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Beware of ERISA Responsibilities
ongratulations! Your newest client is a company retirement plan. Now let's talk about your newest responsibilities under ERISA - the Employee Retirement Security Act of 1974.
Most brokers know that ERISA covers large company pension plans. But many brokers do not know that ERISA covers all qualified employee retirement plans, with as few as one common law employee.
Why should brokers care? ERISA imposes personal liability upon those violating the statute - stripping away any kind of corporate liability shield that might exist. And the statute imposes high standards of care. In fact, as one court stated, ERISA imposes the "highest [standards of care] known to law". Now that I have your attention, let's outline how ERISA applies to your business.
ERISA applies to plan fiduciaries. Not everyone qualifies as a plan fiduciary, but most brokers do qualify. Under ERISA, all that is required is that the broker either have discretion over the purchase and sale of plan securities, or that the broker render investment advice for a fee, which includes recommending the purchase or sale of securities. Please note that brokers who provide only investment allocation advice may or may not be considered a fiduciary. In this event, brokers should consult a lawyer to draft contract language that outlines the respective roles of the plan and the broker.
Assuming that the broker falls within the ERISA definition of a fiduciary, as most will, what must he or she do? ERISA details certain so-called "Prohibited Transactions" (which are beyond the scope of this article). In addition to those prohibited transactions, brokers must understand each of four general fiduciary duties.
First, brokers must act in accordance with the documents and instruments governing the plan. This requires reading the plan documents and understanding any limitations being placed upon the rendering of investment advice. Second, brokers must act for the exclusive purpose of providing benefits to the plan, and defraying reasonable expenses of administering the plan.
Brokers must pay especially close attention to the third and fourth general fiduciary duties imposed upon them. These are that brokers must act with the care and skill of a prudent person in like capacity - the "Prudent Investor Rule". Finally, brokers must diversify plan assets so as to minimize the risk of large losses to the plan, unless it is not prudent to do so under the circumstances.
What does this mean in practice? In investing prudently, applicable regulations list these specific considerations to provide some guidance:
The composition of the plan portfolio with regard to the diversification of risk;
The volatility of the plan portfolio with regard to general movements in investment prices;
The liquidity of the plan portfolio relative to the funding objectives of the plan;
The projected return of the plan portfolio relative to the funding objectives of the plan; and
The prevailing and projected economic conditions of the entities in which the plan has invested and proposes to invest.
Does this mean that a plan can make only "Blue Chip" investments? No, but securities issued by a small company or by a new company may be riskier and hence more suspect.
Likewise, ERISA's diversification requirement is designed to protect against large losses to the plan. Here are some factors for brokers to consider in satisfying the diversification requirement:
The purpose of the plan;
The amount of assets involved;
The types of investments (stocks, bonds, etc.);
Financial and industrial conditions;
Geographic dispersion; and
Dates of maturity.
As an example, a court imposed liability on an investment company when it invested over 70% of a plan's assets in long term government bonds. This was improper diversification, the court held, because the investment company failed to determine the plan's cash flow needs. As a result, the plan was forced to sell some bonds at a loss to meet the plan's need for cash.
In the event that a broker breaches one or more of his fiduciary duties to the plan, he faces serious consequences. As stated above, brokers are personally liable to make good any losses to a plan. Equitable relief also can be granted, including removal of the fiduciary. Brokers may be ordered to disgorge any profits. And civil penalties may be imposed.
Keep these points in mind when you open the next qualified retirement account.
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Free Opinion
Sponsored by James J. Eccleston, an attorney representing stockbrokers, financial planners and
investors nationwide in arbitration, litigation and regulatory matters, and a shareholder with the law firm
Shaheen, Novoselsky, Staat, Filipowski & Eccleston
P.C.(www.snsfe-law.com). This Web site contains material
of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
Always consult an attorney and/or investment advisor when building and protecting your wealth.
All content Copyright © 2008 Advocate Capital Management, Inc. except where noted. All rights reserved.
20 North Wacker Drive, Suite 2900, Chicago, Illinois 60606
Telephone: 312-621-4400 | Fax: 312-621-0268
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