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Best Practices: Compliance With Retirement Issues

Best Practices: Compliance With Retirement Issues. Marcia S. Wagner, Esq. 1. Recent Updates to ERISA 2. IRC 4975 and IRA Beneficiaries 3. Annuities, TDFs & Stable Value Funds 4. Sales Practice Issues. Priority Objectives from Washington. Outlook on U.S. Private Retirement System

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Best Practices: Compliance With Retirement Issues

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  1. Best Practices:Compliance With Retirement Issues Marcia S. Wagner, Esq.

  2. 1. Recent Updates to ERISA2. IRC 4975 and IRA Beneficiaries3. Annuities, TDFs & Stable Value Funds4. Sales Practice Issues

  3. Priority Objectives from Washington • Outlook on U.S. Private Retirement System • Retirement security remains a major priority. • Pushing for reform through Congress and DOL. • Improving the DC Savings System • Obama Administration’s proposals target 401(k) plans, advisors and other providers.

  4. Recent Updates to ERISA - Participant Investment Advice Prop. Reg’s for ERISA Section 408(g)

  5. How Can Inv. Advice Be Conflicted? • Advisor to 401(k) plan receives 12b-1 fees from funds as compensation for services. • Plan sponsor asks advisor to give fiduciary “investment advice” to participants. • Prohibited conflict arises if advisor’s level of compensation can vary based on advice provided. (e.g., equity funds pay higher 12b-1 fees to advisor, creating incentive to steer participants to them) • ERISA’s prohibited transaction rules. • Conflicted advice is prohibited (even if in good faith). • PPA of 2006 added ERISA 408(b)(14) exemption.

  6. Pension Protection Act of 2006 • PPA statutory exemption for providing participant-level fiduciary advice. • Fiduciary Adviser must be RIA, bank, insurer or broker-dealer. • Eligible Investment Advice Arrangement must have (1) level fees that cannot vary as a result of advice, or (2) advice from computer model certified by expert. • Other conditions for exemption. • Authorization from separate plan fiduciary. • Annual review by independent auditor. • Advance notice to participants with disclosures for fees and material affiliations of parties (i.e., conflicts).

  7. Rulemaking Under ERISA 408(g) • “Rollercoaster” rulemaking for 408(g) reg’s • Proposed in Aug. ’08 and finalized in Jan. ’09. • Rules included (1) interpretive regulations, and (2) class exemption broadening relief for conflicts. • Withdrawn in Nov. ’09 over conflict concerns. • New 408(g) reg’s proposed on Feb. 26, 2010. • Does not include controversial class exemption. • Similar to interpretive portion of original rules.

  8. Eligible Inv. Adv. Arrang. - Level Fee • New proposal is consistent with FAB 2007-1. (a) Individualadvisor must have level compensation. (b) Advisoryfirm must have level compensation. (c) Firm’s affiliates may receive variable compensation. • Example • Advisoryfirm charges asset-based fee offset by 12b-1 fees from plan’s funds (i.e., firm gets level fee). • Individualadvisor receives level compensation from advisory firm for services to plan. • Advisory firm’s affiliate is plan’s bond fund manager, earning more if participants invest in bond fund. • “Level fee” condition for Eligible Inv. Advice Arrang. does not apply to affiliates.

  9. Eligible Inv. Adv. Arrang. - Comp. Model • Advice must be from computer model. • Must consider historical risks/returns of asset classes. • Must consider fees/expenses of investment options. • Must consider participant’s personal info. • Investment expert must certify computer model. • Computer model advice can not be followed by individualized investment advice. • Does DOL proposal favor index funds? • Model must consider historical returns of asset classes (not individual funds) and fees/expenses. • Proposed rules suggest that model should favor cheapest menu option in each asset class.

  10. Recent Updates to ERISA - Fee Disclosures from Providers Interim Final Reg’s Under ERISA Section 408(b)(2)

  11. When Are Service Providers Conflicted? • Plan sponsor is looking for provider of administrative services. • Provider offers two options: • Services ordered a la carte: $10,000.00 • Pre-packaged services and menu: $ 4,000.00 • Plan sponsor may incorrectly conclude pre-packaged option is best for participants. • Doesn’t realize that provider receives “hidden” compensation from funds and fund managers. • Full compensation may be more than $10,000. • Hidden cost is actually shifted to participants. • Provider has incentive to steer uninformed clients to more profitable option.

  12. Retirement Security Initiative • Improving transparency of 401(k) fees. • Administration’s goal is to make sure workers and plan sponsors are getting services at a fair price. • Pushing to “finalize” interim final reg’s this year. • Rationale for interim 408(b)(2) reg’s. • DOL efforts to educate plan sponsors about 401(k) plan fees started with Nov’ 97 hearing. • Plan sponsors still not asking the right questions. • DOL will now require providers to furnish the fee info sponsors should be requesting.

  13. Covered Providers and Disclosures • Covered Service Providers • Fiduciaries (including ERISA fiduciary or RIA). • Providers of recordkeeping and brokerage services. • Providers of accounting, actuarial, legal and other professional services if they receive indirect fees. • Required to disclose compensation in writing. • Must provided before entering into contract. • Formal contract and conflicts disclosure not required. • Indirect compensation requires more detailed disclosure. • Service-by-service disclosure of fees is generally not required.

  14. Disclosure of Compensation • Format and manner of disclosure • Dollar amount, formula, percentage of plan assets, per capita charge, or any other reasonable method. • Whether fees will be billed or deducted and any other manner of receipt must be disclosed. • Compensation shared among related parties • Must disclose if payment flows to related party on transactional basis (e.g., commissions, 12b-1 fees). • Special Rules for Platform Providers • Must provide fee information for investment options. • Requirement can be met by pass-through of prospectus.

  15. Timing of Disclosures UnderInterim 408(b)(2) Regulations • Timing requirements for disclosures. • Disclosure must be made reasonably in advance of entering into, extending or renewing services. • Changes no later than 60 days after provider becomes aware of change. • Erroneous information • Will not result in violation if provider acted with good faith, reasonable diligence. • Errors and omissions must be disclosed within 30 days after coming to light.

  16. Prohibited Transactions and Interim 408(b)(2) Regulations • If provider fails to make disclosure, plan’s payment of fees is a prohibited transaction. • Disclosure failures can be cured. • Plan must make written request for information, and provider must respond within 90 days. • Refusal or inability to comply with request requires plan fiduciary to notify DOL. • No conflicts of interest for fiduciaries. • 408(b)(2) disclosure does not cure self-dealing. • Outlook • Effective date delayed from Jul. 16, 2011 to Jan. 1, 2012, but further changes may be on horizon.

  17. Practice Tips for 408(b)(2) Compliance • Must provide disclosures by Jan. 1, 2012. • Identify all ERISA accounts. • Identify indirect compensation and transaction-based compensation paid to subcontractors and affiliates. • Develop “template” notices. • Special considerations for RIAs and dual registrants. • Establish process for disclosing info changes.

  18. 1. Recent Updates to ERISA2. IRC 4975 and IRA Beneficiaries3. Annuities, TDFs & Stable Value Funds4. Sales Practice Issues

  19. Overview of Prohibited Transactions • “PT” rules are key protection for plans. • Section 406 of Title I of ERISA • Section 4975 of IRC (Title II of ERISA) • ERISA plans are subject to Titles I and II. • Penalty for PT under Title I is civil liability. • Excise tax for PT under Title II: - First tier excise tax of 15% per year - Second tier excise tax of 100% • For example, if IRS discovers uncorrected PT after 3 years, excise tax is 145% (15% + 15% + 15% + 100%). • IRAs are subject to Title II only.

  20. Application of PT Rules to IRAs • PT occurs if disqualified person enters into transaction with IRA. • Disqualified person includes: • IRA owner, fiduciary or other provider • Affiliates (e.g., family, 50% subsidiary, 10% owner) • Penalty for PT may vary: • IRA disqualification • IRA disqualification and excise taxes • Excise taxes only • Taxation as deemed distribution

  21. PTs Involving IRA Owner • Special rules apply if IRA owner engages in PT. • IRA disqualified as of 1st day of year - IRC 408(e)(2). • IRA assets become taxable upon disqualification. • 10% penalty tax under IRC 72(t) may apply. • Do excise taxes apply under IRC 4975? • IRC 4975(c)(3) says “No,” but IRS says “Yes”. • Excise taxes relief does not apply if IRA owner retains investment control. • Typically, if IRA owner engages in PT, disqualification occurs and excise taxes also apply.

  22. Examples of IRA Owner Engaging in PT • Loan to IRA owner • Transactions with IRA owner • Fiduciary “self dealing” by IRA owner • Earning fees from personal IRA

  23. More Examples • Break points for fees on IRA /Non-IRA assets • PTE 97-11 relief for brokerage services • PTE 93-33 relief for “free checking” from banks • No other relief (e.g., investment management fees). • “Checkbook LLC” IRA • IRA transfers assets to new LLC. • IRA owns 100% of LLC, and LLC “owns” assets. • IRA owner can access assets as LLC manager (e.g., buy property without IRA custodian’s approval) • But LLC assets are deemed IRA assets under DOL’s “look through” rule. • Same PT rules apply to IRA owner.

  24. Other Prohibited Transactions • If disqualified person (other than IRA owner) engages in PT, excise taxes only apply. • IRA disqualification upon investment in life insurance contract. • If IRA invests in collectibles (e.g., antiques)... • Prohibited investment is taxable as a distribution - IRC 408(m). • If IRA owner pledges IRA assets as collateral for a loan… • Pledged assets taxable as deemed IRA distribution. • NOTE: Pledge of non-IRA assets as security for any IRA debt is a PT (DOL Adv. Op. 2009-03A).

  25. Practice Tips for IRA Providers • Consider adopting appropriate policies to avoid potential PT issues. • Restrictions on loans from IRA to owner (and any other party). • No principal transactions between IRA and owner. • Limits on transactions between IRA and owner’s affiliates, including business/company. • Restrictions on FAs earning fees from personal IRAs. • Review breakpoints and fee discounting practices. • Review “checkbook LLC” or any similar products. • Restrictions on life insurance and collectibles. • Procedures for reporting/escalating potential PT issues.

  26. 1. Recent Updates to ERISA2. IRC 4975 and IRA Beneficiaries3. Annuities, TDFs & Stable Value Funds4. Sales Practice Issues

  27. DC Plan Annuitization • Obama Administration believes lifetime income options facilitate retirement security. • Initiative to reduce barriers to 401(k) annuitization. • DOL / IRS / Treasury issued a joint release with requests for information on Feb 2, 2010. • Agencies hold joint hearing in Sept. 2010. • Fostering “education” to help participants make informed retirement income decisions. • Disclosure of account balances as monthly income streams. • Modifying fiduciary safe harbor for selection of issuer or product.

  28. Approaches to DC Plan Annuitization • Annuitization outside of DC Plan • IRA annuity portal • Plan sponsor is not IRA fiduciary if employer involvement is limited in accordance with DOL reg’s. • DOL requirements for fiduciary safe harbor • No IRA contributions from employer. • Participation is voluntary. • No endorsement of IRA program from employer. • Employer receives no compensation from IRA provider. TIP: Ensure advisors do not encourage employers to assume role which triggers fiduciary liability.

  29. Approaches to DC Plan Annuitization • Annuitization inside of DC plan • Immediate annuities as plan distribution option, or deferred annuities for plan investment/distribution. • DOL safe harbor protects against fiduciary liability. • Safe harbor requires research of annuity providers, and consultation with experts (if necessary). • DOL requirements for fiduciary safe harbor • Objective, thorough search of providers. • Consider provider’s ability to make future payments. • Consider cost (including fees) relative to benefits. • Consult with experts, if necessary. TIP: Ensure advisors do not assume fiduciary role.

  30. Target Date Funds Popular default investment vehicle for 401(k) plans. Typically, formed as open-end investment companies registered under the Inv. Co. Act. Defining characteristic – “glide path” which determines the overall asset mix of the fund. Performance issues in 2008 raise concerns, especially for near-term TDFs.

  31. Recent Developments for TDFs • DOL and SEC at Senate Special Committee on Aging hearing on TDFs (Oct. 28, 2009). • Investor Bulletin jointly released by DOL and SEC. • DOL’s fiduciary checklist on TDFs is pending. • SEC proposal for TDFs (Jun. 16, 2010). • If name has target date, “tag line” disclosure needed. • Advertising must include glide path information. • On Nov. 30, 2010, DOL proposes rules on TDF disclosures for participants, amending: • QDIA reg’s issued under PPA of 2006 • Participant-level fee disclosure reg’s that were finalized on Oct. 14, 2010 but are not yet effective.

  32. DOL’s Proposed Changes to QDIA Reg’s • Background on QDIA Reg’s • Participant deemed to be directing investment to default choice if QDIA requirements are met. • Default investment must be a QDIA, and QDIA notices must be provided to participants. • DOL proposes change to QDIA notice for TDFs. • Explanation and illustration of TDF’s glide path. • Relevance of target date (e.g., 2030) in TDF name. • Disclaimer that TDF may lose money after retirement. • DOL also proposes general changes to QDIA notice (even if not a TDF).

  33. DOL’s Proposed Changes to Participant-Level Fee Disclosure Reg’s • Background • New rules will require disclosure of plan-related fees and annual comparative chart for plan’s investments. • DOL proposes change to annual comparative chart for TDFs (even if not a QDIA). • Must include appendix with additional TDF info. • Same info as required for QDIA notice. • Informal follow-up guidance from DOL • TIP: Develop “fiduciary friendly” materials that can be readily passed through to participants.

  34. Conflicts of Interest in TDFs • Conflicts arise when a “fund of funds” invests in affiliated underlying funds. • Conflicts are permitted because fund managers are carved out from ERISA’s fiduciary requirements. • Are fund managers ever subject to ERISA? • Firm requested clarification on scope of carve-out. • In Adv. Op. 2009-04A (Avatar Associates), DOL declined to rule that the TDF managers are fiduciaries. • Implications of DOL guidance • Plan sponsors are alone in their fiduciary obligation. • Must ensure TDFs (and underlying funds) are appropriate plan investments.

  35. Congressional Proposal for TDFs • Senator Kohl announced his intent to introduce new legislation (Dec. 2009). • Concerns over high fees, low performance or excessive risk in many TDFs. • Would impose ERISA fiduciary status on TDF managers when TDF used as QDIA in 401(k) plans. • Senator Kohl’s proposal differs from DOL approach to improve disclosures to employers and participants.

  36. Stable Value Funds • Dodd-Frank Act enacted on Jul. 21, 2010. • “Swap” is broadly defined and subject to new rules. • Are stable value contracts swaps? • Joint study by SEC/CFTC due by Oct. 21, 2011 on stable value funds in participant-directed DC plans. • If deemed to be a swap, must determine if regulatory exemption is in public interest. • Any rule changes would be for new contracts only. • Any rule changes will impact industry. • Unclear is stable value investments held by DB plans are viewed as swaps.

  37. 1. Recent Updates to ERISA2. IRC 4975 and IRA Beneficiaries3. Annuities, TDFs & Stable Value Funds4. Sales Practice Issues

  38. SEC, FINRA and NASAA Initiatives • SEC Seniors Summits (2006 - 2008) • Part of coordinated initiative to increase awareness and enforcement of protections for senior investors. • Protecting Seniors - Sept. 2007 Report • Report on exam findings for “free lunch” seminars. • Identified helpful practices on marketing to seniors. • Protecting Seniors - Sept. 2008 Report • Broad report on compliance supervisory practices. • Addendum issued on Aug. 12, 2010. • Covers (1) communication, (2) training, (3) escalation, (4) account opening, (5) suitability, (6) surveillance. TIP: Use Report as guide for evaluating your policies.

  39. Certifications and Prof. Designations • NASAA adopts Model Rule in March 2008. • Addresses use of senior-specific certifications. • Certifications require (1) educational organization, (2) competency standards, (3) disciplinary procedures, and (4) continuing education. • NAIC adopts similar model rule for insurance producers. • Dodd-Frank Act encourages states to adopt both NASAA and NAIC model rules. • FINRA Regulatory Notice 07-43 TIP: Ensure supervisory procedures comply with state laws or model rules as “best practice.”

  40. Suitability in Fixed Annuity Transactions • NAIC adopts Model Rule in March 2010. • Enhances original model rule adopted in 2003. • 2010 Model Rule has new features. • Enhanced suitability standards (similar to FINRA). • Insurer remains responsible for compliance. • Mandatory training for producers.

  41. New Suitability Standard in 2010 Model Reg • Reasonable efforts to obtain suitability info • 2010 Model Reg expands to include 12 separate categories (similar to FINRA). • Reasonable grounds for recommendation, must be supported with reasonable basis to believe: • Consumer is reasonably informed of annuity features. • Consumer would benefit from certain features. • Suitability of annuity as whole and certain aspects. • For contract exchange, suitability in consideration of surrender charges, lock-in period, and other factors.

  42. Other Changes Under 2010 Model Reg • Insurer must establish supervision system. • Reasonably designed to ensure producers comply. • Training for producers. • Must review all recommendations. • Annual report for senior management. • Mandatory training for producers. • One-time 4 credit training course.

  43. Coordination between 2010 Model Reg and FINRA Rules • 2010 Model Reg prevents conflict. • Compliance with FINRA standards is deemed compliance under NAIC’s 2010 Model Reg. • Variable annuities subject to FINRA standards. • Voluntary compliance with FINRA standards for fixed annuities is permitted. TIP: Review current and pending state law, and evaluate compliance policies accordingly, especially for fixed annuities.

  44. Indexed Annuities • May be unsuitable for senior investors. • Long lock-up period inappropriate for investors who need ready access to cash. • Status unclear under securities laws. • Historically, indexed annuities have not been registered under Securities Act. • SEC adopts Rule 151A in Dec. 2008. • Rule subjects indexed annuities to SEC jurisdiction. • But DC Circuit Court vacates in July 2010. • Dodd-Frank Act also exempts them (July 2010). TIP: Review policies regarding suitability of indexed annuities for senior investors.

  45. Best Practices:Compliance With Retirement Issues Marcia S. Wagner, Esq. 99 Summer Street, 13th Floor Boston, MA 02110 Tel: (617) 357-5200 Fax: (617) 357-5250 Website: www.erisa-lawyers.com marcia@wagnerlawgroup.com A0055266

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