U.S. Department of Labor’s Proposed Regulation on the Definition of “Fiduciary”

April 22, 2015

On April 14th, the U.S. Department of Labor (the “DOL”) proposed a regulation expanding the definition of who is a “fiduciary” under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and Section 4975 of the Internal Revenue Code of 1986, as amended (the “Code”). This is the DOL’s second attempt at expanding fiduciary status to persons who provide investment recommendations to retirement plans and individual retirement accounts (“IRAs”). The first attempt, proposed in 2010, drew significant criticism from the financial services industry and lawmakers and was withdrawn by the DOL. This new proposal is largely based on the 2010 proposal, with some expanded carve-outs from fiduciary status and additional exemptive relief for those that would become fiduciaries under the new rule.

Ostensibly aimed at protecting 401(k) participants and IRA owners in the retail market, the proposed regulation is expansive in its reach and would cause a broad swath of financial services professionals to become fiduciaries to the plan investors and IRAs with whom they conduct business. This client alert highlights the provisions of the proposal that are likely to impact our clients that manage private investment funds or retirement plan separate accounts.

1. Marketing to Plan and IRA Investors

Under the proposal, a person would be a fiduciary if, in exchange for a direct or indirect fee or other compensation, he or she provides a plan, plan fiduciary, plan participant or beneficiary, an IRA or IRA owner with a recommendation as to the advisability of acquiring, holding or disposing of securities or other property and the recommendation is pursuant to an agreement, arrangement or understanding (written or verbal) that the advice is individualized or specifically directed to the recipient for consideration in making investment or management decisions for the plan or IRA. The proposal defines the term “recommendation” as any communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the recipient engage in or refrain from taking a particular course of action. This is a very significant expansion of what constitutes “investment advice” from the existing five-part test and would affect managers of both plan asset and non-plan asset private investment funds.

Because the private placement rules require that an issuer have a pre-existing substantive business relationship with a prospective investor, providing offering documents to a plan or IRA investor could be construed as a “recommendation” described above, rendering the issuer’s sponsor/adviser a fiduciary with respect to the decision to invest in the fund. The DOL did include in the proposal a “seller’s carve-out” for incidental advice provided in connection with arm’s length transactions between counterparties and plans. This carve-out is intended to avoid imposing ERISA fiduciary obligations on transactions where it is unlikely that the plan would rely on the counterparty as an impartial adviser. However, this carve-out is limited to recommendations provided to (i) a plan with 100 or more participants or (ii) an independent plan fiduciary that manages at least $100 million in employee benefit plan assets. This carve-out will not apply to sales or marketing presentations to IRAs or participant-directed accounts, notwithstanding the fact the IRA owner or plan investor otherwise meets the sophistication and suitability requirements for investment in a private fund. The DOL noted that excluding IRAs and small plans from the seller’s carve-out was intentional, but did specifically invite comments on the issue.

2. Prime Brokerage and Counterparty Transactions

Documentation with prime brokers and other counterparties (e.g., ISDA and futures arrangements) typically requires a plan asset fund or account and its manager to make specific representations that the prime broker or counterparty is not acting as a fiduciary under ERISA in connection with the arrangement. We would expect that, if the proposed regulation is finalized, these entities will require additional and/or revised representations that take into account the revised definition of fiduciary. Some of these entities may also want representations that will allow them to rely on the seller’s carve-out described above. Although the regulation does not specifically address the application of the carve-out to commingled investment funds, we think that a conservative reading would require a manager that does not have at least $100 million in employee benefit plan assets under management to represent that each plan in the fund has more than 100 participants. This is not something that is typically tracked by private funds, and is not a representation that a plan asset fund with any IRA investors could make. Accordingly, managers of plan asset funds and accounts may need additional documentation from existing investors in order to make the additional representations that may be requested by counterparties.

3. Placement Arrangements

Depending on the nature of the arrangement, a placement agent engaged by a fund could be considered a fiduciary to ERISA plan and IRA investors under the proposed regulation. If a manager has entered into any placement arrangements and the proposed regulation is finalized, existing placement agreements should be reviewed and possibly renegotiated to ensure that either (i) the placement agent is not acting as a fiduciary or (ii) the placement agent has complied with its fiduciary duties and satisfied the conditions of one of the new class exemptions. This is especially important for managers of plan asset funds, but may also be relevant to managers of non-plan asset funds given that ERISA can potentially impose liability on non-fiduciaries who knowingly participate in a fiduciary’s breaches.

4. Reliance on PTE 86-128 and 77-4

As part of the proposed regulation, the DOL offered two new class exemptions as well as amendments to existing class exemptions. The amendments to PTE 86-128 and 77-4 may be particularly relevant to some of our investment management clients.

PTE 86-128 provides relief from the self-dealing prohibitions of Section 406(b) of ERISA when a plan fiduciary receives compensation for effecting securities transactions through an affiliated broker-dealer or effecting agency cross transactions on behalf of a plan. The exemption requires that the trading for a plan or IRA through an affiliate not be excessive, and any compensation received in connection with that trading be reasonable. For ERISA plans only, and not IRAs, the exemption requires that the investment manager receive specific authorizations from plan investors and provide specific disclosures. Under the proposed amendment to PTE 86-128, the authorizations and disclosures that are currently required to be made only to ERISA-covered plans will be applicable to IRA investors as well. Additionally, in order to rely on the exemption, investment managers must also (i) act in accordance ERISA’s prudent expert standard of care when causing an IRA (including through an investment in a plan asset fund) to enter into any transaction covered by PTE 86-128, notwithstanding the fact that this standard of care is otherwise not applicable to IRA fiduciaries, and (ii) disclose all relevant material conflicts of interest (i.e., those that could affect the fiduciary’s best judgment as a fiduciary in rendering advice to the plan or IRA) to the plan or IRA.

PTE 77-4 provides relief from Section 406(b) of ERISA for investments in a mutual fund managed by the fiduciary directing the investment (or its affiliate). As with the proposed amendment to PTE 86-128, the proposed amendments to PTE 77-4 would require that, in addition to the existing conditions of the exemption (e.g., that the investment in the mutual fund is appropriate for the plan) fiduciaries must (i) act in accordance ERISA’s prudent expert standard of care when causing a plan or IRA to enter into the transaction and (ii) disclose all relevant material conflicts of interest to the plan or IRA.


The proposed regulation and accompanying class exemptions are quite lengthy and highly technical; this alert highlights the major provisions applicable to investment managers of private investment funds. If you have any questions or are concerned how these proposed rules might affect your particular circumstance, please do not hesitate to contact John Ryan (212) 574-1679 or Michael O’Brien (212) 574-1505.