ERISA Clarifies Liability of Annuity Sales Agents

Insurance agents and brokers need to pay close attention to laws delineating their liability and the increased scrutiny to which they may be subjected. Those who sell employee benefit plans must familiarize themselves with their status under ERISA. The U.S. Department of Labor, who administers ERISA, is increasing its examination of the purchase of insurance products by employee plans, particularly individual whole life insurance and terminal funding annuities. One of the pitfalls in the ERISA regulatory scheme is that the salesperson can sometimes be held accountable for the plan's insurance decisions. It is crucial, therefore, for salespeople to understand their status under ERISA and to appropriately structure their sales relationships with employee plans.

The Structure of ERISA

One of the fundamental provisions of ERISA is its requirement that "fiduciaries" for retirement, medical, life insurance and other employee benefit plans perform their duties exclusively in the interest of plan participants [ERISA section 404(a)(1)(a)]. Fiduciaries are also prohibited from dealing with the plan for their own interest, or receiving compensation from a third party transacting business with the plan [ERISA section 406(b)(1),(3)]. An insurance salesperson who (a) is a "fiduciary" and (b) influences the plan to buy a commissioned insurance product may therefore be in violation of these ERISA rules.

Who is a Fiduciary?

The key to this issue is understanding the circumstances in which a salesperson may be a "fiduciary." Trustees who make investment decisions for plans are clearly fiduciaries, and salespersons who agree to act in a trustee capacity need to be concerned about this issue. For a recent case where such a salesperson/trustee was held to violate ERISA for receiving commissions on insurance he sold to a plan, see Reich v. Goldstein (S.D.N.Y. 1993).

ERISA regulations also provide that a person who has discretionary management or control over a plan's investments, or who regularly renders investment advice for a fee, is a fiduciary [DOL Reg. section 2510.3-21(c)]. Under this regulation, a salesperson acting as a paid insurance or investment consultant to a plan may violate ERISA if he or she recommends commissioned insurance products.

The unexpected problem is that insurance agents acting in a traditional sales capacity, without any "official" plan standing, may also be "inadvertent fiduciaries." Since 1976, DOL has taken the position that advice on insurance purchases can be "investment advice" and that sales commissions can be an indirect "fee" for that advice. As a result, under the DOL regulation cited above, a salesperson may inadvertently be a "fiduciary" if his or her recommendations functionally control the plan's insurance decisions, or if there is an understanding that the agent's individualized recommendations to the plan will form a primary basis for insurance decisions.

In other words, as an agent becomes a more effective salesperson, and as his or her employee plan clients place more confidence in the agent's recommendations, the agent's exposure to becoming an "inadvertent fiduciary" increases.

Insurance agents have been held liable as inadvertent ERISA fiduciaries. A recent example is Reich v. Lancaster (N.D. Texas 1993). In that case, which was brought by DOL, an insurance agent for two years recommended to a union welfare fund that it purchase individual whole life insurance, then recommended that it replace those policies with individual universal life policies when the original insurer cancelled the agent's contract. These purchases consumed most of the fund's assets, and the agent did not disclose his compensation or his agency with the carriers. Because the fund trustees were not experts in insurance and accepted every recommendation made by the agent, the court found the agent was an inadvertent fiduciary who had violated ERISA.

This is not a new problem. As early as 1981, an insurance consultant was held to have exercised sufficient functional control over a plan's insurance decisions to be classified as a fiduciary. See Brink v. Dalesio (4th Cir. 1981). For like cases, see Marshall v. Carroll (N.D. Cal. 1980); Associated General Contractors Retirement Fund v. Hebets (S.D. Cal. 1984); Miller v. Lay Trucking Co. (N.D. Ind. 1985); Vogel v. Independence Federal Savings Bank (D. Md. 1988, 1990).

Avoiding Fiduciary Status

A recent trend in the cases has found, however, that normal sales activities may not cause the agent to become an "inadvertent fiduciary." In one such case, an agent recommended to several bank officers the purchase of life insurance in a profit-sharing plan. Only two officers accepted that recommendation, and their policies ultimately proved unsatisfactory. The court found that the agent had not exceeded her normal sales role and had not exercised sufficient discretion or control to become an "inadvertent fiduciary." See Schloegel v. Boswell (5th Cir. 1993). For other cases finding that a salesperson was not acting as a fiduciary, see American Federation of Unions v. Equitable Life Assurance Society (5th Cir. 1988); City National Bank v. Chase Manhattan Bank (N.D. Ill. 1989); Consolidated Beef Industries,Inc. v. New York Life Insurance Co. (8th Cir. 1991); Flacche v. Sun Life Insurance Co. (6th Cir. 1992); Kerns v. Benefit Trust Life Co. (8th Cir. 1993).

The line these cases draw between sales activities and fiduciary activities is important and helpful. Salespersons who market to employee plans and wish to minimize their "inadvertent fiduciary" exposure should consciously seek to limit themselves to "normal sales activities." Unfortunately, that line is not always clear in practice, and there is a predictable tendency for trial courts to look for culpable parties if an insurance or any other investment purchase causes a significant detriment to a plan.

In both delineating and defending the "normal sales activity" line, it may be useful to develop a standardized document that describes the agent's sales role and disavows the sorts of responsibilities that can lead to fiduciary status. As part of the sales process, the agent would present that document to an independent plan fiduciary, who would acknowledge in writing his or her receipt of it. The document will not determine the "inadvertent fiduciary" issue; the actual facts of the relationship will control. The document may help, however, to demonstrate the parties' intent and to limit their activities to their intended roles.

The most reliable solution to the "inadvertent fiduciary" problem is to utilize ERISA Prohibited Transaction Exemption ("PTE") 84-24 (originally PTE 77-9), which DOL published specifically to resolve fiduciary issues in insurance sales. To qualify for the exemption, the agent must, among other things, provide advance written disclosure of certain product features and fees, including sales commissions. An independent fiduciary must acknowledge the disclosure and approve of the insurance purchase in writing. The requirement of commission disclosure is, of course, contrary to conventional marketing practice. It is important to remember, however, that employee plans eventually will receive that information; the insurance company must disclose to the plan the actual commissions paid, as part of the information on Schedule A necessary to complete Form 5500 annually. Notwithstanding the commission disclosure, some salespeople routinely take advantage of PTE 84-24. Following this exemption may be particularly advisable where the salesperson has an ongoing relationship with a plan that normally relies on the agent's insurance recommendations and does not seek advice from other consultants.

(Reprinted with permission of the author, W. Mark Smith. Mr. Smith, a partner in the law firm of Sutherland, Asbill & Brennan, Washington, D.C., focuses his practice on employee benefits and insurance matters.)