DOL Publishes Guidance on 401(k) Plan and IRA Investment Advice

March 12, 2010

Since its inception, the Employee Retirement Income Security Act of 1974 (ERISA) has prohibited certain transactions that could lead to conflicts of interest and self-dealing by plan fiduciaries. Recently, both Congress and the Department of Labor (DOL) have expressed concern that some fiduciaries, namely those who provide investment advice for a fee, have provided investment advice to participants that could maximize fiduciary fees or other compensation.

The Pension Protection Act of 2006 (PPA) amended the Internal Revenue Code (the Code) and ERISA to add a new exemption to the prohibited transaction rules and excise taxes for advice provided under “eligible investment advice arrangements” in individual account plans and individual retirement accounts (IRAs). This exemption permits “qualified investment advisers” to give investment advice to 401(k) and other plan participants who direct the investments of their accounts, without running afoul of the prohibited transaction rules.

On February 26, 2010, the Department of Labor (the DOL) published proposed regulations on the investment advice exemption (the 2010 Proposed Regulations) to replace the prior regulations that were published in final form during the final days of the Bush Administration and were later withdrawn by the DOL. Our WorkCite article on the original guidance may be viewed here. The 2010 Proposed Regulations specifically implement the statutory prohibited transaction exemptions under Sections 408(b)(14) and 408(g) of ERISA and sections 4975(d)(17) and 4975(f)(8) of the “Code.

General Exemptions for Fee-Leveling and Computer Model Arrangements

The ERISA prohibited transaction rules generally prohibit investment advisers from giving advice to ERISA-covered individual account plans and IRAs on investments that generate additional income for advisers or their affiliates. However, the DOL has previously approved certain prohibited transaction exemptions that permit an investment adviser and its affiliates to receive variable compensation, and some investment advice programs are designed to satisfy the prohibited transaction rules, including the “SunAmerica Program,” which also involves the use of a computer model developed by an independent third party to provide investment advice.

In addition, the PPA amendments to ERISA and the Code exempt investment advice under an “eligible investment advice arrangement” from the prohibited transaction rules. Generally, an “eligible investment advice arrangement” exists where:

  • Any fees (including any commissions) received by the fiduciary adviser for investment advice or for the sale, holding, or acquisition of any security or other property for purposes of investment of plan assets do not vary on the basis of the investment option selected (fee-leveling exemption); or
  • The fiduciary adviser uses a computer model that is certified by an independent third party as being unbiased in connection with providing investment advice (computer model exemption)

Effective Date

Comments on the 2010 Proposed Regulations are due by May 5, 2010. When the regulations are finalized, the DOL proposes to make them effective 60 days after their publication in the Federal Register.

Changes from the January 2009 Regulations

The DOL has stated that the 2010 Proposed Regulations are “nearly identical” to the final regulations issued in January 2009. The two significant changes included in the 2010 Proposed Regulations:

  • Elimination of the prohibited transaction class relief that was previously available under the January 2009 regulations for individualized investment advice to persons following the furnishing of recommendations generated by a computer model or, in the case of IRAs for which modeling is not feasible, the furnishing of certain investment education material; and
  • Clarification that prohibited transaction relief for advice arrangements that provide for fee-leveling for the individual employee, agent, and registered representative must also prohibit financial incentives from an affiliate to the fiduciary adviser to favor certain investments.

These revisions to the January 2009 regulations were prompted by criticism from members of Congress and others that the January 2009 regulations created conflicts of interest for fiduciary advisers.

Overview of New Proposed Regulations

Fee-Leveling Exemption

  • The level-fee requirement is applied at the individual and entity level. This means that neither the fiduciary adviser providing the advice, nor any of its employees, agents, or registered representatives, may receive any direct or indirect fee or other compensation that varies in whole or in part on a participant’s selection of an investment. Compensation includes commissions, bonuses, salary, awards, promotions and “other things of value.”
  • An affiliate of the adviser may receive fees that vary depending on the investment options selected. However, none of those fees may flow to the fiduciary adviser or any of its employees, agents or registered representatives.

Computer Model Exemption

  • Computer models must be certified in advance as being unbiased and meeting the exemption’s requirements by an independent expert. There are specific qualification requirements and a selection process for determining who may be an independent expert.
  • The computer model must avoid investment recommendations within an asset class on the basis of a factor that cannot confidently be expected to persist in the future. Past investment performance will not be considered an appropriate criterion.
  • The computer model must take into account “all designated investment options … available under the plan” with certain exceptions, such as employer securities, target date or life cycle funds, and annuities. If the plan offers a brokerage window, those investments are not designated investment options and need not be taken into account.

Requirements for Both Exemptions

  • A plan fiduciary or IRA beneficiary (independent of the investment adviser and its affiliates) is required to select the computer model or fee-leveling arrangement.
  • Investment advisers relying on either exemption must abide by certain recordkeeping requirements.
  • There must be an annual independent audit of compliance with the regulations, including a certification that the auditor is independent from the investment advice provider.

Disclosures Required

The 2010 Proposed Regulations maintain the disclosure requirements that were set forth in the original regulation. They also include a model disclosure form.

New Proposed Regulations’ Estimated Benefits

The DOL estimates that the 2010 Proposed Regulations will result in a net improvement in participants’ investment results of between $4 billion and $8 billion. This will be due to:

  • Greater availability of quality, expert investment advice to more retirement plan participants;
  • Improved investment advice and better investment decisions by participants; and
  • Reductions in investment errors such as poor trading strategies and inadequate diversification.

While the 2010 Proposed Regulations are clearly more restrictive than the regulations that they replace, it is by no means clear that they will satisfy individuals in Congress who have sought specific legislation regulating such investment advice.

Other plan fiduciaries, such as the plan sponsor and plan administrator, must continue to comply with ERISA’s fiduciary standards in selecting investment advisers and approving their compensation and computer model, if applicable. Accordingly, other plan fiduciaries should not assume that this prohibited transaction exemption relieves them of these fiduciary duties.