Prudent Management of IRAs: Conflicts and Prohibited Transactions | Faegre Drinker Biddle & Reath LLP | Jobs Vox


Key receivers

  • If an investment advisor charges different fees to manage fixed income in a portfolio and makes the decision to determine the allocation between the two in an IRA, the investment advisor controls the fee, which appears to violate the prohibited transaction provision. In the Internal Revenue Code.
  • The breach can be fixed without notice by using a combined rate where both allocations pay the same amount. In other words, there will be only an account fee, not a fee that varies by allocation under the investment adviser’s control.
  • There are other solutions as well, including turning the classes into positive advice.


Both the Internal Revenue Code (Code) and the Employee Retirement Income Security Act of 1974 (ERISA) contain prohibited transaction provisions that literally prohibit certain transactions (unless there is a statutory or prohibited transaction exemption). Qualified retirement plans governed by ERISA are prohibited by ERISA and the Code. However, self-directed IRAs are subject only to the Code’s prohibitions. In this regard, Law No. 4975(c)(1)(E) and (F) states the following.

(c) Prohibited Transactions

For the purposes of this section, the term “prohibited transaction” means any direct or indirect transaction;

(e) the proceeds or assets of the scheme are dealt with by an unauthorized person who is a trustee for his own benefit or account. Or

(f) Any unauthorized person who is a trustee of any party to the scheme in any transaction involving the income or assets of the scheme for his own personal account.

In plain English, subsection (e) means that a fiduciary advisor cannot manage IRA investments in a way that benefits the advisor. For example, a fiduciary advisor may negotiate a fee of 1% (or 100 basis points) for managing an equity portfolio and 70 basis points for managing a fixed income portfolio smoothly (as long as the amount is reasonable for the services provided). However, when the fiduciary advisor is able to move funds from one portfolio (or portion of a portfolio) to another, and the fees are increased by the movement of funds, the advisor handles “plan” assets (including IRAs). For his own sake. In fact, it is conceivable that the IRS could take the position that, if the fiduciary advisor has the discretion to allocate the entire portfolio to fixed income investments, any allocation to stocks (with high fees) would be a prohibited transaction.

As an extreme example, the advisor in this hypothetical scenario had half of the portfolio in stocks (fees for 100 basis points) and half in fixed income (for 70 basis points), but unilaterally moved the fixed income allocation to equities—thereby increasing the advisor’s value to 100 By maximizing the assets, the fiduciary advisor was using his discretion for his personal benefit or account, which is a prohibited transaction.

Before I go any further, I should point out that ERISA defines a fiduciary advisor to include an advisor who administers any IRA or plans the estate on a discretionary basis – in contrast to the one-part test, that the advisor has discretion. To quote the statute (§ 2510.3-21(c)(1)), if a person is fiduciary:

Such person directly or indirectly (eg, through any partnership or together) –

(a) has, by agreement, arrangement or understanding, binding authority or control to buy or sell securities or other assets for the scheme; …”

To avoid possible confusion, the use of the word “plan” in the specified language includes IRAs for purposes of the prohibited transaction rules. (look up Code section 4975(e)(1)).

Returning to the example, if the fiduciary advisor used a composite fee; example85 basis points, the advisor may have the discretion to shift investments between equities and fixed income without being subject to this restricted trading rule – because those changes may not increase the advisor’s fee.

An alternative solution is to change the classification to unsolicited—which means that changes to the classification are made only with the client’s consent, and then rely on and comply with Restricted Transaction Exemption 2020-02. For firms that comply with that PTE (for example, to advise a rollover), a practical approach is to allow the adviser to maintain different fee levels for fixed income and equities (and possibly additional asset classes). The rules.

Both of these solutions require thought and documentation. As a result, they should only be implemented in consultation with an attorney knowledgeable about these issues and regulations.

Although this clause focuses on distributions between classes of assets for which the advisor charges different fees, the prohibited transaction rules apply to any use of the income or assets for the benefit of the fiduciary advisor. That includes, for example, proprietary investments (example, mutual funds) in managed accounts. The issues of this type of arrangement are more complex. For example, there is an exemption that allows the invoice to be the higher of the two fees (ie, the account fee or the fund fee), but that approach is not an attractive option in most cases. PTE 2020-02 provides opportunities for organizations willing to comply with the exemptions to use the non-root system.

At the beginning of the article, I mentioned Subsection (F) of the Prohibited Transactions Code. It’s a slightly different prohibition. For example, it applies to payments from custodians and 12b-1 payments (or other payments) from mutual funds or their affiliates. But that’s for another article in the future.


It is clear that regulatory and enforcement attention has shifted to rollover IRAs—witness PTE 2020-02. I think the regulators’ focus will be on IRAs in general as well. As a result, it is time to review the practices related to IRAs and ensure that the practices of investment advisors (and other investment professionals) are in compliance with ERISA and the Internal Revenue Code and, in particular, the prohibited transaction rules. This article will help identify some practices that can cause problems.


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