Under ERISA, a fiduciary is a person who has discretionary authority over the management of the plan, or a person who “renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has the authority or responsibility to do so.” Previously, solicitors were not fiduciaries because they were receiving fees in exchange for referrals and, as such, were not rendering investment advice.
Under the Department of Labor’s fiduciary rule, solicitors will be considered fiduciaries for recommendations made in connection with ERISA-covered plans and IRAs. The revised definition of “investment advice” under ERISA includes “recommendations on [the] selection of other persons to provide investment advice or investment management services.”
For new solicitor relationships, referral compensation would be a prohibited transaction, absent an exemption. This would subject the solicitor to onerous requirements in order to align its interests with those of the client under the terms of the Best Interest Contract Exemption (BICE), including voluminous disclosures, a website, and full policies and procedures tailored to mitigate conflicts of interest.
One way to potentially avoid the prohibited transaction issue is through a “co-advisor” relationship. A solicitor relationship is not prohibited simply because the solicitor is now considered a fiduciary, but rather because ERISA generally prohibits fiduciaries from engaging in self-dealing and receiving compensation from third parties in connection with transactions involving qualified plans and IRAs.
The advisory duties would need to be bifurcated between each co-advisor. A co-advisor solicitor could potentially introduce a client to an advisor for the purposes of managing the client’s ERISA-covered assets. After the client is engaged, the advisor and co-advisor would service the client in joint, though distinct, roles. For example, the advisor could handle all aspects of the investment process, while the co-advisor solicitor could handle the client services and relationship management aspects of the engagement. As long as the roles were distinctly delegated to each party, and each party’s separate compensation was reasonable in light of the services provided, the arrangement should satisfy this obligation.
The Form U-4 Defense
Another way to avoid a prohibited transaction is through an affiliated or supervisory relationship. In this case, an individual would file a Form U-4 and become an associated person or investment advisor representative of the firm. Since he or she would be an employee or independent contractor supervised and controlled by the firm, he or she would simply be earning compensation through an employment arrangement. The prohibited transaction is avoided because the client is only paying one firm and the firm is paying an employee.
In either case, both the advisor and co-advisor solicitor would still have to ensure that their fees were reasonable under the circumstances. Additionally, solicitor relationships that are pre-existing and ongoing appear to be spared under the fiduciary rule. Per FAQs published by the DOL, the fiduciary rule applies to “investment recommendations made on or after April 10, 2017.” As such, arrangements in which the solicitor is paid an ongoing fee in exchange for a referral made prior to the fiduciary rule’s effective date are permitted so long as they are disclosed.
However, no new referrals would be permitted after April 10 (unless the rule implementation date is delayed or the rule is modified or withdrawn), other than recommendations regarding the exchange or rebalance of the plan assets, which does not increase compensation. Further, no additions to the investment or new purchases other than as part of a systematic purchase program established prior to April 10 would be permitted.
Caveat: The DOL rule is uncharted territory. Current opinions and guidelines are subject to change without notice. Moreover, there can be no assurance that regulators will not take a different position. The discussion above does not serve as a substitute for individual advice.
— Read 3 Critical Areas Regulators Are Watching on ThinkAdvisor.