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For the 401k Fiduciary Looking to Reduce Fiduciary Liability: Who Is and Who Isn’t a Registered Investment Adviser?

September 26
00:27 2009

The 401k fiduciary typically searches for ways to reduce fiduciary liability. This can be done by hiring what the United States Department of Labor (DOL) terms “prudent experts,” particularly in the area of investments. The DOL permits a fiduciary to appoint, among others, a registered investment adviser to reduce personal fiduciary liability.

In the DOL booklet Meeting Your Fiduciary Responsibilities, the DOL explains how ERISA/401k fiduciaries can reduce their fiduciary liability:

A fiduciary can also hire a service provider or providers to handle fiduciary functions, setting up the agreement so that the person or entity then assumes liability for those functions selected. If an employer appoints an investment manager that is a bank, insurance company, or registered investment adviser, the employer is responsible for the selection of the manager, but is not liable for the individual investment decisions of that manager.

It’s pretty clear what a bank or insurance company is (I hope), but it’s not unusual for the fiduciary to be confused as to who is and who isn’t a registered investment adviser.

First, let’s explain what a registered investment adviser (RIA) is. An RIA is registered with the United States Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940 (40 Act). Several years ago, the SEC no longer required certain smaller RIAs to register under the 40 Act. Instead, those smaller RIAs could register at the state level. Many states exempt certain smaller investment advisers from registering, so it’s possible a firm offering investment adviser services may not be registered.

How can the plan fiduciary tell if an investment adviser is an RIA? That’s pretty simple. The SEC requires all RIAs to provide prospective clients with a Form ADV Part II (or similar brochure). In addition, any RIAs registered with the SEC must file an electronic Form ADV Part I. The ERISA/401k fiduciary can then search for the particular RIA at the SEC’s Investment Adviser Public Disclosure search site. It’s a little bit more difficult for state registered RIAs since every state has its own rules. While there’s no need to outright eliminate state registered RIAs, the prudent fiduciary may want to investigate if a state registered RIA is appropriate.

There are two common misconceptions the ERISA/401k fiduciary often has regarding who is an RIA.

Mutual Funds – Although mutual funds, or Registered Investment Companies, are registered with the SEC under the Investment Company Act of 1940 (this can be perplexing – mutual funds have their own “40 Act”), mutual funds are technically securities. So, selecting a mutual fund is similar to selecting IBM public stock – something that’s obviously not an investment adviser.

Brokers – Any number of types of individuals and firms can be brokers, including insurance companies, (remember, the DOL allows plan fiduciaries to use insurance companies to legitimately reduce fiduciary liability). These firms most frequently include broker/dealers and financial planners. A simple rule of thumb is if the individual you’re dealing with has a securities license, then they’re probably a broker. This doesn’t mean they’re not also a RIA, but, again, you can verify this by checking the SEC Investment Adviser Public Disclosure search site to be sure. Of course, even if they are a RIA, the fact that they’re also a broker means the ERISA/401k fiduciary must undertake suitable due diligence regarding payment terms to insure the relationship does not create a self-dealing conflicts-of-interest problem (but this is the subject for a different article).

Even though the DOL permits plan fiduciaries to reduce their personal fiduciary liability by hiring a registered investment adviser, bank or insurance company, it’s good to keep in mind the following warning offered by the DOL:

However, an employer is required to monitor the manager periodically to assure that it is handling the plan’s investments prudently and in accordance with the appointment.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


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