Recently the Department of Labor released a proposal to broaden its definition of an ERISA fiduciary. The new definition, if adopted, is good news for employees investing in work retirement plans because more people providing advice will be held to a higher level of accountability for that advice.
Currently, there are many ways that consultants, advisers and appraisers can influence employer-sponsored plan investment decisions – at the individual level and the plan level – without taking on fiduciary responsibility for the recommendations they make. The proposal aims to tighten up this area and deem more influencers with fiduciary responsibility.
As the law stands today, an ERISA fiduciary falls into one of three categories. The second category is the subject of this proposed reform. Under the second category, persons who provide investment advice for compensation are fiduciaries. The definition of investment advice is at the heart of the proposed changes.
To define investment advice, the current and proposed regulations each have a two-part test. The new proposal broadens the language and adds new elements to the test:
Two-part Test: Part 1
The first part of both versions (current and proposed) describes the services a person would perform, for a fee or other compensation, to fall into the category of providing investment advice. There are two noticeable changes in the proposal:
- New wording expands the formal written parameters of fee or other compensation to include broader language from court interpretations of the definition. The proposal states fees and compensation can be direct or indirect, incidental or purposeful; compensation can be for current or future advice from any source.
- The new proposal also seeks to include more services than the existing regulation. It would add: (1) appraisers and (2) people who make recommendations about personnel who manage securities – for example, advising someone how to vote in a proxy election to select the managers of plan investments.
The second part of both versions (current and proposed) includes several alternative conditions. Under the new proposal, people must meet at least one condition to fall under the investment advice parameters of a fiduciary.
- Acknowledged ERISA fiduciaries: people who explicitly state they are fiduciaries, whether in writing or verbally, regardless of whether they meet any other criteria.
- Nonadvice ERISA fiduciaries: people who exercise control or discretionary authority over plan investment decisions or over plan administration.
- Securities law investment advisers: people who are investment advisers under the Investment Advisers Act of 1940.
- The Multifactor Test: people who provide advice (individual-level or plan-level) with an understanding that the advice might be considered during decision-making related to investment or management decisions; the advice would be specific to the plan, the fiduciary or the participant involved rather than generic advice/opinion about the market or investing. This condition features two significant and noteworthy changes compared with the old language. The understanding that advice might be considered needn’t now be a mutual understanding. And the advice needn’t be provided on a regular basis, so one-time advice now places an adviser into the fiduciary role.
Many advisers maintain a business model that would probably be unaffected by the proposed regulations. These are the advisers who work with plan sponsors to create retirement plans that feature investments that fit into a plan sponsor’s goals and parameters.
Advisers who likely would be affected are those who act as Investment Consultants, as these individuals would become fiduciaries. Additionally, financial advisers who operate on commission-based contracts would probably assume a new fiduciary role. Lastly, some financial advisers offer distribution advice for employees who have reached retirement or are changing jobs. In many cases, the adviser would receive commission or other compensation for a rollover from the work retirement plan. Previously that has not been considered investment advice, but the Department of Labor is potentially interested in changing that position with this new regulation or in future updates.
WHAT THIS MEANS FOR PLAN SPONSORS (EMPLOYERS)
Whether plan sponsors feel changes from these proposed changes will depend upon the contract in place with the plan adviser. If a plan adviser previously had not been a fiduciary but will become a fiduciary under the new legislation, plan sponsor could see:
- Plan advisers initiating an agreement with an advisory service like Smart401k for participant-level advice and an end to an investment advice arrangement between the plan sponsor and the adviser,
- More ongoing advice from the plan adviser, with possible changes designed to provide less biased advice,
- An effort from a plan adviser to seek a conflict-of-interest exemption after conflict(s) have been illuminated, which would mean more paperwork, or
- A termination of the plan adviser agreement.
Carolyn Humpherson, Financial Communication Specialist
Smart401k is a Web-based investment adviser providing unbiased advice to help employees invest in their employer-sponsored retirement plans. Smart401k provides service to almost 11,000 clients who collectively have more than $1.5 billion in assets. Individuals receive personalized investment recommendations based on the funds in their plan and support of professional investment advisers available to answer all investment questions. Based in Overland Park, KS, Smart401k can be found at Smart401k.com.