On August 22, 2008, the Department of Labor (“DOL”) issued proposed regulations and a proposed class exemption which implement the statutory prohibited transaction exemption for the provision of investment advice under the amendments made by the Pension Protection Act of 2006 (“PPA”) to the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code (“Code”) pertaining to participant-directed individual account plans and individual retirement accounts (“IRAs”). The proposed regulations and class exemption should expand the ability of financial service providers to provide investment advice to participants and beneficiaries of individual account plans and IRAs.
The proposed regulations and class exemption are slated to become effective 60 and 90 days, respectively, after the final rule is published. In response to the DOL’s request for written comments, 39 comments were submitted to the DOL. The DOL also held a hearing on the proposed regulations on October 21, 2008. DOL officials have recently stated that they expect the final rule to be issued before the end of the year.
The prohibited transaction provisions under ERISA and the Code prohibit a plan fiduciary from using its authority to cause additional fees to be paid to itself or related parties without a statutory or administrative exemption. Consequently, a fiduciary is prohibited from rendering investment advice to plan participants that would result in the payment of additional advisory or other fees to the fiduciary and its affiliates. The PPA amended ERISA section 408, and parallel provisions under the Code, to provide an exemption from the prohibited transaction rules for the provision of investment advice by a fiduciary adviser to participants and beneficiaries of individual account plans and IRAs, for the acquisition, holding and sale of investments pursuant to such advice, and for the receipt of fees or other compensation by the fiduciary adviser and its affiliates in connection with the provision of investment advice and any related investment transactions. The statutory exemption requires that such investment advice must be given pursuant to an eligible investment advice arrangement such as a “level fee” arrangement or a “computer model” arrangement.
The DOL also addressed some of the questions raised under the new law in the form of Field Assistance Bulletin 2007–1 (“FAB”). The FAB clarifies that the new PPA provision did not invalidate or otherwise affect prior guidance issued by the DOL relating to the provision of investment advice, most notably the SunAmerica letter (ERISA Opinion Letter No. 2001–09, 2001). See our April 2007 issue for a detailed discussion of the new law and the FAB on investment advice.
An arrangement must be an “eligible investment advice arrangement” in order to qualify for the exemption. To constitute an eligible investment advice arrangement, the arrangement must, among other requirements, be a level or neutral fee arrangement or satisfy the conditions of a computer model arrangement.
With regard to a level fee arrangement, the proposed regulations require that the advice provided under the arrangement be based on generally accepted investment theories taking into consideration historic returns of different asset classes, and on certain relevant information regarding the participant or beneficiary such as age, life expectancy, retirement age, risk tolerance, and other assets or sources of income. The Preamble to the proposed regulation notes that although ERISA itself not does not specifically reference such conditions, these principles are so fundamental to the provision of informed, individualized investment advice that the failure on the part of a plan fiduciary to insist on such conditions in the selection of an investment adviser would, in the view of the DOL, raise serious questions about the fiduciary’s exercise of prudence. In addition, fees or other compensation received by any employee, agent or registered representative that provides investment advice on behalf of the fiduciary adviser (in addition to any fees received by the fiduciary adviser itself) may not vary depending on the investment option selected by the participant or beneficiary receiving the investment advice. The Preamble states that the individual compensation requirement is designed to safeguard against a firm’s creation of incentives for individuals to recommend certain investment products. The proposed regulations also reiterate the DOL’s view previously stated in the FAB that although the fees and other compensation of the fiduciary adviser may not vary, the prohibition does not extend to the fiduciary adviser’s affiliates who do not themselves provide investment advice to participants and beneficiaries.
In the case of the computer model arrangement, the proposed regulations extend the relief provided under the statutory exemption to the provision of investment advice to IRA holders, although the relief provided under the PPA was initially limited to individual account plans. As in the case of a level fee arrangement, the program must be designed and operated to apply generally accepted investment theories and certain relevant information regarding the participant or beneficiary. The computer model must generally take into consideration all designated investment options available under the plan. The proposed regulations provide that the term “designated investment option” does not include brokerage windows, self-directed brokerage accounts, or similar arrangements. The proposed regulations further clarify that a computer model is not required to take into account an investment option that constitutes an investment primarily in qualifying employer securities.
The proposed regulations provide that, prior to the use of the computer model, the fiduciary adviser is required to obtain a certification from an “eligible investment expert” that the computer model satisfies the requirements of the regulations. The proposed regulations specify the form, content, and manner of provision of the certification provided by the eligible investment expert. While the proposed regulations state that the eligible investment expert must have appropriate technical training or experience and proficiency to analyze, determine, and certify whether a particular computer model meets the applicable regulatory requirements, the proposed regulations do not describe the specific training or education required in order to constitute an eligible investment expert for this purpose. The proposed regulations also establish a procedure whereby a person who develops a computer model used in an arrangement, or markets a computer model arrangement, may elect to be treated as the sole fiduciary adviser with respect to such arrangement. The proposed regulations also describe certain aspects of the exemption’s fiduciary authorization, annual compliance audit, and disclosure requirements. In addition, the proposed regulations contain a model fee disclosure notice. While the use of the model notice is optional, a fiduciary adviser who uses it will be deemed to have satisfied the written disclosure requirements with respect to such information.
Proposed Class Exemption
In addition to the proposed regulations on investment advice, the DOL issued a proposed class exemption designed to complement the proposed regulations by providing relief for individualized investment advice to individuals following the furnishing of recommendations generated by a computer model, or in the case of an IRA, where modeling is not feasible, the furnishing of certain investment education materials. The class exemption requires that the computer model satisfy the conditions of the statutory exemption relating to computer models unless the computer model is developed or maintained by a person independent of the fiduciary adviser and its affiliates. Further, the individualized investment advice must not recommend investment options that would generate greater income for the fiduciary adviser (or any employee, agent, registered representative or affiliate thereof) or certain persons having material contractual relationships with the fiduciary adviser, unless the fiduciary adviser prudently concludes that the recommendation is in the best interest of the participant or beneficiary and explains the basis for such a conclusion to that participant or beneficiary. The employee, agent, or registered representative providing the advice on behalf of the fiduciary adviser must document the basis of any investment options recommended to the participant or beneficiary within 30 days following the provision of investment advice.
The proposed class exemption also applies to the provision of investment advice pursuant to a level fee arrangement where the fees or other compensation received, directly or indirectly, by an employee, agent or registered representative providing advice on behalf of the fiduciary adviser does not vary depending on the basis of any investment option selected by the participant or beneficiary. In contrast to the statutory exemption, the proposed class exemption does not impose a level fee requirement on the compensation received by the fiduciary advisor on whose behalf the employee, agent or registered representative is acting.
The proposed regulations are awaiting clearance from the Office of Management and Budget, and are expected to be finalized by the end of the year. As plan fiduciaries become familiar with the requirements of the final rule, it is likely that more plans will consider taking advantage of eligible investment advice arrangements. It is important to remember that plan fiduciaries will continue to be subject to ERISA prudential standards regarding the selection, monitoring and retention of fiduciary advisers. In order to demonstrate that the standard is met, a fiduciary should ensure that there is proper documentation of the selection process and that the fiduciary adviser’s performance continues to be appropriately monitored.