Publication:  ASPPA Plan Consultant
Volume/Issue:  Winter 2017

The New DOL Rules: Why Should TPAs Care?

Ilene H. Ferenczy, Esq.

Among the many questions that are wending their way around the benefits industry in relation to the final Department of Labor (“DOL”) Conflict of Interest Regulation [Labor Reg. §2510.3-21(c) (“COI Reg”)] and the associated prohibited transaction exemptions [Best Interest Contract Class Exemption (“BICE”); Exemption for Principal Transactions; Amendment to PTE 75-1; Amendment to PTE 84-24; Amendment to PTEs 86-128 and 75-1; Amendments to PTEs 75-1, 77-4, 80-83, 83-1 (all dated 4/8/16)] is one that comes from the third party administration (“TPA”) community:  Why do I care?  The fact that this question is being asked reflects not only the insecurity that we all feel about these rules, which need some considerable additional fleshing out by the DOL, but also the fact that the TPA business is not what it used to be.  In fact, the types and levels of services provided by TPAs vary so considerably from one provider to another that this group—which seems so homogenous from the 3,000 foot view—is truly much broader than it appears at first blush.

So, if we are to truly answer this question, we must break up our analysis into the types of TPA organizations and services and go from there.

The TPA-Only Fee for Services “I Don’t Get Nuthin’ Else” Shop

If a TPA is a fee-for-services organization, and gets no revenue sharing from any products or service providers that are related to the investments, then the TPA is considered to provide ministerial services only and is not a fiduciary.  [Labor Reg. §2509.75-8, Q&A D-2] This rule applies both before and after the COI Reg, illustrating one of the most important points of this analysis:  if you do not give investment advice, the COI Reg does not affect you at all.

Beware, however, of the tendency to fool yourself into believing that you are part of this class of TPAs when you are not.  Certain common communications by a fee-only TPA may be interpreted as fiduciary advice, even if neither the TPA nor the client so intended.  This issue may arise whenever either a client asks you or you initiate a conversation about who will be the plan’s investment advisor.

The COI Reg provides that your recommendation of someone to provide investment advice may be advice in and of itself, if you are paid for that recommendation.  [COI Reg. §2510.3-21(a)(1)(ii)].

When is the referral to an investment advisor potentially investment advice? 

Even simply making a referral to an advisor with whom you work or providing a list of advisors you know to your clients may constitute a recommendation under the COI Reg.  [See, Preamble to the COI Reg (“Preamble”), §IV.A(4)]  In particular, the DOL notes in the Preamble that whether a referral constitutes advice depends on whether your communication to your client rises to the level of being a recommendation, which the DOL defines as “a communication that, based on its content, context, and presentation would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.”  [Id., referencing COI Reg. §2510-3(21)(b)(1)]  This definition bases whether you made a recommendation, not on whether you intended to do so, or even if your client thought you did so.  The definition is objective in nature, judging your statement to be advice if a reasonable person would believe that you intended him or her to act or not act based on your statement.

So, if a client comes to you and says, “Who should I get to help me with choosing and monitoring my investments?” and you say either “Joe Smith” or “Here’s a list of people I work with,” that likely constitutes investment advice if you are paid, directly or indirectly, as a result.

What is a “payment” that turns a referral into investment advice?

This is one of the most important unanswered questions of the COI Reg.  To constitute a payment, the amount may be “any explicit fee or compensation … from any source, and any other fee or compensation received from any source in connection with or as a result of the … provision of investment advice services.”  [COI §2510.3-21(g)(3)]  The regulation further provides that a payment of compensation is “in connection with” the recommendation if it would not have been paid but for the recommendation being made.  [Id.]

It is obvious that a TPA who gets a finder’s fee from an advisor for a referral is being paid and that the payment is in connection with a specific referral.  Things become much less obvious, however, when the situation is less definitive.  Suppose, for example, that a financial advisor takes you to lunch to thank you for a referral.  Suppose instead that the advisor gives you an annual holiday basket that gets progressively more impressive each year as you do more business together.  Or, what if there is no such obvious payment, but the advisor to whom you make referrals begins to refer business to you?  Aren’t referrals really quids pro quo understood by all in the business world?  Or, is it just the recognition by the advisor as you work more closely together that you do excellent work and that he believes that you are someone his clients should use?

The COI Reg does not drill down to this level of detail as to what constitutes either a recommendation or compensation.  Unless further information is provided, it appears that the fee-based TPA must take care when asked for a referral to an advisor, or when it offers such a referral, to know in advance whether it will provide one.

The TPA That Receives Revenue Sharing or Other Investment-Related Payments But Gives No Investment Advice

The second category of TPAs to examine is those who provide only TPA services and no intentional investment advice, but who receive revenue sharing from the financial institution that provides a platform for participants to direct their own investments and also recordkeeps the investments.

In principle, the TPA is being paid for services and not for investments.  Furthermore, the TPA’s recommendation may relate to the nature of the financial institution’s recordkeeping and participant service capabilities, with no opinion whatsoever about what investment options are chosen to be offered to the participants.  Indeed, the revenue sharing that is provided to the TPA is commonly considered for services other than giving investment advice, such as administration expenses.

Nonetheless, the fact that the TPA is paid in connection with the purchase by the plan of specific investments and that the level of revenue sharing may be higher with one investment than with another leads one to question if there is enough of a nexus between the TPA and the funds to create a fiduciary relationship.  In other words, if the TPA has a role in directing the client to a given recordkeeper and a structure under which the funds provided in the plan pay the TPA revenue sharing, is this investment advice?

This is another area that is not fully addressed in the COI Reg.  The COI Reg specifies that, if a TPA markets or makes an investment platform available to its clients, that act in and of itself does not represent investment advice.

Marketing or making available to a plan fiduciary of a plan, without regard to the individualized needs of the plan, its participants, or beneficiaries, a platform or similar mechanism from which a plan fiduciary may select or monitor investment alternatives … into which plan participants and beneficiaries may direct the investment of assets held in, or contributed to, their accounts … is not undertaking to provide impartial investment advice, provided the plan fiduciary is independent of the person who markets or makes available the platform or similar mechanism, and the person discloses in writing to the plan fiduciary that the person is not undertaking to provide impartial investment advice in a fiduciary capacity.”  [COI Reg §2510.3-21(b)(2)(i), emphasis added]

The concern with this section is whether the TPA who markets the platform is truly independent of the platform provider if he or she has entered into a revenue sharing contract with the provider.  It is not clear whether “independence” refers to an employment relationship, or a business relationship that is interrelated.  Certainly, TPAs who receive compensation from platform providers enter into a contractual relationship, which might be sufficient to contradict their “independence” under the regulation.

In our experience, some TPAs have revenue sharing contracts with a multitude of platform providers, with little expectation of getting material revenue sharing from any of them, but others tend to work solely with one or a few providers, with expectations of more significant funds coming to them in connection with the investments being held on the platform.  If a TPA falls into the second category, it is harder to argue that it is independent.  Certainly, all the arguments of the prior section in relation to a TPA’s recommendation to a financial advisor can be made here:  the TPA (we would argue) recommends the platform for administrative convenience and quality, not because the assets the plan has on the recordkeeping platform will qualify the TPA for greater revenue sharing or incentives.

An easy means by which categorization as a fiduciary can be avoided is for the TPA to avoid receiving compensation through this relationship.  The most common means for this is for the TPA to offset any compensation normally charged to a client by the revenue sharing received.  This “offset” method was approved by the DOL in the so-called “Frost” opinion letter [DOL Adv. Opn. 97-15A] as preventing a fiduciary recipient from being considered to engage in self-dealing.  It is reasonable to assume that an offset would similarly mean that the TPA has not received additional compensation, thereby preventing fiduciary status by virtue of recommending a platform.

Nonetheless, it would be wonderful if the DOL would clarify whether a TPA that recommends a recordkeeping platform at a financial institution is deemed to be an investment  fiduciary under the COI Reg if it receives revenue sharing, even if the TPA has no direct involvement in the investment selection.

Note that, in any event, the last sentence of the COI Reg that is quoted above requires that the person recommending the platform provide a written disclosure to the recipient client, advising the client that the recommending party is not undertaking to provide impartial advice in a fiduciary capacity.  (“Dear Client:  When I recommend to you a platform to recordkeep your plan’s accounts and investments, I’m not undertaking to provide you with impartial advice in a fiduciary capacity.  Love, Ilene.”)

Can the TPA that receives revenue sharing still get “goodies” from the financial institutions?

Many TPAs who work extensively with one or more financial institutions that maintain platforms are provided with some gifts or opportunities that we will generally refer to in this section as “goodies.”  These types of additional appreciation by the institution to the TPA run from access to investment research or technical ERISA information to dinners to conferences in swanky locations.  Some argue that even a stuffed animal or an iPad stylus provided by the sales booth of a financial institution at a conference is intended to encourage additional sales of their products.  Most TPAs have undertaken to advise their clients of these items (or at least the ones that rise above being de minimis in cost, such as the stuffed animals) in their compensation disclosures provided under ERISA §408(b)(2).  But, if you are a TPA that is trying to demonstrate that directing your client to a given platform is not providing investment advice, that you have nothing to do with assets, etc., why is the financial institution showering you with goodies?

This type of relationship with the financial institution, at the very least, demonstrates that the TPA may not be independent of the institution, which (as discussed above) raises the specter that the TPA is doing more than just suggesting a possible platform for the client.  It also makes it difficult for the TPA to argue that it is not being compensated for that recommendation, particularly when eligibility for these goodies is usually dependent on the level of assets under management with the financial institution.

Will this be the end of the various conferences sponsored by the financial institutions?  Perhaps.  Alternatively, the TPAs may simply decide to accept that they are fiduciaries with regard to this recommendation, the effect of which is discussed below.

The Producing TPA

A Producing TPA is an administration company that has its own or a related investment advisory or management service.  To the extent that the TPA or its affiliate is giving investment advice and getting paid, it is certainly a fiduciary and is significantly affected by the COI Reg.

Can the TPA side of the operation recommend the investment advisor/manager side?

If recommending a third party investment advisor is a fiduciary act, surely recommending oneself is also such an act, yes?  No.  The COI Reg clearly permits an entity to make recommendations to itself or an affiliate without that recommendation being a fiduciary action.   This exception to the fiduciary rules is a little buried in the language of the fiduciary definition, which includes, “A recommendation as to the management of securities or other investment property, including … selection of other persons to provide investment advice or investment management services.”  [COI Reg §2510.3-21(a)(1)(ii), emphasis added]  The italicized language in the above quote was well-considered by the DOL, it turns out, as the Preamble points to this as confirmation that self-promotion is permitted.  “It is not the intent of the Department, however, that one could become a fiduciary merely by engaging in the normal activity of marketing oneself or an affiliate as a potential fiduciary to be selected by a plan fiduciary … without making an investment recommendation.”  [Preamble, §IV.A(4)]

What about vice versa?  Can a fiduciary advisor then recommend its own TPA counterpart without that being self-dealing?

So long as the fiduciary advisor is not a decision-maker in choosing the TPA and does not receive any additional compensation for making the recommendation, recommending its TPA sister company should not constitute self-dealing.  This is distinguishable from a situation in which the fiduciary advisor is a decision-maker as to who is the TPA.  In that circumstance, the fiduciary advisor may not choose itself or an affiliate to provide additional services for additional compensation.  [See, ERISA §406(b)]  In such circumstances, the fiduciary advisor should recuse him- or herself from being involved in the actual decision to hire the related TPA.

It is important that the producing TPA not engage in any other transactions that can constitute self-dealing, such as recommending investments that pay it a larger share than other investments (unless that compensation offsets the fee otherwise paid by the client).  That is also potentially self-dealing, which is why most investment advisors and managers who are fiduciaries will limit themselves to a level fee, so that the investment selections made by either themselves or the plan’s investment fiduciary do not result in additional compensation to the advisor.

Can the Producing TPA make IRA recommendations?

Many investment advisors are interested in “capturing” IRA funds—that is, assisting participants who leave the employ of the plan sponsor in investing plan assets once a distribution is taken.  To do this, the Producing TPA must either not experience any change in compensation from giving that advice (which is difficult, since one option available to the participant is to put his or her money in an IRA product or other plan on which the advisor provides no advice and, consequently, receives no fees).  The solution provided by the COI Reg and the BICE exemption is the Level Fee option, commonly referred to as “BICE Lite.”  Under this option, the advisor must:

1. Acknowledge in writing that it is a fiduciary;
2. Agree to meet the Best Interest Standard in dealing with the participant-client, which generally requires the advisor to follow ERISA’s prudence requirements; base the advice on the objectives, risk tolerance, financial circumstances of the client; and disregard its own financial interests;
3. Get only reasonable compensation; and
4. Not make misleading statements. [BICE II(h)]

If the transaction involves an IRA rollover, the BICE Lite advisor must also keep records that will demonstrate:

1. That the advisor considered other alternatives (including leaving money in the plan); the fees and expenses associated with both the plan and the recommended IRA; whether the employer pays any of the expenses in the plan; and any differences in the levels of service that the advisor will provide in the IRA vs. the plan;
2. Why the new arrangement is in the participant-client’s best interest; and
3. If the transaction involves a switch from a commission-based account to a level-fee arrangement, why the new arrangement is in the participant-client’s best interest. [BICE, II(h)(3)]

Presumably, most investment advisors, including those that work with Producing TPAs, will create a form package that will enable them to easily keep the necessary documents.

Since we know we are fiduciaries, can Producing TPAs still go to investment company-sponsored conferences and enjoy other “goodies”?

If one admits that he or she is a fiduciary, then the goodies received from investment companies represent compensation, and have the potential of being self-dealing income.  After all, the Producing TPA is getting paid an additional, non-level amount for recommending that platform and the investments within.  Therefore, the fact that the Producing TPA is an acknowledged fiduciary does not make the receipt of goodies acceptable; in fact, the Producing TPA should offset fees by the value received for the goodie, to keep the compensation unaffected by the recommendations.

The §3(16) TPA

A TPA that endeavors to provide certain fiduciary services in relation to plan administration is not an investment fiduciary unless it undertakes to give investment advice for a fee or other compensation.  As a result, it will be affected by the COI Reg only to the extent it crosses the line to being an investment advisory fiduciary.

It is worth noting that a §3(16) TPA has the same potential conflicts of interest when it receives compensation from financial institutions in relation to platform services provided to clients as does an investment fiduciary.  It still represents additional compensation that can turn a simple recommendation into fiduciary advice.

Suppose the TPA offers its §3(16) services in a “bundle” with an investment fiduciary.  A client may retain the TPA to provide §3(16) services only if it also retains a particular (unrelated) investment advisor or manager.  Does that somehow turn the TPA into an investment fiduciary?  Probably not.  The decision to buy a “bundled” service is made by the plan fiduciary, and the fact that the TPA and the investment advisor provide the service together is not really a recommendation to the other, but simply a business arrangement.  The plan fiduciary should independently consider this arrangement in the same way that it considers fully bundled or fully unbundled services, and make a decision of yea or nay.

So Why Do I Care if I Become an Investment Fiduciary?

Is being a fiduciary really the worst thing in the world?  If what it means is that you are supposed to act in your client’s best interest and be prudent, conscientious TPAs may be asking themselves why being a fiduciary is such a bad deal.

It is absolutely true that the main reason why ERISA designates people as fiduciaries is to hold them to the standards of conduct it requires of these important players.  Those standards are:  acting exclusively in the interests of the plan and its participants to provide benefits and defray expenses; being prudent; and following the plan’s and ERISA’s terms.  [See, ERISA §404]  If I’m doing that, what’s the problem?

There are a couple of possible issues.  The first is that you may need different insurance.  Many TPA errors-and-omissions coverages do not insure you against fiduciary breaches.  Therefore, by admitting your fiduciary status, you may be putting yourself in the position of requiring fiduciary liability coverage.

Second, when you are an acknowledged fiduciary, you are much more likely to be named in a lawsuit by a participant or even the DOL.  Participants who sue are commonly represented by general business litigators who do not understand the fine points of fiduciary responsibility, particularly at the beginning of a lawsuit.  You may be excused by the court from the lawsuit at some point, but there will be some level of discomfort and cost while the suit is ongoing.

The biggest reason why you should care, however, is the threat of co-fiduciary liability.  Under ERISA §405, a fiduciary is liable for a breach by another fiduciary under the following circumstances:

1. The fiduciary participates knowingly in, or knowingly undertakes to conceal, the other fiduciary’s breach;
2. The fiduciary facilitates the other fiduciary’s breach by not fulfilling his or her own duties; or
3. The fiduciary knows of the other fiduciary’s breach and makes no reasonable efforts to remedy the breach.

Suppose you are a TPA and on Monday, you make a recommendation to a client to use the services of George, the investment advisor.  George pays you a finder’s fee (or otherwise compensates you).  Your recommendation was intended (and appears to be intended) to encourage your client to use George.  Boom!  You are a fiduciary advisor under the COI Reg.

On Tuesday, you get the client’s latest trust accounting information, which shows that the client has not deposited salary deferrals for the latest payroll.  You call the client, who says, “Yep, you’re right.  I kept the money.  I’ll deposit it when I can.”  On Wednesday, the client goes bankrupt with the salary deferrals undeposited.  Can you be successfully sued for a fiduciary breach?

There is an argument to be made that you had knowledge of the client’s breach and you took no action to remedy the breach once you gained that knowledge.  As such, you are liable for the breach (and since the client is bankrupt, the participants want you to pay their salary deferrals).

The COI Reg discusses the scope of the investment fiduciary’s responsibility.  “A person who is a fiduciary with respect to a plan or IRA by reason of rendering investment advice … for a fee or other compensation, direct or indirect,” the COI Reg provides, “… shall not be deemed to be a fiduciary regarding any assets of the plan or IRA with respect to which such person does not have any discretionary authority, discretionary control, does not render investment advice … for a fee or other compensation, and does not have any authority or responsibility to render such investment advice.”  However, this section goes on to outline that this does not exempt such fiduciary from co-fiduciary liability under ERISA §405 or the party-in-interest rules.

So, did the DOL really intend to make a TPA, who has access to plan information, responsible for all areas of the plan it sees as a fiduciary simply for making a recommendation that a client use a give investment advisor?  One would hope not.

The problem is exacerbated by the fact that the DOL did not undertake to limit the fiduciary role to a certain time frame.  In our above example, where you recommended George on Monday, what if the failure to deposit deferrals happened a year later, rather than a day?  Would you remain a fiduciary during that entire year, just because you made one recommendation to the advisor?  For multiple years?  Forever?  ERISA §410 prevents the use of so-called “exculpatory clauses,” which are contractual provisions that limit or relieve a fiduciary from its ERISA responsibility.  But, could you contractually limit your fiduciary exposure by providing the client with a written document that says, “I am acting as an investment fiduciary today by telling you to use George as your investment advisor, but I hereby resign from my fiduciary status, effective midnight tonight”?  Nothing in ERISA prevents a fiduciary from resigning and failing to be responsible for breaches that occur after the tenure is complete.  Will such resignation be valid if the TPA continues to do ministerial work for the client?  It is not clear.

Unless the DOL addresses this issue in its guidance, a TPA must be very careful when entering into a fiduciary relationship with its client.

Is BICE Any Help to TPAs?

A TPA may consider using BICE to deal with any potential prohibited transactions that arise in acting as an even temporary investment fiduciary.  (Note that BICE is a prohibited transaction exemption; it does not relieve the covered person from liability for a fiduciary breach.)  It is important to note, however, that BICE is available only to financial advisors, financial institutions, and their affiliates.  As a result, a TPA who is not a Producing TPA cannot rely on BICE, even if it wanted to do so.

Conclusion

It is clear that there are several reasons why TPAs should be concerned about the COI Reg, even if the TPA does not engage in the provision of what we customarily think of as investment advice.  The most critical of these concerns is the management of TPA relationships with financial advisors and any recommendations that may be made to clients to use these providers.  Until such time as the DOL provides additional guidance to permit TPAs to fully understand the breadth of liability represented by making these recommendations, it is difficult to know what to do.  We certainly hope that the DOL will provide its additional guidance sooner rather than later so as to give TPAs a chance to react before the COI Reg becomes effective.  We also hope that the DOL will take into consideration that changes needed to comply with the final interpretations of the COI Reg may take some time to develop.  Therefore, a delay in the applicability date of the Reg would be helpful—in fact, fair—at this late date.