The Pension Protection Act of 2006 (PPA) facilitated the provision of investment advice to participants in 401(k) plans through a new prohibited transaction exemption. The exemption is aimed primarily at the adviser (referred to in PPA as a “fiduciary adviser”), but the new law—plus Department of Labor (DOL) guidance—also clarifies the role of plan sponsors and adds some requirements to be addressed by the employer in a service agreement with the adviser.
The new PPA exemption says that in offering investment advice to participants, the plan sponsor has to do the following:
1.Prudently select the adviser—this is not a new requirement, but the rules are somewhat clearer after PPA;
2.Obtain an acknowledgment from the adviser that it is a fiduciary to the plan;
3.Monitor the fiduciary adviser by following up on any complaints from participants-also not a new requirement;
4.Obtain a “compliance audit” report from the adviser on an annual basis.
At the same time, the PPA makes it clear that the plan sponsor is not responsible for any advice given by the fiduciary adviser.
In guidance issued earlier this year, the DOL said that to prudently select an adviser, the plan sponsor must take into account the adviser’s experience and qualifications, its registration under the securities laws and the extent to which the advice to be furnished will be based on generally accepted investment theories.
How does this impact service agreements? At a minimum, the plan sponsor needs to have a formal written contract with the adviser that covers the following (at a minimum):
1.Describes the services to be performed (i.e., investment advice to the plan participants) and the specific individuals who will render the advice;
2.Describes whether or not the advice will be rendered by a computer model;
3.Describes how the adviser will be paid for its services and the source of such payments;
4.Contains an acknowledgment that the adviser is a fiduciary to the plan;
5.Contains the following representations and agreements:
a. a representation that the adviser’s services will comply with the PPA exemption (specifically, ERISA Sections 408(b)(14) and 408(g));
b. a representation regarding the adviser’s registration or licensing under applicable securities or other applicable laws—and if the adviser is a registered RIA, a copy of Part II of Form ADV or the adviser’s brochure;
c. a representation that the advice to be given will be based on generally accepted investment theories and prevailing industry practices;
d. an agreement that the adviser will provide to participants all of the information required by the PPA exemption; and
e. an agreement that the adviser will obtain the annual compliance audit required by the exemption and will deliver a report regarding the results of the audit to the plan sponsor on a timely basis each year.
The agreement with the fiduciary adviser does not have to be elaborate—or even very long. Even though the adviser’s services will be provided only to the participants, the plan sponsor still needs to have some involvement, and that involvement should be documented in a proper service agreement.
Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.