The Employee Benefits Security Administration (EBSA) of the Department of Labor (DOL) has proposed dramatic changes to the rules that govern the relationship between employee benefit plans and those who provide investment advice and other financial services to plans and plan participants. As a result, brokers and brokerage houses, appraisers and valuation firms, and various types of financial advisors face a changing regulatory landscape and may soon become exposed to new liabilities.

Specifically, the DOL recently: (1) proposed rules that would more broadly define the circumstances under which a person is considered a “fiduciary” by reason of giving investment advice to an employee benefit plan or to a plan’s participants; (2) published rules for greater disclosure of service provider fees and other plan expenses and fees; and (3) clarified rules pertaining to specific types of asset managers.  

DOL Proposes (and Re-examines) Rules Expanding Definition of “Fiduciary”

In October 2010, the DOL proposed a regulation to expand the definition of “fiduciary,” set forth in ERISA § 3(21)(A), to include any individual who provides advice regarding the value, management or purchasing or selling of securities or other property to an ERISA plan, even if that advice was not delivered on a regular basis or was not the primary reason for the plan’s investment decision, as the rules currently require.

In March and April of this year, the EBSA held hearings and collected comments from stakeholders on the roles and duties of fiduciaries in order to better understand the implications of their proposed changes to the definition. A final “fiduciary definition” regulation is expected to be issued by the end of the year.

Impact of the Definition Expansion

As a result of the expansion of what constitutes “investment advice” in the new rules, brokers, appraisers, financial advisors and others who service employee benefit plans will likely find that they are in a fiduciary relationship with the benefit plans they are servicing and therefore are exposed to additional liability.  

With regard to the definition of “investment advice,” the new regulation:

  • Eliminates the requirement (for fiduciary status) that the investment advice be rendered on a regular basis;
  • Provides that any advice that may be considered in connection with investment or management decisions is now covered;
  • Provides that the advice no longer needs to be provided pursuant to a mutual agreement; and
  • Provides that fairness opinions and appraisals are specifically included as covered types of investment advice.  

It is important to note that an individual or entity can become a fiduciary based on actions alone. Under ERISA’s functional definition of “fiduciary,” a person or entity may be deemed a fiduciary of a plan solely as a result of the functions the person performs with respect to the plan, regardless of whether the person is a “named fiduciary” on plan documents.  

Impact on Valuation Firms/Appraisers

Although the specific implications of the expanded “fiduciary” definition are not entirely clear for all financial advisors, firms and individuals providing valuation and appraisal services are likely to suffer economically from the proposed regulatory modification.

In a 1976 Advisory Opinion, the DOL found that a valuation of closely held employer securities on which an employee stock ownership plan (ESOP) would rely in determining the adequate consideration for purchase of the securities did not constitute investment advice, and therefore, fiduciary status did not attach to the valuation firm. The Opinion clarified that when valuation firms provided advice to sponsors of ESOPs or ESOPs themselves, such advice would not serve as the primary basis for investment decisions with respect to plan assets; nor would it constitute advice as to the value of securities within the meaning of the regulation. The proposed regulation explicitly overturns the DOL’s 1976 Advisory Opinion.

As a result, valuation firms, such as those that provide fairness opinions to ESOPs, may soon acquire the status of “fiduciary.” This new status will, among other things, compel them to procure fiduciary liability insurance, expose them to litigation for potential breach of fiduciary duties and require greater disclosure. These new costs may drive many of these firms out of the marketplace.

DOL Releases Regulations on Fee Disclosure

Adding to the regulatory burden on financial advisors, the DOL has released two new rules on fee disclosures for retirement plans—the “Section 408(b)(2)” regulations and the “Participant-Directed” regulations.

408(b)(2) Regulations

Last year, the DOL released interim final rules concerning required disclosures in connection with services rendered to ERISA plans or Keogh plans. Although the rules initially were set to take effect in July 2011, a DOL Notice published on June 1, 2011, proposes to extend the effective date of the rules until January 1, 2012.

Section 408(b)(2) of ERISA requires that certain service provider arrangements involving ERISA plans be “reasonable” in order to qualify for exemption from the prohibited transaction rules. Generally, a “prohibited transaction” is one between a plan and an interested or related party that may result in liability for those involved due to self-dealing or conflict of interest.  

The rules provide that an arrangement will not be considered “reasonable” unless the service provider discloses its fees and other financial terms to the plan. The goal of the regulation is to ensure that all service provider expenses, including hidden and indirect fees, are provided to plans.  

Participant-Directed Fee Disclosure Regulations

New “participant-directed” plan fee disclosure regulations were released by the DOL in October 2010. The new rules were initially applicable for the first plan year beginning on or after November 1, 2011. However, the DOL effectively extended the applicability date of the rules to January 1, 2012 (or beyond, depending on the start of the plan year) by extending (from 60 to 120 days) the date by which initial disclosures must be provided.  

These rules require fiduciaries of participant-directed individual account plans, such as 401(k) plans, to disclose to plan participants and beneficiaries certain plan and investment-related fee and expense information.  

Changing Regulatory Landscape

There is no question that financial advisors in the retirement plan industry must now operate under new rules. Advisors have a lot at stake if they fail to make appropriate disclosures and meet their new obligations. Failure to comply with these new requirements could result in penalties, monetary damages and the inability to continue providing advice and other financial services to benefit plans.