Business of Benefits : Employee Benefits Lawyer & Attorney : Law Office of Robert J. Toth, Jr. : 403(b) Plans, Annuity & Insurance Law : Business of Benefits Blog

 I have had the pleasure recently of making a presentation to the National Society of Compliance Professionals Midwest Compliance Meeting with Chris Guanciale of PlanMember Services. The NSPC is a nonprofit membership organization dedicated to serving and supporting compliance officials in the securities industry. What we had to say to them was not particularly good news for these overworked professionals. 

There has been a distant relationship in the past between the application of securities law and the application of ERISA. See, for example SEC Release 33-6188 (among other releases) where the SEC describes its essentially "hands off " position with regard to retirement plans.

Over the past few years, with the new found activism of the DOL and the growing impact of retirement plans in the securties market (as of 3rd quarter last year, retirement plans-both ERISA and non-ERISA- had a value equal to about $16 trillion, which was some 88% of the value of publicly traded securities in the Unitied States. Individual account plans like most 401(k) and 403(b) plans, are a "mere" $4 trillion dollars of that total, or some 23% of the value of publicly traded securities), this distance has been "shortening". I have blogged a number of times on this point. 

So now we have the new 408(b)(2) regs, which I often term as potential "business busters" because they speak to the fundamental basis of doing business in this very large retirement plan marketplace: getting paid for the services provided. If you are in this business, compliance with 408(b)(2) is a fundamental issue, because it is a prohibited transaction exemption. Without compliance with 408(b)(2), the business often cannot receive some of their compensation for services related to ERISA retirement plans.

The sorts of things 408(b)(2) covers are at the heart of the Security Compliance Professionals' practice: disclosure, particularly with regard to fees generated off of investments. It seems that "Compliance" is really the only institutional structure many financial firms have under which they can implement, manage and control their 408(b)(2) practices.  And any new "fiduciary" rules only further complicates this task.

Attached is the outline provided for this presentation. Hopefully, you'll find it helpful. 

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I drafted the following article for the DCPI Weekly Exchange as the first of an ongoing series of comments on fiduciary issues.  DCPI's newsletter can be accessed (with a free subscription) at http://www.dcpinstitute.com.

Okay, I will admit it.  I have not spent my entire legal career focused upon ERISA.  In fact, before joining National Retirement Partners as in-house counsel to its broker-dealer and registered investment advisory firm, I served as counsel to an insurance company and, yes, as a plaintiff's attorney. 

However, having such varied experience can sometimes provide a more nuanced perspective.  Take, for example, the ongoing debate regarding the benefits and drawbacks of serving as an investment advisor to ERISA-qualified plans under section 3(21)(a)(ii) or as an investment manager under section 3(38). 

If you were to merely read ERISA, you would likely conclude there are significant differences in the potential liability being assumed under each role.  After all, an investment advisor, by definition, merely provides advice to the ultimate decision-maker.  By contrast, an investment manager manages the fund's assets on a discretionary basis.  In fact, section 405(d)(1) of ERISA specifically provides immunity to plan trustees for the acts or omissions of an appointed investment manager. 

Unfortunately, some commentators have attempted to use these statutory differences to assert that investment advisors have no legal liability because they are providing nondiscretionary advice, while investment managers completely shield plan sponsors from legal liability by acting with discretion.  Upon closer inspection, however, these theoretical distinctions quickly break down. 

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Working through the technical terms of 408(b)(2) is not much different than putting together a picture puzzle. There are a lot of pieces which fit together in some very precise ways. But, in the end, the disclosures which are required are pretty straightforward and-even given the work needed to describe certain ”wrapped” services and estimating their costs- can be made very simply. Keep in mind Asimov’s concept of “Minimum Necessary Change," upon which I blogged a while back.

Long pages of disclosure are not necessary or warranted. 

There are certain keys to making it work, and making the disclosure simple. Keep a few things in mind:

•  Are you really a “Covered Service Provider” (CSP) that has to make a disclosure (see, for example, my piece on annuity investment accounts)? Remember, a CSP has a direct contract or arrangement with the plan, and that is the party that has to disclose-and only certain service providers are subject to disclosure rules. So, for example, a TPA which doesn't maintain the financial records (such as where a 401(k) plan is funded with allocated group annuity contracts; or for most 403(b) plans which are funded with individual annuity and custodial contracts);  whose fees are paid directly by the employer or the plan; and for which the TPA doesn't receive 12b-1 fees, commissions, or other indirect compensation are not CSPs and need not disclose under the new reg.

• Are you an affiliate or a subcontractor? If so, you don’t need to disclose, but the CSP needs to disclose what they pay you. This generally may include insurance agents who sell annuity contracts to 401(k) or 403(b) plans, and who are likely to be "subcontractors" because of their servicing the contract with things like enrollment services.The caution to those folks: make sure you understand what the actual CSP is saying about you.

• Make sure you are a “recordkeeper” before you commit to making financial disclosures. Many TPA’s are not 408(b)(2) recordkeepers on much of their business.

• Keep the disclosures simple, short and sensible. Check existing documents first, as most of the required disclosures may already be in the existing service agreement, policy or other existing agreement.

• For those who will receive indirect comp from a number of sources, try to standardize what you say about them, and create a short disclosure statement. Only send to those plans which generate that comp.

•  Over-disclosure is as bad as under-disclosure. Review and edit the description of indirect comp programs that others give you, to make sure it actually applies to you and properly describes your role in it all.

• Tweak your contract form to accommodate what you say in the disclosure, if necessary. Many existing contracts will not need to be changed to meet the rules.  Even then, however, consider incorporating some helpful changes when renewing the contract.

It does get a bit messier where data on the underlying investment needs to be disclosed, but even this is straightforward and can be simply made from existing data from accessible sources, and can be made in a standardized format.

Follow these guidelines, and you may be surprised with how simple the 408b2 disclosures may really be.

___________________________

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 Generally unnoticed in the DOL’s proposed fiduciary reg was the implicit recognition that the commissioned based sales function is important to the operation of the market, and that you can “sell” until the cows come home (a good friend tells me, by the way, that the cows actually do eventually come home),  or until you become a fiduciary.  Anyone familiar with the successful salesperson knows that they are only able to sell once they establish a level of trust with the plan fiduciary, which is why trade organizations are taking the DOL to task on the requirement that the salesperson, in order to be recognized as not being a fiduciary, must then advise the fiduciary (with whom a relationship is being forged) that he or she may have adverse interests to the plan.

However that language is eventually finalized, it raises an important question that hasn't really been addressed well, being a sort of red-haired stepchild of ERISA: Just what is “sales”and how are commissions treated? Finding your way through it can be trying, as if its a practice in ERISA metaphysics, mysticism and alchemy.

It starts with the basic question of whether or not “sales” is considered a service. It does seems almost metaphysical, and would be amusing if it didn't have a very real impact.   Commissions from pure sales of an investment product to a plan from a party without an existing relationship to a plan (either on its own or through an affiliate) does not seem to be governed either by 408(b)(2) or by the prohibited transaction rules.  “Sales,” by itself does not seem to be a service covered by 408(b)(2), and the payment of a commission to a someone who is not a party of interest may raise fiduciary concerns if too much is paid, but it is NOT, in itself, a prohibited transaction.  But there are times where sales and the payment of commission may eventually be considered services, where there becomes an ongoing, supportive relationship.

Lets go over some “pure sales” scenarios, with the impact of “sales as service” perhaps being handled in a future blogs:

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The DOL's newly delayed 408(b)(2) regs are particularly striking in that they demonstrate a growing sophistication, and efficiency, on the part of the EBSA staff in its approach to retirement plan financial products and services. The regs are short, by almost any measure of federal regulations, yet they are packed with meaningful rules which will apply in different ways to different product and services.  

The marketplace is a fast moving one, with complex instruments and services being used in new and unusual ways. Keeping up with this whirlwind is a challenge for the industry and employers, let alone a government regulatory agency which must somehow craft rules which have broad application to ever-shifting, complex and unanticipated circumstances.  Though not always successful, the DOL is approaching its learning curves impressively-including the way in which continues to seek to know and understand what it does not.

A prime example of this is the manner in which the 408b2 rules apply to variable investment accounts within the annuity contracts used to fund 403(b), 401(k) and other 401(a) plans. What is fascinating is that the word "annuity" only shows up with regard to IRAs;  the words "individual," "group," "variable," "fixed," "registered," or "non-registered"-all of which are descriptors of a variety of different sorts of annuity contracts- never show up; and the word "insurance" only appears once. Yet, it provides clear guidance on how these investment products are to be regulated. 

Lets take a quick look at the way the rules apply differently to registered variable annuity separate accounts (lets call these "Type 1" for purposes of this blog) typically used in the 403(b) market, and the way they apply to non-registered variable annuity separate accounts (which I'll call "Type 2") typically used in 401(k) plans.

This, by the way, is important for plan sponsors to know because they have to sort out whether they are receiving the disclosures they need, and report it to the DOL if they are not.

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But first, an introduction.... 

Today, we are pleased to introduce the writings of Phil Troyer, who has just joined our firm.  Phil brings a fascinating and badly needed skill set to the retirement plan world: a deep knowledge of the broker-dealer and retirement plan advisor marketplace; practical experience on how ERISA, and its fiduciary rules, actually work (and don't work) in that part of the market;  and, rare for our world, being deeply grounded in how insurance liability coverage actually works for fiduciaries and plans.  Check out his bio n the "About" section of this website, and feel free to contact him at pjt@rtothlaw.com.

Phil's blog piece on being a naked fiduciary:

Are You a Naked Fiduciary?

Much has been written about the Department of Labor’s proposal to broaden the definition of “investment advice” to bring more service providers under the fiduciary standard of care. However, lost in the plethora of articles summarizing its potential effects is a question that should be foremost on the mind of every registered representative who provides services to qualified plans; namely, will I be left without insurance coverage (i.e. “naked”) if I am deemed to be a fiduciary as a result of providing investment advice to my plan clients? 

The answer - which may come as a shock to many representatives - is that it depends. Specifically, it depends upon the specific language used in their professional liability policy to exclude coverage for claims arising from the insured’s status as a fiduciary of an ERISA-qualified plan. 

The basis for the ERISA-fiduciary exclusion contained in most E&O policies is understandable because serving as an officer or administrator of a retirement plan is not generally considered to be a service broker-dealers offer to their clients.[1] Furthermore, separate “ERISA Fiduciary Liability” policies are available for individuals who serve as named fiduciaries of a qualified plan. As a result, insurance carriers have a justifiable reason for ensuring their professional liability policies are not used to bootstrap coverage when a registered representative happens to serve as an officer or administrator of a qualified plan.  Unfortunately, though, these exclusions are not always drafted with sufficient care.

For example, a policy that excludes coverage for “any services performed by any Insured acting as a fiduciary under ERISA,” creates a significant landmine for registered representatives with retirement plan clients because - even under the current definition of “investment advice” - they could be deemed to have acted in a fiduciary capacity by providing investment recommendations to the plan on a regular basis. Obviously, this risk will increase dramatically if the DOL’s expanded definition is enacted to remove the requirement that the recommendations be provided on a regular basis.

Conversely, exclusions based upon the insured’s status as a “named fiduciary, as defined by ERISA” miss the point that the law allows a plan’s named fiduciaries to “designate persons other than named fiduciaries to carry out fiduciary responsibilities.”[2] As a result, the exclusion may not be sufficient to prohibit coverage for a registered representative who was not specifically designated as a fiduciary by the plan but is later deemed to be acting as one as a result of providing management or administrative services to it on a contractual basis.

If insurance companies intend to exclude coverage for services not typically performed by registered representatives (i.e., managing or administering a qualified plan) while preserving coverage for services which are (i.e., providing recommendations regarding investments), then the carriers should be careful to base their exclusionary language on the activity being performed as opposed to the insured’s status as a fiduciary under ERISA. 

At the same time, registered representatives would be well served to dust off their E&O policies to determine whether they will currently have coverage if they are deemed to be a fiduciary under ERISA – especially before a new definition of “investment advice” makes it more likely to occur. Otherwise, they could find they were walking around naked at the time they most needed coverage.

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As 403(b) plan sponsors continue to understand and apply new regulations, meet expectations in their roles as fiduciaries and seek assistance with some very tough decisions, the comparison between 403(b) and 401(k) plans generally takes place.  Spending time pondering this question is not a waste of time.  However, there is NO blanket statement declaring either plan type is better than the other for every plan sponsor.  Facts and circumstances must be identified and considered before starting up a new plan or terminating a plan possibly with the intent to set up a different type of plan.

Expenses related to plan documentation, investment products and administrative services are usually the first items to hit the list for consideration on what plan is best suited for the plan sponsor. Weighing the cost is certainly an appropriate approach.  But don't end up paying the piper because you failed to consider potential limitations with your new plan design... 

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