As increasing numbers of traditional defined benefit pension plans are being frozen or terminated, making participation in such plans an increasingly rare event, defined contribution plans having a cash or deferral arrangement ("CODA") feature, better known as 401(k) plans, are becoming the predominant retirement savings vehicle for millions of Americans. Furthermore, 401(k) plans that allow participants to direct the investment of their own accounts, thereby granting plan sponsors certain protections from fiduciary liability with respect to the investment performance of the individual funds offered under the plan1, have, for all practical purposes, become the norm. As such, the retirement security of increasing numbers of American workers is largely dependent upon the investment decisions made by the workers themselves. Many plan participants, however, for various reasons, lack the financial sophistication and know-how required to manage the investment of their 401(k) plan accounts wisely, or to maximize the investment return of their accounts over the course of their careers. In response, many employers have been searching to find ways in which their employees may be provided with investment education and/or advice with respect to the management of their 401(k) plan accounts. Unfortunately, doing so may run afoul of the prohibited transaction rules of ERISA and the Internal Revenue Code of 1986, as amended (the "Code"), or lead to other liability issues under ERISA.
Under Section 3(21)(A)(ii) of ERISA, a "fiduciary" includes, inter alia, any person that renders investment advice for a fee or other compensation, directly or indirectly, with respect to any moneys or other property of an ERISA plan, or has the authority or responsibility to do so. Under the prohibited transaction rules of ERISA and the Code, absent a statutory or administrative exemption, ERISA plan fiduciaries are prohibited from rendering investment advice to such a plan's participants with respect to any investments that would result in the payment of additional fees to the fiduciaries or their affiliates — thus, in practical terms, virtually prohibiting such arrangements.
Plan sponsors and other fiduciaries have been pressed on both sides, believing, on the one hand, that the provision of investment advice is vital to the financial health of their participants, but not wanting to overstep the prohibited transaction rules or otherwise incur liability, on the other hand.
Previous DOL Guidance
To help address this situation, the DOL has issued a series of pronouncements designed to help plan sponsors to determine what is, and what is not, permissible with respect to the provision of investment advice to participants.
DOL Interpretive Bulletin 96-12, issued on May 22, 1997, addressed the circumstances under which the provision of investment-related information to participants and beneficiaries in ERISA Section 404(c) plans does not constitute the rendering of investment advice under ERISA. This bulletin identified specific categories of investment-related information and materials that, when properly administered, do not constitute "investment advice." Generally stated, these are:
(i) basic information concerning the plan;
(ii) generalized financial and investment information;
(iii) non-specific asset allocation models and
(iv) certain interactive investment materials.
DOL Advisory Opinion 97-15A3 and DOL Advisory Opinion 2005-10A4 generally provided, inter alia, that a fiduciary investment advisor may provide investment advice with respect to investment funds that pay the advisor (or an affiliate) additional fees, provided that such fees are offset against fees that the plan is otherwise obligated to pay to the fiduciary.
DOL Advisory Opinion 2001-09A5 generally provided, inter alia, that the provision of fiduciary investment advice does not constitute a prohibited transaction, where the advice with respect to investment funds that pay additional fees to the fiduciary is the result of the application of methodologies developed, maintained and overseen by an independent party.
Together, these DOL pronouncements allowed plan sponsors to put into place certain limited participant investment education and advice programs; however, the employee benefits community lobbied long and hard for either a statutory exemption from the prohibited transaction rules or other legislation designed to help facilitate the provision of employee investment advice.
The Pension Protection Act of 2006
The Pension Protection Act of 2006 (the "PPA") amended the prohibited transaction sections of ERISA and the Code to add a statutory exemption with respect to "eligible investment advice arrangements" under ERISA Section 404(c) plans. If the statutory provisions are met, then the provision of investment advice, the investment transaction entered into pursuant to the advice, and the direct or indirect receipt of fees or other compensation by the fiduciary investment advisor or its affiliate, are each exempt from the prohibited transaction rules; plan sponsors are generally granted immunity from any corresponding fiduciary liability associated with the investment advice.
Generally stated, under the PPA, an "eligible investment advice arrangement" is any arrangement that either:
- provides that any fees or other compensation received by the fiduciary advisor for investment advice do not vary depending on the basis of any investment option selected; or
- uses a computer model under an investment advice program that meets the following statutory requirements:
- the program must apply generally accepted investment theories and utilize relevant information about the participant (e.g., age and life expectancy),
- the program must utilize prescribed objective criteria to provide asset allocation portfolios comprised of investment options available under the plan,
- the program must operate in a manner that is not biased in favor of investments offered by the advisor or its affiliate and
- the program must take into account all available plan investment options without being weighted in favor of any particular option. In addition, the PPA, inter alia:
- implements detailed disclosure requirements with respect to fees rendered in connection with the advice and
- requires an annual independent audit and written report to the authorizing fiduciary.
DOL Field Assistance Bulletin No. 2007-01
On February 2, 2007, the DOL, acknowledging that it has received a number of inquiries since the enactment of the PPA regarding the status of its previous (i.e. pre-PPA) guidance with respect to investment advice, issued Field Assistance Bulletin No. 2007-01 (the "Bulletin"). The Bulletin, written in question and answer ("Q&A") format, briefly addresses three of the major concerns that have been voiced in this respect since the enactment of the PPA.
The first Q&A. The first Q&A addresses the issue of whether, generally, the enactment of PPA invalidates or otherwise affects the prior DOL guidance. According to the Bulletin, the view of the DOL is that, while the PPA provides that persons who develop or market qualifying computer models, or who market investment advice programs using such models, are fiduciaries, and requires advisers to expressly acknowledge their fiduciary status, such PPA provisions do not alter the fundamental framework for determining fiduciary status under ERISA, or recast otherwise permissible forms of investment advice. Therefore, the prior DOL guidance is not invalidated, and it continues to represent the views of the DOL.
The Second Q&A. The second Q&A addresses the extent to which the standards for selecting and monitoring a qualifying fiduciary adviser under the PPA differ from the standards applicable to plan fiduciaries who offer an investment advice program with respect to which the new statutory exemption is not required. The Bulletin states that it is the view of the DOL that, with the exception of certain sections of the PPA that set forth the specific requirements of the statutory exemption, the same fiduciary duties and responsibilities apply to the selection and monitoring of ERISA Section 404(c) plan investment advisers, regardless of whether the investment advice program qualifies for the statutory exemption. Noting that the PPA provisions addressing a plan fiduciary's insulation from liability with respect to advice provided under an "eligible investment advice arrangement," where such fiduciary has prudently selected and monitored the investment advice, are consistent with the prior DOL guidance, the Bulletin states that it is the view of the DOL that a plan sponsor or other fiduciary will not incur liability under ERISA solely by reason of offering an investment advice program that is not an "eligible investment advice arrangement." Therefore, generally stated, plan fiduciaries who select an investment advice program with respect to which no statutory exemption is required must meet the same standards with respect to the selection and monitoring of an investment advisor as are set forth in the PPA.7
The Bulletin states that it is the view of the DOL that, with respect to the prudent selection of investment advice providers:
- a fiduciary should engage in an objective process to ascertain:
- the provider's qualifications (including the provider's experience, registration with the proper federal and state agencies, and willingness to assume ERISA fiduciary status),
- the provider's quality of service and
- the reasonableness of the provider's fees; and
- the selection process must avoid self-dealing, conflicts of interest or other improper influence.
With respect to the monitoring of investment advisers, it is the view of the DOL that fiduciaries should review, inter alia:
- whether there have been any changes in the information that served as the basis for the decision to retain a particular adviser;
- whether the advice is based upon generally accepted investment theories;
- whether the advice provider is in compliance with the contractual arrangement between the parties;
- the utilization of the advice services by participants in relation to the cost of such services to the plan and
- any participant complaints with respect to the advice services.
Finally, the second Q&A notes that, under the PPA provisions, plan assets may be used to pay reasonable expenses in providing investment advice to participants, provided that the advice providers have been prudently selected and monitored — which is consistent with the long-held view of the DOL.
The Third Q&A. The third Q&A addresses the issue of whether, for purposes of an "eligible investment advice arrangement," an affiliate of a fiduciary adviser is subject to the PPA's level fee requirement8. Generally stated, a "fiduciary adviser," for PPA purposes, must be
- a registered investment adviser, a bank, insurance company, broker dealer or similar entity
- an affiliate of such an entity or
- an employee, agent or registered representative of such an entity.
However — interestingly — the strict wording of the PPA only requires that the fees of the fiduciary advisor (not the fiduciary adviser or an affiliate) be level. Therefore, the DOL concludes that an affiliate generally is subject to the varying fee limitation only if that affiliate itself provides investment advice to plan participants and beneficiaries.
The third Q&A concludes by stating, parenthetically, that, generally speaking, a party seeking to avail itself of an exemption (statutory or administrative) to ERISA's prohibited transaction rules has the burden of establishing compliance with the conditions of the exception. Therefore, the DOL expects that parties offering investment advice pursuant to the PPA statutory exemption will be able to demonstrate compliance with the PPA provisions, and that policies and procedures will be established and reviewed on an annual basis, as part of the annual audit and reporting requirement.
Given the dependence of increasing numbers of employees upon participant-directed 401(k) plans to supply the biggest share of their retirement income, participant investment advice programs are essential. The enactment of the PPA and its statutory exemption from ERISA's prohibited transaction rules with respect to "eligible investment advice arrangements" should give plan sponsors and fiduciaries a measure of comfort, allowing them to retain investment advisory services without fear of running afoul of ERISA. In this regard, the Bulletin offers certain clarifications and reiterates the long-held views of the DOL concerning the provision of investment advice, concluding that such views are not invalidated or supplanted by the enactment of the PPA.
As always, White & Case would be happy to assist or advise you with respect to the setting up and maintenance of investment advice services with respect to your 401(k) plan.