The Employee Benefits Security Administration of the U.S. Department of Labor (the “DOL”) issued proposed regulations (the “Proposal”) on October 22, 2010, that would significantly broaden the definition of “fiduciary” for purposes of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).1 In a masterful statement of the obvious, “[the DOL] expects that more service providers would be determined to be fiduciaries under the proposed rule than under the current [definition].”2 Anyone providing services in respect of benefit plans, including IRAs, or even just presenting investment opportunities, potentially will be affected.
Current Law
Under the current definition of “fiduciary” for purposes of ERISA, a person without authority or control over a plan or its assets will not be a fiduciary to the plan unless such person renders advice as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing or selling securities or other property, and either
1. such person directly or indirectly has discretionary authority or control with respect to purchasing or selling securities or other property for the plan, or
2. such person directly or indirectly renders such advice or makes such recommendations on a regular basis pursuant to a mutual agreement, arrangement or understanding with the plan or a plan fiduciary that such advice or recommendations (i) will serve as a primary basis for investment decisions with respect to plan assets, and (ii) will be individualized based on the particular needs of the plan.
The definition of fiduciary is critical under ERISA because ERISA generally only imposes duties on fiduciaries, such as an obligation to act prudently and in the exclusive interest of a plan’s participants, to avoid any self-dealing and other specified transactions with persons related to a plan, and in some circumstances even to prevent or remedy breaches of fiduciary duty by other fiduciaries. A fiduciary who fails to satisfy its responsibilities as such can be held personally liable for losses incurred by a plan and can be subject to excise taxes, penalties and other remedies, including rescission of the transaction and disgorgement of fees.
The Proposal
Under the Proposal, the DOL would reinterpret the portion of the definition of fiduciary regarding the provision of investment advice such that a person without authority or control over a plan or its assets would nevertheless be a fiduciary if, subject to the exceptions below, the person
1. provides investment advice or recommendations with respect to securities or property to a plan, a plan fiduciary, or a participant or beneficiary (“Investment Advice”), and
2. directly or through or together with any affiliate,
a) represents or acknowledges that it is acting as a fiduciary, or
b) has discretionary authority over the management of plan assets or exercises any discretion in the administration of the plan, or
c) is an “investment adviser” within the meaning of the Investment Advisers Act of 1940 (the “Advisers Act”), or
d) provides advice or makes recommendations pursuant to an agreement, arrangement or understanding, written or otherwise, that the advice (i) may be considered in connection with making an investment or management decision with respect to plan assets and (ii) will be individualized to the needs of a plan, a plan fiduciary, or a participant or beneficiary, and
3. receives, or any affiliate receives, a fee or other compensation for the Investment Advice rendered, including any fee or compensation incident to a transaction in which the Investment Advice has been or will be rendered. Such fees can include brokerage, mutual fund sales, and insurance sales commissions and commissions based on multiple transactions involving different parties.
The following activities alone (the “Exceptions”) will not result in a person being deemed a fiduciary by reason of providing Investment Advice:
1. Counterparties. Providing Investment Advice in circumstances where the recipient knows or reasonably should know that the provider is acting as purchaser or seller of a security or other property, or as agent of, or appraiser for, such a purchaser or seller, whose interests are adverse to the interests of the plan or its participants or beneficiaries, and that the provider is not undertaking to provide impartial investment advice.
There has been speculation as to whether “open” transactions, such as notional principal contracts (such as swaps) or lending transactions, would constitute “securities or other property” for purposes of this Exception. However, it is difficult to imagine that these transactions could not be covered by the Exception if it otherwise would apply. First, the concept of property has traditionally been broadly interpreted in the ERISA context. Second, concluding these transactions do not involve “other property” would imply that advice concerning them would not be Investment Advice that would potentially make one a fiduciary, as that requires investment advice or recommendations “with respect to securities or other property.”
2. General Investment Information. Providing investment education information and materials permitted under previously issued DOL regulations.
3. Investment Platforms for Individual Account Plans (such as 401(k) plans). Marketing or making available through a platform or similar mechanism (without regard to the individualized needs of the plan or its participants or beneficiaries), securities or other property from which a plan fiduciary may designate investment alternatives into which plan participants or beneficiaries may direct the investment of assets contributed to their individual accounts (a “menu”), if the provider has disclosed in writing to the plan fiduciary that it is not undertaking to provide impartial investment advice.
In connection with the marketing of investment platforms, a provider may also provide general financial information or data to assist a plan fiduciary’s selection or monitoring of the investment alternatives available under a plan’s menu, if the person providing such information has disclosed in writing to the plan fiduciary that it is not undertaking to provide impartial investment advice. It is not certain but one would hope that the exclusion of platforms “individualized to the needs of a plan” will not prevent use of this exception by providers who provide multiple investment platforms intended for different categories of potential clients.
4. Information Provided Solely for Reporting and Disclosure. Providing a general report or statement that merely reflects the value of an investment of a plan, a participant or beneficiary for purposes of complying with the reporting and disclosure requirements of ERISA and the Internal Revenue Code (“the Code”).
Presumably, such reporting for other purposes as well as ERISA and the Code would still be within this exception but that is not actually stated. This Exception is not available if the report (i) involves assets for which there is no generally recognized market and (ii) serves as a basis on which a plan may make distributions to plan participants and beneficiaries. Unfortunately, many such reports on the value of non-marketable assets will serve as a basis for distributions (for example, minimum required distributions after a participant’s attainment of age 70½), and therefore may not qualify for this Exception.
Refinements and Comments on the New Standards
Criterion One — Investment Advice. Under the Proposal, a person would be deemed to give Investment Advice if such person (i) provides advice, or an appraisal or fairness opinion, concerning the value of securities or other property; (ii) makes recommendations as to the advisability of investing in, purchasing, holding or selling particular securities or other property; or (iii) provides advice or makes recommendations as to the management of securities or other property.
If the DOL adopts the securities law view of a “recommendation” (i.e., that if a security is brought to the attention of an investor by a broker-dealer, such broker-dealer is deemed to have recommended its purchase), anyone presenting investment opportunities is arguably rendering Investment Advice. On that basis a broker-dealer affiliated with an investment adviser within the meaning of the Advisers Act would have no refuge from fiduciary status unless the exception for counterparties and their agents would apply. That would not be the result under current law, unless (among other conditions) the parties agreed that the recommendation was to be a “primary basis” for a plan’s investment decisions.
Rendering appraisals and fairness opinions would be included as Investment Advice for the first time. This would, among other matters, reverse the DOL’s long-standing position that valuations of closely held stock do not constitute investment advice. It would also mean that a single appraisal made at the request of a fiduciary, such as the investment manager of a hedge fund deemed to hold plan assets, could now be considered to be rendering Investment Advice, unless the Exception for valuations provided solely for reporting or disclosure compliance would apply.
The definition of Investment Advice would also include for the first time advice or recommendations regarding “management” of securities or other property. According to the DOL, “management” includes advice regarding voting proxies and selecting persons to manage plan investments. Thus, persons providing advice or recommendations in manager searches will now be providing Investment Advice and may become plan fiduciaries even without discretionary authority or control if the applicable criteria are all otherwise satisfied. Presumably such “management” would also include advice on corporate transactions affecting securities, such as tender offers.
Criterion Two — Circumstances.
Providing Investment Advice in any one of the listed circumstances to a plan, plan fiduciary, or plan participant or beneficiary for a fee will result in fiduciary status. So, for example, just being an investment adviser or being affiliated with one would satisfy the second criterion, apparently even if the affiliate investment adviser has no role or even contact with the recipient of the Investment Advice. Registration as an investment adviser under the Advisers Act will not be required.
One of the alternatives under this criterion is being, or being affiliated with, a person who has discretionary authority over the management of plan assets or exercises any discretion in the administration of the plan. The current definition has a similar alternative but it is much more limited. For example, it does not include exercising discretion in plan administration or discretionary authority regarding asset management not involving purchasing or selling. The apparent objective then of the DOL here is to sweep in persons who are, or are affiliated with, recordkeepers and other administrative service providers who cross the line into exercising discretion in plan administration or asset management.
The last of the alternatives under this criterion (“provides advice or makes recommendations pursuant to an agreement, arrangement or understanding. . .”) resembles current law, but with changes that will substantially increase the number of persons who may be deemed fiduciaries. The phrase “on a regular basis” is deleted, so that isolated, one-off instances of Investment Advice would be covered. Furthermore, the Investment Advice need not be a primary basis of investment decisions, but only something that “may be considered” in making an investment or management decision. Finally, the agreement, arrangement or understanding need not be a mutual one but, possibly, merely an understanding on the part of the recipient of the advice or recommendation not shared by the provider.
Conclusion
While the DOL is confident these rules will result in more service providers being deemed fiduciaries, the DOL is uncertain whether that will mean higher fees to plans, or a reduction in the services or investment opportunities available to plans. Affected parties should consider apprising the DOL of what the likely consequences of such a broad definition of fiduciary would be. Comments on the Proposal may be made until January 20, 2011. The Proposed Regulations would become effective 180 days after the issuance of final regulations.
Please direct any questions to any of the listed lawyers or to any other Bingham lawyer with whom you ordinarily work on related matters.
Russell E. Isaia, Partner, Tax and Employee Benefits
russell.isaia@bingham.com, 617.951.8427
Barbara Klippert, Partner, Tax and Employee Benefits
barbara.klippert@bingham.com, 212.705.7323
Amy Kroll, Partner, Broker-Dealer Group
amy.kroll@bingham.com, 202.373.6118
David Boch, Partner, Broker-Dealer Group
david.boch@bingham.com, 617.951.8485
Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area
roger.joseph@bingham.com, 617.951.8247
Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area
timothy.burke@bingham.com, 617.951.8620
1 The new definition of fiduciary will also apply for purposes of determining whether persons providing investment advice or recommendations to individual retirement accounts and other arrangements not necessarily subject to ERISA but subject to the prohibited transaction rules of Section 4975 of the Internal Revenue Code of 1986, as amended, will be fiduciaries for purposes of those rules.
2 75 Fed. Reg. 65263, 65275 (October 22, 2010).
This article was originally published by Bingham McCutchen LLP.