Category Archives: service providers

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.


408(b)(2) Guide and More

The DOL recently issued a proposal to require a 408(b)(2) “guide.” The guide has also been referred to as a roadmap. But I think of it as an index to the disclosures.

This is the DOL’s response to their review of provider disclosures and problems the DOL has seen. The DOL has at least two more significant concerns.

The proposal is that plan sponsors be given a stand-alone guide or index to provide directions to where each of the 408(b)(2) disclosures is found in the disclosure documents. It will only apply where covered service providers use multiple or lengthy documents. As a result, it will primarily impact recordkeepers and broker-dealers (as opposed to other covered service providers, such as RIAs and TPAs).

There is time to comment on the proposal. Hopefully, the comments will enable the DOL to find the “fine line” between meaningful disclosure, on the one hand, and overly burdensome requirements on the other.

But, that’s not the end of the story. I have heard of two other DOL concerns. The first is that some covered service providers are not giving fiduciaries information that specifically applies to their plan. For example, the disclosures might instead provide a list of services or compensation amounts that might or might not apply to a particular plan. The Department’s view is that the disclosures should include only the services and compensation for the plan receiving the disclosures. The second concern is that service providers are using overly-broad ranges to make disclosures. For example, if a service provider were to disclose that the fees will be somewhere between 0% and 5%, the Department would likely take the position that the information was not specific enough to enable the responsible plan fiduciaries to evaluate the compensation of the adviser relative to the services being provided.

That’s it for now. But, be forewarned, there is more to come.

As a footnote to these comments, we anticipate that the DOL will begin their first wave of 408(b)(2) investigations in the second half of this year.

To read the Client Alert I co-wrote on this subject in March 2014, visit the Drinker Biddle website here: DOL Proposed Regulation on 408(b)(2) “Guide” – Impact on Service Providers.


Responsible Plan Fiduciaries and Disclosure Issues

The 408(b)(2) regulation requires that its service, status and compensation disclosures be made to “responsible plan fiduciaries” or “RPFs.” In the rush to make the 408(b)(2) disclosures, most recordkeepers, broker-dealers and RIAs sent their disclosure documents to their primary contact at the plan sponsor. In at least some of those cases, the primary contact was not the RPF. As a result, we added language to our clients’ disclosures to the effect that, if the recipient was not the RPF, the written disclosure should immediately be forwarded to the RPF.

The regulation defines RPF as “a fiduciary with authority to cause the covered plan to enter into, or extend or renew, the contract or arrangement.” In other words, it is the person or committee who has the power to hire and fire the particular service provider, e.g., the broker-dealer, recordkeeper or RIA.

Because of the work involved in making mass disclosures, any inadvertent errors in properly identifying the RFPs may be excusable. However, going forward, it may not be. Because of that, all future agreements, account opening forms, and so on, with ERISA plans should specify that the person signing on behalf of the plan is the RPF. Furthermore, we recommend that service providers obtain the email address and other contact information for the RPFs (and that they contractually require plan fiduciaries to inform them of any changes of the RPFs).

We do that for two reasons. First, as covered service providers bring in new plan clients, the documents need to be executed by the RPFs and the disclosures need to be delivered to the RPFs. Second, the information is also needed for existing clients. Fiduciaries who have already received disclosures, they will need to be provided “change” disclosures in the future within 60 days of any changes. And, it is likely that more requirements will be imposed on service providers in the future and, therefore, providers will need to have an efficient and effective way of communicating with the RPFs.

Now is the time to put these new procedures in place.


Managing Plan Costs

Many recordkeepers and bundled providers charge plans based on the number of participant accounts. Many others do not explicitly charge on a per-participant basis, but incorporate the number of accounts (and possibly the average account balances) into their pricing. It is likely that this practice will increase in the future . . . due to the new 404a-5 participant disclosures, which must be made to every eligible employee, as well as to every participant of an account balance.

With that in mind, advisers, recordkeepers and plan sponsors should consider mandatory distributions of small account balances (that is, $5,000 or less) to manage plan costs.

If a plan has the required provisions, and if the provisions have been appropriately communicated to eligible employees and beneficiaries through summary plan descriptions, plans can make distributions of account balances of $5,000 or less. If the participants don’t take those distributions, then the plans can directly roll the money over into IRAs for them. In either case, the effect of the mandatory distributions will be to improve the pricing for the plan . . . either because it reduces the number of accounts or, alternatively, because it increases the average account balance (due to the elimination of small accounts).

As you might expect, both the IRS and the DOL have issued guidance on how to do that. The combined effect of the guidance is that plan fiduciaries essentially have a safe harbor for making mandatory distributions of small accounts . . . if they follow the rules. Unfortunately, there are too many requirements for a short email like this. However, my partner, Bruce Ashton, and I have written a white paper that describes the requirements.

In writing that white paper, we took an approach that I think will be helpful to advisers and plan sponsors. The body of the white paper is a discussion of the benefits of mandatory distributions . . . in terms of plan pricing. Then, there are three appendices: the first two discuss the IRS and DOL guidance, respectively; and the third one covers adviser compensation related to a mandatory rollover program.

If this subject is interesting to you, you may want to look at the Inspira white paper. It is located at


Fiduciary Advice and 12b-1 Fees

The DOL recently settled a case for $1,265,608.70 with a firm that provided investment advice to retirement plans. Based on the DOL’s press release, the firm served as a fiduciary investment adviser to ERISA plans and recommended investments in mutual funds. In addition to the firm’s advisory fee, it also received 12b-1 fees.

Based on the press release, it appears that the DOL asserted two claims. The first is that the receipt of additional fees (which could include both 12b-1 fees and some forms of revenue sharing) is a violation of the prohibited transaction rules in section 406(b) of ERISA.

The second theory appears to be that, where a fiduciary adviser receives undisclosed compensation, the adviser has, in effect, set its own compensation (to the extent of the undisclosed payments). In the past, the DOL has successfully taken the position that, by receiving undisclosed compensation, a service provider has become the fiduciary for the purpose of setting its own compensation and has used its fiduciary status for its own benefit.

In any event, RIAs and broker-dealers need to be particularly conscious of undisclosed payments and/or payments in addition to an advisory fee. In recent years, the DOL has gained a greater understanding of RIA and broker-dealer compensation and is actively investigating both.

I have reviewed the 408(b)(2) disclosures of a number of broker-dealers. In a few cases, the broker-dealers specifically state that, where they were serving as fiduciary advisers, they were also receiving additional compensation (e.g., revenue sharing). Those disclosures raise issues about prohibited transactions.


Anticipated DOL Guidance

The Department of Labor recently issued its agenda for regulatory guidance. Several of the projects will impact retirement plans and particularly 401(k) plans. This email focuses on a DOL project to amend the 408(b)(2) regulation to possibly require that cover service providers furnish a “guide” or similar tool, along with the disclosures. In its description of the project, the DOL states: “A guide or similar requirement may assist fiduciaries, especially fiduciaries to small and medium-sized plans, in identifying and understanding the potentially complex disclosure documents that are provided to them or if the disclosures are located in multiple documents.”

As background, the final 408(b)(2) regulation contain a sample guide. Covered service providers may want to review that part of the regulatory package in order to understand the DOL’s approach. Briefly described, though, that guide would require that, for each mandated disclosure, a covered service provider indicate the section number and page number where the particular disclosure was made. They might be viewed as a one or two page index of exactly where the required information was located. In other words, it is not a summary, but instead a “map.”

It appears that the DOL is concerned that—by using multiple disclosure documents or lengthy or complex documents—service providers may have presented the disclosures in a manner that is difficult for plan sponsors to understand. While the guide would likely benefit plan sponsors, it can impose a significant burden on providers who have used multiple documents and/or lengthy documents to make their disclosures. That would be particularly true where the paragraph numbers and/or page numbers can change from plan to plan. That would also be difficult for covered service providers who refer to other documents, such as a mutual fund prospectuses.

Unfortunately, the DOL description of the project does not indicate whether the requirement will be applied only prospectively or whether it would apply retroactively. If I had to guess, it would be that the DOL would make the application prospective…simply because of the cost and burden of the “re-disclosing” to existing plans.

In any event, the guidance will be issued in proposed form and there will be a comment period. At this point, the DOL has indicated that it is targeting a May date for release.



408(b)(2) Violations and Service Provider Correction Program

The failure of a covered service provider (for example, a broker-dealer, RIA or recordkeeper) to provide adequate 408(b)(2) disclosures results in a prohibited transaction . . . for both service providers and plan sponsors. While the regulation has an exemption for plan sponsors (if they follow certain steps), there is no similar exemption for covered service providers.  Continue reading 408(b)(2) Violations and Service Provider Correction Program


408(b)(2) Disclosures for Related Parties

One of our concerns about disclosures by broker-dealers (and affiliated RIAs) is that they may not fully appreciate the concept of related parties under the 408(b)(2) regulation.

When a broker-dealer is a covered service provider and contracts with others to provide some of the services, the broker-dealer and those other parties are “related” for purposes of the regulation and its disclosure requirements. In those cases, the compensation of the related party (as opposed to the broker-dealer) must be disclosed if it is (1) transactional or (2) charged against the plan’s investments. In some cases, there may be other required disclosures.

Continue reading 408(b)(2) Disclosures for Related Parties