TO: Robert Wuelfing, Executive Director, The SPARK Institute FROM: Michael Hadley, Partner DATE: April 2, 2015 RE: You have asked us to provide views on the implications under the Employee Retirement Income Security Act of 1974 ( ERISA ), the Internal Revenue Code of 1986 ( Code ), the rules of the Financial Industry Regulatory Authority ( FINRA ), and the Investment Advisers Act of 1940, of a proposed that The SPARK Institute ( SPARK ) is contemplating. The analysis regarding securities law in this memorandum has been drafted by Clifford Kirsh of Sutherland Asbill & Brennan LLP. I understand that you may share this memorandum with firms whose advisors have been nominated for an Advisor Award. Although this memorandum may be helpful, advisors and their firms should come to an independent conclusion in consultation with counsel regarding the matters addressed herein. In our view, as described in more detail below: The receipt of the benefits of the should not violate ERISA s prohibited transaction rules with respect to any advisor that serves as a fiduciary to an ERISA-governed plan. There is some uncertainty as to whether the benefits of the would need to be disclosed to an advisor s client plans under the Department of Labor ( DOL ) 408(b)(2) and Form 5500 disclosure rules. The better answer is that those disclosure rules are not triggered. Nonetheless, we recommend that SPARK offer to provide recipients of an Advisor Award information regarding the value of the benefits of the award and alert recipients to consider whether disclosure to ERISA plan clients may be a best practice. Although generally the value of a prize or award is ordinarily taxable income reportable on Form 1099-MISC, SPARK can reasonably take the position that no reporting is required because the benefits provided are analogous to reimbursements and working condition fringe benefits. The receipt of the benefits of the should not violate FINRA s compensation and gift rules, and the relevant provisions of the Investment Advisers Act
Page 2 of 9 Background of 1940, as long as such receipt conforms to any compliance policies and procedures in place at an advisor s broker-dealer or investment adviser s firm. The SPARK Institute is a not-for-profit trade association that represents record keepers, mutual fund companies, brokerage firms, insurance companies, banks, consultants, trade clearing firms and investment managers. SPARK is a leading voice on retirement plan policy and particularly focuses on defined contribution plans. SPARK is not itself a fiduciary, service provider or other party-in-interest to employee benefit plans. 1 The will be designed as follows. Each year, SPARK will make two awards to advisors that serve retirement plans. The Investment Innovation award will be for advisors that demonstrate leadership in designing, developing and delivering investments within defined contribution plans. The Plan Design and Administration Innovation award will be for advisors who demonstrate leadership in designing plans and administrative processes that improve participant outcomes while managing plan costs. In order to be eligible for the Investment Innovation award, an advisor must be either a registered broker with FINRA, or a registered investment advisor ( RIA ) representative. It is expected that the advisor will also serve as a fiduciary under ERISA to one or more ERISA-governed plans. Nominees for the Plan Design and Administration Innovation award are not required to be registered with FINRA or an RIA, but they may be. Nominees for the Plan Design and Administration Innovation award will likely be plan consultants, and therefore may or may not serve as an ERISA fiduciary to their client plans. Nominees for both awards can be an individual advisor or a team of advisors that work together. A team of advisors would have a representative of the team to accept the award. Both awards will be awarded through the following process: Nominations will come from SPARK member firms. Each SPARK member firm can nominate up to five advisors. The firms of nominated advisors will be contacted and asked to sign off on the nomination, and agree to accept the award if won. All SPARK members will be entitled to vote. Each SPARK member can only vote for one nominee for each award. Finalists will be selected through votes tabulated by SPARK staff. A FINRA/SEC check will be run on all FINRA/SEC registered advisors being nominated. Finalists will be reviewed and final winners will be determined by SPARK s Governing Board. 1 I have assumed that the advisor, if any, to the SPARK Institute s in-house retirement plan will not be eligible for an Advisor Award.
Page 3 of 9 For purposes of this memorandum, because the final decision will be made by SPARK s Governing Board, taking into account the member voting, we have assumed that no single member of SPARK has the authority to determine the winner of an award. As currently contemplated, the winner of each award will receive the following benefits: The winner will receive an honorary membership to the SPARK Institute for the year following the win. If a team wins, the team will receive one honorary membership. The winner will receive free conference registration to the SPARK Forum 2 (and may receive a free hotel room if allowed by the advisor s firm). If more than one advisor from a winning team attends the Forum, SPARK may offer free conference registration to more than one member of the winning team. The winner will lead a general session at the Forum on the morning of the second day or the afternoon of the first day. The session may be in a Q&A format with the nominating company and the winning advisor(s) addressing the group. The winner will have an interview that will be printed in the SPARK Journal in the first edition after the winners are announced. The winner will have a profile published on the SPARK Institute website for the entire year until the next winner is announced. The winner will receive a plaque commemorating the award. The winner will be asked to participate in planning advisor-centric topics for upcoming SPARK events. The winner will serve as the host for an advisor dinner at the next SPARK conference. The first two benefits (one-year honorary membership to the SPARK Institute and conference registration and hotel room at the SPARK Forum) have, we assume, a value that can be quantified. The other benefits generally do not have a direct value, but some of these benefits are similar to benefits that conference sponsors of SPARK events receive. ERISA Prohibited Transaction Rules For purposes of this section, we have assumed that the winners of the Advisor Awards act as fiduciaries to one or more ERISA-governed plans, because the winner exercises discretionary authority or control respecting management of ERISA-plan assets, renders investment advice for a fee with respect to plan assets, or has discretionary authority or responsibility over plan administration. 3 You have asked us to consider whether receipt of the benefits of an Advisor Award would violate the prohibited transaction rules in ERISA section 406. 4 2 The SPARK Forum is an annual conference with educational and networking opportunities for a broad array of companies and executives. 3 ERISA 3(21). 4 For purposes of this memo, references to ERISA section 406 are deemed to include the parallel provisions of section 4975 of the Internal Revenue Code.
Page 4 of 9 Section 406(a) of ERISA prohibits a fiduciary of a plan from causing the plan to engage in a variety of transactions with a party-in-interest to the plan. Because the SPARK Institute is not a party-in-interest to any plan, and the does not result in any transaction between a plan and a party-in-interest, section 406(a) of ERISA is not implicated. Section 406(b) of ERISA prohibits certain self-dealing transactions by fiduciaries. As most relevant here, section 406(b)(1) prohibits a fiduciary from deal[ing] with the assets of the plan in his own interest or for his own account and section 406(b)(3) prohibits a fiduciary of a plan from receiving any consideration for his own personal account from any party dealing with such plan in connection with a transaction involving the assets of the plan. DOL has summarized the application of these rules as follows: [A] fiduciary does not engage in an act described in section 406(b)(1) of ERISA if the fiduciary does not use any of the authority, control, or responsibility that makes such person a fiduciary to cause a plan to pay additional fees for a service provided by such fiduciary or by a person in whom such fiduciary has an interest that may affect the exercise of such fiduciary's best judgment as a fiduciary. Similarly, it is the view of the Department that a fiduciary does not engage in an act described in section 406(b)(3) of ERISA if the fiduciary does not use any of its authority, control, or responsibility to cause a third party to pay to the fiduciary any compensation in connection with a transaction involving the assets of the plan. 5 SPARK itself does not deal directly with ERISA-governed plans and therefore the giving of the benefits contemplated by the Advisor Awards do not implicate section 406(b) of ERISA. We have also considered that recipients of the award may sell products and services for SPARK members. 6 As noted above, because the final decision will be made by SPARK Institute s Governing Board, for purposes of this memorandum, no single member of SPARK has the authority to determine the winner of an award. Further, we are aware of no authority that would treat the nomination for an award as compensation or consideration that could implicate the conflict of interest concern implicit in section 406(b) of ERISA. Any advisor that wins an Advisor Award would need to continue to act on behalf of the plans the advisor serves consistent with the duties of loyalty and prudence that ERISA requires. 7 Disclosure of Compensation to ERISA Plans Recipients of an Advisor Award, whether or not they are fiduciaries with respect to ERISA plans, will be service providers to such plans. Under relatively recent new rules, service 5 ERISA Advisory Opinion 99-03A. 6 Depending on the facts and circumstances, it could be a violation of section 406(b) for an advisor to use his or her authority to cause a SPARK member to pay the adviser additional compensation. 7 ERISA 404(a).
Page 5 of 9 providers to ERISA plans must furnish information regarding compensation received in connection with those services. Form 5500 Schedule C. Plans with more than 100 participants that file an annual report on Form 5500 must include Schedule C, which reports information regarding compensation paid to service providers during the most recent plan year. This includes indirect compensation, which is compensation received from sources other than directly from the plan or plan sponsor, if the compensation was received in connection with services rendered to the plan during the plan year or the service provider s position with the plan. DOL states the following in the Schedule C instructions: For this purpose, compensation is considered to have been received in connection with services rendered to the plan or the person s position with the plan if the person s eligibility for a payment is based, in whole or in part, on services that were rendered to the plan or on a transaction or series of transactions with the plan. Indirect compensation would not include compensation that would have been received had the service not been rendered or the transaction had not taken place and that cannot be reasonably allocated to the services performed or transaction(s) with the plan. Although the instructions suggest that compensation is not reportable if the compensation would have been received had the service not been rendered, DOL suggests in FAQs that if the eligibility for a gift is based, in whole or in part, on assets under management, the gift would be reportable. 8 Thus, compensation not attributable to any single client but to an overall book of business may be reportable. On the other hand, DOL also concludes that if a brokerage firm invites employees of investment managers to a business conference, including reimbursement for travel, meals, and lodging, where eligibility for the invitation or the value of gifts provided is not based, in whole or in part, on whether the investment manager does business with ERISA plans or on the value or amount of business conducted that includes ERISA covered plans, the expenses for the conference, travel, meals and lodging would not constitute Schedule C reportable indirect compensation received by the investment managers or their employees. 9 This suggests that a benefit or award may not be reportable solely because it is available to service providers that are relatively successful. DOL concludes that waiver of a conference and hotel registration fees (if received in connection with services) would be reportable as indirect compensation, but conference overhead expenses are not. 10 The Schedule C instructions also include a de minimis rule for non-monetary compensation. Under the rule, the gift or gratuity must be valued at less than $50, and the aggregate value of gifts from one source in a calendar year must be less than $100, but gifts with a value of less than $10 do not need to be counted toward the $100 limit. If the $100 aggregate value limit is exceeded, then the value of all the gifts over $10 will be reportable. The FAQs also clarify that a service provider may use reasonable allocation methods for allocating among a 8 Department of Labor, Frequently Asked Questions about the 2009 Form Schedule C (July 2008) ( DOL 5500 FAQs ), Q&A-35. 9 Department of Labor, Supplemental FAQs about the 2009 Schedule C (October 2010), Q&A-3. 10 DOL 5500 FAQs, Q&A-33.
Page 6 of 9 service provider s client plan. Thus, even if the value of the Advisor Award is reportable indirect compensation, when allocated to all of an advisor s clients, it may be below the de minimis threshold. 408(b)(2) Disclosure. Service providers to ERISA-governed pension plans must furnish information under DOL s 408(b)(2) regulation. 11 The disclosure must be furnished to the responsible plan fiduciary in writing in advance of a contract or arrangement being entered into, extended, or renewed. The disclosure must include information regarding any indirect compensation that the service provider reasonably expects to receive in connection with the services that the will be provided. For this purpose, indirect compensation means compensation received from any source other than the plan, the plan sponsor, the service provider itself, or an affiliate. The regulation does not define what it means for compensation to be received in connection with services, but the preamble to the final regulations contains the following discussion: The Department intends that the concept of compensation to be received by a covered service provider, or its affiliates or subcontractors, in connection with a particular contract or arrangement for services be construed broadly. To the extent a covered service provider reasonably expects that compensation will be received, which is based in whole or in part on its service contract or arrangement with the covered plan, the compensation will be considered in connection with such contract or arrangement. For example, a recent report pertaining to conflicts of interest prepared by the Department s Office of Inspector General identified a fact pattern in which a service provider had not disclosed that certain financial institutions subsidized the cost of attendance at a conference that the service provider offered for its clients. Specifically, to help defray the costs of the conference, plan sponsor attendees paid a registration fee of $850, while the financial institution paid a subsidy fee of $20,000. In this regard, it is the Department s view that, when a covered service provider is engaged to provide consulting services to a covered plan (or plans) and receives subsidies or other remuneration from financial institutions or other parties with respect to whom the service provider may be making recommendations to attending plan sponsors or representatives, such subsidies or remuneration could be compensation received in connection with the service provider s contract or arrangement with the covered plan. 12 The fact pattern the DOL describes does not fit the Advisor Award for a few reasons. First, when a service provider makes the 408(b)(2) disclosure, it cannot reasonably expect to receive the Advisor Award. 13 Second, the Department envisions a direct relationship between a service 11 29 C.F.R. 2550.408b-2. 12 77 Fed. Reg. 5632, 5637 (Feb. 3, 2012). 13 Covered service providers must disclose a change in the information previously provided as soon as practicable after the service provider is informed of the change. 29 C.F.R. 2550.408b-2(c)(1)(v)(B). If the Advisor Award otherwise is subject to disclosure under the 408(b)(2) regulation, it is not clear in the 408(b)(2) regulation whether an unexpected award that was not contemplated when the service provider entered into a contract would be subject to the change notice requirements.
Page 7 of 9 provider and the entity that is subsidizing a conference fee the service provider consults with a plan and receives this subsidy from a financial institution with respect to whom the service provider may be making recommendations. In the case of the Advisor Award, a SPARK member is, at most, indirectly subsidizing SPARK membership and conference fees but so are all other SPARK members and conference attendees that have no relationship with the advisor. Even if the non-cash value of the Advisor Award is considered to be received in connection with services to an advisor s plan clients, it is possible that no reporting is necessary when allocated to all clients. Compensation, for purposes of the section 408(b)(2) disclosure, does not include non-monetary compensation valued at $250 or less, in the aggregate, during the term of the contract or arrangement. The DOL has stated that service providers may allocate compensation that is not attributable to a particular client among all of its clients using rules similar to those for Form 5500 (described above). 14 Even though the two disclosure regimes are not identical, it is generally thought that whether a particular item of compensation is in connection with services provided to plans, should be interpreted similarly under the Schedule C and 408(b)(2) rules. Taking into account all of the guidance that has been issued regarding what it means for an item of compensation to be received in connection with services to an ERISA plan, there is some uncertainty as to whether the benefits of the would need to be disclosed to an advisor s client plans under the above rule. In my view, the better answer is that these disclosure rules are not triggered. Nonetheless, we recommend that The SPARK Institute offer to provide recipients of the award information regarding the value of the benefits and alert recipients to consider whether disclosure to ERISA plan clients may be a best practice. 1099-MISC Reporting The recipient of the value of a prize or award must generally include the value of the prize or award in gross income. 15 If a prize or award is not made in money but is made in goods or services, the fair market value of the good or service is the amount to be included in gross income. 16 Generally the payor of a prize or award must report the fair market value of the prize or award on Form 1099-MISC. There is good reason to conclude, however, that the quantifiable benefits that are being provided by the Advisor Award are not, in fact, taxable income to the recipient. Even though membership in The SPARK Institute, waiver of the SPARK Forum conference fees, and a free hotel room can be quantified in value, if the advisor were to pay for these items directly, they would be deductible as a business expense. Generally, gross income does not include funds received by a taxpayer in reimbursement for expenses paid on behalf of another. 17 Similarly, if an employer 14 77 Fed. Reg. at 5646 n.32 (referencing FAQs in connection with Form 5500). 15 IRC 74. 16 26 C.F.R. 1.74-1(a)(2). 17 For example, in Revenue Ruling 67-407, the IRS concluded that where a couple needed to be near a hospital where their daughter was participating, voluntarily, in a research project, reimbursement for a motel bill and other
Page 8 of 9 pays the cost of travel, conference registration, or membership in a business-related organization on behalf of an employee, the employee would not recognize income because this is a working condition fringe benefit: property of services provided to an employee that would be allowable as a deduction if paid by the employee are not gross income. 18 There is, however, some uncertainty here. Code section 74, which deals with prizes and awards, does not contain a specific exception for non-cash prizes and award that would be deductible if paid by the recipient. Nonetheless, we think the better analysis is that the Advisor Award is less a prize or award as contemplated by Code section 74 and more a decision by The SPARK Institute to designate two worthy advisors who will attend SPARK meetings and events as a complementary arrangement. Viewed in this light, the benefits of the Advisor Award, such as SPARK membership and waiver of conference and hotel fees, are necessary expenses for that arrangement. FINRA and Investment Advisers Act of 1940 Compensation and Gift Rules The receipt of the benefits of the should not violate FINRA s compensation and gift rules and relevant provisions of the Investment Advisers Act of 1940 as long as such receipt conforms to any compliance policies and procedures in place at an advisor s broker-dealer or investment adviser. FINRA Rules. FINRA rules govern the payment of compensation for securities transactions. Certain rules pertain explicitly to variable contracts, others apply to mutual funds, and other rules apply broadly across product lines. In particular, FINRA rules prohibit, with certain exceptions, the payment to registered representatives of non-cash compensation in connection with the distribution of variable products and mutual funds. The non-cash compensation rules currently appear in FINRA Rule 2320(g) and NASD Rule 2830(l), with respect to variable products and mutual funds, respectively. At the outset, we note that the rules define non-cash compensation as any form of compensation received in connection with the sale and distribution of variable contracts (or mutual funds in the case of NASD Rule 2830(l)) that is not cash compensation, including but not limited to merchandise, gifts and prizes, travel expenses, meals and lodging. This definition restricts such compensation to the extent that it is paid in connection with the sale and distribution of either variable contracts or mutual funds. As we understand the, it is not tied or connected in any way to the sale of any particular variable product or mutual fund and in fact not tied to such product sales even more generally. We further note that the product is not being granted by a product issuer or an affiliate of the issuer, rather it is being awarded by SPARK itself. Given all of this, good arguments may be advanced that any award should fall outside FINRA s definition of non-cash compensation. necessary costs were not includable in gross income. See also Price v. Comm r, T.C. Memo 1999-142 (April 29, 1999). 18 Code 132(d).
Page 9 of 9 As a matter of good compliance practices, any award granted to a registered representative should be made with the full consent of the award recipient s broker-dealer. This will allow the broker-dealer to review any award under its policies and procedures and allow for proper recordkeeping prior to the grant of any such award. We would also note that, as a matter of good compliance practices, any written material prepared by or distributed by an adviser in connection with an adviser s appearance at the Forum, should be reviewed and approved by that adviser s firm prior to use. Likewise, the advisor s profile that is published on SPARK s website should be reviewed and approved by the adviser s firm prior to any such publication. Investment Advisers Act of 1940. To the extent that an award recipient is an SEC-registered investment adviser or investment adviser representative, we will want to refer to the Investment Advisers Act and the rules thereunder. Although there is no specific gift provision in the Advisers Act or the rules thereunder, an adviser and its associated persons are fiduciaries who are charged to put their client s interest before their own. 19 Any gift received by an adviser or its associated persons cannot be inconsistent with an adviser s fiduciary duty. Many investment advisory firms have implemented specific policies and procedures relating to gifts and entertainment, and an award recipient must ensure that receipt of an award conforms with his or her firm s policies and procedures. Related, Investment Advisers Act Rule 204A-1 requires SEC registered advisers to adopt a code of ethics which is required to include provisions setting forth standards of conduct. Many advisers include in their codes limitations on the acceptance of gifts. Similar to what we noted above with respect to FINRA requirements, as a matter of good compliance practices, any award grant should be with the full consent of a recipient s adviser to allow the adviser to review the award and to allow for proper recordkeeping. * * * * We hope the foregoing is helpful to you. Please let us know if you would like additional information. 19 Sutherland Asbill & Brennan LLP did not review state adviser laws but further noted that generally speaking state adviser laws do not contain any specific gift rule.