Keeping Up With DC

Marcia S. Wagner, Esq.

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1. Broader “Fiduciary” Definition 2. Target Date Funds3. Automatic IRA Legislation

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Broader “Fiduciary” Definition

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ERISA and ConflictsFiduciary standards under ERISA are the

highest known to the law.◦ Conflicts can not be mitigated through disclosure.◦ Must eliminate conflict or meet conditions of a PTE.

Administration’s campaign to reduce conflicts.◦ Proposal to change “fiduciary” definition to include

more consultants and advisors.◦ Would impose ERISA fiduciary standard on

consultants and advisors who do not meet current “fiduciary” definition.

◦ Would require new segment of providers to eliminate conflicts or comply with PT exemption.

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DOL’s Agenda on “Fiduciary” DefinitionDOL Unified Agenda (Dec. 7, 2009)◦ Announces that it will be publishing proposed reg’s on

“fiduciary” definition.◦ Will change “investment advice” definition used to

determine fiduciary status of provider.

DOL Fact Sheet on Proposal◦ Need to re-examine types of advisory relationships that

should be subject to fiduciary standards.◦ Fact Sheet specifically cites pension consultants and

financial asset appraisers.◦ DOL is concerned that current definition allows advisers

from whom plans expect impartial advice to evade fiduciary responsibility.

◦ Current definition has a 5-part test for fiduciary “investment advice.”

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What Does It Mean to be a Fiduciary?Statutory definition – ERISA 3(21)(A)(ii)◦ Any person who renders investment advice for

compensation is a fiduciary.

DOL definition of “investment advice” :◦ Advice on value or advisability of investments,◦ that is provided a regular basis,◦ pursuant to a mutual agreement or understanding,◦ that such services will serve as a primary basis for

investment decisions, and◦ that individualized advice will be based on the particular

needs of the plan.

DOL definition of investment advice is more narrow than federal securities law definition.

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Potential ImplicationsImplications of broader “fiduciary” definition.

◦ Dovetails with initiatives to improve transparency.◦ Broader definition increases impact of DOL’s other

mandates, including PT rules.

If regulatory change goes into effect, potential impact on providers:◦ Need to adopt fee-leveling.◦ Need to change nature of services so that they are

not deemed to include fiduciary advice.◦ Eliminate conflicts.

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New Fiduciary Standards Under Dodd-Frank Act of 2010

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.◦ Requires SEC to study standards of conduct for

brokers and RIAs.◦ Empowers SEC to impose fiduciary standard on

brokers.

Financial advisors who are non-fiduciary brokers are currently subject to a duty of suitability only.◦ SEC rulemaking may impose new disclosure

obligations and fiduciary standards on brokers.◦ DOL rulemaking may also impact brokers advising

plans in a non-fiduciary capacity.

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Target Date Funds

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Background on Target Date FundsPopular default investment vehicle for 401(k)

plans. Typically, formed as open-end investment

companies registered under the Inv. Co. Act.Defining characteristic – “glide path” which

determines the overall asset mix of the fund.Performance issues in 2008 raise concerns,

especially for near-term TDFs.◦ Based on SEC analysis, the average loss for TDFs with

a 2010 target date was -25%.◦ Individual TDF losses as high as -41%.

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Administration’s Proposals for TDFsImproving transparency of TDFs and other default

retirement investments.DOL and SEC at Senate Special Committee on Aging

hearing on TDFs (Oct. 28, 2009).DOL’s new guidance on TDFs.◦ DOL announces proposal for QDIA regulations.◦ Investor Bulletin jointly released by DOL and SEC.◦ “Best practices” fiduciary checklist is pending.

SEC proposal for TDF advertising materials.◦ If name has target date, “tag line” disclosure needed.◦ Advertising must include glide path information.

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Conflicts of Interest in TDFsConflicts arise when a “fund of funds” invests in

affiliated underlying funds.◦ Fees are payable to underlying fund managers.◦ TDF uses affiliated underlying funds for every single

asset class.

Conflicts regarding mix of funds also exist.◦ Equity funds typically pay higher fees.◦ Certain 2010 TDFs invested up to 68% of assets in

underlying equity funds.

TDF-related conflicts found in mutual funds would not be permitted if fund managers were subject to ERISA.

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Fund Managers Are Exempt from ERISAERISA Section 401(b)(1)

When a plan invests in a security issued by a mutual fund, “the assets of such plan shall be deemed to include such security but shall not, solely by reason of such investment, be deemed to include any assets” of such fund.

ERISA Section 3(21)A plan’s investment in a mutual fund “shall not by itself cause such [fund] or such [fund’s] investment adviser” to be deemed a fiduciary.

Combined effect of these provisions is to create a carve-out from ERISA’s fiduciary requirements for fund managers.

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Are Mutual Fund Managers Ever Subject to ERISA?

Fund managers are not automatically deemed to be fiduciaries.◦ But can they be ERISA fiduciaries in certain

circumstances?

ERISA Section 401(b)(1)When a plan invests in a security issued by a mutual fund, “the assets of such plan shall be deemed to include such security but shall not, solely by reason of such investment, be deemed to include any assets” of such fund.

ERISA Section 3(21)A plan’s investment in a mutual fund “shall not by itself cause such [fund] or such [fund’s] investment adviser” to be deemed a fiduciary.

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Request for DOL GuidanceFirm requested clarification on scope of exemption for

TDF mutual fund managers.◦ Adv. Op. 2009-04A on behalf of Avatar Associates.◦ DOL declined to rule that the TDF mutual fund managers should

be viewed as fiduciaries.

Implications of DOL guidance◦ Plan sponsors are alone in their fiduciary obligation.

Fiduciary duty to evaluate plan’s QDIA.◦ Participants responsible for default allocation choice.◦ Plan sponsors must ensure QDIA is prudent choice.◦ Must ensure TDF’s underlying investments are appropriate and

monitor TDF on ongoing basis.

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Congressional Proposal for TDFsSenator Kohl announced his intent to

introduce new legislation (Dec. 2009).◦ Concerns over high fees, low performance or

excessive risk in many TDFs.◦ Would impose ERISA fiduciary status on TDF

managers when TDF used as QDIA in 401(k) plans.

Senator Kohl’s proposal differs from DOL approach to improve disclosures to employers and participants.

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Automatic IRA Legislation

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Automatic IRA Legislation ProposedAutomatic IRA Act of 2010 introduced in

both Senate and House.Senate version introduced on Aug. 6, 2010.◦ After phase-in period over 4 years, employers with

10 or more employees must set up Auto IRAs.

◦ Covers all employees who are age 18 with 3 months of service.

◦ Choice of Traditional or Roth IRA (Roth is default).

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Senate Version of Automatic IRA Legislation (cont’d)

Investment provisions◦ Investment firms not required to sell Auto IRAs.◦ 3 investment options only, which must be low-cost.

Noncompliance results in $100-per-employee penalty.

New tax credit for small employers of $250 for start-up costs.◦ $1,000 maximum start-up tax credit for small

employers establishing 401(k) plans.

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House Version of Automatic IRA Legislation

House version introduced on Aug. 10, 2010.Differences from Senate version.◦ All employers with 10 or more employees are

immediately covered (and no phase-in over 4 years).◦ Default choice for employee is Traditional IRA (and

not Roth IRA).◦ 3 investment options for Auto IRAs are somewhat

different than in Senate version.

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Keeping Up With DC

Marcia S. Wagner, Esq.

99 Summer Street, 13th FloorBoston, MA 02110

Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.erisa-lawyers.com

marcia@wagnerlawgroup.com A0044038