ERISA bonding – When do advisors need an ERISA bond?
So you’ve broken away—your strategy and your key structures are in place, and you just received notification from custodial that you are required to have an ERISA bond. This bonding requirement comes from the Department of Labor, and you know you need to be compliant with the DOL—but what are the specific requirements? Often, it’s not ideally clear. Obviously, not only do we want the correct bond, but we want to meet what is specifically required with the bond, while not overpaying for it. This post covers the key things you need to be aware of regarding ERISA bonding requirements, with informational reference links throughout.
The first thing we need to recognize is the difference between a 1st party ERISA bond and a 3rd party ERISA bond. These labels are in reference to who the plan sponsor (the “1st party”) is, and who the advisor (the “3rd party”) to the ERISA plan is. If, for example, you have sponsored a 401k plan, then you need a 1st party ERISA bond. A plan sponsor can easily secure these through any generalist broker. Most of the time, they are placed with minimal cost on a 3-year term. 1st Party ERISA bonds can be included with crime coverage (we will discuss crime insurance in a separate post).
When you are the advisor to an ERISA plan, then you serve as that “3rd party” to the plan, and may need to secure a 3rd party ERISA bond. What this also means is that, depending on their structure and the nature of their clients, some firms may need both a 1st and 3rd party ERISA bond (if they are a plan sponsor and an the advisor to an ERISA plan). 3rd party bonds cannot be included in crime bonds, like 1st party ERISA bonds can.
So, you are providing investment advice to an ERISA plan. Do you need a 3rd party ERISA bond? The answer is—it depends. Just as with the exclusions, exemptions, and gray areas that you deal with as an RIA, we need to understand the nuance. The Department of Labor states that only those who “handle” the funds (or other property) of an employee benefit plan are required to be bonded. The DOL then goes on to state that the firm that does “NOT exercise or have the right to exercise discretionary authority with the respect to purchase or selling securities or other property for the plan, is not required to be bonded solely by reason of providing such investment advice.” What this means is, if you have discretionary authority on an ERISA plan, then it is clear you need to secure a 3rd party ERISA bond, unless another exemption applies (the key exemption is for SEPs and SIMPLE IRAs). If you do not “handle” funds on these ERISA assets, then they do not need to be bonded. We completely acknowledge that this definition by the DOL of “handling” meaning “having discretion” is silly to the point of being absurd (because an RIA will almost never have custody of ERISA assets, which is what “handling” assets really implies), but that is the flawed reality before us.
The good news is that 3rd party ERISA bonds are not particularly expensive, although they are still more expensive than a 1st party ERISA bond. The mistake that we frequently see is that most insurance brokers recommend that all ERISA assets be bonded across the board. Even if the bond is not expensive, the cost and complexity of needless insurance coverage is still a mistake. This mistake becomes abundantly clear when the ERISA plans grow to the point where you have multiple plans hitting the $5,000,000 asset limit that is taken into account when bonding.
To simplify the choice of whether to purchase a 3rd part ERISA bond or not, this is the criteria we use. If you are a 3(38) advisor to an ERISA plan, then by definition you have discretionary authority of the plan, and you need an ERISA bond. The RIA is bonded at a firm level, and there is a specific calculation used with the current plans that need to be bonded to establish pricing. So, when you have a new client that has just signed the first 3(38) ERISA advisory agreement, that is the moment you should establish the ERISA bond. We are not going to include any of the AUM that is exempt from bonding (wasteful, needless cost and complexity). Most of the time, we establish 3rd party ERISA bonds on a 2 year renewal cycle, because this helps contain costs while still meeting regulatory requirements.
In the end, let’s make sure you have the correct amount of ERISA bonding—no more and no less than what is required. The ERSIA Bonding covers you if there is theft of funds from the ERISA plan. Your E&O insurance covers you if a plan sponsor or participant makes a claim against the investment advice that has been provided. More likely than not, as an RIA, you do not have custody, so the likelihood is extremely slim that an IAR could steal funds. That said, the DOL is the DOL, and must still address their regulatory requirements. You can explore the links above, or call me and we can walk through the methodology with you.
Written By: Chad Ramberg
Today’s BPI Advice: Have a vetted methodology for the 3rd party ERISA bonding process when you place it. Sticking with a consistent standard will make it easier to make the right bonding choices, and to address questions that anyone might ask about them. Statutes change all the time—when the statute changes, you need to change your standard. That’s why working with a specialist is critical.
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