The Advisor’s Guide to the DOL Fiduciary Rule, 2nd Edition

By Marcia S. Wagner and Barry Salkin

The Department of Labor’s (DOL) fiduciary rule constitutes the single biggest change in the financial advisory area since the passage of ERISA, but the DOL fiduciary rule was invalidated by a federal court of appeals last year. That begs the question then of what rules do apply for financial advisors helping clients make important decisions affecting their retirement?

As a result, every attorney, advisor, or consultant whose practice, or the practice of their clients, directly or indirectly include advising on retirement plans must ensure they are in compliance with the new DOL Fiduciary Rule.

The Advisor’s Guide to the DOL Fiduciary Rule, 2nd edition, explains in detail what practices are permitted, prohibited, and required when dealing with retirement accounts. This includes the rendering of advice, fee structures, developing training courses, evaluating operating procedures and forms, and correcting noncompliant activities.

Written by two of the most respected legal experts in the field — Marcia Wagner, founder of the Wagner Law Group, and Barry Salkin, also of the Wagner Law Group, who have been practicing in the area of ERISA and employee benefits for many years — this 2nd edition has been fully updated, including:

• Valuable information on the current Fiduciary Rule now in place as a result of court invalidation on the most recent fiduciary rule
• Current status and analysis of proposed SEC rule
• Current state of financial industry on compliance
• Employee benefits consultants or specialists
• Potential scenarios for 2019
• And more!

With this latest edition, advisors, planners, agents, producers, attorneys and other professionals will be able to confidently navigate the change surrounding this rule.

• Language: English
• Publisher: The National Underwriter Company
• Release date: Dec 21, 2018
• ISBN: 9781945424687

Book preview

Standard.

Impartial Conduct Standards of Conduct

To comply with the Impartial Conduct Standards, a financial institution and its advisors must (i) give advice that is in the investor’s Best Interest, (ii) charge no more than reasonable compensation (within the meaning of ERISA Section 408(b)(2) and Code section 4975(d)(2)), and (iii) make no misleading statements about investment transactions, compensation, and conflicts of interest.⁶

Best Interest Standard – The key condition for each of the four versions of the BIC is adherence by the financial institution, as well as the individual advisor, to the Best Interest Standard of Care, which is a component of the Impartial Conduct Standards.⁷ This new fiduciary standard, which blends ERISA’s prudent man standard of care and the duty of loyalty, requires an advisor to provide investment advice that reflects the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Advisor, Financial Institution or any Affiliate, Related Entity, or other party.⁸

The Best Interest Standard requires advisors not only to take a retirement investor’s particular circumstances into account, but also to exclude any compensation incentives from consideration in making a recommendation. This means that in choosing between two investments, an advisor cannot select the one that is better for the advisor’s or the financial institution’s bottom line. It should be noted that the without regard to phrase in the standard is intended to impose a higher standard than FINRA’s existing suitability standard for broker-dealers which permits selection of the least suitable but more remunerative of available investments.

Special conditions apply to the Best Interest Standard when advice is limited to proprietary products.⁹ Under these circumstances, the financial institution and advisors are deemed to satisfy the Best Interest Standard described above if prior to or coincident with a recommended transaction, the retirement investor is furnished with a prominent written notice that the universe of investments the advisor may recommend has been limited. The notice must also include information about any material conflicts the advisor or institution may have with respect to the transaction. Further, the financial institution must internally document its limitations on the universe of investments that can be recommended and the conflicts associated with the sale or promotion of its proprietary products. It must then reasonably conclude that these limitations will not cause its compensation or that of its advisors to be unreasonable or result in imprudent recommendations. Further, the financial institution needs to internally document its reasons for making this determination. In other words, the firm must show why it is not motivating advisors to preferentially recommend products on the investment menu that are the most lucrative to themselves and the institution.

Where investment recommendations are limited to proprietary products, the financial institution must also adopt and adhere to the compliance policies and procedures addressing the firm’s conflicts including a supervisory structure. This structure should include systems to determine whether the firm’s advisors recommend imprudent reliance in selling proprietary products. Systems should be in place to assess the validity of any assumptions used in making determinations as to the reasonableness of the compensation of the firm or its advisors or the prudence of advisor recommendations.

OBSERVATION: The DOL seems particularly interested in assumptions about how much money a prudent investor would invest in particular product classes. There should also be mechanisms to ensure that advisors actually provide advice consistent with the firm’s analysis.¹⁰

Reasonable Compensation – The reasonable compensation requirement limits what a financial institution and its affiliated advisors can receive as compensation for their services.¹¹ At bottom, this standard simply requires that compensation not be excessive, as measured by the market value of the particular services rendered or benefits delivered by the financial institution and advisor. Relevant factors other than market pricing include the nature of the underlying asset, the complexity of the product and extent of the monitoring duties that come with it. The DOL emphasizes that advisers are not required to recommend the lowest cost investment alternative.¹²

Life insurance and annuity products present unique challenges in determining reasonable compensation, because they bundle together services, investment guarantees and other financial benefits. The DOL has confirmed that it is appropriate to consider the value of all the guarantees and benefits in assessing the reasonableness of such arrangements, as well as the value of the services. This includes compensation by affiliates of the financial institution and related parties.¹³

The fact that the level or structure of fees attached to certain products has been long prevalent in an industry, however, is no guarantee that it will be accepted as reasonable. The DOL has stated that it is unwilling to condone all customary compensation" and declines to adopt a standard that turns on whether an agreement is customary. Thus, even if it is customary to charge customers fees that bear little relationship to the value of the services rendered, doing so does not make the fee reasonable.¹⁴

Misleading Statements – Under the Impartial Conduct Standards, statements by the financial institution and its advisors about the recommended transaction, advisor compensation issues, conflicts of interest and any other matters relevant to investment decisions may not be materially misleading. The final fiduciary rule clarified that the determination as to whether a representation is misleading is to be made at the time it is made. Guidance contained in FINRA Rule 2210 is relevant for this purpose, but not determinative, because the FINRA rule is limited to written communications and the requirement under the BIC Exemption’s Impartial Conduct Standards has a broader scope than written communications.

Another consequence of the Fifth Circuit decision was to restore the rollover guidance set forth in DOL Advisory Opinion 2005-23A, which opinion had been superseded by the Fiduciary Rule. Under the Fiduciary Rule, a recommendation to take a distribution from a plan and to rollover such a distribution was considered fiduciary investment advice. Furthermore, earning additional compensation by the advisor for such rollover advice was a prohibited transaction for which the Best Interest Contract Exemption provided relief.

On its face, DOL Advisory Opinion 2005-23A suggests that any rollover related advice from an advisor providing fiduciary advice to a plan sponsor or plan participant could result in a prohibited transaction. On the other hand, an advisor who did not serve as a fiduciary to a plan sponsor or plan participant could freely advise participants on rolling over accounts to IRAs and the manner in which rollover proceeds should be invested.

While it is clear under Advisory Opinion 2005-23A that providers of fiduciary advice to plan participants cannot capture rollover assets from that client base, it appears that a different result should apply where the advisor is only a fiduciary with respect to the plan. As a result, if advisors are only providing advice at the plan level, their service agreement with the plan sponsor should indicate the limited scope of their services. Further, an agreement to advise the participant with respect to the possible disposition of his or her account balance should make clear that this arrangement is separate and apart from the adviser’s relationship to the plan.

Fiduciary Definition and Investment Advice

Under the DOL’s existing fiduciary definition for service providers, the provider is deemed to be a fiduciary to the extent it provides investment advice relating to plan assets for a fee or other compensation. Once the provider is deemed to be a fiduciary, the provider becomes subject to a higher standard of care under ERISA, as well as particular limitations on the conduct of fiduciaries, i.e., prohibited transaction rules.

Five Factor Test

The Secretary of Labor first issued regulations defining when a person renders investment advice¹⁵ for a fee or other compensation,¹⁶ so as to fall within ERISA’s definition of fiduciary under ERISA Section 3(21), in 1975. The purpose of the regulation was to separate compensated investment advice-giving rise to fiduciary status-from mere sales efforts touting a security.¹⁷ That regulation set out a five part test,¹⁸ under which a person was deemed to render investment advice only if he (i) renders advice to the plan as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property, and he does so (ii) on a regular basis; (iii) pursuant to a mutual agreement arrangement or understanding, written or otherwise, between such person and the plan or a fiduciary with respect to the plan, that the advice (iv) will serve as a primary basis for investment decisions with respect to plan assets, and (v) the advice will be individualized¹⁹ based on the particular needs of the plan.²⁰ The regulation provides that an adviser is a fiduciary with respect to any particular instance of advice only if he or she meets each and every element of the five-part test with respect to the particular advice recipient or plan at issue.²¹ Consequently, suggesting investing advice to a trustee of a plan does not automatically confer fiduciary status.²² Determining whether an advisor is a functional fiduciary under a multi-part test is a fact-intensive inquiry,²³ but clearly occasional or intermittent advice was intended to be excluded from the definition²⁴ because such advice would not be regular.²⁵ With respect to the issue of whether under the regulation there existed a mutual agreement or understanding between the parties that [the broker’s] advice would be the primary basis for a Plan’s investment decisions,²⁶ the Court of Appeals for the Seventh Circuit concluded that this issue is comparable to the corresponding meeting of the minds component of contract cases. Whether a meeting of minds exists is an issue for the trier of fact.²⁷ The mutual agreement, which need not be in writing²⁸ and can arise from the party’s course of conduct,²⁹ must contemplate that the person will render individualized investment advice based on the particular needs of the plan regarding matters such as investment policies or strategies, overall portfolio compensation, or diversification of plan investments.³⁰ The agreement or understanding is not necessarily that the party would be a fiduciary, but only an agreement that the plan would receive investment advice that would be the plan’s primary basis for the investment decision.³¹ The Court of Appeals for the Seventh Circuit has imposed a gloss on the 5-part test that would make it more difficult for the DOL of plaintiff in a civil litigation to satisfy, requiring the adviser to have influence approaching investment control over the plan’s investment decisions,³² but that decision has not been followed.³³

In October 2010, the DOL first proposed to amend the 1975 regulation. At that time, the DOL explained that it proposed to amend a thirty-five year old rule that may inappropriately limit the types of investment advice relationships that give rise to fiduciary duties on the part of the investment advisor.³⁴ In proposing these amendments, the DOL raised both legal and policy concerns about the 1975 regulations.³⁵ From a legal perspective, the DOL asserted that the 1975 regulation had significantly narrow[ed] the plain language of the statutory definition of fiduciary.³⁶ As a policy matter, the DOL stressed the significant changes that had occurred in both the financial industry and the expectations of plan officials and participants who receive investment advice.³⁷ In particular, according to the DOL, the retirement plan community ha[d] changed significantly, with a shift from defined benefit…plans to defined contribution… plans,³⁸ while at the same time the types and complexity of investment products and services available to plans [had] increased."³⁹

On April 20, 2015, the DOL reproposed the regulations describing rendering investment advice for a fee. The DOL again stated that the 1975 regulation significantly narrowed the breadth of the statutory definition of fiduciary investment advice by creating a five part test, which included the on a regular basis limitation".⁴⁰ It explained, however, that the five part test was created prior to the existence of participant directed 401(k) plans, widespread investments in IRAs, and the now commonplace rollover of plan assets from fiduciary-protected plans to IRAs.⁴¹ As the DOL further explained, in 2015, unlike in 1975, individuals, rather than large employers and professional money managers, have become increasingly responsible for managing retirement assets as IRAs and participant directed plans, such as 401(k) plans, have supplanted defined benefit plans.⁴² At the same time the variety and complexity of financial products have increased, widening the information gap between advisers and their clients, adding to the risk that small retail investors will obtain lower returns to their retirement savings. In light of these changes in the marketplace for retirement advice, the DOL proposed discarding the five part test, including the on a regular basis component, in favor of a new standard, explaining that: Instead of ensuring that trusted advisers give prudent and unbiased advice in accordance with fiduciary norms, the 1975 regulation erects a multi-part series of technical impediments to fiduciary responsibility. The Department is concerned that the specific elements of the five-part test – which are not found in the text of the Act or the Code – work to frustrate statutory goals and defeat advice recipients’ legitimate expectations. In light of the importance of the proper management of plan and IRA assets, it is critical that the regulation defining investment advice draws appropriate distinctions between the sorts of relationships that should be treated as fiduciary in nature and those that should not. The 1975 regulation does not do so. Instead, the lines drawn by the five-part test frequently permit evasion of fiduciary status and responsibility in ways that undermine the statutory text and purposes.⁴³

Nonetheless, despite this clear rejection of the five part test, in light of the decision of the Fifth Circuit vacating the DOL fiduciary rule, the five factor test, at least on an interim basis, is the applicable law. The DOL is likely to enforce it on a more aggressive basis than it has previously done, but the concerns that led the DOL to substantially revise the test still exist.

Actions to Take by Financial Advisors

The authors are not aware of any studies or surveys with respect to the manner in which financial advisers and broker-dealers are currently managing compensation in light of the invalidation of the DOL’s Fiduciary Rule by the Fifth Circuit. However, the market trend, based upon discussions we have had with our clients, appears to support acknowledgment of fiduciary status and a conflict-free fee structure. Regardless of the current state of the law, most firms and their representatives are holding themselves out as fiduciaries and leveling their compensation, most often by migrating the ERISA plan clients to an advisory platform.

There is no way to predict at this date what final DOL Regulations defining fiduciary with respect to providing investment advice for a fee will look like, or whether the DOL will close the project in light of the SEC Regulation Best Interest, although unless there are some significant changes made to the scope of coverage under that Regulation, total inaction by the DOL would appear unlikely. Further, the statutory mission of the DOL is different from that of the SEC, and the SEC Regulation does not regulate all areas that the DOL could address, such as fixed annuities and fixed indexed annuities. (Variable annuities are securities and can be regulated by the SEC). The DOL may issue additional prohibited transaction exemptions, such as an exemption for clean shares, if the fiduciary project continues. The BICE exemption, if the Fiduciary Rule Project continues, might be streamlined, to reduce the number of bells and whistles associated with it. One difficulty in predicting how a revised Fiduciary Rule may be drafted is that the decision of the Fifth Circuit significantly limited the DOL’s scope of permissible activity.

The actions that a financial adviser should take depend in part on where they were when the DOL’s previously announced suspension of the Fiduciary Rule went into effect. Financial advisers need to assume that regulation of them will continue, and perhaps even if not formally designated as fiduciaries, they will be subject to fiduciary type principles. However, attempting to satisfy all aspects of the current BICE Exemption is likely to be overkill. Thus, even if the DOL abandons the Fiduciary Rule update, measures that financial advisers have taken, while more than the SEC may ultimately require, should provide compliance with SEC rules. These actions would include identifying and coding all retirement investors as ERISA plans, non-Title I plans (plans with no common law employees, such as a one-person 401(k) plan, or a plan limited to coverage of partners and their spouses, sometimes referred to as Keogh plans or HR10 plans), IRAS, health savings accounts, Archer Medical Savings Accounts, and Coverdell Educational Savings Accounts. This action will enable the financial advisor to track disclosures, procedures, policies and practices that apply to each type of retirement investor. The financial advisor should ensure that its written policies and procedures incorporate the impartial conduct standards and require compliance with those requirements in making recommendations for retirement accounts.

Periodic compliance training for advisors is also a recommended measure. Compliance manuals and written supervisory procedures (as required by FINRA Rule 3120) should be reviewed and updated. If not already undertaken, agreements should be reviewed to make clear the services for which a firm is acting as a fiduciary and the services in which it is not acting in a fiduciary capacity. Unfortunately, these lines are easier to draw on paper than in the actual give and take discussions between a financial advisor and a plan fiduciary, in which discussions regarding plan administration can morph into discussions with respect to plan design. Processes and controls for the delivery of nonfiduciary services should be implemented, to ensure that fiduciary advice is not inadvertently provided. Any registered representatives of broker-dealer firms should be licensed as investment advisor representatives, if not previously done. Compensation structures and revenue streams to identify any potential conflicts of interest. Steps should be taken to review recommendations to retirement accounts and surveillance should be conducted to ensure compliance with the best interest standard. Advisor compensation for recommendations to retirement accounts should be reviewed to ensure that it is reasonable in the context of the financial institution as a whole. While the determination of reasonable compensation is fact-specific, financial advisors should consider reviewing corporate compensation and individual compensation against market benchmarks to understand where the organization’s corporation and individual compensation is set with respect to the market. All sales and marketing materials and disclosures should be reviewed with a view to identifying and eliminating any statements that could be viewed as misleading or inadvertently deemed to constitute a fiduciary recommendation. It is possible that final regulatory guidance may not be so strict or provide clearer guidance as to what constitutes a recommendation. Disclosures for retirement accounts should be reviewed to ensure that the disclosures are accurate and fairly inform retirement investors of direct and indirect compensation received by the Firm and its advisors and potential conflicts of interest.

A one-time recommendation with respect to rollovers would not be fiduciary activity under the five part test, because it is not provided on a regular basis. However, if an entity is otherwise a fiduciary with respect to a plan participant, if an individual is being advised with respect to a potential IRA rollover, an area also addressed under the SEC Proposed Regulation Best Interest the conservative approach would be to treat that activity as fiduciary in nature unless it can be clearly established that the firm’s role is purely informational. Additionally, even if internal documentation is not a technical requirement, firms should consider maintaining records in support of the rollover decision, which would be very useful in an audit or litigation context. Firms should be sure that appropriate persons such as the Chief Compliance Officer, general counsel, or their delegates are made responsible for overseeing compliance with the impartial conduct standards. Finally, existing fiduciary insurance and E & O policies should be reviewed to ensure persons responsible for compliance with the Impartial Conduct Standards are covered for discharge of their duties. In addition or alternatively, these individuals can be indemnified by the Financial Institution.

Conclusion

Although the new DOL Fiduciary rule has been invalidated, it is clear the DOL will proceed with the previous rules outlined above, and care must be taken to be familiar with and understand how these rules can effect future actions by financial firms.

Chapter Endnotes

1.    2018 WL 1325019 (5th Cir. 2018).

2.    Civil Action 18-10508-NMG.

3.    Samuel Bray, Multiple Chancellors: Reforming the Nationwide Injunction, 131 Harv. L. Rev. 417,451(2017)

4.    885 F. 3d at 388.

5.    Civil Action 18-10508-NMG at p. 5.

6.    Id.

7.    Best Interest Contract Exemption, §§ II(c), II(g)(2), II(h)(2) and IX(d)(1)(i).

8.    Best Interest Contract Exemption, § II(c)(1).

9.    Best Interest Contract Exemption, § IV. Section II(b)(6) of the exemption slightly tailors the definition of Best Interest so that recommendations from the limited universe of investments offered by the financial institution may not be based on the individual advisor’s financial interests or any other factors or interests, other than the retirement client’s objectives, risk tolerance, financial circumstances and needs.

10.  Preamble to Best Interest Contract Exemption, 81 Fed. Reg. 21039, Example 4 (April 8, 2016).

11.  Recent litigation in this area has suggested that defendants breached their fiduciary duty by: (i) selecting investment options that carry high fees; (ii) selecting inferior investment options; (iii) selecting retail v institutional class funds; (iv) selecting actively managed funds rather than passively managed funds such as index funds;(v) selecting mutual funds rather than collective investment trusts or separately managed accounts; and (vi) selecting money market rather than stable value funds.

12.  See Preamble to Best Interest Contract Exemption, 81 Fed. Reg. 21030 (April 8, 2016).

13.  See Preamble to Best Interest Contract Exemption, 81 Fed. Reg. 21031 (April 8, 2016).

14.  Id.

15.  There are actually two prongs to the test-one of which needs to be satisfied. The first prong, which is not relevant for purposes of this chapter, is having discretionary authority or control with respect to purchasing or selling securities or other properties of the plan.

16.  Compensation for services can be any compensation, including receiving fees or commissions from the plan, so long as individualized advice is given. Meyer v. Berkshire Life Ins Co., 250 F. Supp. 2d 544, 561(D. Md. 2003); Ruppert v. Fairmont Park Inc. Retirement Savings Plan, 2011 WL 13114913 (S.D. Iowa March 30, 2011).

17.  F.W. Webb Company v. State Street Bank, 2010 WL 3219284 (S.D.N.Y. August 12 2010).

18.  Although the test is frequently referred to as the 5 factor test, it is sometimes expressed as a 6 factor test, with the 6th factor being that the advice is rendered for a fee. See, for example, Goldenberg v. Indel, Inc., 741 F. Supp. 2d 618,627 (D.N.J. 2010); Severstall Wheeling Retirement Committee v. WPN Corporation, 2015 WL 4726860(S.D. N.Y. August 10, 2015).

19.  Advice that is individualized with respect to the needs of a pooled investment fund should also be considered individualized with respect to the plans that invest in it. In re Beacon Associates Litigation, 52 EBC 2352, 2012 WL 1123728 (S.D.N.Y. April 4, 2012).

20.  29 C.F.R. 2510.3-21(c)(1).. The Department of Treasury issued a virtually identical regulation at 26 C.F.R. 54.4975-9(c), which interprets Code Section 4975(e)(3). Under Section 102 of Reorganization Plan No. 4 of 1978, the authority of the Secretary of the Treasury to interpret Code Section 4975 was transferred to the Secretary of Labor.

21.  Thomas, Head & Griesen Emp. Trust v. Buster, 24 F. 3d 114, 1117 (9th Cir. 1994); Santomenno v. John Hancock Trust, 2014 WL 4783665 (3d Cir. 2014).

22.  Mid-Atlantic Perfusion Associates, Inc. v. Professional Association Consulting Services, Inc., (W.D. Pa. August 9, 1994).

23.  Barnett v. Great Plains Trust Company, 2018 WL 1035162 (D. Kan. February 23, 2018).

24.  National Association for Fixed Annuities v. Perez, 2016 WL 6573480 (D.D.C. November 4, 2016).

25.  Illustrative cases in which the regular basis requirement was not satisfied include Schloegel v. Boswell (994 F. 2d 266 (5th Cir. 199__) (1977 and 1980 recommendations to a plan fiduciary and one other recommendation insufficient to satisfy regular basis requirement); Brown v. Roth, 729 F. Supp. 391, 397 (D.N. J. 1990) (proposing advice on two occasions is too infrequent to raise the inference that advice was provided on a regular basis) p; Sullivan v. Lampf, Lipkind, Pripus, Pettigrew and Labue, 1994 WL 669624 (D.N.J. November 21, 1994) one time recommendation to each of two trustees insufficient); Capital Creations Company v. Metropolitan Life Ins. Co., 1992 WL 218296 (N.D. Ohio August 26, 1992).

26.  Farm King Supply, Inc. v. Edward D. Jones & Co., 957 F. 2d 288,293 (7th Cir. 1989).

27.  Id. at 293, n. 6. See also Ruppert v. Fairmont Park, Inc. Retirement Savings Plan, 2011 WL 13114913 (S.D. Iowa March 30, 2011).

28.  Ellzey v. Carter, 920 F. Supp. 26 (D. Conn. 1995); Thomas, Head, & Greisen Employees Benefit Trust v. Buster, 24 F. 3d 1114, 1119 (9th Cir,. 1994), cert. den. 115 S. Ct. 935(1995); Olson v. EF. Hutton & Co., 957 F. 2d 622, 626 (8th Cir. 1992); Daniels v. National Employees Benefit Services, 858 F. Supp. 684, 689 (N.D. Ohio 1994).

29.  Ellzey v. Carter, 920 F. Supp. 26 (D. Conn. 1995). In determining whether such an agreement exists, courts look to the duration of the relationship and weigh various factors, including the regularity of the advice; the defendant’s knowledge of the plans; the relevant fiduciary’s expertise in financial matters; whether the relevant fiduciary was receiving any other investment advice with respect to plan assets; whether the relevant fiduciary ever rejected any of the recommendations of the defendant; and whether the relevant fiduciary believed that any agreement had been reached based upon the conduct of the other party. However, it is equally clear that it is not relevant what the parties thought., because a person’s state of mind does not determine his or her fiduciary status under ERISA. Donovan v. Mercer, 747 F. 2d 304, 308 n.4 (5th Cir. 1984).

30.  Ellis v. Rycenga Homes, Inc., 484 F. Supp. 2d 694, 704-05 (W.D. Mich. 2007).

31.  Farm King Supply v. Edward Jones & Co., 884 F. 2d 288 (7th Cir. 1989).

32.  83 F. 3d 847 (7th Cir. 1996).

33.  Ellis v. Rycenza Homes, 2007 WL 837224 (W.D. Mich. March 15, 2007).

34.  75 Fed. Reg. 65,263-64 (October 22, 2010).

35.  National Association for Fixed Annuities v. Perez, 2016 WL 6573480 (D.D.C. Nov. 4, 2016).

36.  75 Fed. Reg. 65264.

37.  Id.

38.  Id. at 65265.

39.  Id.

40.  81 Fed. Reg. 21928 (April 20, 2015).

41.  Id.

42.  Id. at 21932.

43.  Id.

The Fiduciaries

Background

ERISA requires every employee benefit plan to identify at least one fiduciary whose duty is to ensure that the plan operates within the terms of the law and the applicable plan documents. Reflecting the essential principles of the common law of trusts, ERISA also sets forth four standards of conduct to which those who have fiduciary status under ERISA must adhere: (i) loyalty to the plan and its participants, (ii) prudence, particularly in dealing with plan assets, (iii) the duty to diversify plan investments so as to minimize the risk of loss; and (iv) the duty to follow the terms of plan documents to the extent that they comply with ERISA.¹ These are not the only duties that an ERISA fiduciary has, and the duties of an ERISA fiduciary are informed by the common law of trusts.² However, this chapter will focus solely upon the statutory obligations on an ERISA fiduciary.

In order to ensure that these duties are met, it is important to understand which persons are considered to be fiduciaries for purposes of ERISA. As discussed below, ERISA fiduciaries are either named in the plan document or identified by the function they perform for the plan.

Named Fiduciaries in Plan Document

Named Fiduciary – The Named Fiduciary of a plan, as defined under section 402(a) of ERISA, is the person with the authority to control and manage the operation of the plan as named in the plan document. In traditional arrangements, it would be customary for the plan document to identify the employer sponsoring the plan as the Named Fiduciary, and in this capacity, the employer would have the formal authority to make all benefit- and investment-related decisions on behalf of the plan as well as hire the plan’s service providers. The Named Fiduciary generally has the authority to appoint and give instructions to the plan trustee and, therefore, also has ultimate control over the plan’s assets.³ Although, a named fiduciary may delegate responsibility to an investment manager. A plan may have multiple Named Fiduciaries, in which case the fiduciary responsibilities of a Named Fiduciary may be allocated among the various parties holding this position.

Administrator – The plan document usually names the employer as the plan’s Administrator as defined under ERISA Section 3(16). The Administrator is a special type of fiduciary with key reporting and disclosure responsibilities under ERISA. The Administrator is responsible for the plan’s annual regulatory filings on the Form 5500 (and related Schedules), and for engaging an accounting firm to perform audits of the plan’s financials, as necessary. In addition to these reporting duties, the Administrator is responsible for providing summary plan descriptions (SPDs) and other required disclosures to participants. The Administrator alone is subject to statutory penalties for any violation of ERISA’s reporting or disclosure requirements, even if it relies on a third party provider to help it discharge it’s reporting and disclosure duties.⁴ Vendors performing ministerial third party administrator functions are generally not treated as a plan’s Administrator for purposes of section 3(16) of ERISA and do not have fiduciary duties arising from that role.

Trustee – ERISA requires a plan to hold its assets in a trust maintained by a Trustee that either is named in the trust instrument or appointed by a procedure contained in the plan.⁵ Generally speaking, the Trustee has the exclusive authority to manage and control plan assets unless the plan reserves such authority to the Named Fiduciary or an appointed Investment Manager, as discussed below. Given this power, a plan Trustee will always be considered to be a plan fiduciary. However, if a Trustee is subject to the direction of a Named Fiduciary or Investment Manager, its responsibilities and exposure to liability will be restricted to those matters over which the trustee has actual authority.

In general, directed Trustees have extremely limited fiduciary duties over a plan’s assets. As a result, a directed Trustee’s liability is limited to instances in which it fails to follow proper directions or it complies with directions that are improper, or contrary to the plan or ERISA. Where a directed Trustee knows or should know that a fiduciary’s direction is imprudent, there is a duty to disobey the direction.⁶

Appointed Fiduciaries

The Section 3(16) Fiduciary – In addition to being designated as a fiduciary in the plan instrument, a person can become a fiduciary pursuant to a procedure specified by the plan. An example of this is a plan provision authorizing a Named Fiduciary to appoint another party, e.g. a third party administrator (TPA), as Administrator with fiduciary duties toward the plan. TPAs willing to assume this role are called Section 3(16) Fiduciaries in recognition of the fact that they are serving as the plan’s Administrator within the meaning of section 3(16) of ERISA.

A Section 3(16) Fiduciary can also accept appointment as the plan’s Named Fiduciary, provided the plan document has given the fiduciary appointment powers. Once the plan document has been amended, the employer will no longer be subject to ERISA penalties for any reporting or disclosure failures occurring while a TPA serves as Administrator. Moreover, if a TPA or other party replaces the employer as the Named Fiduciary, the new Named Fiduciary would have ultimate responsibility for controlling and managing the plan’s operation.

Unfortunately, even if a Section 3(16) Fiduciary agrees to assume complete plan administrative responsibilities as both Named Fiduciary and Administrator, it cannot fully eliminate the plan sponsor’s fiduciary oversight responsibilities. Given the fact that it is the sponsor’s decision to hire and retain a Section 3(16) Fiduciary, the sponsor remains ultimately responsible for the diligent selection and monitoring of such a service provider. The courts have held that even if a plan sponsor gives the Administrator control over the plan, the sponsor remains responsible for the Administrator’s appointment.⁷

It is important for plan sponsors to understand that their decision to appoint a Section 3(16) Fiduciary is itself an affirmative fiduciary act that must be made prudently in accordance with the fiduciary standards of ERISA. Moreover, plan sponsors should realize that they have an ongoing duty to monitor the performance of its Section 3(16) Fiduciary firm at reasonable intervals (e.g., annually).

OBSERVATION: Plan sponsors should be wary of any arrangement in which the Section 3(16) Fiduciary has the discretion to appoint itself to serve as the plan’s Investment Manager. If the unilateral exercise of such discretion results in any increase in the aggregate compensation of the Section 3(16) Fiduciary, it would be in violation of ERISA’s prohibited transaction rules, which bars fiduciary self-dealing.⁸ To the extent the plan sponsor considers hiring a Section 3(16) Fiduciary that holds itself out as both Named Fiduciary and Investment Manager (in addition to being the Administrator), the sponsor should ensure that it is paying a single fee for all bundled services. No prohibited self-dealing would occur under ERISA so long as the sponsor ensures that the Section 3(16) Fiduciary is unable to unilaterally increase the compensation that it earns.

The Section 3(38) Investment Manager – As with the position of Administrator, ERISA gives a Named Fiduciary the ability to hire an Investment Manager.⁹ ERISA defines an Investment Manager as any fiduciary who has the power to manage, acquire or dispose of plan assets and who has acknowledged in writing that it is a fiduciary with respect to the plan.¹⁰ In addition, an Investment Manager must be a registered investment advisor, bank or insurance company. When appointing such an advisor to serve in this capacity, the Named Fiduciary or plan sponsor should confirm that the advisory agreement properly includes a written acknowledgement of the advisor’s fiduciary status and that the other conditions of ERISA Section 3(38) have been met. Once an Investment Manager is appointed, the Plan’s Named Fiduciary and the Trustee are no longer responsible for the investments under the Investment Manager’s control.¹¹ However, the Named Fiduciary remains responsible for the prudent selection of the Investment Manager and for monitoring its performance.

A recent trend has been for certain financial advisors to volunteer their services as an Investment Manager. Such an advisor may refer to himself as a Section 3(38) Investment Manager in reference to the statutory provision under ERISA which sets forth the requirements for being an Investment Manager. As such, the advisor will generally have discretionary investment authority.

A properly appointed Investment Manager is fully responsible for its investment decisions relating to plan assets, including selection of a plan investment menu. Thus, an advisor that has assumed Investment Manager status is potentially liable for investment losses that result from acts or omissions that do not comply with ERISA’s fiduciary standards, (i.e., loyalty, prudence, diversification and operating within the terms of the plan document).

If a plan sponsor does not feel comfortable handing over all investment authority to an advisor, a Section 3(38) Investment Manager may offer hybrid section 3(38) services wherein the plan sponsor retains a significant degree of effective control over the plan’s investments. Under this hybrid section 3(38) service model, the Investment Manager would meet with the plan sponsor regularly, but all investment decisions would be made by the Section 3(38) Investment Manager. If the plan sponsor were to disagree with any proposed investment action, it would have the opportunity to terminate the advisor’s services before any investment changes were implemented. The plan sponsor would also be able to influence the advisor by amending the plan’s investment policy statement (IPS), since the Section 3(38) Investment Manager would have a duty to follow any investment guidelines included in the IPS under ERISA’s plan governance rules.¹²

The Section 3(21) Fiduciary – ERISA Section 402(c) (2) expressly permits Named Fiduciaries to hire providers of non-discretionary fiduciary advice on behalf of their plans. In recognition of the fact that investment advice is provided under section 3(21) of ERISA, these advisors are commonly referred to as Section 3(21) Fiduciaries. When a plan has participant-directed investments, a core responsibility of these advisors is to render advice on the selection and monitoring of the plan’s investment menu. The employer remains answerable for following or disregarding this advice, as well as for the prudence of any investment advice that is actually implemented. Both the employer and the Section 3(21) Fiduciary are jointly responsible for the plan’s investments. Because a party is only a fiduciary to the extent it exercises or has discretion with respect to matters of plan administration and management, a party acting as a 3(21) fiduciary is not necessarily liable for all breaches of fiduciary duty relating to plan investments. For example, in Bowers v. BB&T Corp.,¹³ a Federal District Court in North Carolina dismissed a claim of breach of fiduciary duty against a plan’s outside investment advisor, which alleged that the advisor had allowed the plan to invest in BB&T’s proprietary funds, which were alleged to have charged excessive fees and underperformed. In dismissing the claim, the Court concluded that plaintiff had only alleged that the advisor had provided general investment advice, while failing to allege any specific facts that advisor had breached its fiduciary duty to the plan.

Section 3(21) Fiduciaries have considerable flexibility in defining their role as investment advisors. In order to assist employers that prefer to retain full control over the plan’s investment menu, the advisor can choose to provide only non-discretionary advice and other core services as a Section 3(21) Fiduciary. In these arrangements, the advisor typically meets with the plan sponsor regularly in order to help it with the management of the investment menu.

Functional Fiduciaries

In addition to fiduciaries named in the plan document (i.e., Named Fiduciaries and Administrators) and appointed fiduciaries (i.e., fiduciaries under ERISA Sections 3(16), 3(21) and 3(38)), ERISA Section 3(21) provides three classes of ERISA fiduciaries that will attach to a plan service provider to the extent¹⁴ the provider performs the following specified acts:

•    Managing the plan on a discretionary basis or managing plan assets regardless of the lack of authority.¹⁵

•    Administering a plan pursuant to discretionary authority or responsibility.¹⁶

•    Providing investment advice with respect to the moneys or other property of a plan for a direct or indirect fee or other compensation.¹⁷

OBSERVATION: Plan sponsors and financial advisors that provide investment assistance to plans should be aware that these functional definitions can override the terms of an agreement for plan-related services by redefining the relationship between the parties and revising their respective duties. Each of these classifications is discussed in more detail below.

Fiduciaries Who Manage the Plan or its Assets – Section 3(21)(A)(i) of ERISA contemplates two discrete activities: (1) the exercise of discretionary management or discretionary control over the plan; and (2) the exercise of any authority or control over the management or disposition of plan assets. When evaluating the actions of a plan service provider, the threshold question is whether the service provider was performing one of these functions (i.e., acting as a fiduciary) when taking the action subject to a complaint.¹⁸ To the extent that a Trustee exercises discretionary control over a plan or its assets, the Trustee will be treated as acting in a fiduciary capacity and can be held liable if it breaches its fiduciary duties. This generally requires a close examination of the factual circumstances in which the purported management activities occurred.¹⁹ Note, however, that under the first prong, discretion is required, while under the second prong no discretion is required.

Courts have held that an investment provider’s selection of which mutual funds and which mutual fund share classes are to be included on a plan’s investment menu does not constitute management of plan assets and, therefore, does not transform the provider into a functional fiduciary under the management prong of the fiduciary definition.²⁰ In addition, an investment provider’s decision not to exercise its contractual right to replace funds on the plan’s investment menu with less expensive funds is not an exercise of fiduciary authority.²¹

On the other hand, an employer which has assumed control over managing plan assets by its conduct comes within the meaning of this fiduciary classification which entails the exercise of management authority over plan assets.²²

The DOL has taken controversial positions with respect to what constitutes discretionary management of a plan. In Advisory Opinion 2005-23A, it responded to the question as to whether an advisor’s recommendation that a participant roll over the account balance to an individual retirement account to take advantage of investment options not available under the plan constituted fiduciary investment advice with respect to plan assets. The DOL answered this question in the negative, but went on to state that such a rollover recommendation would, if the advisor were already a plan fiduciary in another capacity, constitute an exercise of discretionary authority respecting management of the plan.²³

Fiduciaries with Discretionary Administrative Authority or Responsibility – Section 3(21)(A)(iii) imposes fiduciary status on a person who has any discretionary authority or discretionary responsibility in the administration of a plan.²⁴ According to its dictionary meaning, the administration of a plan entails performing the duties imposed by the terms of the plan documents and exercising the powers conferred therein. The Supreme Court has concluded that trust administration means acting with those powers as are necessary or appropriate for carrying out the purposes of the trust,²⁵ a potentially broad definition. For example, while determining an employee’s eligibility for plan benefits or hiring a plan service provider can come within the meaning of administration, so might the discretionary authority of a platform provider to substitute funds.²⁶ The Supreme Court has also held that an employer’s false statements about the security of benefits made to plan participants amounted to an act of plan administration.²⁷

Regardless of the nature of the activity, however, a person will be deemed to be acting in a fiduciary capacity with respect to plan administration only if he or she has discretionary authority in the performance of the administrative services. If an administrator is given complete discretion to grant or deny benefits claims, the administrator acts as a fiduciary in performing that function. Moreover, fiduciary status flows from the mere possession of discretionary administrative authority, regardless of whether the authority is ever exercised.²⁸

On the other hand, if a party only makes a non-binding recommendation respecting coverage determinations, there is no fiduciary relationship created. Similarly, a court has held that acting strictly within the terms of a plan services agreement, for example, by passing through investment operating expenses in accordance with the agreement’s terms will not give rise to fiduciary to fiduciary duties.²⁹

Based on this need for an activity to have a discretionary component, the DOL has recognized that fiduciary status will generally not attach to persons who have no power to make any decisions as to plan policy, interpretations, practices or procedures. Thus, persons who perform administrative functions for an employee benefit plan within a framework of policies, interpretations, rules, practices and procedures made by other persons will generally not be treated as fiduciaries with respect to the plan.³⁰

Accordingly, the following functions have been held to not give rise to fiduciary status: (i) application of rules determining eligibility for participation or benefits; (ii) calculation of services and compensation credits for benefits; (iii) preparation of employee communications material; (iv) maintenance of participants’ service and employment records; (v) preparation of reports required by government agencies; (vi) calculation of benefits; (vii) orientation of new participants and advising participants of their rights and options under the plan; (viii) collection of contributions and application of contributions as provided in the plan; (ix) preparation of reports concerning participants’ benefits; (x) processing of claims; and (xi) making recommendations to others for decisions with respect to plan administration.³¹

Fiduciary Investment Advice (1974-2016) – Fiduciary status can also be imposed on a plan service provider or investment provider that renders investment advice with respect to plan assets for a fee or other compensation.³² As with those who exercise management powers with respect to a plan or its assets, fiduciary status may be based on a person’s conduct rather than title or formal designation and without regard to whether the person acknowledges, accepts or is aware of such status. In the case of an advisor providing investment advice, this kind of fiduciary is commonly referred to as a 3(21) Fiduciary after the ERISA provision establishing the criteria for imposing fiduciary status based on the provision of investment advice. (It should be noted that this is the same name given to advisors and others who voluntarily undertake to provide fiduciary investment advice.³³) In order to determine when fiduciary status attaches without consent, the DOL issued regulations in 1975 specifying the criteria to be applied in deciding whether or not advisory services are fiduciary in nature.

The DOL’s 1975 regulations amplified the statutory definition of an investment advice fiduciary by stating that a person would be viewed as rendering investment advice if the following five-factor test, discussed more fully, infra, was satisfied.

The DOL took the view that providing investment advice to a participant in an individual account plan that allowed participants to direct the investment of their accounts (as distinguished from providing plan-level advice) could also come within this Regulatory definition.³⁴ However, providing investment education or general advice relating to investment strategy, such as describing the asset classes that are consistent with long-term investing, would not fall within the definition of investment advice, because it was not geared to the particular needs of a plan or participant. Since 2010, as discussed more fully, infra when it initially proposed revising the five-factor definition, the DOL has taken the position that it is too narrow in today’s world, allowing many advisors to effectively provide advice without having to answer to the fiduciary standard of care under ERISA. In April 2016, the DOL issued final regulations, deleting the 1975 regulation and substituting a more expansive definition, along with a series of related prohibited transaction exemptions.

Chapter Endnotes

1.    ERISA§ 404(a)(1).

2.    Varity Corp. v. Howe, 516 U.S. 489 (1996); Tatum v. RJR Pension Investment Committee, 761 F. 3d 346 (4th Cir. 2014).

3.    ERISA §§ 402(c), 403(a).

4.    ERISA § 502(c). The failure to file a timely Form 5500 may result in a civil penalty of up to $ 1,100 per day. The failure to provide timely disclosures to a participant may result in a civil penalty of up to $110 per day.

5.    ERISA § 403(a).

6.    For a discussion of the fiduciary responsibilities of directed trustees, see DOL Field Assistance Bulletin 2004-03.

7.    See, e.g., Gelardi v. Pertec Computer Corp., 761 F.2d 1323 (9th Cir.1985) (holding that the employer and the employer’s board of directors remain liable with respect to the selection of the plan’s administrator).

8.    ERISA § 406(b). Section 4975 of the Internal Revenue Code includes mirror provisions imposing excise taxes on such prohibited transactions., except there is no parallel provision to 406(b0(2).

9.    ERISA § 402(c)(3).

10.  ERISA §§ 3(38), 402(c)(3).

11.  ERISA 402(c(3) and 405(d)(1).

12.  ERISA § 404(a)(1)(D).

13.  (M.D.N.C. April 18, 2017), No. 1-15-cv-00732.

14.  The inclusion of this language in ERISA Section 3(21) establishes that fiduciary status is not an all or nothing proposition. See, Coleman v. Nationwide Life Ins. Co., 969 F. 2d 54 (4th Cir. 1992); Kerns v. Benefit Trust Life Ins. Co., 992 F. 2d 214 (8th Cir. 1993); Payonk v. HMW Industries, Inc., 883 f. 2d 221, 225 (3rd Cir. 1989); Cotton v. Mass. Mutual Life Ins. Co., 2005 WL 604905 (11th Cir. 2005).

15.  ERISA § 3(21)(A)(i) provides that a person is a fiduciary with respect to a plan to the extent he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets.

16.  ERISA § 3(21)(A)(iii) provides that a person is a fiduciary with respect to a plan to the extent he has any discretionary authority or discretionary responsibility in the administration of such plan.

17.  ERISA § 3(21)(A)(ii) provides that a person is a fiduciary with respect to a plan to the extent "he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan,