Fiduciary Status for the Unwary

If you thought that avoiding fiduciary status would be a slam-dunk after the “new” DOL fiduciary advice rule was vacated, think again. The DOL’s old fiduciary regulation is back and it casts an unexpectedly wide net.

Let’s start with the background. The reinstated fiduciary definition says that a broker-dealer and its advisor (a “broker”) are fiduciaries to a plan if a functional five-part test is satisfied: (1) the broker provides advice about investments for a fee or other compensation, (2) on a regular basis, (3) under a mutual understanding, (4) that the advice will form a primary basis for the plan’s decisions, and (5) that the advice is individualized based upon the plan’s particular needs. For this purpose, a “plan” includes not only an ERISA plan, but also an IRA. (In the context of IRAs, being a fiduciary under the five-part test does not itself implicate a standard of care, but does apply to the applicability of certain prohibited transactions.)

The reinstated fiduciary regulation, as with the vacated rule, applies to nondiscretionary investment advice. Discretion over investments has always resulted in fiduciary status. However, our focus is on nondiscretionary investment advice.

Since the determination of whether a broker-dealer is a fiduciary is “functional,” that is, based on conduct, courts consider all of the facts in the relationship in determining whether the five-part fiduciary advice test is met. This includes the terms of the service agreement between the parties, as well as the conduct of the broker and the client’s reliance on the broker’s suggestions. Relevant factors may include: the regularity of the advice; the length of the relationship; the broker’s knowledge about the plan client; the client’s expertise in financial matters; whether the client is receiving any other investment advice for the plan assets; and whether the client has ever rejected the broker’s recommendations.

For example, a court found that a broker was a fiduciary to a pooled (non-participant directed) plan under the following facts:

  • The broker recommended plan investments;
  • The broker met with the plan client on a regular basis to review the plan’s investments and to rebalance the portfolio;
  • The client never failed to accept a recommendation – which evidenced that the broker’s recommendation was a primary basis for the plan’s decision;
  • The plan trustee gave the broker regular access to information regarding its portfolio so the broker could tailor the advice to the needs of the plan, and the broker periodically rebalanced the portfolio and adjusted the asset allocation; and
  • The broker received commissions and other compensation for its services.

While that case involved a pooled retirement plan, it’s easy to see how a court could make a similar finding in the context of a 401(k) or other participant-directed plan, where the broker regularly provides recommendations with respect to the plan’s menu of investment options.

One consequence of the “facts and circumstances” approach to determining fiduciary status is that the written terms of a brokerage agreement will generally not be dispositive. On one hand, contractual language stating that a broker will not act as a fiduciary may help bolster an argument that the required “mutual understanding” does not exist. But, a court could still find that such an understanding does in fact exist if the plan sponsor customer consistently and continuously follows specific recommendations from the broker, and those recommendations are reasonably tailored for the plan’s needs.

What all of this means is that brokers who do not intend to act as fiduciaries need to consider not only their written service arrangement terms, but also the scope and nature of advice services they provide. Some broker-dealers may assume that if they suggest a list of, say, three investments, they won’t fall under the five-part test because they aren’t recommending a single investment. Unfortunately, that is not a safe assumption. Even though the customer needs to make a selection, the broker-dealer can still be seen as having made a recommendation. The same would be true if the broker-dealer recommends an investment strategy. On the other hand, if a broker makes a recommendation – even of a specific investment – at the outset of the relationship with the customer and then makes other recommendations on an episodic (i.e., not quarterly or annually) basis thereafter, the broker may be able to show that the arrangement does not meet the “regular basis” requirement.

In short, brokers need to understand how the five-part test functions and adapt their service models accordingly if they wish to avoid fiduciary status as to plan and IRA customers.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

About the Author: Joan M. Neri

Joan Neri represents plan service providers – including broker-dealers and registered investment advisers – and employer plan sponsors and counsels them on fulfilling their obligations under ERISA and complying with the Internal Revenue Code rules governing retirement plans and accounts. Joan advises on ERISA fiduciary status and responsibilities, avoidance of prohibited transactions, the considerations associated with structuring, developing and offering investment products and services to ERISA plans and day-to-day plan operational compliance issues.

About the Author: Joshua Waldbeser

Joshua J. Waldbeser counsels plan sponsors and committees with respect to their fiduciary responsibilities under ERISA, as well as design and operational considerations for 401(k) plans, ESOPs and other defined contribution plans, cash balance and traditional defined benefit plans, and deferred compensation arrangements of all types. Josh also works extensively with insurance companies, investment advisors and funds, banks and trust companies, broker-dealers, record keepers, TPAs and other service providers with respect to ERISA, tax, securities and other compliance matters, including investment and fiduciary issues, as well as prohibited transactions and exemptions.

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