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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

Marcia S. Wagner, Esq.

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

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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.

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

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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.

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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).

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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.

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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.

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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.

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

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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

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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.

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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

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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.

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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

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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.

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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).

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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.

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

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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.

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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.

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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.

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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.

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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.

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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).

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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.

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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.

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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.

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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.

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

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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.

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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.”

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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.

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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.

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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.

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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.

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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.

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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


[email protected]