The Ups and Downs of the Federal and State Framework

Here we go: Up and down, around and around. Step right up and hop on the legal and

regulatory roller coaster.

PEOs are no strangers to this wild ride, but in times like these, it’s not any less exhilarating, or nauseating, as the case may be.

On the federal level, these measures are currently in flux as the new administration comes in:

  • The Department of Labor’s (DOL’s) fiduciary rule;
  • Blacklisting rules and a minimum wage increase for federal contractors;
  • The new overtime regulations under the Fair Labor Standards Act (FLSA);
  • The applicability of joint employer status to PEOs; and
  • The allocation of client and PEO responsibility for Occupational Safety and Health Administration (OSHA) and state rules for recordkeeping obligations and worker safety.

One thing that is not in flux is the new EEO-1 form: The old form had 121 data points, while the new one has 3,360. PEOs should be ready for this new twist, however, because the Equal Employment Opportunity Commission (EEOC) for the first time will use analytics software to identify indicators of potential discrimination on the front end.

On the state level, the rules in the states and local jurisdictions remain a jumble. State licensing and registration laws offer a mix and match variety of provisions addressing everything from direction and control to hiring and firing and treatment of taxes to benefits payments. Human resources and employment laws, governing things such as “ban the box” rules and paid sick leave, can vary down to the local level. Proposals designed to raise revenue, which affect PEOs, are on the rise among the states.

Finally, two PEO execs offer their experience keeping up with and navigating issues in the states, which may make your journey a bit smoother.

So, hang on, and don’t be surprised if by the end of the ride things have changed again.

The Effect of the Department of Labor Fiduciary Rule on PEOs

On April 8, 2016, the Department of Labor (DOL) published a final regulation defining who is a fiduciary of an employee benefit plan under Section 3(21)(A)(ii) of the Employee Retirement Income Security Act (ERISA) as a result of giving investment advice to a plan or its participants. The final rule also applies to the definition of a fiduciary of a plan under Section 4975e(3)(B) of the Internal Revenue Code of 1986, as amended (Code), which includes individual retirement accounts (IRAs).

The final rule treats persons who provide investment advice or recommendations for a fee or other compensation with respect to assets of a plan or IRA as fiduciaries to a wider array of advice relationships than was true of the definition under DOL regulations issued in 1975. On the same date, the DOL published a new prohibited transaction class exemption and amended existing prohibited transaction class exemptions the purpose of which was to allow, subject to appropriate safeguards, certain broker-dealers, insurance agents, and others who previously did not regard themselves as ERISA fiduciaries, that act as investment advice fiduciaries, to continue to receive a variety of forms of compensation that would otherwise violate prohibited transaction rules, triggering excise taxes and civil liability.

The new definition of fiduciary and the related prohibited transaction exemptions became effective on June 7, 2016, with an applicability date of April 10, 2017. President Trump, by memorandum to the secretary of labor dated February 3, 2017, directed the DOL to examine whether the final fiduciary rule may adversely affect the ability of Americans to gain access to retirement information and financial advice, and to prepare an updated economic and legal analysis concerning the likely impact of that final rule as part of the examination.

In response to the memorandum, on March 2, 2017, the DOL proposed a 60-day delay of the applicability date, until June 9, 2017. The DOL proposed a 15-day comment period, which would provide the DOL with slightly more than two weeks to review the comments and publish a final rule. However, the comment period for the broader purpose of examining the final fiduciary rule and exemptions is a 45-day period, ending on April 17. Upon completion of its examination, the DOL could allow the final rule and prohibited transaction exemptions associated with it to become applicable, issue a further extension of the applicability date, propose to withdraw the rule, or propose amendment to the rule and the prohibited transaction exemptions. At the time this article was drafted, it was uncertain which of these outcomes would occur.


How would PEOs be affected if the DOL Fiduciary Rules were to be implemented without any modifications? PEOs were certainly not the targets of the revised fiduciary rule—entities that were primarily affected were broker-dealers, consultants, and insurance agents who under the 1975 regulations were able to take the position that they were not ERISA fiduciaries. For example, broker-dealers need to satisfy the Financial Industry Regulatory Authority (FINRA, formerly the National Association of Securities Dealers, or NASD) standards of suitability when selling to a plan or a participant, but they would not be subject to the ERISA fiduciary standards. In contrast, under the DOL fiduciary rule and particularly under the Best Interest Contract Exemption, if an individual or a plan fiduciary hired a financial advisor to assist with retirement planning and assets, the financial advisor would need to act in the best interest of the plan or the participant, avoid prohibited transactions, and be transparent with his or her compensation.

If a PEO is the sponsor of a 401(k) plan, it almost certainly is already an ERISA fiduciary, and probably in multiple capacities. Under Section 3(21) of ERISA, without regard to the DOL Fiduciary Rule or even its predecessor regulation, a person is a fiduciary if he or she:

  • Exercises any discretionary authority or discretionary control over the management of a plan;
  • Exercises any management or control respecting the management or disposition of its assets; or
  • Has any discretionary authority or discretionary responsibility with respect to the administration of the plan.

Applying these rules, the PEO will be the administrator of the plan under Section 3(16) of ERISA because it will either be designated as the administrator in the plan document, or, if the plan document is silent, it will be the administrator. An administrator is a per se fiduciary under ERISA, and while this might appear to be a status that the PEO could live with—because under ERISA, being a fiduciary for one purpose generally does not make an entity a fiduciary for all purposes—it is one that under current law exposes the PEO to potential significant liability if the DOL were actively to pursue its closed multiple-employer plan (MEP) theory to PEOs. Under that theory, a PEO sponsoring a multiple-employer plan under Internal Revenue Code Section 413(c) would be regarded as sponsoring a series of single-employer plans under ERISA. The plan document would most likely provide that the PEO is the party that has the ability to interpret the plan, which is another type of fiduciary activity. The PEO would also be the party that selects and monitors the performance of the service providers to the plan, which involves not only ensuring that the fees are reasonable, but also evaluating the quality of services. Most importantly, under Section 402(a)(1) of ERISA, an employee benefit plan such as a 401(k) plan must have a named fiduciary who has the authority to control and manage the operation of the plan, and the PEO is the likely candidate here as well.

Unlike other fiduciaries under ERISA Section 3(21), who are fiduciaries only to the extent that they perform certain functions, the named fiduciary is effectively the quarterback of the 401(k) plan and needs to understand all of its operations. This is not to say that there are no circumstances under which a PEO could become an ERISA fiduciary by providing investment advice for compensation. For example, if a PEO were speaking to a potential client that was operating its own 401(k) plan unsuccessfully and was considering entering into a client service agreement (CSA) with a PEO, if the PEO were, as part of its description of the 401(k) plan, to reference the successful performance of the investment options under the plan, that recommendation would make the PEO an investment advice fiduciary. However, if a PEO is dealing with a potential client that does not maintain a plan and is solely an employer, the fiduciary rule would have no effect, because under ERISA no fiduciary obligations are owed to an employer, and an employer who is not also a plan fiduciary generally cannot maintain a civil action under Section 502 of ERISA for breach of fiduciary duty.

However, the PEO could be affected by the DOL fiduciary rule in its capacity as a plan sponsor. In one sense, the DOL fiduciary rule has no effect upon plan sponsors, who will be subject to the same basic fiduciary duties as they currently are:

  • The duty of prudence;
  • The duty of loyalty;
  • The duty to diversify plan assets;
  • The duty to administer the plan in accordance with its terms; and
  • The duty to ensure that any expenses chargeable to the plan are both reasonable in nature and are attributable to administrative rather than settlor functions.

However, a plan sponsor’s relationship with its service providers may change, particularly if the DOL fiduciary rule changes that person’s status from non-fiduciary to fiduciary. The disclosure required under ERISA Section 408(b)(2) will change because additional disclosure is required from fiduciaries, and the contract with that service provider will also need to be modified. The service provider may increase its fees to address the increased exposure that it has as an ERISA fiduciary. While this is entirely permissible under ERISA, the PEO will need to ensure that the increased fees are within the reasonable range. Also, there is a concept under ERISA of co-fiduciary responsibility, and the presence of another fiduciary means that there is also an increased risk of co-fiduciary liability.

The usual cautionary note about needing to consult with counsel is multiplied with respect to the DOL fiduciary rule because it is such a moving target. For example, efforts by the DOL to delay the applicability date of the fiduciary rule may be subject to legal challenge, or the rule may be rescinded. It is safe to say that a regulatory update one year from now will almost certainly be quite different from this one.

Barry Salkin, Esq. is of counsel at Wagner Law Group, Boston, Massachusetts.

This article is designed to give general and timely information about the subjects covered. It is not intended as legal advice or assistance with individual problems. Readers should consult competent counsel of their own choosing about how the matters relate to their own affairs.

Posted by:

Rada Kleyman
Risk Manager

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