In an effort to improve its enforcement efforts and better protect participants from service provider conflicts of interest and self dealing, the Department of Labor issued proposed regulations on October 21, 2010, that would significantly expand ERISA’s definition of a “fiduciary.” These regulations will, when finalized, replace guidance issued in 1975 which governs when investment advisors become subject to ERISA’s fiduciary duties. The new standards will apply to all employee benefit plans subject to ERISA – including health plans – although their primary application will be to defined contribution retirement plans. They have the potential to substantially change the nature of the relationships between employers and service providers.
The DOL’s existing guidance employs a five-part test to determine when such advisors provide “investment advice for a fee,” and thus become fiduciaries. The proposed regulations do away with that test and, in the process, significantly broaden the range of investment advisory relationships that give rise to fiduciary status.
Although competitive forces over the past few years have forced many consultants who provide advisory services to ERISA plans to embrace – rather than disclaim – their fiduciary role, some continue to contend that they are not subject to ERISA’s prudence, exclusive benefit, and prohibited transaction rules that apply to fiduciaries. They contend that their advice is not given on a “regular basis” under a “mutual understanding” that their advice will be a “primary basis” for plan investment decisions. The new regulations will make it much more difficult to make this argument, as they do away with these prerequisites for fiduciary status.
The proposed regulations also would specifically include the provision of appraisals and fairness opinions in the list of functions that create a fiduciary relationship. This change is designed to address frequent problems that arise involving the valuation of employer securities, such as those held in ESOPs. In addition, the new rules would clarify that any fee or compensation received by the advisor – or an affiliate of the advisor – incident to the transaction in which the investment advice is provided would count for purposes of determining fiduciary status. This would include brokerage, mutual fund, and insurance commissions received from any source, as well as fees or commissions based on multiple transactions involving different parties.
In its proposed regulations the DOL clarified its view that advisors can become ERISA fiduciaries by providing either plan-level advice (i.e., advice to plan fiduciaries) or participant-level advice (i.e., advice to individual participants). The DOL intentionally left open another issue, however, which could even further expand the number of advisors who are ERISA fiduciaries. That issue is whether advice to participants about taking a plan distribution or investing distribution proceeds in options outside the plan (such as IRA rollover options) will create a fiduciary relationship. Although the DOL took the position in a 2005 Advisory Opinion that ERISA’s rules would not apply to such advice unless the advisor was already a fiduciary, the proposed regulations may signal an intention to reconsider that position. (We summarized the DOL’s position in our March 2006 article.)
The regulations also may signal the DOL’s views about an issue that has been raised in litigation involving 401(k) plan fees. In a number of those cases the plaintiffs have argued that service providers like Fidelity, which offer a platform of investment funds from which plan sponsors may choose in creating the plan’s individualized fund lineup, become plan fiduciaries simply by creating and offering that platform. (See our September 2008 article for a summary of that theory.) The proposed regulations identify the creation of such a platform as a function that does not create fiduciary status, as long as the service provider discloses in writing that it is not giving impartial investment advice about constructing the plan’s investment menu. We can expect such service providers to use this aspect of the proposed rules as a shield to fiduciary liability in these cases.
If finalized in their proposed form, the new rules will make it much more likely that investment consultants will be considered ERISA fiduciaries. Advisors who are dually registered as both broker-dealers and registered investment advisors may find it particularly difficult, as they will no longer be able to rely on the old five-part test to avoid fiduciary status when dealing with their nonadvisory clients. Appraisers and valuation experts also are more likely to become subject to ERISA’s fiduciary standards. And all of these changes are likely to have an impact on the relationships that service providers have with plan sponsors.