Proposed Regulations Would Expand ERISA Fiduciary Exposure

James Morphy is a partner at Sullivan & Cromwell LLP specializing in mergers & acquisitions and corporate governance. This post is based on a Sullivan & Cromwell client memorandum.

On October 21, 2010, the Department of Labor (“DOL”) proposed regulations (the “Proposed Regulations”) that would, if adopted, significantly expand the circumstances in which a person will be treated as a fiduciary under the Employee Retirement Income Security Act of 1974 (“ERISA”) by reason of providing investment advice for a fee to an employee benefit plan. A fiduciary under ERISA is subject to strict prudence and conflict of interest standards and it is the DOL’s expressed intention in making the changes to enhance its “ability to redress service provider abuses that currently exist in the market, such as undisclosed fees, misrepresentations of compensation arrangements, and biased appraisals of the value of employer securities and other plan investments.” Because many financial institutions have regular interactions with employee benefit plans and their fiduciaries—as counterparties, service providers, agents, and so forth—the Proposed Regulations are widely relevant for the financial services industry.

To summarize, the Proposed Regulations would:

  • Expand the definition of “investment advice” to include the rendering of appraisals and fair value opinions and making recommendations with respect to the “management” of securities or other property (in addition to the current advisory activities which include advice concerning the value of securities and recommendations regarding the advisability of buying, holding or selling securities and property, but currently exclude valuations of closely held stock);
  • Impose ERISA fiduciary standards when investment advice is made, even on a one-time basis, pursuant to an agreement, arrangement or understanding that (1) the plan “may consider” the advice in making investments and (2) the advice will be individualized (thus eliminating the current law requirement that the investment advice be provided “regularly,” pursuant to a mutual understanding that the advice will be a “primary basis” for making investment decisions); and
  • Define “fees” to include fees received by affiliates and fees received in connection with transactions to which the advice relates, such as brokerage fees, commissions and so forth.

The Proposed Regulations contain exceptions for (1) persons acting as adverse counterparties (or agents thereto) in purchase and sale transactions, where the plan fiduciary knows or should know the counterparty is not undertaking to provide impartial advice (this exception does not apply to a person that represents or acknowledges it is acting as an ERISA fiduciary); [1] (2) certain informational and other materials provided by 401(k) providers, without regard to the individual needs of the plan; and (3) valuation reports provided in compliance with applicable fee disclosure regulations (unless the report includes assets that are illiquid and the report will serve as the basis for plan distributions).

Because of the potential breadth of the Proposed Regulations and the consequences of becoming an ERISA fiduciary, financial institutions should carefully review their interactions with employee benefit plans and their fiduciaries (such as hedge funds [2] and asset managers that are ERISA fiduciaries) to identify and address potential areas of compliance.

The comment period for the Proposed Regulations ends on January 20, 2011. The final regulations would become effective 180 days after publication in final form in the Federal Register.


ERISA imposes stringent duties on persons treated as fiduciaries of an employee benefit plan, including a duty of undivided loyalty, a duty to act for the exclusive purpose of providing plan benefits (and defraying costs) and a stringent duty of care. In addition, ERISA prohibits a fiduciary from causing a plan to engage in certain “prohibited transactions,” such as transactions involving a conflict of interest between the fiduciary and the plan and certain other transactions with parties in interest to the plan (sales, loans, services and so forth). Unless otherwise covered by a DOL exemption, a breach of ERISA’s fiduciary duties or prohibited transaction rules can result in liability under ERISA to make the plan whole for any losses, disgorge profits, pay civil penalties to the DOL and pay penalty taxes under the comparable provisions of the Internal Revenue Code (the “Code”) ranging from 15% to 100% of the face amount of the relevant transaction. [3] Further, the availability of common prohibited transaction exemptions, such as the statutory service provider exemption under Section 408(b)(17) of ERISA, may depend, in part, on whether the counterparty to the employee benefit plan is treated as a fiduciary with respect to the transaction. [4]

Under ERISA, a person who renders investment advice for a fee or other compensation, direct or indirect, with respect to the assets of a plan will be treated as an ERISA fiduciary. Under current law, as set forth in a DOL regulation issued in 1975, a person who does not have discretionary authority or control with respect to the assets of a plan will not be treated as a fiduciary by reason of providing investment advice unless such person renders advice on a regular basis with respect to the value of securities or other property or makes recommendations as to the advisability of investing in particular securities or property pursuant to a mutual agreement, arrangement or understanding with the plan that (1) such services will serve as a primary basis for investment decisions with respect to plan assets and (2) such person will render individualized advice to the plan based on the needs of the plan. [5] In this regard, a 1976 DOL Opinion ruled that valuation of closely held stock would not be treated as investment advice. [6]

In the preamble to the Proposed Regulations (the “Preamble”), the DOL expresses its view that the foregoing rules are too narrow to appropriately protect employee benefit plans in light of current market practices that could give rise to conflicts of interests for the numerous consultants, advisers and appraisers who significantly influence benefit plan investment decisions but may not be treated as ERISA fiduciaries under current law.

Proposed Regulations

The Proposed Regulations would replace the current rules described above with new regulations that would expand the meaning of “investment advice,” expand the types of arrangements that will be treated as the provision of investment advice and provide a broad definition of “fee.” The Proposed Regulations, when effective, would also apply for purposes of Section 4975 of the Code (penalty taxes). Under the Proposed Regulations a service provider to a plan would be treated as an ERISA fiduciary if the person (1) provides “investment advice” to the plan, (2) the advice is provided under specified conditions and (3) receives a fee, direct or indirect for the advice. Each of these elements is discussed in more detail below.

Meaning of Investment Advice. Under the Proposed Regulations, investment advice includes the current law definition of investment advice (advice with respect to the value of securities or other property or recommendations as to the advisability of investing in particular securities or property), but adds:

  • Appraisal or fairness opinions concerning the value of property; and
  • Advice or recommendations as to the management of securities or other property.

The Preamble states that a common problem for plan fiduciaries is the reliance on faulty valuations prepared by professional appraisals. By adding appraisals and fairness opinions to the definition of investment advice, the DOL intends to “align the duties” of appraisers with the fiduciaries who rely on the appraisals. This change is intended in particular to supersede the DOL’s 1976 opinion exempting valuations of closely held stock from the meaning of investment advice. The Preamble states that the addition of advice or recommendations as to “management” of securities or property would include advice “appurtenant” to shares of stock (such as advice regarding voting proxies) and to the selection of persons to manage plan investments, but provides no further examples or rationale for this change. As many types of advice or recommendations made to an employee pension plan could be construed as relating to the “management” of securities or property, this change potentially could cause many service providers to be treated as ERISA fiduciaries. For example, an investment consultant could be treated as an ERISA fiduciary with respect to an employee benefit plan under the Proposed Regulations, if the consultant receives fees when the plan hires an investment manager that is recommended by the consultant.

Lastly, under the Proposed Regulations, investment advice includes advice provided to the plan, a plan fiduciary, or a plan participant or beneficiary. Because hedge funds and asset managers may act as ERISA fiduciaries with respect to their ERISA investors and clients, a service provider who provides investment advice to these entities are at risk of becoming fiduciaries themselves.

Arrangements Treated As Provision of Investment Advice. The Proposed Regulations state that a person will be treated as providing investment advice to an employee benefit plan if the person:

  • Provides investment advice (as described above) pursuant to an agreement, arrangement or understanding that the advice: (1) “may be considered” in connection with making investment or management decisions with respect to plan assets and (2) will be “individualized to the needs” of the plan, fiduciary, beneficiary or participant, as the case may be;
  • Is an investment adviser within the meaning of Section 202(a)(11) of the Investment Advisers Act of 1940 (“Investment Advisers”); or
  • Represents or acknowledges that it is an ERISA fiduciary, or is otherwise a fiduciary under ERISA by having discretionary authority with respect to the assets, administration or management of the plan.

In this regard, the Proposed Regulations are significantly broader than current law. Under current law, ERISA fiduciary status attaches only with respect to investment advice provided on a regular basis, pursuant to a mutual understanding that the advice will serve as a primary basis for the investment decision. By contrast, under the Proposed Regulations, advice given on a one-off basis could trigger ERISA fiduciary liability if the advice were individualized and there was an understanding that the advice “may be considered” by the plan in making an investment decision.

Since advice and recommendations given by financial service providers are often given with the “understanding” that the advice and recommendations might “be considered” when making an investment decision, these changes have the potential for extending the scope of ERISA fiduciary standards to cover common marketplace transactions not currently considered as subject to those standards. While a service provider to a pension plan might possibly avoid this rule by disclosing to the plan that it may not “consider” any advice or recommendations given or arguing that the advice is not “individualized,” such a disclaimer or argument may be impractical or disingenuous in many cases. Further, because the Proposed Regulations expressly do permit 401(k) providers to expressly disclaim an intention to provide impartial advice (in certain circumstances), it is unclear whether such disclaimers in other contexts would be recognized.

With regard to Investment Advisers, many (such as asset managers and hedge funds) will have already accepted fiduciary status under ERISA on account of their employee benefit plan investors and clients. As a consequence, the Proposed Regulation’s broad-brush approach to Investment Advisers may not materially impact these firms. However, it is important to note that the Proposed Regulations apply to Investment Advisers that provide investment advice to an employee benefit plan, without regard to whether there is an agreement, arrangement or understanding that the advice may be considered by the plan and without regard to whether the advice is individualized. As a result, generic advice provided to employee benefit plans could create a fiduciary duty to such plan under the Proposed Regulations, even when such advice is coupled with an express disclaimer it could not be used for investment purposes.

Meaning of Fees. Under the Proposed Regulations, the term “fee or compensation, direct or indirect” means:

  • Any fee or other compensation for the advice received by the person (or by an affiliate) from any source; and
  • Any fee or compensation incident to the transaction with respect to which the investment advice is rendered, such as brokerage fees, sales commissions and so forth.

This definition includes fees based on multiple transactions involving multiple parties. While not expressly stated in the Proposed Regulations, it is likely that brokerage fees and commissions received by an affiliate of the person providing advice would also constitute “fees” for this purpose. Because of the breadth of this definition of fees, a person who is treated as providing investment advice to any employee benefit plan may be hard-pressed to argue that a fee was not received in connection with such advice.


The Proposed Regulations would provide three exceptions:

Adverse Counterparty. The provision of investment advice or recommendations would not cause a person to become an ERISA fiduciary under the Proposed Regulations if such person can demonstrate that:

  • The recipient of the advice knows, or reasonably should know, that the person is providing the advice or recommendation in its capacity as a purchaser or seller of a security or other property (or as an agent thereof) whose interests are adverse to the interests of the plan or its participants or beneficiaries; and
  • The person is not undertaking to provide investment advice.

This exception does not apply to a person that represents or acknowledges it is acting as an ERISA fiduciary to the employee benefit plan. This exception should be sufficient to cover most types of proprietary sale transactions and marketed transactions (fund raisings, private offerings and so forth) by a party not otherwise an ERISA fiduciary to the plan, in cases where there is clearly no undertaking to provide investment advice. But it does not address other common classes of transactions involving an adverse counterparty relationship with a plan, such as securities loans, derivative transactions, interest rate swaps and other hedging contracts, which may not be a “security or other property” for this purpose.

Individual Account Plans (e.g., 401(k) Plans). With regard to individual account plans (such as 401(k) plans), the following will not, standing alone, be treated as rendering investment advice:

  • The provision of investment education information and materials permitted under current DOL regulations, such as (1) information and materials that inform a participant or beneficiary about the benefits of plan participation, the benefits of increasing plan contributions, the impact of preretirement withdrawals on retirement income, the terms of the plan, or the operation of the plan and (2) information on investment alternatives under the plan, such as descriptions of investment objectives and philosophies, risk and return characteristics, historical return information, or related prospectuses; [7]
  • Marketing or making available through a platform or similar mechanism (without regard to the individual needs of the plan, its participants or beneficiaries) securities or other property which may be selected by the plan fiduciary as investment alternatives under the plan, if the person making such investments available (e.g., the platform provider) discloses in writing to the plan fiduciary that such person is not undertaking to provide impartial investment advice; and
  • Provision of general financial information and data to assist the plan fiduciary in monitoring such investment alternatives, if the person providing such information (e.g., the platform provider) discloses in writing to the plan fiduciary that such person is not undertaking to provide impartial investment advice.

Note that this exception applies only when the platform provider is marketing investments without regard to the particular needs of the plan. It is not clear how this exception would apply where a 401(k) provider maintains several off-the-shelf plans designed to fit the needs of different types of employers, and markets a small company plan to its smaller clients or makes small adjustments to customize an off-theshelf plan for a particular sponsor.

Required Disclosures. The Proposed Regulations also provide that “advice, or appraisal or fairness opinion” will not include valuation reports and statements provided for purposes of complying with regulatory disclosure obligations (e.g., Form 5500 reporting obligations), unless the report involves assets without a generally recognized market and serves as a basis upon which the plan makes distributions.


[1] Under this exception, a counterparty to an employee benefit plan would not be treated as an ERISA fiduciary on account of providing “investment advice” (within the meaning of the Proposed Regulations). If the counterparty were otherwise an ERISA fiduciary (e.g., by reason of having discretionary authority over the plan assets in question), however, the exception would not relieve the counterparty of its duties under ERISA.
(go back)

[2] Under applicable DOL regulations, a hedge fund with 25% or more benefit plan investors (by class) can be treated as an ERISA fiduciary to the investing plans.
(go back)

[3] See, e.g., Section 409 of ERISA and Section 4975 of the Code.
(go back)

[4] See, e.g., Section 408(b)(17) of ERISA.
(go back)

[5] DOL Regulation Section 2510.3-21(c)(1).
(go back)

[6] DOL Advisory Opinion 76-65A (June 7, 1976).
(go back)

[7] See DOL Regulation 2509.96-1(d).
(go back)

Both comments and trackbacks are currently closed.

One Comment

  1. Abe Essig
    Posted Wednesday, November 10, 2010 at 12:29 pm | Permalink

    As a mid-size privately held company, we are concerned that the cost of adding fiduciary responsibility to our annual audit may be very high – and this could lead to our winding down the ESOP.

    As a majority owner, I would have been (and would continue to be)better off financially by converting from a C Corporation to a sub S.
    However, our plan is 15 years old, and hundreds of our retirees have benefited greatly from Employee Ownership