Category Archives: ERISA Law

Is the DOL Fiduciary Rule the End of Solicitor Arrangements? – Part 2

In my last blog, I discussed why the solicitor structure has grown in popularity and why it will continue in the future but without the same benefits enjoyed in the past. In this blog post, I review how the DOL’s Fiduciary Rule will change the role and structure of the solicitor.

First and foremost, every solicitor will become a fiduciary on April 10, 2017. As a fiduciary, a financial adviser (FA) is subject to an ERISA fiduciary standard. This alone may be sufficient reason for some FAs to exit the industry, but what is more likely to happen is a flood of new fiduciaries will be marketing to retirement investors. Consider that there are approximately 700,000 retirement plans filing a 5500, but this number is dwarfed by the 40+ million homes that hold an IRA. In other words, there are approximately 60 times more IRAs than retirement plans, so it is safe to assume there are more FAs handling IRAs than retirement plans. In short, we will see a drastic increase in the number of fiduciary advisors in the market.

In addition, based on our own internal survey, IRA assets held by a Broker-Dealer (B-D) range between 40 and 80% of B-D total assets. However, many of these FAs know very little about ERISA fiduciary standard of conduct. This lack of knowledge increases B-D litigation risk as tens of thousands of misguided fiduciary missiles seek to secure new engagements or service existing clients. B-Ds will have to establish new training protocols in conjunction with compliance oversight to mitigate this risk. More on training to follow in our next blog.

Keep in mind that many of the FAs that handle IRA assets have historically avoided the retirement plan market place altogether; however, if they want to continue working and building their IRA practice they now have they have no choice but to become familiar with and adopt the ERISA fiduciary standards and obligations into their practice. As a result, we will likely see a drastic increase in FAs and Insurance Agents taking the Series 65, and I would not be surprised to see testing centers unable to accommodate FA’s date requests the longer the FA procrastinates. My advice, order the Series 65 study materials now and take the test ASAP.

After the Series 65 is passed, FAs will have to secure Fiduciary Errors & Omissions (E&O) coverage. Trust me, your competitors that live and breathe ERISA will be sure to tell your clients (their prospects) they should not deal with anyone that does not have Fiduciary E&O. Of course, this is an added cost of doing business that has not been necessary in the past for most FAs. Small B-Ds that have prohibited their registered reps from using the “f” word will find this cost difficult to swallow, whereas many of the larger B-Ds have turned this cost area into a profit center due to their bulk buying power. I suspect between this cost and the technology costs necessary to monitor the FAs business subject to the new DOL Fiduciary rule, many small B-Ds will give consideration to a merger or acquisition.

Once the FA has secured the Series 65, consideration should be given to the FA’s business model. Whether an FA decides to adopt a fee-based business model or continue exclusively in a commission-based, new agreements, contracts, policies, procedures, and website disclosures will need to be created. The cost for ERISA legal counsel to draft these documents after gathering an understanding of the business model will be a new cost for the FA, their B-D and/ RIA. Small independent RIAs will bear the full brunt of this cost whereas much larger organizations may be able to secure these documents as part of normal overhead. Either way, these new documents and disclosures represent more work and cost.

Regarding the business model, an FA currently in a solicitor arrangement will need to update their contract with the client to reflect their fiduciary status. This represents additional work and client education, but, more importantly, it changes the dynamic of the FA’s relationship with the RIA they referred. First, the FA will need to address their responsibility to monitor the RIA. Remember, recommending an RIA to a retirement investor is a fiduciary act. As a fiduciary act you must monitor the RIA to ensure they continue to meet the client’s needs and objectives. So, there is more work and risk to the FA for no additional pay. Second, since the FA is a fiduciary, the recommendation to use an RIA could be challenged as a prohibited transaction. You may recall, a fiduciary cannot use its position to increase its compensation. This is found under 29 C.F.R. 2550.408b-2(e)(1) which states:

“Thus, 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(or to a person in which such fiduciary has an interest which may affect the exercise of such fiduciary’s best judgment as a fiduciary) to provide a service. Nor may a fiduciary use such authority, control, or responsibility to cause a plan to enter into a transaction involving plan assets whereby such fiduciary (or a person in which such fiduciary has an interest which may affect the exercise of such fiduciary’s best judgment as a fiduciary) will receive consideration from a third party in connection with such transaction.[Emphasis added.]

I suspect this is more of a concern for the FA that provides no service other than a referral, than for the FA that was engaged to provide non-fiduciary services. However, every financial institution will need to consult with their legal counsel to determine the extent to which this issue presents a fiduciary risk.

As you can see there are numerous issues that both the Financial Institution and the FA will need to address. I am sure that some FAs will choose to leave the industry, but it seems hard to fathom a smaller number of marketing RIAs in the future. Those that choose to stay engaged will need to change their business model to align with the new DOL Fiduciary Rule. It will cost more, there will be more work, more risk, and no additional pay at this point. FAs that have never provided an investment review to monitor the investments will need to do so in the future to justify their compensation especially on complex products. Of course, there is plenty of opportunity but even the optimistic FA will need to temper their enthusiasm with a large dose of pragmatism.

As printed in the eMoney Blog.

Education Isn’t a Best Practice It Is A Requirement

Expect to see more articles on the subject of Fiduciary Education in the months to come e.g., (Investment News) and do not be surprised to see the following Department of Labor (DOL) position on training from the preamble quoted in those articles:

In particular, Financial Institutions must ensure that Advisers are provided with information and training to fully understand all investment products being sold, and must similarly ensure that customers are fully advised of the risks.” 

While we await the DOL’s response to many questions, a plain reading of the statement above implies a new fiduciary standard of product expertise, not previously expected of advisers in the past, has been established. Although adviser success has historically been measured by who they know, it now appears that adviser success will be based on what they know especially if fiduciary risk mitigation is an adviser priority.

More specifically, does the adviser fully understand the risk associated with the recommendation and has the adviser fully educated the investor of all risks so s/he can make an informed decision? Furthermore, is the adviser educated on the role a recommendation might fill under an ERISA standard of care? In other words, the adviser not only needs to be educated about the products they recommend but also why the products recommended are prudent and meet the best interest standard of care.

With less than 7 months before April 10, 2017, effective date, product manufacturers are under the gun to provide the necessary product education to their distribution channels. Smart compliance officers will demand documentation to support a claim their adviser has been adequately trained on each product they sell before permitting an adviser to sell that product after April 10, 2017. I also foresee a compliance officer prohibiting any adviser from selling products without documented proof they have been properly trained to mitigate litigation risk. Unfortunately, it is impossible for a product manufacturer to train all the advisers they have agreements with by April 10, 2017, if the education is delivered face to face. To reach all advisers that have or may sell your products you must establish an online Learning Management System (LMS) deliverable.

In other words, training must be web-based, on-demand, and gamified. Training tracks should include multiple modules that are content-rich. Between the education and the test, it should take no more than 15 minutes per module. Upon completing each module and successfully passing the test the adviser should be given a certificate of completion with a compliance officer access to pull reports that track adviser activity. Content must not only cover the product comprehensively, it must also address ERISA nuances especially fiduciary duties. ERISA training should be provided by a law firm since plaintiff attorneys tend to hold training from the peers in higher regard than ERISA laypeople. In short, training provided by an attorney on ERISA statutes, regulations, and judicial decisions is a strategy that maximizes risk mitigation.  However, product modules should be prepared by the product manufacturer to avoid liability for education that cannot be controlled by a party outside of the product manufacturer.

FRA PlanTools and Wagner Law Group have partnered together to provide a low-cost solution that can be provided for free to advisers if structured properly.

To learn more about this solution visit www.erisatraining.com. For more information, contact David Witz at 704-564-0482 or dwitz@fraplantools.com

Is the DOL Fiduciary Rule the End of Solicitor Arrangements?

Is the DOL Fiduciary Rule the End of Solicitor Arrangements?

David Witz post on eMoney Advisor

A solicitor arrangement is a common practice among financial advisers (FAs) who want to avoid fiduciary status but still receive compensation in exchange for a referral that results in a sale to a retirement investor. In some instances, the referring FA serves in any number of ongoing non-fiduciary roles such as a communication and/or education specialist, or vendor manager.

The structure has been widely marketed by many registered investment advisors (RIAs) who offer Employee Retirement Income Security Act (ERISA) Section 3(21) investment advisory or Section 3(38) discretionary investment management services to retirement plans through FAs as a distribution channel.

There are several primary reasons this collaborative effort has prospered in the past including:

  1. Fiduciary risk and liability for the FA is avoided.
  2. The referring FA does not need to become an RIA or IAR to receive compensation.
  3. The referring FA does not need to acquire fiduciary E&O.
  4. The referring FA can solicit IRA rollovers from the plan participants without engaging in a prohibited transaction.

Although the July 2012 changes to ERISA Section 408(b)(2) made the solicitor arrangement more complicated, it did not eliminate the structure as an ongoing solution. In fact, the 2012 changes to 408(b)(2) actually became the impetus to accelerate the continued proliferation of the solicitor model. Growth of this model is based on the assumption that an FA can recommend a client or prospect retain the services of an RIA without becoming a fiduciary. The industry has relied on the following section of the Regulation that defines the term “fiduciary”:

A person shall be deemed to be rendering “investment advice” to an employee benefit plan, within the meaning of section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974 (the Act) and this paragraph, only if…Such person renders advice to the plan as to the value of securities or other property, or makes recommendation as to the advisability of investing in, purchasing, or selling securities or other property.  [Emphasis Added] 29 C.F.R. § 2510.3-21(c)(1)(i) (Oct 31, 1975)

Notice the Regulation does not state fiduciary status is tied to “advice to the plan as to the value of an RIA” or a “recommendation as to the advisability of investing with or through an RIA.” The focus of the Regulation is on advice rendered in regards to a “security” not an “RIA”. Of course, this has been debated and even litigated in a case involving investments made with Madoff but the popularity of the solicitor arrangement has continued to grow in reliance on this Regulation. Unfortunately, this approach is on life support with an imminent end in sight.

Effective April 10, 2017, the solicitor arrangement will no longer operate with the same benefits FAs have enjoyed in the past. Instead, any FA that refers an RIA to a retirement plan or IRA investor (i.e., a retirement investor) will become a fiduciary as that term is defined under ERISA. More specifically, any FA that refers an RIA to a retirement investor in exchange for compensation is a fiduciary. Of course, the referring FA’s liability is tied directly to the RIA recommendation not necessarily to the investments recommended or selected by the RIA. This also means the FA has an obligation to monitor the RIA to ensure the RIA continues to execute the investment mandate as promised. Should the FA fail to monitor the RIA, the FA could be liable for investment results should the RIA fail to execute its responsibilities prudently and according to the investment mandate. The liability associated with an FA recommendation is supported by the following wording found in the preamble:

“As amended the Regulation provides that a person renders investment advice with respect to assets of a plan or IRA if, among other things, the person provides, directly to a plan, a plan fiduciary, plan participant or beneficiary, IRA or IRA owner, the following types of advice, for a fee or other compensation, whether direct or indirect…A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services . . .[Emphasis added.] FR 21005 (April 8, 2016)

Bottom line, the new DOL Fiduciary Rule has not prohibited the solicitor structure, but the DOL has made a solicitor a fiduciary under ERISA; and as a fiduciary the solicitor now has more liability and responsibility. What impact this change will have on this popular structure one can only guess, and since I’m not bashful about guessing I will provide you with what my crystal ball suggests could happen to solicitors in the future in Part II of this blog, coming soon.

As printed in eMoney Blog.

Risk Mitigation Starts with Retaining Demonstrated Experts

by David J. Witz AIF®, GFS™ – February 17, 2014

It is widely understood that a plan sponsor that lacks expertise is obligated to seek the advice of qualified experts to assist them in their fiduciary duties. But to what extent can a plan sponsor rely on their expert’s advice? According to Clark v. Feder Semo and Bard, P.C., No. 12-7092 (D.C. Cir. Jan. 7, 2014), reliance on an expert is consistent with a fiduciary’s obligation to act with loyalty and prudence.  While this case focused on reliance on legal counsel, it provides important direction for both plan sponsors and service providers.   

The suit was filed on behalf of Clark, an attorney/employee/plaintiff, against her employer/law firm for assumptions used when calculating Clark’s distribution upon termination of the retirement plan. Clark argued that the plan’s fiduciaries were not entitled to rely on outside counsel’s advice but instead should have undertaken an “independent investigation.”

The D.C. Circuit ruled in favor of the plan sponsor. According to the court, the plan sponsor:

  1. “Properly” relied on the advice of outside counsel,
  2. Was “reasonably justified under the circumstances” to rely on counsel’s advice,
  3. Made a reasonable decision that any prudent trustee would have made under similar circumstances, and
  4. Made a prudent decision “based on the circumstances at the time of the challenged decision”

The court came to this conclusion based on ERISA’s adoption of the common law’s standard of fiduciary care in Section 404(a)(1)(B) which the court has interpreted to mean a plan sponsor can rely on counsel’s advice in “appropriate circumstances” when making important decisions. In coming to this conclusion, the court relied on several other decisions, including:

  1. Roth v. Sawyer–Cleator Lumber Co., 16 F.3d 915, 918 (8th Cir. 1994);
  2. Howard v. Shay, 100 F.3d 1484, 1489 (9th Cir. 1996);
  3. Bussian v. RJR Nabisco, Inc., 223 F.3d 286, 300–01 (5th Cir. 2000);
  4. Gregg v. Transp. Workers of Am. Int’l, 343 F.3d 833, 841 (6th Cir. 2003).

Important to all covered service providers (CSP) is the court’s conclusions in Clark that reliance on counsel’s (an expert) recommendation was “reasonable” because counsel:

  1. Had expertise in ERISA…the CSP was “qualified”
  2. Had been advising the plan since the 1990s…the CSP was “familiar” with the plan
  3. Had conducted a thorough review of the relevant documents…the CSP was “deliberate”
  4. Made recommendations based on a reasonable investigation…the CSP adopted “procedural prudence”
  5. Documented their recommendations…the CSP adopted “substantive prudence” and
  6. Made recommendations consistent with the plan sponsor’s understanding…the CSP was “collaborative”

Because the plan sponsor’s expert made recommendations based on procedural (process) and substantive (merits) prudence, the court concluded the plan sponsor did not need to conduct any further investigation as claimed by Clark. The moral of this case: there is value in retaining qualified expert CSPs. Unfortunately, many CSPs provide counsel to plan sponsors beyond their education, experience, or skills. There is liability for both the plan sponsor and the CSP in this situation. Plan sponsors should engage in a documented process to select their CSPs and CSPs should provide plan sponsors with validation they are capable of doing the job.

Bottom line, a plan sponsor should trust but verify and a CSP must not misrepresent their expertise. In fact, the court noted that a plan sponsor’s reliance on a CSP would be “improper” if there are “significant reasons to doubt the course counsel suggested.” This suggests that a plan sponsor should not blindly rely on their CSPs in all circumstances especially when they counsel a plan sponsor about issues they lack expertise in. This is when a plan sponsor is obligated to investigate or seek additional experts depending on the circumstances.

It’s a Matter of When, Not If: Validity of Class Action Waivers in ERISA Plans To Be Tested

In addition to reporting on active ERISA litigation, the authors of this blog take a great interest in potential future litigation. One such area is the validity of class action waivers (as part of arbitration clauses) in ERISA plans.

On Friday, the Securities Law Prof Blog*** by University of Cincinnati College of Law professor Barbara Black reported on Schwab’s decision to withdraw the class action waiver clause from their brokerage account agreements in light of the fact that the issue is now on appeal before the FINRA appellate body. Click here to read the blog post. For a full copy of Schwab’s statement, click here. For history’s sake, here is Schwab’s statement in part:

Effective immediately, Schwab is modifying its account agreements to eliminate the existing class action lawsuit waiver for disputes related to events occurring on or after May 15, 2013 and for the foreseeable future.

While the company believes that dispute resolution is best handled via FINRA arbitration, we have chosen to voluntarily remove the waiver going forward until the issue is resolved by the appropriate regulatory and/or court decisions. Given that the process will likely take considerable time to resolve, and may leave clients with a degree of uncertainty about their dispute resolution options in the meantime, we have elected to remove that uncertainty until the legal and regulatory process is completed.

So why does this matter for ERISA plans? The opportunity to test on a nationwide preclusive fashion whether class action waivers are valid will be too tempting for those that have a vested interested in seeing it happen.

The issue skyrocketed to prominence after the Supreme Court’s 2011 decision in AT&T Mobility v. Concepcion essentially ruled in favor of class action waivers in consumer contracts despite state law prohibiting them. For the best information on the case, head over to the SCOTUSblog and read their excellent summary and commentary. Probably 4 out of every 5 contracts you sign as an American consumer have such a clause now (based upon my own non-scientific survey of reading every page of every contract I sign).

In the well researched article entitled Requiem for ERISA Class Actions? by ERISA litigator James P. Baker, a case is laid out for validity of arbitration clauses in ERISA plans. Here are some relevant excerpts:

The ERISA statute does not expressly preclude the arbitration of statutory (also known as fiduciary breach) claims. It indicates that while both state and federal courts have concurrent jurisdiction over claims for benefits, federal courts have “exclusive jurisdiction” over statutory claims. Nowhere, however, does ERISA state that statutory violations cannot be arbitrated.

The trend among federal courts is to permit arbitration of fiduciary breach claims. For example, a district court in Massachusetts held that “no external legal restraints foreclose the arbitration of ERISA claims.”

Taking the next step, in the October 2012 ERISA Litigation Newsletter published by Proskauer Rose, LLP, after a detailed discussion of relevant case law, they argue that although it may be an advantage for plan sponsors to include class action waivers, it is by no means a slam dunk:

Given the current state of the law, there appears to be enough of a possibility to prevail on enforcing class waivers in arbitration agreements that plan sponsors and fiduciaries should include them in their arbitration agreements and plan documents if perceived to be an advantage. Even if enforced, however, their impact remains unclear in light of the fact that, as mentioned, a single participant may commence a lawsuit in a representative capacity under ERISA, without resorting to the class action devices available under the Federal Rules of Civil Procedure.

Although this issue is years away from being resolved, we have no doubt that plan sponsors and service providers will soon enough be faced with making a decision regarding the inclusion of arbitration clauses and class action waivers. As ERISA fiduciary consultants, we have no dog in the fight. However, we believe that after nearly 40 years of jurisprudence in the federal courts, ERISA offers a scheme of rules and regulations that strongly attempts to balance the interests of both plan sponsor/fiduciaries and plan participants, despite not being perfect all the time. The creation of dueling venues of public resolution (courts) and private resolution (arbitration) has great potential for unintended consequences for all involved parties.

[*** The Securities Law Prof Blog is a sister blog to a favorite of mine, and many other readers, the Workplace Prof Blog.]