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The ERISA Mystery

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I advise many clients throughout the U.S. regarding Employee Retirement Income Security Act (ERISA) engagements. Many of our clients are being engaged as a discretionary investment manager for retirement plans or as consultants to self-directed 401(k) plans. Two common themes remain: confusion and, at times, failure to follow applicable laws and rules.

The Department of Labor is conducting reviews of plans and advisors (to a much lesser extent) to ascertain compliance with ERISA, and the SEC will routinely address ERISA engagements during regulatory exams, including such issues as bonding, proxy voting, fee-leveling (self-directed plans), revenue sharing, conflict disclosure, custody and whether the plan’s assets can be counted as assets under management on their ADV Part 1.

I am always looking to enhance our clients’ knowledge regarding ERISA engagements, including engagement limitations (especially in a self-directed plan where the advisor generally serves as the consultant to the plan). All too often, the agreements that I see are a disaster. They reflect little to no understanding of ERISA issues.

ERISA is an extremely complex federal law that governs 401(k) plans in the private sector. It remains an unsettled issue for advisors who provide consulting and investment services to 401(k) plans whether they may charge an additional fee for providing model allocation services to 401(k) plan participants. For registered investment advisors (RIAs) to better understand this issue, they must be aware of certain terms and definitions under ERISA.

Section 3(14) of ERISA defines a “party in interest” as “any fiduciary (including, but not limited to, any administrator, officer, trustee or custodian), counsel or employee” of a plan and “a person providing services to such plan.”

Section 3(21) of ERISA defines a “fiduciary” as a person who exercises discretionary authority or control over management of a plan or its assets, or who provides advice for compensation.

Section 406(a) prohibits certain transactions between a party in interest and the plan. Specifically, Section 406(a) prohibits a fiduciary of a plan to cause the plan to transfer any assets to or for the benefit of a party in interest. In addition, Section 406(b) prohibits certain transactions between the plan and a fiduciary. Section 406(b) prohibits a fiduciary to “deal with the assets of the plan in his own interest or for his own account” or “act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests” of the plan or its participants or beneficiaries.

Sections 406(a) and 406(b) are commonly referred to as the self-dealing prohibition and the conflict of interest prohibition, respectively. Together they cause much anxiety for investment advisors who provide consulting services to plan sponsors. Specifically, investment managers who provide model allocations to plan participants for an additional fee may be taking a risk by entering this type of arrangement. While these matters have not yet been litigated, we regularly caution our clients to structure their relationships with plan sponsors and plan participants in conservative ways.

For example, advisors regularly ask whether they may engage in rollovers for 401(k) plan participants where the advisor serves as a fiduciary to the plan. In an advisory opinion, the DOL stated that if “a fiduciary exercises control over plan assets [and] cause[s] a participant or beneficiary to take a distribution and then to invest the proceeds in an IRA account managed by the fiduciary, the fiduciary may be using plan assets in his or her own interest, in violation of [the prohibited transaction rule in] ERISA section 406(b)(1).”

By analogy, the DOL could take the same approach with advisors who charge an additional fee to participants for investing in a model allocation program. The advisor could be viewed as using plan assets in their own interest. Therefore, we try to limit the odds or likelihood that the DOL would find an activity of our clients to be in violation of the law.

While I don’t endorse non-level fees, if an advisor will be charging dual fees for consulting and model allocation, it must disclose these fees to the sponsor and the participant and make all parties aware of the compensation terms and corresponding conflicts of interest.


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