Advisory fees

[Guest Junior]

I am a CFP practicing in northeast Ohio. A client of mine inquired about whether or not we could manage his 401k investments. Is it possible to directly deduct our fee for such services directly from his 401k account with some type of limited power of attorney. Thanks for your help.

[Jon Chambers]

Assuming the fees are otherwise permissible, yes, they can be deducted directly from the account. This is a relatively common practice.

[Kirk Maldonado]

That assume, of course, that the plan permits such an arrangement. You need to verify that point.

[KJohnson]

Jon and Junior,

Could you clarify? Is the client the plan administrator/trustee or an individual participant?

Jon,

Are you saying its a fairly common arrangement that with participant directed accounts that a participant go out and hire a CFP for advisory services for the particiant's 401(k) account and have the fees for the CFP paid for by the Plan. In other words a large plan could be paying fees to 100's of CFP's? If so, what kind of language is in the document?

[Guest Junior]

KJohnson,

In my situation the client is a participant in the plan. It is my understanding that if the client has a self directed brokerage account there should be no problem deducting the fees. However, I lack sufficient documentation to state this. Thanks for the help.

Marc

[alanm]

I think you have a problem. Investment advisory fees incurred by an individual are supposed to be an above the line item(2% floor) under misc. deduction in schedule A of the 1040. Only if they exceed 2% of adjusted gross income do you get to deduct them. this is the case where an individual is allowed to hire his own manager that is not selected by the trustee/sponsor of a plan and universally offered to all participants as part of the administration service. The plan may allow payment of the fees, but I think the participant may have to report it on Schedule A.

[Guest asire2002]

It is possible for an individual to be appointed by the responsible plan fiduciary as an investment manager over the participant's self-directed account, which would allow investment management fees (not transactional fees) to be deducted from the account if otherwise permissible. There are a lot of hoops to jump through, and you must qualify as an investment manager as that term is defined under ERISA. See the regs under 404© (I think near the end of those regs) for an example of how this might be structured.

[KJohnson]

asire2002--What is the basis for your assertion that only an investment manager could be paid advisory fees? While appointing an investment manager relieves a fiduciary of certain co-fiduciary responsibilites, I am not sure how this gets you to the conclusion that only an investment manager can be paid fees? Also in the situation raised by Junior are you saying that the named fiduciary of the plan would have to appoint the investment manager rather than the participant himself or herself? Then, would the named fiduciary have an ongoing duty to monitor each individual participant's "investment manager?

[Guest asire2002]

KJ:

In order for fees to be paid from plan assets, they must be expenses of the plan. In part this means that the plan alone must be liable for those fees, so that they are not considered personal expenses of the participant. In addition, only certain entities are empowered under ERISA to manage plan assets. A trustee, an investment manager, or a participant. I have heard some argue that a participant can authorize someone else to manage their account, e.g., through a power of attorney, and in some cases that might be appropriate, but I do not think any fees charged by the attorney-in-fact can be paid by plan assets.

Usually, under the plan documents, only a specific entity can appoint an investment manager. That entity is probably the employer/plan sponsor. There are at least two ways this could be structured. One way would be for a participant to identify an investment manager and direct the employer to appoint him or her as investment manager over his or her account. In this type of structure, the employer would not, if the plan is 404© compliant, be liable for monitoring the investment manager. Another way would be for an employer to, on its own, identify certain individuals who are qualified to manage assets, and allow the participants to select from a list. In this type of structure, the employer would have a duty to monitor the actions of the managers. These two types of structures are described in the 404© regs.

[KJohnson]

Asire I went back and looked at the 404© regulations and saw examples 8 and 9 that you reference. Example 8 did not surprise me at all because the 404© regulations contemplate offering investment alternatives that are actively managed by investment managers. Since an investment manager can only be appointed by the named fiduciary in the plan document-- 402©(3)-- and since the 404© regulations specifically say that participants are not fiduciaries(much less named fiduciaries )--it would appear that it would be impossible for a participant to designate an investment manager. Therefore "offering" the investment manager would be the same as offiering any mutual fund. There would be an ongoing duty to monitor and remove an underperfoming investment manager just like they would any other investment that "underperforms" the benchmarks that are set. This all seems to be set forth in Example 8.

What did surprise me was Example 9 which came to the conclusion that a participant can have total discretion over choosing an investment manager and that the named fiduciary would be protected in this case. This seems contrary to 402©(3) which provides that only a named fiduciary can name an investment manager. Oh well you learn something new every time you go back and re-read the regulations. Thanks for the citation.

However, I wonder whether the situation raised by Jon and Junior might still work. I know that 401(k) plans retain individuals with regard to picking the "menu" of investments that will be offered under a plan. These individuals are not investment managers but render investment advice and are compensated by the plan. In other situations plans specifcally retain specified individuals who are available to offer partcipants investment advice with regard to their individual accounts. In such a situation these individuals are not investment managers but are paid by plan assets The regulaitons specifically contemplate fiduciaries being advised with regard to investments by persons or entities who are not investment managers. 2590.75-8 Q-FR-15. Of course in such situations the fiduciaries retain the ultimate discretion.

The same regulation I just cited confirms that actual discretion regarding plan investments cannot be delegated to individuals who are not investment managers or participatns. Therefore to the extent that a CFP who is not an investment manager wants to "manage" a participant's account I agree he or she could not.

I guess the quesiton then becomes whether, short of actual discretionary management, investment advisory services rendered to a participant regarding plan investments COULD be reimbursed from the plan. To the extent that such advisory services could be paid for by the plan as a whole, I am not sure why there would be a distinction regarding whether these expenses are 'allowable" just because the advisor is selected by the participant. You would not seem to lose 404© protection because the participant stil has "control" and he or she is just obtaining advice.

Jon--what is your view what is the plan fiduciary's responsibility in such a situation? Is it only to monitor reasonable plan expenses? What kind of plan language is included that allows such expenses to be paid? Also, in your experience how common is this?

[mbozek]

The preamble to the 404© regs notes that examples 8,9,10 and 11 in the 404c regs illustrate that: 1. the individual participant can designate an investment manager to manage the participant's account, 2. the investment manager is a fiduciary to the participant but not to the plan, 3. the fiduciary is is not liable as a co-fiduciary for decisions made by the investment manager which result from the exercise of control by the participant and 4. the fiduciary is responsible for the designation of the investment manager and would be required to review any imprudent acts in determining whether to continue the designation of the investment manager. It appears that the investment manager is a fiduciary managing plan assets and the manager's fee can be paid from the participiant's account in the plan.

[KJohnson]

mbozek--It seems like example 9 is contrary to the 4th proposition that you stated above. That is what surprised me about example 9 when I went back and read it. In example 8 it is clear that the fiduciary has a duty to monitor the investment manager, but in example 9 the fiduciary seems to be absolved of this duty. Also, even though a participant may be able to "designate" an investment manager it still seems like you would need the actual action taken by the named fiduciary.

[Guest Junior]

Gentlemen,

I greatly appreciate the attention you have given this topic. It appears you are pondering the same dilemma as am I. In my opinion, as long as the participant has "control" the advisory fees can come directly from their account. Assuming that is correct, is there any type of private letter ruling or other situation that can be used as a precedent for future cases? Again, thank you for your suggestions. Take Care.

Junior

[Guest asire2002]

Junior:

I am not at all comfortable with your summary of the discussion above. If you are not a registered investment advisor or someone else who a named fiduciary can appoint as an investment manager (albeit at the prompting of the participant), then I do not believe your fees can be deducted from the participant's account. But regardless of what I believe, you may find the plan provider extremely resistant to paying those fees because they will take the position it is tantamount to a distribution from the plan, rather than the payment of a plan expense, unless very specific procedures are followed. Good luck as you try to sort this out. There are some PLRs but they mostly address this issue in the context of a 403b plan. And, p.s., we are not all gentlemen writing on these boards (no offense taken, as I'm sure none was intended).

[Guest Junior]

asire2002,

I am sorry to disappoint. I found no reason to restate the obvious. The issue at hand is not whether or not it can be done, but rather how to setup such a relationship. This area I am not familiar with. Do I need a PLR? Are there other avenues I can pursue? Also, I apologize for my lack of consideration.

Junior

[Jon Chambers]

Wow. This thread really took off since last I checked in.

In my early post, I was presuming that the advisor was a QPAM (Qualified Professional Asset Manager, probably an RIA), hired by the plan administrator under Section 402©(3) of ERISA. This addresses KJohnson's question. In this case, the plan administrator hires the advisor, and clearly has the duty to monitor such appointment. This is the structure we generally work under.

The second type of arrangement, where the advisor is engaged by the participant raises various issues, although we see this relatively often also. I've seen these situations quite frequently where Schwab acts as custodian for the SDBA, and also with Fidelity SDBAs. The advisor probably should still be a QPAM. While I haven't researched the issue of whether or not the plan administrator has a duty to monitor the advisor, it would seem that the 404© protections afforded in an SDBA structure should extend to the advisor (presuming the plan otherwise qualifies for 404© protection.

alanm raises a good point about the taxability of fees paid out of the plan. I have to say this is outside my area of expertise, so I will refrain from commenting on it.

The other point made by various individuals, that the plan must provide for payment of fees, is clearly also on point.

[mbozek]

KJ: The difference between examples 8 and 9 is who selects the investment manager under the terms of the plan. In 8 it is the fid who designates investment mgrs who participants can appoint to manage assets in the plan under the terms of the plan. Thus the fid is responsible for the prudence of the investment mgrs overall but has no obligaton to provide investment advice to a part. on which mgr to choose. In Example 9 the participant selects the investment mgr and gives the mgr total discretion over investing the assets. In this case since the fid did not select the investment mgr. the fid has no liability for the mgr's imprudence. In example 9 the Fid has no duty to monitor the investment mgrs suitability to manage investments because the plan did not designate the mgr as an investment mgr. The preamble language implying fid responsibility under ERISA for decisions of a mgr not designated by the plan can be disregarded because it is not part of the regulation. My reason for citing it was to demonstrate that the DOL regards an investment mgr selected by a participant as managing plan assets so that the mgr's fees can be paid from the part. account under the plan but I do not agree that the plan fid would have fid responsibility to review the investment decisions of a mgr designated by the part. to manage assets in his/her account since the reg cleary states that a fid is not liable for any loss that results from the participant's exercise of control. reg. 404c-1(d)(2).

[KJohnson]

Mbozek--The preamble language implying fid responsibility under ERISA for decisions of a mgr not designated by the plan can be disregarded because it is not part of the regulation

I take it, then, that you agree that the language in the preamble seems inconsistent with the language of the 9th example itself.

I am glad the 9th example is there but it still seems inconsistent with the notion that only a named fiduicary can select an investment manager. Also you look at the following kind of language in the preamble and it makes you wonder where the 9th example came from:

The Department emphasizes, however, that the act of designating investment alternatives…in an ERISA section 404© plan is a fiduciary function to which the limitation on liability provided by section 404© is not applicable. All of the fiduciary provisions of ERISA remain applicable to both the initial designation of investment alternatives and investment managers and the ongoing determination that such alternatives and managers remain suitable and prudent investment alternatives for the plan. Therefore, the particular plan fiduciaries responsible for performing these functions must do so in accordance with ERISA.

That being said, it seems clear that the 404© regs bless the individual selection of an investment manager by a participant and it would seem logical that then the fees for that manager could be paid from that participant's account under the Plan.

I am still interested in comments by anyone who has experience with investment advisory fees being paid from individual plan accounts to people who are not investment managers--i.e. those that render advice but leave the actual decision/discretion to the plan participant. It would seem like the DOL guidance on investment advice/education contemplates this arrangement but does not deal with paying the investment advisor:

The Department notes, however, that, in the context of an ERISA section 404© plan, neither the designation of a person to provide education nor the designation of a fiduciary to provide investment advice to participants and beneficiaries would, in itself, give rise to fiduciary liability for loss, or with respect to any breach of part 4 of title I of ERISA, that is the direct and necessary result of a participant’s or beneficiary’s exercise of independent control. 29 CFR 2550.404c-1(d). The Department also notes that a plan sponsor or fiduciary would have no fiduciary responsibility or liability with respect to the actions of a third party selected by a participant or beneficiary to provide education or investment advice where the plan sponsor or fiduciary neither selects nor endorses the educator or advisor, nor otherwise makes arrangements with the educator or advisor to provide such services. [DOL Reg. §2509.91-1(e)]

[Jon Chambers]

Good question KJohnson. While I can't speak to all the specifics, I'm aware of plans that offer on-line investment advice through programs such as Financial Engines, Morningstar or mPower (recently acquired by Morningstar). In certain configurations, I understand that employees pay the fee for these services from their individual accounts. However, Financial Engines, Morningstar or mPower are not "Investment Managers" in the traditional sense, since although they will make recommendations based on the employee's inputs, it is up to the employee to implement the recommendation. Is this the type of arrangement you were thinking about? Perhaps someone from one of the referenced on-line investment advice firms could comment on how this works in practice.

[Guest jmckean]

I am new to this board and late to this discussion but thought I might be able to add to it. A couple of weeks ago I attended a satellite seminar broadcast nationally by the American Law Institute - American Bar Association entitled "ERISA Fiduciary Responsiblity - Issues Update". Investment advice to participant directed plans was, among other things, a hot topic.

First of all, there is no question that an individual participant may obtain investment advice for a fee and have that fee paid from the participant's account. Anyone giving investment advice on a regular basis for a fee must, of course, be a Registered Investment Adviser. The adviser as a result becomes a fiduciary to the plan. This comes about because the named fiduciary of the plan who is responsible for investment management, has delegated that responsibilty to the adviser for that participant's account. This does not mean, however, that the named fiduciary is off the hook. The "delegating fiduciary" has a continuing responsibilty to monitor the "appointed fiduciary".

A lot of guidance in this area falls outside of DOL regs. There are many court cases involving these issues. For example, the courts have ruled the "duty to monitor" is (1) a duty of prudence, (2) a lasting duty and (3) an affirmative duty to seek information i.e., actively seek knowledge and information about the appointed fiduciary's actions. This is why, as a practical matter, you will never see a lot of individual appointed advisers for a large plan. Too much monitoring.

As to fees, the DOL has laid out a model which allows employees to obtain advice and take it or leave it. They pay for it only if they use it and it is charged to their account as a fee based on a percentage of assets in the account. This is found in DOL Advisory Opinion 2001-09A which can be found on their website at www.dol.gov/ebsa. It is commonly known as the Sun America opinion. The purpose was to describe how advice can be given and avoid the Prohibited Transaction rules. The advice must be from a source independent of the plan provider. If you are considering giving advice to a plan participant, I suggest you read this opinion and other guidance found on their website.

The panel members for the seminar included the person who wrote the Sun America opinion. It was obvious from his comments and the other panelists that the DOL actually encourages participant advice as long as the advice is independent of the plan sponsor which avoids a conflict of interest.

[KJohnson]

jmckean--Thanks for the detailed post. I had always thought that the duty to monitor was as you described until Asire pointed out example 9 to the 404© regulations. It would seem that the DOL comes to a different conclusion where the participant actually "picks" the investment manager. I would assume that this same analysis also applies if the participant, with not input from the plan fiduciary, "picks" the investment advisor. Did the panel discuss example 9 at all?

As to the Sun America letter, I always thought that the problem was that Sun America had the potential to receive increased fees, in addiiton to the fees they were receiving for providing investment advice to participants, if the individuals rendering investment advice to partipants actually picked and/or recommended Sun America investments. Therefore you had the potential 406(b) PT problem.

Also in Sun America a plan fiduciary would be "selecting" Sun American to perform the advisory services.

I guess my questions still are:

1) Can plan fiduciaries allow a participant to pick an investment manager and/or investment advisor and be "off the hook" pursuant to Example 9:

2) If the participant selects an investment advisor do you even have a 406(b) issue since the plan fiduciary has not "done" anything? If you still have an issue do you get around 406(b) problems if the invesment advisor is compensated only from plan assets and does not receive additional compensation based on the investments selected? Wouldn't the plan fiducairy at least have a duty to verify that there is no "double ocmpensation" that could create a PT? Or could the rationale of the Sun America decision get you around this as well.

3) Is anyone aware of any arrangement where the plan fiduciary steps back completely from designating investment advisors, allows participants to choose any advisor, and let's the advisor be paid from the participant's plan account?

[mbozek]

Thank you for the update and analysis. I would be interested in any cases under ERISA that cite the duty to monitor by a fiduciary. Second I dont see how this applies to investment direction under 404© since example 9 explicitly states that the plan fid has no liability for imprudence of the advisor appointed by the participant, is not a co-fiduciary with the advisor and has no duty to determine the suitability of the advisor as an investment mgr. So how is a fid on notice of a duty to monitor under ERISA. Also the duty to monitor is too vague to be of any use since there are many recognized investment strategies that will appear unorthodox/imprudent at any particular point in time. For example, in contrarian investing the mgr invests in out of favor stocks that may perform on a below average basis for years before taking off and reaching full value. If a fid was to terminate a mgr because of prolonged below average performance would the fid be liable for imprudence under ERISA for the gains made in the stock after the mgr is removed? The problem with the duty to monitor is that the plan fid can be liable under ERISA for taking action adverse to the advice of investment mgr appointed by the participant who is the fiduciary to the participant.

[Guest Gordy]

This is a little off the subject, but, under 404© there is a requirement for the participant or beneficiary to exercise control. (2)(i)(A) specifies that the participant be given and opportunity to give investment instructions to an identifed plan fiduciary. The programs I've seen are generally set up through mutual fund companies and the participant contacts them directly or sometimes contacts the broker. The broker does not sign on as an investment advisor (requiring fiduciary status). There is no fiduciary (trustee) involved in executing transactions. Most of the trustees don't want to know.

What is the interpretation of this? Does the above scenario somehow fit the regulations? Or, is this a failure and therefore ther is not 404© protection? Can the "opportunity to give investment instructions" be delegated to the broker or mutual fund company?

Back more specifically to the post, do you see brokers/insurance agents signing on as investment managers [ERISA (3)(38)] as required in examples 8 and 9?

[KJohnson]

I think that is one of the major issues with regard to whether directed brokerage accounts can really obtain 404© protection. No broker is going to want to "sign on" as a fiduciary. I think that the best way to get around it is to have the indentified fiduciary name one (or maybe several) brokers that the participants can use. In that way you may be able to argue that the broker is the "agent" of the identified fiduciary and you "identify" both the fiduciary and the broker in your 404© materials. I don't know if this works, but I think it is the best you can do unless you get the broker to acknowledge that he or she is a fiduciary.

As an aside, I think limiting participants to one or perhaps two brokers also helps substantially with administration and, assumng a knowledgeable broker, helps make sure there are no prohibited transaction issues or prohibited investments.

[Jon Chambers]

Thought you all might be interested in the following summary of a recent press release:

"June 11, 2003 (PLANSPONSOR.com) – Plan sponsors in defined contribution plans at MetLife now have available a new participant service to automatically rebalance the investor’s portfolio annually.

According to a news release, MetLife Resources is offering the service through a partnership with asset allocation provider ProManage, Inc. ProManage will assume fiduciary responsibility for the advice, the announcement said.

ProManage aims its service at participants who do not want to do their own investing, don't have the time, or would rather have a professional do it for them. Armed with participant data provided by MetLife, ProManage reallocates the employee’s plan assets for them without their having to do anything. Only those participants in the ProManage PROgram pay for the service - and each ProManage participant can choose to opt out of the ProManage PROgram at any time, according to the announcement."

This is a hybrid scenario of what has been discussed in the thread. The plan sponsor has partial responsibility for selecting an IM to provide asset allocation advice (ProManage). However, the participant decides whether or not to engage ProManage's services, and only those participants choosing the service pay for it. While the release is silent on the topic, I believe fees can be paid from the account.

On a couple of other topics in the thread, the advisor does not have to be an RIA, but must be a QPAM (check ERISA for the QPAM definition). I acknowledge that in practice, most QPAMs will be RIAs, particularly in this area.

mbozek asked for case cites relating to the fiduciary duty to monitor. Frankly, as a non-attorney, I don't spend a lot of time on cases. I'll note that the DOL has frequently asserted that fiduciaries have a duty to monitor (e.g., the following quote from "A Look at 401(k) Plan Fees",

"Employers are held to a high standard of care and diligence...Among other things, this means that employers must:...

Monitor investment alternatives and service providers once selected to see that they continue to be appropriate choices."

I know from prior postings, mbozek has taken the position that unless there is a current case cite, there is no relevant legal authority. I take the position that the DOL's opinion also matters, since the DOL can audit, sue, and otherwise make life miserable for an employer. Similarly, cites are only available on cases that get litigated. We see plenty of cases that get settled without the court making any judgment. Plaintiffs attorneys will regularly use regulations and other DOL pronouncements as source material for their complaint. Whether or not they would win in court is perhaps less important than whether they can create a colorable claim that pressures the defendant into a settlement. We recommend that clients manage their plans in a "squeaky clean" manner, such that they will have a perceived impenetrable defense against possible claims of breach of fiduciary duty.

[Jon Chambers]

With respect to Gordy and KJohnson's most recent posts, the 404© requirement that plans have a designated fiduciary responsible for ensuring that valid participant investment directions are in fact executed can be satisfied within the brokerage (SDBA) structure, without making the broker a fiduciary. The "designated fiduciary" is typically the Plan Administrator. The PA reviews the broker's transaction processing structure to determine whether the broker can reasonably be expected to execute transactions as directed by the participant. The PA has the ability to act on behalf of the participant in circumstances where the broker has not followed the participant's (otherwise valid) direction.

Some commentators allege that without the designated fiduciary, 404© protection is not available. Without opining on this issue, I suggest that plan's intending to avail themselves of 404© protection should list a designated fiduciary, and that in an SDBA structure, the designated fiduciary should review the broker's transaction process. I agree with KJohnson that this requirement argues for limiting the number of brokerage firms that the plan works with.

[KJohnson]

Jon,

The language of the regulations require:

"Under the terms of the plan, the participant or beneficary has a reasonable opportunity to give investment instructions (in writing or otherwise, with an opportunity to obtain wirtten cofirmation of such instructions) to an identified plan fiduciary who is obligated to comply with those instructions...

This seems to require more than the identified fiduciary taking reasonable steps to make sure that the broker has the ability to execute trades. The reg states that investment instructions must be "given to" the identified fiduciary. I still don't see how giving instructions to a broker is giving instuctions "to an identified plan fiduciary" unless the identified fiduciary reviews every trade so the fiduciary can actually say that he or she was "given" the instructions.

[mbozek]

Most plans consider compliance to be effected by having duplicate confirmations sent to the plan fid. I have one question- How are instructions given to the fid in 404© plans that allow many mutual fund investment options (100 or more)? Does the fid review each instruction in plans that have thousands of participants and permit daily transfers.

[KJohnson]

I guess you could argue about whether receiving the confirmation is the same thing as receiving the original instruction. If you are only receiving confirmations, how would the identified fiduciary know of any trade where the broker received the instruction but for some reason did not make the trade?

I think that this is another area that the wording of the regulations need to be examined by DOL. If participants are given the name of the identified fiduciary, the names of the brokers designated by the identified fiduciary and if the identified fiduciary receives confirmation of all trades---I really don't see how DOL (or the Courts) could ask for more. To do so would make brokerage accounts truly infeasible and there is no doubt that the 404© regulations contemplate that brokerage accounts would exist.

[mbozek]

Ok- so how about sending duplicate instructions to the plan admin. But how does the plan admin get instructions in plans where there are 100s of mutuual fund options available to thousands of participants? Why is the directed brokerage compliance issue any different?

[Guest Gordy]

mbozek

I'm in agreement with kjohnson. The law is pretty clear on requiring an identified plan fiduciary to receive instructions. I do not see a valid arguement that this is somehow delegated without the statutory reauirements of "investment manager" being met or that with all the choices offered to participants it is to difficult for the trustee to oversee his responsibilites. Also confirmations are after the fact.

Clarification is needed very badly in this area.

[mbozek]

G: I am asking a simple question- How does the plan admin comply with the instruction requirement in plans that offer many mutual fund options and daily transfers? Does the participant give the instructions to an identified plan fiduciary who is obligated to comply? Is the vendor who handles the transfers a fid? In most of the 401(k) plans that I know of, the participants give their instructions directly to the fund family by phone or on the net. How is this different than giving instructions to a discount broker?

[KJohnson]

mbozek--I am not sure that it is any different. I would imagine that in any number of instances the "identified fiduciary" issue arises such as when participants change mutual funds via internet access... In such a situation has the "identified fiduciary" been given the instruction?

The regulations just have not kept up with the technology and the reality of the way business is done. It would be great to have a "rewrite" of the reg but I am not sure that this is a DOL priority.

However, rumor had it that they were going to get out an advisory letter on that thorny prospectus delivery requirement.

[mbozek]

So then every plan that contains language that it complies with 404© is in violation of the plan terms and perhaps could be disqualfied by the IRS because it is not being administed in accordance with its terms. (Only kidding)

As for Mr Chambers position that the DOL position on the duty to monitor also matters I dont think that an advisor must suspend his analytical abilities and not question the authority for such a position in the applicable law. One need only review the recently revoked DOL position regarding fees/expenses that could not be assessed on participants in Op 94-32A to recognize that the DOL takes unsupportable positions that are abandoned when challenged. What I have been trying to convey is that plan fids, sponsors, administrators and counsel cannot perform their duties in in an unsettled regulatory environment which promulgates alice in wonderland type rules ( "first the sentence, then the verdict") on fiduciary responsibility.

[Jon Chambers]

mjb:

So we are supposed to take the position that the IRS should disqualify plans b/c they claim to be 404© compliant, but don't follow the 404© regs, so aren't administered in accordance with their terms, but we should disregard DOL regs and pronouncements regarding fiduciary duties to monitor b/c we believe that the DOL position is unsupported by case law. Can I generalize here? We should follow IRS regs and disregard DOL regs? (only kidding)

My main point is why not monitor? It may do some good, and by monitoring, a plan sponsor can mount a reasonable defense against breach of fiduciary claims that the sponsor should have monitored, but didn't. A plan sponsor that doesn't monitor may still win the litigation, but I believe it's better to avoid the litigation in the first place.

KJohnson:

You note: "Under the terms of the plan, the participant or beneficary has a reasonable opportunity to give investment instructions (in writing or otherwise, with an opportunity to obtain wirtten cofirmation of such instructions) to an identified plan fiduciary who is obligated to comply with those instructions...", and observe that this looks more like a definitive duty than a delegable function. A colleague, Stuart Hack, who has done significant consulting on 404© compliance suggests the approach I briefly outlined. Stuart develops 404© compliance manuals that identify a "Participant Investment Directions Administrator" (generally the Plan Administrator) that has a fiduciary duty to transmit and confirm participant instructions to plan's investment provider. Stuart's structure then has the Plan Administrator delegate this function to the plan's recordkeeper (as we all know, ERISA permits fiduciaries to delegate tasks. Most of us agree that fiduciaries maintain a residual duty to monitor the results of the delegation).

Would Stuart's proposed approach withstand a legal challenge? I don't know. Does it appear to be a reasonable attempt to comply with a complex regulation? In my opinion, it does.

[KJohnson]

Jon,

I use a similar structure. I typically provide that the Trustee is the identified fiduciary but the trustee may delegate the task of receiving instructions to the broker or recordkeeper. In the event of such a delegation, the SPD states that participants will be informed in a separate mailing of the identity of the broker(s) or recordkeeper(s) who may receive participant investment instructions. I let clients know that this may or may not work from a 404© standpoint, but it certainly seems reasonable.

The problem is that if you consider it a "fiduciary function" then your recordkeeper or broker is not going to want to acknowledge that it is a fiduciary If it is not a fiduciary function, have instructions been given to a "identified fiduciary?" I guess one way to look at it is that accepting and executing investment instructions is a ministerial task rather than a fiduciary task (best execution issues aside). The identified fiduicary has delegated this non-fiduciary ministerial function to its recordkeeper or broker as the identified fiduciary's agent. Therefore, instuctions to the broker/recordkeeper are instructions to the identified fiduciary and the broker/recordkeeper does not have to accept a designation as a fiduciary.

[Guest jmckean]

I will respond to both kjohnson & mbozek individually but would like to make a general comment that might help clarify overlapping issues. 404© and the underlying regs have a narrow focus & application. They apply only when a plan is attempting to limit plan fiduciaries' liability because the plan allows participants to choose from a menu of investment alternatives. The purpose is to not hold plan fiduciaries liable if some employee puts all of his money in one find that goes south. Remember the regs are over 10 years old and the 401(k) environment was much different than it is now. Implicit in 404© is the offering of diversified investment options. Typically these are mutual funds. Herein lies some of the confusion. The mutual fund is the investment manager in the context of 404©. But not an investment adviser to the participant. 404© does not contemplate investment advice directly to the participant, rather the participant can pick from a list of investment managersi.e., mutual funds. With respect to example 9 of the regs, an example might be appropriate. Let's assume a plan is 404© compliant and uses ABC fund family. A broad range of funds are available but P puts all of his money in a small cap fund which is imprudently managed and causes great loss to P's account. F is not liable as a result. Distinguish this from a participant receiving investment advice from a registered investment adviser for a fee. The latter situation (which is what the original discussion was about) is outside the scope of 404© and is subject to the broader constraints of ERISA. By the way, there is still a duty on the part of F to monitor an investment manager. See example 8 of the regs.

I believe the original question had to do with charging fees for advice. By law (not ERISA but securities regulation), anyone who charges fees for investment advice on a regular basis must be a Registered Investment Adviser.

To:kjohnson Regarding the SunAmerica opinion, you are correct SunAmerica would receive additional fees on assets that participants elect to have in the advisory program. The fees, however, were for the implementation and extra adminstration of the program, not for advice. The advice comes from an independent third party called "Financial Expert" by the DOL. Additional fees are paid to the Financial Expert for their advice. Therefore no conflict of interest and no prohibited transaction according to the DOL.

To answer your specific questions:

1) No. As I said, 404© does not apply. Allowing an investment adviser to give advice and charge a fee is delegating a duty which requires monitoring.

2) To avoid a PT, the investment adviser must be independent and not receive compensation from the plan for any reason other than rendering advice. This is the point of SunAmerica.

3) I am not aware of any and believe it would not be prudent unless you screen and monitor all advisors.

To:mbozek I will list some cases from the seminar materials that I mentioned before. Again, example 9 does not apply for the reasons I mentioned above.

You raise an excellent question regarding the "how to" of ongoing monitoring. Passing along what the experts said at the seminar: It "depends on the circumstances". How about that for a good attorney answer. Unfortunately, just because there are no clear guidelines, the duty to monitor still exists. It turns out that courts have approached it differently due to the varying circumstances they have been faced with. I will now give you some cases from the materials and leave it to you to pursue the different approaches as you see fit.

One last comment: It was clear from the panel members (nationally known ERISA attorneys and two top DOL officials) that advice is here and is needed but must comply with the approach under SunAmerica and does requirew monitoring! Good Luck to all.

Sandoval v. Simmons 622 F.Supp 1174

Mehling v. New York Life 163 F.Supp 2d 502

Donovan v. Cunningham 716 F.2d 1455

Whitfield v. Cohen 682 F.Supp 188

Leigh v. Engle 727 F.2d 113

Harley v. 3M 42 F.Supp2d 898

Coyne & Delany v. Selman 98 F.3d 1457

See also: ERISA Interpretive Bulletin 75-8

[mbozek]

JON: Perhaps you ought to ask all the TPAs and plan admin on this board whether they would want to add the duty of monitoring the investments made by participants in directed brokerage accounts to their overburdened list of responsibilites- I dont think too many have room in their budget for the additional expense. Second what would the plan monitor and what would the standards for monitoring be? Would the fid monitor individual trades or just investment styles, allowing some ("dogs of the dow", monte carlo analysis, etc) but not others (contrarian). What if the participant insisted on following the advisor's instructions for which he is paying a fee. Would the Fid have obtain the opinion of an independent investment advisor to review the advice of the participant's own manager and who would pay for such an opinion? If the fid removed the advisor does the fid now have a duty to appoint a sucessor acceptable to the participant and now have fid responsibility for investing the participants assets? I think there is greater risk of fiduciary liability where the fid assumes the duty to monitor advisors selected soley by participants than to the fid who does not monitor (since the duty to monitor conflicts with the duty of a plan fiduciary under the current 404© regs) because that fid assumes a duty to prevent losses due to decisions made by a person who is solely a fid selected by the participant. It give the participants deeper pockets to sue.

[KJohnson]

JMcKean

1) Investment Managers

If there is always a duty to monitor, why did DOL include examples 8 and 9 and not just stop at 8? It appears that DOL is stating that where a participant has "total discretion" in selecting an investment manager there is no duty to monitor (Example 9). However, when a fiduciary selects an investment manager and allows the participant to allocate assets to that manager as he or she chooses there is a duty to monitor the manager (Example 8). Again, I was surprised when I went back and looked at example 9 because I had always assumed that the duty to monitor would remain. Also, I thought that the notion of a participant having "total discreiton" over a investment manager was contrary to the statutory constraint that only a named fiduciary could appoint a investment manager.

2) Investment Advice/Investment Advisors--

I believe DOL has specifically contemplated investment advice in the context of 404© and has made the exact same distinction that it made with regard to investment managers. The following is from the advice/education reg a portion of which is cited in my previous post--

(e) Selection and Monitoring of Educators and Advisors. As with any designation of a service provider to a plan, the designation of a person(s) to provide investment educational services or investment advice to plan participants and beneficiaries is an exercise of discretionary authority or control with respect to management of the plan; therefore, persons making the designation must act prudently and solely in the interest of the plan participants and beneficiaries, both in making the designation(s) and in continuing such designation(s). See ERISA sections 3(21)(A)(i) and 404(a), 29 U.S.C. 1002 (21)(A)(i) and 1104(a). In addition, the designation of an investment advisor to serve as a fiduciary may give rise to co-fiduciary liability if the person making and continuing such designation in doing so fails to act prudently and solely in the interest of plan participants and beneficiaries; or knowingly participates in, conceals or fails to make reasonable efforts to correct a known breach by the investment advisor. See ERISA section 405(a), 29 U.S.C. 1105(a). The Department notes, however, that, in the context of an ERISA section 404© plan, neither the designation of a person to provide education nor the designation of a fiduciary to provide investment advice to participants and beneficiaries would, in itself, give rise to fiduciary liability for loss, or with respect to any breach of part 4 of title I of ERISA, that is the direct and necessary result of a participant's or beneficiary's exercise of independent control. 29 CFR 2550.404c-1(d). The Department also notes that a plan sponsor or fiduciary would have no fiduciary responsibility or liability with respect to the actions of a third party selected by a participant or beneficiary to provide education or investment advice where the plan sponsor or fiduciary neither selects nor endorses the educator or advisor, nor otherwise makes arrangements with the educator or advisor to provide such services.

I think the only question left is if "the the plan sponsor or fiduciary neither selects nor endorses the educator or advisor, nor otherwise makes arrangements with the educator or advisor to provide services" whether that advisor could be paid from the participant's plan assets. Or, is approving the payment of these expenses making "an arrangement" with the advisor.

[mbozek]

I concur with KJ: the crucial distinction between examples 8 and 9 is who has discretion to select the investment mgr. In 8 the plan fid selected investment mgrs who participants could appoint as advisors so the plan fid has a duty to monitor performance. In 9 the participant appoints the advisor without approval of the plan fid (plan does not designate advisor as investment advisor available to advise other participants in the plan). In example 9 the participant is the fid who has the duty to monitor the advisor's performance since the advisor is liable to the participant and not the plan fid for imprudent investing. The two cited cases I have read say the same thing: the fid who exercises discretion to appoint the investment mgr has the duty to monitor the mgrs performance. Since the plan fid did not appoint the mgr in example 9 under the plan, the plan fid has no duty to monitor performance.

[Jon Chambers]

In Example 9 the participant selects the investment mgr and gives the mgr total discretion over investing the assets. In this case since the fid did not select the investment mgr. the fid has no liability for the mgr's imprudence. In example 9  the Fid  has no duty to monitor the investment mgrs suitability to manage investments because the plan did not designate the mgr as an investment mgr.

I'm in full agreement with this position. My point on monitoring is that appointing fiduciaries have a duty to monitor the IMs/funds/service providers etc. that they DID select.

I don't believe recordkeepers have a fiduciary duty to monitor. I do believe Plan Administrators have a fiduciary duty to monitor, presuming they are the appointing fiduciary. What monitoring standards are appropriate is an entirely different topic. ERISA merely requires procedural prudence, what constitutes procedural prudence is a facts and circumstances determination. Our firm has developed monitoring protocols we believe are appropriate for our clients' plans, I'm sure other advisors have similar and equally prudent monitoring protocols.

Just because something is difficult, doesn't mean you shouldn't do it. Discrimination testing and cross-testing is difficult, but important. Similarly, monitoring investment performance is difficult, but important.

[Guest Gordy]

mbozek

In response to your "simple question". Your questions are a major part of trying to establish 404© protection for our clients. The regs require communication between the specified two parties. In my case, the business owner and the employee. From a practical point, having the secretary give instructions to the doctor with regard to her investments doesn't work. He doesn't want to know and has better things to do. Next, few brokers, insurance agents or vendors are going to step up to fiduciary capacity. The definition of fiduciary is pretty well established.

I agree. In all of my plans, the participants deal directly with the mutual fund company and to a much lesser extent with the broker. Therefore, there are no instructions being given, as is required, from the participant to the named plan fiduciary. I do not think we can skip one of the requirements because it's to hard or it takes to much work or someone doesn't want to do it and still expect protection. If you don't comply with the requirements for 404© protection, you don't have protection.

I do not see the revelance of the participant contacting the broker , mutual fund company or vendor by phone, internet or smoke signal. That contact is the problem as far as (b)(2)(a) reads. This is unless the broker etc has signed on as a named plan fiduciary as required.

How do you delegate fiduciary authority? Would it not take specific plan authority to delegate? In any event, the other party would have to affirmatively accept it. The brokers I know shy away from this.

jmckean: (3)(38)© requires the investment manager to acknowledge in writing that he is a fiduciary with respect to the plan. Do you receive that acknowledgement?

[Jon Chambers]

As I re-read the thread, I realize we have diverged significantly from the original question. Additionally, we have responded to follow-on questions based on our individual biases and experience. For example, I work with larger plans that almost always engage institutional trustees. So I thought it might make sense to go back to the original question, and summarize consensus of opinion, and where opinions differ.

1) Who can provide investment advice to individual participants?

jmckean indicates that only a registered investment advisor (RIA) can provide investment advice, citing SEC guidelines. ERISA 3(38) indicates that banks and qualified insurance companies also qualify. My opinion is that there is a bit of a turf war going on here, with SEC trying to assert authority it may not have. In any event, it is clear that a traditional broker cannot provide investment advice. This is because the broker's compensation derives from his or her recommendations. Brokers providing advice create prohibited transactions (PTs), because their fiduciary activities (providing investment advice) generate variable and unrelated compensation (commissions) payable specifically to them.

2) Can fees for investment advice be paid from participant accounts?

Posters seem to agree that fees can be paid, provided that the advisor is qualified under ERISA. AlanM notes a concern that fees paid may create a tax issue if the fee is not otherwise deductible.

3) Does the plan sponsor (or other fiduciary) have a duty to monitor the investment advisor?

We seem to be split on this issue. Most posters agree that where the plan sponsor plays no role in selecting the advisor, there is no residual duty to monitor the advisor. jmckean and KJ seem concerned that where the sponsor facilitates payment of fees, they play a role in administration that may infer the need to monitor. jmckean also expresses concerns that only the plan sponsor can appoint investment managers (IMs), hence the plan sponsor has a duty to monitor.

My opinion on this topic is that the plan sponsor's duties relating to the IMs may depend on the plan document and plan structure. I'll cite as an example plans using Charles Schwab Trust Company (CSTC) as trustee. CSTC supports many plans offering individual brokerage accounts. Their prototype document provides that participants can engage IMs, and that IMs can receive fee payments from participant accounts. CSTC even has a structured program for referring participants with brokerage accounts to qualified IMs. In this type of structure, I don't believe that the plan sponsor has any duty to monitor the IM. The sponsor plays no role in engaging or paying the IM. So I don't think the sponsor has a duty to monitor. But there are also scenarios where the sponsor must play a more active role, and I can see how this could conceivably introduce a duty to monitor.

4) Can 404© protection be maintained where the participant works with an IM and a broker, not an "identified plan fiduciary obligated to comply with the participant's investment instructions"?

We are also split on this issue. It's my opinion that this is a form over substance issue. It's easy to come up with other examples of how fiduciaries delegate ministerial functions. For example, a payroll officer that calculates and wires salary deferrals to the trust is not a fiduciary if they are simply following established procedures--they have no discretion, and are simply performing an administrative function for the real fiduciary. I'd argue that the broker or fund company executing a trade is performing a similar administrative function on behalf of the plan's identified fiduciary. When we work with plans offering individual brokerage accounts, we typically help the fiduciary identify transactions that the broker is always authorized to execute,

transactions that the broker is never authorized to execute, and transactions that require discretion--i.e., the broker must contact the fiduciary prior to executing. A simple mutual fund purchase might be always approved, purchase of collectibles might be never approved, and purchase of options might require fiduciary approval.

I believe that in these circumstances, the sponsor retains 404© protection (assuming they had it to begin with). I also believe the sponsor has a fiduciary duty to monitor the broker. For example, the sponsor might want to place some test trades to see if the broker follows the established procedures.

5) Do brokers/advisors/insurance agents in practice accept written designation as fiduciary?

Brokers and insurance agents definitionally can't act in a fiduciary capacity for the PT reasons discussed above. While our firm normally works at the plan level, we are occasionally engaged by individual participants, and we accept written designation as a fiduciary, because it's what we do as an RIA, and because we believe that it's required under ERISA if we want to get paid. That being said, our agreement is with the individual participant, and as several other posters have noted, it is not clear whether the individual participant has the authority to make us a fiduciary.

In conversations with other RIA firms, I believe their procedures with respect to advising individual participants are reasonably similar to ours.

I hope this summary overview helps. My apologies if I misstated anyone's position--if I did, it was an honest mistake.

[Guest landgcpas]

The knowledge of the people posting to this thread is impressive. To throw in another curve, what is your opinion of the following scenario:

1) investment options are all no-load funds

2) plan sponsor appoints RIA and signs investment advisory agreement for management fees to be deducted from participant accounts

3) the investment advisory agreement states that RIA is a plan fiduciary

4) the RIA provides education material and recommended portfolios to the plan and is available to meet with individual participants

5) the management fee is deducted from every participant's account

Thanks in advance for your input.

[Guest Junior]

This discussion has addressed the majority of issues I was contemplating regarding providing investment advice for my client's 401k. Whether the posts have been confirming my beliefs or proposing new points of view it has all been extremely helpful. One issue which I would like to address is #2 on Jon Chambers' recent summary. While we are mostly in agreement fees can come from participant's account, the tax consequences of such are unclear. It would be in the client's best interest if the fees were not considered taxable withdrawals, such as with advice regarding investments in IRA's. It is my opinion the fees for advice from participants 401k accounts should not be considered taxable withdrawals. Let me know what you think. Again, thank you for your thoughts.

Junior