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A compliance attorney fields four tough 401(k) questions amid crossfire provoked by Ric Lager's column

Peter Savarese's answers show how RIAs can manage 401(k) assets and avoid land mines

Friday, May 28, 2010 – 4:39 AM by Brooke Southall
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Peter Savarese: If the DOL does its job and promulgates 408(b)(2) as expected, all RIAs will have a competitive advantage

Brooke’s note: Ric Lager wrote a column on Tuesday for RIABiz describing how he has built a 401(k) business advising plan participants but not the plans themselves. It was a lightning rod for comments, some from people who agreed with his contention that advisors could succeed in the 401(k) space without being experts on ERISA, and others who say that advisors need more specialized resources and knowledge to engage in the business. A supporter of Lager’s view point was Peter Savarese, senior regulatory counsel for National Compliance Services Inc. of Delray Beach, Fla., which has over 600 RIA clients. He is also a corporate and securities attorney with a private practice devoted to servicing the financial services industry. In those roles, he counsels RIA clients on compliance and legal matters. Lager is one of them. I thought readers in general might be interested to hear how he responded to some of the criticisms and so I’m presenting it here as a column. To read Lager’s column, click here. One more note: I asked Phillip Chiricotti — a recognized voice of authority in the 401(k) business and who left one of the critical comments — if he would like to write a separate column to further explain his views on the matter. We’re hoping that he, or someone else who feels up to the task, accepts the invitation.

The comment thread on Ric Lager’s column Why gathering big-time 401(k) assets — and charging regular fees — is in reach for most experienced RIAs raised a number of crucial questions about the 401(k) market.

One was whether Lager’s business model was efficient for participants and the advisor. A second was whether an advisor who has his or her clients password for purposes of asset allocation is deemed to have custody. A third was whether an advisor advising plan participants but not the plan is an ERISA fiduciary. The question of the relationship between the RIA acting as an advisor to a plan and the RIA acting as an advisor to individual participants also arose.

These are my answers to those questions.

Ric’s article describes a business model that works for him and provides needed services for 401(k) participants who are not offered participant-level advice through the Plan’s adviser.

The article does not describe providing plan-level services, or participant-level services under an arrangement put in place by the Plan Sponsor, but asset allocation services (discretionary in this scenario) for Plan Participants within investment options made available by the Plan Sponsor.

Some comments seemed to be dismissing alternative business models. Ric’s model helps the Participants in the context of a Plan that they did not design and that they have to live with. Unfortunately, if a Plan Sponsor has made bad choices the Participants have to live with it.

Is serving Plan Participants efficient and effective?

Periodically reviewing the Participant’s Plan statements, then managing the account, can be efficient if the RIA can properly serve the Participant and earn a fee commensurate with the amount of time he or she expends. This business model fills a need for certain types of Participants because they now have the benefit of a professional advisor performing periodic asset allocations rather than selecting the investment options themselves. Participants are stuck with the Plan design and investment options made available through the Plan. At least in this business model, the assets can be properly allocated.

What does the SEC say about logging in as client for 401(k) assets?

SECwhat it says

Question II.6. Q: If an adviser has the ID number and password to a client’s pension fund account to rebalance and adjust investments in the account, does the adviser have custody? A: The adviser has custody if password access provides the adviser with the ability to withdraw funds or securities or transfer them to an account not in the client’s name at a qualified custodian. (Posted May 20, 2010)

Under this business model, is the advisor an ERISA fiduciary?

Based on Ric’s stated business model, he would be an ERISA fiduciary even if his agreement with the participant said he was not. Ric is exercising discretion over Plan assets. He is definitely a fiduciary and knows it. But the more important point is that an RIA can become a ERISA fiduciary without realizing it. One example is providing non-discretionary investment advice. The lesson here is that a person can become an ERISA fiduciary simply by his actions not withstanding anything he or she includes or disclaims in a written agreement. It is called a functional fiduciary and arises under regulations promulgated under ERISA Section 3(21).

What about the relationship between the Plan advisor and the Participant advisor?

When Plan assets are used to pay the fees for any service provider, they must first be authorized under the Plan document and, if so, also must be “reasonable” in the judgment of the fiduciary authorizing the payment. In Ric’s article, he stated that the Participant hired him directly, yet his fees were paid from the Participant’s Plan assets. Someone had to authorize the payment of the RIAs fees from the Participant’s account. With the exception of the scenario discussed below, I would bet that the Plan fiduciary authorizing such payment is not aware that they may be at risk for that decision. I would argue that they are (whether knowingly or not) responsible for vetting the RIA as to “capabilities, qualifications and insurance, including ERISA bonding” (which, by the way, arises from having discretion to manage the Participant’s assets).

It would be easy for an RIA to incorrectly assume that since the Participant hired them they do not need to answer to the Plan sponsor or other responsible plan fiduciary. That is not always the case when Plan assets are used to compensate the RIA. If the fees are authorized by the Plan sponsor or responsible plan fiduciary (I rarely see this but it could happen), I would argue that the use of Plan assets to pay the Participant’s chosen RIA now makes the Plan sponsor or responsible plan fiduciary responsible for all aspects of that RIAs engagement. I would advise my client to have those fees paid from non-plan assets or an SDBA.

I suspect that in Ric’s scenario, the participant has a SDBA (self-directed brokerage account) which would make the decision to pay the fees a decision made by the Participant and not the Plan sponsor or other responsible plan fiduciary.

RIAs poised to win every time

National Compliance Services, Inc. handles compliance for over 600 RIAs, many of which provide non-fiduciary consulting, or fiduciary advice or management services at the plan and/or participant level. There are more business models out there than you can imagine. One thing is for sure, if the DOL does their job and promulgates 408(b)(2) as expected (and extremely overdue – I may add), all RIAs will have a competitive advantage over their former BD/RR competition. See: Why the DOL’s proposed 401(k) rules could ding brokers and leave the spoils to RIAs The RIA’s value proposition, if structured properly, can win every time.

That being said, being a fiduciary to a qualified plan carries many risks. Even providing advice to a Plan Participant without any contract to the Plan can cause the RIA to be deemed a Plan fiduciary and subject the RIA to ERISA, including but not limited to, the prohibited transaction rules. Remember, always consult with an ERISA attorney when structuring your engagements with 401k Plans or other tax-qualified accounts. My comments are not, nor are they intended to be, legal advice. These comments are mine alone and do not necessarily reflect the opinion of National Compliance Services or my law firm.

Peter A. Savarese, Esq. is Senior Regulatory Counsel to National Compliance Services, Inc. (“NCS”),and a corporate and securities attorney primarily counseling financial service professionals regarding legal issues arising in connection with their investment advisory practices and related businesses. For compliance related issues, he can be reached at NCS at 561-330-7645, Ext. 204, or Peter@NCSOnline.com or for legal related issues, at (561) 207-7400 or Peter@SECLegalServices.com.

Mentioned in this article:

NCS Regulatory Compliance
Consulting Firm
Top Executive: Mark Alcaide, COO/Partner

Ric Lager

Ric Lager

May 28, 2010 — 1:45 PM

Peter, I know how valuable your time is. Thank you very much for your expert commentary here so other RIA’s can understand this issue more clearly.

Thomas Mullooly

Thomas Mullooly

May 28, 2010 — 2:48 PM


It has been my experience that individuals that truly want this 401k advice have no problem paying for it outside of plan assets.
Yes, a little additional bookkeeping, but a terrific business.

Thomas Mullooly
<a href="http://www.mullooly.net">Mullooly Asset Management</a>

Vince Birley

Vince Birley

May 29, 2010 — 7:22 PM

Peter, I’d like to walk through a scenario with participants and hear your thoughts on risk for plan sponsors.

Scenario: Participant A is 55 and has $150,000 in her 401k account. She has no money outside of her 401k account. She would like advice on when and how she can retire. The plan sponsor has nobody for her to get advice from. She finds a RIA who will charge her a flat fee to give her advice. She can’t pay for personally, so she asks her plan sponsor to pay for it out of her 401k account. The plan sponsor says no because it is too much risk as a plan fiduciary.

Fast forward 10 years. The lady doesn’t get the advice and she had invested in small cap stocks that tank at correction and she has $75,000 and she can’t retire. She calls an attorney and decides to sue her plan sponsor for not making available an advisor.

The plan sponsor’s defense is…my attorney said it was too much risk to make this service available.

Isn’t the risk here for plan sponsors unhappy and uneducated plan participants who will not be able to retire and want to blame somebody? I hear that the advisor is a fiduciary now and is the sponsor’s responsibility. But isn’t safer to make an advisor available than not? Especially if the participant brings the advisor to the table?

How else does the sponsor get into trouble for allowing a participant’s account balance be debited for advisory fees other than a participant complaint? And why will participant’s complain? Bad advice from an advisor the participant requests or denying the participant the resources to pay for their advisor?

This is where the fiduciary risk issue of compliance with regulations (not saying you shouldn’t know them and do your best to abide by them) don’t seem to address the real risks in sponsoring retirement plans…participant complaints of no advice or direction.

Brian C. Hubbell

Brian C. Hubbell

June 3, 2010 — 11:58 AM

Peter Savarese’s “comments” above are right on point except for one issue. Payment of advisor fees from the SDBA account under a qualified plan does NOT eliminate the fiduciary responsibitiles he espouses throughout his string of comments. An SDBA account is still a “plan asset” and the plan document must permit such payments to be made which exposes other plan fiduciaries to the issues Peter raises in his comments under the sub-heading regarding the relationshiop between the “......Plan Sponsor advisor and the Participant advisor”.

Vince Birley’s above comment on 5/29/2010 illustrates the lack of knowledge concerning ERISA and a Plan Sponsor’s responsibilty. ERISA does NOT require participant “education” or “advice” nor does ERISA require the partipant to attain a sufficient level of retirement income. Vince’s last sentence asserts there is a “fiduciary risk” in sponsoring retirement plans in the event of participant complaints of no advice or direction. This is NOT correct. Let me reiterate that ERISA does NOT mandate providing any advice or education. In fact, when a plan sponsor provides such services, they are exposing themselves to greater risk e.g. vetting process of “participant” advisors, reasonable fees for such services, and on-going monitoring.

I recongize the ultimate goal among all participants and their respective individual weatlh planning advisors is to acheive their various objectives (e.g retirement savings, college savings, long term care etc.). In this regard, advisor’s whose primary practice is individual wealth planning will benefit (and elimate frustration!) if they understand the parameters of ERISA and how that may impact their approach to advising their clients with respect to these assets e.g. whether or not to assume “control” of these assets, attempting to get paid for their services from plan assets.

Brian C. Hubbell

Thomas Mullooly

Thomas Mullooly

May 28, 2010 — 12:17 PM

This is an enormous niche market for advisors, as Ric Lager and I have discovered over the years. Individual investors often have some of the largest amounts of their liquid net worth invested through their deferred compensation plan or 401k account at work (http://www.mullooly.net/my-401k-how-to-get-help), and get little or no direction. Advisors who are positioned properly can gain an entirely new market.

Peter, great article. Thanks for clearing up some of the big questions in this arena today.

Thomas Mullooly
<a href="http://www.mullooly.net">Mullooly Asset Management</a>

Jan Sackley

Jan Sackley

May 28, 2010 — 2:22 PM

Peter’s comments are right on the money, with one requiring further enhancement. On the point of fund withdrawals to pay fees, Peter correctly points out that such withdrawals cannot be done without the consent of the plan administrator. Peter expresses concern that plan fiduciaries may not be aware of their duties in this area. That may or may not be true, but it is a plan administrator responsibility and not the responsibility of the investment fiduciary, except to the extent that the investment professional must cooperate in providing proof of bonding and any other due diligence material requested by the plan. I advise plan fiduciaries to be sure that the investment management agreement that is presented by a plan participant to the plan, hiring his or her own advisor, contains language from the advisor acknowledging that he or she is a fiduciary with respect to the participant’s plan assets.

The DOL should make it easier, not more difficult, for participants to seek the professional advice they need. Advisors who do not accept any fees from any particular fund or other investment are already on the right path to providing this needed service. Please find a way to keep it economical for the participant.

Jan Sackley, CFE
Fiduciary Foresight, LLC
Risk and Regulatory Compliance Consultants

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