In 2005, the DOL issued a little-known advisory opinion which creates a trap for advisers to 401(k) plans ... or does it?

In the advisory opinion, the DOL asked and answered three questions. RIAs and financial advisers must be aware of those questions and answers and of their implications.

The first question was: “Is an individual who advises a participant, in exchange for a fee, on how to invest the assets in the participant’s account, or who manages the investment of the participant’s account, a fiduciary with respect to the plan within the meaning of section 3(21)(A) of ERISA?”

In answering the question, the DOL takes over 200 words to say, “yes.”

The second question is: “Does a recommendation that a participant roll over his or her account to an individual retirement account (IRA) to take advantage of investment options not available under the plan constitute investment advice with respect to plan assets?”

The DOL answers the question in a somewhat more concise fashion—a little over 100 words—by saying that, “merely advising a plan participant” about those issues is not fiduciary investment advice. However (and this is a big “however”), the DOL goes on to say:

“Where, however, a plan officer or someone who is already a plan fiduciary responds to participant questions concerning the advisability of taking a distribution or the investment of amounts withdrawn from a plan, that fiduciary is exercising discretionary authority respecting management of the plan and must act prudently and solely in the interest of the participant. [Citation omitted.] Moreover, if, for example, a fiduciary exercises control over plan assets to cause the participant to take a distribution and then to invest the proceeds in an IRA account managed by the fiduciary, the fiduciary may be using plan assets in his or her own interest, in violation of [the prohibited transaction rule in] ERISA section 404(6)(b)(1).”

Some, and perhaps many, people interpret that language to say that, if an RIA or financial adviser is a fiduciary to a plan—for example, giving investment advice to the plan fiduciaries or to participants—then they are effectively prohibited from assisting participants in the investment of their distributions. Because any fees or commissions that would be received as a result of the investment of the distributions would be a prohibited transaction under 406(b)(1)—at least, so long as you accept that the meaning of the advisory opinion is this broad or, alternatively, that the interpretation is correct.

In our view, the determination of fiduciary status is, by and large, a fact-and-circumstances test; the extent of the fiduciary status of an adviser is largely limited. As a result, making of recommendations related to distributions and to the investment of distributions may or may not be a fiduciary act, depending on the scope of fiduciary responsibility and on other factors. In other words, we think that many people are over-interpreting the advisory opinion.

Let’s examine the details of the ruling. First, it is clear that the DOL does not think that the mere recommendation of a distribution or recommendations regarding investments for an IRA are fiduciary acts. In fact, in the advisory opinion, the DOL states:

“The Department does not view a recommendation to take a distribution as advice or a recommendation concerning a particular investment (i.e., purchasing or selling securities or other property) as contemplated by regulation §2510.3-21(c)(1)(i). Any investment recommendation regarding the proceeds of a distribution would be advice with respect to funds that are no longer assets of the plan. [Citation omitted.]”

Therefore, the issue is whether such recommendations can become fiduciary acts simply because they are made by someone who is already a plan fiduciary, as opposed to someone who is not. The DOL concludes that such recommendations are the exercise of “discretionary authority respecting the management of the plan ...”. However, a fiduciary for investment advice does not have “discretionary authority respecting the management of the plan.” That is because, under ERISA, a person is a fiduciary only “to the extent” of their specific responsibilities; beyond that, a person may be a service provider, but is not a fiduciary. Based on our experience, it is not common for an RIA or a financial adviser to have either discretionary authority or to exert actual control over the management of plan assets (except where the RIA is serving as an acknowledged discretionary investment manager). It is possible that the DOL is taking the position (which is not stated in the advisory opinion) that, because a fiduciary stands in a position of trust, any recommendations made to a participant may be so impactful as to be the equivalent of actual control. However, that can only be determined with a close examination of the facts and circumstances of a particular case and, cannot in our opinion, be stated as a matter of law.

On the other hand, other fiduciaries, for example, the primary fiduciaries for a plan, would have that type of control. Therefore, while it is unlikely that an RIA or financial adviser would have the requisite degree of control, we think that it is more likely that the primary plan fiduciaries could be found to have that requisite control, especially if they “pushed” the participants to take distributions and to invest them in particular ways. On the other hand, it would be uncommon for the primary plan fiduciaries of the plan sponsor to be receiving any fees or commissions from an investment in an IRA. So, while that case is conceptually more likely to produce the result discussed in the advisory opinion, it is, in the real world, highly unlikely to occur.

The DOL’s third question and answer discuss the situation where an adviser who is not a fiduciary makes such recommendations. The answer simply re-affirms the prior conclusion that the non-fiduciary adviser would not be a fiduciary for purposes of distribution even if the adviser “recommends that a participant withdraw funds from the plan and invest the funds in an IRA ... if the adviser will earn management or other investment fees related to the IRA.”

While we believe that the advisory opinion is being interpreted too broadly, it is creating a great deal of concern in the 401(k) community, particularly with broker-dealers. Because of that, we recommend that, where an adviser is serving as a fiduciary to a plan (which includes both acknowledged fiduciaries and functional fiduciaries), there should be an agreement in place which limits the adviser’s fiduciary status, if any, to the specific investment recommendations made to the plan. By virtue of that, the adviser will be an acknowledged fiduciary only “to the extent” of investment recommendations to the plan sponsor and/or to participants. If the fiduciary status is limited to that service, the responses to any questions concerning distributions and re-investments would be beyond the scope of the adviser’s fiduciary duties.

While having such an agreement in place would not entirely end the inquiry, it would be quite helpful. We way this because there would still be the question of whether the adviser has become a functional fiduciary by virtue of giving advice on distributions. In the advisor opinion, the DOL specifically states that, “Any investment recommendation regarding the proceeds of a distribution would be advice with respect to funds that are no longer assets of the plan.” Therefore, advice about the re-investment of the distribution could not be fiduciary advice.

Since advice about the distribution could not be fiduciary advice under ERISA, a thorough analysis requires an examination of whether the adviser could be a fiduciary for any other reason. The only other reason that we can imagine is that the adviser has become a functional manager of a participants plan assets. For that to happen, we believe that an adviser would have to exert a high degree of control over the participant, to the point that, for example, the participant was not exercising free will and judgment. However, that would, in our experience be an unusual case. In any event, it would require a facts-and-circumstances analysis. As a result, it cannot be stated categorically that an adviser who becomes a plan fiduciary (functional or acknowledged) by virtue of investment advice is also a fiduciary with regard to distributions and IRA investments.

As a final note, this article does not cover the fiduciary and prohibited transaction rules under the Internal Revenue Code. It is worth noting, though, that the Internal Revenue Code also has a definition of fiduciary investment advice that applies to IRAs and that there are IRA prohibited transaction rules (which are similar to those found in ERISA and discussed in this advisory opinion). Based on changes enacted in the Pension Protection Act, the DOL is working on guidance that will impact the Internal Revenue Code rules for IRAs and that should provide an exemption for investment advice to IRAs at some point in the future. However, we expect that there will be conditions for obtaining the relief of that exemption.

Source: The Adviser Report