New Developments Regarding 'Investment Advice Arrangements' under the Pension Protection Act

by ELIZABETH L. GROENEWEGEN
Before enactment of the Pension Protection Act of 2006 (PPA), a dichotomy of sorts had emerged regarding the provision of investment information to participants in an ERISA-governed plan. Plan fiduciaries were fairly comfortable that offering "investment education" to participants was both commendable and relatively risk-free for the plan fiduciaries. In contrast, the provision of "investment advice" raised a number of significant issues regarding fiduciary duties, and particularly, the prohibited transaction rules of the Internal Revenue Code (IRC) and ERISA. First, since the provision of investment advice for a fee fits squarely within ERISA's definition of a fiduciary (ERISA § 3(21)(A)(ii)), the person (or entity) offering the advice would likely be deemed to be a fiduciary. Second, the risk of a prohibited transaction occurring substantially increased if the investment adviser's compensation were in any manner related to the investments selected by participants. This could occur, for example, if the adviser received commissions (or 12b-1 fees) and the level of those fees varied among the investment options offered under the plan. Finally, a plan fiduciary might find itself responsible for the investment advice provided by a service provider under ERISA's co-fiduciary liability provision (ERISA § 405(a)).

The PPA addresses these concerns by providing a new statutory mechanism for providing advice to participants without running afoul of the prohibited transaction provisions of the IRC and ERISA. Section 601 of the PPA exempts provision of investment advice under an "eligible investment advice arrangement" (EIAA) from the sanctions ordinarily imposed upon a prohibited transaction (ERISA § 408(b)(14), ERISA § 408(g), Code § 4975(f)(8)). This article describes the basics of EIAAs, including some of the questions that have been addressed recently by the Department of Labor (DOL). There are a number of significant questions that remain to be answered about advice arrangements and the EIAA rules. Nonetheless, it seems clear that plan sponsors with concerns about the investment acumen of their participants will soon have more opportunities to provide investment advice without substantially increasing the exposure of the plan's fiduciaries under ERISA.

Scope of the Exemptive Relief under the PPA

If an investment advice arrangement satisfies the numerous statutory requirements for EIAAs, the receipt of fees and commissions by the investment adviser will generally be exempt from the prohibited transaction rules. In addition to being exempt from the prohibited transaction sanctions, a plan fiduciary (other than a fiduciary adviser) will not fail to meet the fiduciary requirements of ERISA solely because investment advice is offered in conformity with the new law. This relief applies if:

• the advice is provided under an arrangement between the employer (or other plan fiduciary) and the fiduciary adviser that is structured as an EIAA;

• the terms of the arrangement require the fiduciary adviser to comply with the requirements of the new law; and

• the terms of the arrangement include a written acknowledgement by the fiduciary adviser that the fiduciary adviser is a plan fiduciary with respect to providing the investment advice.

The employer or fiduciary does not have a duty to monitor the specific investment advice given by the fiduciary adviser. Unsurprisingly, the new law does not exempt the employer or a plan fiduciary from fiduciary responsibility under ERISA for the prudent selection and periodic review of the fiduciary adviser chosen to provide investment advice. This role should be familiar to plan fiduciaries; it is their duty in selecting and monitoring service providers generally, and investment advisers in particular.

Statutory Requirements Regarding an Eligible Investment Advice Arrangement

The investment advice must be provided by a "fiduciary adviser." To qualify as an fiduciary adviser under the EIAA rules, one must be:

• registered as an investment adviser under the Investment Advisers Act of 1940 (or similar state securities law);

• a bank (or similar financial institution);

• an insurance company;

• registered as a broker or dealer under the Securities Exchange Act of 1934;

• an affiliate of any of the preceding; or

• an employee, agent, or registered representative of any of the preceding who satisfies the requirements of applicable insurance, banking, and securities laws relating to the provision of investment advice.

The "investment advice" itself may be provided in only one of two ways. First, the advice may be offered on a fee-neutral basis. That is, the fees to be received by the fiduciary adviser for the advice, or with respect to an investment transaction related to the advice, (including any commissions or other forms of compensation) may not vary based upon the investment options selected by participants.

Alternately, the advice may be provided pursuant to certified computer program. The statute includes numerous requirements for an arrangement that uses a computer program. The program must:

• apply generally accepted investment theories based on historic returns of different asset classes over time;

• use relevant information about the particular participant (or beneficiary);

• use prescribed objective criteria to provide asset allocation portfolios comprised of investment options under the plan;

• operate in a manner that is not biased in favor of the fiduciary adviser as to the investments offered; and

• take into account all the investment options under the plan in specifying how an individual's account should be invested without inappropriate weighting of any investment option.

The computer program must be certified by an expert as satisfying the statutory requirements. The qualifications required to be eligible to certify such a program are to be issued in future DOL regulations. In addition, if a computer model is used, the only investment advice that may be provided under the arrangement is the advice generated by the computer model, and any investment transaction made pursuant to the advice must occur solely at the direction of the participant or beneficiary.

There are other requirements imposed upon both the fee-neutral and the computer program arrangements. The EIAA must be authorized by a plan fiduciary unrelated to the fiduciary adviser. An EIAA must be audited annually for compliance with applicable requirements by an independent auditor (i.e., one unrelated to the investment adviser) who has appropriate technical training or experience, and proficiency, and who so represents in writing. The auditor is required to issue a report to the fiduciary that authorized use of the arrangement.

A fiduciary adviser must also provide a notice to participants before offering any advice under the arrangement. The notice must include:

• the role of any party that is affiliated with, or contractually related to, the financial adviser regarding the investment advice arrangement and the investment options available under the plan;

• the past performance and historical rates of return of the investment options available under the plan;

• all fees or other compensation that the fiduciary adviser (or an affiliate) is to receive regarding the investment advice arrangement (including compensation provided by any third party);

• any material affiliation or contractual relationship of the fiduciary adviser (or its affiliates) in the securities or other property offered as investments under the plan;

• the manner in which, and under what circumstances, any participant or beneficiary information provided under the arrangement will be used or disclosed;

• the types of services provided by the fiduciary adviser in connection with the provision of investment advice by the fiduciary adviser;

• an acknowledgement that the adviser is acting as a plan fiduciary in connection with the provision of the advice; and

• a statement that the participant is free to arrange for investment advice from another adviser that would have no affiliation with (and receive no fees or other compensation in connection with) the securities or other property offered under the plan.

The certification of the computer model and the qualifications of those eligible to offer such certification will be made pursuant to formal guidance from the DOL. Also, the statute calls for the DOL to provide a model for the disclosure of fees to be included with the notice for participants. Thus far, the DOL has not published such guidance. The DOL has recently issued informal guidance that answers some of the questions raised under the new law.

New Guidance Regarding Investment Advice Arrangements

The DOL addresses some of the questions raised under the new law in the form of Field Assistance Bulletin 2007-1 (the "FAB"). First, the FAB states that fiduciaries may continue to rely upon the previously published guidance regarding investment advice. In particular, the FAB emphasizes that the reasoning articulated in the existing guidance reflects the current views of the DOL, which of course must take into account PPA section 601. It seems reasonable to conclude that the DOL believes that Congress followed the tenor of the existing guidance in crafting the new statutory authority regarding investment advice arrangements.

Four pieces of guidance are specifically noted in the FAB: one is an interpretive bulletin (Interpretive Bulletin 96-1) and the other three are opinion letters (Advisory Opinion Nos. 97–15A, 2001–09A and 2005–10A). In each, the DOL concluded that certain aspects of particular investment advice arrangements did not give rise to violations of ERISA, and in particular of the prohibited transaction rules. Fiduciaries and advisers interested in implementing an arrangement for the provision of investment advice can continue to look to these documents for guidance.

The viability of current advice arrangements is underscored by the second point made in the FAB. An investment advice arrangement is not required to be an EIAA to be in compliance with ERISA. The selection and retention of a "fiduciary adviser" (as defined under the new law) is subject to the same general standards of prudence that apply to the selection and retention of any investment adviser under ERISA. If the plan fiduciary exercises appropriate prudence in selecting an investment adviser, that fiduciary will not be liable for the advice furnished by the provider, regardless of whether the advice is provided under an arrangement that otherwise qualifies as an EIAA.

The final point made by the DOL in the FAB involves the concept of fee neutrality. The FAB makes clear that the ‘level fee' requirement applies to the fiduciary adviser who is rendering the advice under the EIAA only, and not any of its affiliates (unless they are also providing advice to the plan participants). For this purpose, it is important to note that an employee or agent rendering advice on behalf of the fiduciary adviser is not an affiliate. The acts of the fiduciary adviser and the employees and agents of the fiduciary adviser are subject to the level fee requirement. If an affiliate of a fiduciary adviser is otherwise involved with a plan, the affiliate's activity with respect to the plan should be maintained separately to avoid issues arising under the fee neutrality standard. Clear documentation of the plan's relationship with each plan service provider would assist in meeting this objective.

Conclusion

As plan fiduciaries become acquainted with the new EIAA rules, it seems likely that more plans will elect to take advantage of such an arrangement, particularly since the cost of the arrangement may be paid from plan assets. As is generally the case with any decision subject to the standards of ERISA, however, care should be taken. A plan fiduciary will be subject to ERISA's standard of prudence regarding the selection, monitoring, and retention of a fiduciary adviser. To demonstrate that the standard is met, the fiduciary should follow the dictates of procedural prudence and retain records sufficient to demonstrate how the selection was made and that the adviser's performance continues to be appropriately monitored.

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