Fiduciary Investment Advice for Participants


403(b), DOL, fiduciary, prohibited transaction, prudent

The DOL recently issued its final regulation on conflicted investment advice to participants. Unfortunately, the scope of the regulation is not well understood. For example, if an adviser does not have any conflicts (that is, if the adviser cannot vary its revenue or that of any affiliates based on the recommended investments), then the adviser does not need to comply with the new regulation. For example, the adviser would not need to comply with the certification or audit requirements. However, if the adviser has financial conflicts of interest and can affect its own revenues (or those of an affiliate), then the adviser must comply with those requirements in order to give fiduciary investment advice to participants.

Together with other attorneys from my law firm, I have written a bulletin on the subject. If you are interested in having further information, please click on the linke below to see a copy of the bulletin:

https://www.faegredrinker.com/en/insights/publications/2011/12/fiduciary-investment-advice-for-participants

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What the 408(b)(2) Changes Mean to RIAs


404a-5, 408(b)(2), broker-dealers, DOL, fiduciary, plan sponsors, recordkeeper, registered investment advisers

Two other Drinker Biddle attorneys (Bruce Ashton and Joan Neri) and I just released a bulletin discussing what changes in the 408(b)(2) final regulation mean to registered investment advisers (RIAs). You can obtain a copy of the bulletin at:

http://www.drinkerbiddle.com/resources/publications/2012/the-final-408b2-regulation-impact-on-rias

While the final regulation clarifies a number of issues and grants an extension of time to comply, it also raises two issues which may come as a surprise to RIAs. The first is that asset allocation models (AAMs) may be treated as designated investment alternatives (DIAs), resulting in a number of disclosure requirements (both under 408(b)(2) and the participant disclosure regulation). The second is that the DOL has interpreted “indirect compensation” very broadly in a way that could require additional disclosures from RIAs. That would apply, for example, where investment providers (like mutual funds) or service providers (like independent recordkeepers or bundled providers) provide financial assistance to RIAs. Once specific example would be a conference put on by an RIA for its plan sponsor clients. Another example would be where an investment provider or a service provider offers “free” services to RIAs for their plan sponsor clients. Both of those issues, and others, are discussed in some detail in the bulletin.

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Finally the Final … 408(b)(2) Regulation


403(b), 408(b)(2), DOL, fiduciary, service providers

The DOL issued the final 408(b)(2) regulation on February 2, 2012.

Key points are:

  • The extension of the effective date to July 1, 2012;
  • The fact that service providers are not required to provide a summary of the disclosures, though the DOL provided a sample “guide” that is not mandatory;
  • The addition of a requirement to describe the arrangement between a covered service provider and the payer of indirect compensation;
  • Clarification that electronic transmission of the disclosures is permitted;
  • Relief from the disclosure requirements for “frozen” 403(b) contracts;
  • A new requirement that plan sponsors terminate the relationship with a service provider who fails or refuses to provide information on request;
  • Limited relief for disclosures for brokerage accounts and similar arrangements.

Bruce Ashton and I have drafted a more detailed Alert for our law firm, Drinker Biddle & Reath LLP.  That Alert is located at:

http://www.drinkerbiddle.com/resources/publications/2012/finally-the-final-408b2-regulation

 

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Capturing Rollovers


broker-dealers, DOL, registered investment advisers

I have recently written an article on “Capturing Rollovers.” The article discusses the DOL’s guidance on the issues involved in capturing rollovers, both by broker-dealers and RIAs. The article analyzed that guidance and discussed programs for RIAs and broker-dealers. You can download a PDF of the article by clicking on the link below:

http://www.drinkerbiddle.com/files/ftpupload/pdf/CapturingRollovers.pdf

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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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New Disclosure Rules


408(b)(2), General, plan sponsors, service providers

All of the service provider disclosures must be made by April 1, 2012. Once the disclosures are made, the focus will shift from service providers to plan sponsors. That is, after plan sponsors receive the disclosed information, they must prudently review and analyze it. In other words, they must engage in a prudent process to evaluate the services and compensation. That will inevitably lead to a benchmarking of service provider compensation.

My partner, Bruce Ashton, and I have written a detailed Alert on that subject for our firm, Drinker Biddle & Reath, LLP. A copy of that Alert can be accessed through the Drinker Biddle & Reath LLP website, at:

http://www.drinkerbiddle.com/resources/publications/2011/service-provider-disclosures-the-impact-on-plan-sponsors?Section=Publications.

Please copy and paste the link into your browser to access the publication.

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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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Consequences of Failure to Comply


408(b)(2), fiduciary, plan sponsors, prohibited transaction, service providers

This is another in the series of articles about the 408(b)(2) disclosures – and the consequences of a failure to comply.  This article discusses the legal responsibilities of plan sponsors.

If a service provider fails to make the required disclosures, then under ERISA both the service provider and the plan sponsor (that is, the responsible plan fiduciary) have engaged in a prohibited transaction. The 408(b)(2) regulation provides a procedure where plan sponsors can obtain relief for the failures of service providers; however, there is no similar provision for service providers.

What if the disclosures are made, but are not reviewed by the plan sponsor? Then the plan sponsor will have committed a fiduciary breach . . . since there is an affirmative obligation on fiduciaries to review and evaluate the compensation of service providers.

To take it a step further, what if the plan sponsor either fails to review the information, or does review the information, but fails to spot that excessive compensation is being paid to the covered service provider (for example, the recordkeeper or advisor). In that case, both the plan sponsor and the service provider will have engaged in a prohibited transaction. The service provider’s prohibited transaction is the receipt of the excessive compensation; the plan sponsor’s prohibited transaction is that it allowed the plan to pay unreasonable compensation. In these circumstances, there is not relief for the plan sponsor or for the service provider.

As a result, if the DOL or a plaintiff’s attorney spots the issue and files such a claim, both the plan sponsor and the service provider will be in a position of bearing the burden of proving that the compensation was reasonable. With benchmarking services and other comparative information, it will be easier for the Department of Labor and the plaintiff’s attorneys to identify cases where compensation may be excessive.

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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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