Publication - 8/1/1998

Where Does Investment Advice Begin?

The Reish & Luftman ERISA Controversy Report

Problem: Retirement plan service providers—such as third party administrators (TPAs), accountants and consultants—are consulted by their clients on a wide range of issues, including which type of plan best suits their needs, and what investment strategies are best for the plan. Because of that relationship, it's no surprise that clients seek their input and come to trust their advice. Most service providers are aware that, if they provide investment advice for a fee, they cross the line from service provider to fiduciary, and therefore take on the personal liability of an ERISA fiduciary for those investments. But the line is rarely easy to spot. One recent case illustrates the danger of trying to "be all things to all people."

Discussion: We recently handled a series of cases in which our TPA client was sued by former clients. Each of the former clients alleged similar facts. In the late 1980s, when real estate investments promised excellent returns for investors, some of the TPA's clients wanted to share in the boom. They asked the owner of the TPA firm for guidance on how to invest their plan assets in real estate. He directed some of these clients to a broker-dealer who specialized in real estate limited partnerships and other syndications. Allegedly unbeknownst to his clients, however, the TPA owner received commissions or "kickbacks" from the broker-dealer in exchange for referring clients who invested in the real estate ventures offered by the broker-dealer.

Some of the real estate investments went bad. Several investors alleged that the broker-dealer was paying off old subscribers with monies from new investors--in other words, engaging in a "Ponzi scheme."

Where does the TPA fit in all this? The clients alleged that the TPA firm, and its owner, had discretion regarding the manner in which plan assets were invested, since they turned to him for advice regarding all aspects of their plan management and administration, including investment strategies. As evidence of this allegation, one of the clients referred to notes discovered in the TPA's file in which the TPA owner wrote that the client would sign "anything [the owner told] them to sign." While this statement was taken out of context (it had nothing to do with plan investments), it suggested that the client deferred all decisions regarding plan management to the TPA owner.

ERISA provides that a fiduciary is a person who, among other things, (1) exercises discretionary authority or control respecting management of the plan, (2) exercises any authority over management or disposition of the plan's assets, or (3) provides investment advice for a fee or other compensation, direct or indirect, with respect to any plan assets. The plaintiffs in these cases were trying to establish that the TPA was a fiduciary under all three prongs. Traditionally, the courts have been somewhat reluctant to find that service providers—or investment vendors—become fiduciaries simply because they recommend someone as an investment advisor, or because they received a payment in connection with the sale of an investment product. That trend seems to be changing. Several federal circuit courts of appeals have found fiduciary liability in these types of cases.

Conclusion: When service providers are involved in the investment process, or even make recommendations about who the plan administrator should hire as an investment advisor, there is a risk that the service provider may be deemed an ERISA fiduciary. In those circumstances, service providers should consider obtaining fiduciary liability insurance. Or, alternatively, they should consider not rendering any investment advice or referrals. Service providers and fiduciaries are subject to prohibited transaction rules. If they do accept fees related to plan investments, they should make certain to review prohibited transaction exemption 84-24 to determine whether the transaction may be exempt and under what circumstances.