Basics of ERISA

Marcia S. Wagner, Esq.

Z. Jane RileyThe Leaders Group, Inc.

Christopher GuancialePlanMember Services Corporation

Basics of ERISA

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1. Basic Fiduciary Duties and Standards

2. ERISA Bonding Requirements

3. Prohibited Transactions

4. Exemptions from PTs

5. Status of the Fiduciary Standards

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Fiduciary ResponsibilitiesEmployee Retirement Income Security Act of

1974, as amended (ERISA)◦ Plan fiduciaries have a “great responsibility.”◦ Personal liability for fiduciary breaches.◦ Penalties can also apply to non-fiduciary parties.

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Overview of Fiduciary RulesERISA plan must have at least one fiduciary.Plans may also have multiple fiduciaries.

◦ Responsibility and potential liability for co-fiduciary’s actions.

Person is not a fiduciary if only performing ministerial functions.

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Who Is a Fiduciary?Named Fiduciary

◦ Fiduciary named in plan document with principal responsibility over plan.

◦ Typically, the plan sponsor.

Functional Fiduciary ◦ Person with discretionary authority over plan

management;◦ Person with authority over disposition of plan assets;◦ Advisor who provides investment advice for a fee; or◦ Person with discretionary authority over plan

administration.

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Investment Advice FiduciariesPerson provides “investment advice” if:

◦ Advice on value or advisability of investments…◦ …is provided to plan on regular basis…◦ …under mutual understanding that advice will be…◦ …primary basis for investment decisions…◦ …and based on particular needs of plan.

Investment “education” is not fiduciary advice.

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Investment ManagersAlso known as “3(38) Fiduciaries”

◦ Named Fiduciary is not responsible for individual actions of Investment Manager.

◦ Investment Manager must have discretionary authority over plan assets.

◦ Must also be a RIA, bank or insurance co.◦ Must acknowledge fiduciary status in writing.

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Financial AdvisorsRIAs are typically plan fiduciaries.Broker-dealers typically do not want to be

plan fiduciaries.◦ But is broker-dealer providing investment advice?◦ If so, firm is a functional fiduciary.◦ Ellis v. Rycenga Homes, Inc. (2007)

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Fiduciary ResponsibilitiesFiduciary standard of care under ERISA.Must act solely in interest of plan

participants.◦ Exclusive purpose of providing benefits to plan

participants.◦ Carrying out duties prudently.◦ Following terms of plan document unless inconsistent

with ERISA.◦ Diversifying plan investments.◦ Paying only reasonable expenses of plan operation.

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Focusing on Specific DutiesExclusive purpose of providing benefits

◦ Primary responsibility to act solely in interest of participants.

◦ New participant-level disclosure reg’s require plan and investment disclosures for participants (effective May 31, 2012 for calendar year plans).

Carry out duties prudently◦ Must manage plan assets with care, skill, prudence

and diligence…◦ …that a prudent person acting in a similar situation…◦ …and familiar with such matters would exercise.◦ Duty of prudence focuses on process.

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Focusing on Specific Duties (cont’d)Following terms of plan document

◦ Must obey unless inconsistent with ERISA.

Diversifying plan investments◦ Must diversify plan’s investments in order to

minimize risk of large losses.

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Focusing on Specific Duties (cont’d)Paying only reasonable plan expenses

◦ Must ensure fees paid to plan’s providers are reasonable.

◦ Separately, prohibited transaction rules also require: (1) service arrangement must be reasonable, (2) services must be necessary, and (3) compensation must be reasonable.

◦ ERISA 408(b)(2) reg’s will require providers to deliver fee disclosures to plan sponsors (Apr. 1, 2012).

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Fiduciary Liabilities and PenaltiesERISA allows civil actions to be brought

against any fiduciary in breach of duties.◦ Fiduciary is personally liable for plan losses caused by

breach.◦ Other equitable relief may be awarded by court.

DOL Penalty◦ Civil penalty equal to 20% of amount recovered by

DOL on behalf of plan.◦ DOL may waive civil penalty in its discretion.

Additional penalties for prohibited transactions, including IRS excise taxes.

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Co-Fiduciary LiabilityERISA Section 405(a) imposes potential

liability on a co-fiduciary:◦ If he participates knowingly in the other fiduciary’s

breach;◦ If his failure enables the other fiduciary’s breach; or◦ If he knows of the other fiduciary’s breach and does

not make reasonable efforts to remedy the breach.

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CoverageERISA Section 412 requires bonding for every

fiduciary who handles plan funds.Bond must protect plan against loss due to

fraud or dishonesty.Person is deemed to “handle” plan funds if

there is risk that funds could be lost.◦ Non-discretionary advisor does not handle plan funds,

and is not subject to ERISA bond requirement.

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Other Requirements for ERISA BondAmount of ERISA Bond

◦ 10% of plan assets.◦ Minimum of $1,000.◦ Maximum of $500,000 ($1M for plan holding

employer securities).

Special Rule for Broker-Dealers◦ Exempt from ERISA bond requirement, if subject to

SRO’s fidelity bond requirement.

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Other Types of Fiduciary CoverageProfessional Liability Insurance

◦ Not required, but it is a customary form of protection for the advisor (rather than the plan).

◦ Protects against claims for fiduciary breaches as well as errors and omissions.

◦ Policies typically provide for coverage exclusions.◦ Consider policy limits.

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Overview of Prohibited Transactions“PT” rules are key protection for plans.

◦ Mere disclosure will never cure a PT.

Scope of Coverage ◦ Retirement plans are subject to prohibitions under

both Title I of ERISA and Internal Revenue Code.◦ IRAs and “Keogh” plans are subject to prohibitions

under Internal Revenue Code only.

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Title I of ERISAERISA Section 406(a) prohibits transactions

between plan and any Party in Interest.◦ Party in Interest includes plan sponsor and providers.◦ Prohibits transactions involving: (1)

a sale or exchange of property, (2) an extension of credit, (3) furnishing of goods or services, (4) transfer or use of plan assets, or (5) acquisition of employer securities or real property.

◦ Net Result: Exemption needed for even routine plan transactions.

ERISA Section 406(b) prohibits self-dealing by any plan fiduciary.

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Internal Revenue CodeIRC Section 4975 mirrors the PT rules under

ERISA Section 406.Two levels of excise taxes under IRC 4975.

◦ “First tier” excise tax for 15% of PT amount, which is imposed in each subsequent year until PT is corrected.

◦ “Second tier” excise tax for 100% of PT amount if PT has not been corrected when IRS assesses tax.

◦ Example: IRS assesses tax in Year 3 after PT occurs. Cumulative Excise Taxes = 15% + 15% + 15% + 100%

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Prohibited Transactions for IRAsSpecial Rule for PT Caused by IRA Owner

◦ IRA is disqualified.◦ If IRA Owner has investment discretion, IRA Owner is

also subject to excise taxes.

Regular excise taxes apply for PT caused by service provider to IRA.

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Statutory ExemptionsERISA Section 408(a) and “mirror” rules under

IRC contain numerous PT exemptions.Examples include:

◦ Providing services for reasonable compensation from plan.

◦ Providing bank ancillary services.◦ Investments in bank’s collective investment trust. ◦ Providing participant advice under an “eligible

investment advice arrangement.”

Statutory exemptions allow plans to enter into routine transactions.

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Administrative ExemptionsClass Exemptions

◦ Issued by U.S. Department of Labor◦ Permit any person to engage in covered transactions.◦ Like statutory exemptions, class exemptions have

requirements and conditions.◦ Example: PTE 77-4 (for proprietary mutual funds),

PTE 86-128 (for directed brokerage).

Individual Exemptions◦ Also issued by DOL.◦ Only person requesting exemption may rely on it.

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Status of the LawERISA’s standards are “the highest known to

the law” (as often cited in case law).In Oct. 2010, DOL proposes to modify

definition of “investment advice fiduciary.”◦ If adopted, DOL’s proposal would broaden existing

regulatory definition considerably.◦ Withdrawn on September 19, 2011.

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DOL’s Proposed Change to DefinitionCurrently, you provide “investment advice” if:

◦ Advice on value or advisability of investments…◦ …is provided to plan on regular basis…◦ …under mutual understanding that advice will be…◦ …primary basis for investment decisions…◦ …and based on particular needs of plan.

Proposed Changes◦ Advice no longer needs to be on a regular basis.◦ Advice no longer needs to be primary basis for plan’s

investment decisions. ◦ Thus, a one-time recommendation and even casual

advice might trigger fiduciary status.

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DOL Proposal: The Safe HarborDOL’s proposal has a “safe harbor” for

avoiding fiduciary status.Advisor must be able to demonstrate that

plan client should know that:◦ Advisor is acting in a capacity as seller of securities;◦ Its interests are adverse to those of the client; and◦ Advisor is not undertaking to provide impartial

advice.

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DOL Proposal: Potential ImpactFinancial Advisors

◦ Brokers would need to change service model. ◦ To remain as non-fiduciary advisors, they would need

to furnish the “safe harbor” disclaimers.◦ If broker receiving variable compensation is deemed

to be investment advice fiduciary, PT would result.◦ DOL proposal may encourage transition to becoming

dual registrants.

Outlook for DOL Proposal◦ Withdrawn on September 19, 2011 for

reconsideration, harmonization with Dodd-Frank.◦ Clarify that fiduciary advice is limited to individualized

advice directed to specific parties, will apply to IRAs.

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New Fiduciary Standard Under Dodd-FrankDodd-Frank Wall St Reform and Consumer

Protection Act (enacted Jul. 21, 2010)◦ SEC authorized to issue rules imposing fiduciary

standard on broker-dealers. ◦ Existing law has different standards of care:

Suitability (for broker) vs. Fiduciary (for RIA)

SEC Staff Report (Jan. 21, 2011)◦ Recommends uniform fiduciary standard.◦ 2 SEC commissioners are critical of staff report.

Outlook for SEC Rulemaking

Marcia S. Wagner, Esq.

99 Summer Street, 13th FloorBoston, MA 02110

Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.erisa-lawyers.com

[email protected]

Z. Jane RileyThe Leaders Group, [email protected]

Christopher GuancialePlanMember Services Corporation

[email protected]

Basics of ERISA

A0061101

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Basics of ERISA