Advice to Plans and Participants

ADVISER QUESTION: I am a registered investment adviser (RIA) who provides investment services to Employee Retirement Income Security Act (ERISA) retirement plans, individual retirement accounts (IRAs) and individual plan participants. I acknowledge my ERISA fiduciary status when I provide advice to these clients. I understand that Department of Labor (DOL) investigations of advisers are on the rise. I believe everything is in order, but is there anything I should be concerned about?

ANSWER: Maybe. The DOL is especially looking for prohibited transactions (PTs) that have been committed.

408(b)(2) fee disclosures now play an important role in DOL investigations. These investigations include specific questions about such disclosures. We are also seeing the Securities and Exchange Commission (SEC) raise prohibited transaction issues about plans and IRAs it encounters in its examinations.

Whenever a fiduciary adviser makes investment recommendations to an ERISA plan and earns $1,000 or more in the course of performing those services, the adviser is a “covered service provider” (CSP) under the 408(b)(2) disclosure rule. Similarly, if an individual participant hires an investment adviser to provide investment advice about his account and the adviser is paid $1,000 or more out of it, the adviser is a fiduciary CSP. As a result, the adviser needs to disclose his services, compensation and status, as an ERISA fiduciary and RIA, or the engagement would be a prohibited transaction.

A nonfiduciary adviser can also be a CSP. For instance, a representative of a broker/dealer (B/D), or financial adviser, who is not a fiduciary but provides investment services to a plan or participants is a CSP if he receives indirect compensation of $1,000 or more from the investments—e.g., insurance commissions or 12b-1 fees.

The failure of a CSP adviser to make the 408(b)(2) disclosures is a prohibited transaction. To correct it, the adviser would need to return his compensation to the plan, plus interest. He would also need to file a Form 5330 with the Internal Revenue Service (IRS) and pay a 15% excise tax on the amount involved.

But not all retirement plans are covered by the 408(b)(2) disclosure rule. 408(b)(2) does not apply to simplified employee pension plans (SEPs) and savings incentive match plan for employee (SIMPLE) IRAs. Also, 408(b)(2) does not apply to non-ERISA plans, such as IRAs and so-called “one-person” plans—retirement plans that cover only the owner or the owner and his or her spouse. As a result, the written disclosures are not required.

However, the Internal Revenue Code (IRC) prohibited transaction rules apply to IRAs—including SEPs and SIMPLEs—and to one-person, non-ERISA plans. These rules mirror ERISA’s PT rules. Both the IRC and ERISA prohibit fiduciary advisers from receiving “additional” compensation for their advice. That could occur where a fiduciary adviser receives a stated fee and then also receives compensation from the investments he recommends. In other words, advisers are prohibited from receiving any compensation above and beyond their stated fees if that additional compensation is because of their investment advice.

Here are some examples of where the DOL has found prohibited transactions:

• In one case, a fiduciary received 12b-1 fees from mutual funds he recommended—along with the adviser’s stated fee. The additional compensation was a prohibited transaction.

• In a second case, a fiduciary adviser received a finder’s fee from a hedge fund he recommended to his plans.

• A third example is where a fiduciary recommended his own firm’s collective investment trust (CIT) to retirement plans. In that case, the adviser was receiving both his stated fee for advice to the plans and his fee for managing the CIT. The adviser was required to return the management fees for the CIT to the plans, together with interest.

While these examples are about fiduciary advisers, they are also informative for nonfiduciary advisers. The DOL’s proposal to broaden the definition of fiduciary investment advice means almost any recommendation of an investment or investment manager to a plan, participant or IRA owner could be considered a fiduciary act.

Fred Reish is chair of the Financial Services ERISA practice at the law firm Dirnker, Biddle & Reath. A nationally recognized expert in employee benefits law, Reish has written four books and many articles on the Employee Retirement Income Security Act (ERISA), Internal Revenue Service (IRS) and Department of Labor (DOL) audits, as well as pension plan disputes. Joan Neri, who has been associated with the firm since 1988, is counsel on the Employee Benefits and Executive Compensation Practice Group. Her practice focuses on all aspects of employee benefits counseling.