Securities Broker Giving Plan Sponsor Advice; Prohibited Transaction?

[Guest RIA]

I recently reviewed a case wherein a securities broker (from a large national wire house) was receiving commissions from a group annuity contract brokered to a 500 pp 401(k) with over $40 million in assets. The broker was providing written investment policy statements and fund specific advice to the plan committee and other advice related activity as evidenced by a review of plan committee minutes and reports. The broker does not deny this and even stated in the meetings that he felt that his recommendations and whether they were actually "advice" was a "nuance". We pointed out that this was a prohibited transaction and he may be required to disgorge his compensation as a result. The broker and his broker dealer have been very quiet since our findings were provided to the committee (we assume they now realize they are functional fiduciaries involved in a prohibited tranaction). The Plan Sponsor wants to know if they have any responsibility regarding this prohibited transaction with the plan. Is the burden of repair entirely with the Broker? Does the Plan Sponsor have any liability or obligation to curtail or repair this activity? Has any plan or plan sponsor liability been created?

In addition to giving investment advice to the plan committee, it also appears that the broker may have done so with plan participants. When confronted with this the borker indicated they were complying with the provisions of PPA. However, no formal PPA program or third party audit for participant investment advice exists.

Comments regarding this behavior and consequences or repairs would be appreciated (especially as it pertains to the interaction with the plan committee)

[Peter Gulia]

Under ERISA, the plan fiduciaries have duties to act prudently in managing the plan's assets, which could include a plan's claim for restoration from a prohibited transaction. The plan fiduciaries also are personally liable to the plan for the plan's losses from a breach, which could include an approval, or an imprudent failure to prevent, a prohibited transaction.

(Because some facts are missing, I'm not saying whether the situation you describe does or doesn't include a prohibited transaction. Also, it might be inappropriate to state a conclusion in a web-board post.)

In seeking help to evaluate the plan's rights and remedies, consider that the plan fiduciaries could be harmed by conveying or receiving information in a way that doesn't have confidentiality protection.

Some lawyers will provide without fee an initial consultation, and, even if not engaged, will keep confidences under the lawyers' conduct rule for information from a prospective client.

[Guest padmin]

RIA

Help me out with this one. As a third party administrator the vast majority of our plans are brokered by life licenses selling group annuities. They perfrom the functions you described( as well as most of securities licensed advisors). Exactly who is supposed to assist small plan sponsors with these decisions and their participants?

Thanks for your input

[Bird]

padmin, your frankness is appreciated. I think the reality is that many, if not most, plan sponsors, especially small plan sponsors, look to their brokers for practical investment "advice" although the broker is getting paid a commission for sales, not a fee for "investment advice." It's not uncommon for brokers to provide "sample" investment policy statements that are adopted verbatim, and for them to "suggest" certain funds for inclusion in the plan or for selection by individual participants. The cautious ones will toe this line carefully, not-so-cautious ones will cross it occasionally, and I suppose there are some bold ones who will hold themselves out as "investment advisers" even if they're getting paid as brokers.

In this case, if we start with RIA's last comment about providing advice to plan participants, I seriously doubt that there will be any traction on that, unless the broker is independently acting to make investment transactions without any input from the participant(s), or is making written recommendations.

As far as the first point about advice to the committee, etc., I'd want to know more details (don't take that literally) but I'm not sure there's a problem. The broker might be acting a lot like a fiduciary, but he's not getting paid to provide investment advice, and I think that will go a long way in support of his "case" that the distinction is a "nuance."

I think a fair question, RIA, is to ask what is your role?

[Guest RIA]

GO to Fred Reish's website http://www.reish.com/ and type in "prohibited transaction" or broker investment advice; there are 4 or more articles there that explain this dilemma. Any broker dealer worth it's salt has the same position. If a broker delivers a policy statement, makes a recommendation of any type regarding investments to the plan committee, the broker and its broker dealer become a functional fiduciary. As a fiduciary, the receipt of commissions is a prohibited transaction. As such, the commissions would have to be disgorged and returned to the plan. Advice is not a nuance. Recommendations cannot be made in any way. We are a strictly fee for service RIA. The ERISA and NASD rules are regarding broker behavior are very clear. Please review Fred's opinion and let me know what you think - thanks!!

quote name='Bird' date='Sep 13 2007, 10:22 AM' post='153044']

padmin, your frankness is appreciated. I think the reality is that many, if not most, plan sponsors, especially small plan sponsors, look to their brokers for practical investment "advice" although the broker is getting paid a commission for sales, not a fee for "investment advice." It's not uncommon for brokers to provide "sample" investment policy statements that are adopted verbatim, and for them to "suggest" certain funds for inclusion in the plan or for selection by individual participants. The cautious ones will toe this line carefully, not-so-cautious ones will cross it occasionally, and I suppose there are some bold ones who will hold themselves out as "investment advisers" even if they're getting paid as brokers.

In this case, if we start with RIA's last comment about providing advice to plan participants, I seriously doubt that there will be any traction on that, unless the broker is independently acting to make investment transactions without any input from the participant(s), or is making written recommendations.

As far as the first point about advice to the committee, etc., I'd want to know more details (don't take that literally) but I'm not sure there's a problem. The broker might be acting a lot like a fiduciary, but he's not getting paid to provide investment advice, and I think that will go a long way in support of his "case" that the distinction is a "nuance."

I think a fair question, RIA, is to ask what is your role?

[Guest mjb]

GO to Fred Reish's website http://www.reish.com/ and type in "prohibited transaction" or broker investment advice; there are 4 or more articles there that explain this dilemma. Any broker dealer worth it's salt has the same position. If a broker delivers a policy statement, makes a recommendation of any type regarding investments to the plan committee, the broker and its broker dealer become a functional fiduciary. As a fiduciary, the receipt of commissions is a prohibited transaction. As such, the commissions would have to be disgorged and returned to the plan. Advice is not a nuance. Recommendations cannot be made in any way. We are a strictly fee for service RIA. The ERISA and NASD rules are regarding broker behavior are very clear. Please review Fred's opinion and let me know what you think - thanks!!

RIA: Would an attorney who provides an opinion to plan trustees recommending that a participants's claim be paid because of applicable law become a functional fiduciary over plan assets if the payment decision can only be made by the trustees? If not, what is the difference between the attorney and the broker who recommends an investment for which only the trustees have discretion to purchase. Why is delivery of a proposed IPS for the consideration of the trustees and their counsel to act on a fiduciary duty?

[Guest RIA]

GO to Fred Reish's website http://www.reish.com/ and type in "prohibited transaction" or broker investment advice; there are 4 or more articles there that explain this dilemma. Any broker dealer worth it's salt has the same position. If a broker delivers a policy statement, makes a recommendation of any type regarding investments to the plan committee, the broker and its broker dealer become a functional fiduciary. As a fiduciary, the receipt of commissions is a prohibited transaction. As such, the commissions would have to be disgorged and returned to the plan. Advice is not a nuance. Recommendations cannot be made in any way. We are a strictly fee for service RIA. The ERISA and NASD rules are regarding broker behavior are very clear. Please review Fred's opinion and let me know what you think - thanks!!

RIA: Would an attorney who provides an opinion to plan trustees recommending that a participants's claim be paid because of applicable law become a functional fiduciary over plan assets if the payment decision can only be made by the trustees? If not, what is the difference between the attorney and the broker who recommends an investment for which only the trustees have discretion to purchase. Why is delivery of a proposed IPS for the consideration of the trustees and their counsel to act on a fiduciary duty?

I don't know the answer to your question regarding legal counsel and what legal/ethical boundaries they must follow. I do know that the NASD prohibits brokers from rendering advice to ERISA plans and ERISA defines brokers as parties in interest. Once the broker gives "advice" by defninition he becomes a functional fiduciary. The payment of commissions then creates the prohibited transaction. Read the Reish article titled, "Who Are The Investment Fiduciaries for a 401(k) Plan - Part IV . It fuly explains the issue. The simple delivery of a DRAFT policy statement in template form or an IPS "how to kit" would more than likely not be deemed advice but editing or drafting an IPS would.

[Bird]

Please review Fred's opinion and let me know what you think - thanks!!

Done. Well, I didn't read everything, but here's something that backs up my point:

"ERISA provides a functional definition of fiduciary; that is, the functions that a person performs determine fiduciary status, even if the person is not a named fiduciary. Stated briefly, a broker, or any other person, is a fiduciary to the extent that (1) he or she exercises discretionary authority or control over the management of the plan, or any authority or control over plan assets; (2) he or she exercises discretionary authority or control over plan administration; or (3) he or she renders investment advice for a fee or other compensation. [ERISA §3(21)(A)] When brokers become fiduciaries, it is usually because they have rendered investment advice. As pointed out in our earlier columns, courts have found that, when the relationship between brokers and plans have gone beyond the typical commercial relationship of a salesperson and a customer, and has involved advice about the suitability of the investments for the particular plan, the salesperson can become a fiduciary. [see, e.g., Thomas, Head & Griesen v. Buster, 24 F.3d 1114 (9th Cir. 1994)]"

Note the italicized text. He's not getting paid for the investment advice, that's an ancillary freebie (or at least that should be his argument). He's getting paid sales commissions. I'm not saying he's squeaky clean, but I'm not so sure that there really is a problem.

Admittedly, I didn't read every word of every article and if there's something elsewhere that says it doesn't matter if he doesn't get paid for the advice I don't mind being enlightened.