Category Archives: broker-dealers

Plan Brokerage Account


404a-5, broker-dealers, DOL, plan sponsors

This is another in a series of articles about interesting issues related to plan and participant disclosures.

The DOL disclosure regulations for both plan sponsor and participant disclosures are not clear about the treatment of brokerage accounts for a plan (for example, a small profit sharing plan) or for a participant-directed plan (for example, a self-directed brokerage account in a 401(k) plan).

For participant disclosures, the DOL has given informal guidance about the disclosures that must be made to participants . . . and those disclosures are minimal.

However, where a 401(k) plan consists exclusively of individual brokerage accounts, there are practical issues about how to comply with the 404a-5 disclosures generally. Since the brokerage accounts are not “designated investment options,” there are only minimal disclosures which must be made concerning the brokerage accounts. However, where only brokerage accounts are offered, the structure will not ordinarily include a recordkeeper. As a result, the plan sponsor (perhaps in conjunction with a compliance-only third party administrator) must make the non-investment participant disclosures, which includes the general disclosures, the administrative expense disclosures, and the individual expense disclosures – as well as the quarterly statements.

Based on our discussions with broker-dealers, there is a lack of awareness of the requirements for the non-investment disclosures under the 404a-5 participant disclosure regulation. As a result, there will be compliance issues in this scenario.

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Proposed Fiduciary Advice Regulation


broker-dealers, DOL, fiduciary

As you may know, the Department of Labor recently announced that it was going to re-propose its proposed fiduciary investment advice regulation. As background, that proposal was intended to modify the Department’s current regulation that defines fiduciary investment advice . . . and also intended to expand the definition, so that more people would be viewed as providing fiduciary investment advice under ERISA. However, the proposed regulations had a number of serious problems and, as a result, the financial services industry (and particularly broker-dealers and insurance companies), strenuously objected to the proposed changes. Because of those objections, as well as some congressional support of the objections, the DOL has agreed to re-propose the regulation.

If you are interested in understanding the problems with the initial proposal, I have provided a downloadable copy of my current letter to the Department of Labor. The letter includes a discussion of the changes, as well as some of the problems.

June 22, 2011 letter to DOL re Proposed Fiduciary Advice

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A Departure from the Recent Series of Articles


broker-dealers, DOL, fiduciary, prohibited transaction

In a departure from the recent series of 408(b)(2) articles, in this one I will be discussing the DOL’s decision to re-propose the fiduciary advice regulation.

On September 19th, the Department of Labor announced that, rather than issuing a final regulation on fiduciary investment advice, it would be re-proposing the regulation, which would allow additional comments on the re-proposed version. This is a victory for the private sector, and particularly for insurance companies and broker-dealers, who objected to a number of the provisions in the initial proposal. However, the victory may be limited, in the sense that the DOL will likely provide relief on certain issues, but not on others.

My “best guess” is that the DOL will provide relief in the following areas:

  • Individual retirement accounts: It is likely that the DOL will extend the exemptions of Prohibited Transaction Class Exemption 86-128 to virtually all advice given to the owners of IRAs. In other words, it is likely that both broker-dealers and RIAs will be able to give individualized advice to IRA owners and receive compensation that is not level, that is, the compensation may vary based on the recommendations, which would be more consistent with a broker-dealer business model than with an RIA business model. It will be interesting to see if the DOL imposes any limitations on that exemption, for example, disclosures concerning any variable compensation.
  • Commissions: Many of the people who criticized the proposed regulation asserted that it precluded commissions as compensation. That is because, where advice is given and compensation is variable, it can result in prohibited transactions. On the other hand, level compensation, regardless of whether it is a fee or a commission, would not result in a prohibited transaction. It seems likely that, in response to the criticism, the DOL will clarify that, commissions are not per se precluded as a form of compensation for fiduciary advice, so long as they are level.
  • Insurance: In certain cases (for example, insurance agents), the agent represents the provider (i.e., the insurance company) and not the customer (e.g., the plan). The proposed regulation created an exemption for those cases, so long as, among other things, the agent made it clear to the customer that the agent’s interests were “adverse” to the customer’s. Needless to say, there were strong objections to the use of the word “adverse,” with the argument being that the agent could be looking out for the best interests of the customer and at the same time recommending a product offered by an affiliate. It is likely that the DOL will offer a “softer” version of that exemption that will be more acceptable to the private sector and more consistent with common understandings.
  • Appraisals: The proposed regulations would have classified appraisers as fiduciaries in a variety of cases. It is likely that the range of cases will be limited, because of objections to the general nature of the rule—and since the primary focus of the change was for appraisers of closely held stock in ESOPs. It is also possible that there will be some clarification of the responsibilities of the appraiser. For example, the preamble or the regulation should specify that the appraiser is a fiduciary for purposes of determining the most accurate valuation and not for the purposes of determining a valuation most favorable to the participants.
  • Commercial transactions: A number of commercial transactions, such as swaps, could have been covered by the literal wording of the proposed regulation. The DOL has stated that it will clarify those issues and permit the continuation of transactions that are clearly commercial in nature and that are arm’s-length.
  • Exemptions and opinions: The DOL has also stated that the re-proposed guidance will provide for the continuation of existing exemptions, advisory opinions and other guidance related to fiduciary transactions.
  • “Individualized” advice: Under the proposed regulation, in a number of circumstances the provision of investment recommendations, whether individualized or not, would have resulted in fiduciary status. The DOL has suggested that it will limit the regulation to circumstances in which individualized advice is provided and is directed to specific parties.

Noticeably absent from the DOL’s September 19th release, and statements by DOL officials, is any suggestion of a broad revision of the regulation. In other words, it appears that the basic structure of the proposal will remain in place, but that there will be “adjustments” to deal with specific issues. While that may be of welcome relief to the financial services industry, it will probably not be helpful to those who are concerned about fiduciary status for ongoing services and recommendations to qualified retirement plans, such as 401(k) plans. In those cases, specific recommendations are made and the services are ongoing. As a result, it is likely that the changes in the re-proposal will continue to be expansive in terms of broadening the definition of fiduciary advice—particularly for small- and mid-sized plans.

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DOL Investigations: Broker-Dealers and RIAs as Targets


408(b)(2), broker-dealers, DOL, fiduciary, prohibited transaction, registered investment advisers

Together with Bruce Ashton and Summer Conley, I have authored an article titled “DOL Investigations: Broker-Dealers and RIAs as Targets.” To see the full text of the article, click on the link included here:

http://www.drinkerbiddle.com/resources/publications/2011/dol-investigations-broker-dealers-and-rias-as-targets

In the article we discuss that in recent months, we have heard of at least eight, and been involved in three, Department of Labor (DOL) investigations of broker-dealers related to their services to ERISA retirement plans. These investigations appear to be part of the DOL’s ongoing Consultant/Adviser Project (CAP). The CAP initiative is a national enforcement project designed to focus on “the receipt of improper or undisclosed compensation by employee benefit plan consultants and investment advisers.” This article discusses the background that led to the creation of CAP, the issues that financial advisers need to focus on and steps they may wish to take now to avoid liability exposure under ERISA.

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Short article about interesting issues under the DOL’s new disclosure requirements


408(b)(2), broker-dealers, DOL, fiduciary, prohibited transaction, registered investment advisers

This is another in a series of short articles about interesting issues under the DOL’s new disclosure requirements.

If a covered service provider (for example, an RIA or a broker-dealer, or their individual advisers) fails to timely provide the disclosures required under 408(b)(2), the “arrangement,” or relationship, between the service provider and the plan is a prohibited transaction. But, what are the consequences? Unfortunately, the law is not clear. Here are some possibilities:

  • The entire arrangement must be unwound . . . investments, services, compensation, and so on. This would be Draconian . . . especially since it would probably be asserted after the investments had suffered losses. In that case, to unwind the arrangement the provider would have to bear those investment losses. However, I do not think this is the likely outcome (except, perhaps, in egregious cases).
  • All of the compensation received by the provider (plus interest) would have to be restored to the plan. This appears to be the likely outcome.
  • Only the non-disclosed part of the compensation would need to be restored to the plan. If the compensation that was not disclosed to the fiduciary was insignificant (that is, would not have affected the decision of a reasonable fiduciary), this interpretation has some appeal.

In addition to those payments, there are 15% and 100% taxes under the Internal Revenue Code and a  20% penalty under ERISA. Those will be discussed in a future article.

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Extension to Compliance Date for 408(b)(2)


408(b)(2), broker-dealers, DOL, service providers

Last week, the Department of Labor (DOL) extended the compliance date for 408(b)(2) to April 1, 2012. While that only gives us another three months (from the current deadline of January 1), it is welcome relief. We have several observations about the extension:

  • Generally speaking, our service provider clients were on course to provide disclosures to their ERISA plans and to modify their intake procedures for new clients. However, they were feeling pressure to complete the work by the January 1 deadline.
  • The pressures primarily related to compensation disclosures. That is, our clients, by and large, have completed the work on the disclosures about services and status. However, the compensation disclosures are complex and often voluminous . . . particularly for broker-dealers and recordkeepers. At this point, the procedures for most of the easier compensation disclosures have been determined. However, work remains to be done on more complex compensation disclosures, for example, brokerage accounts and open architecture compensation disclosures by broker-dealers.
  • It is unlikely that there will be another extension. In its release, the DOL explained that the reason for this extension was that it had not released its final guidance under 408(b)(2) and, as a result, many service providers would need to make additional systems changes once the guidance is published. At this point, that will likely be October or possibly even November, depending on when the amended regulation is sent to the Office of Management and Budget.
  • It appears that the holdup is that the DOL is having difficulty resolving the new “summary and roadmap” disclosure requirements, which we understand is provided for in the amendment. The Department will need to either resolve the methodology for that disclosure or will need to eliminate the provision. We assume it will be the former.

The DOL thinks that the 3 month extension will be adequate because it will not take significant additional effort to incorporate the changes into the work already being done.  This suggests that the changes will either be relatively minor or possibly that some of the changes will make the regulation easier, rather than harder, to implement.

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Another in a series of discussions of interesting issues regarding disclosures under new DOL rules


408(b)(2), broker-dealers, DOL

The 408(b)(2) regulation requires that covered service providers disclose all “compensation.” On the face of it, that seems clear, but in practical application, it is more difficult. For example, must broker-dealers and others disclose all compensation, including revenue sharing? The answer is “yes.” Must all revenue sharing be disclosed? The answer is, “It depends on whether it is compensatory.”

While the regulation provides little guidance on what is “compensatory,” the DOL has explained its position in guidance about Schedule C to the 5500 Form:

“If a person providing services to the plan is provided a meal or other entertainment based on a general business relationship that includes both ERISA and non-ERISA business, is it required to be reported on Schedule C?

It depends.  The Schedule C instructions state that indirect compensation would not include compensation that would have been received had the service not been rendered to the plan or the transaction had not taken place with the plan and that cannot be reasonably allocated to the services(s) performed or transaction(s) with the plan.  However, if a person’s eligibility for receipt of a gift (such as meals, travel, or entertainment) is based, in whole or in part, on the value (e.g., assets under management, contract amounts, premiums) of contracts, policies or transactions (or classes thereof) placed with ERISA plans, the gift would constitute reportable indirect compensation for Schedule C purposes.  Where the eligibility for or amount of the gift is based on a book of business, including ERISA plan business, a pro rata share of the value of the gift should be treated as indirect compensation for the ERISA plans involved.”

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Interesting Issues under 408(b)(2)


408(b)(2), broker-dealers, DOL, fiduciary, registered investment advisers

This is the second in a series of short articles about disclosures to plan sponsors and participants under the new DOL regulations for disclosures to plans and to participants.

FACT: Many investment advisers (RIAs) and broker-dealers (BDs) use asset allocation models (AAMs) to help participants invest appropriately.

RULE: The DOL regulations require certain disclosures about “designated investment alternatives” (DIAs), including the performance history of the investments (to participants).

ISSUE: Are asset allocation models considered to be DIAs, which would invoke the disclosure requirements under both regulations?

ANSWER: Based on informal discussions with the DOL, it appears that they are leaning toward the conclusion that models are DIAs. If so, the disclosure requirements would include, among other things, reports from recordkeepers about the performance history of the models.  However, we believe that most recordkeepers have not been, and may not be able to (on a reasonable basis), calculate and report those returns. (Similar difficulties may exist for AAMs for other disclosures required by the regulations.) This could result in the inability to continue to use those models.

However, if the model is “managed” by a discretionary fiduciary, it appears that the DOL may conclude that is not a model, but instead an investment management service–which apparently would not be considered a DIA.

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Overlooked Issues Under 408(b)(2)


408(b)(2), broker-dealers, registered investment advisers, service providers

As we do work for “covered’ service providers to ERISA plans, we have seen a number of issues that we think are “flying under the radar.” As a result, I plan to write a series of short articles, like this one, about those issues.

The first is the “related parties” and “subcontractor” issue. Under the 408(b)(2) regulation, if a service provider pays money to an affiliate or a subcontractor, it may be necessary to separately report that payment. Without going into too much detail, the regulation requires that the payment be disclosed in writing if it is incentive compensation or is charged directly to the investments.

While this can affect several of types of service providers, it occurs most often in connection with broker-dealers. Let me explain. While the large wirehouses may treat their financial advisers (or registered representatives) as employees, many broker-dealers treat some or all of their financial advisers as independent contractors. The independent contractor financial advisers typically receive a percentage of the commission paid to the broker-dealer. In other words, they receive incentive compensation. As a result, the payment to the independent contractor financial adviser must be separately disclosed to the plan.

This could also apply to RIAs—investment advisers—where, for example, an IAR receives part of a solicitor’s fee for recommending an investment manager

The regulation is going to be amended before it becomes effective. As a result, some of the 408(b)(2) requirements could change.

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