Implications of the DOL’s Proposed Expanded Definition of “Fiduciary” for Hedge Fund Managers, Placement Agents, Valuation Firms and Pension Consultants
Hedge Fund Law Report
On October 22, 2010, the Department of Labor’s Employee Benefits Security Administration proposed rule amendments that would considerably expand the definition of “fiduciary” for purposes of the Employee Retirement Income Security Act of 1974, as amended (ERISA). Under current regulation, a person can be deemed a fiduciary for ERISA purposes by reason of rendering investment advice if the person meets a five-part test. The proposed amendments would replace that five-part test with a two-part test. Generally, the new two-part test would be easier to satisfy – that is, would capture a wider range of entities and activities – than the old five-part test. Thus, under the new rule, more entities would qualify (often involuntarily) as ERISA fiduciaries and thereby become subject to a range of duties, at least one of which (the duty of prudence) has been characterized by courts as the “highest known to the law.” According to the preamble to the proposed rule release in the Federal Register, the DOL proposed the new rule for two primary reasons: to address purported changes in relationships between investment advisers and employee benefit plan clients occasioned by the increasing complexity of investment products and services, and to more efficiently allocate its enforcement resources. The investment management industry has already voiced skepticism with respect to both rationales. Regarding the first, commentators have suggested that while investment products and services have become more complex, the fundamental nature of investment advisory relationships has not changed in the 35 years since the current regulation was put in place. Regarding the second, commentators have suggested that the DOL’s enforcement efforts may be largely moot because if the amendments become effective in their proposed form, many financial services firms – notably, broker-dealers, valuation agents and placement agents – may cease offering services directly or indirectly to employee benefit plans. Surprisingly, the DOL appears to be cognizant of the potential adverse business consequences of its proposed amendments. In the rule release, the DOL noted that “plan service providers that fall within the Department’s rule might experience increased costs and liability exposure associated with ERISA fiduciary status. Consequently, these service providers might charge higher fees to plan clients, or limit or discontinue the availability of their services or products to ERISA plans.” However, the DOL apparently determined that the benefits of increased enforcement efficiency and a more pervasive fiduciary duty are worth increasing the costs and reducing the choices available to plans. This article explores the implications of the proposed rule amendments for four categories of hedge fund industry participants: hedge fund managers, placement agents, valuation firms and pension consultants. The article concludes that the amended rule would have a limited effect on most hedge fund managers, and a potentially direct and adverse effect on placement agents, valuation firms and pension consultants. However, the proposed amendments also contain exceptions – and this article explains how various hedge fund industry participants may use those exceptions to avoid undesired characterization as an ERISA fiduciary.