Borzi Tells House Committee Current Fiduciary Regs Flawed; Must Fix Loopholes In Investment Advisor Definition To Protect Plans


Assistant Secretary of Labor, Employee Benefits Security Administration (EBSA) Phyllis C. Borzi testified Tuesday, July 26, 2011 to the House Committee on Education and the Workforce Subcommitte on Health, Employment, Labor, and Pensions that EBSA a proposed fiduciary regulation  that would update EBSA regulations defining when a person is considered a “fiduciary” by reason of giving investment advice for a fee with respect to assets of an employee benefit plan or IRA will help protect employee benefit plan participants by correcting “loopholes” in a “flawed 35-year-old rule” that allow many parties providing advice about the investment of retirement plan assets to escape coverage by ERISA’s fiduciary responsibility rules.  The proposed regulations and other stepped up regulations and enforcement of ERISA’s fiduciary protections by the EBSA means that plan sponsors, fiduciaries, investment advisors and other plan service providers and others involved in the sponsorship, design, and administration of an employee benefit plan need to act to manage expanding fiduciary responsibilities and exposures.

  • Borzi Says Loopholes & Other Flaws In Existing Regulations Hurt Plans & Their Participants

Borzi told the Committee that EBSA believes its rules about the types of advisory relationships that give rise to fiduciary status under the ERISA on the part of those providing investment advice services need to change because “technicalities” and “loopholes” in the current EBSA fiduciary regulations definition of “investment advisor” in effect since 1975 harms participants and beneficiaries by allowing many advisers to easily dodge fiduciary status.

Borzi testified that the five-part regulatory test used under the current regulations to determine when ERISA’s fiduciary requirements apply to “investment advice” and when the advisor is a “fiduciary” significantly narrowed the plain language of the ERISA statute so that much of what plainly is advice about plan investments is not treated as investment advice as fiduciary conduct under ERISA and the person paid to render that advice is not treated as an ERISA fiduciary.

Under current fiduciary regulation, an investment adviser is not treated as a fiduciary accountable for complying with ERISA’s prudence, exclusive benefit, prohibited transaction and other fiduciary responsibility safeguards if and when providing advice that meets each element of a five part test.

Under the current regulation, a person is a fiduciary under ERISA and/or the tax code with respect to their advice only if and when he or she:

  • Make recommendations on investing in, purchasing or selling securities or other property, or give advice as to their value;
  • On a regular basis;
  • Pursuant to a mutual understanding that the advice;
  • Will serve as a primary basis for investment decisions; and
  • Will be individualized to the particular needs of the plan.

Borzi told members of Congress this narrow definition of investment advisor exempts a wide range of parties receiving compensation for providing advice about the investment of employee benefit funds from coverage by ERISA’s fiduciary responsibility requirements.  Borzi testified that the narrowness of the existing regulation opened the door to serious problems, and changes in the market since the regulation was issued in 1975 have allowed these problems to proliferate and intensify. Borzi says the narrowness of the regulation has harmed some plans, participants, and IRA holders. Research has linked adviser conflicts with underperformance. SEC reviews of certain financial sales practices may also reflect these influences. Finally, EBSA’s own enforcement experience has demonstrated specific negative effects of conflicted investment advice.

  • Borzi Says Proposed Regulation Would Strengthen Protections For Plans & Their Participants

Borzi said the proposed regulation published in the Federal Register on October 22, 2010 would change the rules defining a person is considered to be a “fiduciary” by reason of giving investment advice for a fee with respect to assets of an employee benefit plan or IRA by modifying the current regulation in effect since 1975 would replace the five-part test of “investment advisor” with a broader definition more in keeping with the statutory language while providing clear exceptions for conduct that should not result in fiduciary status.

According to Borzi, types of advice and recommendations that generally would trigger fiduciary status under the proposed regulations include: (1) appraisals or fairness opinions concerning the value of securities or other property; (2) recommendations as to the advisability of investing in, purchasing, holding or selling securities or other property; or (3) recommendations as to the management of securities or other property.

To be a fiduciary for performing these or other activities treated as fiduciary investment advice, Borzi explained that a person engaging in one of these activities must receive a fee and also meet at least one of the following four conditions:

  • Represent to a plan, participant or beneficiary that the individual is acting as an ERISA fiduciary;
  • Already be an ERISA fiduciary to the plan by virtue of having any control over the management or disposition of plan assets, or by having discretionary authority over the administration of the plan;
  • Be an investment adviser under the Investment Advisers Act of 1940; or
  • Provide the advice pursuant to an agreement or understanding that the advice may be considered in connection with investment or management decisions with respect to plan assets and will be individualized to the needs of the plan.

At the same time, Borzi testified that the proposed regulation recognizes that activities by certain persons should not result in fiduciary status. Specifically, these are:

  • Persons who do not represent themselves to be ERISA fiduciaries, and who make it clear to the plan that they are acting for a purchaser/seller on the opposite side of the transaction from the plan rather than providing impartial advice;
  • Persons who provide general financial/investment information, such as recommendations on asset allocation to 401(k) participants under existing Departmental guidance on investment education;
  • Persons who market investment option platforms to 401(k) plan fiduciaries on a non-individualized basis and disclose in writing that they are not providing impartial advice; and
  • Appraisers who provide investment values to plans to use only for reporting their assets to the DOL and IRS.
  • EBSA Still Working To Address Expressed Concerns

The proposed regulation has prompted a large volume of comments and a vigorous debate. Borzi testified that the EBSA is working hard to hear and consider every stakeholder concern and shared some examples of how EBSA is considering addressing certain of these concerns.   Borzi said EBSA is taking multiple steps in its effort to respond to these and other concerns in its efforts to finalize the regulation including:

Borzi told the Committee EBSA is working to better understand how specific compensation arrangements would be affected by the proposed rule and whether clarifications of existing prohibited transactions exemptions would be appropriate. Borzi said EBSA has already begun to issue subregulatory guidance describing some of these clarifications and will continue to do so as necessary as it completes its analysis.

Borzi also said that as EBSA further develops its thinking in this rulemaking, EBSA is paying special attention to the two primary exceptions to fiduciary status under the proposed rule: (1) clarifying the difference between investment education that does not give rise to fiduciary status and fiduciary investment advice; and (2) clarifying the scope of the so-called “sellers’ exception” under which sales activity is not fiduciary advice. In both cases, Borzi said EBSA intends to analyze and address the comments and concerns that were raised during our extensive public comment period.

Finally, Borzi said EBSA is exploring a range of appropriate regulatory options for moving forward, taking into consideration public comments submitted for the record, EBSA’s economic analysis, and relevant academic research. In so doing, Borzi told the Committee EBSA is aiming to address conflicted investment advice while not unnecessarily disrupting existing compensation practices or business models.

  • Plan Sponsors, Fiduciaries, Service Providers Should Prepare For Tighter Rules While Continuing To Provide Input To EBSA

The proposed changes to the definition of investment advisor is one of many steps that EBSA is taking to tighten the regulations implementing ERISA’s fiduciary requirements and to enforce the protections of ERISA.  The proposal to expand the conditions that providing investment advice regarding retirement plan assets will trigger the fiduciary protections of ERISA is designed to expand the reach of those regulations.  Service providers involved in providing these or other related services generally will want to review and update their processes, documentation and training to manage new exposures likely to arise from these proposed regulations, while continuing to share feedback to EBSA and other rulemakers. 

Service providers are not the only parties that need to update practices and provide input about these rules.  Plan sponsors, fiduciaries, service providers, participants and beneficiaries also are impacted.  Employers and other plan sponsors, fiduciaries and others need to anticipate and respond effectively to the inevitable efforts by providers of investment advice and other services to avoid or shift liability.  Parties securing or relying on advice or services about investments or other responsibilities should:

  • Carefully, prudently conduct a documented investigation and critical analysis of existing and proposed advisors and other service providers credentials, analysis, performance, contract, recommendations and other conduct;
  • Carefully review contracts and other materials and secure appropriate constractual and other safeguards;
  • Require indemnification, insurance and other protections;
  • Ensure that appropriate action is taken to appoint parties intended to perform fiduciary advisory or other services to manage risks
  • Secure and maintain appropriate fiduciary and other liability insurance coverage;
  • Carefully conduct an appropriate, well-documented prudent review of performance, credentials and other relevant factors on a regular basis to preserve ongoing evidence of prudence; and
  • Other appropriate safeguards to manage risks and liabilities.

To help guard and position themselves to defend against fiduciary exposures plan sponsors, fiduciaries, service providers and others involved in the administration of health or other employee benefit plans should seek the advice of legal counsel with appropriate experience with employee benefit and other related matters to develop an understanding of ERISA and other laws and the duties and liabilities that these rules may create for their organizations and themselves personally.  For additional tips and information about managing these risks, see here.

For Help With These Or Other Risk Management Matters

If you need assistance in auditing or assessing, updating or defending your wage and hour or with other labor and employment, employee benefit, compensation or internal controls practices, please contact the author of this update, attorney Cynthia Marcotte Stamer here or at (469)767-8872.

Board Certified in Labor & Employment Law by the Texas Board of Legal Specialization, management attorney and consultant Ms. Stamer is nationally and internationally recognized for more than 23 years of work helping employers; employee benefit plans and their sponsors, administrators, fiduciaries; employee leasing, recruiting, staffing and other professional employment organizations; and others design, administer and defend innovative workforce, compensation, employee benefit  and management policies and practices. Her experience includes extensive work helping employers implement, audit, manage and defend wage and hour and other workforce and internal controls policies, procedures and actions.  The Chair of the American Bar Association (ABA) RPTE Employee Benefits & Other Compensation Committee, a Council Representative on the ABA Joint Committee on Employee Benefits, Government Affairs Committee Legislative Chair for the Dallas Human Resources Management Association, and past Chair of the ABA Health Law Section Managed Care & Insurance Interest Group, Ms. Stamer works, publishes and speaks extensively on wage and hour, worker classification and other human resources and workforce, employee benefits, compensation, internal controls and related matters.  She also is recognized for her publications, industry leadership, workshops and presentations on these and other human resources concerns and regularly speaks and conducts training on these matters. Her insights on these and other matters appear in the Bureau of National Affairs, Spencer Publications, the Wall Street Journal, the Dallas Business Journal, the Houston Business Journal, and many other national and local publications. For additional information about Ms. Stamer and her experience or to access other publications by Ms. Stamer see here or contact Ms. Stamer directly.

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This entry was posted on Thursday, July 28th, 2011 at 8:29 AM and is filed under Bankruptcy, Corporate Compliance, Defined Benefit Plans, Defined Contribution Plans, Employee Benefits, Employers, ERISA, Fiduciary Responsibility, Health Plans, Human Resources, Insurance, Internal Controls, Internal Investigations, Professional Liability, Reporting & Disclosure, Restructuring, Retirement Plans, Risk Management, Union. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.

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