Planners are facing considerable competition from brokers in the arena of retirement plans, and the reality that brokers typically don't work as fiduciaries is a thorn in planners' sides. Most clients aren't aware of this distinction; many of those who are don't seem to care.

More clients might care if they were aware of differences in the sources of compensation behind the advice they receive. In the coming months, these differences between the two types of advice will probably become crystal clear. Under a proposed Department of Labor regulation pertaining to ERISA Section 408(b)(2), anyone who provides services to qualified pension or profit-sharing plans must provide significantly expanded financial disclosure.

Broad Scope

The scope of this disclosure would go well beyond what most service providers currently reveal in their client contracts and disclosure documents. If you are an investment advisor, your ADV already provides much of the information covered by the new disclosure rule; even so, the proposed rule will definitely have an impact on you. If you are a broker or a rep, however, the new regimen would turn your practice upside down.

ERISA Section 408(b)(2) requires service providers to operate under a "reasonable contract or agreement" with the plan sponsor or they will be deemed to have engaged in prohibited transactions. Until the proposed regulation was introduced in December 2007, "reasonable" had gone essentially undefined. In the absence of clear guidelines from the DOL, this ERISA provision has received scant attention. Essentially, the only contracts deemed "unreasonable" were those including provisions making them difficult to terminate.

If, as some observers anticipate, this proposed regulation is adopted without significant modification in the coming weeks, then this narrow avenue of restriction could go into effect as early as New Year's Day of 2009. Service providers, such as financial planners, would be required to provide—in advance of establishing a contract—written disclosure of direct and indirect compensation and as well as potential conflicts of interest. The new definition is that a contract is inherently unreasonable if the "responsible plan fiduciary," (i.e., a retirement plan's named fiduciary) doesn't take into account complete and accurate information about compensation arrangements, service provider affiliations and potential conflicts.

If you have an unreasonable contract, under the new definition, you would be deemed to have committed a prohibited transaction. If plan sponsors fulfill their obligation to select service providers wisely and demand this disclosure, then they are in the clear. But if their disclosures are inadequate—incomplete or in error, to the best of the provider's knowledge—they will have undertaken/executed a prohibited transaction. Penalties typically require that the advisor refund all compensation and pay excise tax. Thus, you get fired, you're forced to refund the money and you get a nasty tax bill to boot.

Full Disclosure

In introducing the regulation, the department noted that "a plan fiduciary must have sufficient information regarding fees and compensation that the service provider receives regarding whether there are relationships or interests on the part of the service provider that may call into question the objectivity of the service provider in providing services to the plan." This is in keeping with the fiduciary obligations imposed on the plan under ERISA to prudently select and monitor service providers. If plan sponsors establish written agreements with service providers that conform to the terms of the proposed new regulation, they not only have evidence of their prudence, but they have also ensured that it is the ultimate responsibility of the service provider to avoid undisclosed sources of compensation and conflicts of interest.

As defined by the DOL, the proposed regulations will apply to any service provider who:

• Is a fiduciary under ERISA or the Investment Advisers Act of 1940.
• Provides banking, consulting, custodial or insurance services, or investment advice, investment management, recordkeeping, security or investment brokerage or third-party administration services, or
• Receives indirect compensation and provides accounting, actuarial, appraisal, auditing, legal or valuation services.
  

Almost all financial planners working with retirement plans may be subject to the proposed rule under either the first or second parts of the definition of covered service providers (or both).

The rule would require service providers to identify whether they would be providing their services in a fiduciary capacity. Based on the definition mentioned above, planners generally will be regarded as fiduciaries. Administrators, custodians and brokers, on the other hand, generally will not. The "responsible plan fiduciary" is obligated to understand who is and isn't a fiduciary and to take this into account when performing due diligence in selecting service providers.