Advisors who dabble with the Employee Retirement Income Security Act of 1974 (ERISA)
can unwittingly run afoul of its regulatory requirements and/or prohibitions.
ERISA is one of the most impactful
pieces of legislation passed in the world
of investment management.
Along with various structural, administrative, and disclosure requirements,
ERISA also introduced the concept of
prohibited transactions. Broadly speaking, prohibited transactions could be
characterized as certain types of transactions that are presumed to have been
improperly influenced due to an interested individual’s role or financial interest in the transaction. My colleague and
DOL expert regarding advisory matters,
Ryan Walter, elaborated.
Advisors face plenty of prohibited
transaction concerns in their everyday
practices, he said. Prohibited transactions could occur in a variety of common
contexts, whether by directing retirement investors to proprietary products,
pulling advisory fees from retirement
plan assets or using ERISA fiduciary
status to solicit new business. Sometimes
there are exemptions to prohibited transactions, and often there are not.
These pitfalls can be particularly
dangerous when working with a client
who is a business owner. Countless businesses of all sizes across the country
offer ERISA-qualified retirement plans
to their employees. The company offering the plan is generally considered the
sponsor of the plan and is tasked with
the fiduciary responsibility for managing
and administering the plan.
Unique prohibited transaction con-
cerns arise when an individual or entity
acts as a fiduciary to an ERISA plan. Ryan
stressed that certain restrictions mean that
a business owner cannot use the assets of
his or her business ERISA plan to strike a
deal with an advisor for preferential fees
or services. A common example is:
• Business owner hires advisor to
manage the assets of his company’s
ERISA-qualified retirement plan;
• A few years pass, and the business
owner is so thrilled with advisor’s work
that (s)he considers placing some personal assets under advisor’s management;
• As a seasoned professional, the business owner recognizes the value of his
ERISA plan engagement and, consequently, reaches an agreement with advisor that, in order for the business owner to
bring over personal assets, the advisor will
need to give the business owner a 50%
discount on its traditional fee schedule;
• Advisor, happy to gain the new
assets, and with a mind towards potential future deposits, gladly accepts.
On the surface, this seems like a stan-
dard business transaction. Each party
uses its unique positioning and leverage
to reach a mutually agreeable deal. The
ERISA plan took no part in the transac-
tion and was seemingly unharmed.
But a closer look reveals that an ERISA
prohibited transaction takes place when
a fiduciary uses an ERISA plan’s assets
in their own interest or when the fiduciary receives a benefit from another
party dealing with the plan. By using
the ERISA plan engagement with the
advisor as negotiating leverage, and by
receiving discounted fees for personal
services from the advisor, the business
owner has unwittingly breached both
fiduciary prohibited transaction rules
Further, the advisor is not insulated from liability. Under ERISA exists
the concept of “co-fiduciary liability”
in which one fiduciary to an ERISA-qualified plan is equally culpable for the
fiduciary breaches of another fiduciary
to that plan, if the non-breaching fiduciary either participates in the breach or
has knowledge of the breach and takes
no action to correct it.
Although both the business owner and
the advisor feel like they engaged in a fair,
arm’s length negotiation, both parties have
put themselves and their firms at risk.
As shown here, ERISA is fraught with
both seen and unseen dangers. One party’s negotiating tactic is another party’s
prohibited transaction. When working
with ERISA plans and business owners,
advisors must be ever vigilant of potential abuses of ERISA fiduciary status.
Thomas D. Giachetti is chairman of the
Investment Management and Securities
Practice Group of Stark & Stark, and is a regular
contributor to Investment Advisor. He can be
reached at email@example.com.
THE COMPLIANCE COACH
By Thomas D. Giachetti
Watch Out for ERISA-Prohibited Transaction
Be extra cautious when dealing with the landmines of retirement plans.