On October 25, 2011, the Department of Labor (DOL) published its final regulation implementing the ERISA prohibited transaction exemptions for participant investment advice enacted in the Pension Protection Act of 2006 (PPA). This final regulation brings to a conclusion an almost five-year process to implement the PPA exemptions permitting “level fee” and “computer model” advice for retirement plan participants and IRA beneficiaries. In broad scope, the final regulation retains the general structure and terms of the Obama Administration’s March 2, 2010 proposal, with several refinements and clarifications. The regulation is effective as of December 27, 2011.

Background

The shift towards participant-directed retirement plans that took hold in the 1990s had the unintended consequence of reducing the portion of retirement assets that are invested with the benefit of professional investment advice. Moreover, the businesses already in service relationships that could accommodate that advice — the retirement platform, product and service providers that evolved to serve the defined contribution and IRA markets — often have been 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), is one of the three ways to become an ERISA fiduciary.)

Even before the PPA, DOL issued guidance elucidating circumstances in which investment support for participants would not raise this 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.3

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 the 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 section 601 of the PPA and provides relief for certain “level fee” and “computer model” advice arrangements.4

Starting in December 2006, the Bush Administration commenced a regulatory process that culminated in the January 21, 2009, publication of a regulation not only implementing the statutory exemptions, but completing the logic of the legislation by adding administrative exemptions for “modified level fee” and “off-model” advice. The Obama Administration took exception to this and other “midnight regulations” of the Bush Administration and, in this case, ultimately withdrew the January 2009 regulation in favor of its own March 2010 proposal. The March 2010 proposal differed from the January 2009 regulation in the following important respects:

  • DOL did not retain the modified level fee and off-model administrative exemptions; and
  • In enumerating the details of the computer model advice program, DOL added in the proposal that the model may not “[i]nappropriately distinguish among investment options within a single asset class on the basis of a factor that cannot confidently be expected to persist in the future.” That limitation was intended specifically to exclude consideration of historic rates of return of a particular investment.

The Final Regulation

The final regulation makes limited changes to the March 2010 proposal. Among the more significant developments:

  • With commendable intellectual honesty, DOL again declined to move away from its position in FAB 2007-1, the January 2009 regulation and the March 2010 proposal that affiliates of the fiduciary adviser may, under the level fee exemption, receive revenue that varies with investment choices. This means that a structurally separate fiduciary adviser can provide exempted level fee advice, even if affiliates are investment product or service providers that receive varying revenue by reason of the investment choices made by the participant taking account of the advice. DOL refined the formulation of the level fee requirement applicable to the fiduciary adviser. 
  • DOL receded on its proposal to exclude from consideration in computer models the historical performance of a particular investment. DOL concluded that it did not have a basis to add this constraint to the statutory “generally accepted investment theories” standard, relying instead on the fiduciary responsibilities of the persons selecting the model for the plan and on the certification of the model by an independent investment expert to guard against specious, unorthodox or inappropriate use of historical performance data. Performance data for a particular investment, if utilized, may not be “inappropriately weighted” in comparison to the other factors considered in developing the model advice, however. 
  • DOL made explicit a requirement under both the level fee and computer model exemptions that the fiduciary adviser request from the participant age, time horizon, risk tolerance and other specified information, and added a requirement of notice from the fiduciary adviser to authorizing plan fiduciaries.
  • DOL modified the plan investment options that may be excluded from consideration under a computer model.

A detailed summary of the operation of the final regulation, with other clarifications and refinements noted, is available here.

The practical import of these exemptions on the investment advice available to plan participants and IRA beneficiaries remains uncertain. The conditions imposed by Congress under these exemptions range from meaningful (in the case of the level fee exemption) to formidable (in the case of the computer model exemption). Providers that require prohibited transaction relief to offer participant advice will have to assess whether the compliance costs and risks under the exemptions are acceptable. If not, except where DOL’s preexisting guidance offers workable solutions, the desire to protect the potential recipients of such investment advice may mean that such advice remains less widely available than optimal.