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In response to participant demand, companies have considered providing investment advice to retirement plan participants. Many companies, though, have refrained, due to the cost of advice and concern over fiduciary liability. The House of Representatives has passed the Retirement Security Advice Act, known as the Boehner bill, as part of the Pension Security Act (H.R. 3762); the bill could have the effect of decreasing the cost of advice and alleviating some company concerns. On Oct. 1, an identical bill, the Retirement Security Advice Act of 2003 (S. 1698), was introduced in the Senate. However, even if the act is enacted, companies will still need to consider carefully how and whether to provide participants with advice about their retirement plan investments. The Employee Retirement Income Security Act of 1974 (ERISA) and its corresponding guidance create a two-pronged test to determine whether information given to participants will be considered investment advice. See ERISA, § 3(21), 29 C.F.R. 2510.3-21(c)(1), 2509.96-1(c). First, there must be advice regarding the value of securities or recommendations as to the advisability of investment choices. Second, the person giving the advice must either have discretion over the participant’s account or must render the advice on a regular basis with the understanding that the advice will serve as the primary basis for the participant’s investment decisions and that the advice is individualized based on the needs of the participant. Individuals who receive direct or indirect compensation for rendering investment advice, known as investment advisors, are fiduciaries of those plans. ERISA § 3(21). Their roles as fiduciaries are limited to the plan assets for which they render investment advice. See 29 C.F.R. 2510.3-21(c)(2). There are some restrictions on providing investment advice. Investment advisors are fiduciaries of plans. They are prohibited from dealing with plan assets for their own interests and they may not cause themselves to be paid by the plan for their services. ERISA, § 406(b)(1) and (3). “[A] fiduciary may not use the authority, control, or responsibility which makes such person a fiduciary to cause a plan to pay an additional fee to such fiduciary . . . to provide a service.” Labor Regulation § 2550.408b-2(e). Similar provisions are contained in the Internal Revenue Code. Code § 4975. These are known as prohibited transactions. Investment advisors as plan fiduciaries will violate ERISA by engaging in prohibited transactions if they receive compensation as a result of their advice. These issues arise when advice affects the advisor’s own income. For example, some mutual fund companies and their affiliates receive investment advisory fees from the mutual funds they manage; some insurance companies, banks and trust companies receive revenue sharing from their multifund family offerings. These providers, however, may give advice on investments without violating ERISA if done properly. The most frequent methods used by investment advisors for complying with ERISA include offsetting fees by revenue-sharing amounts, leveling the revenue sharing received on the investment options and being independent from the investment provider and receiving a fixed fee. Investment advisors offset their fees by the revenue sharing they receive. To the extent the revenue sharing exceeds the fees, it would be paid to the plan. If the fees exceed the revenue sharing, the plan will be expected to pay the difference. This method is derived from an advisory opinion issued by the Department of Labor (DOL), known as the Frost Opinion. Advisory Opinion 97-15A. By “leveling,” investment advisors receive the same amount of revenue regardless of which investment they recommend. In order to ensure that they will receive the same amount of revenue for each investment, providers either offer funds only to plans that have the same level of revenue sharing or provide advice only on funds that provide the same level of revenue sharing. Under the second option, the providers may offer funds that provide different levels of revenue sharing as long as they provide investment advice only on the funds that offer the same level of revenue sharing. Consequently, advice would not be provided on certain funds. The investment advisors receive the same compensation under both of these options, regardless of which fund they recommend. As a result, they do not violate ERISA as they do not receive compensation as a result of the investment advice they give. Fixed fees Third, some investment advisors are paid a fixed fee, rather than receive revenue sharing. These investment advisors are independent of the investment providers for the plans. This method is based on a DOL advisory opinion, known as the SunAmerica Opinion. Advisory Opinion 2001-09A (available at www.dol.gov/ebsa/regs/AOs/ao2001-09a/html). As a result of the independence of the investment advisors and their fees, they cannot affect their compensation based on the advice they give. Therefore, this arrangement does not violate ERISA. Plan fiduciaries are required to select and monitor any investment advisor designated by their plan prudently. Interpretive Bulletin 96-1 states, “As with any designation of a service provider to a plan, the designation of a person(s) to provide investment educational services or investment advice to plan participants and beneficiaries is an exercise of discretionary authority or control with respect to management of the plan; therefore, persons making the designation must act prudently and solely in the interest of the plan participants and beneficiaries, both in making the designation(s) and in continuing such designation(s). See ERISA, §§ 3(21)(A)(i), 404(a); 29 U.S.C. 1002 (21)(A)(i), 1104(a).” See 29 C.F.R. 2509.96-1. (The bulletin is available at www.dol.gov/allcfr/Title_29/Part_2509/29CFR2509.96-1.htm). The Senate is currently considering a bill, known as the Pension Protection and Expansion Act of 2003 (S. 9), that provides that fiduciaries would not face co-fiduciary liability for qualified investment advisors if certain requirements are satisfied. Because the investment advisor is a fiduciary, the plan fiduciaries who select the investment advisor face potential co-fiduciary liability if the investment advisor breaches its fiduciary duties. Co-fiduciary liability arises when fiduciaries are liable for breaches of fiduciary duty by another fiduciary under certain circumstances. Interpretive Bulletin 96-1 explains the circumstances under which a fiduciary will have co-fiduciary liability for an investment provider. The bulletin states, “[T]he designation of an investment advisor to serve as a fiduciary may give rise to co-fiduciary liability if the person making and continuing such designation in doing so fails to act prudently and solely in the interest of plan participants and beneficiaries; or knowingly participates in, conceals or fails to make reasonable efforts to correct a known breach by the investment advisor.” 29 C.F.R. 2509.96-1. See also, ERISA §§ 404(a)(1), 405(a). Another question that arises in this area is what effect the Retirement Security Advice Act would have on the providing of investment advice. If it becomes law, the act would provide an exemption for the prohibited transactions described above for investment advice by registered investment advisors, banks, insurance companies or registered broker/dealers if certain disclosure requirements are satisfied. Disclosures required by applicable securities laws would also have to be made. Additionally, any fees and commissions paid to the advisor would have to be reasonable and any sale of investments by the investment advisor would have to be at fair market value. The Retirement Security Advice Act specifically would define the scope of the monitoring of investment advisors required by fiduciaries. It would also clarify that fiduciaries are not required to monitor the specific advice given by the investment advisor to any particular participant. Thus, the fiduciaries would still be required generally to monitor the investment advisor, but not at the transaction level. Labor Department backing The U.S. Department of Labor has stated that it believes participants will be given greater access to investment advice if the proposed legislation is passed. It stated that the prohibited transaction exemption would help plans to provide investment advice at a more manageable cost. The department also indicated that the exemption would alleviate employers’ concerns that they would be held liable for the advice provided by the investment advisors or that they would be required to monitor every recommendation given to every participant. Congressional Testimony of Ann L. Combs Before the Subcommittee on Employer-Employee Relations, Committee on Education and the Workforce, July 17, 2001. See 147 Cong. Rec D 717 (2001) (available at www.gpoaccess.gov/ crecord/index/html). The Retirement Security Advice Act would not remove the requirements that investment advice be provided in a nondiscriminatory manner and that the fees involved must be reasonable. Indeed, restrictions on investment advice may violate the nondiscrimination rules. The Internal Revenue Code requires plans to make certain benefits, rights and features available to participants in a nondiscriminatory manner. Some investment providers impose significant charges or require minimum account balances that potentially violate the code’s nondiscrimination requirements. The code requires qualified plans to make benefits, rights and features available in a nondiscriminatory manner. Treas. Reg. § 1.401(a)(4)-4(a). Although the opportunity to receive investment advice is not specifically listed as a right or feature, it is similar to other benefits, rights and features. Treas. Reg. § 1.401(a)(4)-4(e)(3). Additionally, the regulations state that its list of benefits, rights and features is not exclusive. Treas. Reg. § 1.401(a)(4)-4(e)(3). As such, if a plan offers investment advice, access to that service must be available in a nondiscriminatory manner to employees. Treas. Reg. § 1.401(a)(4)-4(a). Some investment advisors require minimum account balances or impose significant fees in order to provide advice. If the plan designated an investment advisor whose minimums or fees effectively excluded too many employees who are not highly compensated from being able to use the service, the plan would violate the nondiscrimination rules. The Retirement Security Advice Act would not have any effect on this issue. However, assuming there is a discrimination issue, the following methods may be used to comply with ERISA. First, the plan can allow participants to use any outside investment advisor, rather than to select a specific advisor for the plan. Thus, participants would not be required to use any particular investment advisor. Second, as an alternative, the plan could perform testing to determine if the investment advisor is available to employees who are not highly compensated in a nondiscriminatory manner. However, as a practical matter, few plans would want to take on this additional testing burden or the risk of failure. The third method is to choose an investment advisor who does not require a minimum balance or assess a high fee. If a plan offers the services of an investment advisor who is available to all participants, the nondiscrimination rules will be automatically satisfied. If the plan designates an investment provider, the cost of the advice may not be unreasonable. Under the Retirement Security Advice Act, both the fees for the investment advice and the compensation received by the investment advisor in connection with the buying, selling or holding of securities would be required to be reasonable. Additionally, ERISA requires fiduciaries to ensure that plan assets are used to provide benefits to participants and to defray reasonable expenses. ERISA §§ 403(c)(1), 404(a)(1)(A). Thus, the Retirement Security Advice Act would require the fees involved to be reasonable, as does ERISA. If passed, the act would permit investment advisors to receive compensation based on the funds they recommend to participants (e.g., management fees, revenue sharing and commissions) so long as disclosure requirements are satisfied and the total fees are reasonable. With the removal of the prohibited-transaction issues, participants may finally get the investment advice they need and want. Debra A. Davis ([email protected]) is an associate practicing in the area of employee benefits at Los Angeles’ Reish Luftman Reicher & Cohen.

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