We recently assisted an adviser in a DOL investigation brought on, at least in part, by a complaint by a disgruntled former employee. The employee alleged that the advisory firm was keeping funds that rightfully belonged to the firm’s clients. We were able to show that the employee’s allegations were false, but the DOL insisted on a settlement that resulted in a change in the firm’s advisory agreements.

To put this in perspective, let’s look at some background. In 1997, the DOL told plan fiduciaries in two Advisory Opinions that they had a duty to understand the compensation being paid to service providers. In the dozen years that followed, however, the DOL issued no regulation imposing a corresponding duty on advisers to make any specific disclosures to assist the fiduciaries. While many firms adopted fair disclosure policies as a best practice, firms were left to their own devices on this issue.

When the DOL made changes to the Schedule C requirements (for after-the-fact reporting of direct and indirect compensation by service providers to large plans) and issued the proposed 408(b)(2) regulation in the last year or so, it looked like the disclosure gap was going to be closed. But we never got the final regulation–though the DOL has indicated that in May of this year it will issue a regulation, requiring advance disclosure of service provider compensation and potential conflicts of interest and mandating written service agreements.

Now back to our advisory client. Through its enforcement authority under the settlement agreement, the DOL imposed the exact same disclosure and written agreement requirements that are in the proposed 408(b)(2) regulation.

Normally, we would object to entering into a settlement agreement with the DOL because of the 20% penalty that can be imposed under ERISA Section 502(l) for a fiduciary breach or knowing participation in such a breach. But here, the DOL said it would not seek to impose the penalty and only wanted the adviser to agree to provide written agreements to all of its clients and make advance disclosure of its direct and indirect compensation, and potential conflicts of interest. In essence, the DOL imposed through the enforcement process the same requirements that would have been imposed under the 408(b)(2) regulation.

This was a pretty easy agreement for our client to make, inasmuch as we had already started working with the firm on a new service agreement and the firm was already fully disclosing its compensation, remitting revenue sharing to plans for allocation to participant accounts and disclosing potential conflicts of interest. The biggest issue came up in the context of existing plans with which the firm already had service agreements. We were able to get the DOL to agree that the firm would be required to use the new agreement only with new plans or existing plans where the agreement needed to be substantially modified. For all existing plans, the DOL said it would be acceptable to send them a disclosure form with the relevant information. This saved our client the untold effort it would have taken to get new signed agreements from all its clients.

What’s the point of the story? We are seeing heightened enforcement activity by the DOL against broker-dealers and RIAs, often in tandem with the SEC, and we anticipate that the DOL will continue to use its enforcement authority to require written agreements with advance disclosures regardless of what the regulations may – or may not – require.
Source: The Adviser Report