PPA Fiduciary Adviser Legal and Compliance Report

DOL Compliance for Broker-Dealers and RIAs: Investment Advice, 408(b)(2) and Fiduciary Status

2010-04-04T11:35:00.000-07:00

There are three primary initiatives being introduced by the DOL that will significantly impact the way broker-dealers, RIAs and their representatives conduct their ERISA and IRA business.

Investment Advice: Plan Participants and IRAs

First, the DOL introduced it’s proposed regulation affecting the provision of investment advice to participants of self-directed individual account plans and IRAs on March 2, 2010. The regulation essentially sets forth two exemptions from the prohibited transaction rules of ERISA and the Internal Revenue Code (the “Code”) that prohibit investment advice fiduciaries from recommending investments that could increase their compensation or the compensation of an affiliate (e.g., broker-dealer, investment managers, etc.). The comment period will end on May 5, 2010, and the DOL is expected to finalize the regulation by October.

Registered representatives or investment advisory representatives who are affiliated with product manufacturers or other entities that may receive un-level compensation based upon the investments selected by participants may now provide investment advice so long as they meet the conditions of the exemption (e.g., level-compensation at the RIA and producer level, eligible arrangement, disclosures and annual audit; or certified computer model, disclosures and annual audit). The regulation is also expected to highlight the prohibited nature of existing conflicted advice arrangements. The latter is a primary concern for broker-dealers, as un-level 12b-1 fees coupled with ongoing advice (whether rendered inadvertently or otherwise), for example, will give rise to a prohibited transaction under both ERISA and the Code. Other potential areas of exposure may include choice of share classes in IRAs, revenue sharing arrangements, inadequate policies and procedures to detect and prevent prohibited transactions, gaps in errors and omissions coverage for fiduciary services, etc. While the advice regulation is not expected to be effective until 2011, we recommend that, at a minimum, affected firms begin to conduct risk assessments of current policies and begin formulating a strategy to ensure future compliance.

Fee Disclosure and Reasonable Contracts under ERISA 408(b)(2)

On March 3, 2010, the DOL has sent its interim final regulation amending ERISA section 408(b)(2). Under this regulation, it will be a prohibited transaction to contract for services that do not meet the criteria of the regulation. This regulation is expected to significantly affect broker-dealers, as for the first time, registered representatives will be required to execute written agreements with their plan sponsor clients. The agreements are required to contain: a description of the specific services to be provided (i.e., investment advice, plan design, participant education, etc.); a statement as to whether the services give rise to fiduciary status under ERISA and/or the Investment Advisers Act of 1940; disclosure of all direct and indirect compensation; disclosure of all potential and actual conflicts of interest; and policies and procedures designed to address such conflicts.

Given that many registered representatives receive ongoing compensation from investment providers in the form of un-level 12b-1 fees, for example, broker-dealers are at risk for potential prohibited transactions unless they can prove that their representatives are not providing investment advice at the plan or participant level. Additionally, ERISA requires plan sponsors to manage plan investments prudently. If they do not have the requisite expertise, they are required to hire it. Many plans look to registered representatives to recommend investments, and to the extent the new agreements are silent or expressly prohibit the rendering of investment advice, plan sponsors will be forced to look elsewhere for advice providers. Lastly, many plan sponsors will be surprised to learn the nature and extent of the compensation paid to their adviser out of the participants’ investments. Plan sponsors that thought they were, or in fact were, receiving investment advice from their representative will likely look to the representative to explain their value proposition in light of the perceived or actual reduction in services. We are working with many broker-dealers to develop and deploy strategies that will seek to retain and attract these arrangements by utilizing the services of remote advice providers while simultaneously creating programs to add value through participant education with a focus on retirement readiness and the tracking of participant success measurements.

Based upon this experience, as well as that in preparing our clients for the initial 408(b)(2) regulation, which was set to become effective in January 2009, we have found that many firms require significant time to adopt and implement the necessary operational and organizational changes. For example, 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 firms begin formulating action plans to address 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).

Expansion of the Definition of Fiduciary

The DOL has also announced its plan to introduce a proposal to redefine the test for fiduciary status under ERISA by July. While the goal of this initiative is to capture the activities of pension consultants (that traditionally services large plans), which may have escaped the definition in the past, it is expected to also capture the activities of registered representatives (that traditionally service the small plan market). While we have yet to see a draft of the proposal, we are working with our broker-dealer clients to anticipant and adapt to the expected challenges of a broader definition of fiduciary status.

Compliance Challenges for Broker-Dealers under ERISA

2009-11-21T17:04:00.000-08:00

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).

New Andrews Bill - CIAPA - Could be a Gamechanger.

2009-05-15T14:36:00.000-07:00

The DOL is currently reviewing questions of law and policy implicated by the Final Rule Re Investment Advice to Participants of Self-directed Individual Account Plans that were raised during the most recent comment period. During the delay of the effective date, Congressmen Miller and Andrews have continued to work cooperatively on legislation addressing fee transparency and increased disclosure obligations of conflicts of interest for retirement plan service providers. After finding that “401(k) plan holders have access to a self-interested or conflicted advisor,” and that “conflicts of interest can have an adverse affect on defined benefit and defined contribution plans,” on April 21, 2009, Congressman Andrews introduced the Conflicted Investment Advice Prohibition Act of 2009 (“CIAPA”) in the U.S. House of Representatives.

CIAPA seeks to eliminate the fiduciary adviser exemption in its entirety and replace it with a new exemption for “independent investment advisers.” Specifically, CIAPA would strike ERISA section 408(g) (the underpinning of the Final Rule) and amend section (b)(14)(B) to create a prohibited transaction exemption where “the investment advice is provided by an independent adviser (as defined in section 3(43)).” Given that section 408(g) provides the framework for the Final Rule, to the extent CIAPA is enacted in its current form, the fiduciary adviser – EIAA exemption would cease to exist.

While many of the requirements set forth in section 408(g) (e.g., computer model certification, annual audit, disclosures, etc.) would be retained under CIAPA (at proposed ERISA section 3(43)), the level fee provisions would be substantially modified. The Final Rule required only the fiduciary adviser and the individual providing the investment advice to receive level compensation; CIAPA would require that all compensation received by any affiliate of the investment adviser to also be level. Paragraph (d), entitled “Regulatory Authority,” may provide a reprieve for PPA fiduciary advisers, as it authorizes the Secretary of Labor to issue regulations providing that:

“an investment adviser can still be considered as meeting the requirements of section (3)(43)(B) of [ERISA] despite the receipt of a de minimus amount of compensation that fails to meet the requirements of section (3)(43)(B)(iii) of [ERISA] due to the existence of previously existing contracts.”

It is, therefore, conceivable that the DOL may determine that existing EIAAs are not ineligible to the extent compensation received by an affiliate is determined to be de minimus. Stay tuned…

Investment Advice for Participants: Prohibited Transactions and Level Fee Advice

2009-03-30T13:48:00.000-07:00

The preamble to the DOL final regulation for investment advice for participants (the so-called “Fiduciary Adviser Rule”) contains a number of interesting—and, in some cases, unexpected— statements. Those statements are valuable in understanding the DOL’s thinking about critical issues for advisers to 401(k) plans.

Background
The Pension Protection Act of 2006 (PPA) created a statutory exemption from the prohibited transaction rules for fiduciary investment advice to participants. The scope and effect of that regulation on advisers—and particularly on registered investment advisers (RIAs)—is not fully understood in the 401(k) community.

The PPA added two sections to ERISA to expand the availability of investment advice for participants. Those are sections 408(b)(14) and 408(g). Among other things, those sections create an exemption from the general prohibited transaction rule that says a fiduciary cannot use its authority or control to affect its own compensation. For example, they create an exemption for mutual fund complexes and broker-dealers to offer advice where the advice could result in a participant’s money being invested in affiliated mutual funds (thereby resulting in increased investment management fees) or in mutual funds that pay higher compensation to the broker-dealer.

The statute and the regulation create two types of exemptions: the first is called the computer model exemption and the second is inappropriately called the level fee exemption. (We say “inappropriately” because it applies only to situations where the fiduciary adviser’s fees are level, but not to situations where the compensation of affiliates—or under the class exemption in the regulation, of supervisors—is level. In other words, it is an exemption for a “limited” level fee. This “limited” level fee structure was first explained by the DOL in Field Assistance Bulletin (FAB) 2007-1 and is retained in the Fiduciary Adviser Rule.)

So, how do these new rules apply to registered investment advisers?

Unfortunately, there is confusion about that question in the 401(k) market place. However, from a legal perspective the answer is fairly clear—at least for “pure” level fee advisers. Since 408(b)(14) and 408(g) are exceptions to the prohibited transaction rules, it should be clear that, if investment advice to a participant would otherwise be a prohibited transaction, then an adviser needs to meet the conditions of the exemption. However, it should also be equally clear that, if the advice would not and could not result in a prohibited transaction, the exemption is not needed. In other words, you don’t need to rely on an exception to a rule if you don’t violate the rule.

What does that mean in practical terms?

Many RIAs, particularly those that are truly independent (with no broker-dealer or investment company affiliation), operate in a “pure” level fee environment (as opposed to a “limited” level fee environment). In other words, regardless of the advice given, the only compensation received by the adviser (or by any affiliate or other person in whom the adviser has an interest) is the fee that is being charged for the advice. (Under ERISA, the definition of compensation is broad . . . it includes money or any other thing of value.) Where that fee is level, like a percent of assets or a set dollar amount, there is not and cannot be a prohibited transaction. Therefore, a pure level fee RIA firm does not need the benefit of the new exemptions and, consequently, does not need to comply with the requirements in the regulation—for example, the annual audit of the investment advice and certification of the computer model by an independent expert, and so on. Obviously, that should substantially reduce the cost and complexity of the pure level fee investment advice program.

Preamble Statement

With that background, what does the DOL say in the preamble to the final regulation?
First, because of some concern in the 401(k) community that people might construe the regulation as applying even to “pure” level fee advice, the Department explains that:
“In response to the concerns of some commenters that the conditions of the final rule might be construed as being applicable to all investment advice arrangements, without regard to whether the provision of advice pursuant to such arrangements involves prohibited transactions, paragraph (a)(1) makes clear that the requirements and conditions of the final rule apply solely for the relief described in the final rule and, accordingly, that no inferences should be drawn with respect to the requirements applicable to the provision of investment advice not addressed by the rule.”

So, the DOL is telling us that, where the provision of advice does not constitute a prohibited transaction, the regulation should not be interpreted as applying to those advice providers.
Later in the preamble, the DOL gives additional guidance:

“The Department further explained that, consistent with earlier guidance in this area, if the fees and compensation received by an affiliate of a fiduciary that provides investment advice do not vary or are offset against those received by the fiduciary for the provision of investment advice, no prohibited transaction would result solely by reason of providing investment advice and thus there would be no need for a prohibited transaction exemption, such as provided under sections 408(b)(14) and 408(g).*
*See AO 97–15A and AO 2005–10A.”

In that explanation, the DOL is pointing out that, where the fiduciary adviser is a pure level fee adviser, no prohibited transaction would result from the investment advice and, therefore, there would be no need for a prohibited transaction exemption, including the 408(b)(14) and 408(g) exemption. In other words, pure level fee investment advice can be given to participants without the burden of satisfying the requirements in the regulation.

Where an affiliate of the adviser (or other person in whom the adviser has an interest) receives additional compensation because of fiduciary advice to a participant, the advice is not “purely” level and, as a result, the PPA prohibited transaction exemption is needed.

Conclusion

The DOL has done a service to the benefits community by explaining these differences. While the structure of the statute, and the application of the exemptions, should have been clear to ERISA attorneys, that type of technical analysis shouldn’t have been required for non-lawyers, like plan sponsors and advisers. As a reminder, “pure” level fee advice is that in which the adviser (including its affiliates or any other persons in whom the adviser may have an interest) cannot receive anything more than its stated fee or where, if the adviser – or an affiliate or person of interest – can receive income as a result of the advice, it is offset against a stated fee, such that the adviser can receive no more than the stated fee. In the preamble, the DOL has clarified that the fiduciary adviser exemption is needed only for advice that would otherwise be a prohibited transaction.

Keep in mind that even though the regulation limits the prohibited transaction exemption to the provision of non-discretionary advice to participants (and thus does not extend to discretionary investment management of participant accounts), the pure level fee arrangement also applies to investment management. So, if a fiduciary adviser offers discretionary investment management for participants, the pure level fee arrangement would also be permitted (that is, it would not be a prohibited transaction).

One final note: based on our experience, it appears that the DOL has markedly increased its examination and enforcement activity directed at broker-dealers and registered investment advisors. Moreover, some clients have recently reported being the subject of DOL/SEC joint or concurrent examinations. We believe that supervision will be a key area of concern in these examinations; therefore, we are working with clients to identify potential areas of exposure and recommending actions to mitigate or eliminate activities that may give rise to regulatory enforcement, especially in the area of investment advice to participants.

DOL Final Rules Re: Investment Advice

2009-03-25T19:38:00.000-07:00

On January 21, 2009, the Department of Labor (DOL) issued a regulation under ERISA Section 408(g). The regulation is designed to provide guidance on the statutory exemption (the “statutory exemption”) enacted in the Pension Protection Act of 2006 (PPA) for investment advice to participants in participant-directed individual account plans and in individual retirement accounts (IRAs). The regulation also contains a class exemption (the “class exemption”) providing additional relief.

This posting examines the effect of the regulation on broker-dealers and registered investment advisers that provide investment advice to 401(k) plan participants and IRA beneficiaries (referred to collectively as “participants”). We first discuss the regulation and then suggest steps that firms should begin taking now to come into compliance with the new rules, whether or not they are effective in their current form.

Current Status
The regulation was scheduled to go into effect on March 23, 2009, but on February 3, 2009, the DOL released a notice proposing to extend the effective date by 60 days (to May 22, 2009). Additionally, the DOL notice requested comments, which are due by March 6, 2009, to help in its review of the rules as requested by the Obama administration. When and in what form the regulation will be finalized is unclear in light of strong Congressional opposition that is primarily aimed at the class exemption. Critics argue that the proposed safeguards for the class exemption do not go far enough in ensuring that the advice will be unbiased and free of conflicts of interest. Indeed, a statement issued by Congressman George Miller (D-California), Chairman of the House Education and Labor Committee, and Congressman Rob Andrews (D-New Jersey), immediately preceding publication of the final rule, stated that they would “use every tool at [their] disposal to block the implementation [of the regulation].”

Notwithstanding the delay and the opposition, we believe that the DOL and/or Congress will seek to implement the less controversial provisions of the regulation. To the extent all or part of the regulation becomes effective in May 2009, firms should begin preparing to respond to the associated operational, logistical and compliance-related challenges.

Background
Anyone who gives individualized investment advice to plan participants for a fee is a fiduciary under ERISA and the Internal Revenue Code (but is a fiduciary only under the Code if he provides advice in certain non-ERISA situations, e.g., to an IRA beneficiary or to a one-person plan). It is a prohibited transaction under Section 406(b) of ERISA and section 4975 of the Code for a fiduciary to use his position to increase his compensation. Absent an exemption, if an adviser (or its affiliates or other persons in which the adviser has an interest) receive additional fees from the recommendation of investments, the adviser would be engaging in a prohibited transaction. Prior to the enactment of the PPA, the adviser could avoid engaging in a prohibited transaction if its fees (and any compensation received by affiliates or other parties in which the adviser has an interest) did not vary based on the advice given (for example, through a purely level fee—for itself, affiliates and interest persons—or by offsetting such revenues against a stated fee). Those “pure” level fee arrangements continue to be acceptable after the PPA and, in fact, the providers of that advice do not need to comply with the conditions discussed here.

Because of the prohibited transaction rules and the concern of many plan sponsors that they would be responsible for the advice given to their participants, investment advice to participants was not as widespread as it could have been. In 2006, the PPA added a new prohibited transaction exemption to ERISA and the Code in an effort to increase the availability of participant-level investment advice.

The Statutory Exemption
The PPA amended ERISA and the Code to provide exemptive relief for certain transactions in connection with the provision of investment advice to participants. To qualify for relief, each fiduciary adviser (identified as, among others, an RIA or broker-dealer, and their representatives) must either:

ensure that any fees received (by the individual adviser and the adviser’s firm) in connection with the provision of investment advice will not vary based on any investment options recommended by the adviser and selected by the participant; or

utilize an objective computer model that is independently certified not to inappropriately favor investment options offered by the fiduciary adviser or those that generate greater income for the fiduciary adviser or its affiliates.

We refer to the first of these as the “limited level fee” exemption because the requirement of level compensation applies only to the individual adviser and the firm of which he is a representative. The level fee requirement in the regulation does not extend to affiliates of the adviser. If the compensation of the adviser, his firm and all affiliates did not vary, this would be a “pure level fee” arrangement, which would not constitute a prohibited transaction and would not require an exemption.

Under the second exemption, the computer-model exemption, the compensation need not be level for the adviser, his firm and their affiliates. In other words, the compensation may vary based on the investment options recommended to and selected by the participant.
In either case, the fiduciary adviser must acknowledge that it is acting as a fiduciary and provide details of its fees and compensation, affiliations (and their related compensation) and services to be rendered. Each fiduciary adviser must submit to an annual audit that evaluates the adviser’s compliance with the conditions for the exemption, as well as the adequacy of its policies and procedures.

The final regulation and the preamble provide guidance on the requirements for the annual audit and certification of the computer model. It also has an acknowledgment by the DOL that, if a fiduciary adviser provides advice under a “pure” level fee arrangement (for itself and all affiliates), no prohibited transaction exists and, therefore, compliance with the conditions for the exemption is not required.

Class Exemption
The regulation also includes a class exemption that the DOL considered “necessary to provide comprehensive relief for fiduciary investment advice and to address certain aspects of the statutory exemption that were unclear or that did not extend relief to certain arrangements.”

Under the class exemption, there are two separate methods of avoiding prohibited transactions while giving participant advice. The first is an expansion of the computer model exemption, and the second is a relaxation of the level fee exemption. The computer model class exemption covers cases where computer model advice has been given or where the plan or IRA offers so many options that computer model advice is not feasible. We refer to that as the “class model” exemption. The expanded level fee advice class exemption is referred to as the “class level fee” exemption.

Under the class model exemption, participants must first be provided with investment advice generated by a computer model that either (1) meets the requirements of the statutory exemption (including the certification requirement) or (2) meets the requirements with respect to content and absence of bias (but that does not need to meet the certification requirement so long as it is designed and maintained by a person independent of the fiduciary adviser). If class model advice is given, there is no requirement that the compensation of the adviser, his firm or affiliates be level (which is the same as the statutory exemption).

In the case of a plan that offers self-directed brokerage accounts, brokerage windows and the like and in the case of IRAs, where the types or number of investments effectively precludes the use of computer model advice (for example, a brokerage account or mutual fund window), the participant must be given investment education materials related to investment concepts generally.1 However, a plan or IRA that offers designated investment options in addition to the self-directed brokerage account or window, must also provide the participant with class model advice related to the designated options.

The class level fee exemption permits individualized advice under a level fee approach. The class exemption creates a third category, or definition, of level fee advice. (The first two are: (1) the pure level fee arrangement, where the fees of the individual adviser, his firm, and any affiliates do not vary, and (2) the limited level fee arrangement, where the fees of the individual adviser and the fiduciary advisor—that is, the entity—do not vary, but the fees of affiliates may vary based on the options selected.) The class fee leveling requirement applies solely to the compensation received by the individual providing the advice on behalf of the supervisory entity (e.g., the broker-dealer or the RIA) and not to the compensation of that entity, or other employees of that entity (e.g., the individual’s manager), or affiliates of that entity.
In an attempt to mitigate potential conflicts of interest, the class exemption requires the fiduciary adviser to make a determination that the advice is prudent and in the best interest of the participant and to explain the basis for that determination. The fiduciary adviser must explain why and how the advice deviates from the computer model recommendations (or investment education materials) and, to the extent applicable, why the advice includes an option with higher fees than other options in the same asset class available under the plan. The exemption further requires the fiduciary adviser to document the explanation within 30 days of the delivery of such advice. This documentation must be maintained by the adviser’s firm for a period of not less than six years after the provision of the investment advice.

Finally, the class exemption requires the fiduciary adviser to adopt and follow written procedures designed to assure compliance with the conditions of the exemption. As with the statutory exemption, fiduciary advisers providing advice to participants under the class exemption must have an annual audit of:

their compliance with the conditions for the exemption; and

their compliance with the required internal policies and procedures.

The model and class level fee exemption contained in the class exemption are not included in the statutory exemption and thus will go into effect only if the class exemption becomes final.

General Requirements
The requirements for both the class exemption and the statutory exemption also contain provisions relating to noncompliance. It may seem obvious that the exemptions will not protect against any prohibited transaction where the conditions have not been satisfied. However, there is an additional requirement: in a case of a pattern or practice of noncompliance with any of the conditions of the regulation, the exemption(s) would not apply to any advice by the fiduciary adviser during the period over which the pattern or practice extended. If a prohibited transaction occurs, the disqualified person (and/or firm) may be personally liable for disgorgement of revenues received and be subject to significant excise taxes.

While the DOL believes that these safeguards will help to ensure compliance with the class exemption and eliminate the potential for conflicts of interest, the issue was hotly debated during the comment period and remains a source of controversy.

The regulation contains a model disclosure form, which appears in an Appendix, that may be used for purposes of satisfying the fiduciary adviser’s disclosure obligations under both the statutory and class exemptions. This optional model disclosure form appears to be exhaustive, and the regulation states that the use of an appropriately completed model disclosure will be deemed to satisfy the requirement that such information be written in a clear and conspicuous manner calculated to be understood by the average participant.

Discussion
While the status of the final rule is pending, broker-dealers and RIAs that wish to provide advice to participants should begin the process of evaluating the risks and benefits of adopting a fiduciary adviser program. Regardless of whether these rules are ultimately adopted, in whole or in part, there are a number of compliance and operational challenges that must be addressed. The following are some examples:

Regardless of whether the advice is delivered through a level fee or computer model arrangement, fiduciary advisers are required to acknowledge their fiduciary status to the participant. Broker-dealers that have been reluctant to do so in the past must decide whether to accept fiduciary responsibility, move their plans and IRAs to an advisory platform or refrain from providing advice so as to avoid engaging in a prohibited transaction. In practice, avoiding giving advice may be difficult.

Affected firms should begin by undertaking a review of their errors and omissions policies to ensure that the proffered method of advice delivery is covered and to determine whether there are any exclusions to providing advice as fiduciaries.

We recommend implementing fiduciary-based training, which is specific to providing advice as fiduciary advisers. This should be aimed at both the producer and those conducting supervisory reviews of the advice arrangements.

These firms should also begin to develop written agreements and create procedures to address the requirements of the exemption(s). In our experience, this will be more of a challenge for broker-dealers than RIA firms.

RIAs should update their Form ADVs (or disclosure brochures) to explain how advice will be delivered to participants and to include the required disclosures.

Because there is no equivalent document to the Form ADV Part II for broker-dealers, most firms will need to create the fiduciary adviser disclosure document from scratch. In our experience, we have found that creating these documents takes considerable time and effort to account for the receipt of indirect payments and revenue sharing arrangements and to develop policies and procedures to avoid the potential for conflicts of interest.

With respect to the provision of advice under the statutory exemption, the final rules contain numerous requirements relating to information required to be elicited from participants and evaluated prior to rendering advice. It is important to note that these requirements differ from those set forth in the PPA as well as those contained in the proposed rules released in August 2008. Consequently, even those firms that have previously developed fiduciary adviser programs must now reconcile their agreements and disclosures to ensure that they are meeting the requirements of the final rules.

Conclusion
We may or may not see the implementation of a final regulation exempting the provision of investment advice to participants in the immediate future. Even if a regulation is issued, it may take a form different from the final rules released in January. Nevertheless, in our view, the information contained in the final rules is valuable for risk management purposes to avoid legal problems that may arise from engaging in prohibited transactions. It is important to evaluate the extent to which your firm may be engaging in such activities and to take appropriate steps to mitigate these risks immediately. At a minimum, many of the requirements of the final rules establish a standard for best practices and should serve as a guide for complying with future regulatory action.

1 To the extent it is determined that the number of investment choices would reasonably preclude the use of a computer model to generate investment recommendations, paragraph (d)(3)(ii)(B) of the final rule requires that participants and beneficiaries be furnished with material, such as graphs, pie charts, case studies, worksheets, or interactive software or similar programs that reflect or produce asset allocation models taking into account the age (or time horizon) and risk profile of the beneficiary, to the extent known.

DOL’s Release of Proposed Regulations Re Investment Advice

2008-09-24T13:10:00.000-07:00

On August 22, 2008, the Department of Labor (DoL) issued two proposals to regulate advisers servicing IRA, 401(k) and other plan participant clients (Fiduciary Clients). The proposals were issued in response to directives contained within the Pension Protection Act of 2006 (PPA) and are expected to be finalized by the end of the year. While the proposals are scheduled to become effective during the first quarter of 2009, the comment period ends on October 4, 2008.

As proposed, the regulations require all advisers with Fiduciary Clients to acknowledge their fiduciary status and comply with the following:

1. Each affected adviser must have a written agreement with the Fiduciary Client, described as an eligible investment advice arrangement (EIAA). The EIAA must make contain specific representations, including a fiduciary statement, details of fees and compensation, affiliations and services rendered.
2. Fiduciary Clients must receive disclosures each year that update information provided in the EIAA.
3. Advisers providing “off model” advice to a Fiduciary Client must document the basis of any such recommendations and include the reasons for any deviation from advice generated by the computer model or asset allocation portfolio.
4. Fiduciary adviser firms must adopt and follow written policies and procedures designed to assure compliance with the conditions of the exemption.
5. Each adviser must undergo an annual “408g Audit” that evaluates the adviser’s compliance with the EIAA as well as its own policies and procedures.

These new regulations will require significant changes in a number of areas. We are in the process of assisting our clients with developing and implementing solutions (e.g., updating existing agreements, drafting disclosure documents, amending compliance and supervisory procedures, obtaining suitable fiduciary insurance, etc.). E&W is also working with DALBAR, Inc. to further assist our clients in conducting 408g Audits and educating advisers on the new requirements.

Once the regulations are finalized, we will issue a comprehensive report and sponsor a webcast to discuss the impact of the regulations on broker-dealers, RIAs and their representatives. In the meantime, please feel free to contact Jason Roberts with any questions or for assistance in preparing a comment for submission to the DoL.

DOL Press Release re Investment Advice

2008-08-21T16:47:00.000-07:00

U.S. Labor Department proposes rules on investment advice exemption for 401(k) plans and IRAs WASHINGTON

WASHINGTON — The U.S. Department of Labor today announced publication of two proposed rules under the Pension Protection Act (PPA) to make investment advice more accessible for millions of Americans in 401(k) type plans and individual retirement accounts (IRAs). The proposed regulation and class exemption are to be published in the Aug.22, 2008 Federal Register.

"These proposals would give workers greater access to investment advice so that they are better equipped to manage and monitor their 401(k) plans and Individual Retirement Accounts," said U.S. Secretary of Labor Elaine L. Chao.

The PPA amended the Employee Retirement Income Security Act (ERISA) by adding a new prohibited transaction exemption that allows greater flexibility for participants of 401(k) plans and IRAs to obtain investment advice. One of the ways in which investment advice may be given under the exemption is through the use of a computer model certified as unbiased, the other is through an adviser compensated on a "level-fee" basis. Several other requirements also must be satisfied, including disclosure of fees the adviser is to receive.

In December 2006, the department solicited public comments to determine what expertise and procedures may be needed to certify a computer model under the exemption, and to assist in developing a model form for the exemption's disclosure of adviser fees.

The proposed regulation provides general guidance on the exemption's requirements, including computer model certification, and includes a non-mandatory model form that advisers may use to satisfy the exemption's fee disclosure requirement. In addition, to further the availability of quality, professional investment advice, the department is proposing a class exemption that permits advisors to provide individualized advice to a worker after giving advice generated by use of a computer model.

Separately, the department also released its determination relating to the feasibility of using computer models for providing investment advice to participants of IRAs.

Written comments on the investment advice proposals should be addressed to the Office of Regulations and Interpretation, Employee Benefits Security Administration, Room N-5665, U. S. Department of Labor, 200 Constitution Ave., NW, Washington, D.C. 20210, Attn: Investment Advice Regulations. The public also may submit comments electronically by email to e-ori@dol.gov, or through the federal e-rulemaking portal at www.regulations.gov.

Questions from Plan Sponsors Re 408(b)(2)

2008-06-01T21:06:00.000-07:00

What are the New Disclosure/Reporting Requirements for ERISA Plan Service Providers and Where Can I go for Help in Evaluating the Disclosures?

The Department of Labor (DoL) is expected to release its final regulations on proposed amendments to ERISA §408(b)(2) later this summer. The new regulations, which are expected to become effective January 1, 2009, will shift the burden of providing documentation demonstrating compliance with ERISA’s prohibited transaction rules from plan sponsors to service providers. Affected service providers that fail to comply with the exhaustive disclosures relating to direct/indirect compensation and potential/actual conflicts of interest could face significant risk of legal liability as well as financial penalties.

The DoL has provided a mechanism that exempts plan sponsors from liability associated with the prohibited transaction that is conditioned upon documentation of the basis for the engagement. Selecting a service provider requires the responsible plan fiduciary to evaluate and differentiate services offered by competing companies. The new rules will require affected service providers to have written agreements with plan sponsors that disclose all of their compensation and any conflicts of interest prior to entering into an engagement with the plan. This requirement is designed to give the plan sponsor time to evaluate the reasonableness of the arrangement. Consequently, plan fiduciaries should carefully document the process undertaken to make such a determination. The DoL has published a “Fact Sheet” containing tips for selecting and monitoring service providers available at http://www.dol.gov/ebsa/newsroom/fs052505.html.

An affected service provider must disclose all services provided to the plan and whether it is acting as a fiduciary with respect to the delivery of those services. It must also disclose any and all fees received in connection therewith. The DoL has issued guidance to assist plan fiduciaries with documenting fees charged by service providers. The 401(k) Plan Disclosure Form is available at http://www.dol.gov/ebsa/pdf/401kfefm.pdf.

While cost is once of the criteria for evaluating a service provider, other factors of equal or greater importance should be considered. Conflicts of interest, for example, should be reviewed and documented. The proposed rules will require affected service providers to disclose any and all relationships or interests that raise conflicts, describe such arrangements and describe any policies and procedures that address actual or potential conflicts. Again, the DoL has issued guidance for plan sponsors in this regard. “Selecting and Monitoring Pension Consultants – Tips for Plan Fiduciaries” is available at http://www.dol.gov/ebsa/newsroom/fs053105.html.

As discussed, plan sponsors are relieved from liability if a service provider fails to meet its disclosure obligations to the extent they can demonstrate that they were unaware of the provider’s failure and reasonably believed the disclosure requirements had been met. The plan sponsor must also take corrective action by requesting the missing information and notifying the DoL of any provider’s failure to deliver the requested disclosures within a specified time.

Indeed, the proposed rules contain numbers specific requirements for documentation and notice. Plan sponsors should begin familiarizing themselves with the new requirements so they can develop policies and procedures for documenting and assessing contracts with existing and prospective service providers.

Risk Alert: New Disclosure/Reporting Requirements for ERISA Plan Service Providers

2008-05-28T14:08:00.000-07:00

The Department of Labor (DoL) is expected to release its final regulations on proposed amendments to ERISA §408(b)(2) later this summer. The new regulations, which are expected to become effective January 1, 2009, will shift the burden of providing documentation demonstrating compliance with ERISA’s prohibited transaction rules from plan sponsors to service providers, including broker-dealers and registered investment advisors (RIAs). Firms that fail to comply with the exhaustive disclosures relating to direct/indirect compensation and potential/actual conflicts of interest could face significant risk of legal liability as well as financial penalties.

The new rules will require advisers and brokers to have written agreements with their plan sponsor clients that disclose all of their compensation and any conflicts of interest prior to entering into an engagement with the plan. This requirement is designed to give the plan sponsor time to evaluate the reasonableness of the arrangement. Consequently, broker-dealers and RIAs will want to examine their internal policies and procedures with respect to delivery of the relevant information. Additionally, the proposed rules require that the disclosures be made to the “responsible plan fiduciary.” Given that some plan sponsors delegate the administrator functions to committees or third-parties, careful attention must be paid to ensure the disclosures are delivered to the proper party.

The rules will also require the service provider to state whether or not it is acting as a fiduciary under ERISA or the Investment Advisers Act of 1940. Given the reluctance on the part of many broker-dealer firms to accept fiduciary responsibility in any capacity, this requirement may pose a significant challenge to such firms. At a minimum, broker-dealers should reexamine their service models and compliance procedures to determine whether or not fiduciary services are being rendered. RIA firms, which are more accustomed to acknowledging fiduciary status under the Advisers Act of 1940, will nevertheless need to identify those services that give rise to ERISA fiduciary status and specifically acknowledge the same in their service agreements.

As discussed, to the extent the aforementioned requirements are not met, the service provider will have engaged in a prohibited transaction and may be subject to excise taxes and disgorgement of compensation for any services rendered under the prohibited agreement. Firms will need to act quickly to address these issues and develop compliant service models and agreements. In addition, affected service providers should examine their insurance coverage for fiduciary and non-fiduciary activities to determine whether the proffered services are covered sufficiently.

Recent Questions from Plan Sponsor Clients Re LaRue

2008-04-04T11:24:00.000-07:00

I’ve read about this new 401(k) Supreme Court case—how far back can employees sue us if they claim we mishandled their accounts?.

Generally speaking, the statute of limitations for an ERISA claim grounded in breach of fiduciary duty is six years from the date of the last action that is alleged to be a breach or six years from the latest date the fiduciary could have cured a breach based upon an ommission. For plaintiffs who are found to have been on notice or have had actual knowledge of a breach, however, the statute of limitations runs three years from the date he/she discovered facts sufficient to put them on notice of the alleged breach. Claims grounded in fraud are also subject to the discovery rule, and the statute runs six years from the date of discovery. Depending upon the circumstances, claims can also be brought pursuant to applicable state laws where the limitations periods would vary from state to state and from claim to claim.

Anything we can do to protect ourselves going forward?

Assuming the same facts as LaRue, where the plaintiff was a participant in an employer-sponsored 401(k) plan, there are a number of steps one can take to mitigate and/or transfer the risk of being sued for investment losses in a participant’s account. Most claims arise from either investment-related activities or the lack of prudent administrative processes and procedures. While many of the investment-related functions can be effectively delegated to third parties, the plan sponsor remains liable for the prudent selection and monitoring of service providers. It is, therefore, imperative that such decisions are documented and the factors considered are detailed in written minutes.

For example, in many of the recently-filed cases alleging excessive fees, the plaintiffs allege that the respective plan fiduciaries failed to adequately investigate fee arrangements and alternatives. Given that ERISA does not require that the plan negotiate the lowest cost arrangement, documents evidencing negotiations between the plan and its service providers would generally suffice to demonstrate that the arrangement at issue was prudently selected. The plan sponsor should also continuously monitor these arrangements to identify “hidden fees” and determine whether they are reasonable in light of the services provided. Again, the process for selecting and monitoring service providers and their respective fees should be documented and reported periodically.

The Department of Labor (DoL) has produced two guides for fiduciaries to better understand their obligations with respect to fees charged by service providers. The guides are available through the DoL’s website at:

www.dol.gov/ebsa/pdf/401kfefm.pdf

www.dol.gov/ebse/publications/fiduciaryresponsibility.html

As discussed, plan sponsors can delegate investment-related decisions to professionals, and the plan remains liable only for the prudent selection and monitoring of those individuals. An investment advisor can be engaged to select the investments that are offered to participants and to monitor the performance of those investments, and ERISA provides for the appointment of an investment manager to actively manage plan assets with discretion.

The Pension Protection Act also provides two safe harbors by which plan sponsors can insulate themselves from investment-related claims brought by plan participants: the Qualified Default Investment Alternative (“QDIA”); and fiduciary advisers. The QDIA safe harbor serves to protect plan sponsors from liability associated with the allocation of a participant’s account to a more diversified investment option when the participant fails to provide any investment directions. We recommend engaging an investment adviser to help with the selection of a suitable QDIA. The fiduciary adviser safe harbor insulates plan sponsors from liability for investment losses in a participant’s account where a fiduciary adviser is retained to provide specific investment recommendations pursuant to an eligible investment advice arrangement between the plan sponsor and the investment adviser. A comprehensive collection resources to assist plan sponsors with these safe harbors can be found at www.ppa-law.com.

Anything we can do to protect ourselves relating to any claims that might already be out there?

To the extent you suspect that a breach may have occurred, we recommend undertaking a comprehensive risk assessment that examines the plan as a whole. A risk assessment program looks for procedural prudence as it relates to investments and administrative functions and operates to detect fiduciary breaches before they result in claims. Because fiduciary exposure often begins with participant complaints either in the form of phone calls or letters from participants claiming benefits, we also recommend retaining experienced counsel to assist with drafting responses to such inquiries and to document the issues that relate to a denial of benefits. Courts do not review fiduciary decisions with 20/20 hindsight, so the proper response and documentation will go a long way in establishing that the plan sponsor’s actions were prudent and appropriate at the time they occurred.

Critical Supreme Court Ruling for Investment Professionals

2008-02-26T12:43:00.000-08:00

On February 20, 2008, the Supreme Court issued a procedural ruling in favor of James LaRue, a defined contribution plan participant, which will allow him to seek recovery of individual investment losses caused by an alleged breach of fiduciary duty. The ruling is significant because, prior thereto, courts interpreted ERISA to provide a remedy only for systemic breaches and resulting losses to a plan as a whole. Participants and their lawyers will now be able to recoup individual losses caused by any negligent act or omission on the part of a plan fiduciary.

Wednesday's ruling is critical for investment professionals, as it opens the door to potential lawsuits for an additional 50 million American employees who have approximately 2.7 trillion dollars invested in 401(k) plans. Numerous studies have shown that the majority of investment firms and their registered and/or advisory representatives do not fully appreciate the extent of their fiduciary duties owed to ERISA plan clients. As a result, many firms have inadequate controls to avoid, detect or remedy fiduciary breaches and prohibited transactions. Moreover, the compliance challenges faced by broker-dealers and RIAs in the wake of the Pension Protection Act and increased regulatory scrutiny relating to disclosure of fees and conflicts create additional exposure and enhanced standards of care.

Fortunately, this enhanced liability can be mitigated through effective risk management initiatives. Our ERISA Plan and Investment Fiduciary Group is working with many of our existing clients to assist them in avoiding prospective exposure through the implementation of fiduciary-based training, supervisory controls and compliance procedures. Additionally, our new ERISA Plan Risk Assessment Program works directly with plan sponsors and their providers to identify and remedy fiduciary breaches and prohibited transactions. For more information on developing a compliant advisory program or plan, please contact Jason C. Roberts, Esq. at (310) 210-1679 or via email at jroberts@edgertonweaver.com.

Emerging Trends for PPA Fiduciary Advisers

2008-02-17T18:41:00.000-08:00

Recognizing the need for professional investment advice for participants and beneficiaries of defined contribution plans, the Pension Protection Act of 2006 (“PPA”) fashioned a new category of investment specialist – the fiduciary adviser. If an adviser adheres to certain enumerated procedures relative to compensation and disclosures, he/she can now deliver individualized investment advice to plan participants. Since the passage of PPA in October 2006, broker-dealers and registered investment advisers have been scrambling to synthesize PPA’s investment advice provisions and determine how best to execute and support the fiduciary adviser business model. This post provides a brief overview of the investment advice provisions of the PPA and examines the emerging business structures being implemented by broker-dealers and registered investment adviser firms in response thereto.

In examining the various approaches undertaken thus far, it is clear that these firms view the PPA fiduciary adviser as a conduit by which to maintain and grow their assets under management through capturing participants’ household assets and rollovers. Firms are able to access participants’ assets held outside of the plan by offering a comprehensive financial planning option as part of the initial client assessment and engagement. In addition to receiving recommendations on contributions and allocations within the plan, participant assets held outside of the plan are placed into a wrap account where the adviser’s compensation is level.

With respect to rollovers, 401(k) plans perpetually loose participants with the highest balances as they retire and withdraw these assets. By becoming, or partnering with a fiduciary adviser, registered representatives and investment adviser representatives are hoping to be in the best position to offer guidance to participants who are seeking to consolidate investments and/or rollover assets into an IRA.

Pursuant to ERISA Section 3(21)(A)(ii), any person that renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of a plan, or has any authority or responsibility to do so is a “fiduciary.” The prohibited transaction provisions of ERISA and the Code prohibit an investment advice fiduciary from using the authority, control or responsibility which makes it a fiduciary to cause itself, or a party in which it has an interest that may affect its best judgment as a fiduciary, to receive additional fees. As such, in the absence of a statutory or administrative exemption, fiduciaries are prohibited from rendering investment advice to plan participants regarding investments that result in the payment of additional advisory and other fees to the fiduciaries or their affiliates. Section 601 of the PPA added a statutory exemption under section 408(b)(14) of ERISA (and section 4975(d)(17) of the Code) for investment advice rendered pursuant to an “eligible investment advice arrangement” (“EIAA”). An EIAA is a contract between the fiduciary adviser and the plan sponsor that guarantees that the adviser’s compensation will not vary on the basis of any investment option selected[1].

The fiduciary adviser must acknowledge his/her fiduciary status in writing and can only be held civilly liable for losses caused by a breach thereof on those accounts where he/she has delivered investment advice. Such breaches are also subject to civil and criminal penalties by the DOL and the IRS.

Plan sponsors, on the other hand, are relieved from liability on those accounts so long as they can demonstrate prudent selection, monitoring and compliance[2] of the fiduciary adviser. PPA does not require plan sponsors or co-fiduciaries to monitor the specific investment advice given by a fiduciary adviser to any particular recipient of the advice.

PPA allows fiduciary advisers to charge reasonable fees, which based upon the extent of the services offered, are ranging from $300 - $1,500 per participant. Many firms are allowing these fees to be deducted from plan assets or paid from participant accounts, depending upon the desired usage. For example, in plans where the majority of employees are making substantial contributions (i.e., hospitals, law firms, etc.) fiduciary adviser firms are seeking to have fees deducted from the plan thereby encouraging more participants to opt for individual advice. In plans with low average balances, where the majority of participants into qualified default investment alternatives (“QDIAs”), firms are encouraging the plan to deduct advisory fees from participant accounts. The belief is that only those with significant assets are likely to engage the fiduciary adviser, leaving the fiduciary adviser with more time to service senior employees with higher balances.

As discussed, many firms are using fiduciary advisers to reach participants’ household and rollover assets. An estimated one in ten employees that will use a fiduciary adviser has household assets averaging $150,000, and one in twenty will be in a position to rollover plan assets averaging $500,000. In order to issue a suitable recommendation, a fiduciary adviser will need to review and consider the participant’s overall financial situation including assets and investments held outside of the plan. By offering a comprehensive financial planning option to participants, some firms are betting that participants will seek to consolidate their finances and deal with a single investment professional.

According to an August 2007 study by Spectrem Group, 67 percent of individuals who completed a rollover during the two-year period through April did so with the help of a professional adviser. The same study showed that the higher the balance the more likely there’s an adviser involved in the decision. With nearly $500 billion now eligible for rollovers, which are expected to increase 10 to 12 percent annually over the next five years, firms are looking to their fiduciary advisers to be in the best position to capture their participants’ rollovers.

There are three basic business structures emerging to facilitate such relationships: 1) stand alone; 2) full service team; and 3) partnerships. The pros and cons of each arrangement is being determined by the relative expertise of the individual advisers, their average plan size (both in terms of participants and assets), preexisting affiliations and considerations relating to revenue distribution.

PPA does not prohibit advisers from acting as both plan-level and participant-level fiduciary advisers so long as their compensation is unaffected by the investments recommended by the fiduciary adviser. Under the stand alone model, the unconflicted plan-level adviser is, therefore, permitted to act as both an adviser to the plan and as a fiduciary adviser to plan participants. Given the obvious limitations on the adviser’s time, this arrangement is being employed by advisers with a book of business consisting primarily of plans with high average balances.

Alternatively, group of advisers who are able to meet the level compensation and other requirements are seeking to capitalize on their collective strengths by forming full service teams. Under this arrangement, the plan adviser practice employs one or more fiduciary advisers and/or associate advisers. Associate advisers are not parties to the EIAA with the plan sponsors but provide the administrative services under the supervision of the named fiduciary adviser. This arrangement permits the full service team to scale their business by hiring and replacing associate advisers without altering the EIAA. Because there are no restrictions on how fiduciary adviser revenue is distributed, the full service team can determine how each member is compensated and are free to dedicate their revenue towards external expenditures.

Under the partnership arrangement, a plan adviser practice has an exclusive arrangement with a fiduciary adviser practice, and each partner participates in the revenue of the other. The level compensation requirements are not violated so long as the fiduciary adviser does not recommend plan related services to participants for which a partner is paid (i.e., recommending investments to participants that are not in the current lineup that would trigger a vendor search).

By implementing any of the aforementioned arrangements, broker-dealers and registered investment advisers are looking to grow assets by building meaningful personal relationships with participants through fiduciary advisers. While nothing in PPA prohibits fiduciary advisers from managing a participant’s household assets, DOL Advisory Opinion 2005-23A (the “Deseret Letter”), cautions plan fiduciaries with respect to advising participants to take a distribution and invest the proceeds in an IRA account managed by the fiduciary. Given that PPA requires fiduciary advisers to acknowledge their fiduciary status in writing, fiduciary advisers and their respective firms should determine whether such arrangements would be in violation of ERISA section 406(b)(1), which prohibits plan fiduciaries from using plan assets in his/her own interest.

[1] PPA also includes provisions for parties in conflict to provide advice through a computer model. This second conflicted advice program is not discussed in this article.

[2] PPA requires that an independent expert conduct an audit of the fiduciary adviser to determine compliance with the provisions of Section 601 of the PPA.

DOL Warns of Further Scrutiny of Investment Advisers and Pension Consultants

2007-07-02T17:41:00.001-07:00

The Department of Labor (“DOL”) recently announced the launch of its newest national project, the Consultant/Advisor Program (“CAP”), through its Employee Benefits Security Administration (“EBSA”) enforcement website. According to the release, CAP will focus on the receipt of improper, undisclosed compensation by pension consultants and other investment advisers. EBSA’s investigations will seek to determine whether the receipt of such compensation violates ERISA because the adviser/consultant used its position with a benefit plan to generate additional fees for itself or its affiliates. EBSA expressed its intent to investigate individual plans in order to address such potential violations as failure to adhere to investment guidelines and improper selection or monitoring of the consultant or adviser. The CAP will also seek to identify potential criminal violations, such as kickbacks or fraud.

CAP is the EBSA’s response to a May 16, 2005, SEC study, entitled Staff Report Concerning Examinations of Select Pension Consultants. The SEC Report summarizes an examination sweep into the practices of pension consultants, which focused on any conflicts of interest in their operations, and was initiated as part of the SEC’s program to identify and investigate risks in the securities industry.

The Office of Compliance Inspections and Examinations conducted a study of 24 pension consultants over a 23 month period. The findings revealed that there was indeed cause for concern because over 50 percent of the consultants in the study provided services to both clients and to money managers. Providing such services presents a conflict of interest in which the consultant stands to gain substantially through “brokerage commission recapture programs.” When offering services to both pension clients and to money managers, consultants are obligated under the Advisers Act to fully disclose all potential conflicts of interest to their clients. The SEC Report revealed, however, that most consultants do not fully disclose other business activities and some did not disclose any additional business activities. Of those consultants that engaged in disclosure, most of the disclosure was bogged down with confusing language, such that an individual with common-knowledge could not understand the potential ramifications of the disclosure. The SEC Report, therefore, concluded that consultants must have better policies and procedures in place so that consultants are inline with their fiduciary obligations to their clients.

The SEC Report, CAP and the recent spate of 401(k) lawsuits signal a widespread concern regarding the performance of consultants and a growing anti-consultant sentiment. Consequently, plan sponsors and co-fiduciaries will be expected to further scrutinize the adviser’s performance, conflicts and disclosures thereof in order to meet their duties to prudently select and periodically monitor plan consultants and investment advisers. For more information on fulfilling these duties, please feel free to contact Jason C. Roberts at Edgerton & Weaver, LLP.

E&W Launches PPA/Fiduciary Adviser Legal Resource Center

2007-05-13T15:54:00.000-07:00

Edgerton & Weaver, LLP recently announced the launch of itsPPA Fiduciary Adviser Legal Resource Center at http://www.ppa-law.com/. The new site contains a comprehensive collection of PPA legal and compliance resources and provides convenient access to recent articles and case summaries concerning PPA fiduciary advice. The site also contains a list of E&W-approved service providers, including plan consultants, fiduciary adviser training, certification and audit providers as well as investment risk and valuation analysis professionals. The most relevant governmental links for PPA fiduciary advisers, investment managers and plan sponsors are easily accessible from the site’s homepage. For more information about the PPA Fiduciary Adviser Legal Resource Center or for assistance with establishing a PPA-compliant investment advice program or plan, please contact Jason C. Roberts, Esq. at jroberts@edgertonweaver.com.

Further Discussion on the Opportunities and Challenges for PPA Fiduciary Advisers

2007-03-07T15:09:00.000-08:00

The PPA allows fiduciary advisers to charge reasonable fees for helping participants select specific funds within their employer-sponsored plans. The fees are deducted from plan assets or paid by the participant. Careful consideration should be given to the desired “pick-up” rate of participant advice based upon the nature of the plan being serviced. For example, in plans where the majority of employees are making substantial contributions (i.e., hospitals, law firms, etc.) the fiduciary adviser should seek to have fees deducted from the plan, which will encourage more participants to opt for individual advice. In plans where the average balance is, for example, less than $50,000 and default investments are preferred, we recommended that fees be paid for by the individual participants such that only those with significant assets are likely to engage the fiduciary adviser.

Depending upon the extent of the services offered, reasonable fees are expected to range from $300 - $1,500 per participant. Consequently, business generated from fees alone has the potential to create significant revenues. A projection developed by DALBAR, Inc. and published on www.FiduciaryAdviser.com estimates that an adviser could earn $50,000 annually from just one employer with 100 employees. A fiduciary adviser going it alone could reasonably expect to service roughly 600 employees and receive $300,000 in fiduciary fee revenue. Moreover, these revenues are easily scalable to the extent the fiduciary adviser recruits and trains advisers to additional plans.

The PPA also opens the door to additional growth through the ability to reach participants’ household and rollover assets and via referrals. An estimated one in ten employees that will use a fiduciary adviser has household assets averaging $150,000, and one in twenty will be in a position to rollover plan assets averaging $500,000. Common sense dictates that employees will seek to consolidate their finances and deal with a single investment professional. Thus, not only will fiduciary advisers and their firms benefit by establishing a presence in this newly-created market, we expect that those who fail to do so will see a measurable degree of attrition from employees who, for lack of a better term, “gave at the office.”

As with most opportunities, there are certain pitfalls that must be addressed prior to entering this market. First, the PPA requires that any advice be rendered by a qualified “fiduciary adviser” that is fully regulated by applicable banking, insurance, and securities laws. Fiduciary advisers are also subject to civil and criminal penalties by the DOL, the IRS and could be held civilly liable to the participant. Existing supervisory and compliance procedures must, therefore, be examined and updated upon the release of ongoing guidance from regulators.

The PPA further requires that the proffered advice be made pursuant to an “eligible investment advice arrangement” (“EIAA”) that is either fee neutral or based on a computer model under an “investment advice program” such as that addressed in the Department of Labor’s (“DOL”) advisory opinion 2001-09A (the SunAmerica Letter). Under the fee neutral arrangement, the adviser’s total compensation, including indirect compensation derived from the purchase or sale of securities in reliance on the proffered advice, cannot vary based on the advice given.

Recent guidance from the DOL (Field Assistance Bulletin No. 2007-01) makes clear that registered investment advisers and broker-dealers must be PPA compliant if their advisers/reps become PPA fiduciary advisers. Consequently, these firms are subject to the level compensation requirement as well. This provision is problematic to the degree that a fiduciary adviser firm shares revenues with and/or is otherwise compensated by affiliates. Although affiliates are subject to the level compensation requirement only to the extent they provide investment advice to participants, because firms must ultimately accept fiduciary liability for participant accounts, affiliated RIAs and broker-dealers seeking to enter this market should establish a separate RIA to guarantee that compensation does not vary among investment options.

Because the PPA requires advisers to act as fiduciaries, firms must scrutinize their supervisory procedures to help ensure that the proffered advice is dispensed prudently, objectively, and is being rendered for the exclusive purpose of providing benefits to the plan's participants and beneficiaries. Given that many broker-dealers have taken the position that a stockbroker is never a fiduciary and have, therefore, failed to define an appropriate standard of care, amendments to compliance materials and service agreements may also be necessary. Even where a firm has previously allowed advisers to act as fiduciaries, enhanced fiduciary-related due diligence procedures for selecting and monitoring investment options should be established. Again, we stongly recommend creating a separate PPA-compliant RIA.

The PPA also requires fiduciary advisers to provide participants with exhaustive disclosures concerning, among others, fees charged, services to be rendered, past performance and historical returns of investment options, potential conflicts, and the participant’s ability to seek advice from an independent adviser. These disclosures must be written in plain, easy-to-understand language, and are required to be made when advice is first given, and at least annually thereafter. Disclosures must also be provided upon the request of the participant and whenever there is a material change to the adviser’s fees or affiliations. Given the increased focus on excessive fees and revenue sharing (due to a flood of lawsuits against 401(k) providers), particular attention should be paid to the extent and specificity of the disclosures.

The PPA expressly places the burden of establishing compliance with the foregoing provisions on the firm and anticipates that such compliance will be reviewed as part of the required annual audit. For additional information concerning the PPA, the DOL Bulletin, or for assistance with developing procedures to ensure your firm’s compliance with the requirements set forth therein, please contact Jason Roberts by phone at (310) 937-2066 or email at jroberts@edgertonweaver.com.

DOL Bulletin Provides Guidance on PPA Compliance

2007-02-12T17:00:00.000-08:00

On February 2, 2007, the Department of Labor (“DOL”) released Field Assistance Bulletin No. 2007-01 (the “Bulletin”) setting forth additional guidance regarding statutory exemptions for investment advice offered to 401(k) participants pursuant to the Pension Protection Act of 2006 (the “PPA”). This post summarizes the Bulletin as it relates to registered investment advisers (“RIAs”) and broker-dealers seeking to offer these services.

The Bulletin makes clear that RIAs and broker-dealers must be PPA compliant if their advisers/reps become PPA fiduciary advisers. Consequently, firms are subject to the level compensation, prudent selection, and periodic monitoring requirements contained within the PPA. The Bulletin expands upon these provisions in the following respects:

Level Compensation

The investment advice exemption created by the PPA requires that proffered advice be made pursuant to an eligible investment advice arrangement (“EIAA”), which, among other things, requires that any fees (including commissions or other compensation) received by the fiduciary adviser do not vary based upon the investment option selected. The Bulletin clarifies “level compensation” as it relates to affiliates of fiduciary adviser firms by explaining that such affiliates are subject to this requirement only if they are providing investment advice to plan participants and beneficiaries. Nevertheless, because firms must ultimately accept fiduciary liability for participant accounts, affiliated RIAs and broker-dealers seeking to enter this market should consider establishing a separate RIA to ensure compliance with the level compensation requirements as well as the fiduciary standards imposed upon PPA advisers.

Prudent Selection

The Bulletin also significantly broadens the prudent selection requirements contained in the PPA. PPA advisers are to be subjected to an objective process, designed to elicit information necessary to assess the adviser’s qualifications, the quality of services offered as well as the reasonableness of fees charged for those services. The process must avoid self dealing, conflicts of interest or other improper influence. It must also take into account the experience and qualifications of the fiduciary adviser, their registration in accordance with applicable federal and/or state securities laws, their willingness to assume fiduciary status and responsibility for the advice under ERISA, and the extent to which the advice is based upon generally accepted investment theories.

Periodic Monitoring

The Bulletin also requires plan sponsors to review the extent to which there have been any changes in the information that served as the basis for the initial selection of the fiduciary adviser, including whether the adviser continues to meet applicable federal and state securities law requirements, and whether the advice being furnished to participants and beneficiaries is being based upon generally accepted investment theories. The Bulletin further requires plan sponsors to consider whether the fiduciary adviser is complying with the contractual provisions of the engagement and to examine utilization of the investment advice services by the participants in relation to the cost of the services to the plan. It directs plan sponsors to monitor and address participant feedback and complaints about the quality of the furnished advice.

The Bulletin expressly places the burden of establishing compliance with the foregoing provisions on the firm and anticipates that such compliance will be reviewed as part of the required annual audit. For additional information concerning the Bulletin, the PPA, or for assistance with developing procedures to ensure your firm’s compliance with the requirements set forth therein, please contact Jason Roberts by phone at (310) 937-2066 or email at jroberts@edgertonweaver.com.

Federal Regulation of Hedge Funds: A Blessing in Disguise?

2007-01-08T20:58:00.000-08:00

Notwithstanding the fact that most hedge fund investments are sold as Regulation D private offerings, which are “covered” securities under the National Securities Markets Improvement Act (“NSMIA”) of 1996, states are taking an increasing interest in study and oversight of the private investment industry.

Connecticut’s Department of Banking, for example, recently formed its own task force to oversee hedge fund operations within its borders. Although Connecticut has yet to pass any additional regulations specific to hedge funds, it has pledged to help prevent and detect fraud in the widely dispersed industry.

The task force is expected to conduct background checks and monitor registered persons affiliated with Connecticut-based hedge funds. At the same time, it appears as though Connecticut’s approach to regulation would include overseeing not just those hedge funds organized under its laws but all private investment companies operating within its borders. Thus, any hedge fund soliciting investors in Connecticut would presumably be subject to oversight.

And just last week, Massachusetts’ Secretary of State William Galvin reported that his office is probing UBS's ties with hedge funds to which it provides services, and that the state is examining relationships between hedge funds and other investment banks.

The potential for hedge fund oversight by individual states is problematic insofar as it could lead to piecemeal regulation and added compliance costs. Proponents argue that the $1.3 trillion industry is incompletely monitored and largely removed from oversight, therefore, leaving unsophisticated investors at risk. Last month, however, the SEC proposed to increase the threshold for investing in hedge funds. The new rules would require individuals to have $2.5 million in available assets to invest in hedge funds, up from $1 million currently. If the rules are adopted, it should lessen concerns relating to the sophistication of hedge fund investors and could deflate the momentum of individual state regulators. Consequently, the industry that once fought against mandatory registration may ultimately wind up embracing some degree of federal oversight and regulation.

Fiduciary Advisers and the Pension Protection Act

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A December 12, 2006, financial-planning.com article reports that "[n]early 90% of advisors polled in a recent survey said they planned to give investment advice to retirement plan participants, yet only one-third of them said they understood the fiduciary responsibilities involved." This report is problematic insofar as the effective date of the investment advice provision of the PPA is December 31, 2006. Moreover, the same article reports that "[m]any advisors polled believe the Pension Protection Act will boost their business from retirement plan sponsors [and that] [s]ixty-nine percent of respondents expected work from plan sponsors to help grow their business between 10 and 49 percent over the next three years." We expect a wave of advisers and their affiliates scrambling to make sense of the investment advice provisions in the coming months. Fortunately, E&W has already synthesized this information into plain English and developed a series of recommendations to ensure your practices are compliant with the PPA.

There are several considerations that must be addressed before giving advice to plan participants and many of these issues will need to be raised and blessed by your compliance departments. For example, tough fiduciary and disclosure safeguards must be met. Investment advisers who fail to adhere to these requirements are subject to civil and criminal penalties by the Department of Labor and may be civilly liable to the participant. For a brief article outlining the necessary disclosures and fiduciary standards, click here. And for a detailed discussion and slideshow, click here to download our most recent Webinar.

Welcome

2006-12-12T13:06:00.000-08:00

Welcome to the West Coast Securities Law Blog hosted by Jason C. Roberts, Esq. and Edgerton & Weaver, LLP. Our blog will officially launch on January 1, 2007. Please check back with us next year. Thank you.