Hedge Funds and Prohibited Transactions


Posted on July 12, 2012, by Fred Reish in 408(b)(2), Broker-Dealers. Comments Off on Hedge Funds and Prohibited Transactions

In working with broker-dealers and RIAs, I have come to realize that there is some misunderstanding about the application of ERISA’s provisions to investments in hedge funds.

If ERISA plan fiduciaries are given “individualized” advice based on the “particular needs” of the plan (such as asset allocation or non-correlated investments), then the recommendation of an investment in a hedge fund is like any other recommended investment. That is, it can be a fiduciary act by the broker-dealer or the RIA firm.

When the recommendation rises to the level of fiduciary advice, it implicates both the fiduciary standard of due diligence (that is, the prudent man rule), and the fiduciary prohibited transaction rules (found in section 406(b) of ERISA). Generally stated, 406(b) prohibits the receipt of any compensation above and beyond the advisory fee received for making the recommendation.

That principle is illustrated by a recent settlement between the Department of Labor and Morgan Keegan. Based on a DOL press release, Morgan Keegan agreed to settle a DOL investigation of the “sale” of hedge funds by paying $633,715.46 to 10 ERISA-governed pension plans.

While the press release does not provide detailed facts, one plausible conclusion is that the DOL asserted that Morgan Keegan was a functional fiduciary by virtue of recommending the hedge fund investments and that Morgan Keegan received payments in addition to its fee for making the recommendation.

The point of the case—for this article—is that hedge funds and other illiquid investments are subject to ERISA’s fiduciary advice rules. And, of course, even “sales” of hedge funds to ERISA plans are subject to the 408(b)(2) disclosure requirements.

 







Recent Insights

Interesting Angles on the DOL’s Fiduciary Rule #70

The Fiduciary Rule and Recordkeeper Services

This is my 70th article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and exemptions. These...

Interesting Angles on the DOL’s Fiduciary Rule #69

Compensation Risks for Broker-Dealers and RIAs

This is my 69th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles...

Interesting Angles on the DOL’s Fiduciary Rule #68

Recommendations of Distributions: The SEC Joins the Fray

This is my 68th article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and...