Proposed Regulations Would Greatly Expand Reach of ERISA Fiduciary Exposure: Adoption Would Extend ERISA’s Prudence and Conflict of Interest Rules to Those Providing “Investment Advice” to Employee Benefit Plans

Sullivan & Cromwell LLP - October 25, 2010
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On October 21, 2010, the Department of Labor (“DOL”) proposed regulations (the “Proposed Regulations”) that would, if adopted, significantly expand the circumstances in which a person will be treated as a fiduciary under the Employee Retirement Income Security Act of 1974 (“ERISA”) by reason of providing investment advice for a fee to an employee benefit plan. A fiduciary under ERISA is subject to strict prudence and conflict of interest standards and it is the DOL’s expressed intention in making the changes to enhance its “ability to redress service provider abuses that currently exist in the market, such as undisclosed fees, misrepresentations of compensation arrangements, and biased appraisals of the value of employer securities and other plan investments.” Because many financial institutions have regular interactions with employee benefit plans and their fiduciaries—as counterparties, service providers, agents, and so forth—the Proposed Regulations are widely relevant for the financial services industry.

To summarize, the Proposed Regulations would:

  • Expand the definition of “investment advice” to include the rendering of appraisals and fair value opinions and making recommendations with respect to the “management” of securities or other property (in addition to the current advisory activities which include advice concerning the value of securities and recommendations regarding the advisability of buying, holding or selling securities and property, but currently exclude valuations of closely held stock);
  • Impose ERISA fiduciary standards when investment advice is made, even on a one-time basis, pursuant to an agreement, arrangement or understanding that (1) the plan “may consider” the advice in making investments and (2) the advice will be individualized (thus eliminating the current law requirement that the investment advice be provided “regularly,” pursuant to a mutual understanding that the advice will be a “primary basis” for making investment decisions); and
  • Define “fees” to include fees received by affiliates and fees received in connection with transactions to which the advice relates, such as brokerage fees, commissions and so forth.

The Proposed Regulations contain exceptions for (1) persons acting as adverse counterparties (or agents thereto) in purchase and sale transactions, where the plan fiduciary knows or should know the counterparty is not undertaking to provide impartial advice (this exception does not apply to a person that represents or acknowledges it is acting as an ERISA fiduciary); (2) certain informational and other materials provided by 401(k) providers, without regard to the individual needs of the plan; and (3) valuation reports provided in compliance with applicable fee disclosure regulations (unless the report includes assets that are illiquid and the report will serve as the basis for plan distributions).

Because of the potential breadth of the Proposed Regulations and the consequences of becoming an ERISA fiduciary, financial institutions should carefully review their interactions with employee benefit plans and their fiduciaries (such as hedge funds and asset managers that are ERISA fiduciaries) to identify and address potential areas of compliance.

The comment period for the Proposed Regulations ends on January 20, 2011. The final regulations would become effective 180 days after publication in final form in the Federal Register.