PROspective Vol II No V June 2011

ERISA regulations were first issued to protect participants in employee benefit plans from plan sponsors and plan providers from acting in ways that are detrimental to their interests... like stealing plan assets or using unscrupulous professional services.

These entities were governed by ERISA's fiduciary standard: that all actions taken were to be in the best interests of participants. Any action that best served a sponsor or a provider would violate the standard making them liable for legal damages.

The Department of Labor is issuing new regulations to expand the definition of fiduciary to include investment advisers. This has caused quite a stir among advisers, since no entity wants added legal liability.

Attorney and ERISA expert David Wolfe explains the new regulations and how they affect investment advisers, plan sponsors and participants.

Chuck Miller: The Department of Labor is attempting to broaden ERISA's definition of "fiduciary" to include investment advisers. What has been the definition and how will it be expanded?

Dave Wolfe: Under the existing rules, in effect since 1975, a person isn't considered to be a fiduciary investment adviser unless he or she is making recommendations regarding investments or investment valuation on a regular basis, and the adviser and the party receiving the advice have a mutual understanding that the advice is individualized, based on the particular needs of the plan, and will be the primary basis for the plan's investment decisions. All of these requirements have to be met before a person is considered to be a fiduciary investment adviser. The DOL calls this the five part test.

Under the proposed, expanded definition, the DOL has dropped the five-part test in favor of a three-part test and has added additional categories of persons who would be considered fiduciary investment advisers. Under the proposal, a person who is providing advice on plan investments, or investment valuation services, would be a fiduciary in any of the following situations:

(1) The adviser acknowledges his or her status as a fiduciary, regardless of whether or not the adviser is one, and regardless of whether the advice falls within the new three part test;

(2) The adviser is already a fiduciary on account of having discretion or control over the plan's assets or administration;

(3) The adviser is a Registered Investment Adviser under the Investment Advisers Act of 1940, regardless of whether the advice falls within the three-part test; or

(4) There is an agreement, arrangement or understanding that the advice may be considered in making investment or investment management decisions and the advice is individualized to the needs of the plan. This is the three-part test.

If any one of these is true, the adviser would be a fiduciary under the new rules. As to the last of these, it would no longer matter if the advice is provided on a regular basis or is the primary basis for the investment decisions being made by the plan fiduciaries. There are some significant exceptions, however, including situations where the provider discloses that it is not acting as a fiduciary and is representing a seller of investment products, or is otherwise not committing to provide impartial advice.

CM: Who may now be a fiduciary that was not one before?

DW: There are a number of groups that would be affected by the proposed regulation. They include:

• Those who provide appraisals or fairness opinions concerning the value of securities or other property;
• Those who state they are fiduciaries, regardless of what type of service they provide to a plan, the fiduciaries, or participants;
• Registered Investment Advisers, again regardless of the type of service they provide; and
• Those who provide investment advice on a periodic basis, or in situations where it is not clear whether the advice will be the primary basis for investment decisions.

Again, two of the most significant changes in the proposed definition are that it would no longer be required that the advice be provided on a regular basis, and the parties would only need to understand that advice given may be used in making investment decisions.

As to the latter, for example, advisers will sometimes assist plan sponsors only periodically, or even on a one-time basis, such as with choosing their initial fund lineup under a 401(k) plan. Under the current standard, such an adviser arguably isn't an ERISA fiduciary with respect to the advice given, and this is the case even if the adviser represents that it is a fiduciary, is a Registered Investment Adviser, or is already a plan fiduciary for other reasons.

Under the new rule, an adviser in this circumstance would be a fiduciary with respect to the advice. By the same token, a party that provides periodic appraisals or fairness opinions regarding the value of investment securities would likewise be a fiduciary under the proposed rules, unless the valuations are used strictly for Form 5500 reporting purposes and may not be used to make investment decisions.

CM: What would these new fiduciaries have to do to comply?

DW: The new fiduciaries would be held to the same standards of conduct as any other ERISA fiduciary – they would have to perform their duties solely in the best interests of plan participants and beneficiaries, and for the exclusive purpose of providing plan benefits and defraying reasonable expenses. They would be required to act with the same degree of care, skill, prudence, and diligence that a prudent person would exercise under the circumstances. They would have to comply with the ERISA prohibited transaction rules that apply to acts of fiduciary self-dealing, which means they would have to ensure that their compensation doesn't vary based on the advice they give, among other things.

Essentially, advisers would have to disregard their own self-interests and any other considerations when providing investment advice. I should mention that there are a lot of good investment advisers out there who already satisfy these standards.

CM: How would the expanded definition affect plan sponsors?

DW: It should help them understand who they are dealing with and whether to rely on their advice. The basic idea behind the Department of Labor's proposal is to prevent advisers from giving advice in situations where they have a conflict of interest – for example, where they receive compensation from investment providers or products they recommend, but avoid fiduciary status because the advice doesn't fall within the existing five part test. I think the DOL's expectation is that the proposed rule would help the responsible plan fiduciary – the plan sponsor – have a better understanding of the quality of the advice they are receiving. That is, when coupled with the new fee disclosure regulation, which requires a service provider to state in writing whether it is a fiduciary, the plan sponsor will be able to determine up front whether the person providing it with advice is doing so in accordance with ERISA fiduciary standards or not. And if the adviser or provider discloses that it is not providing impartial advice, the plan sponsor will be in a better position to assess whether to accept that advice or look elsewhere for it. I should also mention that I recommend to all my plan sponsor clients that they utilize an independent, third party fiduciary investment adviser if they are able to do so from a financial standpoint.

CM: Will participants notice?

DW: In the plan context, I suspect not much, though in the case of IRAs, it might have a bigger impact. The Department's proposed rule would apply both to advice given to a plan's investment fiduciaries, as well as advice to individual participants. In cases where an adviser is dealing strictly with a plan sponsor or its plan investment committee, participants might not notice any immediate differences, although the hope is that they would benefit in the long term because the advice the plan receives as a whole would be more fair and unbiased. In cases where a provider discloses that it is not undertaking to provide impartial investment advice, the plan sponsor may make available to the participants a fiduciary to provide individual investment advice, though again, it would not be obvious to the participants that this new service was an outgrowth of this regulation. The new rule would apply to IRAs as well as retirement plans, and for IRAs, providers are often making recommendations about their own proprietary investment vehicles, or about investments on which they receive significant commissions or 12b-1 payments. It isn't clear that the new definition would put a stop to this, though it might lead some service providers to disclaim a fiduciary role. This would give the IRA beneficiary the opportunity to decide whether or not to do business with that service provider.

Also, the proposed rule is clear that providing individuals with investment education only, such as general recommendations on asset allocation, risk vs. reward, etc. that do not rise to the level of individual investment advice would not be considered fiduciary investment advice, and providers who intend to provide this type of general investment education only would likely provide individuals with written disclosures of their intentions, to avoid any ambiguity.

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