The DOL has proposed a new regulation to re-define fiduciary investment advice. The proposal broadly expands the activities that result in fiduciary status by virtue of giving advice. In addition, it formalizes a long-standing DOL position that the referral of an investment manager can result in fiduciary status for the adviser making the referral. As a result, if a solicitor’s fee or finder’s fee is paid to the adviser who makes the referral, that payment can be a prohibited transaction.

Before delving further into the proposal, let me describe the statute—so that you have a context for the discussion.

ERISA section 3(21)(A) is the provision that defines fiduciary status. There are three categories of ERISA fiduciaries. The first and third definitions deal with the management and administration of a plan and its assets. It is only the second definition—the so-called “investment advice” provision—that can cause a person to become a fiduciary by virtue of giving advice. Stated slightly differently, under the first and third definitions, a person will need either discretionary control or actual control in order to be a fiduciary. However, under the second definition, recommendations can result in fiduciary status. But that begs the question . . . recommendations about what? Conversationally, people have described the section as applying to advice about buying, selling, or holding investments. However, the DOL has historically had a broader definition. For example, the DOL considers the definition to include advice about the advisability of investing in securities and other property, including recommendations of investment managers. There is DOL guidance on that subject as early as 1984.

However, that position is not well known and, as a result, it is fairly common for advisers to refer investment managers to plan fiduciaries and participants, but not to consider themselves fiduciaries. By specifically including the referral of investment managers in its proposed regulation, the DOL has, at least from its perspective, taken steps to remedy the situation.

However, a reading of the proposed regulation would not necessarily lead to that conclusion. The proposal provides that a person can be a fiduciary if he “provides advice or makes recommendations as to the management of securities or other property.”

However, the preamble to the proposed regulation is clear. It says: “This would include, for instance, advice and recommendations . . . as to the selection of persons to manage plan investments.”

But it takes more than a referral to result in fiduciary status. The proposed test for fiduciary status has two prongs. The referral of an investment manager would satisfy the first prong. However, one of four conditions in the second prong must also be satisfied. The condition that is most likely to be applied—and undoubtedly to be argued about—is the requirement that the advice be individualized to the needs of the plan, a plan fiduciary, or a participant or beneficiary. While it may be possible to refer an investment manager to a plan in a way that is not “individualized,” it will probably be difficult to show that the adviser did not consider the needs of the plan. That would be the case if, for example, the adviser gathered information about the plan or the participants.

This may be viewed as only a proposal. However, it is a long-standing DOL position. As a result, advisers and providers who work with investment managers should review their practices to ensure that they engage in a prudent process to select investment managers (and, possibly, to monitor them). In addition, broker-dealers, RIAs, providers and others who refer investment managers should ensure that they are not engaging in prohibited transactions because of, e.g., the receipt of solicitor’s fees.

Finally, as a risk management suggestion, advisers should review their insurance coverage to make sure that they are covered for fiduciary claims of this type.
Source: ERISA Controversy Report