Several years later, one of my friends – a Vice President in the Claims Department of my prior employer – decided to retire. The company was owned by General Electric at the time, and its 401(k) plan offered a surprisingly paltry array of investment options - most of which were dogs. Because the price of GE stock had skyrocketed under Jack Welsh’s leadership, my friend chose to roll all of his retirement plan funds into GE stock. A year later, he too would have been in about the same shape as if he had flushed half his funds down the toilet. 

Needless to say, my friend and I would have benefited greatly from the counsel of an investment professional at the time we made these decisions. However, no advisor reached out to us and, now that I have spent the past several years providing legal counsel to advisors in the retirement plan industry, I understand why.

That fact alone should be a clear signal that current regulations are preventing employees from getting advice they need to avoid making obvious mistakes as they try to build their retirement nest egg. However, the DOL has also worked to prevent employees transitioning into retirement from receiving investment advice as they roll their funds out of the plan and into an IRA.

To begin with, because most advisors refuse to be associated with qualified plans due to ERISA, they cannot proactively respond when an employee experiences a separation event. More importantly, though, many employees incorrectly assume the plan’s fiduciaries – including its investment advisor - will help guide them as they pull their funds out of the plan and invest them in an IRA. This often does not occur, however, because the DOL strongly discourages fiduciaries from providing this critical assistance.

Specifically, in Advisory Opinion 2005-23A, the Department of Labor took the position that, if an individual who is already acting as a plan fiduciary “responds to participant questions concerning the advisability of taking a distribution or the investment of amounts withdrawn from the plan,” the act of assisting the participant would be deemed to be the exercise of “discretionary authority respecting management of the plan.” Furthermore, if the fiduciary derives any monetary benefit in exchange for that assistance, then the act will likely be deemed the use of plan assets for the fiduciary’s own benefit in violation of §406(b)(1) of ERISA.

In other words, an advisor will be held to a fiduciary standard when responding to a participant’s request for assistance but may face significant penalties if he or she dares to seek compensation for incurring that duty by providing professional advice. Given that position, I can understand why retirement plan advisors might wish to refuse to help newly-retired participants – no matter how loudly they beg for assistance.

To be fair, I can understand the DOL’s concern from a purely theoretical standpoint. If an advisor being paid 25 basis points to provide advice to the plan could charge participants 100 basis points to manage their investments outside of the plan, the advisor would have a financial incentive to encourage participants to pull their investments out of the plan.

While this is certainly possible, real world considerations greatly lessen the probability that most advisors would actually attempt such a scheme. To begin with, the plan would quickly terminate the advisors contract and, the advisor would encounter difficulty in attracting future plan clients. Furthermore, if the advisor acted with a malicious intent and in violation of his fiduciary duties, the plan and its participants would have a legal claim against him.

However, malicious intent does not even appear to be a consideration under Advisory Opinion 2005-23A. In other words, even if the plan’s investment advisor reluctantly gave into a retired employee’s pleas for help in rolling her funds into an appropriate IRA and charged a fee for the service that everyone agreed was reasonable, the DOL appears to indicate that the advisor’s actions could still be deemed a prohibited transaction.

As in-house counsel for a broker-dealer that catered to retirement plan consultants, I sought advice from some of the top attorneys in the industry as to whether that interpretation of the DOL’s position was accurate. I was initially advised that a plan’s investment advisor could handle rollover accounts if a myriad of safeguards were in place to ensure that the participant acknowledged that he or she initiated the request for assistance and had only done so after already completing the rollover of the funds, etc., etc., etc. However, when I pressed, the attorneys always included the caveat that, even with all of these safeguards in place, allowing a plan’s investment advisor to handle any participant rollovers was extremely risky given the DOL’s position.

As a result, I always had to inform our advisors that they were not permitted to assist participants in rolling over their funds into an IRA – even if the participant specifically requested the assistance and even though I knew other plan advisors (who were not affiliated with our firm) were handling participant rollover accounts on a routine basis. Therefore, if this truly is the DOL’s position, then its lax enforcement is only harming those who chose to play by the rules.

However, if the DOL truly wants to protect employees who participate in their companies’ 401(k) plans, it needs to recognize that constructing barriers to prevent those employees from receiving professional advice actually does more harm than good. In most cases, the greatest danger plan participants face is not an unscrupulous investment advisor seeking to manage their IRA. Instead, the greatest risk plan participants face is their own ignorance in making important investment decisions.

As the former General Counsel of a broker-dealer and registered investment advisory firm that served the largest network of independent investment professionals working with retirement plan clients, I witnessed the absurdity of having two financial professionals provide essentially the same services to a qualified plan – with one accepting the obligation to charge a level fee as an investment advisor/fiduciary, while the other was able to collect varying amounts of indirect compensation as a “mere broker.” 

It is not surprising that we have arrived at this point once you consider how the retirement plan services industry evolved. With the explosion 401(k) plans and the advent of daily valuation technology,  many human resource directors and chief financial officers suddenly found themselves responsible for overseeing complex investment operations over which they had little, if any, expertise. Not surprisingly, once they realized the personal liability the faced under ERISA, they began to rely heavily on the brokers who sold the group annuity contracts used to manage those plans. Because these brokers offered services that went far beyond those typically associated with the sale of an investment (i.e. – participant enrollment and educational services, vendor search support, advice on meeting the plan’s fiduciary duties, etc.), these brokers were able to establish close and long-lasting relationships with their plan clients.

More recently, the marketplace has been shifting toward a fee-based, advisory platform as consultants recognize the advantages of marketing their status as fiduciaries. Needless to say, though, some professionals who have serviced retirement plan clients as brokers for many, many years have understandably balked at the notion they must rush out and take their Series 65 exam if they want to continue assisting their long-term plan clients. 

And that is one of the primary flaws in the DOL’s current approach. In trying to re-characterize every important vendor relationship as “investment advice,” the Department is bumping into other established regulatory regimes. However, while the services may not constitute “investment advice” – as the term is commonly understood - that fact does not diminish the importance of such relationships or the reliance many plan sponsors place upon them. In other words, while a CPA’s evaluation of a closely-held company’s stock price may not constitute “investment advice,” it is not unreasonable for a plan participant or committee member to expect that such an important service should be free from any conflict of interest.

In §3(21) of ERISA, Congress cited three types of persons who must act as fiduciaries to a qualified plan – those that exercise discretionary authority over the management of the plan, those that exercise discretionary authority over the administration of the plan, and those who are paid to provide investment advice to the plan. The difference between the groups should be readily apparent. Unlike the other two, a person providing investment advice does not have exercise any discretion to be deemed a fiduciary. The mere fact of providing advice, which the plan is free to accept or reject, was deemed sufficiently important to impose this heightened degree of duty. 

This, then, begs the question – What is so different about investment advice? Presumably, it is the danger of self-dealing. In other words, because an advisor could vary his or her compensation based upon the advice provided, plan participants could only be protected by a law that ensured there was no such conflict of interest. However, it would seem that the same principle would apply to vendors such as appraisers and brokers who provide services to a plan that go beyond merely selling a particular product.

Even for a small government conservative zealot like myself, this seems like an easy sale. The overarching goal of ERISA was to protect retirement plan participants from unethical practices and expanding the scope of vendors who will be held to a fiduciary standard is necessary to accomplish that end. Therefore, as I mentioned in my earlier article, I do not dispute the Department’s intentions (although I do agree with Mr. Scalia that ERISA should not be extended to IRAs). I merely disagree with the method it has chosen. The DOL should press Congress to amend §3(21) to address the fiduciary issues the industry is currently confronting. 

By now it should be apparent the Department of Labor (“DOL”) has opened a proverbial can of worms by proposing to expand the category of service providers who will be subject to ERISA’s fiduciary standard. Not only has the proposal been met with a tidal wave of negative comments from industry insiders, but Members of Congress from both parties have also weighed in with their objections.

While it may come as a surprise that an attorney who works with retirement plan professionals would support the DOL’s attempt to expand the fiduciary standard, I actually agree with the assertion that a change in the law is needed. As in-house counsel for a broker-dealer that supported the nation’s largest network of independent retirement plan professionals, I pushed hard to require our registered representatives to adopt the principles that form the basis for the proposed rule. Specifically, I encouraged our registered representatives to consider moving their practice to a fee-based advisory platform and affirm their fiduciary status. For those unwilling to make the switch, I pushed to require client agreements that affirmatively stated the representative was not intending to act in a fiduciary capacity. Like the DOL, I have my share of battle scars from the effort.

However, while I agree with the DOL’s goal, I cannot support its methodology for bringing about this change. Specifically, I believe the proposed rule (as currently drafted) violates the constitutional separation of powers by permitting an executive branch agency to rewrite existing law rather than interpreting the law as it is currently written.

The DOL has actually provided support for this argument by attempting to justify the revised rule with the argument that the world has changed dramatically since it last addressed this issue in 1975. While this is certainly true, our Constitution does not empower an administrative agency to change any law it believes has become outdated. While federal agencies have broad powers to adopt regulations necessary to enforce legislation, only Congress has the authority to fundamentally change the law (i.e., to legislate) – a prerogative I wish Members of Congress were more forceful in asserting.

In fact, the DOL announced its true intent in the title it assigned the proposed rule - “Definition of the Term ‘Fiduciary’.”  As the title clearly indicates, the DOL’s was seeking to use the new rule to broaden the types of services that will render the provider a plan “fiduciary” pursuant to §3(21)(A) of ERISA. The constitutional issue with this approach, however, is that Congress already defined the term “fiduciary” in the statute and did so somewhat narrowly. While the DOL believes the definition must be expanded, it also realizes it lacks the constitutional authority to directly revise the statutory language. As a result, the Department has attempted to pound a square peg into a round hole by using over 1,100 words to redefine the meaning of the phrase “investment advice” – as used within the statute – to significantly broaden the definition of a plan “fiduciary.” 

Needless to say, by straying so far from the common usage of the phrase, the DOL opened itself up for criticism stemming (presumably) from the unintended consequences of its proposed rule. For example, federal securities laws – namely, The Investment Advisers Act of 1940 – already regulate those who provide investment advice for compensation, and those rules apply whether the client is an 85-year old widow or a multi-billion pension fund. Therefore, if the DOL has its way, accountants offering to appraise the value of closely-held stock for an ESOP could find they are providing “investment advice” under one federal statute (ERISA) but not acting as an “investment advisor” under another (The Advisers Act). Similarly, brokers who have been servicing retirement plan clients for many years would be left to wonder whether they would now be required to register with the SEC to provide services to qualified plans when no such requirement existed for similar recommendations provided to non-ERISA clients. Needless to say, this seems to run afoul of President Obama’s recent instructions to federal agencies to avoid such confusing, inconsistent results.

Given that I have previously stated my support of the DOL’s stated goal, how would I recommend that it accomplish this end? Without intending to sound flippant, if the DOL wants to expand the definition of a “fiduciary” under ERISA, it must expand the definition of a “fiduciary” under ERISA. In other words, the language in §3(21)(A) should be amended to include those additional services (beyond providing investment advice or exercising control over plan assets) that will be subject to ERISA’s fiduciary standard. By taking this approach, brokers and appraisers could be brought within the definition of a “fiduciary” while not erroneously labeling their services “investment advice.”

However, only Congress has the power to amend ERISA in this fashion. As a result, the Department should be focusing its efforts on convincing Members of Congress of the value of its position rather than assuming it has the authority to change any law it feels has become outdated. While this is eminently more difficult, our Constitution created a series of checks and balances to ensure that ideas were thoroughly debated and flushed out before the law could be changed.

As I noted, I believe the DOL has a compelling argument for revising §3(21)(A), and it has already attracted the attention of important congressional leaders. The Department should use this opportunity to lobby Congress to enact the needed revisions to the language.

As I review advisors’ websites and advisory agreements, I sometimes see “plan design consulting” as a service offered to retirement plan clients. While there is nothing inherently wrong with assisting clients with the design of their plans, I would caution that the DOL has long viewed such services as being materially different from other non-fiduciary activities. 

Specifically, in a publication entitled “Guidance on Settlor v. Plan Expenses,” the DOL noted:

The department has taken the position that there is a class of activities which relates to the formation, rather than the management, of plans. These activities, generally referred to as settlor functions, include decisions relating to the formation, design and termination of plans and, except in the context of multi-employer plans, generally are not activities subject to Title I of ERISA. Expenses incurred in connection with settlor functions would not be reasonable expenses of a plan.

While the same publication claims that, “Plan design expenses clearly constitute settlor expenses and, therefore, are not payable by the plan,”[1] the basis for the DOL’s position is less than clear.  In fact, the term “plan design” is never used in ERISA. Neither is “settlor expenses.” Instead, the DOL appears to draw support for its position from the law’s emanations and penumbras. 

For example, in Advisory Opinion 97-03A, the DOL indicated its position was required, in part, by the following language in §403(c)(i):

(T)he assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purposes of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan. 

In order to tie its position to this statute, the DOL must necessarily conclude employers do not form retirement plans “for the exclusive purpose of providing benefits to participants in the plan” but, instead, primarily to further their own interests. To be fair, our Supreme Court has opined that employers derive some incidental benefits by forming a retirement plan (e.g., in the recruitment and retention of employees).[2] Surprisingly, though, the DOL brushed aside any reliance on this argument, arguing that such incidental benefits are not sufficient to convert an activity into a “settlor expense.”[3]

As a result, advisors should be forgiven for not having a good understanding of when their advice becomes a “plan design expense” that cannot be paid from plan assets. The best guidance the DOL has offered in that regard is that, “Typically, plan design expenses are incurred in advance of the adoption of the plan or a plan amendment.”[4] 
 

As a result, the issue may be one of simple semantics. Specifically, if any portion of your fee will be derived from plan assets, your advisory agreement should not offer “plan design consulting,” “plan design audits,” or “plan design (anything else).” Instead, your services (whatever you decide to call them) should be limited to providing ideas for improving the implementation of the plan’s governing documents as opposed to suggesting changes to them. 

If you do provide “plan design” services, they should be offered under a separate agreement in which the plan sponsor pays your compensation directly. However, even that may not be sufficient. Keep in mind that DOL considers “plan design” services to be settlor expenses, which are defined as activities primarily designed to benefit the employer.  Taking this argument to its logical conclusion, there would seem to be an inherent conflict of interest if a plan fiduciary (who is required to act solely in the interests of the plan’s participants) is simultaneously performing settlor functions. As a result, there may be a risk in offering “plan design” services to the plan’s sponsor if you are already providing investment advice to the plan or its participants.

Finally, as always, I would caution practitioners to review their professional liability policies to ensure they have coverage for "plan design services."  Because these policies are typically drafted for advisors and brokers who service retail investors and no FINRA license is required to consult on retirement plan design, your policy may not define this activity as a covered professional service.

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. 

If an employer appoints an investment manager the employer is responsible for the selection of the manager, but is not liable for the individual investment decisions of that manager.  However, an employer is required to monitor the manager periodically to assure that it is handling the plan's investments prudently and in accordance with the appointment.¹ 

As a result, it would be erroneous to maintain that the appointment of an investment manager under section 3(38) completely absolves a plan from any potential responsibility and, thus, liability for the plan's investment decisions.  Instead, consistent with the standards set forth in the Uniform Prudent Investors Act, ERISA plan sponsors have a duty to prudently select an investment manager and periodically review the manager's activities.  As with any legal duty, a breach may result in liability.

Conversely, it is equally absurd to claim an investment advisor incurs no legal risk in providing advice to a plan.  If that were true, advisors who focus solely upon assisting ERISA qualified plans should immediately cancel their E&O coverage - a stance I would certainly not encourage.

In reality, most plan committee members have little or no expertise with investments.  In fact, you may be surprised by the sudden transformation of the company's CFO, who tried to convince you he was the second-coming of Warren Buffett before the plan's participants filed the class action suit, but now asserts in deposition he knows nothing about investing.  After all, if the committee members had the requisite expertise, why would they need to hire an investment advisor?

Under the "prudent man standard of care" which can be found at section 404(a)(1)(B) - any plan fiduciary is required to act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters...(emphasis added).  So what is the prudent response when you lack the requisite expertise to perform your duties?  You hire an expert for advice.

However, as the courts have noted, securing an independent assessment from a financial advisor is not a complete defense to a charge of imprudence.  Instead, The fiduciary must: (1) investigate the expert's qualifications, (2) provide the expert with complete and accurate information, and (3) make certain that reliance on the expert's advice is reasonably justified under the circumstances.²

Therefore, just as with the delegation to an investment manager, the plan must conduct proper due diligence before retaining an investment advisor and evaluate the reasonableness of the advisor's proposed plan of action.  Assuming these requirements are met, the court will likely find the plan satisfied the prudent man standard and then evaluate the advisor's recommendations based upon the higher standard applicable to an investment expert.

As a result, from a practical standpoint, while a plan may be have slightly more cover in relying upon an investment manager as opposed to an investment advisor (given the difference between monitoring decisions after they have been made as opposed to approving them in advance), in either instance, the court will likely look to the professional who was paid for his expertise as the party most responsible for a plan's investment losses.

¹ Meeting Your Fiduciary Responsibilities at
http://www.dol.gov/ebsa/publications/fiduciaryresponsibility.html

²Howard v. Shay, 100 F.3rd 1484, 1489 (9th Cir. 1996).

While I rarely shy away from expressing my opinion on the political issues of the day, it is not my intent to weigh in on the broader debate regarding the role of public employee unions. In fact, I would note that Bob Toth (with whom I practice) and I come from decidedly different sides of the political spectrum. However, as attorneys focused on retirement plan issues, there is one aspect of the current debate on which we agree; namely, that states, like most private employers before them, need to shelve their current approach of handling their defined benefit plans.

This is not a new issue for either of us. Bob actually penned an article and a follow-up noting the limitations of traditional pension plans back in 2009 and, in 2010, I based my campaign for the Indiana General Assembly on a pledge to address our state’s public retirement plans (which were estimated to face a funding gap of almost $47 billion). While my run for public office was unsuccessful, I was recently asked to testify in favor of a bill (SB 524), which would require the state to study the prospect of switching to a defined contribution plan to provide retirement benefits for public employees and teachers.

According to a recent article in the New York Times entitled “Pension Funds Strained, States Look at 401(k) Plans,” Indiana is not alone in realizing the risks posed by promising lifetime payments to public employees without proper funding. Furthermore, this trend is bound to continue as taxpayers become educated regarding the huge deficits currently faced by many public pension plans. As I noted in my testimony to the Indiana Senate Committee on Pensions and Labor, unlike private plans, public pension funds have been permitted to discount future liabilities based upon projected future annual investment returns. 

For example, Indiana’s retirement funds assume a 7.25% annual return when projecting the current funding necessary to provide promised benefits to future retirees. However, according to Standard & Poor’s, the total return of S&P 500 over the past five years was just 2.4%! Furthermore, according to Joshua D. Rauh, who is with the Kellogg School of Management at Northwestern University, even if Indiana’s retirement funds were to achieve an average annual return of 8% on their investments, they would still run out of cash by 2019 (assuming cost of living adjustments based upon a 3% inflation rate).

Unfortunately, few state legislators know how to manage their own retirement portfolios, let alone the complex requirements of a multi-billion pension fund. However, as noted, the potential risk to future state finances posed by these plans is enormous. Our firm has offered its expertise to Indiana lawmakers to assist them in designing a program that will assist public employees in achieving income security at retirement while also protecting state taxpayers. In this regard, we are fortunate to have associations with several prominent think tanks from which we can derive additional support.

We would urge other retirement plan professionals to do the same; namely, take a look at the public retirement plans in your own state to determine if they are in need of additional professional guidance. As the saying goes, “The cobbler’s children go unshod.” However, let’s not let this maxim apply to the retirement plans managed by our state and local governments when we can offer assistance - either directly or through referrals to qualified experts. Our own financial future may depend upon helping them manage their way out of this current crisis.

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.