I respond to readers’
questions regarding the DOL/EBSA’s re-proposed “Definition of Fiduciary” Rule.
Table Of Contents
(1) “Ron, when will the DOL’s re-proposed rule be
available to see? And when would it be finalized?”
(2) Will the DOL’s Rule Only Apply to Individuals (Not
BD Firms)?
(3) Will Proprietary Products Be Available Under the
DOL’s Re-Proposed Rule?
(4) Will ERISA’s Standards Now Apply to IRAs and to
the IRA Rollover Decision?
(5) Specifically, How Will the EBSA’s Re-Proposed Rule
Expand the Definition of “Fiduciary”?
(6) Will There Be Any Exemptions Provided from the
Expanded Definition of Fiduciary?
(7) What Should Plan Sponsors Do Now?
Introduction
As many readers are aware,
the U.S. Department of Labor’s (DOL’s) Employee Benefits Security
Administration (EBSA) is likely to re-promulgate, later this year, its proposed
expansion of the “Definition of Fiduciary.” Under current regulations many of
those who provide advice relating to investment selection to plan sponsors are
not considered fiduciaries. Under the new regulations two major changes are
anticipated:
First,
nearly everyone who provides investment advice to ERISA-covered plan sponsors
(and to plan participants) would be considered a fiduciary.
Second,
those providing investment advice to IRA account holders would also be
considered fiduciaries.
As I’ve previously written,
these rules – if finalized by DOL/EBSA – are likely to be “game-changers”
within the financial services industry. Current ERISA regulations, with their
pre-emptive nature, prevents the application of common law fiduciary status to
many who provide advice on investments to plan sponsors. As a result, many
current advisors to defined contribution plan accounts are not fiduciaries
under the law. Also, with the inclusion of IRA accounts, and the IRA
distribution decision, many more “financial advisors” will be considered
fiduciaries, at least respect to such accounts. According to the Investment
Company Institute, at the end of 2012:
The
largest components of retirement assets were IRAs and employer-sponsored DC
plans, holding $5.4 trillion and $5.1 trillion, respectively, at year-end 2012.
Other employer-sponsored pensions include private-sector DB pension funds ($2.6
trillion), state and local government employee retirement plans ($3.2
trillion), and federal government plans—which include both federal employees’
DB plans and the Thrift Savings Plan ($1.6 trillion).
2013 Investment Company Fact
Book, Chapter 7, available at http://www.icifactbook.org/fb_ch7.html#snapshot.
While not all of the
foregoing accounts are governed by ERISA’s rules, approximately $15 trillion
dollars (or more) of retirement accounts would be subject to the new
“Definition of Fiduciary” rules. This is a significant portion of the overall
capital markets.
For example, “the sum of the
market-cap of the NYSE, NASDAQ and AMEX on Bloomberg today (04-02-2012) is
$21.4 Trillion — pretty close numbers for the kind of data gathering these
summaries involve. Going with the SIFMA and Bloomberg numbers, the US capital
market is about $58.4 Trillion, consisting of 63.4% bonds and 36.6% stocks.”
QVM Group, LLC, “World Capital Markets – Size of Global Stock and Bond Markets,”
Perspectives, April 2, 2012),
available at http://qvmgroup.com/invest/2012/04/02/world-capital-markets-size-of-global-stock-and-bond-markets/.
I’ve received several
questions from readers regarding the EBSA’s re-proposed rule, believed to be
re-promulgated by EBSA later this year. Here are my replies thereto.
(1) “Ron, when will the DOL’s re-proposed
rule be available to see? And when would it be finalized?”
The re-proposed rule must
first be submitted by DOL/EBSA to the Office of Management and Budget. At that
point it would go through a 90-day review process. Only with OMB’s approval
would the re-proposed rule be released for all to see.
It is not certain that the
re-proposed rule will be released to OMB, nor that it survives OMB scrutiny.
Why? First, there is tremendous opposition from the wirehouses and insurance
companies to the rule, and they are flooding Congress with lobbying in
opposition to the rule ever seeing the light of day. They are also extensively
lobbying OMB to not permit the rule’s release. In addition, a new U.S.
Secretary of Labor needs to be confirmed, and when confirmed that person is
likely also likely to be lobbied extensively. While Asst. Secretary Phyllis
Borzi remains, by all accounts, committed to re-proposing the rule, I would not
be totally surprised if lobbying by Wall Street firm and the insurance lobby
stops the rule from ever seeing the light of day.
When the re-proposed rule is
released, there is likely to be a long comment period – perhaps 3-4 months (or
even longer). Thereafter, the EBSA must consider all of the comments prior to
finalizing the rule. During this time lobbying against the rule will again be
heavy, in an attempt to get the DOL/EBSA to withdraw the rule or delay the
process.
My current guess is that the re-proposed rule would
be released by October or November of this year, although that timeline could
be delayed. It would then likely take another year before any rule is finalized,
given the necessity to review all of the hundreds (if not thousands) of
comments likely to be submitted.
Having said that, be aware
that delays in agency rule-making occur frequently. And, as stated above, given
the tremendous opposition to this rule from some sectors, it is altogether far
from certain that a re-proposed “Definition of Fiduciary” rule will ever be
released, much less finalized and enacted.
(2) Will the DOL’s Rule Only Apply to
Individuals? A reader asks: “Under the DOL’s proposal, will the fiduciary obligation
fall only on the individual financial advisor, or does it also apply to their
associated broker-dealer as well? More specifically, if a financial advisor
works for a large broker-dealer, and the broker-dealer has a fixed compensation
model for financial advisors (to comply with the newly proposed fiduciary
guidelines), would the broker-dealer be able to maintain revenue-sharing
arrangements with the asset manager? If not, why not?”
Yes, a broker-dealer firm is liable,
in most instances, for a breach of fiduciary duty by its registered
representative. This is because, under general principles of law, employers are
vicariously liable, under the respondeat
superior doctrine, for the acts or omissions by their employees in the
course of employment (sometimes referred to as “scope of employment”). For an
act to be considered within the course of employment it must either be
authorized or be so connected with an authorized act that it can be considered
a mode, though an improper mode, of performing it.
The delivery of “advice” –
which leads to the imposition of fiduciary status – results from actions
undertaken by the registered representative in furtherance of the objectives of
the firm. Hence, under ERISA, it is clear that (in nearly all cases) both the firm
and the individual advisor possess the fiduciary duty to the client.
But wait, you say … how can a
registered representative owe a fiduciary duty to a client, when the registered
representative also owes a fiduciary duty to the broker-dealer firm (as the
employee of the broker-dealer firm)? Isn’t this a conflict? No. This is because
the fiduciary duties are ordered –
i.e., the fiduciary duty to the client comes first, and any fiduciary duty the
registered representative owes to the broker-dealer firm is secondary.
For example, an attorney
might be an employee of a law firm. The attorney, as an employee of the law
firm, represents the law firm and has a fiduciary duty of loyalty to the law
firm, under general principles of agency. But the individual lawyer also has a
fiduciary duty to the client. If the individual lawyer breaches his or her duty
of loyalty to the client, such as engaging in a prohibited commercial
transaction with the client to further the law firm’s interest (e.g., a commercial transaction in which
the client did not receive independent legal advice before entering into the
transaction with the lawyer), the lawyer is individually liable, and the law
firm is liable as well vicariously, under the doctrine of respondeat superior.
Hence, if and when the
“Definition of Fiduciary” rule is applied by the DOL, it will apply to both the
broker-dealer firm and its registered representatives. This means that, absent
an exemption to the prohibited transaction rules under ERISA (see discussion,
below), revenue-sharing arrangements between the broker-dealer firm and an
asset manager recommended to a plan sponsor are not permitted (unless, if an
exemption is so granted under the new regulations, the fees charged by the
fiduciary broker-dealer are reduced by the amount of the revenue-sharing
received from the asset manager).
I believe it is very unlikely
that revenue-sharing arrangements, so common in the investment industry today,
will continue if the “Definition of Fiduciary” regulation is put into effect.
(3) Will Proprietary Products Be
Available Under the DOL’s Re-Proposed Rule?
A reader ask: If the broker-dealer is affiliated with the asset manager
(i.e., under common ownership, etc.), will the broker-dealer be able to provide
products from that asset manager (i.e., proprietary products)?
Look for an exemption here,
but the scope of the exemption and its conditions are uncertain.
The issue of sales of
proprietary products is a vexing one under fiduciary law. Many states had to
deal with this issue, in their statutes, about 2-3 decades ago, when banks and
their trust companies desired to switch fiduciary “common trust funds” into
bank-owned, proprietary mutual funds. Most states required that the “management
fees” charged by the fund be credited against the separate trustee fees charged
on the account. However, it has become obvious that this “solution” to the
conflict of interest was not perfect. For example, the “administrative fees”
paid to other affiliates of banks (or their holding companies) sometimes far
exceed similar amounts of administrative fees paid by similar-sized,
similarly-managed funds who engage independent third-party firms for services
paid for by such fees.
Even with fee crediting, many
states also require that the proprietary fund recommended be in the best
interests of the client. In practice, according to many trust officers I have
spoken with, this results in recommending only those proprietary funds which
outperform the average of their peers over a specified time frame. (Since
outperformance over any period of time has been shown to be not indicative of
future performance, especially when an adjustment is made for the level of fees
incurred by the fund’s shareholder, the use of such a benchmarking technique is
questionable, in the author’s view).
Australia’s new fiduciary
requirements on its financial services professionals take effect soon.
Australia’s approach is more stringent, when proprietary products are involved:
RG
175.267. In determining the scope of the advice, an advice provider will need
to use their knowledge about a range of strategies, classes of financial
product and specific financial products commonly available and which are
relevant considering the subject matter of the advice sought by the client ….
RG
175.367 An advice provider must prioritise the interests of the client if the
advice provider knows, or reasonably ought to know, when they give the advice
that there is a conflict between the interests of the client and the interests
of:
(a)
the advice provider;
(b)
an associate of the advice provider;
(c)
the advice provider’s [firm]….
RG
175.372 An advice provider cannot comply with the conflicts priority rule
merely by disclosing a conflict of interest or getting the client to consent to
a conflict. [Note: A condition of a contract (or other arrangement) is void if
it seeks to waive any of the obligations in s961J: s960A. Additionally, these
obligations cannot be avoided by any notice or disclaimer provided to the client:
see RG 175.213.] ….
RG
175.379 The conflicts priority rule does not prohibit an advice provider from
accepting remuneration from a source other than the client (e.g. a fee from a
product issuer). However, Div 4 of Pt 7.7A prohibits advice providers from
accepting certain types of remuneration which could reasonably influence the
financial product advice they give or the financial products they recommend to
clients ….
RG
175.380 If an advice provider gives priority to maximising or receiving the non-client
source of remuneration over the interests of the client, the advice provider
will be in breach of the conflicts priority rule ….
RG
175.381 The conflicts priority rule means that:
(a)
an advice provider must not recommend a product or service of a related party
to create extra revenue for themselves, their AFS licensee or the related
party, where additional benefits for the client cannot be demonstrated;
(b)
where an advice provider uses an approved product list that only has products
issued by a related party on it, the advice provider must not recommend a
product on the approved product list, unless a reasonable advice provider would
be satisfied that it is in the client’s interests to recommend a related party
product rather than another product with similar features and costs ….
Australian Securities &
Investments Commission (ASIC), “REGULATORY GUIDE 175: Licensing: Financial
product advisers—Conduct and disclosure” (December 2012).
As seen, the ASIC requires a
“tough test” – the “demonstration” of “additional benefits” for the client.
Yet, in a note to RG 175.381(b), the ASCI also endorses the use of
“benchmarking,” stating: “One way that an advice provider may be able to do
this is by benchmarking the product against the market for similar products to
establish its competitiveness on key criteria such as performance history,
features, fees and risk. The benchmarking must be reasonably representative of
the market for similar products that are offered by a variety of different
issuers.”
Hence, I would expect that,
under the application of ERISA’s tough sole interests standard, we will likely
see a similar result. Three requirements are likely to be imposed by EBSA when
proprietary funds are recommended: (1) management fees earned must be credited
back against other fees charged by the advisor in some fashion; (2)
administrative fees paid to affiliates will receive enhanced scrutiny, to
ensure no “double dipping” occurs; and (3) benchmarking to the entire universe
of similar funds or to broad indexes (not just an index of “actively managed
funds” - as used by Lipper indices, for example) will be required.
I suspect that a trend that
began more than a decade ago – the divestment by broker-dealer firms of their
asset management divisions – will continue. Otherwise, the recommendation of a
proprietary fund will always receive a heightened degree of scrutiny, both by
regulators and plantiffs’ attorneys alike. Additionally, a competition
disadvantage exists when competitors – who don’t utilize proprietary funds –
point out the inherent conflict of interest that exists.
(4) Will ERISA’s Standards Now Apply to IRAs
and to the IRA Rollover Decision?
A
reader asks: “Based on the proposed DOL regulations, are 401k-to-IRA rollover
discussions considered a fiduciary conversation? If so, why? If this is the
case, does this make it virtually impossible for any financial advisor to
solicit for rollover business? Why or why not?”
Yes, and yes.
As to the Dept. of Labor and
IRA accounts, under the Internal Revenue Code issue: First, section 4975(e)(3)
of the Internal Revenue Code of 1986, as amended (Code) provides a similar
definition of the term "fiduciary" for purposes of Code section 4975
(IRAs). However, in 1975, shortly after
ERISA was enacted, the Department issued a regulation, at 29 CFR 2510.3-21(c),
that defines the circumstances under which a person renders ``investment
advice'' to an employee benefit plan within the meaning of section 3(21)(A)(ii)
of ERISA. The Department of Treasury issued a virtually identical regulation,
at 26 CFR 54.4975-9(c), that interprets Code section 4975(e)(3). 40 FR 50840
(Oct. 31, 1975). Under section 102 of Reorganization Plan No. 4 of 1978, 5
U.S.C. App. 1 (1996), the authority of the Secretary of the Treasury to interpret
section 4975 of the Code has been transferred, with certain exceptions not here
relevant, to the Secretary of Labor.
Hence, when the DOL/EBSA, as
is expected later this year, issues a re-proposal of its "definition of
fiduciary" regulation, in essence the broad exemptions previously provided
disappear, and virtually any provider of personalized investment advice to a
plan sponsor or plan participant would be a "fiduciary" and subject
to ERISA's strict "sole interests" fiduciary standard and its prohibited
transaction rules.
In its 2010 release, the DOL
sought comment on whether any distribution decision should be subject to a
fiduciary standard. I suspect that the DOL will state, in any re-proposed rule,
that the decision to undertake a distribution, when the decision involves a
transfer of funds into an investment or insurance product, will be subject to
the fiduciary standard of conduct. There is much abuse in this area, already.
For example, one “strategy” which is taught to some financial advisors, and
subsequently deployed with clients (through seminar-based marketing, mainly),
is the withdrawal of funds from IRA and other investment accounts for placement
of the funds in a (nonqualified) Equity Indexed Universal Life Policy. A
dubious technique, considering the high commissions resulting form the sale of
most EIUL policies, and the other limitations and features of such products
(which falls outside of the discussion of this article).
(5) Specifically, How Will the EBSA’s
Re-Proposed Rule Expand the Definition of “Fiduciary”?
We
don’t know for certain what the re-proposed rule will look like, but
commentators largely expect that the 2010 Proposed Rule from EBSA, which
redefined “fiduciary” broadly, will be largely followed. (As discussed below,
certain exemptions will be provided from the definition of “fiduciary,” under
the re-proposed rule.)
Statutory Definition. The definition of fiduciary under ERISA can be found
at Section 3(21)(A). This definition includes parties rendering investment
advice for a direct or indirect fee with respect to plan assets. This statutory
definition appeared very broad.
1975 DOL Regulations. In 1975, the DOL issued regulations interpreting when
offering advice resulted in fiduciary status. The regulations provided a 5-part
test. The 1975 regulations, which remain in effect until any new regulation is
finalized, provide that in order to be deemed a fiduciary as a result of
providing investment advice, the advisor must:
(1) Render advice as to the value of securities or other
property, or make recommendations as to the advisability of investing in,
purchasing or selling securities or other property;
(2) Provide the advice on a regular basis;
(3) Provide the advice pursuant to a mutual agreement,
arrangement or understanding, with the plan or a plan fiduciary;
(4) The advice will serve as a primary basis for
investment decisions with respect to plan assets, and
(5) The advice will be individualized based on the
particular needs of the plan.
The
DOL believed the five-part test was obsolete and the regulations as a whole
needed an overhaul. The retirement plan industry and financial investment
community have changed dramatically since then, especially with the rise of the
401(k) plan, the rapid growth of IRAs, and the increased moving of retirement
money from plan to plan as employees changed jobs more often. Accordingly, EBSA
proposed the new regulations to bring the definition of “fiduciary” in line
with the times.
2010 Proposed Regulation (Now
Withdrawn). Reflecting the tremendous growth of defined
contribution plans (the tremendous growth of 401(k) plans, and the replacement
of most pension plans, was not foreseen when ERISA was adopted), as well as the
tremendous growth in the complexity of investment and insurance products over
the past 35 years, the DOL’s EBSA proposed in 2010 that the definition of
fiduciary, found in the regulation, be significantly expanded.
The
2010 proposed regulation clarified that rendering the advice for a fee included
any direct or indirect fees received by the advisor or an affiliate from any
source, including transaction-based fees such as brokerage, mutual fund or
insurance sales commissions.
Under
the 2010 proposed regulation, fiduciary status under ERISA could then result in
several different ways, which included:
A) Provides
advice or make recommendations pursuant to an agreement, arrangement or
understanding, written or otherwise, with the plan, a plan fiduciary or a plan
participant or beneficiary, where the advice may be considered in making
investment or management decisions with respect to plan assets, and the advice
will be individualized to the needs of the plan, a plan fiduciary or a
participant or beneficiary.
While this language is similar to some of
the language from the old test, there are a couple notable changes. First, the
advice no longer needs to be offered on a regular basis—offering advice on a
single occasion could result in fiduciary status. Second, the advice no longer
need be offered as part of a mutual understanding that the advice will serve as
the primary basis for investment decisions— the advice could be part of several
factors that the plan sponsor considers and still result in fiduciary status.
This would mean that any
investment advice, even provided on a non-continual basis, could lead an
advisor to become subject to ERISA fiduciary obligations. While many
commentators questioned the “expansion” of fiduciary law to cover the provision
of discrete advice, other commentators noted that the test should be whether
advice is provided, not how often; even one-time advice might be instrumental
in a plan sponsor’s or plan participant’s decision-making.
B) Acknowledgement
of fiduciary status for purposes of providing advice.
This provision is significant because
under the old test, a party could acknowledge fiduciary status, and yet still
fail to be held liable if they did not meet all five parts of the old test.
In the 2010 proposed rule, the
EBSA that persons who say they are ERISA fiduciaries are ERISA fiduciaries
irrespective of the nature of the advice provided to a plan, plan fiduciaries,
participants or beneficiaries. This seems entirely logical; it is possible to
contract for an advisor to be a fiduciary (although contracting out of
fiduciary status is largely restricted under fiduciary law). In addition, holding
oneself out as a fiduciary, but not then acting as same, would likely
constitute intentional misrepresentation (i.e., actual fraud). Seems pretty
straight-forward, i.e., “say what you do, do what you say.”
C) Is an investment advisor under Section 202(a)(11) of the Investment Advisors Act of 1940.
D) Provides
advice, appraisals or fairness opinions as to the value of investments,
recommendations as to buying, selling or holding assets, or recommendations as
to the management of securities or other property.
The
DOL noted that part of the intent of this portion of the test is to establish
fiduciary responsibility on parties who provide valuations of closely held
employer securities (such as securities held in ESOP plans) and other hard to
value plan assets.
Reaction to the 2010 Proposed
Regulations. There was a “passionate”
and “robust” response from many segments of the securities and insurance
industry to the EBSA’s 2010 proposed rule. Lobbying was successful in getting
about 100 members of Congress to write to the DOL to question the need for the
rule, the pace of the rule’s enactment, the apparent lack of coordination by
DOL with SEC, or all three of the foregoing.
Yet,
many consumer groups and pro-fiduciary advocates supported the EBSA’s proposed
rule. This author submitted two comments, including one which rebutted many of
the arguments made by Wall Street’s proxies. See http://www.dol.gov/ebsa/pdf/1210-AB32-PH026.pdf.
For
a complete listing of public comments, as well as transcripts of a two-day
hearing DOL held on the 2010 proposed rule, visit: http://www.dol.gov/ebsa/regs/cmt-1210-AB32.html.
The DOL Re-Tools. The DOL has engaged economists (both within and
without EBSA) to beef up the economic case for expanding the current definition
of fiduciary. (This economic analysis is to be shared with the SEC, as well).
EBSA has reviewed all of the comments submitted, and any new re-proposed rule
is likely to try to resolve some of the “ambiguities” which some commentators
complained about. In addition, EBSA’s Asst. Sec. of Labor Phyllis Borzi remains
firmly committed to coming out with a re-proposed rule. See http://scholarfp.blogspot.com/2013/03/most-courageous-phyllis-borzi-and-her.html.
(6)
Will There Be Any Exemptions Provided from the Expanded Definition of
Fiduciary?
Let
me preface this by stating that exemptions are often granted to agency rules,
and yet sometimes the unintended (or intended) consequence is that the
exemptions end up “swallowing” the entire rule.
For example, many commentators believe that the “incidental advice”
exemption swallowed the rule for the definition of “investment adviser” under
the Investment Advisers Act of 1940, under subsequent SEC rule-making. Hence,
exemptions must be carefully worded in order to achieve their intended
objective, while still achieving the objective of the main rule itself.
Under
the 2010 proposed regulation, three major exemptions were provided by EBSA from
the definition of “fiduciary”:
The “Seller’s
Exemption.” This exemption was available if recommendations made
in the capacity of a seller or purchaser of a security to a plan or participant
whose interests are adverse to the plan or its participants, provided that the
recipient of the advice or recommendation knows or should have known that the
seller or purchaser was not undertaking to provide impartial investment advice
(this exception would not include an advisor who has acknowledged fiduciary
status).
As stated in the issuing release, “[t]his
provision reflects the Department’s understanding that, in the context of
selling investments to a purchaser, a
seller’s communications with the purchaser may involve advice or recommendations,
within paragraph (c)(1)(i) of the proposal, concerning the investments offered. The Department has determined that such
communications ordinarily should not result in fiduciary status under the
proposal if the purchaser knows of the person’s status as a seller whose
interests are adverse to those of the purchaser, and that the person is not
undertaking to provide impartial investment
advice.”
What is interesting about this exemption
is that the DOL was proceeding down a path which the SEC has avoided for decade
– i.e., drawing a line between “advice” and “sales.”
In my opinion, there is certainly a place
for “product sales” – i.e., situations where one is involved in merchandizing
investment products. The key is to
carefully distinguish “merchandizing” from “advice” in a fashion where: (1) if
advice is in fact provided, fiduciary status attaches; (2) if advice is not
provided, and only a description of the product occurs (with no
“recommendation” as to whether the product would be “good” for the customer),
that the customer clearly understand that caveat
emptor (“let the buyer beware”) applies and that the customer cannot and
should not “rely” upon the product provider, other than for an accurate
description of the product itself. In addition, the use of titles and designations which denote an advisory relationship should trigger "advisor" ("fiduciary") status.
The
“Education Provider” Exemption. Providing investment education information and
materials. Many commentators to this aspect of the proposed regulation
questioned how the line between “education” and “advice” would be drawn.
The “Menu of
Products” Exemption. Marketing or making available a menu of investment
alternatives that a plan sponsor may choose from, and providing general
financial information to assist in selecting and monitoring those investments,
provided this is accompanied by a written disclosure that the party is not
providing impartial investment advice.
We do not know how each of
the foregoing exemptions will be modified under any re-proposed rule.
NOTE: The Prohibited Transaction Rules, and
Exemptions Thereto. Over the past two
years Asst. Sec. of Labor Phyllis Borzi has hinted that the re-proposed rule may
include some special exemptions from the prohibited transaction rules where it
is obvious that the participant would benefit from such exemption.
Under ERISA, the term
"prohibited transaction" includes any direct or indirect:
- The sale, exchange, or leasing of any property between a plan and a disqualified person;
- The lending of money or other extension of credit between a plan and a disqualified person;
- The furnishing of goods, services, or facilities between a plan and a disqualified person;
- The transfer to, or use by or for the benefit of a disqualified person, of the income or assets of a plan;
- An act by a disqualified person who is a fiduciary whereby the fiduciary deals with the income or the assets of a plan in his own interest or for his own account; or
- Receipt of any consideration by a disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.
These prohibited transaction
rules are contained in both the Internal Revenue Code and in Title I of
ERISA. The labor law provisions also
prohibit fiduciaries from acquiring certain percentages of employer securities
or real property.
Also, under current DOL provisions,
a fiduciary may not (1) deal with plan assets in his own interest, (2) act in
any transaction involving a plan on behalf of a party whose interests are
adverse to the plan's interests or those of the participants or beneficiaries,
and (3) receive any consideration for his own personal account from any party
dealing with the plan in connection with a transaction involving the plan’s
assets.
Unlike the application of the
“best interests” fiduciary standard under state common law and/or the
Investment Advisers Act of 1940, “ERISA’s prohibited transaction rules are
unique in that they are absolute. You can never enter into a non-exempt
prohibited transaction under ERISA, even if conflicts have been fully disclosed
and the client provides its written consent.”
Marcia S. Wagner, Esq., Wagner Law Group, “BASICS OF ERISA” outline,
Oct. 17, 2012, at p. 9, available at http://www.wagnerlawgroup.com/documents/BasicsERISADoc101711_000.pdf.
There already exist various
exemptions from the prohibited transaction rules. However, these exemptions
were granted prior to the EBSA’s 2010 proposed rule. In addition, it should be
noted that ERISA provides that “the Secretary may not grant an exemption under
this subsection unless he finds that such exemption is — (1) administratively
feasible, (2) in the interests of the plan and of its participants and
beneficiaries, and (3) protective of the rights of participants and
beneficiaries of such plan.” 29 USC § 1108(a).
Class exemptions, which
possess broad applicability, have been granted in the past. As explained by
Marcia S. Wagner, Esq.:
The
DOL may grant administrative exemptions allowing a person to engage in a
variety of transactions involving employee benefit plans. DOL administrative
exemptions can come in the form of ‘class exemptions’ that are available to all
persons that can satisfy the applicable conditions, or ‘individual exemptions’
that may only be utilized by the person who requested the exemption.
Class
exemptions are administrative exemptions that permit any person to engage in a
covered transaction with a plan so long as it is done in accordance with the
terms and conditions of the class exemption. Class exemptions typically cover routine
plan transactions that were not foreseen when the statutory exemptions in ERISA
were enacted. For example, DOL class exemptions permit:
•
Investments in mutual funds by a plan when a plan’s investment fiduciary is
also affiliated with the fund’s investment manager (subject to fee-leveling so
that plan fiduciary does not receive ‘double’ compensation and other conditions
of PTE 77-4); and
•
Providing brokerage services for a commission, where the broker-dealer or its
affiliate is also acting as the plan’s investment manager or adviser (subject
to enhanced disclosure requirements and other conditions of PTE 86-128).
“BASICS OF ERISA” at p.12.
Whether these exemptions
would continue under the re-proposed rule is the subject of some discussion.
Can current industry practices survive under a re-proposed rule? This author
thinks that many industry practices will not survive, given the substantial
academic research in support of the proposition that higher fees and costs
imposed upon plan participants and investors result, on average, in lower
returns. Clearly a focus of the EBSA’s disclosure regulations (already adopted)
and its “Definition of Fiduciary” re-proposal is to eliminate the often-hidden
fees and costs incurred by investors.
In essence, ERISA-governed
accounts, and IRA accounts, would be advised upon by “purchaser’s
representatives.” Selling of funds to plan sponsors would still be permitted by
non-fiduciaries (“seller’s representatives), provided they clearly disclosed
their status as such, that they were not providing unbiased advice, and
(hopefully) that they only limit their activities to a description of their
products.
(7) What Should Plan Sponsors Do Now?
The fact is that litigation
against plan sponsors for offering only high-cost, high-fee funds is growing,
even under the current ERISA standards.
It is extraordinarily risky
for a plan sponsor, for a plan of any size, to deal with a financial services
person (or firm) which does not accept full fiduciary obligations. To assist a
plan sponsor (as well as individual investors) in locating a “true fiduciary,”
I have provided guidance in a prior blog post. See http://scholarfp.blogspot.com/2013/05/how-to-choose-financialinvestment.html.