Individual retirement account holders may find themselves brokerless if the Department of Labor (DOL) adopts a recently proposed rule that would subject investment professionals associated with the accounts to a fiduciary standard. Testifying before the U.S. House Education and Workforce Committee (the Committee) Kenneth Bentsen, a vice president at the Securities Industry and Financial Markets Association (SIFMA), a securities industry lobbying group, warned that brokerages will drop millions of IRA account owners if the proposed rules are finalized.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the SEC’s forthcoming universal fiduciary duty regulations in Advisor’s Journal, see Financial Planners and Insurance Producers at Odds over Fiduciary Standard (CC 11-131), SEC Fiduciary Standard Study Answers Few Questions (CC 11-25), Study Finds that Universal Fiduciary Standard Will Hurt Investors (CC 10-97), What You Don’t Know Yet Might Hurt You: A Broker’s Duties under the Financial Reform Act (CC 10 40), & SEC Unprepared to Implement a Fiduciary Standard for Broker-Dealers (CC 11-33).

Why is this Topic Important to Wealth Managers? This blogticle presents discussion on trades made based on inside information. We have all heard about Enron and the fraudulent practices, but liability can actually extend well beyond insiders. It is thus important to realize sensitive information shared with wealth managers could be subject to federal regulation to prevent trading based on manipulative or deceptive devices.

What is the liability imposed by federal law with regards to trading based on inside information?

Generally trading based on inside information is legislated under Section 10(b) of the 1934 Securities Exchange Act, [1] and SEC Rule 10b-5 promulgated thereunder. [2]

As the law is currently stated, it is unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange:

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

Generally liability can occur for civil and criminal penalties when an insider or temporary insider tips or trades based on material non-public information. Not only are tippors liable though, tippees may be as well. When an individual trades on material non-public information which was given to him by a tippor, he may be held liable if he knew or had reason to know the tippor was breaching a fiduciary duty (owed to the corporation) by tipping.  A breach of fiduciary duty generally occurs if there is a personal financial gain, increase in reputation or quid pro quo.

Moreover, there may be investor and SEC liability for those who are considered “misappropriatiors”. Under the misappropriation theory an individual may be held criminally or civilly liable based on the purchase or sale of securities on the basis of, or the communication of, material non-public information misappropriated in breach of a duty of trust or confidence.

A duty of trust or confidence generally exists when:

(1) Whenever a person agrees to maintain information in confidence;

(2) Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or

(3) Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling. Provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties’ history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information. [3]

Tomorrow’s blogticle will continue to discuss issues related to the practice of wealth management.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] 17 C.F.R. § 240.10b-5.

[3] 17 C.F.R. § 240.10b5-2.

Why is this Topic Important to Wealth Managers? Advanced estate planning almost always involves some attention to concept of the legal trust. It is thus essential that wealth managers understand the purposes of trusts and the ways which trusts may be incorporated into in a comprehensive financial plan. Our discussion then focuses on building a foundation to present the credit shelter trust.

“If we were asked what is the greatest and most distinctive achievement performed by Englishmen in the field of jurisprudence, I cannot think that we should have any better answer to give than this, namely, the development from century to century of the trust idea.” [1]

Generally defined, an express trust “is a fiduciary relationship with respect to property, subjecting the person by whom the title to the property is held to equitable duties to deal with the property for the benefit of another person, which arises as a result of a manifestation of an intention to create it.” [2]

The trust is unique in that there is a separation of legal and equitable title in a trustee and beneficiary, respectively. The trust may be a very effective vehicle for accomplishing the grantor’s desires. As was expressed in the beginning of this article, to appreciate the all-important role of the trust in personal and business estate planning, an understanding of the fundamentals of trust law is important.

As was presented in the general definition, an express trust is created only if the grantor manifests an intention to create it. Such manifestation may be evidenced by conduct or words. Generally the creation of an express trust is through a trust document. A great majority of U.S. jurisdictions today require the creation of an express trust to be in writing, with the exception of trusts in some states dealing with personal property.

The trust is a device or instrument for the administration and disposition of property. No other device for this purpose possesses comparable flexibility. This factor of flexibility makes the trust unique; and this extreme flexibility makes the trust a valuable instrument for the framing and execution of estate plans.

The purposes for which trusts may be created are almost unlimited. However, a trust which has as its purpose the accomplishment of illegal objectives or which is against public policy would, of course, not have a valid purpose. Thus, a person may create a trust for any lawful purpose that he or she deems wise and expedient.[3]

One of the basic purposes of most trusts is protection. It may be the protection of a spouse, child, parent, dependent (or even a tax credit) that is desired. It may be the protection of a beneficiary against his or her own possible errors of judgment in the management of the trust property. There may be a desire to protect someone else later, by giving the income to certain persons for their lifetimes, and the principal to others at death. The intention of the grantor, as discussed above, will dictate the terms of the trust arrangement.

See a detailed analysis of trust law in the Main Library Section 21. Trusts, Guardianships And Minors B—The Law Of Trusts.

Tomorrow’s blogticle will discuss the credit shelter trust in general terms.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] Restatement (Second) of Trusts § 2. (1959).

[3] 90 C.J.S. Trusts § 17 (2011).

Retirement plan sponsors face increasing regulatory scrutiny and significant liability as plan fiduciaries. Can you leverage off these fiduciary concerns and generate advisory business for your firm?

There are a couple of key approaches you can use to address sponsors’ concerns about their fiduciary responsibilities and sell to the plans and their sponsors.

Believe it or not, there are a number of plans that don’t use an advisor—with the plan sponsor choosing to go it alone to save a few dollars. As reported in a previous edition of the Advisor’s Journal, a significant of number of employee retirement plans (19%) don’t use an outside investment advisor.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of plan sponsor’s fiduciary duty in Advisor’s Journal, see Plan Clients: Where Are the Advisory Margins? (CC 11-63).

For in-depth analysis of qualified retirement plans, see Advisor’s Main Library: Qualified Retirement Plans.

A significant of number of employee retirement plans don’t use an outside investment advisor, often because of the cost. Demonstrating your firm’s flexibility and splitting fiduciary responsibility for the plan could be the key to reaching those underserved plans. Customizing your level of service gives these plans what they need—advice—while allowing you to prune services that aren’t cost effective for your firm.

According to the Retirement Plan Survey 2011, released by Grant Thornton LLP, Drinker Biddle & Reath and Plan Sponsor Advisors, greater than 50% of plans use a limited scope investment advisor and 14% of plans use an outsourced investment advisor. Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

You’d better think twice before agreeing to act as trustee for your clients’ trusts, since doing so can cost you far more than the goodwill and fees it generates.

We all know that, depending on the circumstances, a trust, its grantor, or its beneficiaries can be held responsible for tax liability stemming from trust income.

What about its trustee?

Although trustees are not usually personally responsible for a trust’s taxes, a trustee can be stuck with the tax bill if the trustee breaches his or her fiduciary duty to the beneficiaries. A U.S. District Court recently considered a trustee’s liability for GST taxes when the trust’s beneficiaries claimed that the trustee failed to keep them informed of their potential liability for taxes stemming from trust distributions.

The trustees’ mistake in this case could cost them over $1 million.  Read the full analysis by linking to AdvisorFX!

The SEC has finally released its anxiously awaited study of whether a fiduciary standard of care should be applied to broker-dealers; but, like the study on adviser examinations, the report leaves as many questions as it answers. The fiduciary standard study—released on January 21, 2011—recommends that brokers be held to the same standard as register investment advisers (RIAs). Although the study doesn’t provide details on how the switch to the fiduciary standard will be implemented, there are hints as to what brokers can expect.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the fiduciary standard in Advisor’s Journal, see Study Finds that Universal Fiduciary Standard Will Hurt Investors (CC 10-97) and What You Don’t Know Yet Might Hurt You: A Broker’s Duties under the Financial Reform Act (CC 10 40).  Comments are welcome below.

The SEC recently approved FINRA proposed rules—FINRA Rules 2090 and 2011—that amend and consolidate know-your-customer and suitability obligations for broker-dealers and their authorized representatives. The new rules are based on, and replace in-part, similar NYSE and NASD rules. According to FINRA, the amended know-your-customer and suitability rules are intended to protect investors by “promoting fair dealing with customers and ethical sales practices.”

The new rules are effective as of October 7, 2011.  For previous coverage of the suitability standard and the debate over the proposed fiduciary standard in Advisor’s Journal, see What You Don’t Know Yet Might Hurt You: A Broker’s Duties under the Financial Reform Act (CC 10-40) and Study Finds that Universal Fiduciary Standard Will Hurt Investors (CC 10-97).

Under the know-your-customer rule, firms are required to use reasonable diligence respecting the opening and maintenance of every account and to know essential facts about every customer. “Essential facts” are facts required to …. Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

Why is this Topic Important to Wealth Managers? Discusses retirement plan investments with regards to client retirement planning.  Provides types of investments retirement plans can and cannot make.

What types of investments can a retirement plan make?

Although there is no list of approved investments for retirement plans, there are special rules contained in the Employee Retirement Income Security Act of 1974 (ERISA) that apply to retirement plan investments.

In general, a plan sponsor or plan administrator of a qualified plan who acts in a fiduciary capacity is required, in investing plan assets, to exercise the judgment that a prudent investor would use in investing for his or her own retirement.[1]

In addition, certain rules apply to specific plan types.  For example, there are different limits on the amount of employer stock and employer real property that a qualified plan can hold, depending on whether the plan is a defined benefit plan, a 401(k) plan, or another kind of qualified plan. [2]

Nevertheless, certain plans, such as 401(k) plans, that permit participant-directed investment can avoid some fiduciary responsibilities if participants are offered at least three diversified options for investment, each with different risk/return factors. [3]

As many wealth managers already know, however, individual retirement accounts are not permitted to invest in life insurance. [4]

Moreover, under the Code, both participant-directed accounts and IRAs cannot invest in collectibles, such as art, antiques, gems, coins, or alcoholic beverages, and they can invest in certain precious metals only if they meet specific requirements. [5]

Are there other transactions that are prohibited?

A prohibited transaction is a transaction between a plan and a disqualified person.  Prohibited transactions generally include the following transactions:

• a transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person;
• any act of a fiduciary by which plan income or assets are used for his or her own interest;
• the receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets;
• the sale, exchange, or lease of property between a plan and a disqualified person;
• lending money or extending credit between a plan and a disqualified person; and
• furnishing goods, services, or facilities between a plan and a disqualified person.

How do prohibited transactions affect IRAs?

A prohibited transaction with respect to an IRA occurs if the owner or beneficiary of the IRA engages in any of the transactions prohibited transactions described above.  In the case of an individual retirement account the Code provides that the account is no longer an individual retirement account, and it is treated as if the assets were distributed on the first day of the taxable year in which the prohibited transaction occurred.[6] Of course, this may trigger an early withdrawal penalty.

Tomorrow’s blogticle discusses additional changes wealth managers can expect in 2011.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] ERISA § 407.

[3] See generally, Labor Reg. §2550.404c-1.

[4] IRC §408(a)(3).

[5] IRC §408(m).

[6] IRC §408(e)(2).

Why is this Topic Important to Wealth Managers? Provides information and action steps wealth managers can use and take with regards to acting in the capacity as a trustee for retirement account purposes.    

Recently some wealth managers have established trustee services with regards to retirement accounts.  It’s a good fit, generally, when the wealth manager can offer clients information regarding deductible contributions to a retirement account, and further act as a fiduciary vis-à-vis trustee of those funds. 

What are the basic requirements in order to act in the capacity as a trustee for IRA and other retirement account purposes? 

First, an Individual Retirement Account (IRA) must be a trust created or organized in the United States for the exclusive benefit of an individual or his beneficiaries. Such trust must be maintained at all times as a domestic trust in the United States. The instrument creating the trust must be in writing. [1]

Secondly, the trustee of an IRA trust may be a person other than a bank if the person demonstrates to the satisfaction of the Commissioner of the Internal Revenue Service that the manner in which the person will administer trusts will be consistent with the requirements of the tax code.  The person must submit a written application including the information discussed below. [2]

The trustee applicant must demonstrate its ability to act within the accepted rules of fiduciary conduct. Such demonstration must include the person’s: [3]

(1) ability to provide continuity (generally satisfied when a legal entity which is owned by one individual who holds more than 20 percent of the voting stock, in the aggregate, but no more than 50 percent of such stock),

(2) ability to provide for an established location within the United States. 

(3) fiduciary experience or expertise sufficient to ensure that it will be able to perform its fiduciary duties.

Furthermore, the trustee applicant must show its capacity to account demonstrating its experience and competence with respect to accounting for the interests of a large number of individuals. [4]  The applicant must also demonstrate its experience and competence with respect to other activities normally associated with the handling of retirement funds. [5]

In addition, the trustee applicant must show proper net worth (generally at least $250,000) to accept retirement funds acting as a fiduciary. [6]  Also, at least once during each period of 12 months, the applicant is required to cause a detailed audit of the fiduciary books and records to be made by a qualified public accountant. [7]

Generally, the trustee applicant is also required to maintain retirement funds in a manner whereby investments of each account will not be commingled with any other property. [8]   This also includes the requirement that the applicant keep its fiduciary records separate and distinct from other records. [9]

Special, less stringent rules apply to passive trustees which may waive some of the specific requirements in an application as discussed above. [10]  A trustee is a passive trustee only if under the written trust instrument the trustee has no discretion to direct the investment of the trust funds or any other aspect of the business administration of the trust, but is merely authorized to acquire and hold particular investments specified by the trust instrument.

Tomorrow’s blogticle discusses additional changes wealth managers can expect in 2011.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] 26 CFR § 1.408-2(e). 

[3] 26 CFR § 1.408-2(e)(2).

[4] 26 CFR § 1.408-2(e)(3).

[5] 26 CFR § 1.408-2(e)(4). 

[6] 26 CFR § 1.408-2(e)(5(ii).

[7] 26 CFR § 1.408-2(e)(5)(iii).

[8] 26 CFR § 1.408-2(e)(5)(v).

[9] 26 CFR § 1.408-2(e)(5)(vii).

[10] 26 CFR § 1.408-2(e)(6).