Compliance Challenges for Broker-Dealers under ERISA

The DOL is scheduled to reissue the 408(b)(2) regulation early next year. While we expect it will provide reasonable lead time to allow the private sector to get ready for the change, based upon our experience in preparing for the initial regulation, which was set to become effective in January 2009, most of our clients experienced difficulty in preparing to comply. For example, the regulation requires all service providers to have a written agreement in place with ERISA plan clients that outlines the scope of services provided, the compensation received for those services, an explanation as to how that compensation is paid (e.g., directly from the plan, via revenue sharing arrangements with providers, etc.) and a statement as to whether the services give rise to fiduciary status under ERISA or the Advisers Act. We found that many BD/RIAs had problems identifying the accounts that would be subject to the regulation. In many cases, profit sharing plans, for example, were not coded as subject to ERISA and appeared to be individual brokerage or advisory accounts. This issue is problematic, as non-compliance with the written agreement, disclosure and delivery requirements will result in the arrangement being a prohibited transaction - and can lead to disgorgement, excise taxes, personal liability, etc.

With regard to disclosure, the regulation requires the service provider (brokers and advisers) to deliver a disclosure document along with the written agreement to the responsible plan fiduciary (the individual(s) having the authority to enter into agreements on behalf of the plan) sufficiently in advance such that he/she can determine whether the arrangement is reasonable - both with respect to compensation as well as conflicts of interest. We found that most firms had difficulty obtaining the information required to be disclosed (revenue sharing arrangements, proprietary products, affiliated parties in interest, etc.) - particularly broker-dealers, as there is no existing equivalent to the Form ADV Part II. Moreover, in addition to disclosing all potential and actual conflicts, the regulation requires the disclosures to specify the firm's procedures designed to address those conflicts. Identifying, implementing, communicating and testing such procedures is also time consuming and presented challenges for our clients.

In light of the foregoing and our belief that the regulations will be issued in roughly the same form as previously published, we recommend that the firm begin formulating an action plan that addresses the following issues:

1. Identifying all accounts that are subject to the regulations;

2. Determining the scope of services to be offered (i.e., fiduciary vs. non-fiduciary, investment advice vs. education);

3. Reconciling those services with existing errors and omissions coverage;

4. Conducting due diligence on and narrowing the list of "approved" service providers (recordkeepers, TPAs, etc.);

5. Examining compensation arrangements (for ERISA and IRA accounts), including solicitor and referral payments, and developing procedures to meet the level compensation requirements;

6. Implementing procedures to address "cross-selling" and capturing of IRA rollovers from qualified plans (an area in which the DOL has expressed concern and vowed to increase enforcement efforts); and

7. Considering solutions to outsource fiduciary services (plan and participant-level investment advice) and redefining value proposition in light of revised services (i.e., emphasis on retirement readiness, education, participation and contributions).