The Department of Labor (“DOL”) proposed an amendment (the “Proposed Amendment”) to the regulation that defines “investment advice” for purposes of determining fiduciary status under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). The Proposed Amendment would significantly expand the circumstances under which financial services companies and other persons providing services to ERISA plans are considered to be plan fiduciaries. The deadline for submitting comments to the DOL regarding the Proposed Amendment is January 20, 2011.
ERISA imposes strict standards of conduct on fiduciaries, prohibits specified transactions involving plans, and subjects fiduciaries to substantial potential liability if those standards or prohibited transaction rules are violated. Under ERISA, a person is a fiduciary to the extent he has or performs certain specified functions – including rendering “investment advice” for a fee or other compensation, or having the responsibility or authority to do so. Over the past 35 years, an understanding regarding the scope of what constitutes “investment advice” for this purpose has developed based on two DOL pronouncements issued shortly after ERISA’s enactment.
Since 1975, the current ERISA regulation defining investment advice has provided that, for this purpose, a person or entity generally is considered to render investment advice to a plan only in the following circumstances:
the person or entity provides advice 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,
on a regular basis,
pursuant to a mutual agreement, arrangement, or understanding, with the plan or plan fiduciary, that
the advice will serve as a primary basis for investment decisions with respect to plan assets, and that
the advice will be individualized based on the particular needs of the plan.
In addition, a 1976 DOL advisory opinion concluded that, under this definition, an entity was not rendering investment advice when it provided a valuation of closely-held securities to be relied upon by an ERISA plan in making a decision whether to purchase the securities.
The Proposed Amendment would fundamentally change the standards established by the existing regulation and the 1976 advisory opinion. As discussed below, the Proposed Regulation would (i) provide a new, broader definition of “investment advice;” (ii) identify conditions under which rendering investment advice would confer fiduciary status; (iii) establish exceptions regarding certain aspects of the definition; (iv) provide an expansive definition of the types of fees (or other compensation) for purposes of fiduciary status based on investment advice; and (v) make clear that the Proposed Amendment would apply for purposes of the prohibited transaction excise tax provisions of Section 4975 of the Internal Revenue Code of 1986, as amended (“IRC”), regarding individual retirement arrangements (“IRAs”) and other tax-favored plans.
Definition of Investment Advice
Under the Proposed Amendment, “investment advice” would encompass making recommendations as to the advisability of investing in, purchasing, holding, or selling securities or other property. In addition, investment advice would include providing advice, or an appraisal or fairness opinion, concerning the value of securities or other property. In its preamble to the Proposed Amendment, the DOL specifically noted that this change was intended to supersede the 1976 advisory opinion, and emphasized that the modified definition would include valuations and appraisals of not only securities but also other property such as real estate. Finally, the definition would also include providing advice or making recommendations as to the “management” of securities or other property (e.g., advice regarding the voting of proxies or the selection of investment managers).
Conditions to Fiduciary Status
Even if a person’s activities fall within the definition of investment advice, he will not be considered to be a fiduciary under the Proposed Amendment unless one or more of the following conditions are satisfied by such person directly or indirectly (e.g., through or together with an affiliate):
the person represents or acknowledges that it is acting as an ERISA fiduciary with respect to providing advice or making recommendations within the scope of the definition of investment advice described above;
the person is a fiduciary with respect to the plan based on other components of the ERISA statutory definition of fiduciary (i.e., the person exercises discretionary authority or control respecting management or administration of the plan, or any authority or control regarding management or disposition of plan assets);
the person is an investment adviser within the meaning of Section 202(a)(11) of the Investment Advisers Act of 1940; or
the person provides advice or makes recommendations within the scope of the definition of investment advice described above, pursuant to an agreement, arrangement, or understanding, written or otherwise, between such person and the plan, a plan fiduciary, or a plan participant or beneficiary that such advice may be considered in connection with making investment or management decisions with respect to plan assets, and will be individualized to the needs of the plan, a plan fiduciary, or a participant or beneficiary.
While this fourth condition may in some respects resemble the standards of the current regulation (as discussed above), there are a number of significant differences. For example, under the Proposed Amendment there would be no requirement that the advice be provided “on a regular basis” and there need only be an understanding that the advice will “be considered in connection” with the decision, rather than serving as “a primary basis” for decision-making. Moreover, the requirements of the fourth condition would not need to come into play if any of the other three conditions are satisfied.
Even if a person’s activities fall within the definition of investment advice, and one or more of the conditions described above are satisfied, he would not be considered to be a fiduciary by reason of such advice if one of the following exceptions under the Proposed Amendment applied.
One exception would apply if the person can demonstrate that the recipient of the advice knows (or reasonably should know), that the person providing the advice or recommendations (i) is acting as purchaser or seller (of securities or other property) whose interests are adverse to the plan (or an agent of, or appraiser for, such a purchaser or seller), and (ii) is not undertaking to provide impartial investment advice. This exception is not available where the person, directly or indirectly (i.e., through an affiliate) represents or acknowledges that it is acting as an ERISA fiduciary with respect to providing advice or making recommendations within the scope of the definition of investment advice above.
Other exceptions would be available where the plan is an individual account plan (such as a 401(k) plan). For example, a person would not be considered to be a fiduciary solely by reason of providing investment education and materials to participants and beneficiaries of an individual account plan, as described in the DOL’s Interpretive Bulletin 96-1. Another exception would apply to a provider of an investment platform (through which the plan makes investments available to participants and beneficiaries) so long as the provider discloses in writing to the plan fiduciary that the provider is not undertaking to provide impartial investment advice. This exception would be available where the platform provider provided the plan fiduciary with general financial information and data to be used for selection and monitoring of the plan’s investment alternatives.
The Proposed Amendment also includes an exception for preparation of general reports or statements reflecting the value of a plan investment that is provided for purposes of complying with reporting or disclosure requirements of ERISA or federal tax law. However, this exception would not apply where the report (i) involves assets that have no generally recognized market, and (ii) is the basis for making distributions to plan participants or beneficiaries.
Definition of Fee or Other Compensation
As noted above, a person is a fiduciary by reason of rendering investment advice only if that advice is “for a fee or other compensation, direct or indirect.” The Proposed Amendment would expansively define this term to include fees or other compensation received by the person rendering the advice (or the person’s affiliate) from any source, and any fee or other compensation incident to the transaction in which the advice has been (or will be) rendered. This would include, for example, commissions for brokerage, or mutual fund or insurance sales, and would encompass fees and commissions based on multiple transactions involving different parties.
Application to IRAs and Other Arrangements Subject to IRC §4975The Proposed Amendment would apply not only for purposes of the fiduciary provisions of ERISA, but also to determinations made under IRC §4975, which imposes excise taxes on certain “prohibited transactions” involving IRAs and certain other tax-favored arrangements (such as qualified retirement plans under IRC §401(a)), whether or not subject to ERISA. For example, the Proposed Amendment would apply for purposes of determining whether a financial services company is acting as a fiduciary of an IRA where the financial services company may be subject to excise taxes under IRC §4975 if it engages in self-dealing with respect to assets of the IRA.