Advisers are increasingly identifying themselves as ERISA fiduciaries in response to employer demands and new disclosure requirements. Some advisers have been hesitant to take on fiduciary status due to lack of education on ERISA rules and responsibilities. Failure to understand and properly manage fiduciary duties can result in severe penalties such as fines and lawsuits. Advisers can protect themselves by obtaining education on ERISA regulations, purchasing errors and omissions insurance, and establishing infrastructure to audit their compliance with fiduciary obligations.

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Battle Lines
Advisers increasingly are embracing ERISA plan fiduciary status. Why they’re doing it, and
how to prevent problems
Judy Ward – 12/01/2008
Adviser Charles Snyder and his colleagues at Robert W. Baird & Co. Inc. saw the new
reality emerging a few years ago: A growing number of employers want their retirement
plan advisers to serve as Employee Retirement Income Security Act (ERISA)
fiduciaries—and openly acknowledge it.
“When we began to move up-market to larger plans, we were seeing a need for companies to formalize
the relationship with their adviser, moving from a traditional broker/dealer arrangement to something
contractual that stipulates clearly what services the adviser has been hired to perform, and what the
compensation is going to be,” says Snyder, a Cleveland-based Senior Vice President at the financial
services company and broker/dealer. So, the company spent a couple of years developing internal
controls that allow it to “audit advisers like me to make sure that we meet all of our contractual
obligations,” he says.
For the past two years, Robert W. Baird’s plan-advisory contracts have specified that the firm serves as
an ERISA fiduciary. Audit staffers at the company annually examine the files of Snyder and his adviser
colleagues, making sure, for example, that the advisers did all the investment-review meetings and
employee meetings stipulated in their contracts.
Increasingly, Snyder sees it becoming the norm for plan
advisers to identify themselves as ERISA fiduciaries.
“Definitely in the past two years, it has been more in that
direction,” he says. “Disclosure requirements are coming
from the DoL [U.S. Department of Labor] that will require this
type of more-formalized arrangement. It takes a lot of the
potential conflicts of interest out of play. You are paid by the
plan or sponsor; you are not compensated differently
depending on the provider or fund recommended or
selected. The relationship is transparent, and objective
decisions can be made.”
“I find that there are many
advisers who are
effectively investment-advice
fiduciaries, and
they do not seem to
realize that they are
fiduciaries.”
Others in the industry foresee the same reality. “The need for a product salesperson who does not accept
fiduciary responsibility is quickly coming to an end,” says David Witz, Managing Director of Charlotte,
North Carolina-based Fiduciary Risk Assessment LLC. Between the Pension Protection Act and
employers’ concern about participant lawsuits and potential liability, he says, more plans will use a menu
of low-cost index funds and turn to auto-enrollment and auto-increase plan provisions. “What role will the
adviser play in that market?” he asks. “Not quarterly investment reviews, because now they have a bunch
of index funds. Not education meetings, because they just auto-enrolled everyone.
“What he or she needs to be is an ERISA consultant. That basically means that 80% of advisers are out
of a job unless they can adapt,” says Witz, who bases that percentage on talking to providers about the
expertise of advisers working with plans. “I am very bearish on advisers, because most advisers are not
technically strong on ERISA issues.”
For those who do adapt, opportunity looms. Adviser Chip Morton has identified himself as a fiduciary
since he started working with plans in 1992. Morton, a Destin, Florida-based retirement plan consultant at
National Retirement Partners, and his team do three types of fiduciary work: at the plan level, with
individual participants, and/or rollover-counseling services for those who terminate employment. Clients
can use one of those services, or a combination. Sponsors have not objected to their work with both the
plan and participants, he says, and, in fact, like knowing that their participants get proper guidance when
they leave the plan.
Stricter fee-disclosure requirements for advisers do not worry Morton, since ERISA already requires him
to be clear about his fees. “This whole thing about fee disclosure enhances our ability to get clients,” he
says. “What we make is on the Form 5500.” He hopes the Feds ultimately go further and require all
advisers working with plans to become fiduciaries. Those giving sponsors the service they need already
have crossed that line, he says. “If they really know what they are doing, then they already are
fiduciaries,” he adds, “whether their employer lets them say so or not.”
The Ostrich Mentality
The issue is not that few plan advisers serve as ERISA fiduciaries now, sources interviewed for this
article say—it is that most of them do, but many do not know it, or know it but do not acknowledge it. “I
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find that there are many advisers who are effectively investment-advice fiduciaries, and they do not seem
to realize that they are fiduciaries,” says Marcia Wagner, President at Boston-based The Wagner Law
Group, a law firm specializing in ERISA and employer benefits. “They are not holding themselves out as
fiduciaries. The question is, are people being willfully blind? There is a lot of the ostrich mentality out
there now.”
“You cannot be a plan-level adviser and not be a fiduciary, I do not care what anybody says,” Morton
says. “If it walks like a duck and talks like a duck, it is a duck. If you give advice, you are a fiduciary.”
Says Witz, “Ultimately, your function determines if you are a fiduciary.” In a nutshell, an adviser is a
fiduciary if he receives a fee from a plan and can invest plan assets as he sees fit, or if he gives advice to
the plan based on the plan’s demographics.
ERISA section 3(21)(A)(ii) includes within its definition of fiduciary a person who gives a plan investment
advice for a fee or other compensation—direct or indirect—or who has any authority or responsibility to
do so, Wagner says. She adds that DoL regulations have amplified the definition to say that a person
renders investment advice only if two conditions are met: first, the advice relates to the value of securities
or other property, or constitutes a recommendation about investing in, purchasing, or selling securities or
other property; and, second, either the person has discretionary authority or control to purchase or sell
securities for the plan, or the person renders advice to the plan on a regular basis under an agreement or
understanding—written or otherwise—that the advice will be the primary basis for investment decisions
about plan assets, and that the adviser individualizes the investment advice based on that plan’s
particular needs.
Say that an adviser serves a plan with a vendor that has hundreds of investment options available. “The
sponsor is typically looking at the broker and saying, ‘Which do we put in our plan?’” says Pete Swisher, a
Lexington, Kentucky-based senior institutional consultant at Unified Trust Co., N.A., and author of the
book 401(k) Fiduciary Governance: An Advisor’s Guide. Some advisers may believe they respond in a
way that gives information and education, but not individualized investment advice. “That notion is a silly
subterfuge,” he believes. “There is not a sponsor out there who does not perceive that the broker is giving
investment advice. That is the whole point to the plan sponsor.”
Advisers serving as ERISA fiduciaries need to have a clear understanding of potential ERISA violations—
and many may not understand that ERISA is a personal-liability statute.
When is an advisory business responsible, versus the adviser individually? “In my experience, the firm
that employs an adviser is the one that agrees to provide advisory services. The services are provided by
an individual—an employee or a rep—but the firm would be on the hook for the activities of its agent. This
is true under state employment and ‘principal/agent’ laws,” says Bruce Ashton, a Partner at Los Angeles-based
law firm Reish Luftman Reicher & Cohen. “However, under ERISA, to the extent the individual also
is considered a fiduciary, the individual could have personal liability for the advice he or she gives or the
failure to disclose compensation” or a prohibited transaction relating to his or her compensation. “That
said, in most instances I am aware of, the employer/firm would wind up actually paying the liability under
some indemnification principle or contract,” he adds.
The prohibited-transaction issues are the most significant for advisers, Ashton believes. “They often come
up in the context of a failure to disclose compensation and, while this is labeled a fiduciary breach, the
real ‘hammer’ is under the prohibited-transaction rules,” he says.
As a fiduciary, an adviser cannot have unlevel compensation, Witz says. “The regs are pretty clear:
Advisers cannot do anything that uses their position to gain additional income,” he explains. ERISA’s
prohibited-transaction rule can make revenue-sharing a tricky area, Ashton says. Advisers can avoid that
by charging level compensation that does not vary based on the investments included, he says, or by
offsetting any revenue-sharing they receive against the total fee they charge a plan.
Ashton cited the following offsetting example: Suppose a plan agrees to pay an RIA 30 basis points on
total plan assets for plan-advisory services. The RIA receives revenue-sharing in varying amounts from
the funds he or she recommends, ranging from zero to 25 basis points, but the adviser’s total receipts
amount to 15 basis points of revenue-sharing on total plan assets. The RIA agrees to offset the 15 basis
points against the 30 basis-point fee. As a result, the adviser receives no more than 30 basis points of
compensation, and the plan pays no more than 15 basis points for the RIA’s services.
Penalty Phase
ERISA violations bring hefty penalties for advisers. “If you are a fiduciary and you receive variable fees,
and you do not have an applicable prohibited-transaction exemption—these are statutory exemptions
under ERISA itself and class and individual exemptions granted by the U.S. Department of Labor—you
could be committing a big violation of ERISA,” Wagner says. “There is significant exposure out there right
now. When the markets are up, people are happy and overlook the issue but, when the markets are
down, people get upset.”
Penalties could come as a result of either a Labor Department investigation or a lawsuit, Ashton says, but
most likely the latter. “You have the obligation to ‘correct’ a prohibited transaction, which almost certainly
means unwinding the transaction and giving back the money you got from it. It can be pretty painful,” he
says. In addition, a prohibited-transaction violation also can bring excise taxes of 15% under Internal
Revenue Code section 4975, and 20% under ERISA section 502(l), Wagner says of the statutes that
regulate the penalties for prohibited transactions. “Both are allowed,” she says. “Basically, the exposure is
really insane.”
Ashton says that cases against advisers for failure to disclose compensation and conflicts of interest
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properly often get arbitrated or settled, so do not get reported anywhere, but there are at least a dozen
lawsuits related to fees and compensation of plan service providers, he says. These class-action suits
target a fairly broad group, he says, but advisers likely will become more of a specific focus once the
Labor Department’s new 408(b)(2) disclosure regs go into effect. “We will start seeing more investigations
and litigation on the issue of adequate disclosure of compensation by advisers,” he predicts. “In terms of
legal issues, it should be a fairly easy lawsuit, too, since all that would need to be shown is that the
adviser failed to make the required disclosure.”
Three Keys To Avoiding Trouble
Advisers serving as ERISA fiduciaries need to focus on three keys to staying out of trouble, Swisher says:
education, insurance, and infrastructure.
Education: “Education is number one,” Swisher says. “My experience with advisers is that even when
they consider themselves well-educated on fiduciary status, they are not.” Although they typically
understand the fiduciary investment process, he says, “that is woefully insufficient.” He believes that
many advisers do not know the ERISA definition of a fiduciary, the prohibited-transaction rule’s specifics,
or the regs’ particulars on the steps needed to avoid a conflict of interest. “There are lots of ways that you
can trip up, because you have a little fiduciary education—enough to be dangerous,” he says.
Advisers need a firm grasp of the ERISA and DoL rules on plan fiduciaries, Swisher says. Witz
recommends going to government Web sites to read the actual rules, as well as attending educational
sessions through organizations like ASPPA.
Advisers also need to educate their employer clients about fiduciary responsibility, says Christopher
Rowlins, President of Investment Advisory Services and Senior Investment Strategist at Glastonbury,
Connecticut-based USI Consulting Group. “The perception in the marketplace is that, by retaining an
adviser, the plan sponsor believes it is abstaining from the fiduciary responsibility,” he says. “The adviser
really needs to educate a plan sponsor in understanding the sponsor’s fiduciary responsibility.” Adds
Christina Gorskey, USI Senior Vice President and Director of Legal Services, “We are educating clients
very diligently to understand, ‘You cannot offload this responsibility. You can hire experts to help you but,
at the end of the day, you—the plan sponsor—have the ultimate responsibility.’”
Insurance: Advisers get E&O (errors and omissions) insurance to cover them on fiduciary liability. No
government body requires registered investment advisers (RIAs) to purchase insurance, but their
contracts with employer clients may require it, says Ken Golsan, Co-President of Golsan Scruggs, a
Portland Oregon-based risk management and insurance brokerage company. He attributes growing
adviser interest in this type of insurance to an increase in the number of independent RIAs as well as
growing concern over lawsuits alleging fiduciary breaches. “There is much wider recognition that advisers
need to have this insurance,” Swisher agrees.
RIAs usually are truly independent of a broker/dealer, Golsan says, so they purchase their own coverage.
Registered reps usually are covered under their broker/dealer “master” policy and receive a certificate as
evidence that coverage exists for their particular practice, he says. Yet, some reps purchase their own
coverage if the broker/dealer allows, and Golsan says that is typically the best route for reps to go if they
can. “With a pooled broker/dealer program, an underwriter has to provide coverage for pooled exposure
of, for example, thousands of registered reps, each with potentially a wide variance of practice
applications,” he explains. “The underwriter’s exposure is great: It has extreme difficulty ascertaining the
risk it is accepting for each and every registered rep. Therefore, the contract of coverage issued by the
underwriter will be both limiting—not broad—and restrictive.” Moreover, as a certificate holder, a
particular rep may have no legal rights or limited legal rights to the contract of insurance, he says, since in
that case the broker/dealer is the named insured.
An adviser purchasing this type of insurance buys one-year coverage with a per-claim limit and an
aggregate amount of coverage, Golsan says. So, a policy may offer annual coverage maximums of $1
million per case and $2 million overall. About a half-dozen providers have a consistent presence in the
market for this insurance, including AIG (American International Group, Inc.); Markel Corp.’s The
Cambridge Alliance and Evanston Insurance Co. units; The Chubb Corp.; The Hartford Financial
Services Group, Inc.; The Travelers Companies, Inc.; and Zurich Financial Services Group, he says.
Although prices do not vary that much among carriers to cover the same adviser, he says, costs can vary
substantially from one adviser to the next. The coverage price varies based on factors such as an
adviser’s assets under management and gross revenues, whether the adviser has any regulatory filings
against him, and when an audit of the investment policy statements used with clients last occurred.
Because of that, he declines to cite a typical price for this coverage.
The biggest difference comes in these policies’ terms, Golan says. ISO (Insurance Services Office, Inc.),
an organization that calculates rates and develops standardized insurance policies for its insurance-company
members, issues a recommended policy form for most types of insurance coverage, he says.
Most carriers of common insurance simply issue that form. “However, there is no such standardized form
issued by the ISO for this type of insurance,” he says, because it is very specialized. As a result, he says,
the terms that providers have “are all over the map.”
For instance, Golsan says, pay close attention to how an insurer defines a “wrongful act” by an adviser.
Does that definition refer specifically to a criminal act, or would it cover an innocent mistake? “Some
underwriters have more limited terms, and it is a very tight door to walk through for claims to be
accepted,” he says.
The thing that makes this type of insurance difficult “is that advisers have to read the contract carefully
and, in particular, read the exclusions,” Swisher says. “They need to make sure that the work they do is
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not included in the exclusions.” Golsan says that limitations and exclusions may include things like these:
certain types of investments such as private placements and alternative-investment vehicles; advice
relating to initial public offerings (IPOs), mergers and acquisitions, or divestitures; ERISA limitations;
transactions not defined as “approved activity” by the broker/dealer or custodian; investments in which an
RIA has partial ownership; cost of corrections, such as trading errors; and limitation of coverage to what
is defined under investment agreements advisers have with clients.
Infrastructure: This starts with a contract that spells out clearly what the adviser will do. “You need a
contract with a very specific scope of services,” Swisher says. Clients want a detailed contract, too. ”They
want to know exactly what the adviser will do,” Snyder says. “Every one of my contracts is very
specialized to each client’s needs, such as the frequency and scope of employee meetings.”
Once a detailed contract gets signed, Swisher says, an adviser needs processes to do the work. “The
most important thing is to establish an internal process that can be adapted to every client,” Witz says.
For instance, advisers need a boilerplate investment policy statement that they can customize to each
client, and a standard procedure for investment oversight. Yet, the need goes beyond investments, to
areas such as written policies for the fiduciary governance process, for minimizing conflicts of interest,
and for periodically reviewing summary plan documents.
In addition, with new disclosure requirements looming, Witz says, an adviser should have a written policy
about how to communicate with clients about the fees that they receive. “[New disclosure regs] are going
to require them to build out detailed internal-compliance features, and automation is going to be key,” he
adds.
Snyder and his colleagues keep very careful records. “It is kind of intensive,” he says. “Another thing—
and I cannot stress how important this is—is that we keep minutes from all meetings. We have
documentation of what we agreed to do, and what we agreed to table. That documentation is critical.”
Moreover, infrastructure means not just processes, but people. To compete, those advisers who do not
take on the time-consuming task of becoming ERISA experts will need to hire a staff ERISA compliance
guru, Witz says. Advisers may find it tough to grow their own technical knowledge while in an economic
environment that puts downside pressure on their revenues, he says. “The only other way to do it, if they
do not grow it organically, is to go hire it,” he says. “The ‘pension geek’—the guy who maybe has not
been the best salesperson, but spends a lot of time educating himself—may end up having a bright
future.”
Illustration by Jillian Tamaki
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