working together to develop their respective fiduciary definitions (and, in the case of the SEC, a fiduciary standard of care) or, perhaps, they will develop an identical definition of fiduciary advice.

In addition, the DOL has asked for input concerning the structure and requirements of the prohibited transaction exemptions, including the two exemptions that impact most advisers . . . the Best Interest Contract Exemption (BICE) and Prohibited Transaction Exemption 84-24. Those exemptions are exceptions from the prohibited transaction rules, but come with strings attached. On the other hand, the SEC does not have a statutory basis for adopting similar prohibited transactions or, for that matter, exemptions from prohibited transactions. Because of those differences, it is likely that, even if the two regulatory bodies adopt a common definition of fiduciary advice (and a common standard of care), their treatment of conflicts of interest will vary.

As mentioned earlier, the transition period for the DOL’s exemptions is only until December 31. And, if I haven’t made clear, there isn’t any transition period for the fiduciary regulation; it is in full force and effect.

What does this mean in terms of timing? My view is that it will be virtually impossible for the DOL and SEC to collaborate on the development of a common, or at least compatible, definition of fiduciary advice and standard of care before December 31. Because of the Administrative Procedures Act, the final regulation would need to be published in early November, which means a proposed regulation would probably need to be published in early to mid-September. To hit those deadlines, the two regulatory bodies would need to develop a proposed regulation within that time frame. That seems almost impossible —partially because of the need for coordination and partially because the SEC hasn’t previously proposed guidance on these issues. In other words, even though the DOL has a basis for revising its regulation and exemptions, the SEC doesn’t.

As a result, my view is that the DOL will extend the transition period, perhaps for as much as a year. That would allow time for the two agencies to work together in a thoughtful manner and at a reasonable pace.

That is both good news and bad news to the regulated community, that is, for financial services companies. It is good news because it allows more time to fully adapt to the new rules and because the compliance requirements for the transition exemptions are not that difficult or burdensome. It is bad news—at least for those firms that strenuously object to the fiduciary rule, because, by a year from now, financial services companies will be in compliance with the fiduciary standard and fiduciary advice will have become the standard course of business. The training will have been done, products will have been developed, solutions will have been implemented, and so on. In other words, the fiduciary standard will have become the norm. As a result, it may be more difficult to change the fiduciary definition and standard of care. On the other hand, there will still be significant changes to the exemptions and, particularly, to the Best Interest Contract Exemption.

One way or another, I expect that we will hear, in August or September, that the transition period is being extended.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.


Interesting Angles on the DOL’s Fiduciary Rule #49

The Requirement to Disclose Fiduciary Status

This is my 49th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

When the new fiduciary rule applies on June 9, it will convert most non-fiduciary advisers into fiduciaries.

While there is not a disclosure requirement for new fiduciary advisers to IRAs, there is for these newly minted fiduciary advisers to plans. But it’s not part of the new regulation. Instead the requirement is found in the 408(b)(2) regulation which was effective in 2012.

As background, that regulation required that service providers to ERISA-governed retirement plans, including advisers, make written disclosures to plan fiduciaries of their services, compensation and “status.” The status requirement was that service providers disclose if they were fiduciaries under ERISA and/or the securities laws (e.g., RIAs). The regulation describes the status disclosure as follows:

If applicable, a statement that the covered service provider, an affiliate, or a subcontractor will provide, or reasonably expects to provide, services pursuant to the contract or arrangement directly to the covered plan…as a fiduciary…; and, if applicable, a statement that the covered service provider, an affiliate, or a subcontractor will provide, or reasonably expects to provide, services pursuant to the contract or arrangement directly to the covered plan as an investment adviser registered under either the Investment Advisers Act of 1940 or any State law.

(The reference to “subcontractor” includes representatives of broker dealers who are independent contractors.)

For the most part, broker-dealers, and insurance agents and brokers, have taken the position that they were not fiduciaries and therefore did not make the fiduciary disclosure. And, if they were not in fact fiduciaries, those disclosures worked from July 1, 2012 until June 9, 2017, when the new definition will make them fiduciaries.

Technically, that last sentence is not absolutely correct. Let me explain. First, the new regulation requires that, to be considered a fiduciary, the adviser (and the supervisory entity) must make an investment recommendation. And, until the first investment recommendation is made, the adviser and entity are not fiduciaries. However, the definition of investment recommendation is so broad that it may be best to treat June 9 as the day they became fiduciaries. For example, a recommendation is a “suggestion” that the plan fiduciaries select, hold or remove investments; that the fiduciaries use a fiduciary adviser to give advice on investments or to help participants with investments; that the fiduciaries include certain specified policies in the IPS; and so on.

In other words, under the new rules it’s hard for an adviser to work with a plan without being a fiduciary.

So, accepting that virtually all advisers to plans become fiduciaries on June 9, what does that mean for disclosure of fiduciary status?

The 408(b)(2) regulation generally provides that, after the initial notice is provided, no subsequent disclosures are required until there is a change in the information initially provided. But, of course, where the first notice was silent about fiduciary status, the transition to fiduciary status is a change. Here’s what the regulation says about changes:

A covered service provider must disclose a change to the information…as soon as practicable, but not later than 60 days from the date on which the covered service provider is informed of such change, unless such disclosure is precluded due to extraordinary circumstances beyond the covered service provider’s control, in which case the information must be disclosed as soon as practicable.

In other words, the service provider (e.g., the broker dealer and adviser) must make a written disclosure of the change to fiduciary status to the “responsible plan fiduciary” within “60 days from the date on which the [broker dealer/adviser] is informed of such change.” Unfortunately, there isn’t any guidance on when a service provider is “informed” of the change to fiduciary status under these circumstances. For example, was it the day that it was finally determined that the fiduciary regulation would be applicable on June 9? Or, will it be on June 9? Or, will it be the first day that the adviser makes the first post-June 9 recommendation?

In the absence of clear guidance, a conservative approach may be advisable. So, my suggestion is that the change notice be sent in June. That’s not my conclusion about the outer limit; instead, it’s a conservative position.

The consequence of the failure to make 408(b)(2) disclosures is that compensation paid the broker-dealer and the adviser is prohibited.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.


Interesting Angles on the DOL’s Fiduciary Rule #26

Reasonable Compensation for IRAs: When and How Long?

This is my twenty-sixth article about interesting observations concerning the fiduciary rule and exemptions.

This article is a little different than most of my previous posts. However, it is equally as important. To get to the point, I am writing this article about reasonable compensation for advice to IRAs because of a common misunderstanding about the requirement.

In the last month or two, I have seen a number of articles and heard several comments to the effect that it will be difficult to determine reasonable compensation for IRAs because the rule is so new. Stated a little differently, the point is that the reasonable compensation requirement for IRAs will first become effective on April 10, 2017. That is not correct.

Section 4975(c)(1)(C) provides that the “furnishing of . . . services . . . between a plan and a disqualified person” is a prohibited transaction. However, section 4975(d)(2) permits, as an exception to that general prohibition, “any contract, or reasonable arrangement, made with a disqualified person for . . . services necessary for the establishment or operation of a plan, if no more than reasonable compensation is paid therefor.” (Section 4975(e)(2) defines a “disqualified” person as “a person providing services to the plan.” Then, 4975(e)(1)(B) defines a “plan” as “an individual retirement account.” And, (C) includes “an individual retirement annuity.”)

In other words, the reasonable compensation limitation is not new. It’s been with us for decades.

But, if that’s the case, why hasn’t there been more discussion and, in the bigger picture, more enforcement of the rule? There are two reasons. The first is that, by and large, the rule has been ignored. How is that possible? That’s because only the Internal Revenue Service can enforce the rule, but it hasn’t. In this case, the 15% excise tax under section 4975 would be enforced against the service provider, that is, the adviser. But, if the rule has been in effect for years without much publicity, why is there so much discussion now?

The answer is that the Department of Labor has, in conjunction with the fiduciary rule, issued two exemptions—84-24 for life insurance policies and fixed rate annuities, and the Best Interest Contract Exemption (BICE) for any and all investments that can be sold to plans and IRAs. Both of those exemptions—which are needed where prohibited compensation results from the investment or insurance recommendation—limit the adviser’s compensation for recommended investments and insurance products to be no more than a reasonable amount. In the case of BICE, for example, the Financial Institution (e.g., the broker-dealer) must agree that its compensation and the adviser’s compensation for their services will not exceed a reasonable amount. IRA and plan investors will be able to pursue breach of contract claims for excess compensation.

So, while the law limiting the compensation of advisers (and Financial Institutions) is not new, the enforcement mechanism will be.

While the new rules seem burdensome, I believe that a variety of services will be developed to assist Financial Institutions in determining reasonable compensation for different levels of services related to different types of products.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.


ERISA Issues for Solicitor’s Fees

Not much has been written about ERISA considerations for referring investment managers to retirement plans . . . and the receipt of solicitor’s fees for a referral.

However, there are a host of legal issues.

First, the person making the referral is receiving “indirect” compensation (that is, the solicitor’s payment by the investment manager), which makes that person a “covered service provider” or “CSP.” As a CSP, he must make 408(b)(2) disclosures (i.e., services, status and compensation). The failure to make timely disclosures is a prohibited transaction.

Second, the compensation cannot be more than a reasonable amount . . . as measured by the value of the services to the plan. But, what if the CSP doesn’t provide any ongoing services to the plan? Does the “compensation” become unreasonable after five years of payments? Ten years? I am not aware of any guidance on that point.

Third, the referral can result in the CSP becoming an ERISA fiduciary adviser. The DOL takes the position that a referral to a discretionary manager is the same as the recommendation of an investment. If it is individualized, based on the particular needs of the plan (or a participant), the DOL says it’s a fiduciary act. For example, in the preamble to its participant advice regulation, the DOL said:  “. . .the Department has long held the view that individualized recommendations of particular investment managers to plan fiduciaries constitutes the provision of investment advice within the meaning of section 3(21)(A)(ii) in the same manner as recommendations of particular securities or other property. The fiduciary nature of such advice does not change merely because the advice is being given to a plan participant or beneficiary.” That conclusion means that the CSP should engage in a prudent process and its compensation must be “level” (that is, cannot vary depending on which investment manager is recommended). I am not aware of any enforcement activity on these issues. However, the DOL position is clear.

While I have opinions about these unanswered questions, the purpose of this article is to alert people about the issues and risks.


Aging Boomers and Rollovers to IRAs

As baby boomers approach retirement in a defined contribution world, the regulators are focusing on distributions and rollovers to IRAs. The SEC, FINRA, DOL and GAO have all spoken on the subject. Their conclusion appears to be that plan fiduciaries, advisors and recordkeepers need to reconsider their current practices and, in some cases, change their practices.

Why? The reason is relatively straightforward. As large numbers of 401(k) and 403(b) participants approach retirement, regulators are becoming increasingly aware that they will be moving from a plan environment where they are “bubble wrapped” by plan fiduciaries . . . and have the benefit of being able to select from investments that have been vetted by the fiduciaries and that are, as a result, good quality and relatively low-cost investments. Based on current practices, most of those participants will rollover into IRAs with investments and advisors that are using retail pricing.

In addition, participants will go from a fiduciary environment that is protected from conflicts of interest into a retail environment that allows conflicts of interest. (Note that there is a difference between a conflict of interest and “succumbing” to a conflict of interest. In my experience, most—but not all—advisors provide good advice at reasonable costs.)

The regulators are asking, “Does it make sense for participants to leave the protected environment of retirement plans and go into the retail environment of IRAs?”

To create a worse-case scenario, imagine a 401(k) participant who is defaulted into a target date fund and stayed there during his working career. In effect, the participant has never selected an investment, and it is possible that the participant never learned anything about mutual funds. At retirement, that participant is encouraged to rollover his money into a retail market.

So, where does that leave us? For plan sponsors, I think that it means that they should consider allowing participants to stay in the plan, even after retirement, and should provide flexible distribution alternatives through their recordkeeper. For advisors and recordkeepers, I think that it means that they need to create meaningful educational materials and help participants make the right decisions, depending on the participants’ needs and preferences.

This is just the beginning of this story. There is too much at stake for it to end here. For example, it is estimated that over two trillion dollars will become eligible for distribution between January 1, 2014 and December 31, 2018.