Department of Labor, SEC prepare to change definition of 'fiduciary' while AICPA balks

The Department of Labor's (DOL) Employee Benefits Security Administration (EBSA), the government group responsible for educating Americans about how retirement and health and certain welfare plans work, has proposed that the definition of the term "fiduciary" be updated. Working with the Securities and Exchange Commission (SEC), the EBSA's goal, according to EBSA Assistant Secretary Phyllis Borzi, is to "harmonize both [agencies'] statutes" regarding who is a fiduciary when giving investment advice.
The definition of fiduciary currently in use was determined in 1975 under the Employee Retirement Income Security Act (ERISA) and sets out stringent duties that describe a plan fiduciary which, according to the Society for Human Resource Management, include "a duty of undivided loyalty, a duty to act for the exclusive purposes of providing plan benefits and defraying reasonable expenses of administering the plan, and a duty of care grounded in the 'prudent man standard.' Fiduciaries are personally liable for losses sustained by a plan that result from a violation of these duties."
The 1975 definition includes a five-part test to determine if a person providing investment advice is to be deemed a fiduciary. To qualify as a fiduciary, the person must:
  1. Render advice as to the value of securities or other property, or make recommendations as to the advisability of investing in, purchasing or selling securities or other property
  2. Provide the advice on a regular basis
  3. Provide the advice pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary
  4. The advice will serve as a primary basis for investment decisions with respect to plan assets, and
  5. The advice will be individualized based on the particular needs of the plan.
The new proposal would broaden the definition of fiduciary and replace the original five-part test with a new four-part test that expands the definition of who can be considered a fiduciary. J.P. Morgan reports that, under the new proposed regulations, the following activities of a financial advisor could give the advisor fiduciary status: 
  1. Providing advice, appraisals, or fairness opinions as to the value of investments, recommendations as to buying, selling or holding assets, or recommendations as to the management of securities or other property. The DOL notes that part of the intent of this portion of the test is to establish fiduciary responsibility on parties who provide valuations of closely held employer securities and other hard to value plan assets.
  2. Acknowledgement of fiduciary status for purposes of providing advice. This provision is significant because under the old test, a party could acknowledge fiduciary status, and still fail to be held liable if they did not meet all five parts of the old test.
  3. Is an investment advisor under Section 202(a)(11) of the Investment Advisors Act of 1940.
  4. Provides advice or make recommendations pursuant to an agreement, arrangement or understanding, written or otherwise, with the plan, a plan fiduciary or a plan participant or beneficiary, where the advice may be considered in making investment or management decisions with respect to plan assets, and the advice will be individualized to the needs of the plan, a plan fiduciary or a participant or beneficiary. While this language is similar to some of the language from the old test, there are a couple notable changes. First, the advice no longer needs to be offered on a regular basis—offering advice on a single occasion could result in fiduciary status. Second, the advice no longer need be offered as part of a mutual understanding that the advice will serve as the primary basis for investment decisions— the advice could be part of several factors that the plan sponsor considers and still result in fiduciary status.
At a hearing before the EBSA on Wednesday, March 2, Robert Reilly, CPA, ABV, member of the American Institute of Certified Public Accountants' Forensic and Valuation Services Committee, testified against proposed changes to the definition of fiduciary.
His testimony discussed the fact that many CPAs perform business valuation services for many employee benefit plans, and that "treating the sponsor company valuation analyst as a fiduciary will be disadvantageous to benefit plan participants." The AICPA reports that there are currently about 11,500 Employee Stock Option plans with over 10 million participants. Most ESOPS are offered in small businesses.
Reilly's testimony highlighted four significant concerns with the proposed change: 
  • "The proposed change to the definition is incompatible with the Internal Revenue Service's requirements for an independent appraisal of employer securities,
  • "The proposed change does not address the underlying issue of proper qualifications and standards for performing valuation services,
  • "The proposed change will increase the cost of valuation services for ESOP plans, and
  • "The proposed change will restrict the number of valuation specialists willing to do valuations for ESOP plans."
The testimony is below.
Statement of Robert Reilly, CPA/ABV/CFF
On behalf of the American Institute of Certified Public Accountants Forensic and Valuation Services Executive Committee
Before the United States Department of Labor Employee Benefit Security Administration
Proposed Rule on Definition of the Term "Fiduciary"
March 2, 2011
I am Robert Reilly and I am here today representing the American Institute of Certified Public Accountants' (AICPA) Forensic and Valuation Services Executive Committee (FVSEC). Thank you for the opportunity to present our views on the Department's proposed rule redefining the circumstances under which a person is considered to be a fiduciary under ERISA by reason of providing advice to an employee benefit plan or a plan participant. The proposal specifically includes the provision of appraisals in connection with plan transactions concerning the value of securities or other property.
The AICPA is the national professional member organization of over 360,000 certified public accountants. The AICPA has a Forensic and Valuation Services Section for CPAs that perform business valuation services, and administers the Accredited in Business Valuation (ABV) credential program. ABV credential holders must hold a valid CPA certificate, pass a rigorous examination, and have a sufficient level of business valuation experience and continuing education. ABV credential holders are commitment to continuously improving valuation skills and expertise, resulting in increased professional competency.
Many CPAs perform business valuation services. Many of these CPAs regularly value the stock of employer corporations that sponsor an employee stock ownership plan (i.e., an ESOP) or other employee benefit plans. These employer stock valuations are typically performed for transaction, taxation, or plan administration purposes.
We commend the Department for its concern and diligence related to the quality of employee benefit plan sponsor company valuations. The issue of the quality of sponsor company valuations is real and affects plan participants. Substandard valuations of the sponsor company may cause the associated benefit plan to make an incorrect investment decision if the sponsor company stock was improperly valued at the time of the benefit plan purchase of the employer securities. If the employer stock valuation is too high then plan participants would earn a decreased rate of return on their investment.
We firmly believe, however, that treating the sponsor company valuation analyst as a plan fiduciary is exactly the wrong way to address this issue. In fact, defining the valuation analyst as a fiduciary will be disadvantageous to benefit plan participants for several reasons.
Let me take a few minutes to summarize our concerns as discussed in our comment letter. Then I will spend the remainder of my time discussing what we believe is an appropriate and cost-effective solution to the problem of substandard valuations.
As stated in our formal comment letter to the Department, we have four significant concerns with the proposed change:
  • The proposed change to the definition is incompatible with the Internal Revenue Service's requirements for an independent appraisal of employer securities,
  • The proposed change does not address the underlying issue of proper qualifications and standards for performing valuation services,
  • The proposed change will increase the cost of valuation services for ESOP plans, and
  • The proposed change will restrict the number of valuation specialists willing to do valuations for ESOP plans
The conflict with the IRS's requirements for independence is a real and significant issue. As a fiduciary, a valuation analyst would have to perform the valuation in a manner that is in the best interest of the plan participants, whereas the IRS requirements require the valuation to be performed such that the value is the most correct, without regard for the impact of the value to the end user. Holding valuation preparers to the standard of a fiduciary would open the door to increased litigation, which in turn would significantly drive up the cost of insurance for valuation analysts, if they could get insurance at all. Many of the most reputable and well established firms would likely quit offering valuation services for plans due to the increased risk, driving the very people who are best suited to preparing valuations away from this work. For firms that continue offering these services, the increased cost would be passed on to the participants, through higher plan administration costs or reduced earnings of the company.
So what is the solution? An appraisal should be prepared by a qualified individual in accordance with appropriate valuation standards. We believe a qualified appraiser should have proper credentials that demonstrate the individual has the education and experience to perform plan valuations. We recommend that the Department require all sponsor company valuations to be performed by professionally credentialed valuation analysts who would be required to prepare the valuations in compliance with generally accepted business valuation standards, similar to those standards encompassed in Internal Revenue Code Section 170(f)(11)(E) on qualified appraisers. Those standards include minimum education, experience and licensure or certification requirements. We recommend the Department establish similar minimum qualification requirements for employer stock valuations. If the Department were to require similar requirements for the preparation of valuations for employee benefit plans then the risk of a plan receiving a poor quality appraisal would be substantially mitigated.
The AICPA issued Statement on Standards for Valuation Services No1 (SSVS1) in June of 2007 which established standards for AICPA members who are engaged to estimate the value of a business, business ownership interest, security, or intangible asset. Since SSVS1 was issued, all other domestic valuation organizations have changed their valuation standards so that they are all significantly equivalent. These standards outline minimum requirements for the development of an opinion of value and the reporting of that opinion.
We believe the AICPA professional credentials and professional standards meet the current valuation analyst requirements of the Internal Revenue Code. In contrast, the definition of the sponsor company valuation analyst as a fiduciary is fundamentally in conflict with the independence requirements for valuation analyst in the Internal Revenue Code.

Again, thank you for your time and interest today. I would be happy to answer any questions.


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