Marcia S. Wagner, Esq. Z. Jane Riley The Leaders Group, Inc. Christopher Guanciale PlanMember Services Corporation Basics of ERISA

2 1. Basic Fiduciary Duties and Standards 2. ERISA Bonding Requirements 3. Prohibited Transactions 4. Exemptions from PTs 5. Status of the Fiduciary Standards

3 Fiduciary Responsibilities Employee 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.

4 Overview of Fiduciary Rules ERISA 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.

5 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.

6 Investment Advice Fiduciaries Person 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.

7 Investment Managers Also 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.

8 Financial Advisors RIAs 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)

9 Fiduciary Responsibilities Fiduciary 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.

10 Focusing on Specific Duties Exclusive 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.

11 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.

12 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).

13 Fiduciary Liabilities and Penalties ERISA 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.

14 Co-Fiduciary Liability ERISA 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.

15 1. Basic Fiduciary Duties and Standards 2. ERISA Bonding Requirements 3. Prohibited Transactions 4. Exemptions from PTs 5. Status of the Fiduciary Standards

16 Coverage ERISA 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.

17 Other Requirements for ERISA Bond Amount 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.

18 Other Types of Fiduciary Coverage Professional 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.

19 1. Basic Fiduciary Duties and Standards 2. ERISA Bonding Requirements 3. Prohibited Transactions 4. Exemptions from PTs 5. Status of the Fiduciary Standards

20 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.

21 Title I of ERISA ERISA 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.

22 Internal Revenue Code IRC Section 4975 mirrors the PT rules under ERISA Section 406. Two levels of excise taxes under IRC ◦ “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%

23 Prohibited Transactions for IRAs Special 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.

24 1. Basic Fiduciary Duties and Standards 2. ERISA Bonding Requirements 3. Prohibited Transactions 4. Exemptions from PTs 5. Status of the Fiduciary Standards

25 Statutory Exemptions ERISA 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.

26 Administrative Exemptions Class 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 (for directed brokerage). Individual Exemptions ◦ Also issued by DOL. ◦ Only person requesting exemption may rely on it.

27 1. Basic Fiduciary Duties and Standards 2. ERISA Bonding Requirements 3. Prohibited Transactions 4. Exemptions from PTs 5. Status of the Fiduciary Standards

28 Status of the Law ERISA’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.

29 DOL’s Proposed Change to Definition Currently, 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.

30 DOL Proposal: The Safe Harbor DOL’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.

31 DOL Proposal: Potential Impact Financial 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.

32 New Fiduciary Standard Under Dodd-Frank Dodd-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, 13 th Floor Boston, MA Tel: (617) Fax: (617) Website: Z. Jane Riley The Leaders Group, Inc. Christopher Guanciale PlanMember Services Corporation Basics of ERISA A