The Investment Advisor Body of Knowledge + Test Bank - IMCA

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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

      Consultants should pay particular attention to items (1) and (2). In general, as a disqualified individual, the consultant should not benefit from the relationship as the guidelines describe above.

      Laws and Regulations

      Consultants must be aware of different laws and the application of those laws for their clients. The laws serve as a basis of rules that ultimately are designed to protect the beneficiaries and plan participants that are covered.

      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. Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985 and Health Insurance Portability and Accountability Act (HIPAA) of 1996 also are covered under ERISA.

      The Department of Labor, Internal Revenue Service (IRS), and the Pension Benefit Guarantee Corporation (PBGC) each have responsibilities under ERISA.

      The Department of Labor is responsible for the fiduciary and reporting requirements for company-sponsored ERISA plans such as 401(k)s, profit sharing plans, and defined benefit plans. Companies that sponsor these plans must disclose to their employees information about the financial health of the plan, how to participate, and other information that can allow employees to make informed decisions. Business owners and investment advisors can be sued by plan participants for breach of this fiduciary duty.

      Though not a requirement, section 404(c) of ERISA provides minimum responsibilities and disclosures that plan participants should be provided with to lessen (but not eliminate) fiduciary liability. If the plan is intended to be compliant with section 404(c), plan participants must be explicitly made aware.

      Minimum standards for participation, vesting, benefit accrual, and funding are provided for under ERISA and administered by the IRS. Certain standards must be met for these plans to receive favorable tax treatment; otherwise the IRS can disqualify the plans and assess penalties. The rules that plans must follow to maintain tax benefits include the following: pension plans must offer joint and survivor options and any ERISA plan cannot discriminate in favor of highly compensated employees or officers.

      The Pension Protection Act of 2006 (PPA) specified two vesting options for any defined contribution plan offered by an employer. Participants can either become 100-percent vested in employer contributions after three years (cliff vesting) or gradually vest by 20 percent annually until 100-percent vested.

      Employee contributions to a defined contribution plan are always 100-percent vested. Defined benefit plan vesting schedules differ slightly. Instead of a three-year lump vesting schedule, defined benefit plans can vest at 100 percent for up to five years of service. Alternatively, 20 percent of the plan can vest each year starting in year three.

      Minimum funding rules established by ERISA and the PPA are meant to keep defined benefit plans properly funded for their beneficiaries. The PBGC provides a form of insurance for defined benefit plans only and does not provide protection for defined contribution plans such as 401(k) plans. If a pension plan cannot meet its obligations to its beneficiaries, the PBGC takes over the plan and provides some amount of pension benefit up to a guaranteed maximum that is adjusted annually.

      A defined benefit plan sponsor may terminate a plan in either of two ways:

      (1) a plan may undergo a standard termination when assets exist to provide benefits promised to the participants; (2) a distress termination occurs if the plan sponsor voluntarily terminates the plan, but there are either not enough assets to fund each participant's benefit or providing the benefits could potentially put the sponsor out of business. The PBGC also can initiate a plan's takeover on its own if it determines that a plan is unsustainable.

      In addition to employer plans, ERISA also gave rise to the individual retirement account (IRA) or individual retirement arrangement, allowing individuals to defer taxes on some savings without necessitatingan employer-sponsored plan.

      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. COBRA is most widely known for allowing a participant to continue under employer-provided health coverage for a limited period of time under certain conditions after separation from employment. COBRA also prohibits employers from limiting participation in retirement plans for new employees close to retirement age and freezing benefits for participants 65 or older.

      HIPAA intended to make health insurance more portable by eliminating pre-existing conditions as the basis for an employer to refuse coverage in some cases. HIPAA also prevents the refusal of coverage due to health status, genetic information, or disability.

      Uniform Prudent Investor Act (UPIA)

      UPIA was adopted in 1992 and essentially updates the Prudent Man Rule.

      UPIA makes it possible for investment managers and fiduciaries to manage a portfolio using methodologies from modern portfolio theory. Measurement of a portfolio's performance is based on the entire portfolio and not each individual underlying asset. Individual securities, once considered too risky to include in a portfolio, such as commodities, futures, and derivatives, now are acceptable, based on the concept of managing a portfolio's overall risk.

      Because UPIA now puts greater emphasis on the total return of a portfolio, fiduciaries should consider the impact on the portfolio caused by general economic conditions, inflation or deflation, tax consequences, the purpose of each individual investment within the total portfolio, other resources available to the beneficiaries, liquidity needs, and any special value or relationship any beneficiary or beneficiaries have with an asset.

      One of the major complaints of the previous Prudent Investor Rule was that it did not specifically allow trustees to delegate investment management. UPIA corrects this oversight, allowing for professional investment management when this better fulfills the purpose of the trust.

      Uniform Management of Institutional Funds Act (UMIFA) and Uniform Prudent Management of Institutional Funds Act (UPMIFA)

      UPMIFA was designed to replace UMIFA. Both UMIFA and UPMIFA are at the core of law for endowments and charities. They provide rules regarding the guidelines for amounts a charity or endowment can spend and on what they can spend the funds. They also provide rules for the investment of funds.

      UMIFA and UPMIFA differ based on the historical dollar value rule.

      UMIFA considered the historical dollar, while UPMIFA states that institutions “may appropriate for expenditure or accumulate so much of an endowment fund as the institution determines to be prudent for the uses, benefits, purposes, and duration for which the endowment fund is established.” In general, it is believed that the UPMIFA rules brought UMIFA up

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