Bar None?

By Fred Reish

Plan sponsors and providers are steadily increasing the investment services for plans and participants, including investment advice. However, plan sponsors, investment advisors and providers must be careful to avoid running afoul of the nondiscrimination and prohibited transaction rules in the Internal Revenue Code and in Title I of ERISA.

There are typically two kinds of investment services for participants that give rise to these issues. The first is investment advice where guidance is provided to the participant, who decides whether to accept the advice and is responsible for taking action to implement it. The second is investment management, where the account is actively managed for the participant—-that is, the participant selects an investment manager to make and implement investment decisions for the participant’s account. Both investment advice and investment management, as described above, are covered by ERISA’s definition of fiduciary investment advice.

Some investment providers impose significant charges or require minimum account balances that may violate the nondiscrimination requirements of section 401(a)(4) of the Internal Revenue Code, conditions that make it likely that the availability of these providers’ services will be disproportionately skewed towards highly compensated employees (HCEs). This, of course, raises the concern that a plan using this service would discriminate in favor of HCEs—-in violation of Code section 401(a)(4).

Qualified plans make benefits, rights and features (BRFs) available in a nondiscriminatory manner. The definition of BRF includes all optional forms of benefits, ancillary benefits and other rights and features available to any employee under the plan. The term other right or feature generally means “any right or feature applicable to employees under the plan.”

The opportunity to receive investment advice is not listed specifically as a right or feature. However, the Treasury regulations do include, in the definition of rights or features, the analogous right to direct investments and the right to a particular form of investment, and the regulations also state that the list is not exclusive. Further, the right to use an investment advisor does not appear to fit within the “no meaningful value” exception, as evidenced by what participants are charged for investment advice services. As a result, there seems to be little question but that investment advice services would be an “other right or feature,” subject to the qualification requirements for nondiscrimination.

As such, if a plan offers investment advice, access to that service must be both currently and effectively available to employees. Treas. Reg. § 1.401(a)(4)-4 provides a safe harbor for the current availability requirement-—satisfying the ratio percentage test (i.e., the percentage of NHCEs to whom the BRF is available equals or exceeds 70% of the HCEs to whom the BRF is available). However, there is no safe harbor for the effective availability requirement. A determination as to whether the effective availability requirement has been met (i.e., the right does not substantially favor HCEs) is, instead based on the “relevant facts and circumstances.”

Similarly, if a plan charges an unreasonably high fee for the advice, it may violate the Code’s nondiscrimination requirements. For example, a nondiscrimination issue could arise if the plan required a fee of 25 basis points for investment advice with a minimum of $2,500 per year. If this was a plan-imposed limit, then the fee would likely be so high (for small accounts) that it would preclude most NHCEs from being able to use the service. As a result, the advice service would likely not satisfy the Code’s nondiscrimination rules regarding current and effective availability.

An argument can be made that the selection by the plan of an investment advisor that requires a minimum account balance or imposes a significant fee does not violate the nondiscrimination requirements, since participants are not required to use the investment advisor designated by the plan, and may even select their own investment advisor without even notifying the plan.

However, where the plan sponsor designates an investment advisor who imposes minimum account balance requirements or significant fees, and does not expressly allow the use of other investment advisors by participants with smaller balances or advisors with lower fees, it may, as a practical matter, effectively be imposing plan restrictions.

© 2004 Article was reprinted, with permission, from Plan Sponsor magazine (May 2004). Copyright 2004 Asset International, Inc. All rights reserved.

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