ERISA and the Retirement-Plan Account

A representative selling a private placement to a retirement plan is selling into a relationship ERISA already regulates. Before the sale, know whether ERISA even applies, who the plan's fiduciary is, what duties bind that fiduciary, and what transactions ERISA forbids without an exemption.

What Plans Does ERISA Cover, and What Plans Does It Exclude?

• ERISA governs an employee benefit plan: an employee welfare benefit plan, an employee pension benefit plan, or a plan that is both, established or maintained by a private-sector employer, an employee organization (a union), or both.
• ERISA applies when the plan is established by an employer engaged in commerce, by an employee organization representing employees engaged in commerce, or by both.

Five plan types fall outside ERISA's coverage entirely:

Exam Tip: Gotchas

• Government and church retirement plans are a common exam trap. Absent an election, ERISA's fiduciary and prohibited-transaction rules simply do not apply to them, even though the plan looks and functions like a private-sector pension.

Who Is a Plan Fiduciary?

A person is a fiduciary with respect to a plan to the extent the person meets any one of three tests:

• Exercises discretionary authority or discretionary control over managing the plan, or exercises any authority or control over managing or disposing of the plan's assets. The word discretionary matters in the first limb. The second limb does not need discretion at all.
• Renders investment advice for a fee, or has authority or responsibility to do so.
• Has discretionary authority or responsibility in administering the plan.

A representative opening or maintaining a retirement-plan account deals with the plan's named fiduciary, commonly a trustee or a plan committee, not with individual plan participants.

The Department of Labor (DOL) applies a five-part test to decide when giving investment advice makes someone a fiduciary "for a fee," separate from the discretionary-control test above. All five parts must be met:

• The person renders advice on the value of securities or other property, or makes a recommendation on the advisability of investing in, purchasing, or selling them.
• The advice is given on a regular basis.
• The advice is given under a mutual agreement, arrangement, or understanding between the person and the plan, or between the person and a fiduciary of the plan.
• The understanding is that the plan will treat the advice as a primary basis for its investment decisions.
• The advice is individualized to the particular needs of the plan.

Think of it this way: a person who meets the discretionary-control test is a fiduciary regardless of the five-part test. The five-part test only decides whether someone who merely advises, without discretion, has crossed into fiduciary territory.

One boundary is worth knowing, though it is background rather than a likely question. A registered broker-dealer that simply executes a plan's securities trades in the ordinary course of its business, on specific instructions from the plan's own fiduciary, does not become a fiduciary just by executing them. Carrying out an order is not managing the plan.

Exam Tip: Gotchas

• A single, one-off recommendation to a plan does not by itself make the representative an ERISA fiduciary. The five-part test requires a regular, mutually understood, individualized advice relationship, not an isolated suggestion.

What Duties Constrain a Plan Fiduciary?

ERISA imposes four fiduciary duties, and all four run to the participants and beneficiaries rather than to the employer:

• Exclusive purpose: act solely in the interest of participants and beneficiaries, for the exclusive purpose of providing them benefits and paying the plan's reasonable administrative expenses.
• Prudence: act with the care, skill, prudence, and diligence, under the circumstances then prevailing, that a prudent person acting in a like capacity and familiar with such matters would use in an enterprise of like character and aims. This is a prudent-expert standard, not merely a prudent-layperson standard.
• Diversification: diversify plan investments to minimize the risk of large losses, unless it is clearly prudent under the circumstances not to.
• Plan documents: act in accordance with the documents and instruments governing the plan, so far as they are consistent with ERISA.

These duties run to the plan's investments as a whole and constrain what a plan fiduciary may prudently purchase for the plan.

Exam Tip: Gotchas

• The diversification duty is not absolute. Concentrating plan assets is allowed where that is clearly prudent under the circumstances, which is a high bar to meet. That is not the only route either: ERISA separately protects a plan built to hold employer stock, such as a profit-sharing or stock bonus plan, when it acquires or holds qualifying employer securities or employer real property.

What Transactions Are Prohibited, and When Is an Exemption Available?

• Party in interest: a broadly defined term that includes the plan's own fiduciaries, anyone providing services to the plan, the sponsoring employer, an employee organization with members in the plan, and certain large owners of, or relatives connected to, those parties.

A fiduciary who knows or should know that a transaction falls into one of five categories may not cause the plan to engage in it with a party in interest:

• A sale, exchange, or lease of property.
• A loan or other extension of credit.
• The furnishing of goods, services, or facilities.
• A transfer of plan assets to, or for the benefit of, a party in interest.
• Acquiring employer securities or employer real property beyond ERISA's limits on holding them.

A separate provision covers the passive case. A fiduciary with authority or discretion over plan assets may not permit the plan to keep holding employer securities or employer real property, if the fiduciary knows or should know that holding them breaks those limits. Acquiring and continuing to hold are two different prohibitions.

A fiduciary also may not:

• Deal with plan assets in the fiduciary's own interest.
• Act on behalf of a party whose interests are adverse to the plan, or adverse to the plan's participants or beneficiaries.
• Receive personal consideration from any party dealing with the plan in connection with a transaction involving the plan's assets.

Dealing with a party in interest is not automatically prohibited. It requires an exemption, either one already written into ERISA or one granted by the DOL. The DOL may grant that relief to a single fiduciary or transaction, or to a whole class of fiduciaries or transactions.

The most commonly tested statutory exemption permits contracting with a party in interest for office space, legal, accounting, or other services necessary to establish or operate the plan, if no more than reasonable compensation is paid for them.

Exam Tip: Gotchas

• A broker-dealer that provides services to a plan, and is paid for them, is itself a party in interest. That transaction is not automatically illegal; it needs a qualifying exemption, most often the reasonable-compensation exemption for necessary services.

Why Is a Private Placement a Hard Fit for an ERISA Plan?

• Illiquidity versus prudence: an illiquid, hard-to-value private placement position is difficult for a plan fiduciary to justify against the prudent-expert and diversification duties, which are measured against the plan's investments as a whole.
• The plan-assets question: if benefit plan investors hold 25% or more of the total value of any class of equity interest in an entity, such as a private placement issuer or fund, the underlying assets of that entity are themselves treated as plan assets. That pulls the issuer, and whoever manages the entity's assets, into ERISA's own fiduciary and prohibited-transaction rules.
• How much of the entity converts: only the share matching the percentage of the equity interest the benefit plan investors hold. Crossing the threshold does not turn all of the entity's assets into plan assets.
• Who counts as a benefit plan investor: a retirement or other employee benefit plan covered by these rules, and an entity that itself holds plan assets.
• How the 25% is measured: leave out any equity held by a person with discretionary authority or control over the entity's assets, by anyone paid to advise on those assets, or by an affiliate of either. Stripping the manager's own stake out shrinks the base, so a holding that looks safely under 25% on a plain count can cross the line.

Representatives selling a private placement to an ERISA plan should expect the plan's fiduciary to scrutinize both the position's liquidity and whether the offering crosses the 25% plan-assets threshold before investing.

Exam Tip: Gotchas

• The 25% plan-assets threshold is measured against each class of equity interest in the entity being invested in, not against the total dollar size of the private placement offering.

What Should You Check on Exam Day?

• Confirm a retirement plan is actually ERISA-covered before applying any fiduciary or prohibited-transaction rule; government and church plans usually are not.
• Count the fiduciary duties: four (exclusive purpose, prudence, diversification, plan documents).
• Separate the discretionary-control fiduciary test from the DOL's five-part advice test; only the second has five required elements.
• Count the prohibited transactions a fiduciary may cause the plan to enter: five, plus a separate passive-holding prohibition and three self-dealing prohibitions.
• Check the plan-assets threshold: 25% of a class of equity interest, not 25% of the offering's total size.