An Interesting Question: Investment Managers and IRAs

In recent months, we have received phone calls from several investment advisory firms asking about the need to comply with the disclosure rules under Prohibited Transaction Class Exemption 86-128, where they provided investment management services for IRAs. We thought you might be interested in the questions and the answers.

As a matter of background, virtually everyone knows that an investment manager for an ERISA-governed qualified plan is a fiduciary. That is because the investment manager has discretionary authority and control over the investment of the plan assets—which is a classic definition of fiduciary. On top of that, the investment manager probably acknowledged its fiduciary status in its advisory agreements.

However, it is less well known that investment advisory firms can also be fiduciaries where they manage the assets of individual retirement accounts or IRAs.

The questions posed to us by the investment managers deal with commissions and other payments related to investment transactions.

Where an investment manager uses it discretionary authority to execute transactions through an affiliated broker-dealer (or receives compensation in any form from a broker-dealer for directed transactions), the investment manager has, as a general rule, violated the prohibited transaction provisions of section 406(b) of ERISA. As a result, the payments are required to be turned over to the plans or to ERISA-governed IRAs and the investment manager is subject to specified penalties. Similar rules apply to IRAs under the Internal Revenue Code.


However, the DOL has provided a measure of relief through Prohibited Transaction Class Exemption (PTCE) 86-128. Those rules require notices to the general fiduciaries of ERISA plans, as well as detailed reporting about the transactions and the amounts earned. Many investment managers are aware of those requirements, at least with regard to plans, and take advantage of the PTCE to avoid the application of the prohibited transaction rules.

Unlike the requirements for ERISA plans, however, PTCE 86-128 provide that, for IRAs, none of the notice and disclosure requirements apply. In other words, the class exemption gives the investment managers of IRAs a “free pass.” Unfortunately, many investment managers, and perhaps their attorneys, do not read the “fine print” in the exemption. If you follow the exemption’s references to ERISA and its regulations, it quickly becomes clear that the free pass does not extend to IRAs where employers have made any contributions. Since employers are required to contribute to SEP-IRAs and SIMPLE IRAs, any IRA that is part of a SEP-IRA or a SIMPLE program is not exempted. As a result, compliance with all of the conditions of 86-128—i.e., the notice and disclosure requirements—is required. If an investment manager has not provided the notices and other required information, and has received direct or indirect benefit from the execution of brokerage transactions for the se employers-involved IRAs, the investment manager has committed prohibited transactions and should seek advice from a knowledgeable ERISA attorney about correction of those transactions, as well as about its future course of conduct.

By the way, some qualified plans are treated the same as basic IRAs, that is, are not required to provide the notices or information. For example, a qualified plan sponsored by a corporation where the participant and his or her spouse are the owners and the only participants, the plan is considered as not covering any employees, even if there are employer contributions for the owner or the owner and spouse.

The practical dilemma for investment managers is that they may not know whether an IRA has employer money in it or whether an individual plan covers a rank-and-file employee. And, of course, circumstances could change at any point along the way; for example, the small corporation could hire its first regular employee.

As a result, investment managers need to have procedures in place to determine whether IRAs and small plans are entitled to the relief from the requirements of 86-128. Without adequate procedures, investment managers may need, as a practical matter, to assume that the IRAs and small plans are not entitled to reduced reporting and, as a result, provide full-detailed reporting in all events.

Disclaimer Required by IRS Rules of Practice:
Any discussion of tax matters contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding any penalties that may be imposed under Federal tax laws.