On January 21, 2009, the Department of Labor (DOL) published in the Federal Register its final regulations implementing the ERISA participant investment advice exemptions enacted in the Pension Protection Act of 2006 (PPA). That guidance is the culmination of the most substantial effort to date, on the part of Congress and DOL, to support retirement plan participants and IRA beneficiaries directing the investment of their retirement accounts with professional investment advice. At this time, however, it is unclear whether the Obama Administration or the new Congress will allow that guidance to take effect — further delaying both business plans and, in turn, the important objective of expanding the reach of investment advice for plan participants.  

Background and Status

The shift, over the past 20 years, in employer-sponsored retirement plans away from defined benefit plans to defined contribution plans has been well-documented. For both design and legal reasons, those defined contribution plans most often allow participants and beneficiaries to direct the investment of some or all of their plan accounts. Also, an increasing share of retirement savings is shifting to individual retirement accounts, where the IRA beneficiary necessarily is making investment choices.  

These trends had the unintended consequence of reducing the portion of retirement assets that are invested with the benefit of professional investment advice. Moreover, the firms best positioned to provide that advice — the retirement platform, product and service providers that evolved to serve the defined contribution and IRA markets — often were impeded by ERISA from providing investment advice. To the extent those providers (or an affiliate) had an economic stake in the investment options available and thus in the investment choices made under the retirement plan or IRA, an ERISA prohibited transaction generally would occur if the investment advice would cause the provider to be an ERISA fiduciary. (Providing “investment advice for a fee,” within the meaning of ERISA § 3(21) and an implementing regulation, is one of the three ways to become an ERISA fiduciary.)  

As the trend toward participant direction emerged, DOL issued guidance elucidating circumstances in which investment support for participants would not raise a prohibited transaction concern:  

  • Investment “education” is not, in DOL’s judgment, investment “advice” and thus can be provided to participants without committing a prohibited transaction.1
  • If properly structured, the investment advice function can be outsourced to an independent financial expert, as a means to avoid the prohibited transaction concern.2
  • Similarly, reducing the amount due to the provider for its services by the fees or other economic benefits accruing to the provider or its affiliate by reason of the investment choices made under the plan — that is, enterprise-wide fee leveling — avoids the prohibited transaction concern.

Also, certain class exemptions issued by DOL providing relief for specific investment transactions at least arguably include relief for any investment advice leading to those transactions. Where prohibited transaction concerns were present, however, there was no comprehensive ERISA solution for providing investment advice to participants, and that regulatory gap (coupled with incremental cost of investment advice) meant that no more than 10% of participants and IRA beneficiaries were making investment choices with the benefit of professional assistance.  

Recognizing the importance to national retirement security of improving the quality of the investment choices made by plan participants and IRA beneficiaries, Congress undertook in the PPA to provide at least that comprehensive legal solution. Both the House and Senate versions of the bill contained an investment advice exemption that would allow these well-positioned providers, among others, to offer investment “advice” without enterprise-wide fee leveling; a more conditional exemption was included in the House bill, a somewhat less conditional version in the Senate bill. The conference committee agreement generally favored the House version, which was enacted as § 601 of the PPA and provides relief for certain level fee and computer model advice arrangements.  

Following enactment, DOL engaged in a considered, two-year process to develop guidance implementing the new exemption.  

The final regulations, described below, are faithful to the requirements of the statutory exemption, and enhance the likelihood that these arrangements will be feasible in practice and will actually improve investment results for participants and IRA beneficiaries. The regulations also address important questions left to the regulators by Congress.  

The regulations were approved in the final two weeks of the Bush Administration and published in the Federal Register on January 21, 2009, the first full day of the Obama Administration, with an effective date of March 23, 2009.  

On the afternoon of January 20, consistent with a practice dating to the Reagan Administration, one of the first acts of the Obama White House was to issue a memorandum to federal departments and agencies effectively suspending any unpublished proposed or final regulations and requesting that the effective date for any published final regulations not yet in effect be delayed for 60 days with the notice-and-comment period reopened for 30 days. It is reported that career DOL officials gave immediate attention to the White House directive and determined that it was not possible to withdraw the investment advice regulation before publication in the Federal Register, while noting that the regulation was not yet in effect — perhaps presaging further reconsideration at DOL when Obama political appointees are confirmed there.

Further clouding the status of the regulation, Representative George Miller (chair of the House Committee on Education and Labor, which has jurisdiction over ERISA) and Representative Robert Andrews, in a joint statement, were highly critical of the Bush Administration’s promulgation of the regulation in its final days and announced that they would undertake to block its implementation. In a competing statement, House Minority Leader John Boehner applauded the regulation.  

Accordingly:  

  • The timing of the regulation inevitably means that the political establishment will continue to compete over this issue;
  • Business plans to expand investment advice offerings to plan participants and IRA beneficiaries that are contingent on the PPA exemptions almost certainly will remain on hold until that political competition is resolved; and
  • The status quo, which nearly all agree is less than optimal, will continue to prevail at a time — of historically atypical volatility in the capital markets in general and underperformance of the equity markets over a 10-year period in particular, including a second significant bear market in less than a decade — when the need for professional investment advice to assist the long-term retirement savings goals of plan participants and IRA beneficiaries could not be clearer.  

Final Regulations

The final regulations materially change the form of the proposed guidance, merging the proposed administrative class exemption for certain transactions into the final regulation. The administrative exemption expands the statutory relief, subject to additional conditions, to:  

  • Arrangements that satisfy the level fee requirement as to the individual employee, agent or representative who provides investment advice, but not as to the fiduciary adviser entity; and
  • “Off-model” individualized advice, generally in a computer model environment.  

Statutory Exemption. The substance of the statutory prohibited transaction relief, which is described in detail in the chart beginning on page 7, largely follows the proposal with certain modifications and clarifications, including the following:  

  • Effect of Exemptions. Investment advice arrangements for participants are not obligatory for plans or plan fiduciaries, nor do the PPA exemptions (as stated in FAB 2007-1) supersede any other available guidance or relief for investment advice arrangements.
  • Scope. Transactions in connection with the provision of investment advice, for which relief is provided by these exemptions, includes otherwise permissible transactions necessary for the efficient execution and settlement of trades, including credit extensions in connection with settlements. Advice concerning the selection of an investment manager to manage some or all of the participant’s account also is within the scope of the exemptions. The rebalancing of an account to an asset allocation strategy authorized by the participant, including a dynamic rebalancing approved by the participant through a conventional negative consent process, can rely on the exemptions provided that the particular investments are known to the participant at the time of authorization. DOL opined, however, that these exemptions are not available for a recommendation to take a distribution from the plan and roll it over to an IRA managed by the fiduciary adviser.
  • Factors to Be Considered. The rules for both level fee and computer model arrangements were revised (1) to require consideration of investment management and other fees and expenses attendant to the recommended investments and (2) to recognize that the adviser will not always be provided or have access to the personal variables about the participant enumerated in the statute and regulation (which also were modified in part to refer to “time horizons” rather than retirement age or life expectancy).
  • Level Fee Arrangements. DOL reiterated and defended its conclusion that the level fee requirement attaches only to the fiduciary adviser, and not to its affiliates of the fiduciary adviser. In this regard, DOL commented that bonus arrangements based on the overall profitability of the organization might be consistent with that requirement if the investment advice arrangements were excluded from or constituted a “negligible portion” of that profitability, depending on the details, which would be a subject for the annual compliance audit, under the exemption.
  • Computer Model Arrangements. While computer models need not provide recommendations with respect to employer securities, they must take those holdings into account in generating their advice, unless the participant elects otherwise. Similarly, investment options that inherently manage to time horizon or risk objectives of the participant (e.g., target date funds) or in-plan annuity options need not be included in the advice, provided that the participant receives a description of those investments contemporaneously with the advice. DOL allowed IRA computer models to limit “buy” advice to investments that can be purchased through the IRA (even where the model can handle hold or sell recommendations for other investments), provided that limitation is made clear to the IRA beneficiary. DOL again declined to describe (much less proscribe) the credentials for the eligible investment expert who must certify the computer model.
  • Authorization by Plan Fiduciary. An adviser may act as the authorizing fiduciary for its own plan provided that (1) the same advice arrangement is offered to unaffiliated plans in the ordinary course of business and (2) the selection of the affiliated adviser does not violate ERISA § 408(b) (which may require that any fee for the advice not exceed the adviser’s direct costs). Plan-sponsor fiduciaries may provide the authorization even if the plan makes available employer securities. The authorizing fiduciary may rely on the fiduciary adviser’s representations as to compliance with the exemption, unless that reliance is inconsistent with a reasonable and prudent review process.
  • Annual Audit. The selection of the independent auditor, as of the certifying eligible investment expert, is a fiduciary function on the part of the fiduciary adviser; the audit itself generally is not a fiduciary function. The independent auditor may not limit its audit based on internal audits the fiduciary adviser may conduct, but may assist the fiduciary adviser in developing compliance policies and procedures. For any audits required to be completed before the effective date of the regulations, the auditor may take into account good faith compliance with the statute. DOL declined to relax the audit requirement for small advisers or the requirement that all audit reports identifying instances of noncompliance affecting IRAs be filed with DOL.
  • Disclosure. The required disclosure, which is identical for the statutory exemption and the class exemption, was modified in certain respects, including to report compensation and fees earned in connection with the rollover of assets or the reinvestment of distributed plan funds. The disclosure may be made through materials prepared to comply with securities laws or otherwise, so long as the PPA disclosures are not compromised by that approach.  

Class Exemption. The final guidance merges the proposed administrative class exemption, which expands the statutory relief in certain respects, into the final regulation. The class exemption extends the scope of the level fee relief by limiting the level fee requirement to the individual adviser, and not applying it to the fiduciary adviser employing the individual adviser. This is helpful to financial service business structures where the investment advice function and the investment product manufacturing function must be integrated into a single corporate entity.  

The class exemption also allows a fiduciary adviser to provide “off-model” advice — i.e., advice that is not provided by a computer model that either has been certified or is developed and maintained by an person independent of the fiduciary adviser (in which case the certification requirement does not apply). More specifically, the adviser may provide individualized investment advice following the furnishing of:  

  • Recommendations generated by such a computer model, or
  • Certain investment education materials, in the case of (1) IRAs where the fiduciary adviser determines that computer modeling is not feasible in light of the number and types of investment choices available, or (2) plan brokerage windows, self-directed brokerage accounts or similar arrangements.  

The class exemption is subject to the following conditions:  

  • The class exemption generally incorporates the conditions applicable to the statutory exemptions;
  • The fiduciary adviser must adopt and follow written compliance policies and procedures, and the auditor is to examine the adviser’s observation of those policies and procedures;
  • The investment advice may not recommend investment options that may generate greater income than other options of the same asset class for the fiduciary adviser or certain other persons, unless the fiduciary adviser prudently concludes that the recommendation is in the best interest of the participant, and explains that conclusion and its basis to the participant; and
  • The advice is documented within 30 days, including (as applicable) how the advice relates to recommendations generated by computer model and how advice that would generate such greater income is in the participant’s best interest.  

In changes from the proposal, (1) the third and fourth conditions apply to the level fee class exemption as well as the off-model class exemption, and (2) the class exemption takes effect 60 days (not 90 days) after publication, along with the rest of the regulation.  

Noncompliance. The position in the proposed class exemption as to the effect of noncompliance was extended to the statutory exemption as well. Thus, under the final regulation, each of the exemptions is unavailable not only with respect to particular investment advice where the conditions for relief were not satisfied, but also for otherwise compliant advice during a period where there was a “pattern or practice” of noncompliance with any of the conditions of the applicable exemption. DOL suggested that “isolated, unrelated or accidental” violations would not constitute such a pattern or practice, but that “intentional, regular, deliberate practices involving more than isolated events or individuals, or institutionalized practices will almost always constitute a pattern or practice.”

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