New federal regulations mandating fee and compensation disclosure are the latest reminder to plan advisers and fiduciaries of the perils of providing services to ERISA-regulated benefit plans. Many investment advisers are unaware of how recent rule changes affect their duties as fiduciaries. The new Labor Department regulations and long-standing requirements of the Employee Retirement Income Security Act of 1974 make clear that investment advisers have their own fiduciary responsibilities and corresponding liabilities.
ERISA plan fiduciaries include investment advisers with discretionary authority over investment decisions on behalf of an employee benefit plan and its participants. Also designated as fiduciaries are financial advisers who advise plan sponsors but don't directly control the sponsor's investments.
Advisers in both categories assume fiduciary risk and are subject to Section 412 of ERISA bonding requirements.
Liability risks often rise as employee benefit plans and related laws become more complex. What is sometimes overlooked is that fiduciaries' liabilities may involve their personal assets.
It is imperative that investment plan advisers understand their potential legal and financial exposure, as well as limitations on indemnification.
Last year, the Labor Department collected $1.38 billion from ERISA-related cases through prohibited-transaction corrections, restoration of plan benefits or the voluntary fiduciary-correction program.
Three-quarters of the 3,472 closed investigations included a monetary recovery. According to a survey by Towers Watson, the average settlement was $994,000, with average defense costs reaching $365,000.
Conscientious advisers would do well to consider liability insurance, which can address the fiduciary exposure, including legal fees and other costs to defend lawsuits and certain investigations, and to comply with ERISA bonding requirements.
A grasp of appropriate issues is vital to avoiding potential pitfalls. Essential information includes:
Time for a status update: Many investment advisers may not know their fiduciary status or attendant duties, such as new disclosure requirements under ERISA 408(b)(2).
Plaintiffs often prevail:
ERISA lawsuits are expensive and frequently won by plaintiffs.
Reliance can be risky: There may be broadly assumed responsibilities and potential liabilities when discretionary control is provided as a 3(38) investment manager.
“Unsafe” harbors: ERISA Section 404(c)'s “safe harbor” provides plan sponsors with assurances, such as redirecting certain discretionary liability to the selected fiduciary adviser.
Focus on 401(k) plans: The Labor Department and Internal Revenue Service are showing more interest in 401(k) plan compliance, as evidenced by their increasingly active oversight of 3(38) investment managers.
Exposures go beyond selection of investment options: Other exposures for investment managers under ERISA include investments for plan participants; regular monitoring of plan participant options and models; annual reporting and documenting of options; and with Regulation 408(b)(2) now final, disclosing of total compensation and potential conflicts of interest to the plan sponsor.
Small companies can have big risks: Retirement plans sponsored by small companies are more likely to run afoul of ERISA and the IRS than those sponsored by larger companies with deeper compliance resources.
Follow the code: Failure to comply with the IRS Code's employee benefit plan provisions is increasingly costly, with the Labor Department expanding its reach to levy fines and assess liability.
The right insurance is critical: Professional liability products have varying applicable coverage exten- sions. Adviser errors-and-omissions, professional liability, fiduciary liability and third-party ERISA bonds provide different protections and may be beneficial for entities deemed fiduciaries under ERISA.
With closer regulatory scrutiny and high litigation costs, investment plan advisers protect themselves from risk. Insurance professionals can advise on risk management and appropriate coverage, but the first task for advisers — with guidance from legal counsel — is to assess and understand their status and exposures.
Investment advisers who make important risk decisions every day on behalf of clients must be sure that they don't neglect their own essential needs for risk management and protection.
Rich Fachet is a practice leader for investment advisers and funds, bond and financial products at The Travelers Cos. Inc.