Joining the conversation were Bradford Campbell, Counsel at Schiff Hardin LLP and former head of Employee Benefits Security Administration (EBSA); Jason Roberts, founder and CEO of Pension Resource Institute; and Roberta Ufford, Principal, Groom Law Group.
The discussion began be looking at how the definition of fiduciary is currently applied. The governing body over broker/dealers (B/Ds) is the Financial Industry Regulatory Authority (FINRA), which is a self-regulating organization (SRO). The body of law B/Ds adhere to is the Securities Exchange Act of 1934 and the standard of care applied to them is the suitability standard–not a fiduciary standard. Registered investment advisers (RIAS) on the other hand, are held to the fiduciary standard of care. Their body of law is the Investment Advisers Act of 1940 and the Securities and Exchange Commission (SEC) serves as their governing body.
In January, the SEC issued two reports, as mandated by the Dodd-Frank Act. One report examined if RIAs should continue to be regulated by the SEC, or if an SRO would be more effective (see “SEC Publishes Report about RIA Oversight”). The second report questioned if there should be a uniform fiduciary standard for both B/Ds and RIAs (see “SEC Report Leaves Unanswered Questions”). The SEC staff had this to say about a uniform fiduciary standard:
“The Staff recommends the consideration of rulemakings that would apply expressly and uniformly to both broker-dealers and investment advisers, when providing personalized investment advice about securities to retail customers, a fiduciary standard no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2). In particular, the Staff recommends that the Commission exercise its rulemaking authority under Dodd-Frank Act Section 913(g), which permits the Commission to promulgate rules to provide that: the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice. The standard outlined above is referred to in the Study as the ‘uniform fiduciary standard.’”
Redefining “fiduciary” would require redefining “advice”
The Employee Retirement Income Security Act (ERISA) and the Advisers Act employ different definitions of “advice,” the panelists pointed out. The ERISA definition includes advice relating to “property” other than securities. The Advisers Act definition is broader because it includes any advice about the advisability of investing in securities, and issuing reports or analysis relating to securities. Also under the Advisers Act, advice doesn’t need to be “individualized” or “regular,” nor be “a primary basis for decision-making.” Brokers who are exempt from RIA registration may still provide fiduciary “advice” for ERISA purposes (ERISA does not include an exception for advice “incidental” to brokerage services).
Fiduciary status under ERISA and Securities law is different:
- ERISA fiduciary must act prudently (objective duty of care)
- ERISA fiduciary must act solely in the interest of the participants and beneficiaries
- ERISA fiduciary is personally liable to make whole losses due to breach of duty
- ERISA fiduciary status a “functional” test based on conduct—if you act like a fiduciary, you are one, despite disclaimers in your contract
- ERISA fiduciaries are subject to prohibited transaction rules and generally cannot receive variable compensation from investments regarding which the fiduciary provides advice
Do you pass the test?
Since 1975, the Department of Labor (DoL) regulation has defined a fiduciary investment adviser through a five part test. The adviser is an ERISA fiduciary if it gives advice regarding the value of or advisability of investing in securities or other property, and:
1. The advice is individualized
2. Provided for a fee
3. Provided on a regular basis
4. Pursuant to a mutual understanding
5. The advice will form a primary basis for the plan’s decision-making
Campbell noted that it does not matter if you say you are not a fiduciary–if you performed these five services, you are an ERISA fiduciary.
The DoL proposed a new rule in October 2010 to redefine and expand “fiduciary” advice. The proposal revises the definition of “advice” to include recommendations as to advisability of investing in securities or other property appraisals and fairness opinions, and “management,” which isn’t defined in the proposal, but includes advice regarding proxy voting and investment manager selection.
The proposal also outlines four categories of “advisers”:
- Person holding him or herself out as an investment advice fiduciary
- Person who is already a fiduciary for another purpose (including affiliates)
- Adviser as defined in 202(a)(11) (primarily RIAs)
- Person providing individualized advice for a fee that “may be considered” in decision-making
The proposal eliminates “regular basis” and “a primary basis for investment decision-making” requirements.
Ufford emphasized that the proposal is very complex. Not that the five-part test was simple, she said, but this seems to be exceptionally complicated.
The proposed rule includes several “exceptions” as well. One is the “Seller’s Exception” – one must be able to demonstrate that the recipient of advice knows (or reasonably should know) that the seller represents a person with adverse interests and is not trying to provide impartial advice. There is also a “Platform Operators” exception, which says those who operate or make available a menu of defined contribution plan investment alternatives, and provide general information to assist sponsors in selecting from the menu. Investment education (IB 96-1) provided to plan participants is not included in the new fiduciary advice, nor are valuations for reporting and disclosure purposes, but only if there is a generally recognized market for the asset.
How will this affect your practice?
The panelists said that advisers or brokers who now avoid ERISA fiduciary status will have to limit their services, or acknowledge fiduciary status. And even if you already accept fiduciary status, some “non-fiduciary” activities may become “fiduciary” activities, such as recommending other advisers or advice to participants on rollovers. This will require redesigning compliance infrastructure and a review of compensation procedure.
Business partners or competitors may reposition their services as well:
- Providers or recordkeepers may seek to partner with advisers to limit their fiduciary risk
- Brokers may increase service levels by agreeing to provide ERISA fiduciary advice or increasing non-fiduciary services
- Trustees/custodians may change valuation related services for “alternative assets” or limit services for alternative assets
The panelists concluded by giving advisers some actionable ideas:
- Meet frequently with plan sponsors to educate on new and changing regulations
- Conduct due diligence on remote advice programs offered by providers
- Enhance commitment to participant education with a focus on increasing participation and contributions and retirement readiness
- Track participant success measurements
- Develop tools and training to assist plan fiduciaries in assessing service arrangements, disclosures, etc.
- Standardize plan sponsor and participant communications and resources (such as ERISA compliance checklists or investment education)
These changes should be looked at as new opportunities to redefine your value proposition, leverage provider-based fiduciary solutions, or fill the need for stronger participant advice.