Advisor Do’s and Don’ts

By Bruce Ashton

In the last Adviser Do’s and Don’ts column, we talked about the importance of proper disclosure of fees and the proper characterization of the role of the adviser. This has taken on even greater importance in light of the DOL’s proposed regulation under ERISA Section 408(b)(2), which specifically addresses these items (along with conflict of interest disclosure).

Because of the importance of this regulation, the focus of this column is on some of the issues the regulation raises. And we have reversed the “do’s” and the “don’ts” in order to emphasize a key point about the regulation.

Don’t — forget that a violation of this regulation results in a prohibited transaction. Under ERISA, if a transaction is prohibited, you simply can’t do it — there is essentially no room for interpretation, as there may be, for example, when looking at whether a fiduciary has acted prudently. And if the DOL establishes an exemption, as they did here, there must be strict compliance with its requirements.

Why do we stress this? For two reasons:

• If you don’t comply with each of the requirements of the exemption, the transaction is prohibited. We have asked the DOL to apply a “substantial compliance” standard or a standard that says if you fail in some immaterial respect, you will still be ok; but we don’t know if the DOL will adopt this approach. So you must know the requirements of the regulation and take steps to make sure you comply with each of them.

• If the transaction is prohibited, you may be subject to excise taxes imposed under the Internal Revenue Code (15% of the amount involved, which is probably the total amount of your fees), and the transaction must be “corrected.” This probably means that you would have to give back all of your compensation if you fail to comply with the exemption. Not a desirable outcome.

So, the key don’t we want to emphasize is don’t fail to comply with the requirements of the regulation.

Do — start working on revisions to your service agreement now. The amended regulation could go into effect as early as this fall — though we hope it will not be earlier than January 1, 2009 — and the required changes are sweeping. Here are some important elements to address:

• You must have a written contract or arrangement. For some advisers, this will not be a problem, but for others — broker/dealers in particular — this will mean establishing new procedures for taking on clients.

• You must make disclosures about services, compensation and potential conflicts of interest before entering into the contract or arrangement. Presumably, the disclosures can be made in the written contract itself, but this will require providing prospective clients with the contract before they make the final decision to hire you.

• The disclosures must be made and the arrangement approved by a responsible plan fiduciary. If the plan sponsor is the responsible plan fiduciary, this shouldn’t require a change in procedure; but if the administrator function has been delegated by the sponsor to a committee or other party, the disclosures may have to be made to someone other than the “client.”

• You have to state whether you are acting as a fiduciary under ERISA or the Investment Advisers Act of 1940. This applies even if you are not specifically identified as a fiduciary—i.e., if you are a “functional” fiduciary. This will be especially problematic for advisers who either don’t know they are serving in a fiduciary capacity or who do not want to acknowledge it.

This is just a sampling of the requirements under the proposed regulation. The real heart of it covers the issues we discussed in our last column, disclosure of fees and specification of the services you will provide, along with potential conflicts of interest. We expect to cover the conflicts issue in our next column.

© 2008 Reish Luftman Reicher & Cohen, A Professional Corporation. All rights reserved. The ADVISER REPORT is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish Luftman Reicher & Cohen does not warrant and is not responsible for errors or omissions in the content of this report.

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