United States: DOL Proposes Significant Expansion of ERISA "Fiduciary" Definition in the Investment Advice Context

Introduction

The U.S. Department of Labor (the "DOL") recently published a proposed rule that would amend the regulation interpreting the definition of "fiduciary" and significantly expand the types of investment advice activities that may give rise to fiduciary status under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). The proposed amendment would replace the discussion of what constitutes "investment advice" in the current ERISA regulation, published in 1975, with new and expanded language. Public comments on the proposed amendment to the regulation (the "Proposed Regulation") will be accepted until January 20, 2011. Ultimately, any changes would become effective 180 days after the final regulation is published.

According to the DOL's press release, it was motivated to update the regulation because of its concern that the 1975 regulation's approach to fiduciary status in this area "may inappropriately limit the DOL's ability to protect plans, participants and beneficiaries from conflicts of interest that may arise from today's diverse and complex fee practices in the retirement plan services market." The Proposed Regulation, therefore, has been designed to "protect plan officials and participants who expect unbiased advice, by giving a broader and clearer understanding of when individuals providing such advice are subject to ERISA's fiduciary standards."

Discussion

Under ERISA, a person becomes a fiduciary to a benefit plan to the extent that he or she (1) exercises discretionary authority or control regarding the management of a plan or its assets, (2) renders investment advice for a fee or other direct or indirect compensation with respect to any moneys or other property of a plan, or has authority to do so, or (3) has any discretionary authority or responsibility in the administration of a plan.

In 1975, shortly after ERISA was enacted, the DOL published a regulation interpreting the second prong of the fiduciary test (relating to when a person would be considered a fiduciary based on the rendering of "investment advice for a fee"). Under the 1975 regulation, a person who provides investment advice to a plan for a fee is not considered a fiduciary under this prong of the definition of fiduciary unless each of the following five elements is satisfied: (1) the person must render advice as to the value of securities or other property or the advisability of investing in, purchasing or selling securities or other property, (2) on aregular basis, (3) pursuant to a mutual understanding with the plan, that (4) the advice will serve as a primary basis for the plan's investment decisions, and that (5) the advice will be individualized based on the needs of the plan.

The Proposed Regulation rethinks what actions constitute the rendering of "investment advice for a fee" for the purposes of determining whether the advice-giver is considered a fiduciary to the plan in connection with that advice, and in doing so would largely discard the 1975 regulation's 5-part test. Perhaps most importantly, the "regular basis" and "primary basis" prongs of the 5-part test, which many different service providers have historically relied upon to avoid fiduciary status under ERISA, would no longer apply. Instead, under the Proposed Regulation, an adviser will be an ERISA fiduciary with respect to a plan if:

1. It provides any form of advice or recommendation described in Column A below to the plan, the plan fiduciary or a plan participant or beneficiary; AND

2. Any one of the conditions described in Column B below is satisfied; AND

3. The adviser receives a fee or other compensation for its rendering of investment advice.

Along with the broadened list of actions that may cause an adviser to be considered a fiduciary, the Proposed Regulation also proposes some new exceptions to the rule. An adviser will not be considered a fiduciary in connection with its investment advice if any of the following tests is satisfied:

• The adviser has not represented that it is a fiduciary and can demonstrate that the plan knows or reasonably should know that the adviser (1) is providing advice in its capacity as a purchaser or seller of a security or other property (or as an agent of such a person) whose interests are adverse to the interests of the plan, AND (2) is not undertaking to provide impartial advice; OR
• The plan is a defined contribution plan (e.g., 401(k) plan) and the adviser is (1) providing investment education information, OR (2) is making a menu of investment options available to the plan without regard to the plan's individual needs and has disclosed in writing that it is not undertaking to provide impartial investment advice, OR (3) providing general financial information or data necessary to select or monitor the investment options available under a plan's menu and has disclosed in writing that it is not undertaking to provide impartial investment advice; OR
• The adviser has prepared a general report or statement that merely reflects the value of an investment of a plan or a participant or beneficiary for purposes of complying with the reporting and disclosure requirements of ERISA and the Internal Revenue Code, unless the report involves assets for which there is no generally recognized market and serves as a basis on which a plan may make distributions to participants and beneficiaries.

In addition to its application under ERISA, the Proposed Regulation would also be applied for purposes of the prohibited transaction provisions of the Internal Revenue Code.

Despite these exceptions, the proposal still represents a significant expansion of the existing rule regarding the status of an adviser as a fiduciary in connection with investment advice activities. According to recent public statements of the Assistant Secretary of Labor of the Employee Benefits Security Administration, Phyllis Borzi, it seems the DOL is aware that the Proposed Regulation is likely to lead to debate among stakeholders

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