CMA Exam Quiz 15

Investment advisors and consultants are subject to numerous laws and regulations that apply to the activities in which they engage, the products and services they provide, and the relationships they have with specific clientele they serve.

Investment professionals may be subject to oversight by the following regulators: the SEC (Securities and Exchange Commission), FINRA (Financial Industry Regulatory Authority), and state securities boards or agencies among others.

The fiduciary relationship for a consultant and client can be established with individuals, trusts, foundations, endowments, ERISA plans, and many other circumstances. In each case, certain duties are expected to be performed at a minimum on behalf of the client or clients.

The initial Prudent Man Rule focused primarily on the merits of the individual investments, did not allow for risky investments, and focused on investments in government securities. Over time, interpretation of the rule evolved, with large steps taking place after the Great Depression and after World War II.

The more modern Prudent Investment Rule incorporates the theory of diversification and allows for overall portfolio management as the guiding principle for astute investment management.

If a consultant is named as a trustee, the consultant must be prepared to act in a fiduciary capacity on behalf of the client. The foundational case for trustee fiduciary standards was Keech v. Sandford in 1726.

A consultant who holds himself or herself out as a fiduciary for ERISA plans and pensions may be held to fiduciary standards. In these cases, consultants must be prepared to define the scope and nature of their relationship with the entity for which they are consulting.

According to IRS Publication 560 and the irs website, ERISA prohibited transactions including the following six:
1. A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person
2. Any act of a fiduciary by which plan income or assets are used for his or her own interest
3. 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
4. The sale, exchange, or lease of property between a plan and a disqualified person
5. Lending money or extending credit between a plan and a disqualified person
6. Furnishing goods, services, or facilities between a plan and a disqualified person

According to Publication 560, disqualified individuals include the following
1. A fiduciary of the plan
2. A person providing services to the plan
3. An employer, any of whose employees are covered by the plan
4. An employee organization, any of whose members are covered by the plan
5. Any direct or indirect owner of 50 percent or more of any of the following:
a. The combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of a corporation
b. that is an employer or employee organization described in (3) or (4)
c. the capital interest or profits interest of a partnership that is an employer or employee organization described in (3) or (4)
d. the beneficial interest of a trust or unincorporated enterprise that is an employer or an employee organization described in (3) or (4)
6. A member of the family of any individual described in (1), (2), (3), or (4) (i.e., the individual’s spouse, ancestor, lineal descendant, or any spouse of a lineal descendant)
7. A corporation, partnership, trust, or estate of which (or in which) any direct or indirect owner described in (1) through (5) holds 50 percent or more of any of the following:
a. The combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation
b. The capital interest or profits interest of a partnership
c. The beneficial interest of a trust or estate
8. An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in (3), (4), (5), or (7)
9. A 10-percent or more (in capital or profits) partner or joint venture of a person described in (3), (4), (5), or (7)
10. Any disqualified person, as described in (1) through (9) above, who is a disqualified person with respect to any plan to which a multiemployer plan trust is permitted to make payments under section 4223 of ERISA

ERISA stands for the Employee Retirement Income Security Act of 1974.
This act established the standards for employee retirement, health, and other benefit plans. The act applies to nongovernment employers that offer these benefits. ERISA establishes the general rules for conduct, reporting, disclosures, procedures, and protection.

Because ERISA covers all employer-sponsored benefit programs, the Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985 and Health Insurance Portability and Accountability Act (HIPAA) of 1996 also are part of ERISA.