The Department of Labor (DOL) has recently published proposed regulations under the Employee Retirement Income Security Act (ERISA) to expand the definition of who is a fiduciary with respect to employee benefit plan investment advice.

Service providers will bear the immediate costs of these new regulations through compliance efforts and the need to purchase fiduciary liability insurance. Employers that sponsor benefit plans will want to consider these new costs when contracting for investment related services, and continue to evaluate the reasonableness of fee arrangements because of general fiduciary requirements and in light of the prohibited transaction rules.

The proposed definition of fiduciary replaces a strict five-part test published by the DOL thirty-five years ago that limits the liability for third parties engaged to advise employers sponsoring benefit plans. Under the DOL’s original test, published under ERISA Section 3(21)(A) in 1975, an advisor providing investment advice would only be considered a “fiduciary” under ERISA if it rendered advice (1) as to the value of securities or other property, or the advisability of investing in, purchasing or selling securities or other property, (2) on a regular basis (3) pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary that (4) serves as a primary basis for investment decisions with respect to plan assets and (5) is individualized based on the particular needs of the plan. To trigger the old definition, all five criteria had to be met. Thus, the old definition had limited applicability.

The new definition would expand the old standard by imposing fiduciary liability on any person with discretionary authority or responsibility in the administration of a plan that renders “investment advice” for a fee or other direct or indirect compensation, to an employee benefit plan if such person:

  1.  provides advice, or an appraisal or fairness opinion, concerning the value of securities or other property; makes recommendations as to the advisability of investing in, purchasing, holding, or selling securities or other property; or provides advice or makes recommendations as to the management of securities or other property to a plan, a plan fiduciary, a plan participant, or a plan beneficiary; and
  2.  such person
  1.  either directly or indirectly represents or acknowledges that it is a fiduciary or is acting as a fiduciary with respect to the advice or recommendations; or
  2.  is a fiduciary with respect to the plan under ERISA Section 3(21)(A)(i) or (iii); or
  3.  is an investment adviser within the meaning of section 202(a)(11) of the Investment Advisers Act of 1940; or
  4.  directly or indirectly, pursuant to an agreement, arrangement or understanding with the plan, a plan fiduciary, a plan participant, or a plan beneficiary, in connection with making investment or management decisions with respect to plan assets, provides advice that is individualized to the needs of the plan, a plan fiduciary, a participant or beneficiary.

Significant changes to the definition of a “fiduciary” include the elimination of the requirements that advice be offered on a regular basis or be the primary source upon which to base investment decisions. Moreover, the new regulations impose liability as a fiduciary on advisors who evaluate hard to value plan assets, like employer securities of closely held companies. Finally, the regulations apply the prohibited transaction provisions of Internal Revenue Code Section 4975(e)(3)(B) to the new definition of fiduciary.

The proposed regulations specifically do not include the following communications in its definition of “investment advice” for purposes of fiduciary liability: (1) recommendations in the capacity as a purchaser or seller (or an agent or appraiser of a purchaser or seller); (2) investment education information and materials; (3) marketing materials with investment alternatives that are not individualized to a particular plan; (4) general financial information and data that assists in the monitoring or selection of plan investment alternatives if such communication contains a disclaimer indicating that the person “is not undertaking to provide impartial investment advice”; (5) general report or statement that merely reflects the value of an investment for compliance with reporting and disclosure requirements under ERISA and the Internal Revenue Code, unless there is no generally recognized market for the assets and the report or statement serves as a basis for distributions to plan participants and beneficiaries.